Morning Reads From Our Sector Heads

Keith McCullough (CEO):


Rat Meat Sold as Lamb Highlights Food Fears in China (via NY Times)


Gold Traders Most Bearish in Three Years After Drop: Commodities (via Bloomberg)


Matthew Hedrick (Europe):


Slovenia Sells Bonds Despite Ratings Downgrade (via WSJ)


Brian McGough (Retail):


Impact on Bangladesh Victims Weighed (via WWD)


Kevin Kaiser (Energy):


Angola Plans to Simplify Tax Codes to Boost Non-Oil Revenue (via Bloomberg)


Josh Steiner (Financials):


MBIA Settles Flagstar Mortgage Lawsuit for $110 Million (via Bloomberg Businessweek)


Regulators Scrutinize Auto Lenders Over Add-Ons (via WSJ)


Jay Van Sciver (Industrials):


Fastenal April 2013 Report (via Fastenal)


Big Moves

Client Talking Points

Strong Dollar

The US dollar remains in bullish formation and had a big move to the upside yesterday to the tune of +0.7%. The Yen is coming down further while the dollar is appreciating and taking down commodities with it. This continues to be a bullish catalyst for US consumption stocks which is part of our growth thesis.

Tech Mate

Tech has lagged the broader market and select sectors considerably and is only up +7.2% year-to-date via XLK. Meanwhile, the S&P 500 is up +12% pre-NFP report. The sector has been lagging in large part due to Apple (AAPL) but that's starting to change and the sector is turning bullish. Keep an eye on it over the next week.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Decent earnings visibility, stabilized market share, and aggressive share repurchases should keep a floor on the stock.  Near-term earnings, potentially big orders from Oregon and South Dakota, and news of proliferating gaming domestically could provide near term catalysts for a stock that trades at only 11x EPS.  We believe that multiple is unsustainably low – and management likely agrees given the buyback – for a company with the balance sheet and strong cash flow as IGT.  Given private equity’s interest in WMS (they lost out to SGMS) – a company similar to IGT that unlike IGT generates little free cash – we wouldn’t rule out a privatizing transaction to realize the inherent value in this company 


WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow.


With FedEx Express margins at a 30+ year low and 4-7 percentage points behind competitors, the opportunity for effective cost reductions appears significant. FedEx Ground is using its structural advantages to take market share from UPS. FDX competes in a highly consolidated industry with rational pricing. Both the Ground and Express divisions could be separately worth more than FDX’s current market value, in our view.

Three for the Road


"Big upside revision for US nonfarm payrolls. Last month was an anomaly" -@NicTrades


"Talk sense to a fool and he calls you foolish." -Euripides


U.S. adds 165,000 jobs; unemployment 7.5% in latest NFP report.

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Renaissance Man

“Self-control is more indispensible than gunpowder.”

-Henry Morton Stanley   


Henry Morton Stanley was one the most well known African explorers of the late 19th century.  He is probably most famous for finding the lost Scottish missionary David Livingstone in the small village of Ujiji after an eight month search.  Stanley reported that the first words he uttered when finding Livingstone were the now famous, “Dr. Livingstone, I presume?”


To say Stanley was a remarkable man would be an understatement.  He was orphaned at an early age and spent his formative years in a work house in Wales.  At the age of 15, he crossed the Atlantic as a crewman of a merchant ship and jumped off in New Orleans where he befriended a local merchant and took his name.  He then fought in the Civil War before launching a career in journalism.  Clearly, Stanley was a bit of a 19th century “Renaissance Man”.


His expeditions into Africa, which among other things established the sources of the Nile and Congo, were widely considered the most grueling of that era.  Unlike many of his contemporaries, observers marveled that Stanley never lost his discipline or civility on these long perilous expeditions in the dark heart of Africa.  Biographers discovered an interesting fact about Stanley – he spent most of life, as he called it, “experimenting with will.”


As Roy Baumeister writes in “Rediscovering the Greatest Human Strength – Willpower”:


“Having piously lectured his men about the perils of drunkenness and the need to shun sexual temptations in Arica, he knew how conscious his own lapses would be.  By creating the public persona of himself as Bula Matari, the unyielding Breaker of Rocks, he forced himself to live up to it. As a result of his oaths and image, Jeal said, “Stanley made it impossible in advance to fail through weakness of will.”


This concept of pre-commitment as a way of maintaining discipline and hitting goals has been proven in spades by Yale economists Ian Ayres through a company he started called  Ayres’ company allows individuals to create commitment contracts.  The company has found that when a contract is drawn up without a penalty, the person succeeds about 35% of the time.  Conversely, when the contract includes a referee (so is public) and a monetary penalty (so accountable) the individual succeeds 80% of the time.


So for you young hedge fund analysts that spend too much time partying in the wilds of Manhattan on the weekends, a quick stop at may not be the worst idea to re-establish some discipline. 


Back to the global macro grind . . .


This market year has certainly been one that has required the willpower of sticking with what works.  There have been many times that all of us could have been shaken out of the investment themes that have been effective this year, but growth stabilizing and strong dollar continue to play out in spades.  Nowhere is this seen more clearly than within U.S. sector performance.  On the positive have been healthcare and consumer staples which have outperformed the SP500 by about 50%.  On the negative, materials is up less than half of the SP500.  Unless the macro trends change meaningfully, the right discipline will be to continue to stick with what has been working.


My colleague, and Hedgeye’s U.S. focused economic guru Christian Drake, gave an update on this key theme of growth stabilizing yesterday when he looked at the trifecta of housing, labor and consumer confidence.  Specifically, he highlighted:

  • Employment - The positive acceleration in labor market trends continued this week with both the seasonally adjusted and non-seasonally adjusted Initial Jobless Claims series showing sharp sequential improvement.   The headline number fell 15K to 324K w/w versus the prior week’s unrevised number while the 4-week rolling average in SA claims fell -16.5K w/w to 342K.
  • Confidence - The Bloomberg Consumer Confidence Index (Chart of the Day) made a new 5Y high two weeks ago with confidence measures across age and income demographics showing broad improvement.  The index held those gains last week and made a new 5Y with this morning’s reading improving to -28.9 from -29.9 w/w.  The Conference Board Consumer Confidence as well as the University of Michigan Consumer Sentiment readings were confirmatory with the latest April readings accelerating sequentially to 68.1 and 76.4, respectively. 
  • Housing - Incremental data over the past week has reflected more of the same as Mortgage Purchase Applications remained at their YTD highs while the Pending Home Sales and Case-Shiller HPI data both accelerated sequentially.  The Purchase application data and Pending Home sales numbers both suggest forward housing demand should remain strong.  Additionally, President Obama’s likely nomination of Congressman Mel Watt to replace Ed DeMarco as head of the FHFA should be taken as a positive catalyst for housing.  DeMarco has opposed underwater principal forgiveness for GSE borrowers – a stance that may be lightened should Watt be confirmed.  

Now to be clear, not all economic data has been positive and certainly much of the European data has been depressing.  The primary push back we got with this update yesterday is that regional PMIs have been decelerating and sequestration remains a major headwind. 


While these points are valid, we continue to believe that the performance of consumer related economic indicators trump other weakness in an economy that is 70% consumption.  Last week’s GDP report validated our view as Consumption was up +3.2% year-over-year versus +2.8% and contributed +2.24% of the growth (or 90% of the incremental growth).


Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, UST10yr Yield, VIX, and the SP500 are now $1, $98.13-103.85, $81.46-83.29, $1.29-1.32, 97.11-100.63, 1.63-1.71%, 12.06-14.51, and 1, respectively.


Enjoy your weekends and stay disciplined!


Keep your head up and stick on the ice,


Daryl G. Jones

Renaissance Man


Renaissance Man - Chart of the Day


Renaissance Man - Virtual Portfolio

Energy Gaps

This note was originally published at 8am on April 19, 2013 for Hedgeye subscribers.

“For unless man were to be like God and know everything, it his better that he should know nothing.”

-John Buchanan


The Gap in the Curtain (1932) is a novel by John Buchanan that speaks to the human desire for certainty, and the dangers its quest can bring.


In a London country house, five party-goers partake in an experiment that allows them a glance at a newspaper that will be printed exactly one year in the future.  The rest of the book tells the story of how that information affected each of their lives over the next year. 


One man reads of a business merger, spends the next year painstakingly traveling the world buying every share of the to-be-acquired company he can find, only to find that the business combination he read of was one nearly out of bankruptcy…  Another character reads his own obituary and dies of a heart attack the night before it prints; he does not live long enough to read the correction the paper issues on the following day for the typo…




This exchange from Core Laboratories’ (CLB) earnings call yesterday reminded me of the novel:


Analyst: “So, what’s your prediction, where is oil going from here?”

David Demshur, CEO of CLB: “Don’t have a clue, my friend.”

I sympathize with the analyst’s question – wouldn’t that be nice to know! – but, more so, I appreciated Demshur’s candid answer.


Gold is going to $2,000…  Oil will spike to $200/bbl…  My price target for the S&P500 at year-end 2013 is 1,458…

Wall Street loves making declarative statements.  I used to think that I had to make them too – I was scared to say “I don’t know,” as if I should have the answers to so many inherently unknowable questions.  But after several humbling experiences early in my career – i.e. being wrong – I have “resigned from the professional undertaking of coin-flipping,” to quote one of my favorite risk managers and thinkers, Hugh Hendry.


Sure, I have my biases – commodity prices tend to mean revert, oil lower (possibly a lot lower), Peyto Exploration (PEY.CN) higher (possibly a lot higher), LINN Energy (LINE, LNCO) and EV Energy Partners (EVEP) lower – but really I try to let the market tell me what to do (embrace uncertainty and our complexity-based models) and make solid risk-adjusted investment decisions given those signals.


Our playbook since the beginning of the year has been long USD and US consumption-oriented sectors, and short commodities and commodity beta.  Our Macro Team reviewed our #StrongDollar theme on our 2Q13 Macro Call on Tuesday – we’re bullish on the USD due to:


-          All-time low interest rates with the prospect of a hike;

-          Cessation of QE initiatives;

-          Improving housing and employment picture;

-          Addressing all-time highs in sovereign debt and deficit ratios;

-          USD solidified as world reserve currency at the expense of a weaker Yen and Euro.


From there we think that a #StrongDollar deflates commodity inflation and takes commodity-levered sectors (XLE and XLB) lower with it.  If you don’t think I should paint a broad brush across “commodities,” tell me why gold and oil have a +0.92 correlation since ’09 (see Chart of the Day).  We think it’s the same “inflation hedge” trade that’s now unwinding… 


Today, the risk management signals across the “financialized” commodity complex are still not good:


-          Gold is bearish TREND (needs to recover: $1,681)

-          Copper is bearish TREND ($3.58)

-          Brent Crude is bearish TREND ($110.54)

-          WTI Crude is bearish TREND ($93.88)

-          Energy Stocks (XLE) are bearish TREND ($76.87)


So as our fundamental #StrongDollar theme plays out, and oil and energy stocks begin to break down across our core TREND duration, we want to be underweight energy, looking for energy stocks to sell/short, and know that our energy long ideas have to be really tight (imminent catalysts or special situations) or levered mostly to natural gas prices (bullish TREND).




Two stocks that I think are worth selling are LINN Energy (LINE, LINCO) and EV Energy Partners (EVEP).  I wanted to hit on this in this note because these stocks are hugely popular among retail investors, which are attracted to that juicy yield (LINE 8%, EVEP 6.5%).  It’s kind of funny – any time Keith or I tweet about LINE/LNCO we get borderline hate-mail in return!  But how much cash a company pays out to its shareholders says nothing of the intrinsic value of the business – and these stocks are hugely overvalued, and their distributions sustained with capital raises.  The distributions paid are inconsistent with the economics of the businesses, and we think it ends in tears.  Hedgeye subscribers, do not be left holding the bag!


Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, EUR/USD, UST10yr Yield, VIX, and the SP500 are now $1284-1461, $96.72-102.27, $81.95-83.11, 96.63-101.57, $1.29-1.31, 1.68-1.76%, 14.27-18.68, and 1533-1557, respectively.


Have a great weekend,


Kevin Kaiser

Senior Analyst


Energy Gaps - Chart of the Day


Energy Gaps - Virtual Portfolio


Takeaway: If you have to remain invested in the EM space, we like Brazilian and Indian consumer exposure on the long side from here (TREND duration).



  • Consistent with our #StrongDollar/commodity deflation theme as reiterated throughout the past six months, we want to be consistently taking up our exposure to consumption-oriented names and sectors in lieu of those names and sectors that require commodity inflation to drive revenue and earnings growth. With respect the emerging market space, this call was most recently reiterated on our EME Crises Black Book & Conference Call (i.e. long consumption oriented countries and currencies vs. short commodity producing countries and currencies).
  • In line with this view, we like Brazilian and Indian consumer exposure on the long side from here (TREND duration), as the fundamental research signals confirm. This is a good relative play for those analysts and PMs that must maintain a healthy allocation to emerging markets (we're bearish on them, broadly speaking).
  • Regarding Brazil specifically, Brazil is a 81% consumption-based economy (household = 60.3%; government = 20.7%), so negative commodity beta is a positive factor for GDP growth and equity market sentiment/valuations – as it was during late 2008, when Brazil bottomed ahead of most other major equity markets and economies. Flipping over to India, #StrongDollar commodity deflation is supremely positive, at the margins, for the country’s inflation, balance of payments and fiscal policy dynamics – three factors that have weighed on Indian GDP growth and equity market sentiment/valuations in recent years.



Brazilian swap rates are reversing their hawkish trend amid recent confirmation that inflation may finally be headed in the right direction after last month’s +25bps SELIC rate hike and inclusive of the BRL’s +2.1% YTD gain vs. the USD. 1Y OIS are pricing at 54bps above the benchmark SELIC rate, a spread that has tightened -13bps MoM after widening +51bps over the past three.




Regarding the aforementioned inflation confirmation, on Monday the Getulio Vargas Foundation reported that its IGP-M index of wholesale, construction and consumer prices – which has historically led the benchmark IPCA index by two to six months – rose +7.3% YoY in APR after climbing +8.1% YoY in MAR. Regarding the recent moves in the swaps market, it’s clear investors are now pricing in a more dovish outlook for Brazilian monetary policy, on the margin, than they had been as recently as a few weeks ago. Again, everything that matters in macro occurs on the margin.




As we have outlined in our 1/13 note titled: “WILL BRAZIL HOLD THE LINE?”, Brazil is a particularly interesting economy with respect to global inflation/deflation cycles. On one hand, the predominance of Brazilian industrial production and equity exposure (44.3%) is in the Energy and Basic Materials sectors (Bovespa Index). On the other hand, Brazil is a 81% consumption-based economy (household = 60.3%; government = 20.7%), so negative commodity beta is a positive factor for GDP growth and equity market sentiment/valuations – as it was during late 2008, when Brazil bottomed ahead of most other major equity markets and economies.








All told, we want to be increasing our allocation to Brazilian consumer stocks here in anticipation of further upside over the intermediate term.



The SENSEX was up over one full percent today on rate-cut speculation.  According to 33 of 40 economists in a Bloomberg survey, the RBI will lower its repurchase rate to 7.25% from 7.5% in tomorrow’s monetary policy announcement; six see no change and one predicts a cut to 7%. Consensus has indeed finally come our way on RBI rate cut expectations and we’re seeing that reflected in the swaps market: 1Y OIS are pricing at 31bps below the RBI’s benchmark REPO rate, a spread that has narrowed -27bps MoM.




#StrongDollar commodity deflation continues to auger positively for India’s inflation (at a 40-month low of 6% YoY as of MAR), balance of payments (imports of gold account for ~80% of current account deficit and India imports ~80% of its crude oil consumption) and fiscal policy (subsidies are budgeted at ~14% of total FY14 expenditures) dynamics – as outlined in greater detail in our 3/19 note titled: “BUY INDIA ON WEAKNESS?”.








Also positive for the INR was the recent reduction in the foreign investor withholding tax on rupee-denominated debt (from 20% to 5%); that should accelerate private capital inflows into the Indian economy – something the country desperately needs in order to prevent the Finance Ministry’s bloated FY14 borrowing plan from crowding out much-needed domestic investment. Needless to say, any marginal strength in the rupee (+80bps MoM) is only additive to the aforementioned dynamics.




All told, we want to be increasing our allocation to Indian consumer stocks here in anticipation of further upside over the intermediate term.


Darius Dale

Senior Analyst

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