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Disorderly Risks

“What they lacked was a science of disorder and randomness.”

-George Gilder

 

Gilder could have been writing about adults making life decisions inasmuch as he was alluding to both Keynesian and Hayekian policy makers who still don’t get the core chaos theory concept of non-linearity. If you don’t know what I am talking about, have kids.

 

Both life and market risks are grounded in uncertainty. You can take whatever precautions you want; you can be as proactively prepared as you think you can be – but it’s always the surprise of new information that drives decision making.

 

You cannot learn how to embrace uncertainty in a textbook. You have to learn this game by playing it. Since disorder and randomness typify markets, your risk management process should attempt to absorb that dynamism.

 

Back to the Global Macro Grind

 

Three big macro things have really changed in the last 3 months:

  1. Bond Yields in the USA, Germany, and the UK have been rising alongside their respective stock markets #surprise
  2. Growth Stocks (Low Dividend Yield, High EPS Growth, High Short Interest) have been crushing Slow-Growth Stocks
  3. Asian Emerging Market stocks have been dramatically underperforming US Growth Stocks

That sounds a little disorderly, no?

 

If you are bullish on “growth” doesn’t your local pie chart “diversification” manufacturer have you buying “Emerging Markets”? Or are they re-positioning that bad asset allocation decision to you now as something that looks “cheap.” #ThesisDrift

 

In Hedgeye-Jedi speak, “cheap” gets cheaper when:

 

A)     Country Inflation (or costs in the case of a company) Accelerates

B)      Real (inflation adjusted) Growth Slows

 

Back-test it with Apple (AAPL) and you’ll get my point. It doesn’t matter how “good” a company is if it’s about to see:

 

A)     Revenue Growth Slow (versus peak)

B)      Margins Compress (versus peak)

 

When you get A + B, you get multiple compression.

 

Conversely, in our proprietary GIP Model (Growth, Inflation, Policy), when a country:

 

A)     Sees Growth go from slowing to stabilizing to accelerating … and

B)      Is the recipient of inflation slowing via currency appreciation…

 

You get equity market multiple expansion. Look at the chart of any raging “growth” stock that is USA centric (SBUX, TSLA, DDD, NFLX, OPEN, SODA, etc.) and you’ll get what I mean.

 

Simple, right? Even a hockey player can do it.

 

Yes, in hindsight, most things macro are easier to see looking backwards. It’s in observing the chaotic system of colliding global macro market trends (where Growth and Inflation patterns develop) that you get an edge. It’s a grind.

 

Let’s go back to explaining why the aforementioned point #3 (#AsianContagion) has come to be. What’s happening this morning was as obvious in June as it is today:

  1. Indonesia’s Rupiah continues to crash; down big this morning -4.3% (for a currency, that is a lot!)
  2. India’s Rupee continues to crash as well, down another -1.9% this morning

As a country’s currency gets crushed, #InflationAccelerates and #GrowthSlows – then you get:

  1. Indonesia’s stock market down another -4% overnight (down -15% for the month-to-date)
  2. India’s stocks market down another -3.1% overnight (-11.5% since July 23rd)

Sure, it may seem disorderly and random that Asian “growth” markets can dislocate from US domestic growth stocks. It may appear random to the Macro Tourist who doesn’t stare at the matrix of currency and correlation risk like we do all day too.

 

But the other big point about disorder and randomness embedded in chaos theory is that there is a deep simplicity to it all, in hindsight.

 

Our immediate-term Risk Ranges are now as follows (we have 12 Big Macro risk ranges in our Daily Trading Range product now too):

 

UST 10yr Yield 2.71-2.93%

SPX 1

EEM 32.07-38.99

VIX 13.03-15.44

USD 80.93-81.80

Copper 3.30-3.39

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Disorderly Risks - chart

Disorderly Risks - vp


Consensus Wrong on #RatesRising

Consensus has been telling you over and over again that our top Q3 Macro Theme #RatesRising is going to kill the US stock market for about 9 months now. Well, it's certainly killing bonds, Emerging Markets, and slow-growth, high yielding, stocks maybe, but not US growth stocks.

 

Consensus Wrong on #RatesRising - Sector Performance

 

That style factor is why the Nasdaq and Russell 2000 outperformed the Dow again last week. It's 2.82% on the 10-year now with no resistance to 2.95%. This Hedgeye Q3 Macro Theme remains firmly intact.


BEST IDEAS UPDATE

Starbucks (SBUX)


Starbucks has been on the Hedgeye Real Time Alerts list since 4/21/09, when we added it as a LONG.

 

SBUX continues to be the best run company that we follow and the long-term TAIL seems unlimited.  Impressive FY3Q13 results only enhance this view.  Despite the stock trading at the high end of its historical consensus forward earnings and cash flow multiples, we believe there is more upside in store.  The three bullish factors we remain focused on include rapid unit growth in China, expansion into new segments of the global food and beverage industry and a commodity tailwind that we anticipate will continue well into FY15. 

 

At 15.1x EV/EBITDA, SBUX is trading significantly above its QSR peer group at 12.4x EV/EBITDA, but we believe this premium is warranted.  Sentiment on the street is high, and this, along with the development of La Boulange are two of our main concerns.  While we can argue that the street is not bullish enough on SBUX, we cannot brand La Boulange a success just yet.

 

BEST IDEAS UPDATE - SBUX US

 

BEST IDEAS UPDATE - SBUX EMEA

 

BEST IDEAS UPDATE - china

 


The Cheesecake Factory (CAKE)


We added CAKE to the Hedgeye Best Ideas list on 2/11/13 as a LONG.   

 

Despite reporting disappointing 2Q13 results, the underlying fundamentals of the company remain strong.  We expect 3Q13 to be a challenging quarter for all casual dining companies and CAKE is no exception, as the company faces slowing industry trends and a tough comp.  However, we believe sales will rebound strongly in 4Q13 and carry on into 2014. 

 

At 8.7x EV/EBITA, CAKE is valued in line with its Casual Dining peer group trading at an 8.8x multiple.  While short interest is currently 11.09% of the float, we believe the international story is underappreciated by the street.  International locations have exceeded expectations and management plans to open another three Middle East stores this year.  For each Middle Eastern restaurant that is open for a full-year, we expect $0.01 in incremental annual earnings per share.

 

BEST IDEAS UPDATE - CAKE RIHANNA

 

 

Panera Bread (PNRA)


We added PNRA to the Hedgeye Best Ideas list on 4/5/13 as a SHORT.  

 

Reflected in 2Q13 results, PNRA is facing a bevy of issues.  The company’s position as a healthy QSR option that is relatively free of competitors is gradually changing.  An increasing number of Casual Dining chains are now offering lower price points and other QSR chains are upgrading their menus.  These menu upgrades include items that are being competitively marketed as healthy eating options and are cheaper than PNRA’s core offering.  This means one thing for PNRA: more competition.

 

But this isn’t the only issue that PNRA is facing.  The company has admitted to having numerous and varying operational issues, ranging from a lack of kitchen equipment to a lack of seating.  Capacity issues have dampened lunch time transactions and management has struggled to drive peak hour throughput.  Therefore, we believe the labor line favorability the company has seen lately will wane, as PNRA will have to invest increased labor in some of its cafes in 2H13.

 

The aforementioned issues are manifesting themselves in the components of comparable sales growth as PNRA traffic trends have shown weakness lately.  At 9.8x EV/EBITDA, the stock currently trades at a discount to its QSR peer group at a 12.4x EV/EBITDA.  We believe this discount is justified and expect PNRA to have another rough outing in 3Q13.

 

BEST IDEAS UPDATE - PNRA system

 

BEST IDEAS UPDATE - PNRA COMPANY

 

 

McDonald’s (MCD)


We added MCD to the Hedgeye Best Ideas list on 4.25 as a SHORT.  

 

July sales numbers recently reported by MCD confirm that the company continues to struggles amidst a difficult macro and increasingly difficult competitive environment.  The company has a lot of work to do in order to improve its operational performance and we fail to see any indication that this will transpire soon.  We previously laid out our thoughts on the path management must take in order to generate sustainable revenue and operating growth in our note titled, “MCD – Difficult Decisions Looming?” 

 

Management’s Plan to Win strategy has proven stale, as new products are not working and operational throughput issues persist.  We believe MCD’s attempts to diversify away from core competencies have, to some degree, brought about these issues.  In addition to operational problems, the company faces three near-term issues: flat-to-declining markets, a lack of pricing flexibility and increasing competition.  To touch on the latter, companies like Wendy’s, Chipotle and even Taco Bell have been pressuring McDonald’s sales as they have been able to successfully do what McDonald’s has not: appeal to Millenials.  As the competitive landscape continues to change, MCD must figure out how to appeal to this cohort.

 

Short interest is only 0.92% of the float and at 10x EV/EBITDA, MCD is trading significantly below its QSR peer group at 12.4x EV/EBITDA.  We believe the aforementioned operational and near-term issues validate this discount.

 

BEST IDEAS UPDATE - global

 

BEST IDEAS UPDATE - MCD USA

 

BEST IDEAS UPDATE - MCD EUR FINAL

 

BEST IDEAS UPDATE - MCD APMEA FINALL

 

 

 

Howard Penney

Managing Director

 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.65%
  • SHORT SIGNALS 78.64%

WWW Bolsters Our Bullish Call

Takeaway: WWW hires the most eligible bachelor in global footwear. There is no other way to slice this than hugely positive. WWW remains a top pick.

This note was originally published August 23, 2013 at 13:16 in Retail

Don’t overlook WWW’s announcement today that it hired Gene McCarthy as President of the Merrell brand. It’s a very material announcement, and one that bolsters our bullish call on WWW.

WWW Bolsters Our Bullish Call - merr5 

  1. McCarthy is one of the most successful footwear executives in the world, with a pedigree stretching from Nike, to Reebok, to Timberland, and UnderArmour. WWW is extremely lucky to have nabbed him.
     
  2. Merrell is about $550mm in revenue, or 20% of WWW’s total sales. Yes, it is WWW’s biggest division, and we think that he will have a meaningful impact given that Merrell has been a drag on WWW’s results. It needs the help. He is the kind of individual that can take this to being a $1bn brand, instead of someone that will be content with 3-5% growth annually.
     
  3. But we think that WWW brought McCarthy in with much bigger plans in mind -- whether they are saying it or not (watch what they do, not what they say). Keep in mind that he was brought in to fix the Yellow Boot business at Timberland in April 2006. But by December 2007 he was already Co-President of the parent company. The guy ‘gets it’ when it comes to brand building, and it was a waste for TBL to isolate his talent on only a quarter of the company’s business.
     
  4. But then why did he seemingly fail at UA?  We thought it was a big deal when Kevin Plank hired McCarthy away from Timberland to run UA’s footwear business. But in the end, it did not really work, and we were proved wrong.  We think the problem was two-fold. A) The footwear business at UA needs more capital. It needs more R&D, and more distribution resources both inside and outside of the US. WWW has that already. B) The chemistry between Plank and McCarthy simply did not work. They’re both very ‘type A’, and there was definitely a clash – especially when it came to arguing as to whether the company needed more resources to make the footwear business work

 

Unless WWW paid an ungodly sum of money to get McCarthy on board them team, which is unlikely, there is no way to slice this announcement other than overwhelmingly positive.

WWW Bolsters Our Bullish Call - mcgough

 


Morning Reads on Our Radar Screen

Takeaway: A quick look at some stories on Hedgeye's radar screen.

Keith McCullough – CEO

Capital Flight Drains Reserves as Rupee, Rupiah Fall (via Bloomberg)

Fukushima operator to seek foreign advice on toxic water (via Reuters)

Japan Sales-Tax Decision Due by Early October (KM note: Important macro catalyst … via Bloomberg)

Tweets printed by home-built ticker-tape machine (via BBC http://www.bbc.co.uk/news/technology-23812365)

 

Morning Reads on Our Radar Screen - Bovespa floor

 

Kevin Kaiser – Energy

Working Round the Clock Is a Poor Use of Time (via FT)

Nuverra Environmental: A Sinking Ship With Default Risk (KK note: Rare - a solid SeekingAlpha piece … via Seeking Alpha)

More U.S. oil is moving via truck, barge and train than at any point since 1981 (via WSJ)

 

Howard Penney – Restaurants

McDonald's Operator Tips Mighty Wings Return (via HuffPost)

Filmmaker Lucas-controlled trust buys USD10 million in Starbucks stake (via IVCPost)

 

Jonathan Casteleyn – Financials              

Fed Officials Rebuff Coordination Calls as QE Taper Looms (Contrary to popular belief when the Fed stops QE signaling a recovering USA it is GOOD for the global economy … via Bloomberg)

Server Crash Spurs 3-Hour Nasdaq Halt as Data Link Lost (JC note: Kudos to $NDAQ for not pointing fingers even though it sounds like $NYX system's started last week's issue  … via Bloomberg)


MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE

Takeaway: Keep and eye on Indian banks, as they're crossing decidedly into the danger zone, and doing so at an accelerating rate.

Key Takeaways:

 

* Indian Financial CDS - Indian banks are beginning to show some signs of serious stress. All three major banks have crossed the "Lehman Line" (+300 bps) and are showing no sign of retreat. Last week, they rose a further 49-69 bps, putting them all north of 350 bps currently. 

 

* High Yield – Rates rose another 9 bps last week, ending the week at 6.55% versus 6.46% the prior week. After troughing briefly on July 22nd at 5.91%, rates have been steadily climbing since. Our firm's view on rates is that they'll continue to grind higher making higher highs and higher lows. Historically, we've seen Financials far more correlated with high yield than they are currently. This is a good sign, as the market is differentiating systemic credit risk from risk of rising rates.

 

 

Financial Risk Monitor Summary

 • Short-term (WoW): Negative / 1 of 13 improved / 5 out of 13 worsened / 7 of 13 unchanged

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

 • Long-term (WoW): Negative / 3 of 13 improved / 3 out of 13 worsened / 7 of 13 unchanged

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 15

 

1. U.S. Financial CDS -  Morgan Stanley widened 8 bps last week, making it the ugly duckling. Most of the other large cap names were uneventful. Insurers were similarly little changed. MGIC saw its swaps widen by 33 bps to 449 bps, though Radian tightened by 2 bps. Overall, swaps widened for 19 out of 27 domestic financial institutions, though the average and median change WoW was +4 and +1 bps, respectively.

 

Tightened the most WoW: BAC, WFC, GS

Widened the most WoW: MMC, AXP, GNW

Tightened the most WoW: MET, PRU, AIG

Widened the most MoM: MBI, AGO, AXP

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 1

 

2. European Financial CDS - Swaps were mostly wider last week on EU financials. One callout includes Sberbank of Russia backing up another 22 bps to 261 bps, now wider by 54 bps MoM. We continue to find this puzzling in light of the ongoing rise in crude oil. However, a possible explanation is the growing tension in the Syria/Middle East conflict.

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 2

 

3. Asian Financial CDS - Indian banks are beginning to show some signs of serious stress. All three major banks have crossed the "Lehman Line" (+300 bps) and are showing no sign of retreat. Last week, they rose a further 49-69 bps, putting them all north of 350 bps. China and Japan were quiet last week.

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 17

 

4. Sovereign CDS – Portugal was the only sovereign mover of note last week, widening 35 bps to 471 bps. Elsewhere around the world, swaps ranged from 1 bp tighter (Ireland) to 3 bps wider (Japan). 

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 18

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 3

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 4

 

5. High Yield (YTM) Monitor – High Yield rates rose another 9 bps last week, ending the week at 6.55% versus 6.46% the prior week.

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 5

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 4.0 points last week, ending at 1800.

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 6

 

7. TED Spread Monitor – The TED spread rose 1.1 basis points last week, ending the week at 23.4 bps this week versus last week’s print of 22.3 bps.

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 7

 

8. CRB Commodity Price Index – The CRB index rose 0.3%, ending the week at 291 versus 290 the prior week. As compared with the prior month, commodity prices have increased 1.4% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 8

 

9. Euribor-OIS Spread – The Euribor-OIS spread was again unchanged last week at 12 bps. 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. 

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 9

 

10. Chinese Interbank Rate (Shifon Index) –  The Shifon Index rose 15 basis points last week, ending the week at 3.36% versus last week’s print of 3.21%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 10

 

11. Markit MCDX Index Monitor – Last week spreads widened 8 bps, ending the week at 96 bps versus 88 bps the prior week. 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.

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 11

 

12. Chinese Steel – Steel prices in China rose 1.2% last week, or 42 yuan/ton, to 3610 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 12

 

13. 2-10 Spread – Last week the 2-10 spread tightened to 244 bps, -5 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 13

 

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.9% upside to TRADE resistance and 2.1% downside to TREND support.

 

MONDAY MORNING RISK MONITOR: INDIA'S BANKING SYSTEM IS DETERIORATING AT AN ACCELERATING RATE - 14

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


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