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Danger Deflation!

“The tax on capital gains directly affects investment decisions, the mobility and flow of risk capital . . . the ease or difficulty experienced by new ventures in obtaining capital, and thereby the strength and potential for growth in the economy.” -President John F. Kennedy


As stock and bond market operators, we all know full well that the world is laden with risks.  For any investment, there are macro risks, industry risks, and company risks, to name a few.  As portfolio managers, there are then the universal risks of timing and sizing, which can be critical to performance and ultimately job risk.


On the macro level, I recently happened upon President Kennedy’s quote above and it made me ponder a risk we actually think about very frequently at Hedgeye – government risk.  In this case, Kennedy’s quote refers to the specific issue of taxation and its impact on the economy. 


There are some analysts out there who believe a dollar sent to the government is no different than a dollar left in the hands of the consumer or investor.  Without getting into politics, hopefully the recent debacle over the website for the affordable care act reinforces this idea that government is inefficient at allocating capital, particularly to new businesses. 


Back to the global macro grind...


The one government risk that is improving is the risk of rising federal deficits.  As we highlight in the Chart of the Day, the federal deficit as a percentage of GDP peaked in fiscal 2009 (Obama’s first year in office) and has declined steadily to -4.1% in this fiscal year ending September 30th.   On a notional level, the deficit has declined from -$1.4 trillion in 2009 to -$680 billion in 2013.


Certainly, running an almost $700 billion deficit into the fifth year of a “recovery” is nothing to get overly excited about.  But one marginal positive point, which we do need to give our elected officials credit for, is that actual federal government outlays have declined sequentially for the last two years by -1.8% in 2012 and -2.4% in 2013. And, frankly, the obstructionist “Tea Partiers” probably deserve the most credit for this improvement.


From an investing perspective, this decline in deficit is certainly a positive tailwind for the U.S. dollar.  It takes off the table certain questions of U.S. credit worthiness and the likelihood of future tax increases, which bode more positively for future GDP growth.  As painful as the budget debates have been in the last couple of years, this novel approach of cutting spending and growing the economy has worked.


As quietly as the deficit as improved, the fourth branch of government, the Federal Reserve, appears to be no closer to getting out of the way.  Instead of protecting against inflation, as has historically been the case, the Fed now seems overly focused on the omnipresent evil known as: deflation.  The top headline on Bloomberg.com this morning says it all:


                “Central Banks Risk Asset Bubbles in Battle with Deflation Danger”


The premise that deflation is dangerous resolves largely around the concept that as consumers begin to see that prices are falling they will hold off on purchases in anticipation of lower prices.  Secondarily to this is the idea that in an inflationary environment, inflating assets will allow consumers, and the government, to pay off debts quicker. 


Call me a simpleton, but personally I’m going to pay off more debts when I have more excess cash flow, not due to lower prices for basic goods (food and energy) or lower taxes.   Even if I agreed with the concept of inflation as a way to pay off debts, the broader issue is changing the definition of CPI does not mean deflation exists.  In fact, based on the MIT billion prices index, inflation has been solidly at over 2% for most of this year.


The biggest challenge with the ever moving inflation, GDP and employment goal posts of global central banks is that it breeds contempt and confusion, which ultimately leads to increased volatility (we’ve seen this in spades in the interest rate markets this year).  The longer term issue of central banks trying to save us from every economic threat known to man is that when we do eventually unwind this extreme policy, it will be excruciatingly painful.


Another challenge of course is that central banks have limited room to stimulate from current levels.  As Bridgewater's Ray Dalio recently wrote:


“Because central banks can only buy financial assets, quantitative easing drove up the prices of financial assets and did not have as a broad effect on the economy.  The Fed’s ability to stimulate the economy became increasingly reliant on those who experience the increased wealth trickling it down to spending and incomes, which happened in decreasing degrees (for logical reasons, given who owned the assets and their deceasing marginal propensity to consume) . . . the marginal effects of wealth increase on economic activity have been declining significantly.”


In essence, the more central bankers attempt to stimulate from current levels the less and less impact it will have on real economic activity. 


Luckily for us, not every central banker in the world wants to pursue an activist strategy and attempt to manage every ebb and flow of the global economy.    Fellow Canadian and BoE Governor Mark Carney actually seems rather content to let the improving economy do its thing and not, like his ECB counterparts, double down on easing.  As a result, Carney is also raising his 2014 GDP forecast for the United Kingdom to 2.8%.  Long the pound remains one of our top macro ideas.


Speaking of activists, it was nice to see Dan Loeb from Third Point show up in one of our Best Ideas, Fed-Ex.  The stock is up more than 25% since we added to our Best Ideas list on February 27th of this year and may have more room to run.  If you’d like to learn about access to our Industrials Sector and go through our 60 page presentation on Fed-Ex, ping .


Our immediate-term Risk Ranges are now:


UST 10yr Yield 2.66-2.81% (bullish)

SPX 1 (bullish)

FTSE 6 (bullish)

Shanghai Comp 2067-2044 (bearish)


VIX 12.22-14.51 (bearish)

USD 80.85-81.39 (bearish)

Pound 1.58-1.60 (bullish)

Euro 1.33-1.35 (neutral)


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research 


Danger Deflation! - chartoftheday


Danger Deflation! - rtawoowoo


TODAY’S S&P 500 SET-UP – November 13, 2013

As we look at today's setup for the S&P 500, the range is 30 points or 1.11% downside to 1748 and 0.58% upside to 1778.             










THE HEDGEYE DAILY OUTLOOK - 10                                                                                                                                                                  



  • YIELD CURVE: 2.42 from 2.45
  • VIX closed at 12.82 1 day percent change of 2.31%

MACRO DATA POINTS (Bloomberg Estimates):

  • 7am: MBA mortgage applications, Nov. 8, (pr. -7.0%)
  • 7:10am: Bundesbank’s Weidmann speaks in Frankfurt
  • 8:45am: Fed’s Pianalto speaks to women’s conf. in Philadelphia
  • 11am: Fed to buy $1b-$1.5b TIPS in 2018-2043 sector
  • 11:30am: U.S. to sell $25b 52W bills; also 4W bills
  • 1pm: U.S. to sell $24b 10Y notes
  • 2pm: Monthly budget data, Oct., est. -$104.0b (pr. -$120.0b)
  • 4:30pm: API weekly oil inventories
  • 7pm: Fed’s Bernanke hosts town hall meeting with educators


    • 9am: President Barack Obama speaks to representatives of 566 federally recognized Native American groups
    • 10am: House Homeland Security Cmte holds hearing on security of personal information entered on healthcare.gov website
    • 12pm: Rep. Sander Levin, D-Mich., and Sen. Lindsey Graham, R-S.C., hold roundtable on currency, other trade issues
    • 2pm: House Financial Services panel hearing, “What Is Central About Central Banking?: A Study of International Models”


  • J&J said to reach $4b settlement of hip-implant lawsuits
  • LendingClub said to reach $2.3b valuation in DST funding
  • Calpers said to enter buyout secondaries business to dodge fees
  • PetroChina to buy Petrobras assets in Peru for $2.6b
  • Blankfein says Goldman can boost ROE without major changes
  • Starbucks to pay Mondelez $2.76b to settle coffee dispute
  • Boeing to weigh options for 777X if union rejects deal
  • China pledges bigger market role amid state dominance
  • ICAP sees “marginally” higher full-yr profit on cost cuts
  • Equity traders’ bonuses seen rising as rates salesmen face drop
  • AMR-US Airways Washington focus opens airport to new carriers
  • GIC said to invest in Time Warner headquarters in New York
  • Wynn Resorts says U.S. hasn’t sought information on Macau gift
  • Chegg raises $187.5m in textbook renter’s public offering
  • U.K. unemployment falls to 7.6% in move toward BOE threshold
  • Live Nation said in talks to buy Principle, Maverick: NYT
  • Healthcare.gov may not work fully by Nov.’s end: Wash. Post


    • CAE (CAE CN) 8:22am, C$0.15
    • Canadian Solar (CSIQ) 6:46am, $0.60
    • Loblaw (L CN) 6am, C$0.81
    • Macy’s (M) 8am, $0.39 - Preview
    • Meritor (MTOR) 8am, $0.09
    • Metro (MRU CN) 7am, C$1.22
    • Pinnacle Foods (PF) 8am, $0.35


    • Cisco Systems (CSCO) 4:04pm, $0.51 - Preview
    • Element Financial (EFN CN) 5:29pm, C$0.09
    • Globalstar (GSAT) 4pm, $(0.06)
    • Kinross Gold (K CN) 5pm, $0.03 - Preview
    • Linamar (LNR CN) 4pm, C$0.66
    • Millenial Media (MM) 4:05pm, $0.02
    • NetApp (NTAP) 4:01pm, $0.63
    • NetEase (NTES) 6pm, $1.36
    • SeaWorld Entertainment (SEAS) 4:01pm, $1.19
    • Envision Healthcare (EVHC) Aft-mkt, $0.09


  • Copper Reaches Three-Month Low on Speculation Stimulus to Slow
  • Mutant Crops Drive BASF Sales Where Monsanto Denied: Commodities
  • Silver Coin Sales by U.S. Mint Reach a Record, Topping 2011
  • Brent-WTI Crude Spread Jumps to Seven-Month High on Libya Unrest
  • Gold Advances From a One-Month Low on Signs of Increased Demand
  • Cocoa Retreats as Pound Rallies on U.K. Labor Data; Coffee Falls
  • Soybeans Drop for First Time in Six Days on Increasing Supplies
  • Thailand Spurns IMF’s Call to Rethink Rice-Purchase Program
  • Palm Oil Climbs to One-Week High on Increasing Biodiesel Demand
  • Rebar Futures Fall With China’s Leaders Silent on Policy Details
  • Barrick Share Sale No Twitter as Gold Snubbed: Corporate Canada
  • Black Treasure in Poland Clouds Warming Talks: Carbon & Climate
  • Shanghai-LME Zinc Arbitrage at Highest in Over 3 Years: BI Chart
  • Palm Imports by India Expanding as Crop Delay Cuts Reserves


























The Hedgeye Macro Team















Client Talking Points


The UK is seeing the same 2-stroke pro-growth economic engine that both the US and Europe was seeing before central planners intervened and banned gravity (#StrongPound + Gilt #RatesRising = falling unemployment and rising consumption growth). BOE Governor Mark Carney says he likes that. Good! He's raising his GDP forecast for the UK for 2014 to 2.8%. Buy The Pound (see note below).


The USD Index took another run at Hedgeye TREND resistance of $81.38 yesterday. It failed (again). This makes sense because Janet Yellen will likely remind Washington and the rest of the world who she is in her testimony tomorrow in DC. That ought to be dovish (hence Bearish for The Buck). It is also bullish for Gold. Yes, I bought it back on the oversold signal again yesterday.


The Shanghai Composite is getting smoked. It's back into its down -5.2% year-to-date hole again as Western short-termers don’t like the longer-term duration of Chinese policy plans. Overall, Asia is weakening again with Hong Kong down -1.9%, Indonesia -1.8%, and Korea breaking its Hedgeye TREND line overnight at -1.6%.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Our bullish call on the British Pound was borne out of our Q4 Macro themes call. We believe the health of a nation’s economy is reflected in its currency. We remain bullish on the regime change at the BOE, replacing Governor Mervyn King with Mark Carney. In its October meeting, the Bank of England voted unanimously (9-0) to keep rates on hold and the asset purchase program unchanged.  If we look at the GBP/USD cross, we believe the UK’s hawkish monetary and fiscal policy should appreciate the GBP, as Bernanke/Yellen continue to burn the USD via delaying the call to taper. 


WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.


Financials sector senior analyst Jonathan Casteleyn continues to carry T. Rowe Price as his highest-conviction long call, based on the long-range reallocation out of bonds with investors continuing to move into stocks.  T Rowe is one of the fastest growing equity asset managers and has consistently had the best performing stock funds over the past ten years.

Three for the Road


Looks like Bill Gross is trying to sell some MBS - that's going to take a long long time @PIMCO @KeithMcCullough


If you are going through hell, keep going. -Winston Churchill


A painting by artist Francis Bacon sold for $142,405,000 on Tuesday, breaking the record as the most expensive piece of art ever auctioned. "Three Studies of Lucian Freud" was sold after six minutes of bidding in the room and on the phone at Christie's in New York City.

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 80.51%
  • SHORT SIGNALS 78.32%

November 13, 2013

November 13, 2013 - Slide1



November 13, 2013 - Slide2

November 13, 2013 - Slide3

November 13, 2013 - Slide5

November 13, 2013 - Slide6



November 13, 2013 - Slide7

November 13, 2013 - Slide8

November 13, 2013 - Slide9

November 13, 2013 - Slide10

November 13, 2013 - Slide11

November 13, 2013 - Slide12


Popping Bubbles

This note was originally published at 8am on October 30, 2013 for Hedgeye subscribers.

“It’s imperative that the Fed begins to taper.”

-Larry Fink


Not to be confused with what the CEO of Blackrock (and PIMCO) and anyone who was running levered long Bernanke’s Bond Bubble  was saying from June to August (when they weren’t positioned for bonds getting smoked), this is new.


We should have been tapering now for a few months so, on the margin this is progress, I guess. Don’t forget that guys like Fink and Bill Gross get paid to “advise” our un-elected Fed Chairman on timing. There’s no conflict of interest there vs The Rest of Us, of course.


Fink went on to say in Chicago yesterday that “we’ve see real bubble-like markets again. We’ve had a huge increase in the equity market. We’ve seen corporate-debt spreads narrow dramatically.” Ya think? Bubbles, bubbles, and more bubbles. Now our central planning overlords are going to time both how we inflate and pop them. #cool


Back to the Global Macro Grind


I’ll be seeing some of our top clients in NYC today, and it’s always interesting to see the whites of people’s eyes on USA central-market-planning days. When Bernanke shocked anyone who wasn’t on the inside of it all that he wasn’t going to taper on September 18th, I was seeing clients in Chicago. The look on people’s faces as they checked their iPhones and crackberries was flabbergasting.


I highly doubt Bernanke is going to signal a taper today. But I highly doubted he was going to cancel his entire “communication process” and not taper last time! So what do I know. I’m just a man in a room trying to let Mr. Market tell me who has inside information.


What I do know, and to a degree this is Fink’s blazingly obvious point, is that into both month-end (and Mutual Fund year-end) tomorrow we have a US stock market that is bubbling up to all-time highs.


Check this puppy out:

  1. Yield Chasing is Back! Slow-growth Consumer Staples stocks (XLP) = +7.9% for the month!
  2. SP500 at an all-time high (on no volume) = +5.4% for the month and +24.4% for the YTD
  3. Russell2000 at an all-time high = +32.0% YTD!

Now if you’ve been A) bullish on US stocks and B) bearish on Gold, Commodities, and Bonds for most of 2013 like we have, you’re pseudo cool with all of this. Commodities (CRB Index, 19 Commodities) are actually -5.1% YTD, so being completely out of some big asset classes has been as important as being long US growth when it was actually accelerating.


Now, not ironically, US #GrowthSlowing is what’s starting to marinate, sequentially (month-over-month) in SEP-OCT:

  1. US Pending Home Sales (SEP) reported earlier this week slowed -5.6%
  2. US Retail Sales #GrowthSlowing was reported yesterday at -0.1% vs +0.3% in AUG
  3. US Consumer Confidence for OCT dropped -11% month-over-month to 71.2 from 80.2 SEP

Isn’t this whole Bernanke Down Dollar, Rate Repression thing awesome?


To review our playbook, when they are happening at the same time:

  1. Down Dollar, Down Rates = #GrowthSlowing signal
  2. #StrongDollar, #RatesRising = #GrowthAccelerating signal

In other words, Fink finally has his policy lobby to Bernanke right. There is no US Growth Policy other than letting economic gravity occur. The only hope for 3-4% US growth (and a 4% 10yr Yield, $65 Oil, etc.) is via a consistent #StrongDollar Tapering Policy.


#StrongCurrency is cool guys. India is doing it. The British are doing it. So now all we need are all of our wonderfully and politically connected men and women of the United States of Centrally Planned America to do it.


Fink just did it. My boys tell me that back in the day he was a big Jimmy Carter Democrat. Today, he’s plugged into Obama’s ear too. So he can do this! Warren, you can do it too. Yes You Can!


If the US doesn’t do this, Europe will be the better place to allocate your capital in 2014. If the USA’s said free-market leadership signs off on Burning The Buck and Japanese Rate Repression, the Euro, Pound, and Swiss Franc are going up. If that continues to happen, you’ll basically have the exact same call we made on US growth almost a year ago occur in Europe:

  1. #StrongEuro, #StrongPound, etc. = deflates European inflation
  2. Inflation slowing = real/inflation-adjusted economic growth stabilizing, then accelerating

At the beginning of Q413 we called this Top Global Macro Theme #EuroBulls. And with Spanish consumer prices (CPI) dropping to NEGATIVE year-over-year in the most recent month (-0.1% y/y OCT vs +0.9% in SEP), we’ll reiterate that call again this morning.


As for the popping of the bubbles, to paraphrase my pal Hemingway, at first it happens slowly (#GrowthSlowing), then like in November of 2007, it happens all at once. After locking in its YTD low on September 2nd (when we were long growth), our Bull/Bear Sentiment Spread just ripped to a fresh YTD high this morning – that’s a +60% move to the bullish side in 2 months. #bubbly


Our immediate-term Risk Ranges are now:


UST 10yr Yield 2.40-2.60%

SPX 1752-1774

DAX 8920-9063

Spain’s IBEX 9588-10,097

Euro 1.36-1.39

Pound 1.60-1.62


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Popping Bubbles - Chart of the Day


Popping Bubbles - Virtual Portfolio

Denbury Says, "Upstream MLP? No Thanks"

Funding dividends out of free cash flow ...  what a novel concept!


If any US E&P has an asset base potentially suitable for an upstream MLP, it would be Denbury Resources (DNR), the $7B enhanced oil recovery specialist.  For months DNR has contemplated new strategic initiatives, including forming an MLP.  But on Monday 11/11, DNR officially put the kibosh on that idea, and we couldn’t help but smile as CEO Phil Rykhoek gave the reasons why there is “no clear long-term benefit for Denbury shareholders” (Slide 16) in forming an MLP.


We have been, and remain, highly critical of and negative on upstream MLPs for many of the reasons that Rykhoek cited at the  DNR Analyst Day.  In our view, DNR’s decision to not go the upstream MLP route is a blow to the viability and sustainability of the structure and current E&P MLPs.  While the market is punishing DNR in the short-term for not “playing the game” (down 8.5% this week), we think that Rykhoek will eventually look smart for this decision.  And after listening to that Analyst Day call, we are interested in doing work on DNR … biased long side.

Below we list some quotes from DNR's CEO Phil Rykhoek on Upstream MLPs (our emphasis):


“If you look at the way the MLPs operate, most of them spend more than they make every year.  So how do they handle that?  Well, they continually raise equity, they continually buy things, and that is how they keep it going.


"But on a day-to-day operating philosophy, many of them, if you look at it, spend more than they make.  Now they argue what maintenance capital is versus growth capital, et cetera.  As I will show you on another slide, we would like to operate a bit differently and a bit more conservatively, and so we would expect to fund dividends out of operating cash flow.  So if you have $100, that $100 would be used for CapEx and dividends, and for the most part, we would be self-funded."

"We weren't sure how it would translate into the marketplace if we ran MLP kind of differently, so that is kind of what that comment means.  So long story short, we felt like it was better to not do an upstream MLP. And I think most of our shareholders would agree with that one, in fact, a very high percentage.”




“We expect to fund our dividends with cash flow. So hopefully we don't get into any debate or discussion on what is maintenance capital. We hope to make it very transparent.  Going back to the $100 example, you have $100, you might spend $80 on CapEx and $20 on dividends, but it would all generally be funded with cash flow.”

“If we have extra [cash flow], then we have the option of typical things that you can do at an E&P company. You can increase your CapEx; you can reduce your debt. But the other thing that we want to have in our portfolio is that we can repurchase shares.”




 The biggest positive I think for an MLP is that they usually trade at a higher multiple. Therefore, if you are using the currency to buy things, it's a good currency for acquisitions. If you trade at an 8 multiple versus a 6, if you're going to use equity to buy things, obviously we'd prefer that.  Of course, when you look at our situation, we very seldom use equity to buy things.”




“MLPs have IDRs; that is true. That is a potential value. And, of course, it raises capital. So to the extent you take it public, you raise money. Now there's a trade-off to that one, in the sense that if you look at everything as a whole, if you issue equity, you've also increased dilution. So it's not a free lunch, so to speak. And so we felt like we could manage it basically without having to raise capital.




“We basically felt like the negatives were stronger than the positives.”




“I think it was at the Citi conference where someone asked if we would consider an MLP, and it took a life of its own.  For those of you that I’ve talked to, which is most of you, we have worn this out, I think.  So hopefully we will do this about one more week, and then we won't talk about this again.”



“Question – Audience: Over the long-term, do have a long-term dividend yield target? You show the next couple of years, but as you looked out to the seven years, did you have a target there?


Answer – Phil Rykhoek, CEO: Well, I hope it goes down to about 1%, because I hope the stock price goes up. How's that?



Kevin Kaiser

Managing Director


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