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This note was originally published September 12, 2013 at 06:40 in Restaurants

Editor's note: As many of you know, Darden Restaurants' (DRI) stock soared yesterday after the Wall Street Journal reported that a New York hedge fund took a stake in the company and will press it to break up. Barington Capital Group LP plans to push Darden to split into two companies: one with its high-growth chains such as Capital Grille and the other with established brands Red Lobster and Olive Garden.


As you may also know, Hedgeye Restaurants Sector Head Howard Penney was the first mover on this. About six months ago, Penney identified an opportunity at Darden that he believed could create significant value for shareholders.  His team has been diligent in their work on Darden since that time and has periodically released research notes on the topic. 


To rehash, Penney believes there is an opportunity to take full advantage of some low-hanging fruit and improve profitability.  As he has been saying for some time now, Darden is a strong, proven company that is in dire need of a major overhaul. Darden is being mismanaged, plain and simple.


We have pursued this topic extensively and have put together a 30 page Black Book, highlighting Darden’s inefficiencies and what our plan would be in order to turn the company around.  Please contact sales@hedgeye.com to access this research.



DRI is scheduled to report 1QFY14 earnings on 9/20 and expectations across the board have been reduced significantly for the quarter.  The only question that remains is: how bad is bad?  The current FY14 EPS consensus estimate is $2.99 on Bloomberg.  We could easily get our model down to $2.50.  And, unfortunately, the company needs to pay a $2.25 dividend, which makes earning anywhere near $2.50 a real problem.





We continue to believe the sum of the parts is greater than the whole, at Darden, and we believe there is a striking opportunity for an activist to enter the fray, unlock value, and benefit holders of the company’s stock.


There have been four times in my career when I have seen a company in desperate need of a major overhaul.  In all four cases, I wrote extensively about the issues, much to the ire of management.  Darden and its problems are no different!


The following companies have undergone major corporate overhauls that have led to significant improvements in shareholder value:

  1. McDonald’s (2002): MCD formulated the “Plan to Win” in 2002, which later became a template for success at Brinker.
  2. Wendy’s (2004): The sum-of-the-parts were greater than the whole!
  3. Starbuck’s (2008): With Schultz back at the helm, SBUX focused on attacking the middle of the P&L and improving the guest experience.
  4. Brinker (2010): Facing an industry in the midst of a secular decline, senior management formulated a plan to win, which entailed attacking the middle of the P&L and driving traffic.
  5. Darden (2013): Will the current management team recognize the need for a major restructuring?

We are of the view that DRI is in a secular decline and, until management makes significant changes, we will continue to see erosion in the earnings power of the company.  We believe it is best to wait for these significant changes to occur before we get more aggressive on the LONG side.



Low-Hanging, Bountiful, Fruit


Looking at the four prior examples of past significant corporate action, it is clear that these companies had similar traits.  Specifically, each company had low-hanging fruit and the potential to create significant value for shareholders.  Many of these are similar to the opportunities we currently see in Darden:

  • Tremendous cash flow potential
  • Huge real estate value
  • Non-core, under-utilized assets that can be sold at rich valuation
  • Core assets represent a classic reorganization opportunity
  • Market’s valuation of the whole is far below what we believe the sum-of-the-parts would represent in a reorganization or breakup
  • G&A rationalization opportunities


DRI’s Biggest Problem – It’s Too Big, Too Complex, To Perform

  • This company has over 2,000 restaurants spread out among 8 separate concepts
  • Olive Garden and Red Lobster account for roughly 75% of total revenues




The Complexity Has Led To A Bloated Cost Structure

DRI management has contended for years that its multi-concept structure creates operational efficiencies.  But, a closer look at the numbers suggests the exact opposite.  The average unit volume of DRI’s big three brands is $3.68, which is 23% larger than the average unit volume of EAT’s core brand, Chili’s.

  • Restaurant level margins for DRI are 32% larger than EAT’s and 17% larger than the average of its casual dining peers

The math is quite simple.  If DRI generates more revenues per store and has higher margins per store than its competitors, then it should generate higher operating profit margins as well.  But, this isn’t the case.  The only real explanation we can find for DRI’s lower operating margins is a bloated G&A cost structure.

  • DRI’s operating margins over the TTM are 7.5%, which is 27.2% below EAT’s and 3.7% below the average of its casual dining peers
  • If DRI were to cut G&A by 200 bps, and achieve 9.5% in operating margins, the company would generate an additional $1.10 in earnings per share






Our Vision Of The New DRI


Below we offer our view of what the new Darden should look like.  We believe the company should be broken up into three segments – Seafood, Steak and Italian.  Yard House should be spun off and taken public and Bahama Breeze should be sold.  This would leave each of DRI’s three operating segments with a large brand, in addition to a smaller one in order to help, over time, improve the growth profile of the company.  Additionally, each company would finally be able to focus and zero in on their operations, which, we believe, would allow for a more streamlined operating structure.







It’s Only A Matter Of Time – Restaurants Are An Attractive Sector For Activists

  • McDonald’s (2006): Real estate was the fulcrum of Bill Ackman’s thesis, but better operating performance, including new management, and capital allocations decisions were the real drivers of returns.  The company sold off non-core assets.
  • Wendy’s (2008): Real estate was, once again, the anchor of the thesis here, but the business was also undervalued.  The company, under the influence of Trian Fund Management’s Nelson Peltz, sold off non-core assets.
  • Applebee’s (2006): Breeden Capital Management threatened a proxy contest at the 2007 Annual Meeting of Stockholders, which ultimately was settled with two board seats being opened up for the activist entity.  The company was sold following a period of lackluster returns.
  • Cracker Barrel (2005): Nelson Peltz, again, held real estate central in his thinking on taking the company private.  In 1Q06, the company’s board authorized the use of proceeds from a sale of Logan’s Roadhouse to fund a modified “Dutch Auction” tender offer for $250mm of the company’s common stock (roughly 35% of common shares outstanding).
  • Cracker Barrel (2011): Biglari Holdings contested two proxy battles, but has failed to secure any board seats.  Pressure from Sardar Biglari led to the replacement of CBRL’s CEO and the stock price has appreciated significantly since BH first took a stake in October 2011, rising from $45 to over $100 a share today.
  • DineEquity (2012): Marcato Capital Management suggested a dividend payment in order to maximize its equity value.  The company announced a $0.75 quarterly dividend and a $100mm share repurchase, which amounted to 8% of equity value.  Richard “Mick” McGuire of Marcato was previously an analyst at Bill Ackman’s Pershing Square Capital Management.


Piecing It All Together

  • The current outlook for DRI is dire and we suspect that 1Q14 results will be a disaster
  • There is no cohesive plan to fix the asset base and address significant inefficiencies
  • As we have seen many times before, continuing deterioration will lead ultimately lead to intervention, in one form or the other
  • Given the current trends, the dividend, which was once an asset, could become a liability
  • We know how this is going to end, the only question is when?



Howard Penney

Managing Director




What's New Today in Retail (10/10)

Takeaway: Footwear ASP take a dive, ICSC looking lousy. But somehow athletic apparel crushes it. AMZN gut punches ULTA. JCP, JCP, and JCP. JOSB/MW.



Weekly Athletic Footwear Data


Takeaway: An gnarly looking week for athletic footwear, which was down 4.9% for the week. Units were relatively unchanged, but ASP – which had been the big saving grace for the past three months, took a complete nosedive. Standout brands for the week were UndeArmour and Timberland.  If you want to see some polar opposite results, check out the apparel data. The industry is crushing it. And by ‘the industry’ we mean The Nike.


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Weekly Athletic Apparel Data


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ICSC Same Store Sales


Takeaway: Third week in a row where sales growth is trending below year ago levels. Ouch.


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What's New Today in Retail (10/10) - chart13 10 8




JCP - Retail Industry Leader Stephen Sadove to Join JCPenney Board of Directors



  • "[JCP] today announced that Stephen I. Sadove...has been elected to its Board of Directors. Sadove is currently chairman and chief executive officer of Saks Incorporated and will be leaving Saks upon completion of its previously announced merger with Hudson's Bay Company. His election to the JCPenney Board of Directors is effective upon his leaving Saks. Additionally, Geraldine B. Laybourne is stepping down from the JCPenney Board of Directors. Her departure will enable her to focus more time as chairman of KANDU, a startup consumer technology company for kids."


Takeaway: This is big. A few people have told us that this is bad because the last thing JCP needs is management with a luxury bent. We could care less about what KIND of product he sold throughout his career, the reality is that Sandove gets retailing, and that’s a positive.



JCP - Dockers, Haggar Come Together at J.C. Penney



  • "Dockers, Haggar and J.C. Penney Co. Inc. have joined forces to build lifestyle shops in 297 of the chain’s top doors with an eye on ramping up sales, especially of shirts and sweaters."
  • "The adjoined Haggar and Dockers shops were codesigned by the brands and the retailer with custom fixtures to display complete looks on mannequins and posters, the better to encourage men to buy coordinating pieces instead of only pants. Installation should be complete by Friday, according to John Tighe, Penney’s senior vice president and general merchandise manager."
  • "Dockers and Haggar have about the same or slightly more space as before — an average of 1,000 square feet combined — but the shops pack in more merchandise via back-wall shelves and more efficient fixtures, Tighe noted. The retailer rarely carried Haggar shirts before and has increased its stock of Dockers’ shirts and sweaters."
  • "About 30 percent of Haggar styles are exclusive to Penney’s, including plaid shirts and some tailored clothing."


Takeaway: More merchandise in the same sized space. Minor positive for JCP. But…you guessed it…no one will care.


What's New Today in Retail (10/10) - chart5 10 10


AMZN - Amazon Launches Prestige Beauty Site



  • "Amazon is finally launching its much anticipated foray into prestige cosmetics this morning with the Luxury Beauty Store."
  • “'We have luxury shoppers,' said Chance Wales, director of beauty and health & personal care for the e-commerce giant. 'What we have been lacking is luxury brands, and we hope this is the first step to marry our customer’s needs with what brands expect in terms of displaying and selling their luxury [products].'”


Takeaway: How in the world could this be good for ULTA?


SHLD - Sears Cashes Out of Prime Stores



  • "[SHLD] has been selling off some of its best stores to raise cash...The discounter has sold nearly a dozen profitable Sears stores in the U.S. and Canada over the past 18 months, including two separate deals that were signed this summer for four stores plus an option to sell a fifth, according to former employees and analysts who have tracked the deals.
  • "In July, Sears agreed to sell two locations, one in the Fayette Mall in Lexington, Ky., and another in CoolSprings Galleria in Nashville, Tenn., to mall owner CBL & Associates Properties Inc. for an undisclosed price."
  • "The July deal followed an agreement Sears Canada reached in June to sell the leases of two stores to Oxford Properties Group and Alberta Investment Management Corp. for $191 million. The buyers also have the right to exercise an option to buy a third lease."


Takeaway: The fact that this company is still alive 8-years after one of the worst mergers in history is simply astounding. It should give pause to those who think JCP is a zero.


MW - Men's Wearhouse Adopts Limited Duration Shareholder Rights Plan



  • "[MW] today announced that its Board of Directors has adopted a limited duration shareholder rights plan (the "Rights Plan") and declared a dividend of one right on each share of the Company's common stock outstanding at 5:00 p.m., Eastern time, on October 21, 2013.  The Rights Plan was adopted following the Company's rejection of the unsolicited proposal by Jos. A. Bank to acquire Men's Wearhouse for $48.00 per share as it significantly undervalues Men's Wearhouse, is inadequate and not in the best interests of the Company or its shareholders. The Rights Plan is not intended to prevent an acquisition of the Company on terms that the Board of Directors considers favorable and fair to, and in the best interests of, all shareholders, and will not do so."


JOSB - Jos. A. Bank Will Continue to Pursue Its $48 Per Share Cash Acquisition Proposal



  • "We find the response by Men's Wearhouse to our all-cash $48 per share proposal inexplicable. Our proposal provides substantial, immediate, and certain value for Men's Wearhouse shareholders. We are proposing a 42% premium to the closing price of Men's Wearhouse's common stock on the day before we made our acquisition proposal. Our price is significantly greater than the highest price at which Men's Wearhouse's stock has traded over the last five years."
  • "The formulaic, knee-jerk rejection by Men's Wearhouse, and their refusal to even discuss our proposal, do not serve the interests of their shareholders or their customers."


Takeaway: We were floored that the MW Board turned down this offer. The combined company would be formidable. On the flip side, MW is in the process of transforming into a house of brands. The real question we should be asking is what the REAL earnings power is at MW and how much higher than $48 MW thinks it’s worth.


WMT - Bharti, Walmart call off India JV; to independently pursue retail business



  • "Ending speculations over future of their partnership, Bharti Enterprises and Wal-Mart Stores, Inc. said today they are going separate ways for operations in the Indian retail sector. Subsequently, the US retail major will buy out the Indian partner from their 50:50 wholesale cash and carry joint venture -- Bharti Walmart, for an undisclosed sum."
  • "Walmart on the other hand plans to continue to grow this business while working with the government and interested stakeholders to create conditions that enable foreign direct investment in multi-brand retail. 'Given the circumstances, our decision to operate independently will be beneficial to both parties,' Walmart Asia President and CEO Scott Price said."


Takeaway: This is a seismic shift in WMT’s India strategy. Definitely a near-term negative.


JCP - JCPenney Switches Creative Agencies Yet Again



  • "That was fast. Six months after hiring Young & Rubicam to lead its creative efforts, JCPenney has replaced Y&R with a trio of agencies: Doner, EVB and Victors & Spoils."
    "The change came after a pitch and as the struggling retailer prepared for its crucial holiday shopping season. Indeed, the honeymoon for the new shops will be short, as the first campaign may break as early as next month."
  • "JCP spent more than $435 million in media last year and about $170 million in the first half of 2013, according to Nielsen. Those figures don't include online spending, however."


Takeaway: It always scares us when a company switches Ad agencies. It never happens ‘bc business is just so darn good’. That said, three is better than one. We welcome the competition. Separately, if you don’t follow JCP on Facebook, we suggest you do so. Interestingly enough, JCP has emerged as one of the more progressive social networking retailers.


9983 - Fast Retailing FY Profit Grows 26.1%



  • "Fast Retailing Co. Ltd., Asia's largest retailer, saw higher full-year profits and revenue but warned that sales growth is slowing for the current fiscal year. The company, which owns Uniqlo, Theory and Helmut Lang, saw its net profit for the year ended Aug. 31 jump 26.1 percent to 90.38 billion yen, or $1 billion at average exchange rates for the period."
  • "Net sales for the year rose 23.1 percent to 1.14 trillion yen, or $12.65 billion."
  • "For the current fiscal year, Fast Retailing forecast that net profit will advance 1.8 percent to 92 billion yen, or $936.70 million, while operating profit will increase 17.4 percent to 156 billion yen, or $1.59 billion. Fast Retailing predicted that full-year sales this year will grow 16.4 percent to 1.33 trillion yen, or $13.54 billion."


Takeaway: Another sign that Japan is in the tank – perennially.



DECK - UGG® Australia Launches 'UGG By You'



  • "On October 9th, UGG Australia will launch UGG by You, an online customization tool putting customers in control of the design process...The customization tool allows consumers to mix and match an array of color schemes on two classic styles, the UGG Classic Short sheepskin boot and the Fluff Flip Flop, through a user-friendly design tool.  There are over 11,000 color, outsole and trim combinations possible through the footwear personalization tool."


Takeaway: This is inevitable. Everyone is ultimately going the customization route. Unfortunately, Nike just upped the ante with location-based customization. In other words, you order your shoes, and get them in 3 hours instead of six weeks.


Zulily - Zulily May Make IPO Paperwork Public This Week



  • "E-commerce site Zulily Inc. is planning to make public its plans for an initial public offering this week, people familiar with the matter said…"
  • "The company, founded in 2009, sells children's and women's clothing and counts at least 10 million customers, the company has said previously. It closed an $85 million funding round in November of last year, which gave it a valuation of $1 billion, up from $700 million about a year earlier."
  • "At the time of the last fundraising last year, Zulily Chief Executive Darrell Cavens said the company was nearing $500 million in annual revenue, though he declined to say if it was profitable. The company may be on a pace now for $650 million in annual sales, one of the people said."
  • "Zulily specializes in so-called flash sales, which are products for sale for a short period, often at a deep discount. It competes with other flash sales sites like Gilt Groupe…"


CFR, YOOX - Net-a-porter Group Said to Be on the Block



  • "Could Net-a-porter Group be on the block once again, a little more than three years after Compagnie Financière Richemont purchased it?"
  • "On Wednesday, Yoox.com denied it was in talks with Richemont about a merger with, or acquisition of, Net-a-porter. It was seeking to quash reports in the Italian press that a deal was in the works."
  • "Federico Marchetti, the founder and chief executive officer of Yoox...told WWD on Wednesday: 'Yoox is a global brand and as such it obviously grows not only through internal lines, but it often examines dossiers about possible acquisitions. As I have already said, at the moment there are no negotiations taking place with Richemont.'"




Mobile Advertising Begins to Take Off



  • "...Spending on mobile advertising more than doubled in the first half of the year. Mobile-ad spending in the U.S. totaled $3 billion in the first half, up from $1.2 billion a year earlier, the Interactive Advertising Bureau estimates."


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Bangladesh garment exports swell 24% in Q1 FY’14



  • "From July to September 2013, knitwear exports earned US$ 3.160 billion for Bangladesh, showing an increase of 24.43 percent over exports of US$ 2.539 billion made during the corresponding period of 2012-13, the data showed."
  • "Bangladesh’s woven garment exports stood at US$ 3.043 billion during the first quarter, registering a rise of 23.89 percent compared to exports worth US$ 2.456 billion made during the same period last fiscal."


Burned down Aswad garment factory slipped through new safety net



  • "A Bangladeshi garment factory, where at least seven workers died and more than 50 were injured in a fire on Tuesday, slipped through the net of international safety deals despite making fabric used by brands such as H&M, George at Asda, Primark, Next and Morrisons."
  • "The Aswad Composite Mills factory, in Gazipur, outside Dhaka, was not one of almost 1,600 sites due to be inspected under the accord on fire and building safety because it was not a garment factory dealing directly with brands."


Bangladesh Garment Unit Fire Kills 9 Renewing Safety Fears



  • "A fire at a garment factory on the outskirts of Bangladesh’s capital Dhaka killed at least nine people...Three out of five units housed at the Aswad Composite Mills Ltd. in Gazipur were damaged by the fire that broke out yesterday, police inspector Amir Hossain said in a telephone interview from the scene. Aswad has supplied goods to two Canadian companies, Loblaws Inc. that owns the Joe Fresh brand, and [HBC], according to shipping data provider ImportGenius.com."


China Golden Week Retail Sales Grow



  • "The weeklong public holiday, which celebrates the anniversary of the foundation of the People’s Republic of China on Oct. 1, saw national retail spending rise 13.6 percent on the year to 870 billion yuan, or $142 billion at current exchange. That figure represents a slowdown from the 15 percent growth posted last year, but last year’s holiday period was a day longer than usual due to Golden Week coinciding with the Mid-Autumn Festival."
  • "According to a report released Monday evening by China’s Ministry of Commerce, heavy discounting was largely responsible for the increase in holiday retail spending."
  • "Ministry figures show clothing, shoes, jewelry, electronics and home appliances among the most popular items with local consumers."


Colliers: Fifth Avenue has highest retail rent, at $3,052 per square foot



  • "…according to a new report from Colliers International. Fifth Avenue in Manhattan claimed the highest rent, at $3,052 per square foot, followed by Hong Kong’s Queen's Road Central ($2,086) and Canton Road, Tsim Sha Tsui ($1,993), London’s Old Bond Street ($1,520) and Manhattan’s Madison Avenue ($1,325)."
  • "According to Collier’s 2013 Global Retail Highlights Report, popular retail destinations in major U.S. metro areas are seeing big increases in rents. In New York, rents on Fifth Avenue increased by 11% from the previous year. In Las Vegas, rents on the Boulevard increased by 25%. Philadelphia's Walnut Street had the fastest-rising rent, growing nearly 34% in the past year."


Vietnam Continues to Dominate TPP Debate; Footwear Tariffs Now the Issue



  • "US tariffs on footwear imported from Vietnam have been in place since the 1960’s, in response to a seismic shift in sneaker production to Asia, a movement incentivized by low labor costs. The rationale behind the tariffs was that minimum wages and strict labor laws unduly disadvantaged US manufacturers, diminishing its competitiveness in relation to Vietnam."
  • "...Vietnam is no longer an emerging economy with respect to footwear, now the number two manufacturer behind mammoth-maker China. Those tariffs still remain, though, and average about 10 percent, though in some circumstances they can hit much higher."
  • "Nike...has forcefully argued during TPP discussions that the tariffs are thoroughly obsolete. According to Greg Rossiter, a spokesman for Nike, the exaggeratedly high tariffs punish US consumers who ultimately bear the brunt of inflated prices. 'The question is why high duties should be maintained at a high cost to U.S. consumers and businesses,' he said."
  • "New Balance, a Boston-based footwear and apparel company, argues that the tariffs protect US manufacturers that would otherwise be unfairly hamstrung by the starkly different labor regulations in Vietnam. Matt LaBretton, a spokesman for New Balance, stressed that the tariffs were indispensable instruments in allowing their sizable operations in Vietnam to continue there."





Takeaway: Barington filing on DRI represents the tip of the iceberg!

As many of you know, about six months ago we identified an opportunity at Darden that we believed could create significant value for shareholders.  We have been diligent in our work on Darden since that time and have periodically released research notes on the topic.  The most recent note, “Dismantling Darden”, can be accessed here.  To rehash, we believe there is an opportunity to take full advantage of some low-hanging fruit and improve profitability.  In our view, Darden is a strong, proven company that is in dire need of a major overhaul.  We have previously acknowledged the following positive attributes of the company:

  • Tremendous cash flow potential
  • Massive real estate value
  • Non-core, underutilized assets that can be sold at a rich valuation
  • Core assets represent a classic reorganization opportunity
  • Market’s valuation of the whole is far below what we believe the sum-of-the-parts would represent in a reorganization or breakup
  • G&A rationalization opportunities

Based off of our sum-of-the-parts analysis, we believe the parts are greater than the whole, at Darden.


We have pursued this topic extensively and have put together a 30 page Black Book, highlighting Darden’s inefficiencies and what our plan would be in order to turn the company around.  Please contact to access this research.




Howard Penney

Managing Director


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Takeaway: Recent activist news in the restaurant space has us wondering what company could be next. BLMN looks appetizing & may garner some interest.

With news of potential activist activity hitting DRI yesterday, we thought it might be worthwhile to point out that BLMN is another multi-branded casual dining company that may garner some additional attention from the investment community.


Its important to note that there is a big difference between DRI and BLMN - the management team.


That being said, BLMN needs to go easy on the unit growth story.  In our view, the street will never give the company credit for it and excessive growth will only get them in trouble.    


Highlighted in our SOTP analysis below, it is very likely that the parts are greater than the whole, at Bloomin’.





Leaving the asset value aside, however, we would not be buyers of BLMN heading into its 3Q13 print.  Sales trends for the casual industry have been sluggish of late, and BLMN is not immune to these secular trends.  Highlighted in the table below, 3Q13 same-store sales estimates have actually come down for the majority of BLMN’s brands since last quarter.  We would argue, however, that they have not come down enough.  Additionally, BLMN has previously guided to a very strong 4Q13, which we just don’t see happening.  We believe it is likely that management will guide down when they report 3Q13 results.






Howard Penney

Managing Director



ICI Fund Flow Survey - No Follow Through in Bonds from the Inflow Last Week

Takeaway: Bond funds were unable to follow through on last week's inflow which was the first weekly in 9 weeks with more outflows this week

Investment Company Institute Mutual Fund Data and ETF Money Flow:


Fixed income mutual funds flow showed no follow through with an outflow of $400 million this week, a reversal from the $1.2 billion inflow last week which was the first inflow in 9 weeks


Equity mutual funds booked an another outflow of $3.3 billion for the 5 day period ending October 2nd, a continuation from the $3.7 billion redemption from last week


Within ETFs, passive equity products experienced inflow of $1.3 billion for the 5 day period ending October 2nd with Bond ETFs losing $2.0 billion of investor funds during the week


ICI Fund Flow Survey - No Follow Through in Bonds from the Inflow Last Week - ICI chart 1



For the week ending October 2nd, the Investment Company Institute reported another weekly outflow in combined stock funds to the tune of $3.3 billion, essentially in line with the $3.7 billion outflow last week. The $3.3 billion outflow for the week broke out to a $739 million inflow into international equity products and a $4.1 billion outflow within domestic stock funds. The equity category has been a tale of two tapes recently with domestic equity funds having had outflows in 7 of the past 12 weeks compared to international equity funds which have had inflows every week in the past 12. Despite this weak run in domestic stock fund flows, the year-to-date weekly average for 2013 for all equity mutual funds now sits at a $2.7 billion, a complete reversal from the $3.0 billion outflow averaged per week in 2012.


On the fixed income side, bond funds were not able to maintain the momentum from last week and for the 5 days ending October 2nd, the aggregate of taxable and tax-free bond funds booked a $400 million outflow. The taxable bond category had slight inflows of $468 million which was washed over by the $868 million outflow in tax-free or municipal bonds. While the sharp outflows that marked most of the summer and the start of the third quarter have moderated, the appetite for bonds has hardly rebounded. The 2013 weekly average for fixed income fund flows is now a $525 million weekly outflow, a far cry from the $5.8 billion weekly inflow averaged last year.


We highlighted the year-to-date tallies of this rotation from bonds and into equities last week with the first inflow into total equity funds in 6 years with stock funds running at a $106 billion inflow thus far in 2013. Conversely bond mutual funds are working on their first annual outflow since 2004 with a $23 billion outflow thus far in '13. This is a substantial reversal from the $303 billion inflow into fixed income funds as laid out in our research last week.


Within our asset management sector launch in the middle of the summer, we released our regression models that forecasted an prospective inflow for stock funds of $80 billion and conversely a forward 12 month outflow of $100 billion for bond funds. Thus far into our coverage of the asset managers, the equity rotation has occurred at a faster than expected rate and bond fund flows have been fairly stubborn, although our forecasts have been directionally relevant. As such, we continue to recommend investors are long leading equity manager T Rowe Price (TROW) to capture this shift and conversely avoid or be short a manager more dependent on bonds like Franklin Resources (BEN).


Hybrid funds, or products that combine both fixed income and equity allocation had a surprisingly light week with the first outflow in 14 weeks. The year-to-date weekly average inflow for hybrid products however is still $1.6 billion for '13, almost a 100% increase from 2012's $911 million weekly average.



ICI Fund Flow Survey - No Follow Through in Bonds from the Inflow Last Week - ICI chart 2

ICI Fund Flow Survey - No Follow Through in Bonds from the Inflow Last Week - ICI chart 3

ICI Fund Flow Survey - No Follow Through in Bonds from the Inflow Last Week - ICI chart 4

ICI Fund Flow Survey - No Follow Through in Bonds from the Inflow Last Week - ICI chart 5

ICI Fund Flow Survey - No Follow Through in Bonds from the Inflow Last Week - ICI chart 6



Passive Products:



Exchange traded funds experienced mixed trends during last week with equity products booking an inflow and bond ETFs experiencing redemptions. Equity ETFs gathered $1.3 billion in funds, a deceleration from the $7.3 billion in the prior week and also down from the impressive $25.8 billion two week's ago. Including this week's production however, 2013 weekly average equity ETF trends are averaging a $3.3 billion weekly inflow, a strong improvement from last year's $2.2 billion weekly inflow average.


Bond ETFs experienced the first redemption in 5 weeks of $2.0 billion which was a reversal from the $1.3 billion in new funds garnered last week. Including this most recent outflow within passive bond products, the 2013 weekly bond ETF average is flagging at just a $369 million inflow, much lower than the $1.0 billion average weekly inflow from 2012.


In last week's ICI report we outlined the brewing ETF record for equities with 2013 thus far having produced $129 billion in stock ETF flow, well above the $117 billion produced in 2012 with still a quarter left in the year. Fixed income ETFs are struggling with just a $15 billion annual inflow year-to-date thus far in '13. This is well below 2012's trends of a $56 billion inflow. 



ICI Fund Flow Survey - No Follow Through in Bonds from the Inflow Last Week - ICI chart 7

ICI Fund Flow Survey - No Follow Through in Bonds from the Inflow Last Week - ICI chart 8




Jonathan Casteleyn, CFA, CMT







Joshua Steiner, CFA



Hungering For Less

This note was originally published at 8am on September 26, 2013 for Hedgeye subscribers.

“Always my soul hungered for less than it had.”

-T.E. Lawrence


Suffice it to say, this new book I have been reading (Lawrence in ArabiaWar, Deceit, Imperial Folly and the Making of The Modern Middle East) has provided me both timely and profound context for the times in which we live.


In general, that’s why I read so much history. I believe that leadership starts with having an ability to empathize. If you can’t contextualize where people and/or ideas come from, how can you lead them toward the path you’d like them to take?


And what if the path you thought you should take (like devaluing the purchasing power of your people and establishing a perpetual savings rate of 0%) ends up becoming the wrong path? Only the objective and flexible can change their mind. That’s evolution.


Back to the Global Macro Grind


October is coming. For the US stock and bond markets, that’s not always a good thing. October 1987 is a date that many of you who lead firms today remember. October of 1907 is a date you’ll only respect and remember if you’ve studied economic history.


In October of 1907, a panic on Wall Street sparked a nationwide run on banks and nearly halved the value of the New York Stock Exchange in a matter of days. Among the hardest hit by the panic was the heavily leveraged William Henry Yale, whose enormous fortune was virtually wiped out.” (Lawrence in Arabia, pg 25)


It wasn’t just the Yale family that got crushed. Many “who were born to tremendous advantage… lost it all in the blink of an eye” (pg 24), and that crisis gave birth to a whole new set of growth opportunities. With no job in NYC, William Yale’s son went on to work for Standard Oil in the Middle East (his office was a backpack and a tent). He’s was one of the first Americans on the ground.


How many of your sons or daughters are prepared for a life where you lost it all?


The America that their United States had back then didn’t have hand-holding socializers of risk. In 1907, they didn’t have the Federal Reserve either. Many self made men and women in this country were frugal and, as Nasim Taleb would say, anti-fragile.


How about the President of the United States? What did he stand for then versus now? If you had to pick between Theodore Roosevelt and Bush or Obama, who would you have lead your son or daughter into “the struggle” that Teddy called life?


William Henry Yale’s son didn’t whine and beg for an un-elected bureaucrat called Burns or Bernanke to bail him out. He sucked up his father’s mistakes and made his own path.


That didn’t just happen. Despite having all the money in the world, Yale believed (like Teddy did) that a “true man… was a rugged individualist, physically fit as well as intellectually cultured” (pg 25).


How many of your sons or daughters are well-read individualists who are prepared to take on the tyranny of a centrally planned USA? Too much to think about this morning. I know. But, please, don’t let the government’s groupthink stop you or your kids from thinking. We don’t live in the great depression Bernanke fear-mongers about. We might, if we keep trying to ban the economic cycle.


Moving on, after 5 straight down days for US stocks, here are some USA levels to consider:

  1. US Dollar – US Dollar Index long-term TAIL support = $79.11; intermediate-term TREND resistance = $81.35
  2. US Bonds – US 10yr Treasury Yield intermediate-term TREND support 2.55%; immediate-term TRADE resistance = 2.76%
  3. US Equity Volatility (VIX) – 12.95 immediate-term TRADE support; 18.98 intermediate-term TREND resistance
  4. US Equities (SP500) – 1655 intermediate-term TREND support; 1704 immediate-term TRADE resistance
  5. US Growth Equities (Nasdaq) – 3702 immediate-term TRADE support; 3789 immediate-term TRADE resistance

And here are some risk management questions to consider:

  1. Will the supposed leaders of this country allow an un-elected man to keep devaluing America’s Currency?
  2. Will Ben Bernanke and Janet Yellen be allowed to impose a perpetual depression on American Savers?
  3. Will @FederalReserve’s latest “communication tool” be to drive uncertainty, locking in a YTD VIX low?
  4. Will the all-time high for the US stock market (SPX 1725) be another Bernanke Bubble top?
  5. Will there ever be a bull case America believes in that doesn’t include a #StrongDollar and real growth?

I for one am Hungering For Less government intervention in our currency and bond markets. I’m hungering for a life that doesn’t include having to wake up worrying about what sub-regional-anti-dog-eat-dog-federal-reserve-vice-president says on CNBC next.


I’m hungering for what has always reflected the strength and character of any nation – confidence in both the currency and resolve of its people to be the change born out of crisis.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.57-2.76%

SPX 1683-1704

VIX 12.95-14.98

USD 79.99-81.28

Yen 98.02-98.99

Brent 106.98-110.51


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


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