Three Big Themes

Client Talking Points

Three Big Themes

Now that we can put the political madness of the election behind us, let’s focus on our three macro themes for Q4 and beyond. We’re well into earnings season and our theme of #EarningsSlowing continues as company after company either misses Street expectations or lowers guidance. The commodity bubble given to us courtesy of the Fed is bursting at the seams with commodities down -9.3% since the Bernanke Top (September 14). Lastly, there is the fiscal cliff. It has been said that Republicans are reaching across the aisle and offering compromise on taxes in order to fix this mess, but more than likely, the two sides will bicker until the 11th hour and will kick the can down the road yet again. 

Market Breakdown

Yesterday’s big selloff can be attributed to the election results. Or the trouble in the Eurozone. Really, it can be blamed on anything. That’s how it works. If your strategy doesn’t work, just find someone or something to blame. It’s certainly worked out well for Old Wall. With the pop in the futures this morning, we’ll likely see some upside early on in trading; what really matters is the risk and the range. If you stick to your levels and trade within them, you’ll do just fine. That’s how proper risk management works as opposed to closing your eyes and throwing darts at sheets of paper with tickers written on them.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

After a long downward slide, TCB has finally turned the corner. The margin has stabilized after the balance sheet restructuring. Loans are growing thanks to the equipment finance business. Non-interest income is more likely to go up than down going forward, a reversal from the past 18 months. Credit quality has a tailwind from a distressed housing recovery in TCB’s core markets: Minneapolis, Detroit and Chicago. On top of this, the CEO, Bill Cooper, is one of the oldest regional bank CEOs, which raises the probability that the bank will be sold. Expectations are bombed out at this point, so we think it’s time to move from bearish to bullish on TCB.


Emissions regulations in the US focusing on greenhouse gases should end the disruptive pre-buy cycle and allow PCAR to improve margins. Improved capacity utilization, truck fleet aging, and less volatile used truck prices all should support higher long-run profitability. In the near-term, Paccar may benefit from engine certification issues at Navistar, allowing it to gain market share. Longer-term, Paccar enjoys a strong position in a structurally advantaged industry and an attractive valuation.


While political and reimbursement risk will remain near-term concerns, on the fundamental side we continue to expect accelerating outpatient growth alongside further strength in pricing as acuity improves thru 1Q13. Flu trends may provide an incremental benefit on the quarter and our expectation for a birth recovery should support patient surgery growth over the intermediate term. Supply costs should remain a source of topline & earnings upside going forward.

Three for the Road


“scheduled a meeting at 3pm - people complained because lunch time is from 2 to 4pm#spainisdifferent” -@brilldisruptive


“You must first have a lot of patience to learn to have patience.” -Stanislaw J. Lec


US jobless claims fall by 8000 to 355,000


Takeaway: We are growing more certain that DRI's next earnings release will disappoint shareholders.

Conclusion: It seems likely that Darden is lagging the industry given Knapp trending at -1.8% (on average) for first two weeks of October and Blackbox coming in flat for the month.  Assuming Knapp Track in Oct comes in roughly on trend with the first two weeks, the 180bps spread is far greater than it has been (it was 0 bps in September) and is possibly a poor sign for Darden.  We will be waiting for Knapp’s monthly data to confirm.


Blackbox Intelligence released casual dining same-restaurant sales growth data for October at 0% with traffic at -2.1%. 


Last month, we learned that Knapp Track casual dining comps were down -1.5% and -2.1% for the first and second week of the month, respectively. 


There are many differences between the two metrics, but one significant one is that Darden (the largest system in the business) is not counted in the Blackbox data.  If we assume that Knapp’s October data will come in on trend with the first two weeks, this could be negative for Darden. 


If a significant portion of the spread between Knapp and Blackbox is driven by Darden not being accounted for in the Blackbox data, which is likely to be at least partly true given Darden’s size, we would infer that Darden underperformed the industry in October. 



Howard Penney

Managing Director


Rory Green




The Macau Metro Monitor, November 8, 2012




Private equity company Permira Advisers LLP has agreed to sell its remaining holdings (5.94% stake) in Galaxy. Completion of the sale is expected to be on November 12.  The 249.6 million shares were sold at HK$27.17 (US$3.5) each, putting the deal value at HK$6.78 billion, a source with direct knowledge of the deal told Reuters.

My Business

“My business is making things.”

-William S. Knudsen, May 28, 1940


That’s a quote from one of America’s finest immigrant business men during a time in this country where business builders and innovators built your military and economy, not politicians. It comes from a book that I started reading as I saw the election results roll in – Freedom’s Forge: “How American Business Produced Victory in World War II.”


Election Day 2012 was the 5 year-anniversary of building My Business. I am not in the business of producing a racial, gender, or class war in this country. I am an immigrant who is in the business of manufacturing innovative research and risk management ideas.


I didn’t ask for a bailout in 2008, and I’m not begging for a solution to a #FiscalCliff situation that the beggars themselves perpetuated. My Business is to fight the winds of government intervention in my life. My Business is to stand up and fight for the core values of a liberal – equality and liberty.


Back to the Global Macro Grind


How has My Business thrived during one of the worst secular declines in Wall Street trading commissions on record? First, I don’t have a trading desk. More importantly, I started from a place that more should have the opportunity to rise up from – getting fired.


The problem with both our government and many of my sell-side competitors that they’ve bailed out (and paid) is that they get re-hired to do more of what has not worked.


Every mistake I make, either in building My Business or in research ideas, can and should hurt me. I need to wake-up every morning, lick the blood off my paws, and do whatever I can to make up for my mistakes. There is responsibility in recommendation.


To review where we haven’t made mistakes in Q4 of 2012, here are our Top 3 Hedgeye Global Macro Themes:

  1. Earnings Slowing (worst revenue and EPS slowdown since 2008)
  2. Bubble #3 (Commodities down -9.3% from Bernanke’s September 14th Top
  3. Keynesian Cliff (political gridlock perpetuated by the bubble in US politics and the media that supports it)

My Business only works if I have a great team. While I may personally make a lot of short-term mistakes, I think my research and operating team does a great job getting the intermediate-term TRENDS and TAILS right. If they didn’t, we’d fail.


I can’t tell you how rewarding it was to walk into one of the world’s biggest bond manager offices on Election Day and have him tell us that our #GrowthSlowing call in 2012 has helped him buy every dip and have a great year.


That, of course, may sound a little odd to the Equity only clients we have. But, really, that’s the point about what we do. Multi-factor, Multi-Duration Risk Management, across Global Macro Asset Classes.


Yesterday’s down move in the US stock market wasn’t about Germany. It wasn’t about the #KeynesianCliff either. It was about everything that’s been coming to a boil in the US stock market in 2012 as our economic and fiscal reality disconnected from it.


Blow-up days (biggest down day since June 1st, 2012 of -2.46% SP500) are processes, not points. If you don’t think people who chased the top in commodities in September have been blowing up, think again:

  1. CRB Index -9.2%
  2. Oil (WTIC) -14.7%
  3. Copper -10.6%
  4. Gold -3.2%

Gold isn’t blowing up. But it’s not going up anymore after 2 of the most bearish macro events in US history for the US Dollar either:

  1. Bernanke Printing to Infinity & Beyond
  2. Obama getting re-elected

That last point isn’t a political point. It’s a fact. You can’t say Obama has been great for commodity and stock inflation since 2009 and not, at the same time, acknowledge the loose fiscal and monetary policies that Debauched The Dollar all the while.


This isn’t new. Neither is it an Obama or a Democrat thing. Both Nixon/Carter were as bearish for the US Dollar as Bush/Obama have been. Why? Because both Democrats and Republicans went all-in Keynesian in both periods. And it didn’t work. Romney being advised by a hard core Keynesian (Glenn Hubbard) on the key topic of the debate didn’t work either.


What could work – and God help us all if he doesn’t get this – is Obama reaching across the aisle to people like you and me; people running small businesses who have their costs and taxes rising; people who have to meet a payroll before they can start hiring again; people who really want to see Obama succeed inasmuch as patriot Democrat and Republicans wanted Reagan and Clinton to.


You can judge us and you can demagogue us, but you cannot fire us. After all, we are The People too.


Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $105.46-108.67, $80.22-80.98, $1.27-1.29, 1.64-1.72%, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


My Business - Chart of the Day


My Business - Virtual Portfolio


This note was originally published at 8am on October 25, 2012 for Hedgeye subscribers.

“You can boil down what we're thinking about 2013 to a short statement, and that goes both for economic environment and sales, and that statement is steady-as-she-goes, not much change from 2012.”

– Michael DeWalt, Caterpillar, 10/22/12


This morning, Hedgeye ran a proprietary P/E screen to identify a couple of bargains.  JDS Uniphase (JDSU) is trading at only 3x its 2000 EPS.  Lennar (LEN) is at only 4.5x its 2005 EPS.  Multiples were much higher when those earnings were reported, so today these names are on a big sale.   OK…probably not.  However, those “bargains” highlight the problem with using the peak margins and a simplistic framework to value companies.


The Industrials sector is loaded with mini-bubbles.  Capital equipment goes through replacement cycles, driving sales and margins to very high levels only to have them drop-off following the boom.  Our favorite cycle is shipbuilding.  After World War II, war tonnage was converted to commercial use.  Ships only last for about 30 years, so there was a replacement boom in the mid-1970s.  Tonnage deliveries were nearly three times higher in 1975, at the peak of the boom, than they were in 1980, after the bust.  The industry just had another replacement cycle with deliveries peaking in 2011. The group looks like a promising short today and should be a great long around 2035.    Mark your calendar.


We joke that mining is the world’s second oldest profession and that there is a reason the iron-age was called the iron-age.  Mining is a highly mature industry with long-term cyclical growth slightly below global GDP growth.  It should not boom.  When it does, you know something interesting is going on. 


Mining capital spending is an obvious bubble.  For example, global iron ore output went from ~1 billion tons in 2005 to ~3 billion tons last year.  Capital spending above depreciation at the eight largest miners went from about $10 billion in 2004 to $56 billion in 2011.  And 2004 was a fantastic year for mining capital spending.


Today, Caterpillar is best defined as a manufacturer of mining and resource-related capital equipment.  Among its largest customers are BHP, Rio Tinto, and Vale.   Typical of companies caught up in a boom, CAT has made overpriced acquisitions and added excess capacity to meet peak demand, in our view.  Investors who hold CAT through the down-cycle may end up paying for management’s investment errors in addition to their own.  Buying CAT today is similar to buying Lennar in 2005 or JDSU in 2000.  The peak $9.20/share or so that CAT will likely earn in 2012 may prove just as irrelevant for valuation as any other bubble-driven profit.


The Hedgeye Industrials team hates P/Es.  Extreme profit cyclicality leaves multiples useless in the Industrials sector. We prefer to build DCFs to estimate (wide) valuation ranges.  We forecast reasonable longer-term growth rates, margins, capital needs, and other factors, making assumptions explicit.  November 5th, we are presenting on the Express & Courier Services industry, including Fedex.  Fedex may grow at 2% or 6%, but it isn’t going to grow at 15% in the long-run.  Similarly, global iron ore production is not going to keep tripling every 5 years.  To value CAT by extrapolating recent trends in mining capital investment would be to assume the surface of the earth ends up covered in ferrous rocks.  A normal peak multiple applied to recent profits implicitly makes that assumption.


To note that there is a bubble in many commodities is different from explaining why.  The narratives that drive bubbles tend to be very persuasive and contain much truth.  The internet will revolutionize commerce.  Check.  Home prices rise over time and will be supported by the government.  Check.  A rising middle class in the developing world will need more appliances and cars.  Check.  Narratives allow investors to feel better about applying absurdly simplistic valuation ratios to companies serving highly complex markets. 


We’ll throw out a narrative to explain the commodity bubble to allow CAT short sellers to feel better.  We suspect that the commodity bubble has been driven by world’s second largest economy pegging its currency to the world’s largest economy while the world’s largest economy engages in highly simulative and largely experimental monetary policy.  The peg contributes to inflation in China, which drives savers in China to protect real wealth by investing in property and other hard assets.  Maybe check. Maybe not.


Narratives aside, our view on CAT is straight-forward.  Don’t be the investor who buys a cyclical at a multi-decade peak in margins.  We may well come back to CAT when it hits our proprietary P/E screen in a few years.


Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1699-1733, $106.63-110.71, $79.69-80.25, $1.29-1.31, 1.71-1.89%, and 1401-1419, respectively.


Jay Van Sciver, CFA

Managing Director Industrials


Steady-As-She-Goes? - aa. JAY EL


Steady-As-She-Goes? - aa. Real Time

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.