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Fatal Fear

“Failure is not fatal, but failure to change might be.”

-John Wooden


As I was walking from one client meeting to another yesterday in Boston, I think I changed my US stock market view at least 3 times. Government sponsored volatility does that to a simple “folk” like me. Isn’t it cool?


What isn’t cool is not changing your mind. Especially when the causal factor that is driving the market’s immediate-term volatility is either Congress or the Fed, the best plan is usually accepting that the plan is going to change.


Does Big Government Intervention in your markets A) shorten economic cycles and B) amplify market volatility? In our Q413 Global Macro Themes call tomorrow at 11AM EST, we’ll show you the trivial data that answers that question. #OldWall media “Fed” story count vs Volatility (VIX) has a positive correlation that will make Bernanke’s “price stability” fans cry.


Back to the Global Macro Grind


There’s no crying in risk management. So strap it on and keep moving out there. After watching this government gong show and changing my mind throughout the day, I ultimately opted to hit the buy/cover buttons into yesterday’s closing bell.


In other words, this is the first morning since Bernanke decided not to taper (September 18th) that I’ll be telling clients to buy-the-damn-dip. Unlike how I used to play this game (emotionally), this is purely a quantitative signal.


Other than salvation sent down to us from our overlords from upon high in D.C. (who will be saving us from themselves again), what’s changing this morning?

  1. US DOLLAR Index just v-bottomed off its long-term TAIL line of @Hedgeye $79.21 support
  2. US Equity Volatility (VIX) can easily snap @Hedgeye TREND support of 18.98
  3. US Equities (SP500) can easily recapture 1663 @Hedgeye TREND support of 1663

Yep, that’s about it. That (and US 10yr Treasury Yield holding @Hedgeye TREND support of 2.58%) is just about all this “ordinary folk” needs to see. Fading the false premise of a US “default” just puts a contrarian cherry on top.


But what shall I do if consensus sells the open and the VIX holds 18.98?

  1. I’ll sell

Nope, it’s not any more complicated than that. Remember, I’m just a paper trader newsletter guy who has to keep it simple as Zero Edge sells you some fear and Gold ads (gold nailed Fading Fear again btw - ZeroBid).


Context is always critical when making both asset allocation and net positioning decisions (I started the week net short). Don’t forget that buying US stocks here comes on the heels of a very basic pattern:


1.       Dollar Down

2.       Rates Down

3.       Stocks Down


Oh, and volatility (VIX) up +70% from its August low.


Government sponsored volatility crushes confidence. US stocks have been down for 11 of the last 15 days on that and the only “UP” days have come on moves like you are seeing this morning:

  1. Dollar Up (+1% in the last 48hrs)
  2. Rates Up (10yr Yield +10bps from the OCT low to 2.69%)
  3. Stocks Up (TBD from the 1-month closing low of 1655 SPY)

Again, “keep it simple stupid.” That’s what my old hockey coach used to tell me when I’d try the howdy doody on a defenseman (I had really bad moves) instead of just driving to the net and firing the puck.


“Again!” –Herb Brooks


I’m definitely not saying “this is it!” Only people that don’t timestamp would say something ridiculous like that. All I am saying is that after a 4% correction from the all-time US stock market high (1725 SP500), the reward in buying stocks is in its highest probability position (versus the risk) in 3 weeks. SP500 has +23 handles of immediate-term upside to 1679 versus 1651 support.


And that’s all I have to say about that.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.61-2.71%



VIX 17.65-20.98

USD 79.79-80.81

Gold 1


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Fatal Fear - Fed vs. VIX


Fatal Fear - Virtual Portfolio

Conference Call With CEO of Meritage Hospitality

What's On The Menu For Wendy's Future?

Conference Call With CEO of Meritage Hospitality


Monday, October 14th at 11:00am EDT  

For details please email



The Hedgeye Restaurants Team, led by Howard Penney, will be  will be hosting a call with the CEO of Meritage Hospitality, Bob Schermer, to talk about the current trends in the QSR segment of the restaurant industry and trends in the Wendy's brand. 

The call titled "What's On The Menu For Wendy's Future?" will be held on Monday, October 14th at 11:00am EDT.




  • Image Activation and its Impact on the Wendy's System - Highlighting the good, the bad and the ugly from a franchisee perspective.
  • New Products - The Company has hit a well known home run with the Pretzel Bacon Cheeseburger (and now Pretzel Pub Chicken Sandwich).  But how good is good? And what is next?
  • Breakfast - Why did the Wendy's system have so much trouble launching breakfast?




Meritage is playing a meaningful role in helping to reshape the Wendy's system.  Currently, the Wendy's restaurant system is entering a once-in-a-generation transition as many of the original "legacy franchisees," now at an average age of 62 years old, are beginning to retire from the system. Wendy's management calls this process "system optimization." The net result of "system optimization" will be fewer franchisees, operating larger restaurant portfolios at higher levels of sophistication.


Meritage has made commitments to complete Wendy's Tier II and Tier III "image activation" restaurants in 2013.  As a result, Meritage has an "in the trenches" understanding of the image activation construction cost variables to measure the incremental return on investment.




Please email or call to learn more about the event. Attendance is limited. Please note if you are not a current client of our Restaurants research there will be a fee associated with this call.




Howard Penney

Managing Director



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.  

Early Look

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Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

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


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


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