Currency Armageddon

“Every gun that is made, every warship launched, every rocket fired, signifies in the final sense a theft from those who hunger and are not fed, those who are cold are not clothed.”

-Dwight D. Eisenhower


As I was preparing for my week long sojourn over to the United Kingdom, I actually had to think seriously about what type of currency I wanted to bring.  After all, in this day and age of the modern currency war, the movement of currencies can be dramatic and shocking.  If you don’t believe me, just ask those good folks that were long of Venezuela’s Bolivar going into Friday.  In a split second, the government unilaterally devalued the Bolivar by 32% and likely put a few currency traders out of business.


In terms of global economies, according to the CIA Fact Book Venezuela is just the 34th largest economy in the world at just $400BN in annual economic output.  Despite this, there were a number of multinational companies that were impacted by the devaluation.  Specifically, Colgate-Palmolive and Smurfit Stone have taken charges, with comparable companies like Avon, Proctor and Gamble and Kimberly-Clark certainly at risk of a short term hit to both earnings and assets.


Obviously the popular pushback when we stress currency wars with U.S. focused equity managers is that they are a 3rd world type risk and not a concern or issue that will become broadly prevalent. In fact, this consensus view was verified to me as I opened the Irish Times this morning to an article titled, “Fears of an Imminent Currency War Are Wide Of the Mark.”  Of course, many of these money managers have only been managing money for the last 10 – 15 years, so they may have missed this little critter called the Plaza Accord. 


Now admittedly, the Plaza Accord was not a unilateral devaluation or war, but rather an agreement by Germany, Japan, France, the United States, and the United Kingdom.  The agreement by these five nations was to intervene in global currency markets with an objective of devaluing the U.S. dollar in relation to the Japanese Yen and German Deutsche Mark.


Not surprisingly when the world’s largest central banks gang up to achieve a goal, they succeed, and the U.S. dollar depreciated dramatically over the next two years.  In fact, the dollar depreciated versus the yen by almost 50% from 1985 to 1987.   By some economists, this devaluation was heralded as a glorious success as the devaluation was controlled and did not lead to a financial panic.


While the last point is true, the strengthening of the Japanese yen was likely a key catalyst for one of the most significant bubbles of the last three decades, if not hundred years – the Japanese real estate bubble.  Naturally, given that the U.S. dollar was set to decline, the Japanese that had their assets abroad repatriated and began purchasing Japanese real estate, and purchased more, and purchased more.   In fact, at one point choice properties in Tokyo’s Ginza district were trading hands at $20,000 per square foot.


For Japan, the acquiescence to the United States to devalue the U.S. dollar led to an asset bubble of incomparable proportions and then an effective lost decade(s) of economic activity (and then some) as the Japanese economic system de-levered.  My point in highlighting this is simply that devaluations, like much of government intervention in the markets, has unintended consequences.  In hindsight, the Japanese likely never would have signed up for the Plaza Accord had they understood the unintended consequences.  In part, this experience is likely shaping their new policy of going at their currency strategy alone, rather than suffering the beggar thy neighbor option of a Plaza Accord type agreement.


There is obviously a worst case scenario as it relates to currency wars, that scenario in which all nations devalue at once.  Not unlike during the Cold War, when both the Soviets and Americans were armed to the hilt with nuclear weapons, this global devaluation is also likely a race to MAD (Mutually Assured Destruction).  For lack of a better term, we’ll call it Currency Armageddon.


The broad implications of a massive global currency war actually relate back to the quote from Dwight Eisenhower at the start of this note.  In a normal war, goods are taken from the people to create weaponry.  As a result, the average person is worse off during a war.  On some level, a currency war is no different. 


As currencies are devalued, the purchasing power of the average citizen is degraded and as a result so is their ability to purchase basic goods. If you don’t believe me, ask the average citizen of Venezuela whose purchasing power was decimated by this move on Friday.  This quote from a recent Bloomberg article about a rush to buy airline tickets was particularly apropos:


“I came because I heard American Airlines is going to raise fares by 100 percent, that’s to say, above the devaluation.”


Interestingly, there is an alternative to Currency Armageddon and its unintended consequences. This is the exchange rate system implemented post World War II called the Bretton Woods system.  In this period of semi-fixed exchange rates, competitive devaluation was not an option.  Not surprisingly, under Bretton Woods global economic activity thrived and was stable. 


This is not to say that Bretton Woods was an ideal system, but what seems less than ideal is the ability of major governments to unilaterally devalue on a whim, which is the nature of the monetary system today. The most recent example of this is of course Japan and the rampant devaluation of the yen.  This will last until the average retiree in Japan starts to feel the fiat currency squeeze like the Venezuelans have.  Interestingly, Japan is almost half way there with a Yen that is down over -15% in only three months.


Now, on one hand, shorting the yen was an existing idea we re-presented on our Best Ideas call on November 15th and that trade is up ~14% since then, so we are happy about that.  But as we contemplate risk managing future economic shocks, the idea of Currency Armageddon is a risk that every day seems less and less like a tail risk and more like a 2013 type event, despite what we might be reading in the Irish newspapers.


Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, and the SP500 are now $1, $116.52-118.72, $79.82-80.54, 92.78-94.66, 1.93-2.01%, and 1, respectively.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Currency Armageddon  - Chart of the Day


Currency Armageddon  - Virtual Portfolio

Go With What Is

This note was originally published at 8am on January 29, 2013 for Hedgeye subscribers.

“The world is not the way they tell you it is.”

-George Goodman


That’s easily one of the top opening sentences to any book in my library (The Money Game, by George Goodman). And oh how true does it ring about the game so far in 2013.


You see, so far 2013 is all about you. “You – your identity, anxiety, and money” – that’s what Goodman (under the pseudonym of “Adam Smith”) titled Part I of Chapter 1 in 1968. So what I am about to write this morning is not new. It’s just put another way.


The successful investors I know do not hold to the way it ought to be, they simply go with what is.” (page 19)


Back to the Global Macro Grind


Now maybe people write these sorts of things at all-time highs in markets (the Russell2000 made another all-time closing high yesterday at 906 = +6.7% YTD). Maybe they write them at the lows too. I’d just as soon as think about them all of the time.


One way to contextualize behavior is by using math across multiple-factors and durations. Internally (and at hedge funds I have built and traded portfolios for), we call them STYLE FACTORS.


If you punch in style factors on either Amazon or Wikipedia, you’ll get a promo for the “Otterbox Commuter Series Hybrid Case” (iPhone4) or something about the “Seven Factors of Enlightenment” (Buddhism). So, while I think most quantitatively oriented risk management platforms consider these factors standard, they are far from Jeremy Siegel’s view of portfolio theory.


Style Factors are what are moving your portfolio now – here are some big ones that are outperforming YTD:

  1. High Short Interest = +6.8% (outperforming low-short interest stocks by almost 1%)
  2. High Beta = +8.1% (outperforming low-beta by over 4%)
  3. High Debt/EV = +7.0% (outperforming low-debt/EV by 60bps)

I can also slice and dice your portfolio across geographic, sector, and size (market cap) factors. And I do for our clients who ask us for this custom advisory and risk management work, but for your general reading purposes this morning I guess the bottom line is to take my word for it – it works.  


Why does it work? Particularly when you overlay it with a multi-duration (TRADE/TREND/TAIL) price/volume/volatility model, it basically tells you what the machines are chasing. If you can front-run the machines, you are one step ahead of your competition. And that may not sound like what we all learned at school, but it’s the way that today’s game is.


If you own something like Netflix (NFLX):

  1. You are long High Short Interest
  2. You are long High Beta
  3. You are smiling

Combined with a little storytelling from the management team and a catalyst on top (the recent quarter and conference call), that makes for a tasty YTD return. It also drives the fundamentalist who thinks the stock is “expensive” right nuts.


If thinking of this fascinating, complex, n-person process as a Game helps, then perhaps that is the way we should think. It helps rid us of the compulsions of theology.” (George Goodman)


In other words, don’t play the game you want – play the game that’s in front of you. Modern day math, machines, and real-time signals help augment your go-to-moves. They also help you realize when it’s a good time to just get out of the way.


Yesterday was the 1st down day in the SP500 in the last 8 trading days. Within minutes of the market going down, my contra-stream (I built it on Twitter for my own behavioral observation) lit up like we were about to see the apocalypse. *Note: we didn’t.


I’m as leery about buying high as anyone, but through making many mistakes I’ve taught myself to use the risk of the range (within the context of all aforementioned factors) as my guide instead of my gut.


For the SP500 itself, here are some important Risk Ranges to contextualize and consider:

  1. SP500 = Bullish Formation (bullish TRADE, TREND, TAIL) with immediate-term TRADE support at 1488
  2. S&P Sector Studies = all 9 are bullish TRADE and TREND for the 17th day out of the last 18!
  3. US Equity Volatility (VIX) = Bearish Formation with a Risk Range of 12.04-14.36

In other words, go with what is, until it isn’t. The high-probability hand you keep playing is that US stocks make higher-highs as equity volatility makes lower-lows. If and when that changes (it will, and maybe abruptly), Mr. Market will let you know.


Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr yield, VIX, and the SP500 are now $1651-1676, $112.28-114.62, $79.61-80.14, 89.69-91.14, 1.89-2.01%, 12.04-14.36, and 1488-1510, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Go With What Is - Chart of the Day


Go With What Is - Virtual Portfolio


Burger King is reporting 4Q12 earnings on Friday.  We believe that this release will add credence to our thesis that the company was never “fixed” during its stint as a private company, as the bulls are claiming.


The performance of the U.S. & Canada store base (60% of total) continues to carry the most weight for the BKW investment thesis.  The outlook in this division, for Burger King, is not positive from a comparable sales growth perspective. 


We estimate that 4Q12 comparable sales growth was roughly 2% versus consensus of 3.4%.  January comparable sales among some North America franchisees are tracking as low as -4%, versus consensus for 1Q franchisee comps of +1.6%. 


1H13 is when the company will have to prove the sustainability of its sales growth and, if early indications are correct, some concern may be warranted on that front.  We believe the shares could trade below $13 over the intermediate-term, based on the cash flow multiple contracting by two points.  As the chart below illustrates, consensus is very bullish on 1Q13 comps.  The Street is assuming a 230 basis point sequential acceleration in 1Q13 two-year average trends.





BKW DOWNSIDE REMAINS - ev to ebitda bkw dpz sbux etc




Howard Penney

Managing Director


Rory Green

Senior Analyst

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Best Consumer Ideas: Short UA

Takeaway: Here’s a look at one of the short ideas from the call, courtesy of our Retail team.

SHORT Under Armour (UA)/Retail – Brian McGough


Brian recently came down on the short side of Under Armour, Inc. (UA) a leading sports apparel company.  Brian says the brand “came out of nowhere” and now owns a 12% market share in sports apparel – flanked by Adidas (8%) and Nike (25%).  Brian says UA has “done a great job,” but the perception  driving stock price now is at odds with reality. 


The company describes itself as a designer, developer and distributor of “apparel, footwear and accessories for men, women and youth worldwide.”  Brian says they really dominate one segment: males ages 12-30 in the US.  To get to the next level, UA needs to grow, and McGough cautions there are challenges the market does not recognize.


Growing this business will be expensive.  Very expensive.  And as UA spends to grow, a gap will quickly open between their growth rate and their operating profit.  Brian says when the market recognizes this, there will be a significant move to the downside.


Brian points out that UA’s core consumer will buy apparel associated with any sport.  And men in the 12-30 age group are notoriously not finicky shoppers.  They want to get in, get their shoes, Ts and sweats, and get out.  UA can sell just about anything, just about anywhere.  But to really grow, UA needs to succeed in two markets: international, and women.


The international market is focused on one sport: soccer, a market dominated by Adidas and Reebok which between them have over 90% share.  It will be difficult and expensive to break into this market, and the takings are likely to be extremely small.  And, says, McGough, the “killer” is that, after five successful years, UA still doesn’t even have 1% of the domestic footwear market.  How will they stand up to these established global footwear giants when they try to expand overseas?


The female consumer is very different from the male.  Men hate shopping.  Women connect to shopping.  Women shop preferred locations.  They look for store ambience – compare the inside of a Lululemon with Dick’s Sporting Goods.  And women look for fit and fashion, not just comfort, even in athletic wear.

McGough thinks the company has a capital problem which will become evident as they spend more to push sales growth. 


One final word of caution: Brian thinks the company has orchestrated very good looking quarterly comparisons.  He would definitely not be short the stock with an earnings report due out soon.  But once that report hits the tape, he thinks the game will change significantly for UA, and the rest of the year will be very tough for them.

Best Consumer Ideas: Long CAG

Takeaway: Here’s a look at one of the best long ideas from the call, courtesy of our Consumer Staples team.

LONG ConAgra (CAG)/Rob Campagnino – Consumer Staples


Rob highlights his Long call in ConAgra (CAG), one of North America’s leading food companies serving both the Consumer and the Commercial markets.  CAG has been making new highs in recent weeks, but Rob says it remains undervalued on a number of fronts.


Since 2008, it has consistently traded at about a 10%-15% discount to the consumer staples sector.  CAG is close to finalizing its deal to acquire Ralcorp (RAH), a private-label food producer.  The acquisition, which has cleared both US and Canadian regulatory hurdles, will be transformative allowing CAG to deleverage its operations, while building a higher earnings base. 


Hedgeye’s Global Macro team sees a bubble building in commodities.  Rob says CAG – already a strong player in its space – will be a major beneficiary when that bubble bursts, dramatically lowering its cost of inputs, and also mitigating the inventory issues RAH struggled with last year.  In a nutshell: there is valuation support for higher prices right here; the company is on the brink of closing a transformative deal that will create significant synergies; CAG will benefit tremendously from what we see as the coming deleveraging of commodities. 


Rob says the earnings base could nearly double as a result of these developments.  We note the stock has a low Beta (0.47) and pays a $1 dividend, nearly 3%.


Takeaway: Our factor analysis of performance across Asian & Latin American equity and FX markets reveals both intuitive and less-obvious trends.



  • Over the short-to-intermediate term, factors associated with currency weakness is a common theme among outperforming factors across Asian and Latin American equity markets. The reverse holds true over the long term.
  • Over the short-to-intermediate term, factors associated with the global search for yield is a common theme among outperforming factors across Asian and Latin American currency markets. More traditional fundamentals such as rates of economic growth and fiscal sobriety are more commonly associated with currency outperformance over the long term.




  • In the brief prose below, we walk through the key takeaways from our 17-factor performance model across the 40 country-level equity and currency markets (20 apiece) we track across Asia and Latin America.  
  • To calculate outperformance, we compare the average % change of the respective equity and currency markets where the factor scores below the first quartile to those where the factor scores above the third quartile.  
  • It should be reiterated that the factor scores are all relative to the sample, such that any “high” or “low” reading is associated with the respective quartile and not an arbitrary absolute figure(s).
  • Lastly, the analysis below is not being presented in any way as causal – i.e. the factors aren’t the drivers per se, but rather as common characteristics of leaders and laggards within the samples of market performance.
  • We focus on the top three outperformance deltas across each of the three performance durations, as we believe the factors associated with the most meaningful outperformance may, in fact, be driving the associated market deltas to some degree – likely well beyond what we’d be able ascertain from performing a simple full-sample regression analysis.




  • On a 1M basis, the top three factors associated with outperformance are: a low sovereign debt/GDP ratio, high growth (YoY real GDP) and expectations of currency weakness over the near term.
  • On a 3M basis, the top three factors associated with outperformance are: expectations of currency weakness over the near term, cheap equity market valuation and a low dividend yield.
  • On a 1Y basis, the top three factors associated with outperformance are: a low sovereign budget balance/GDP ratio, expectations of currency strength over the long term and recent currency strength.
  • Easy mean reversion opportunities (LONG screen = 1M outperformance w/ 3M and 1Y underperformance; SHORT screen = 1M underperformance w/ 3M and 1Y outperformance): N/A












  • On a 1M basis, the top three factors associated with outperformance are: high inflation (YoY CPI), high 10Y sovereign yields and high 2Y sovereign yields.
  • On a 3M basis, the top three factors associated with outperformance are: high 10Y sovereign yields, high 2Y sovereign yields and relative equity market weakness.
  • On a 1Y basis, the top three factors associated with outperformance are: high growth (YoY real GDP), expensive equity market valuation and a low sovereign debt/GDP ratio.
  • Easy mean reversion opportunities (LONG screen = 1M outperformance w/ 3M and 1Y underperformance; SHORT screen = 1M underperformance w/ 3M and 1Y outperformance): N/A











Over the short-to-intermediate term, factors associated with currency weakness is a common theme among outperforming factors across Asian and Latin American equity markets. The reverse holds true over the long term.


Over the short-to-intermediate term, factors associated with the global search for yield is a common theme among outperforming factors across Asian and Latin American currency markets. More traditional fundamentals such as rates of economic growth and fiscal sobriety are more commonly associated with currency outperformance over the long term.



We currently hold the following biases across Asian and Latin American asset classes:


  • BULLISH bias on Singapore’s equity market (since 12/21/12; TREND duration)
  • BULLISH bias on Chinese consumer-oriented equities (since 12/10/12; TREND duration)
  • BULLISH bias on Hong Kong’s equity  market (since 11/16/12; TREND duration)
  • BEARISH bias on the Japanese yen (since 9/27/12; TREND and TAIL durations)
  • BEARISH bias on Australia’s equity market and the Aussie dollar (since 6/5/12; TAIL duration)
  • BEARISH bias on the Argentine peso (since 11/4/10; TAIL duration)


If a particular country or asset class isn’t on this list, it’s because we either wash out neutral on it from a fundamental perspective or we simply don’t hold enough fundamental conviction in either a long or short thesis at the current juncture.


Additionally, we could also be waiting on time decay (i.e. specific catalysts closer to materializing) and/or specific price signals (such as our eventual positive view on Indian equities post a [continued] near-term correction).


Please email us if you’d like to dive deeper into any of these ideas and/or if you’d like to further discuss the takeaways and implications of the aforementioned factor study.


Darius Dale

Senior Analyst


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