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Trust Mr. Market

“He knew that he had a gift: the power to make people trust him.”

-Evan Thomas


With the Chinese allegedly hacking US corporations and the Keynesians in an all-out currency war with the world’s savers this morning, what could possibly go wrong? The US stock market doesn’t seem to care. Do you trust it?


The aforementioned quote about old-school trust comes from an excellent leadership book I’m reading titled “Ike’s Bluff: President Eishenhower’s Secret Battle to Save The World.” Since I am finishing up our year-end review process, trust is a factor I thought a lot about while I was in London last week. The people you choose to work with either get it, or they don’t.


Americans believed in President Dwight Eisenhower, big time. He had the highest approval rating of any post WWII President, not because he gave the best speeches (he hated the teleprompter, and it showed) – it was because poll after poll revealed an endearing quality that the modern polarizing #PoliticalClass has not been able to achieve – the underlying trust of The People.


Back to the Global Macro Grind


I trust Mr. Market. I believe in his real-time signals. I trust that The People ultimately trust his scorecard too (he might be a she by the way). You don’t have to like someone in order to trust them.


You don’t get paid to play the market you’d like to have either. You get paid to play the game that’s in front of you.


That’s just too complicated for a dumb bunny like me.” –President Eisenhower (page 29)


Or is it?


At the end of the day, it’s all about your attitude. Sure, it really is hard to let Mr. Market humble you into the daily position of A) embracing uncertainty and B) accepting that risk doesn’t care about your positioning.


You can, however, dynamically (daily) risk adjust your positioning based on the highest probabilities that Mr. Market is giving you. Would you play any other game any other way? For us, since late November, that overall Global Macro position has been:

  1. Long US Dollar, Short Japanese Yen
  2. Long Equities (Asian and US specifically, not Europe)
  3. Short Gold and Treasury Bonds

I can be a dumb bunny too. That’s why I maintain a model that accepts dumb government policy as causal to currency moves. That’s also why we get currencies more right than wrong. Stocks, Bonds, and Commodities tend to react to big policy driven currency moves.


The US Dollar was up for the 2nd consecutive week last week (+1.8% over that time) and for the #1 concern my competitors are signaling as the US stock market’s greatest risk (inflation), Strong Dollar did what it should have done – it Deflated The Inflation:

  1. CRB Commodities Index = down another -0.9% last week (down -2.2% in the 2 weeks of Dollar Up)
  2. Gold = down another -3.5% last week to a fresh YTD low (down for the last 2 weeks as well)
  3. Silver = down -5.3% on the week and Food Prices deflated too (Cocoa -4.1%, Corn -1.4%, etc.)

Now a lot of people in this world (especially Americans) like it when the purchasing power of their hard earned currency appreciates. Others (like Venezuelans for example) don’t have a say in the matter. Their overlords debauch their currency whenever they please.


Eisenhower was lucky in that he was able to compete with British and French debaucherers of currency. These were weak governments who were addicted to debt and the cowardly messaging of #ClassWarfare. No one trusted that then – and they don’t trust it now.


Not all Equity markets like Commodity Deflation. Brazil’s Bovespa Index is the poster child for commodity exposure – it was down another -1% last week and is now down -5% for 2013 YTD.


What could really get this US and Asian Equity party started would be another blast higher in the US Dollar from here:

  1. Then Oil will eventually start to mean revert versus the rest of the CRB Commodities Index (which is breaking down)
  2. And Consumers, globally, will get a much needed TAX CUT at the pump

What’s actually quite amazing is that US Consumption hasn’t been hammered with Brent Oil trading up here at $117-118. In our GIP Model (Growth, Inflation, Policy), a Brent Oil price that is in a Bullish Formation is an explicit headwind.


But maybe that’s more of a headwind for those cheering on a weak currency in Europe. Enter France:

  1. France’s CAC40 snapped its immediate-term TRADE line of 3711 support in the last few weeks
  2. French Services PMI of 43.6 in JAN was god awful relative to A) itself (45.2 in DEC) or any other major country

So, the French have economic issues that, evidently, weren’t resolved with a 75% tax rate…


Now that their economic data really sucks again, the first thing their conflicted and compromised #PoliticalClass does is jawbones for a weaker Euro – then they tell the world they really didn’t do that at the G20 meetings, n’est-ce pas? But, with the CAC and the Euro breaking immediate-term TRADE support, who do you trust? Mr. Market doesn’t trust them.


Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, USD/YEN, UST 10yr Yield, and the SP500 are now $1, $116.09-118.91, $3.67-3.72, $1.31-1.33, 92.53-94.38, 1.96-2.05%, and 1, respectively.


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


Trust Mr. Market - Chart of the Day


Trust Mr. Market - Virtual Portfolio

What is Going on with CPB?

I wrote in an earlier note that a short position in CPB would make me uneasy given some of the characteristics it shares with HNZ.  In this note, I take a look at the reasons why CPB’s operating performance doesn’t warrant the recent move up in the company’s share price.

Since December 31st, CPB’s share price has gone from $34.89 to $39.40 (as of Friday’s close), a year to date performance of nearly 13% versus the S&P’s YTD performance of 6.6%.  Admittedly, CPB has been a multi-year laggard, and so the company’s ability to exceed consensus estimates in the most recently reported two quarters has helped the share price performance, as has the HNZ deal.  However, chasing laggards solely because they have lagged doesn’t represent a compelling long-term investment process to me – I need to start seeing some improvement in the company’s business momentum.

I attribute the better than consensus results to the sell-side’s inability to model in conjunction with CPB’s acquisition of Bolthouse Farms, which has muddied the income statement a bit.  Keep in mind that buying a staples company that is in the process of integrating an acquisition usually isn’t a bad idea, in my experience.  The sell-side is generally crappy at modeling to begin with, and the top line becomes optically much more attractive, and the company has some income statement flexibility as the merger synergies start to flow through – to be honest, it’s a part of the reason I like CAG, STZ, K and BUD.  But it can’t be the only reason.


While reported revenue growth has been close to double-digits (against declines in the comparable quarters of 1H 2012), constant currency organic growth has been +1.1% and +1.5% in the first two quarters of 1H ’13, again against declines in 1H ’12.  The comps turn positive in 2H ’12, though the next two quarters are less seasonally important than the two reported thus far.   Keep in mind that my view is that the primary driver of multiple expansion/contraction in consumer staples is changes in top line momentum – it doesn’t appear to me that CPB has reached that type of inflection point with regard to its core business.

Importantly, EBIT growth (absent the acquisition) was only +1% in the quarter, and this result was flattered by a 14% decline in advertising and consumer promotion expense – never a good sign, in my view.  Even with the acquisition, the company posted only a 7.6% year over year increase in EPS, against a -10.1% comparable in Q2 2012 – and that is with some help from a lower tax rate year on year.  The EPS comps as we move through the remaining two quarters of the company’s fiscal 2013 don’t stiffen all that much.

Taking all that together, I don’t see a path to an EPS miss as consensus currently contemplates the pacing of the remaining two quarters, and that is central to wanting to be short a name.  As we move out closer to calendar ’14, with the HNZ transaction in the rear-view mirror and CPB moving toward more difficult comparisons, I think a short position might make more sense, but I reserve the right to change my mind in either direction or any time should the data suggest.

While I don’t do shorts purely on valuation, it appears to us that a nearly 2 turn improvement in CPB’s P/E multiple (currently 15.0x calendar 2013) to close the gap with the peer average isn’t based on the underlying strength of the company’s business – neither is it a particularly demanding multiple.  Further, I think consensus is secure for the balance of fiscal 2013 and am therefore content to watch and wait.


What is Going on with CPB? - CPB PE


Call with questions.




Robert  Campagnino

Managing Director





Matt Hedrick

Senior Analyst


We’ve got the numbers for the first half or so of the month and they’re not pretty.  Despite the favorable calendar shift of Chinese New Year (CNY) into February this year, Macau gross gaming revenues (GGR), could actually fall YoY.  With 17 days in the bag, we’re now projecting February GGR of $23.0-24.5 billion which would represent growth of -2% to +4%.  These soft results have to be a disappointment to the Macau bulls who had been calling the market as essentially impervious to the smoking ban and the junket crackdown by the Chinese government.


So why are the numbers so weak?  Last February was actually quite a strong month with volumes higher than January despite CNY falling in January.  We believe the smoking ban may have been more impactful on table productivity during the busy CNY period.  We’ve also heard that VIP hold may have been a little low although there is no hard evidence of that.  Finally and most importantly, we think there is a government crackdown on corruption in China which is impacting the junkets.  Some specific junkets may be targeted.  We found this article interesting and relevant:






In terms of market share, Wynn is making a surprising breakout although most of it is likely hold related and comes at the expense of MPEL.  Sands China is having a strong month and we expect that trend to continue absent any hold fluctuations.  Galaxy’s market share is back up after a few disappointing months while MGM and SJM are posting shares below trend. 


Following the disappointing last half of January and February’s results so far, we believe Q1 estimates could be at risk.  However, while we fully expected the junket crackdown to have a material impact on Macau’s VIP numbers, we maintain our belief that the impact will be short lived, 2-3 months.  Our best guess is that the crackdown, while real, is window dressing to show the populace that the new government is serious about combating corruption.



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BEAM: What Were They Thinking?

This note was originally published February 18, 2013 at 08:05 in Consumer Staples

About a week ago (2/11), in a move right out of the saloon owners manual in the Wild West, BEAM announced that it would be cutting the alcohol content of its Maker's Mark bourbon to 42% from 45%.  The company reversed that ill-conceived decision today.


The initial move came about as the result of a high-quality problem - short-term demand in excess of supply.  However, high quality problems demand high-quality solutions, and the initial "solution" boiled down to serving everyone that purchased a bottle of Maker's Mark a watered-down drink.  It was a decision that would have had serious repercussions in 1890's Tombstone as well as 2013 Tribeca.


The company reversed its decision today:


"You spoke. We listened. And we’re sincerely sorry we let you down."


Note to management - all you had to do was ask, or use some common sense.


This note is admittedly more fun than actionable, but I think there is a lesson to be learned about managing the equity of a brand.  Maker's Mark is a great brand whose equity has been built up over many years - it should be tinkered with only after great deliberation and always with an eye toward enhancing the long-term value of the brand.


May your drinks never be watered down.




In some ways, a butcher is similar to a surgeon.  In some ways, they are very different; one uses a cleaver while the other typically opts for a scalpel.  We view some of the cost cutting practices of private equity players in the restaurant space as analogous to surgeons operating with cleavers.  The risk of things going awry tends to be quite high and the equity holders are typically left with the corpse.


Heinz dominated the headlines on Valentine’s Day when it was revealed that 3G Capital and Warren Buffett’s Berkshire Hathaway was buying the ketchup maker for $23 billion.  3G Capital will be in charge of operations, according to media reports, and this is being interpreted as some to mean that heavy cost-cutting at HNZ is soon to come.  The reasoning behind this concern is that servicing the debt and dividend payments may leave inadequate cash flow to cover other obligations. 


We were interested to read, in this past weekend’s edition of The Wall Street Journal, that comparisons are being made between 3G Capital’s takeover of Burger King in 2010 and last week’s much larger Heinz acquisition. 



Cut Costs First, Ask Questions Later


We recently spoke with a Burger King franchisee that told us, “management are sitting on pickle buckets” when we asked for his perspective on the cost-cutting that had occurred at BKW on the corporate level.  Some of the anecdotes about Burger King in the WSJ article on HNZ were fascinating and confirmative of our prior thoughts on BKW and its IPO


Here are a couple of highlights, as far as BKW is concerned, from the WSJ article on HNZ:


“A few weeks after taking over, the firms’ management team fired about half of the 600 employees at the company’s Miami headquarters, got rid of the building’s executive wing and made employees get permission to make color printouts”


“One large Burger King franchisee said that so many managers at the corporate headquarters have been laid off that there is no one to call when there is a problem.  Meetings are conducted via webcast as a way to save money.”


The practices being employed by Burger King managers, according to the article, are said by former Burger King executives to have been inspired by consultant Bob Fifer’s book, “Double Your Profits in 6 Months or Less”.  One of the book’s chapters is called, “Cut Costs First, Ask Questions Later”. 



Bootstrapping Unlikely To Work Over Long-Run


It’s important to acknowledge Burger King’s response to the implication that costs had been cut too much.  Spokesman Miguel Piedra is quoted as saying that corporate headcount had been slashed to enable an increase in the number of field managers within the company.  Time will tell whether or not these cuts have been overly aggressive: we think they have been.


One key aspect of the “turnaround” has been new menu items that have been touted as bringing in incremental customers.  While this may be true, we question the sustainability of the means implemented by management.  No R&D was required in producing these new menu items as the offerings were taken straight from the McDonald’s menu.  This has also been seen in the new coffee and beverage initiative which required little-to-no capex.  Management’s strategy seems to be to compete head-on with McDonald’s.  We don’t believe franchisees are excited about this from a profitability standpoint and we would bet against Burger King bootstrapping its way to success.  Low budget, short-term attempts are unlikely to offer sustainable profitability to the franchisee community.  We think there is a high risk of investors being disappointed with FY13 results when all is said and done.


At this point, operating costs at Burger King have been cut dramatically and investors responded positively to its 4Q12 earnings report on Friday.  We continue to believe, as stated on our Best Ideas call on February 11th, that BKW shares represents an attractive opportunity on the short side.  The company was not “fixed” in the 18 months that it was private.  We believe that the franchisee base is under duress as the butchering of the corporate cost structure, while beneficial over the short run, could result in issues down the road.


For precedent, look no further than Wendy’s.  The company has been starved of capital that has led to “cardiac arrest” for its shareholders as its equity value has flat-lined since the crash in late 2008. 



THE BKW BUTCHER - bkw pod one


Howard Penney

Managing Director


Rory Green

Senior Analyst

Broken France?

This note was originally published February 14, 2013 at 12:17 in Macro

We’ve long had a skeptical eye on Socialist President François Hollande since he entered the stage in May 2012, beginning with his very loud “tax the rich” campaign slogan and lack of focus on reducing France's fiscal fat.  With fears now decidedly marginalized on the dissolution of the Eurozone; no imminent threat of a sovereign needing a bailout; and Draghi’s OMT bazooka still calming markets, we return to France, the region’s second largest economy, for a closer look at the risks we see developing that may be overlooked. 


What’s mattered greatly to many investors at the country level since the “crisis” began is countries meeting or exceeding their growth targets and reducing their debt and deficit levels.  France, not unlike what we’ve seen from peripheral countries since 2009, looks to miss its 2013 GDP and deficit targets.   In recent days President Hollande has hinted at a willingness to change the growth forecast from +0.8% to +0.3%-0.4%, however has not backed off the deficit target of 3% of GDP. We think a revision to both is a question of when, not if.


Interestingly, the sticking point on when this change in forecast could result may have to do directly with the timing of a European Commission’s economic report on the Eurozone. It is expected to come out in late February and show that French growth should be in the +0.3%-0.4% range and that France is projected to undershoot its deficit reduction target. A recent state audit should also influence Hollande – it revealed that in a scenario of +0.3% growth, inline with current IMF projections, the deficit would be 25bps over the target, or 3.25%, and added that the state has relied too much on tax increases and needs to focus on spending cuts to attain its targets.



Beyond the Deficit Are Storm Clouds


While a miss of its deficit target may not cripple confidence in France, it adds to a perfect storm of negative trending risks, which include:

  • Public debt – pushing 91% (as a % of GDP) - France is above the level of 90% that economists Reinhart and Rogoff have indicated as destructive to growth.
  • Credit Rating – Fitch is the only main agency to maintain its AAA status. S&P is at AA and Moody’s at Aa1. We expect all three to be lined up at AA in 2013 and for this reduction in credit standing to weigh on its public finances, and put upward pressure on yields.  Note: The 10YR is currently trading at 2.26% (versus 1.64% in Germany), and has remained stubbornly low over the intermediate term despite the risk premiums we see, a development that we believe has a high probability of inflecting in 2013.
  • Competitiveness Drag – Hollande’s policy to tax the rich (75% on those making €1MM or more) is not only driving out his countrymen but sending negative investment signals to the business community. Hollande has moved the top rate of capital gains tax from 34.5% to 62.2%. For reference these levels compare with 21% in Spain, 26.4% in Germany and 28% in Britain.
  • Hamstrung Spending – we believe that Hollande will not be able to issue additional spending cuts due to push back on the street against austerity. Politically, Hollande also doesn’t have the popular support to make an estimated €5B in additional cuts to attain the deficit target.
  • Bank Leverage – French banks remain an outside concern due to their leverage to the periphery. While we expect Draghi and Co. to keep the union together at all costs, the weight of a still imbalanced financial sector could sway sovereign sentiment.


Economic Misses

Today Eurostat reported initial GDP figures for Q4 2012.  France’s Q4 GDP came in at -0.3% Q/Q versus expectations of -0.2% and +0.1% in Q3. While France outperformed the Eurozone aggregate of -0.6% Q/Q (versus expectations of -0.4%), the high frequency data that we track continues to paint a negative trend for France, one that inflects versus the larger peer economies of Germany and the UK. 


France’s PMI Services number for JAN was 43.6 JAN vs 45.2 in DEC and Manufacturing fell to 42.9 in JAN vs 44.6 in DEC, both decidedly under the 50 line representing contraction.


Broken France? - 33. gdp


Broken France? - 33. pmis


Further, the policy measures that Hollande has implemented are showing up in confidence readings. Business Confidence has rolled down the mountain since a high in March 2012, Consumer Confidence has been flat to down since Hollande’s election, and Consumer Spending has been under 1% since mid 2011 and negative for the last 5 consecutive months. 


Broken France? - 33. business conf


Broken France? - 33. consumer spending



Given France debt drag, likely misses on 2013 GDP and deficit reduction, and financial and economic constrains, the country is one to watch given the downside risks. From a capital markets perspective the country has been surprisingly resilient, but this could well change.  While the wave of sentiment may be more focused on the governments of Italy and Spain currently, we caution that the risks in France could drive a stagflationary set-up in the country for much longer than is currently being priced in.  We think the Hollande’s political handcuffs will prevent necessary spending cuts and his decidedly anti-business tax policy will chase good money out of the country.  Stay tuned.   


Broken France? - 33. indust and manu product



Matthew Hedrick

Senior Analyst

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