On Friday, we were given the chance to pen Hedgeye's Early Look. This product is usually written by our CEO, Keith McCullough, with his take on markets, the economy, and politics. If you do not receive the Early Look, and would like to, please email firstname.lastname@example.org.
Our stab at the Early Look for 1/4/13 is below.
FOOT SOLDIERS OR GENERALS?
“His outward appearance seemed indifferent and unconcerned over the wretchedness of his soldiers…although French and Allies shouted into his ears many oaths and curses about his own guilty person, he was still able to listen to them unmoved.”
-Jakob Walter, German soldier under Napoleon
Two hundred years ago, following one of the most brutal military campaigns in history, thousands of young European men traipsed through the snow of East Prussia, half-dead. The Diary of a Napoleonic Foot Soldier, by Jakob Walter, is a harrowing but thoroughly enjoyable account of what it was like to serve in Napoleon’s Grand Armée during the ill-fated invasion of Russia in June 1812. Given that one is as likely to be born in one country, at one time, as another country at another time, I am particularly grateful I was not one of the 600,000 Napoleonic soldiers that crossed into Russia in mid-1812. Of the 140,000 that were left to retreat from Moscow, only 25,000 actually crossed back over the border in December 1812 to begin the long walk home.
Few individuals have left as indelible a mark on history as Napoleon Bonaparte. That he was born in Corsica of Italian heritage but went on to gain the title “Emperor of the French” is indicative of the strength of personality he possessed. All of his courage and decisiveness meant little without the contribution of his subjects. Napoleon understood this; it is estimated that between 1800 and 1815, he raised approximately two million conscripts, or 7% of the population, in France alone. Was the future of 18th Century France (or 1930’s Germany or Russia) dictated by the common man’s wishes or a charismatic leader dragging a country toward his vision? This question has no definitive answer but it can serve as a loose metaphor for policy versus demographics in our contemporary economy. While demography is concerned with the passive role people play in economies, the roles of the common man and policy maker in driving economic growth are important to consider in 2013. Harry Dent, author of several books on demographics and its importance states: “it’s Homer Simpson that drives our economy, not Ben Bernanke or Barack Obama!”
I recently did some long overdue reading on demography. While my understanding of the subject is tenuous at best, it is clear to me that understanding the role of demographic and technology cycles is key to understanding what drives our economy over the long term. Hedgeye Healthcare Sector Head Tom Tobin and his team have produced some excellent research that anchors off these topics. Recently, his work has suggested that household formation, maternity, and pet ownership (WOOF) rest on a similar age demographic and are likely to see corresponding strength. While the increasingly short-term nature of our industry has marginalized such thought processes, we continue to believe that identifying investment themes that deviate from consensus but are supported by long-term cycles can lead to highly actionable ideas.
Considering some of the key demographic trends pertaining to the consumer economy offers interesting long-term insights. In terms of the sector my team covers, restaurants, the core demographic of casual dining companies tends to be the 45-65 YOA cohort. For any consumer industry executive, decelerating population growth among age cohorts with a high propensity to spend money on your goods or services will act as a top-line headwind. Pertaining to the restaurant industry, it is clear that for many years executives’ lives were made easier by a rising demographic tide. We believe that casual dining is facing a painful adjustment due to excessive unit growth. Trading opportunities on the long side will remain, on immediate-to-intermediate-term bases, but we see casual dining as a group that will experience consolidation for a number of years. It is no coincidence that the management teams that are most demonstratively aware of the demographic headwind are running the companies whose shares we are relatively positive on (EAT – at a price). Darden Restaurants (DRI) is one company that we became bearish on in July. One of the key issues we took with management’s strategy was its growth trajectory and we continue to believe that it is overly aggressive relative to the fundamental performance of its chains and the overall health of the industry. The quote, below, from Brinker (EAT) CEO, Guy Constant, highlights the reality of the situation facing his industry and his company’s awareness of it:
“…We've had to deal with those questions internally because as a company that's only ever been in a growth space, it's been an adjustment for us to adjust to running a business in a more mature space now than we did before. But knowing then that history, we believe, is repeating itself, that helps you understand what you need to do in order to survive in this space.”
While long-term demographic and technology cycles dictate economic growth, from an investment perspective, it is self-evident that policy has a significant impact on market prices as well as the duration and amplitude of economic cycles. The market, after all, is not the economy. Previously, I have wondered if forming an opinion on government policy is a worthwhile exercise. Long-term cycles seem to bear out over time regardless of government policies (give or take a few years). In recent times, our macro team’s process of focusing on Growth, Inflation, and Policy has proven effective in identifying key inflection points in markets, globally. Moreover, the level of government intervention in markets implores investors to form an opinion on policy and to update it, regularly. For example, investors in gold that have ignored policy, and the expectations around it, have had a difficult time of late.
Our view of policy makers in the US (and almost everywhere else) has been decidedly negative. Keith wrote in yesterday’s Early Look: “What if Bernanke is what he usually is – wrong on his growth forecasts? What if unemployment rate expectations start to fall towards 6.5% in 2013 instead of in 2017? Inquiring Bond and Gold bulls would like to know…” Yesterday we saw gold and bonds get crushed on the expectation that Bernanke could be forced to call back his troops if expectations of employment growth improve sufficiently. Every general meets his Waterloo. The only question is when.
Timing, as always, is the critical factor in investing but even more so in life. After all, if not for timing, we could have been Napoleonic foot soldiers.