Dear Mother

“You know, men do nearly all die laughing”

-T.E. Lawrence


As a young enlightened man in the field of war in the Middle East, that’s what T.E. Lawrence wrote to his Mom in 1916. At the time, he was also tasked with writing a weekly letter to the “Mother” (Britain’s War Office) of his homeland. Not surprisingly, this is when he started to “incense his military superiors” with on-the-ground truths (Lawrence in Arabia, pg 125).


“We edit a daily newspaper, absolutely uncensored, for the edification of twenty-eight generals; the circulation increases automatically as they invent new generals. This paper is my only joy. Once can give the Turkish point of view of the proceedings of admirals one dislikes, and I rub it in my capacity as editor-in-chief.” (pg 125)


Ah, the power of the pen. You either have it, or you do not. For an amateur writer like me, I get that my moments are fleeting. But, especially when attacking the tyranny of government spin, I feel as liberated as a man who believes in truth and freedom can feel. That’s why I do this at the top of every risk management morning - to feel free.


Back to the Global Macro Grind


This is not a “free-market.” At least not in its purest definition. At any given moment of the trading day, the government can announce that it is officially saving us from itself. For that, I’ll be damned if I give thanks and praise.


Can money buy your freedom? What if the purchasing power of that “money” is being burned at the stake? What if your money is borrowed from the future of your grandchildren?


These aren’t new questions this morning. Montaigne started asking these questions in 1571 with “Essais” and Shakespeare personified the money/power/freedom conundrum with the Merchant of Venice too.


Can the world’s reserve currency (US Dollar) hold its long-term TAIL risk line of $79.21 support?


It’s still the #1 question in my notebook this morning. And I suspect it will be for some time to come. If you ask Gold, the answer is maybe. If you ask Bernanke, Obama, and Boehner, it’s no.


In addition to the US Dollar’s TAIL risk line imposed upon us by central planners, here are some critical US TREND lines to consider:

  1. US Treasury 10yr Yield = 2.58% TREND support
  2. US Equities (SP500) = 1663 TREND support
  3. US Equity Volatility (VIX) = 18.98 TREND support

That last one is what’s going to drive the other two. For all of 2013 I’ve been Bearish on Fear (VIX). As of the last 2 weeks, that’s changed. I am as afraid of US government intervention in our markets and economies as the VIX has become.


Yesterday’s move on the front-month of fear (VIX) was telling – follow Mr. Market’s flow:

  1. US Equities had a big newsy down-open in the pre-market built on the false media message that the US could “default”
  2. US Bonds and Credit Default Swaps didn’t care about all of the “default” fear-mongering; stocks acknowledge the same
  3. US Equities eventually lifted off the lows and were only down -0.3% by lunchtime

Then …

  1. As the lunch-time lull passed, US Equity market players started to realize that this correction is not just about “default” noise
  2. Almost everything that’s been killing it YTD (Growth Stocks) started to roll over in the early afternoon
  3. Financials (XLF), Consumer Discretionary (XLY), and Small Caps (IWM) all ended up closing down -1.2-1.3% by end of day

And all this happened as US Equity Volatility (VIX) broke out above the @Hedgeye TREND line (18.98) for the 1st time since June. Our process would suggest that there was absolutely no irony in that.


I won’t re-hash the Growth “Style Factors” that I outlined in yesterday’s Early Look again, but the risk management point to embrace was a very simple one. As a market expectation, #GrowthAccelerating has plenty of downside.


The US Government is not going to default on its debt, but it may very well slow growth.


Put another way, the longer that both the fiscal and monetary policy sides of the US House lean on:


A)     Down Dollar

B)     Falling US Interest Rates


The less likely it is that the US economic cycle will be allowed to occur.


Policies to Inflate (devaluing the Dollar) don’t create economic growth; they perpetuate inflation. Under our #StrongDollar + #RatesRising scenario (that may have died 2 weeks ago), inflation is not an issue. Now it is. Mother, be forewarned.


Our immediate-term Risk Ranges are now as follows (we do all 12 Global Macro ranges in our Daily Trading Range product):


UST 10yr Yield 2.60-2.68%


VIX 16.23-20.15

USD 79.67-80.71

Euro 1.34-1.36

Brent 107.97-109.99


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Dear Mother - Chart of the Day


Dear Mother - Virtual Portfolio


TODAY’S S&P 500 SET-UP – October 8, 2013

As we look at today's setup for the S&P 500, the range is 14 points or 0.31% downside to 1671 and 0.53% upside to 1685.                           













  • YIELD CURVE: 2.29 from 2.29
  • VIX  closed at 19.41 1 day percent change of 15.95%

MACRO DATA POINTS (Bloomberg Estimates):

  • 7:30am: NFIB Small Bus. Optimism Index, Sept., est. 94
  • 7:45am: ICSC weekly sales
  • 8:55am: Johnson/Redbook weekly sales
  • 10am: IBD/TIPP Economic Optimism, Oct., est 43.5 (prior 46)
  • 11am: Fed to purchase $1.25b-$1.75b in 2036-2043 sector
  • 11:30am: U.S. to sell 4W bills
  • 12:25pm: Fed’s Pianalto speaks on economy in Pittsburgh
  • 12:30pm: Fed’s Plosser speaks in Johnstown, Pa.
  • 1pm: U.S. to sell $30b 3Y notes
  • 7:50pm: Bank of Japan issues minutes of Sept. 4-5 meeting
  • 9pm: Bank of Japan’s Nakaso holds news conference


    • IMF issues World Economic Outlook; Chief Economist Olivier Blanchard gives press conference during annual meeting, 9am
    • FDIC Board Reviews Deposit Insurance Fund
    • House, Senate in session
    • Senate Armed Forces Committee Hearing on Sequestration
    • SEC Commissioner Michael Piwowar attends Chamber of Commerce’s Center for Capital Markets Competitiveness discussion on “Advancing and Defending the SEC’s Core Mission,” 11:30am


  • U.S. default specter has Japan joining China warning on debt
  • U.S. loses $1.6b from shutdown costing $160m/day
  • Alcoa begins earnings season for 1st time since drop from DJIA
  • Alcatel-Lucent to reduce 10,000 jobs worldwide as losses mount
  • Morgan Stanley seen leading bank profit gains
  • IMF to publish World Economic Outlook, 9am
  • McKesson is in advanced talks to buy Celesio: DJ
  • America Movil, AT&T discuss entering Europe: Telegraaf
  • Vodafone plans to spend $2b on Indian mobile unit buyout: FT
  • U.S. approves China co.’s takeover of Mooney Airplane: Xinhua
  • North Korea has restarted Yongbyon nuclear reactor: Yonhap
  • German exports gained in Aug. as euro-area economy recovered


    • Alcoa (AA) 4:03pm, $0.05
    • Wolverine World Wide (WWW) 6:30am, $1.03, preview
    • Yum! Brands (YUM) 4:15pm, $0.92, preview


  • Cocoa Touches 23-Month High on Shortage Outlook; Sugar Climbs
  • Rubber Glut Shrinking as Car Sales Expand to Record: Commodities
  • WTI Crude Advances as Impact of U.S. Shutdown Seen Limited
  • Morgan Stanley Increases Iron Ore Outlook as Deficit Persists
  • Soybeans Poised for Longest Rally in Four Months on U.S. Weather
  • Copper Rises in London as PMI Report in China Signals Growth
  • Goldman’s Currie Says Gold Is ‘Slam Dunk’ Sell After Shutdown
  • Rebar Gains on Stock Market Rally as China Returns From Holiday
  • Crude Supplies Increase for Third Week in Survey: Energy Markets
  • Asia’s Chocolate Craving Paces Global Demand: Chart of the Day
  • Battery-Stored Solar Sparks Utilities Backlash: Climate & Carbon
  • Iron Ore Demand Expands 7.5%, Keeps Market in Deficit: Bull Case
  • Olam Sees Smaller Arabica Coffee Surplus as Robusta Supply Gains
  • Vale Sees Iron-Ore Market Oversupplied From 2015 on New Capacity


























The Hedgeye Macro Team













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McCullough: Why We're Seeing Red

Takeaway: Watch the relationship between US Equity performance and US Equity volatility (VIX) from here.

This remains the first U.S. stock market correction of 2013 that I haven’t been buying on red. Friday was only the third up day for US equities in the last 12 (when Bernanke wrongly decided to Burn The Buck by not tapering). Today isn't looking much better.


It's simple: Down Dollar + Rates Down = US Stocks Down - that’s precisely what we are seeing again today, and what I told our clients earlier this morning in our Morning Newsletter. From a US growth expectations perspective, that’s not good.


Wall Street was caught off-sides again this morning – too long = wrong. Watch the relationship between US Equity performance and US Equity volatility (VIX) from here. I’m already net short in our RealTimeAlerts signaling product, but I’d get really net short on a VIX breakout over 18.98.


McCullough: Why We're Seeing Red - dale


Takeaway: China may still be an issue, but we expect sales in the region to turn positive in October and ignite a long stretch of outperformance.

YUM continues to be our favorite LONG in the big cap QSR landscape and, despite facing significant volatility since December 2012, it’s long-term growth story remains intact.

The company will report 3Q13 earnings after the close tomorrow while simultaneously releasing same-store sales for the month of September.


As a reminder, Yum! Brands reported a -10% decline in same-store sales, versus an estimate of -7.7%, in August for the China Division.  The August same-store sales results included a decline of -12% at KFC and an increase of +5% at Pizza Hut.  Looking ahead to September, consensus expects a -5.7% decline in China same-store sales.  Importantly, we believe the company will report positive same-store sales for both brands in the month of October and expect this trend to continue throughout the remainder of 4Q13 and into 2014.





As the reality of an improving top-line becomes common knowledge, we believe the stock will outperform its peer group.  As sales begin to improve, the next real driver of sentiment moving forward will be the slope of the line in the margins of the China Division.  All told, China margins actually held up better than expected in 1H13, as significant declines in traffic and mix were partially offset by lower food costs and improved labor productivity.


We expect to see margins in the remainder of 2H13 and 2014 to improve concurrently with an improvement in same-store sales.  Management has previously acknowledged that they need mid-single digit same-store sales growth in China in order to fully offset inflation, and we believe a continued internal focus on margin management will likely lead to better than expected earnings in 4Q13 and 2014.


Since peaking at 22.6% in 1Q10 on a TTM basis, restaurant level margins in China are estimated to have declined by 770 bps in 3Q13.  In our view, YUM will have one more ugly quarter.  The trends in the China division may again, be difficult for some investors to swallow – restaurant level margins are expected to be down 310 bps in 3Q13 versus a decline of 500 bps in 2Q13.  But, there is a light at the end of the tunnel.  By 4Q13, restaurant level margins and operating margins will begin to improve on a year-over-year basis in China.  Essentially, once we get past 3Q13 results, we expect YUM’s China Division will begin to improve significantly.



YUM: ONE MORE QUARTER - yum operating margins



For 3Q13, we expect YUM to report numbers in the YRI and U.S. Divisions in-line with expectations, with the possibility that they could be slightly better.


Sentiment on YUM is still fairly negative.  Illustrated in the chart below, 39.3% of analysts rate YUM a Buy, 57.1% rate YUM a Hold, and 3.6% rate YUM a Sell.  Short interest in the stock is rather muted at 1.75% of the float. 


YUM: ONE MORE QUARTER - YUM short interest




At a 10.9x EV/EBITDA, YUM is trading at a significant discount to its QSR peer group at 12x EV/EBITDA.  We believe this valuation is reasonable – for now.






Howard Penney

Managing Director


ENR – Is the Bottom In?

Our answer: no.


On September 12th, we wrote a note stating that ENR was “Cheap for a Reason”. The crux of our thesis was that the macro and company-specific setup was not suggestive of upside in the stock price. At this level, we remain bearish on the name as the fundamental and quantitative outlook suggest that consensus price targets may need to come down over the near-to-intermediate term.


This stock could be a longer-term winner for investors, given the plethora of positive attributes in the company’s profile but we see material downside in the stock (as far as $80, from a quantitative perspective) over the next three to four quarters.


Summary Bullets:

  • ENR’s wet shave business (37% of revenue) is exposed to declining U.S. industry trends
  • Organic revenue growth remains anemic at best
  • ENR holders may be on the wrong side of a “heads-I-win-tails-you-lose” macro outlook


ENR – Is the Bottom In? - enr levels



Fundamental Outlook: We remain bearish on Energizer’s fundamental outlook as competitive pressures and industry declines impact some of the company’s most important businesses. During the most recent earnings call, on July 31st, management argued that the company was maintaining its share of the razors and blade category due to the successful launch of Hydro Disposables.


Whether or not that claim is accurate, the overall razors and blade category has continued to decline into 3Q and we expect negative top-line growth in that segment for ENR once again.



The household products segment remains challenging for Energizer as a combination of historically high promotional activity and a declining category impair the company’s ability to drive sales. The losses of two U.S. retailers will impact numbers by roughly 6% starting in 4Q and continuing for three quarters of FY14 at the same rate.


Despite earnings growth in the mid-single-digit range, we are reluctant to get behind the stock until the company’s organic growth outlook improves, or the stock becomes cheaper.



Organic Revenue Growth: Consistent organic growth, or the lack thereof, in Energizer’s business is a primary concern. Over the past 10 years, the company has driven revenue growth primarily through acquisitions. While the company can drive revenue through that strategy, we see organic growth as being central to creating shareholder value as the complexity of the company continues to increase. The most recent acquisition of J&J’s feminine hygiene brands has not been met with enthusiasm by the market with the share price declining -12% since the announcement versus the S&P 500 down 42 bps and HPPC peers average of up 23 bps.

Note that the +3.7% organic sales growth in Household Products was due “primarily to increased shipments versus soft prior year comparisons and higher promotional activities in the U.S., and distribution gains in Asia.” In the fourth quarter, HP global sales will decline by more than 10% due to market share losses, promotional and shipment timing, and storm-related volume in the prior year quarter, according to management.


ENR – Is the Bottom In? - ENR organic growth



ENR – Is the Bottom In? - enr sales and acui



Macro: This is a difficult point to prove but we think some readers may find it interesting.

  1. The expectations of interest rates rising makes buying a company (or division of a company) more expensive as buyers rush to complete deals
  2. The prospect of higher rates is likely to be a negative for ENR as the company’s dividend yield (an increasingly important part of the bull case) becomes less attractive on a relative basis.
  3. If, contrary to our Macro Team’s view, employment data deteriorates from here and the Federal Reserve maintains low rates on the basis of a weak labor economy, that would also be negative for ENR and consumption more broadly.



Other Factors: We see Energizer as a company that has many risks weighing on the value of its equity. Besides the slow growth of its major divisions, we see some other risks as being noteworthy:

  1. Sentiment has shot to the upside over the last six months and we see peak or close-to-peak sentiment as bearish. The stock currently has 9 Buy ratings, 6 hold ratings, and 0 sell ratings. As of the most recent data, 4.75% of the float is sold short
  2. Intangible Assets being such a high percentage of Total Assets is a latent risk that could be a factor for ENR and, potentially, the broader HPPC sector if impairment charges are incurred going forward


ENR – Is the Bottom In? - enr sentiment


ENR – Is the Bottom In? - intangible tangible assets



Rory Green

Senior Analyst

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