Morning Reads on Our Radar Screen

Takeaway: Here's a quick look at stories on Hedgeye's radar screen.

Keith McCullough – CEO

Health food fight ramps up as Ackman hits Soros over Herbalife (via NY Post)

Treasuries Are World’s Worst-Performing Bonds (via Bloomberg)

Sri Lanka Opens $500 Million Port Terminal Built by China (via Bloomberg)

World's first lab-grown burger to be cooked and eaten (via BBC)


Morning Reads on Our Radar Screen - earth1


Daryl Jones – Macro

Shale Explorers Outperforming International Oil Titans (via Bloomberg)

U.K.'s services PMI jumps to 60.2 in July (via MarketWatch)


Josh Steiner – Financials

#RatesRising 30-Year Mortgage Rates Have Spent 3 Weeks Between 4.3-4.4% (JS note: Our outlook remains higher highs & higher lows … via Bloomberg)


Jonathan Casteleyn – Financials

Treasuries Proving Safer Than AAA Two Years After S&P Cut (JC note: I don't think Treasuries are safe but a positively sloped yield curve is one of the most important economic tenets  via Bloomberg)

Bond Salesman Who Wasn’t Reveals RBS Human Errors (via Bloomberg)


Matt Hedrick – Macro

Merkel Challenger Says Alienated Voters Are Key to Unseating Her (via Bloomberg)


Takeaway: Both the short and intermediate term FIG setups remain favorable with very few watch areas currrently.

Key Takeaways:

Last week was another ho-hum week from a risk monitoring standpoint. US financial credit default swaps were essentially unchanged. European financial swaps were broadly improved (average -14 bps). High yield rates were nominally higher (+5 bps), TED spread was nominally lower (-1 bp), Euribor-OIS was wider by 1 bp and the Shifon Index tightened by 30 bps. All this points to a broad-based calm globally. 


On a short term basis, the only risk measure that deteriorated was Muni CDS, which rose 4 bps to 95 bps, reflecting modestly higher default expectations as investors re-review pension statuses nationally. On an intermediate term basis, we continue to see a lot of positives. Note the preponderance of green in the middle columns (MoM) of our summary table below. 


Financial Risk Monitor Summary

 • Short-term(WoW): Positive / 5 of 13 improved / 3 out of 13 worsened / 5 of 13 unchanged

 • Intermediate-term(WoW): Positive / 6 of 13 improved / 3 out of 13 worsened / 4 of 13 unchanged

 • Long-term(WoW): Positive / 7 of 13 improved / 2 out of 13 worsened / 4 of 13 unchanged




1. American Financial CDS -  The biggest movers last week were the mortgage insurers, MTG and RDN, which saw swaps tighten 33 bps and 20 bps, respectively, to 416 bps and 377 bps. Overall, swaps tightened for roughly half (15 out of 27) of domestic financial institutions. 


Tightened the most WoW: MTG, RDN, GNW

Widened the most WoW: AXP, MBI, ALL

Tightened the most WoW: MTG, RDN, GNW

Widened the most/ tightened the least MoM: AGO, MBI, MMC




2. European Financial CDS - Last week saw large improvements in French, Greek, Italian, and Spanish swaps. In fact, the only company that saw swaps rise was Sberbank of Russia, where swaps backed up another 14 bps to 238 bps. Sberbank swaps have become increasingly tethered to the outlook for oil prices.




3. Asian Financial CDS - Indian banks were notably wider last week, rising 11 - 19 bps across the group. Swaps in Chinese banks were tighter, while Japanese banks were flat to mixed. 




4. Sovereign CDS – Last week saw another across-the-board tightening in sovereign credit default swaps. Spain, Italy and Portugal led the improvement with declines of 15 bps, 12 bps and 11 bps, respectively. Ireland and France followed with 8 bps and 5 bps. The U.S., Germany and Japan were all tighter by 1-2 bps. 








5. High Yield (YTM) Monitor – High Yield rates rose 5.5 bps last week, ending the week at 6.23% versus 6.17% the prior week.




6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 0.6 points last week, ending at 1805.85.




7. TED Spread Monitor – The TED spread fell 1.3 basis points last week, ending the week at 23.4 bps this week versus last week’s print of 24.7 bps.




8. CRB Commodity Price Index – The CRB index fell -1.4%, ending the week at 284 versus 288 the prior week. As compared with the prior month, commodity prices have increased 0.7% We generally regard changes in commodity prices on the margin as having meaningful future consumption implications.




9. Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread widened by 1 bps to 13 bps.




10. Chinese Interbank Rate (Shifon Index) –  The Shifon Index fell 30 basis points last week, ending the week at 3.25% this week versus last week’s print of 3.55%. The Shifon Index measures Chinese banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.




11. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 16-V1. Last week spreads widened 4 bps, ending the week at 95.3 bps versus 91.1 bps the prior week.




12. Chinese Steel – Steel prices in China fell 0.7% last week, or 23 yuan/ton, to 3447 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.




13. 2-10 Spread – Last week the 2-10 spread widened to 230 bps, 5 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.




14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.9% upside to TRADE resistance and 1.2% downside to TRADE support.




Joshua Steiner, CFA


Jonathan Casteleyn, CFA, CMT


CAT: Incorrectly Impaired Red Flag? (10-Q Review)



Filing a 10-Q at 4:30PM on a Friday is a mistake for a company that has recently been said to have “accounting issues” by one of the world’s best known and most diligent short sellers.  Regardless of the content, a Monday morning filing would have been less provocative.  We have looked through to see what CAT may have been hoping to deemphasize. 


The disclosure that jumps out is that CAT had “incorrectly” reported impaired loans and finance leases at CAT Financial. Even the most ardent CAT optimist has to acknowledge that there have been issues with due diligence at CAT (e.g. Siwei).  “Incorrectly” disclosing impaired loans and finance leases may add to the perceived lack of management attention.  Having investors focused on a new red flag at CAT Financial is unlikely to be positive; cash has poured into receivables in recent years to support equipment sales, growing the unit’s infrequently discussed $35 billion in assets.


We also note additional language that disagrees with the history of resources related capital spending.  When commodity prices stall or decline, resources-related capital spending should return to maintenance-like levels over time.  CAT’s language suggests that they do not believe that the decline in Resource Industries sales is part of a return to normal levels of demand, not a departure from them.


There are other odds and ends, the key aspects of which we think can be gleaned from the quarter’s press release and earnings call.  It is not as though CAT reported an unexpectedly strong quarter.



Incorrectly Reported Impairments


Here is the new disclosure:


“During the second quarter of 2013, we changed the classification of certain loans and finance leases previously reported as impaired.  While these loans and finance leases had been incorrectly reported as impaired, the related allowance for these loans and finance leases was appropriately measured; therefore, this change had no impact on the Allowance for credit losses.  The impact of incorrectly reporting these loans and finance leases as impaired was not considered material to previously issued financial statements; however, prior period impaired loan and finance lease balances reported in Notes 4 and 8 have been revised.” – CAT and CAT Financials’ 2Q 2013 10-Qs


At first, the disclosure does not look all that interesting.  The impaired items were previously overstated and the accruals are reported to have been accurate.  However, the magnitude of the incorrect reporting and the lack of corrected historical replacement financials are of some interest.  Consider the table below:


CAT:  Incorrectly Impaired Red Flag? (10-Q Review) - cat1



This new disclosure raises questions, at least for us.  Did CAT’s management not realize that the disclosed Recorded Investment In Impaired Loans and Finance Leases With An Allowance was being incorrectly reported by ~30%-50% for at least a year?  Did CAT change the methodology to identify impaired loans to reduce the current reported balance and, presumably, those going forward?  Is this a red flag indicating further incorrect disclosures at CAT Financial or efforts to manage something?  We are pretty sure that CAT management does not want to be asked those kinds of questions following Siwei, Chanos and recent guidance cuts.


We do not want to make a mountain out of a mole hill, but context usually matters and these issues are often not isolated to a single item.  At the very least, we would have preferred some background on the cause of the incorrectly reported values.



What is “Normal”


We continue to think that the boom in resources-related capital spending was a deviation from historical norms and that recent declines are just a step back toward them.  CAT disagrees, judging by other comments and this disclosure on an anticipated cyclical recovery.


“Due to the substantial decline in Resource Industries' sales and the uncertainty around when cyclical recovery will resume, we have taken substantial action to adjust production levels and to reduce costs.” – CAT 2Q 2013 10-Q


This differing view may matter going forward in Power Systems, where many expect the stall in energy prices to have a different impact on energy-related capital spending (Power Systems) from that of stalled metals prices on mining capital spending (Resource Industries).  But we note that Power Systems is also under pressure:


“The lower sales were mainly due to decreases in electric power and industrial petroleum applications.”  – CAT 2Q 2013 10-Q





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Client Talking Points


Boom! Another solid #GrowthAccelerating data point out of the UK this morning (60.2 in JUL vs 56.9 last month). It's just a fantastic number. The UK Services PMI print for July was one of the best macro data points of the year (relative and both absolute = 6 year high). That's well above Germany’s 51.3 (which was a miss) as well as France and Italy which were both just inside of 49. Incidentally, the FTSE is up +16% year-to-date. It remains one of the most bullish equity markets in my model.


A mounting headwind for global consumption. Brent was up +1.7% last week and is up again (+0.3%) this morning. It just won’t go down. This is definitely a sequential headwind for Q3 13 US GDP growth. So keep that in mind as we dig into August. Net long (futures/options) position in crude finally went down last week (that was the first down week since late June) to +318,819 net long contracts. It's the biggest net long position in all of big macro, by far.


I've said it before and I'll say it again: Get the dollar right, you get a lot of things right in the market. The US Dollar was up +0.7% last week versus the Yen. But half those gains are lost this morning. We are watching this one very closely. Why? It’s still the intermediate-term TREND front-runner for both US and Japanese Equities from a correlation perspective. USD Index TREND support is now $81.53.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

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. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.


Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016. 


Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward.  Near-term market mayhem should not hamper this  trend, even if it means slightly higher borrowing costs for hospitals down the road. 

Three for the Road


Fear continues to crash. VIX -5.8% w/w to -33.5% YTD. Gold had another bad wk -0.9%, still crashing YTD -22.3%



What’s money? A man is a success if he gets up in the morning and goes to bed at night and in between does what he wants to do.

– Bob Dylan


Treasuries are the world’s worst-performing sovereign bonds this year. U.S. government securities due in 10 years or more fell 6 percent in the past six months, the biggest decline among 144 debt indexes tracked by Bloomberg and the European Federation of Financial Analysts Societies. (Bloomberg)

August 5, 2013

August 5, 2013 - dtr



August 5, 2013 - 10yr

August 5, 2013 - spx

August 5, 2013 - nik

August 5, 2013 - ftse

August 5, 2013 - dxy


August 5, 2013 - oil


August 5, 2013 - VIX

August 5, 2013 - yen

August 5, 2013 - natgas
August 5, 2013 - gold

August 5, 2013 - copper

Don't Cheat

This note was originally published at 8am on July 22, 2013 for Hedgeye subscribers.

“They cheat. You cheat. And yes, I also cheat from time to time.”

-Dan Ariely


This weekend I cracked open a behavioral psych book that is quite relevant to our profession this morning. The book is about how and why people cheat. It’s called The (Honest) Truth About Dishonesty, by the founder of The Center for Advanced Hindsight, Dan Ariely.


“In a nutshell, the central thesis is that our behavior is driven by two opposing motivations. On one hand, we want to view ourselves as honest, honorable people… on the other hand, we want to benefit from cheating and get as much money as possible.”


“This is where our amazing cognitive flexibility comes into play. Thanks to this human skill, as long as we cheat by only a little bit, we can benefit from cheating and still view ourselves as marvelous human beings.” (pg 27)


Back to the Global Macro Grind


Now what happens if your internal view of cheating by a “little bit” ends up being viewed externally as cheating by a lot? Well, in our business, that might mean your firm gets a big fine and/or, alternatively, you get to slap on an orange-jump suit for a while.


With an oversupply of money managers, the pressure to perform in this profession is intense. I get that. That’s why people cheat. I’ve worked in more than enough hedge fund environments to know how some people define grey – and the definition is loose.


I also get what it means to build a family, firm, and culture with principles that are black and white. In the face of temptation, those principles need to stand like a rock. Ariely nails this in quoting Oscar Wilde (pg 28): “Morality, like art, means drawing a line somewhere.”


Enough about that. Our Macro edge isn’t inside info; it’s math – so let’s draw some TREND lines:

  1. SP500 = at the all-time highs, +18.7% YTD, with bullish intermediate-term TREND support = 1602
  2. Russell2000 = at the all-time highs, +23.7% YTD, bullish intermediate-term TREND support = 965
  3. US Dollar Index = -0.5% last week to $82.61 = +3.6% YTD with bullish TREND support = $81.63
  4. US Equity Volatility = -9.4% last week to 12.54 = -30.4% YTD with bearish TREND resistance = 18.98
  5. US Treasury Yield (10yr) = -10bps to 2.48% last week = +41% YTD with bullish TREND support = 2.21%
  6. Gold = +1.1% last week to $1294 = -23.3% YTD with intermediate-term TREND resistance = $1520

In other words, the 2013 Global Macro playbook didn’t require any cheating at all.


So far, from a US centric investor’s perspective at least, all you’ve needed to do was:


A)     Short Fear (Gold, Bonds, Volatility) and

B)      Buy Growth (High Beta, Low Yield, Growth Stocks)


It hasn’t been any more complicated than that.


What has been complicated has been understanding the storytelling of US stock market bears and Gold Bond bulls alike. With Gold, Bonds, and Yens bid up to lower-highs again this morning, there will be nothing new on that front either.


Another thing that isn’t new is “long-term” investors saying they don’t care about “all the short-term stuff” until all the short-term stuff is going the other way. This is where our immediate-term TRADE risk management duration comes in handy:

  1. Japanese Yen (vs USD) immediate-term TRADE support = 98.49
  2. Gold’s immediate-term TRADE resistance line = $1386
  3. 10yr US Treasury Yield’s immediate-term TRADE support = 2.45%

So, what would get me to start doubting our intermediate-term Macro view?


A)     Every one of those TRADE lines being violated on a closing basis, then confirmed for more than three weeks

B)      A fundamental research case that doesn’t lead me to believe in #StrongDollar #RatesRising #CommodityDeflation  


What wouldn’t get me to change my views are things like:

  1. “Hearing Bernanke could do XXX this week”
  2. “Consensus is too bearish on Gold”
  3. Etc. etc.

You know, all the loosy goosy whispering stuff. There’s always someone cheating to aid and abet their position somewhere. It’s our job to absorb all the noise into our process and make the highest probability decisions we can make with public information.


Take for example the latest bull case on Gold (i.e. that people are too “bearish” on Gold, now that it’s crashing). Every man, woman, and child who is still long it is now talking about the “high short position” of a few weeks back…


Meanwhile this morning’s CFTC futures/options data showed consensus ramping the NET LONG Gold position by +56% last week to +55,535 net long contracts.


Ostensibly, the catalyst for buying Gold was what it’s been for both the YTD and the last ½ decade – Bernanke speaking. But, on Bernanke day (last Wednesday), Gold got clocked. The bull catalyst is consensus. Don’t let yourself cheat thinking about the intermediate-term TRENDs of #StrongDollar and #RisingRates otherwise.


Our immediate-term Risk Ranges are now:


UST 10yr 2.45-2.75%

SPX 1675-1702

VIX 12.20-14.53

USD 81.87-83.21

Yen 99.30-101.26

Gold 1241-1318


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


Don't Cheat - Chart of the Day


Don't Cheat - Virtual Portfolio