Energy and Volatility

We’ve already discussed the importance of the CBOE Volatility Index (VIX) hitting 14 and how it affects stocks, but what about other markets like energy? With volume and volatility moving lower, risk increases. Energy is a high beta sector, meaning that when the broader market sells off, energy sells off further and faster (and vice versa). The Energy Select SPDR ETF (XLE) is heading lower and when the VIX hits 14, it’ll likely take a beating.


Energy and Volatility - xle vix

Watching The VIX


Hedgeye CEO Keith McCullough appeared on CNBC’s Fast Money earlier this week and discussed the markets and America’s debt ceiling issues. One topic that’s more important than ever today is volatility in the market. The CBOE Volatility Index (VIX) is the de facto measurement of market volatility and when the index is at 14 (it’s currently at 15), it becomes a clear indicator to sell stocks. Keith calls it one of the most “obvious, clean-cut sell signals” out there. We short the S&P 500 when the VIX hits the low 14s and will continue to do so when the VIX hits those levels.


Watch Keith's full take on the VIX and when to sell stocks in the video posted above.


Mo' Money, Mo' Problems

Client Talking Points

The Vix

Not to be confused with the ‘80s band The Fixx, the CBOE Volatility Index (VIX) is at 15 and fast approaching the key level of 14. When the VIX is at 14, it’s a clear level to sell stocks for us and the rest of the institutional crowd out there. As we head into the weekend, keep an eye in the index in today’s trading. Provided there are no blowout catalysts in today’s market, volatility should remain at current levels.

Turning Japanese

With politicians debating what to do about the Fiscal Cliff on a daily basis and less than a month left until we hit the debt ceiling, things aren’t looking cheery for the United states right now. We’re beginning to look like Japan in ways as population growth slows along with our GDP numbers. The Federal Reserve’s agenda of printing money to solve problems hasn’t fixed anything and has artificially inflated commodity prices and the stock market while devaluing our currency over the years. With the US dollar down two weeks in a row, dollar bulls can’t call the currency the Comeback Kid just yet.

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.


There is improving visibility on 20%+ EPS growth with P/E of only 11x with better content leading to market share gains. New orders from Canada and IL should be a catalyst. Additionally, many people in the investment community are out in Las Vegas at the annual slot show (G2E) and should hear upbeat presentations by management.


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


“I wish one politician would call it what it is..taxes, not revenues” -@upsidetrader


“It is amazing what you can accomplish if you do not care who gets the credit.” -Harry Truman


Unemployment in the Eurozone hit a new high of 11.7% in October.


Takeaway: YUM headlines this morning are an overreaction to last night's release, in our view.

As we said on our Yum call yesterday the company has been, and continues to be, a stock that you buy on China scares. The sell off this morning, in the wake of yesterday’s release from the company, presents another opportunity to buy the best Large Cap restaurant stock.  With regard to China, same-restaurant sales is a critical metric but unit growth is more important, in our view, that allows the company to achieve its stated guidance. 


YUM stated that SRS in 4Q are expected to be +4% at YRI, +3% in the U.S., and -4% in China.  The China numbers are missing consensus by 600bps and represent a +8.5% on a two year basis.  Both YRI and the USA results are better that consensus and consistent with our thesis.


On the development front, international development is expected to be at least 1,850 new units for the year, including at least: 800 new units in China (upside surprise), 950 at Yum! Restaurants International (upside surprise), and 100 at Yum! Restaurants India.


YUM is also lapping a Q4 headwind due to an additional week in 2011 fiscal year which produced a combined $26M operating profit benefit to the U.S. and YRI.


The company reaffirmed its guidance for 4Q12 of “at least” $0.82, but the Street was ahead of the company at $0.85.  The reaffirmation of FY12 guidance highlights one of our points during yesterday’s call: the company’s geographically diverse business model allows it to achieve targets despite weakness in certain markets.  In this case, it is its most important business, China, that is seeing weakness but the company is still expecting to achieve its FY12 guidance. 


FY13 guidance contained no material surprises:

  • The company expects at least 10% in EPS growth (street modeling more)
  • At least 1,800 new international units, including at least: 700 new units in China, 950 at YRI, and 150 at Yum! Restaurants India (as per our theses we expect upside to these numbers)
  • Estimated tax rate of about 27% with quarterly fluctuation
  • Foreign currency translation expected to be flat
  • Global capital expenditures of over $1B
  • Interest expense expected to be flat
  • 2% reduction in average diluted shares outstanding as a result of share repurchases
  • Worldwide G&A increase of 3% due to continued growth in China

This morning, the stock was cut to Neutral vs Buy at UBS, Neutral vs Positive at Susquehanna, and Underperform vs Market Perform at UBS.  We would buy the stock on these downgrades.









Howard Penney

Managing Director


Rory Green




America Reborn?

“America is the only country that is constantly being reborn.”

-William Knudsen, 1945


I’ll be turning my attention to a fresh new history book this weekend. I’m looking forward to that. I always do. It’s the only way I learn how to proactively manage for future risks – by contextualizing history’s behavioral patterns and economic cycles.


The aforementioned quote comes from the conclusion of the book I have been reviewing as of late – Freedom’s Forge. It’s an interesting quote. It probably makes an American feel good. As much as I respect Bill Knudsen, it’s completely inaccurate too.


How do you think the Chinese and Germans feel about that? If you’ve studied the last 400-500 years of economic history, you’ll recall that global economic hegemons are slowly, but constantly, changing. Before its war with Britain began in 1839, China had almost 1/3 of Global GDP. In the last 3 years, the USA has fallen from 23% to 21% of Global GDP. Where will it go from here?


Back to the Global Macro Grind


Now that the bull case for US stocks has gone from “growth is back” (Q112) to “but earnings are great” (Q212) to the government is going to save us from themselves (Q3/Q4 2012, Qe and #Keynesian Cliff), is America Reborn? As what?


If we really are asking to be reborn, maybe we should consider birth rates. Looking at America’s birth rates (officially released this morning), as US GDP as a % of Global GDP has fallen in the last 3 years, the USA’s birth rate has fallen -8% to a record low.


Sound familiar?


Japan has a negative population growth rate. And while the Keynesian Quacks who have been perpetuating unlimited Quantatitive Easing, Currency Devaluation, and Debt Financed Government Spending in Japan for the last 20 years doubt they’ve had a causal impact on the correlation between Japan’s economic decline and societal despair, to me at least, gravity is readily apparent.


So, let’s “get a deal”, kick the can, print some more money, and do more of that…


It’s sad to watch. And while I think I am doing my own part in being the change we need to see in our profession, my hope for an America “Reborn” on the principles of equality, liberty, and “free” markets is fleeting.


My hope for a Strong Dollar isn’t a risk management process either – and risk, of course, works both ways – so the best I can do is attempt to risk manage a tape that’s begging for more of what will ultimately make America look more like a European Social Democracy.


In terms of US Equity performance chasing, where is American risk trading into month-end?

  1. SP500 has rallied back from the thralls of its Q4 lows (on no volume) to down -4% from its Bernanke Top
  2. US Equity Volatility has been stamped right back down to its long-term TAIL risk zone of 14-15
  3. SP500 close > 1419 (TREND resistance) = bullish; a close below 1419 = bearish

All the while, despite the Dollar Debauchery (Cliff can kicking and Qe4 rumors have the US Dollar down for 2 weeks in a row), the US Treasury Bond market doesn’t care:

  1. UST 10yr Bond Yields down 7 basis points on the week, from 1.69% to 1.62%
  2. Treasury Bond Yields remain in a Bearish Formation, reflecting Global #GrowthSlowing expectations
  3. Yield Spread (10yr minus 2yr Yields) has compressed another 5 basis points wk-over-wk to +137bps wide

Now some still think the US stock market is the global economy, so just a reminder on our answer to that:

  1. CHINA – Shanghai Composite hit a fresh 3yr low this week; no China “stimulus” in sight
  2. COPPER – lower-highs continue since March (we shorted Copper yesterday)
  3. BOND YIELDS  - Treasuries are going to beat Corporate Bonds in November (Corporate #EarningsSlowing)

But, again – if you are more concerned about what the government can do for your year-end bonus in December, all we need to see are 2 things:

  1. Japanese Style Can Kicking on the #KeynesianCliff
  2. Rumors from Hilsenrath (WSJ) into the close on Bernanke doubling (heck, tripling) his monthly printing

Who would have thunk? The great American Republic of “free-market liberties” reborn as a casino of market expectations driven by what Pelosi and Boehner might say next. Think about it in historical context before you beg for more of it – then think about it again.


Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $109.88-111.49, $3.43-3.62, $79.94-80.58, $1.29-1.31, 1.57-1.67%, and 1, respectively.


Best of luck out there today and enjoy your weekend,



Keith R. McCullough
Chief Executive Officer


America Reborn? - 55.household


America Reborn? - 55. vp

Daily Trading Ranges

20 Proprietary Risk Ranges

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