Takeaway: This whole mess likely gets resolved with a whimper rather than a bang.

Editor's note: In the interview below, Hedgeye Global Macro Head Daryl Jones clarifies much of the nonsense, half-baked truths and distortion surrounding fears that the United States is on the cusp of a catastrophic default.Click here to watch a brief default discussion between Jones and Hedgeye CEO Keith McCullough on HedgeyeTV.




Is the United States going to default on its debt?


The U.S. government bond market is signaling explicitly that the United States is not going to default.  Specifically, the credit default swap (CDS) market, while slightly elevated over the last couple weeks, remains well below a level that would indicate a credit event is imminent. 


Further, even if Congress did not extend the debt ceiling, both the Treasury Department and President have options to continue servicing U.S. debt.  Ironically, the deficit-to-GDP has narrowed from more than 10% to just under 4% in the last three years, which implies that U.S. is getting more, not less, creditworthy.


So why has the Obama Administration been peddling this “catastrophe” narrative?


The Obama administration wants to portray the Republicans in Congress as reckless in order to win the day on the Affordable Care Act.  The best way to do this is via fear mongering and scaring the voting public into believing that Republicans are willing to risk the economy in order to win an ideological argument. 


What is your thought on media coverage of this whole saga?


The media coverage, no surprise, is lacking in any context or analytics.  As a result, according to a recent poll from Rasmussen, more than 62% of Americans think the U.S. is likely to default on its debt.  The media coverage is shameful in that it is perpetuating a very, very unlikely scenario and thus scaring participants in the real economy and, frankly, hurting consumer confidence.


What’s your best guess on how this whole thing gets resolved?


This whole mess likely gets resolved with a whimper rather than a bang. 


Both parties realize that risking a default is not a practical negotiating tactic, so therefore will come to the table and negotiate a compromise.  It is likely that Obamacare remains largely intact and that the Republicans get some reduction in spending and/or tax reform to further bolster fiscal responsibility.  

RH: Our $8 EPS Thesis. Does The Consumer Agree?

Takeaway: Please join us on Wed, 10/16 at 11 am to review our new Black Book on our $8 EPS thesis, and our detailed consumer survey on RH & the space

RH: Our $8 EPS Thesis. Does The Consumer Agree? - RHdialin 10 16 13


Please join us on Wednesday, October 16th at 11:00 am EST to review our new Black Book on 1) our $8 EPS thesis, and 2) our detailed consumer survey on RH & the space


In addition we'll present the results of our comprehensive consumer survey on the Home Furnishings space, and where RH faces the biggest opportunities and challenges.  While the focus will be on RH, we will also dig into BBBY, WSM, PIR, Design Within Reach, Ethan Allen, and Department Stores.


Some key questions of the 40+ that we asked include…

1. Nailing down the demographic characteristics of RH shoppers vs their competitors.

2. Consumers propensity to try out new categories such as Kitchen, Tablewear, Leather, Artwork, Antiques, Flooring, and Apparel (RH Atelier).

3. If consumers try out new RH categories, which retailers are likely to lose share?

4. What consumers think about smaller Legacy Stores vs. larger Design Galleries, and how will it impact their spending. In other words, as the company moves from 8,000 square feet, to 25,000, to 50,000, should sales per square foot go up? Or just sales per store?

5. What are consumers' attitudes towards the RH Catalogues? How many actually act upon it vs buying product online through RH's promotional emails?

6. Will spending be impacted by the elimination of the Fall source book?

7. What do Consumers think about RH Music? Will it do more harm than good? Or do people understand that it’s a brand-builder? Do they care?



  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 779954#
  • Materials: CLICK HERE


Please email  for further details.



Takeaway: Chinese policymakers appear to be embarking on a clever strategy to offset internal headwinds to growth with foreign capital.

This note was originally published September 25, 2013 at 16:16 in Macro




  • Chinese policymakers appear to be embarking on a clever strategy to offset internal headwinds to growth with foreign capital.
  • If executed properly, China’s structural economic outlook – one that we continue to think has many headwinds – will be much improved, on the margin.
  • Near-term risks remain, however, including an additional round of property market tightening and a potential negative revision to China’s 2014 GDP growth target at the 18th CPC Central Committee's 3rd Plenary Session come NOV.
  • Of course, one of, neither of or both of the aforementioned risks may materialize. We have no edge beyond stating that both are likely more probable than consensus may realize. This is the primary reason we are not outright bullish on China at the current juncture in spite of the developing intermediate-to-long-term bull case we have expanded upon in this note.
  • One of the things we’ll monitor to determine whether or not it’s an appropriate time to A) buy China outright or B) trade it with a bullish bias is whether or not the insider-driven Shanghai Composite Index closes above its late-MAY highs. That lower-high came just before the JUN liquidity crunch and subsequent consensus debate about China’s financial sector risks.


PLEASE NOTE: The discussion below is a direct continuation of an analysis we presented in our SEP 12 research note titled, “DEBATING THE BULL CASE FOR CHINA”. To the extent you have not reviewed that piece, we encourage you to do so prior to examining the analysis below, as it will help elucidate the conclusions we continue to make. In the event you may have missed it come through, please email us for a copy of that note or to set up a call to discuss China more broadly.


This morning we received what we interpreted as positive news with respect to China’s TAIL-duration economic outlook.


Specifically, interest rates will be fully liberalized within the Shanghai Free Trade Zone and there’ll be no restrictions on raising capital – either from domestic or foreign banks – for companies operating inside the zone.


While still very much in the realm of conjecture, this piece of information is positive, on the margin, for the following two reasons:


  1. Interest rate liberalization will allow China’s liquidity-starved banks to compete for the acquisition of foreign deposits. This, of course, assumes some degree of capital account conversion.
    • In a closed setting such as the Shanghai FTZ, the risk of a systemic unwind of the shadow banking system can be offset by continuing to restrict the broader Chinese public's access to liberalized deposit rates or international markets – effectively maintaining their incentive to speculate in the property market and/or in WMP and Trust Products.
    • More deposits = more liquidity and more liquidity = faster credit growth, at the margins. This is a direct offset to what we believe to be the most convincing secular bear case for Chinese economic growth (i.e. sustainably slower credit growth born out of rising NPLs and waning liquidity from the current account).
  2. The unrestricted ability of Chinese firms – particularly credit-starved SMEs – to raise capital in the Shanghai FTZ is also supportive of faster credit growth, at the margins. This, of course, assumes an ample supply of foreign capital.


On that last point, we think the powers that be up in Beijing are no dummies when it comes to making China an increasingly attractive destination for foreign capital.


Not unlike the migration of foreign capital from the imperiled South America to the then-attractive Asian Tigers in the early-to-mid 90s, China appears to be inclined to promote itself as a bastion of economic and financial stability amid rising risk of EM crises in places India, Indonesia, Turkey and Brazil.


Perhaps that’s why the PBoC has been inclined to mark up the CNY over the LTM (+3% YoY and +1.8% YTD).




Amid that process, the CNY has hit an all-time high on a REER basis, imposing systemic risk to China’s export economy and its razor-thin margins. Moreover, they have done so in the face of some fairly obvious international headwinds to export growth.




No doubt, Chinese officials appear keen to sacrifice what little liquidity they are likely to receive from the current account over the long term for what may turn out to be a far deeper and more sustainable source of liquidity in the form of foreign portfolio and direct investment flows.




Furthermore, they appear willing to entice said capital flows with the allure of FX appreciation and higher real interest rates within the Shanghai FTZ (in addition to favorable corporate tax policies). Importantly, their strategy appears to be increasingly effective at improving foreign investor sentiment towards China, on the margin.




All told, if Chinese policymakers are, in fact, pursuing the growth strategy we have outlined above, then it would behoove us to have a bullish bias on the Chinese economy, its currency and under-owned stock market (less than 20% of Chinese households’ financial assets are allocated to equities vs. 33.7%% in the US).


In the face of the bear case getting “less bad” at the margins, easy comps and GDP seasonality support a sanguine 1H14 outlook for Chinese economic growth.






We can’t forget that China’s most recent real GDP growth rate of +7.5% was over a full standard deviation (-1.1x) below the trailing 3Y mean. The balance of risks imply some degree of mean reversion born out of a combination of marginal retracement and continued pressure on the average itself. Net-net, the likelihood of a downside economic surprise(s) in China is declining, at the margins, and should be rather muted on an absolute basis in 2014.


On the bearish front, the two most probable catalysts that would increase the likelihood of a downside economic surprise(s) over the intermediate term are:


  1. An additional round of property market tightening. To recap the recent developments, MOHURD has been investigating local authorities on their potentially lax implementation of the existing nationwide curbs to housing transitions and mortgage lending. Additionally, the latest statistics indicate serious froth in the property market at its most basis levels:
    • Municipal residential land sales (to property developers) are up +26% YTD through AUG;
    • The average price per square meter has increased +43% over that same period, bringing total land sale proceeds for municipalities to 816.5B CNY YTD (+80% YoY);
    • The average starting price at residential land auctions has increased +16% in the YTD and final sale prices have exceeded initial asking prices by +25% on average in the YTD;
    • In MAY ’11, the land ministry required all municipalities to report land sales when the final sale price was +50% higher than the starting auction price… there were 115 such transactions in 2Q13 vs. only 50 in 1Q13 and the average premium on those transactions was +142%!
  2. A negative revision to China’s 2014 GDP growth target. As a refresher, the 2013 target is equal to +7.5% with a “floor” of +7%; will the 2014 target be revised lower to +7% with a “floor” of +6.5%? We don’t know, but it is likely that we will have to wait until NOV’s Third Plenary Session to find out.




Of course, one of, neither of or both of the aforementioned risks may materialize. We have no edge beyond stating that both are likely more probable than consensus may realize. This is the primary reason we are not outright bullish on China at the current juncture in spite of the developing intermediate-to-long-term bull case we have expanded upon in this note.


One of the things we’ll monitor to determine whether or not it’s an appropriate time to A) buy China outright or B) trade it with a bullish bias is whether or not the insider-driven Shanghai Composite Index closes above its late-MAY highs. That lower-high came just before the JUN liquidity crunch and subsequent consensus debate about China’s financial sector risks (i.e. the same risks we called out in our Hedgeye Macro Emerging Market Crisis Risk Index back on APR 23).




Specifically, a close above that level would be akin to receiving a second quantitative “thumbs-up” (i.e. no more lower-highs) in our playbook (the first being the recent TREND line breakout).


Darius Dale

Senior Analyst

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 80.43%
  • SHORT SIGNALS 78.35%


Takeaway: 3Q was fairly ugly & the recovery in China is taking longer than expected. But, it is recovering nonetheless. We remain bullish on YUM.

If you are long YUM, or looking to go long YUM, you are likely asking yourself one question: Is China melting down?


YUM reported a quarter that is fairly consistent with what you would expect from a company that is struggling in its core market, which, in this particular case, happens to be China.  That being said, there are some positives coming from last night’s release.



USA – Better Than Bad

The U.S. reported flat same-store sales, which was below the consensus estimate of +1.5%.  However, same-store sales at YUM’s most important U.S. brand, Taco Bell, grew +2%.  KFC and Pizza Hut same-store sales, on the other hand, declined -4% and -1%, respectively.  Restaurant margins in the U.S. declined 70 bps to 16.0%, due to commodity inflation and increased promotional activity.





YRI – Very Respectable

On balance, YRI is performing reasonably well, despite slowing on the margin.  YRI same-store sales increased +1%, below the consensus estimate of +2.4%.  The slowing sales trends can be partially explained by an earlier Ramadan, which negatively impacted YRI comps by -1%.  YUM reported emerging market same-store sales growth of +4%, but developed markets saw a -1% decline.  YRI restaurant level margins declined 60 bps to 12.7%, as the benefit from refranchising Pizza Hut UK was offset by softer than expected KFC UK and Turkey margins.



CHINA – Disappointing

YUM reported and -11% decline in same-store sales in September (first month of 4Q).  The real issue here, however, is that the stock (and me) has been under the assumption that comps would continue to recover and achieve management’s targeted return to positive growth in 4Q.


Unfortunately, sales trends appear to have actually eroded coming out of the quarter.  China’s September same-store sales for YUM’s two main brands in the region, KFC and Pizza Hut, are estimated to be -13% and +6% in September, respectively.  While YUM’s Pizza Hut business appears to be on track, the same cannot be said for KFC.  The company’s efforts to lift KFC’s brand image and, ultimately, recover traffic, do not appear to be working.


China restaurant level margins were down 190 bps year-over-year, which was actually better than expected.  In our view, this is remarkably impressive given an overall -11% decline in same-store sales.  Food costs were down 70 bps, but this benefit was partially offset by an 80 bps increase in labor costs.  What really caught our eye was the performance of the core assets, which looks even better when considering that YUM attributed 100 bps of the China margin decline to a negative impact from its write-down on the Little Sheep business.  YUM acquired the business in February 2012 and, needless to say, it has been a major disappointment, perhaps most signified by impairment charges of $0.55 included in 3Q results.






Is China Melting Down?

We are about to find out if YUM’s easy same-store sale comparisons are truly “easy” or if there is something else going on here:

  • Are the issues one-time in nature?
  • What is the extent to which secular headwinds – such as weaker spending or increased competition – may be impacting performance on top of the ongoing chicken quality concerns?
  • Is KFC overbuilt in tier 1 cities?
  • Can same-store sales recover in tier 1 cities?  13% of YUM’s new unit growth are going into tier 1’s.
  • How promotional will the company be in order to get traffic back?
  • Do they have pricing flexibility?
  • Can traffic improve simultaneously with lower labor costs?

There are many unanswered questions emanating from YUM’s 3Q earnings release.  For the time being, we are sticking with our bullish thesis on YUM.  The next big event for YUM will be the December 4th Investor & Analyst meeting.  We still have reason to believe that China same-store sales will turn positive in October.  Stay tuned.




Howard Penney

Managing Director



Takeaway: Worth the money. Take out your wallet and buy the book.

Hedgeye Risk Management CEO Keith McCullough shares some of his thoughts on Volcker – The Triumph of Persistence, by William L. Silber (2012).


Bottom line on the book according to McCullough is that it's an easy read that will educate people on how central planning has become so causal to American Purchasing Power (US Dollar) and inflation/growth expectations.


BOOK REVIEW: VOLCKER - volckerbook


Summary Thoughts

  1. Published in 2012, this book provides fresh (and timely) historical context on the causal factors affecting the US Dollar
  2. Monetary Policy Style: critical contrast between the McChesney/Volcker Feds and the Burns/Bernanke Feds #study
  3. The book’s mapping of the sequence of political decisions made prior to Gold’s top in 1980 is well done (Chapter 11, New Territory

Content Highlights

  1. “Five American Presidents (3 Democrats, 2 Republicans), spanning nearly half a century, have called on Paul A Volcker to serve…” (pg 1)
  2. “Do not suffer your good nature to say yes when you ought to say no” –George Washington quote hanging in his father’s office (pg 15)
  3. “I never got along with the coach” –Volcker on his basketball coach @Princeton (1945-1949) #athlete (pg 17)
  4. Morgenstern… left his mark by turning Paul into a professional skeptic” #German born economist, author of Theory of Games (pg 17)
  5. “Martin thought economists’ forecasts rivaled the accuracy of fortune tellers” #WilliamMcChesnyMartin, one of Volcker’s heroes (pg 21)
  6. “Kennedy Pledges He Will Maintain The Value of The Dollar” @NYTimes headline #1960, Gold was $35/oz - #perspective (pg 23)
  7. “Gnomes are imaginary, but speculators are not.” #1960s roots of our friend @DougKass macro machinations? (pg 27)
  8. “All I can remember after that was a word flashing in my brain like a yellow caution sign: Bullshit” #Samuelson #Keynes policies (pg 31)
  9. “Hayek’s words forever linked inflation and deception deep inside my head. And that connection, which undermines trust in government” (pg 33)
  10. “Charles de Gaulle pursued Gold the way Henry VIII did wives.” #1965 context #zeigeist of the times very different than today (pg 42)
  11. “If the US could change the rules in March 1968 and stop selling Gold… it could amend them further” #1968, Martin #StrongDollar (pg 50)
  12. “Failure to maintain those promises undermines trust in America. And trust is everything.” #1969, epic #StrongDollar quote by #JFK (pg 53)
  13. “Preserving the Dollar’s status had been the focus of Volcker’s favorite committee” #1969 Volcker Group, de Gaulle resigned 1969 (pg 60)
  14. “Chairman Martin wants to raise the discount rate.” But #LBJ wanted nothing of it (neither did Nixon) #USD credibility 1969 (pg 69)
  15. “Soon after becoming Fed Chairman in February 1970, Burns began to ease…” sound familiar? #Bernanke, didn’t work either (pg 72)
  16. “We can’t afford to risk a downturn, no matter how much inflation” –Nixon #1970 w/ #Burns Fed, conflicted/compromised (pg 73)
  17. “August 15, 1971… Nixon stunned the world in a televised Sunday night address” #GoldStandard, gone – thanks Nixon (pg 79)
  18. “The Coming Devaluation of the Dollar” @NYTimes May 1971, yep #sad – where it all started #Burns/Bernanke (pg 101)
  19. “If I have to talk to Burns again I’ll do it. Next time I’ll just bring him in” –Nixon, goodbye “independent” #FederalReserve (pg 105)
  20. “I don’t give a shit about the Lira” –Nixon, #1972 Dollar Debauchery (pg 110)
  21. “The difficulty is that no one is ever prepared to move except in a crisis” –Volcker #1973 (Shultz announced a 10% USD devaluation) (pg 117)
  22. “Burns exploited Volcker’s fixation with public service to persuade him to accept the Presidency of the Federal Reserve of NY” #1975 (pg 125)
  23. “The public’s resentment made sense, considering that consumer prices surged by 12% during 1974”, #output of 1971 Policies To Inflate (pg 129)
  24. “Whip Inflation Now” #WIN buttons for Jimmy Carter, elected into office #1976 to do a job he didn’t accomplish;#1970s = Stagflation (pg 133)
  25. “It’s the same old story – lack of confidence in US government policies” –Currency Analyst (in #Frankfurt), sound familiar? (pg 139)
  26. “Volcker participated in the Dollar rescue by requesting an increase from 8.5% to 9.5% in the discount rate” #1978 (pg 140)
  27. “I am not particularly eager to make a major move now or in the fore-seeable future.” –Volcker #1979, so #Gold rallied one last time (pg 156)
  28. “I think there’s a need to come in here as inconspicuously as possible… at diverse hotels” –Volcker #1979, no #Bernanke style #leaks (pg 165)
  29. “The price of Gold hit an all-time high of $850 an ounce on Monday, January 21, 1980” #study history vs causal #Fed factor (pg 182)
  30. “Jimmy Carter ended his honeymoon with Paul Vocker on October 2 , 1980, a month before the presidential election” #compromised (pg 190)
  31. Partisan politics ought not be around the Dollar” –William McChesney Martin #Patriot #1980
  32. “Milton wants to abolish the Fed” –Arthur Burns #1980, the American #zeitgeist was very 2011 @RonPaul #libertarian (pg 194)
  33. “Do we really need the Fed” –Ronald Reagan #1980 message resonated with common sense (pg 195)
  34. “We obviously have a credibility problem – by “we” I mean the United States” –Volcker #1980 in “To Be or Not To Be a Central Banker” (pg 197)
  35. “People have to change their expectations and their behavior… that is always an uncomfortable process” –Volcker #1980 (pg 198)
  36. “I was very pleased to read a prediction that the price of gold will nosedive below $300/oz” –Reagan #1980 #StrongDollar leadership (pg 200)
  37. “None of us really understands what’s going on with all these numbers” –David Stockman (#Reagan’s Budget Director) #classic (pg 209)
  38. “He now refers to you as Paul rather than Chairman Volcker” #Reagan understood #StrongDollar tax cuts #commodities (pg 214)
  39. “I think we’ll re-appoint Paul Volcker for about a year and a half. He doesn’t want a full term” –Reagan #1983 #winning (pg 233)
  40. “Having 2 or 3 $40B institutions in trouble is a horse of a different color” –Volcker in #1984 as #ContinentalIllinoiswas imploding (pg 243)
  41. “Keynesians such as Samuelson said it was impossible, monetarists such as Friedman said Fed was doing wrong” #1985 Volcker right (pg 247)
  42. “Volcker resigned twice, but only one stuck” post #1985, James #Baker politicized everything all over again#PlazaAccord (pg 252)
  43. “The role you have played has been invaluable” –Margaret Thatcher on #Volcker #1987 (pg 265)
  44. “I may be old but I am persistent” –Volcker #2010, #Volcker Rule
  45. “Foreigners hold Dollars because America has demonstrated fiscal and monetary integrity” #basic, pure#Constitution (pg 298)


Morning Reads on Our Radar Screen

Takeaway: A quick look at some stories Hedgeye is reading this morning.

Keith McCullough – CEO

Obama's Nomination Of Janet Yellen Is A Blow To Recovery-Starved Americans (via Forbes)

New CEO cuts Chesapeake Energy's lifestyle largesse (via Reuters)

Red Sox Grind Rays Down and Out of the Playoffs (via NYT)


Morning Reads on Our Radar Screen - dollar1


Josh Steiner – Financials

GM Executive Warns of Impending Auto Bubble (via Free Beacon)

GM Ramps Up Risky Subprime Auto Loans To Drive Sales (via IBD)

Gates’s Future Fuels Speculation as Microsoft Seeks New Chief (via NYT)


Jonathan Casteleyn – Financials

Fidelity Billionaire Johnson Taps ETFs as Profits for Funds Fad (via Bloomberg)


Kevin Kaiser – Energy

Ex-Chesapeake CEO McClendon raises $1.7 billion to drill in Utica Shale (via Reuters)


Tom Tobin – Healthcare

Oxford Nanopore Raises $64 Million for Infrastructure (via Bloomberg)


Brian McGough – Retail

What you should know ahead of Nike’s analyst meeting  (via Marketwatch)

Filling a void: Saks CEO Stephen Sadove is joining J.C. Penney’s board (via Dallas News)


Jay Van Sciver – Industrials

Fastenal Misses Q3 Earnings, Sales (via Zacks)


Matt Hedrick – Macro

Germany's Greens turn frosty towards any alliance with Merkel (via Reuters)

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