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CHART OF THE DAY: The Veil of Ignorance


CHART OF THE DAY: The Veil of Ignorance - US Oil Production

November 29, 2013

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The Veil of Ignorance

“Whenever you feel like criticizing any one . . . just remember that all people in this world haven’t had the advantages you’ve had.”

-F. Scott Fitzgerald


Yesterday, I read a great column in the New York Times by Nicholas Kristof about compassion and empathy.  The point of the article was to look at the distinction between asking someone to be personally accountable versus recognizing in a civil society that it is our responsibility to help others.


The origin of the article was based on some comments Kristof had received from a number of recent columns he’d written on the federal food stamps program. The gist of the feedback was that we shouldn’t be subsidizing families that are “too lazy” to take care of themselves.  As Kristof writes:


“Let’s acknowledge one point made by these modern social Darwinists: It’s true that some people in poverty do suffer in part because of irresponsible behavior, from abuse of narcotics to criminality to laziness at school or jobs. But remember also that many of today’s poor are small children who have done nothing wrong.


Some 45 percent of food stamp recipients are children, for example. Do we really think that kids should go hungry if they have criminal parents?”


The current public debate over healthcare personifies this dilemma we face when trying to emphasize with those that were given less in life.  (Unfortunately, the inability of the government to execute on the implementation of Obamacare has somewhat tainted this debate.)


In “A Theory of Justice” the philosopher John Rawls proposed the veil of ignorance to help us in determining our role in helping others and as a way to find morality in many situations.   According to Rawls, under the veil of ignorance:


“No one knows his place in society, his class position, or social status; nor does he know his fortune in the distribution of natural assets and abilities, his intelligence and strength, and the like.”


As a result, since a person may occupy any position in society after the veil is lifted, the person must then evaluate any position from all perspectives of society.  


Certainly, the idea that I could wake up one day and not be preparing for a festive thanksgiving with friends and family, but rather be a homeless person wandering the icy streets of New York provides a different perspective as to how to treat those that are less fortunate.   


Back to the global macro grind...


As it relates to the U.S. equity markets, today is a day that is a bit of a market veil of ignorance as it is historically is the lowest volume trading day of the year.  As a result, there probably won’t be a lot of read through from the market action today.  Internationally, there has actually been a slew of data out over the last 24 hours and some key points to highlight include:

  1. Euro-area unemployment dropping to 12.1% from 12.2% in October and Eurozone flash CPI coming in at a anemic 0.9% (but higher versus last month’s 0.7%);
  2. German retail sales came in at -0.8% month-over-month versus and estimate of +0.5%; and
  3. Japanese unemployment came in at 4.0%, CPI inline at 1.1%, and industrial production disappointed versus growing 0.5% month-over-month versus an estimate of 2.0%.

In aggregate the big macro data points this morning do not point to any reason for the policy makers in Japan or Europe to change their views.  If anything, there is only increased support for the current extremely dovish policies that are in place.


As it relates to Japan, though, late last week we actually encouraged investors to consider taking off the Abenomics trade, as my colleague Darius Dale wrote there are a number of reasons to consider booking gains, namely:

  1. The Fed will likely dominate headlines with surprising levels of dovish monetary policy amid a 3-6M monetary and fiscal policy vacuum in Japan;
  2. Sentiment towards Japanese equities amongst foreign speculators has reached euphoric levels; and
  3. Speculators have recently adopted an overwhelmingly bearish position on the yen. Historically, the USD/JPY cross has faded hard from such asymmetric setups in the futures and options market. Moreover, what’s bullish for the yen has been almost perfectly bearish for Japanese stocks.

In my purview the point on sentiment may be the most compelling reason to take a break on the long Japan equity trade.  Specifically, in the YTD, foreigners have purchased a net ¥13-plus trillion of Japanese shares – the highest total on record. This contrasts with a net ¥6T of net sales amongst Japanese institutional investors.


Moreover, the aforementioned foreign/domestic bifurcation has intensified in recent weeks. The most recent weekly data shows a net purchase of ¥1.3T by foreign investors, which represents a 7M-high.  Conversely, net sales of domestic assets by Japanese retail inventors hit ¥174B last week – the largest weekly divestment since 2008. 


I think we can all agree, buying when the locals are selling is rarely a good thing!


Switching gears, in the chart of the day today we highlight a key point from our expert call last week with Dr. Tancred Lidderdale from the Energy Information Administration.  As the chart shows, for the first time in more than twenty years, U.S. production of crude oil has surpassed imports.  Arguably, even the environmentalists when wearing the veil of ignorance would agree that increased U.S. oil independence is a good thing.


I’ll be heading to my first Apple Cup later today, which is the annual match-up between Washington University and Washington State in Seattle.   Wherever you spend the rest of the holiday weekend, I hope it is a great one.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.69 - 2.82%



VIX  11.91 - 13.31
USD 80.35 - 81.15

Gold 1


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


The Veil of Ignorance - US Oil Production


The Veil of Ignorance - rta

Early Look

daily macro intelligence

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.


TODAY’S S&P 500 SET-UP – November 29, 2013

As we look at today's setup for the S&P 500, the range is 19 points or 0.68% downside to 1795 and 0.37% upside to 1814.                                                    










THE HEDGEYE DAILY OUTLOOK - 10                                                                                                                                                                  



  • YIELD CURVE: 2.47 from 2.45
  • VIX closed at 12.98 1 day percent change of 1.33%

MACRO DATA POINTS (Bloomberg Estimates):

  • No U.S. economic reports expected


    • House, Senate not in session
    • Washington weekly agenda for Dec. 2-6


  • Australia rejects ADM’s $2b takeover of GrainCorp
  • Microsoft said to lean to Mulally, Nadella in CEO search
  • Basel said to target bundled debt in hunt for capital holes
  • Holiday Sales: Extended Hours, Deeper Discounts
  • Thanksgiving e-commerce sales rose 9% as of noon yday: IBM
  • H-P said to bump Verizon as Obamacare website host
  • Dish holders can’t exclude Ergen from Lightsquared bid
  • Charter said to raise $25b to acquire Time Warner Cable
  • Apple wins bid to dismiss privacy suit over data collection
  • Apple won 76% of Japan Oct. smartphone sales, Kantar says
  • France denies Hess energy exploration permits in Paris basin
  • Obamacare website still frustrates some as deadline looms
  • Obamacare’s small-business health exchange site delayed 1 yr
  • Euro-area inflation climbs more than est.; jobless rate drops
  • China’s neighbors test defense zone oversight
  • Japan, U.S. to boost air surveillance in E. China Sea: Yomiuri
  • NOTE: U.S. equity markets close at 1pm; bond markets at 2pm


  • Palm Bull Market Extending for Mistry as Indonesian Output Drops
  • Gold Bears Persist as Prices Near Year’s Low on Fed: Commodities
  • Rubber Jumps Most in Six Months as Japanese Inflation Advances
  • WTI Set for Longest Monthly Slide in Almost Five Years on Supply
  • Gold Gains in London to Narrow Biggest Monthly Drop Since June
  • Copper Rises Before Report Seen Showing Chinese Factory Growth
  • Palm Oil Posts Second Monthly Gain as Indonesia Output Declines
  • Rebar Posts First Monthly Gain Since August as Inventory Falls
  • EU Power Network Integration Seen Delayed Again: Energy Markets
  • China 2013 Total Grain Output Rises 2.1% Y/y to 601.9m Tons
  • LNG New-Build Choices Loom Amid Low Usage Rates: 2014 Outlook
  • Rio Suspends Gove Alumina Refinery Amid Low Prices, High Aussie
  • Philippines to Decide in January if More Rice Imports Needed
  • SHFE Copper Stockpiles Fall to 17-Month Low as Aluminum Climbs


























The Hedgeye Macro Team














Empirically Bankrupt

This note was originally published at 8am on November 15, 2013 for Hedgeye subscribers.

“Much of the profession is empirically bankrupt because it is no longer taught economic history.”

-Charles Kindleberger


That quote comes from Chapter 12 “The Scandal of Money” (pg 115) in one of the only forward thinking economics books of 2013 (George Gilder’s Knowledge and Power).  It’s market practitioners like me vs the government PH.Ds. And it’s on.


The reason why Gilder gets it is that he combines the weaponry of A) economic history and B) math (chaos theory). The late Charles Kindleberger, of course, wrote one of the most important market history books ever (Manias, Panics, and Crashes) in 1978.


Keynesian economists (who Kindleberger alluded to as “the profession”) don’t do non-linearity, entropy, etc. They are all about “smoothing” cycles, and “equilibrium” (or something like that) which are designed to promise the end-user (Big Government Interventionists) certainty. NEWSFLASH: markets, bubbles, and economies are grounded in uncertainty. Embrace it.


Back to the Global Macro Grind


If you don’t get what I am talking about, take a few minutes to watch and listen to Janet Yellen’s confirmation hearing yesterday. Watching a human being’s body language is always as important as attempting to listen to what it is they are trying to say.


If you don’t want to study the kinesics of it all (the study of lying) or read economic history, read my friendly competitor’s (Zervos) rant yesterday about how he loves Yellen. There’s no math or history in his analysis; it’s all about the storytelling.


Critical to #KeynesianCrack storytelling is the fear-mongering and the emotion of it all. Just so you know the difference between our perspectives, David Zervos is a Ph.D. who worked for the Federal Reserve in Washington, D.C.  I’d boil down his backslapping of his groupthink tank’s (The Fed’s) anti-dog-eat-dog-economic-cycle-gravity-banning-central-planning idea as follows:

  1. “Optimal Control Policy”
  2. “Rule evolution”
  3. “Equilibrium risk-free”

Like many in Washington, he’s entertaining – and he gets markets right too. But how he thinks this all ends for America, her former “free” markets, and economy is about as far off on another planet as I’ll ever be. To him, I’ll sound crazy this morning.


Calling our kings and queens crazy? People often ask me what I’d do differently if I was at the Fed. Since I’m not the central planning type, I’d either do what Volcker did (end the madness of stagflation policy), or just shut the place down.


People also ask me what I’d ask our almighty Federal Reserve Ph.D.’s if I was in Congress. Well, since I have never voted for a politician in my life, I doubt being in Congress is in the cards, but here are some questions for my friends sipping the Keynesian chartreuse:

  1. What the hell is an “optimal control” policy model and why use any model when every model the Fed has used has failed?
  2. Does “rule evolution” mean that when the prior optimal policy doesn’t work, you just change the rules?
  3. How do you think keeping the “risk free rate” at 0% ends when the bond market turns on your expected “equilibrium”?

Traditional anti-Marxists would call trying to mark markets to some damn “optimal” model and/or price floors just plain dumb. But I won’t do that this morning. I am Mucker. How dare I challenge a Ph.D. “science” of charlatans?


Yes I called them charlatans. If you don’t think I’m crazy yet – watch this video I made for my Washington friends yesterday titled #Yellen: Tools, Crickets, and Crack: http://app.hedgeye.com/media/697-yellen-tools-crickets-crack?media=all&page=1


Yep, too many pucks to the head. But before these Ph.D.’s bubble (and blow) up markets for the umpteenth time in world history, I’ll be standing on the front lines against their academic dogmas. Yes, Mr. Zervos – I’m the one who knocks.


Back to how we risk managed the event risk of Yellen being who she is (The Mother of All Doves), we made the playbook move of buying slow-growth Yield Chasing assets that drive what Jefco calls the “spooooz” higher.


But do not mistake Gold, Bonds, and Utilities leading yesterday’s short squeeze to another all-time US stock market (SPY) high for rising growth expectations (the Russell Growth Index was down). Remember, a Policy To Inflate nominal is not real economic growth.


Oh, and I sold all my Gold and Bonds by 11AM EST. Yellen’s darting eyes toward Nero Corker (the Keynesian overlord from Tennessee) did me in. I just couldn’t stomach being long their empirical bankruptcy for more than a few more hours. Keep moving out there!


Our immediate-term Risk Ranges (its math – we have 12 Big Macros in our Daily Risk Range product) are now:


UST 10yr Yield 2.66-2.81%

SPX 1770-1794

VIX 11.99-14.41

USD 80.53-81.41

Pound 1.59-1.61

Gold 1261-1294


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Empirically Bankrupt - Chart of the Day


Empirically Bankrupt - Virtual Portfolio

E-Cigs at the Thanksgiving Table

Happy Thanksgiving!  You never know, as you dive into your second helping of mashed potatoes and gravy, the topic at the table could well be electronic cigarettes!


Below we want to provide recent updates and developments in the category. In our work we continue to express great excitement in the growth prospects for the e-cigs, despite its current diminutive size (~ 1% of the tobacco market).  That said, we expect consumer interest in and investment behind e-cigs to grow, especially following “Big Tobacco’s” entrance into the category.  We think innovation will be a critical component to drive trial and adoption, as improvements in the form, function, and performance of next generation e-cigs meet the combustible cigarette experience.  However, with respect to innovation, and the broader size and shape of the category, much depends on the details of pending regulation from the FDA (more below).


In terms of excitement and interest in the category, just last week Wells Fargo and Morgan Stanley held the first annual e-cig industry conferences, in which both management teams from Big Tobacco and select private manufacturers were featured, including NJOY, Victory, and Ballantyne Brands, which we’ve held conferences calls with in recent months. We believe the interest in this new disruptive category is built on:

  • A “reasonable person’s” belief that e-cigs are less harmful than traditional combustible cigarettes.
  • Attractiveness as a mimic to smoking behavior (hand-to-mouth) with step-down levels of nicotine, and currently priced at a discount to traditional cigs.
  • E-cigs are a bridge to meet changing consumer desires (the consumption of healthier products and social awareness of the stigma of cigarette smoking).
  • Estimates for the e-cig category to double in the U.S. in the years ahead, from sales of $150MM in 2011, $500MM in 2012 ($300MM across retail channels and $200MM over the internet), and estimates of around $1-2B in 2013.
  • A huge runway of smokers (more than 40MM in the U.S.).
  • A giant global opportunity (the global tobacco industry is worth $800B annually).
  • Big Tobacco’s desire to make up for declining volume trends of traditional cigarettes

We expect that these factors will encourage investors to overweight e-cig results in gauging broader company performance as we look out to the coming quarters.



Investment Position: Our preferred Big Tobacco play remains Lorillard (LO), given its leading share in the e-cig category (~50%) and advantaged cigarette portfolio.   We expect LO to continue to see outperformance on strong demand for its full-flavored offerings and dominate share of menthol (~85% of its portfolio), both of which are contributing to volume outperformance versus the industry (in the quarter LO’s vol. +3.5% versus industry’s avg. -4%). The company continues to push gross profit margins higher, improving 80bps to 37.1% in the quarter as domestic retail share of menthol rose.


LO was the first Big Tobacco company to market through the acquisition of “Blu” branded e-cigs (in April 2012 for $135MM) and saw strong sales growth of 11% quarter-over-quarter (+350% year-over-year) to $63MM. LO CEO Murray Kessler’s e-cig strategy appears to forgo short-term profits for long term gains: he sold e-cigs at break-even in the quarter and was able to boost Blu’s market share to 49% from 40% last quarter. We expect similar trends as LO tries to capture brand loyalty. Over time, we do think that e-cigs can be margin-enhancing to the combined cigarette category. Further, the company became an international e-cig dealer through its purchase of UK-based SKYCIG in October 2013 for £30MM in cash, plus an additional £30MM to be paid in 2016 based on the achievement of certain financial benchmarks. SKYCIG is a three year old company with ~ 300,000 users in the UK (there exists around ~ 10MM smokers in the country) that also happens to have nearly identical branding to Blu.


A Changing Marketplace

  • Big Tobacco Is All InAltria (MO) and Reynolds American (RAI) issued their own e-cig in Q3 of this year, under the brands MarkTen and VUSE, respectively, each in individual test-state markets.  Both have plans for national distribution – targeting mid 2014 – and both are competing with Lorillard (LO) and its e-cig brand Blu that currently has national distribution and number one market share. 
  • Philip Morris (PM) announced last week that it is accelerating its launch of an e-cig product to mid-2014, instead of a previous target of 2016/17, at a cost of $100MM.
  • We think Big Tobacco’s entry into the e-cig market lends credibility to the category, and should spur innovation and promote good manufacturing practices along with a handful of select private companies (such as NJOY, Mistic, Krave, Victory, Fin, Logic) that stand to strongly compete with Big Tobacco for category share.
  • We believe that the prospect for regulation on the industry equates to Big Tobacco’s advantage, with its deep pockets, retail distribution, and strong manufacturing practices. We would expect some consolidation from the current large and fragmented group of nearly 2000 smaller e-cig U.S. manufacturers.
  •  Given RAI and MO’s entrance (with PM around the corner), we wouldn’t be surprised to see price wars, especially for rechargeables, to heat up, as the category is still in its infancy and manufacturers look to solidify brand loyalty. This would be negative for profit in the short term. We’d expect more rational pricing in forward years.


Regulatory Uncertainty

  • It’s anyone’s guess when a regulatory announcement on e-cigs may come. Expectations were last set for an October announcement (then came the government shutdown) – the industry seems to guess now that one will come before year-end.
  • We think that industry is bracing for regulation that could include:  1) ban of online commerce, 2) age verification standards at retail, 3) flavor limitations (beyond tobacco and menthol), 4) health/safety certifications, and 5) labeling and marketing requirements.
  • A higher bar, which the industry broadly seems to characterize as “the wrong regulation” could include limits to innovation by mandating premarket approval requirements, tax raises on e-cigs, and in NJOY’s case, very vocal remarks against mandatory shelving to the back counter and the prohibition of TV advertising.
  • The industry is cautiously optimistic around recent statements from Mitch Zeller, the new Director of the Center for Tobacco Products, in which he said that the agency will be giving a high priority to developing a more comprehensive approach to the regulation of nicotine-containing products, which will be based on the continuum of risk.
  • Zeller’s words, including the phrase “continuum of risk”, hint that the FDA may consider e-cigs (along with non-combustible alternative products such as snus, and nicotine gum and patches) in a separate category from combustible tobacco, which the e-cig industry applauds.
  • We expect the FDA to struggle with balancing too little regulation versus too much, fighting for instance PR winds that e-cigs could be a gateway to traditional cigarettes, while recognizing full well the health risks of combustible cigarettes and the opportunity to allow for “healthier” alternatives.  
  • It is likely the FDA takes longer than a few weeks or months to come up with a summary judgment, yet may call for introductory regulations, as there is no current scientific proof of the long-term safety or risk of e-cigs.


Category Color

  • We’re seeing and expect future increased rates of trial and adoption given 1) Big Tobacco’s involvement in the category to bring awareness and credibility to the market and 2) increased innovation given Big Tobacco’s involvement and a strong group of private players competing for share.
  • Talk around innovation and “Next Generation Products” includes everything from puff counters and LED light indicators to signal battery strength and nicotine supply, to improvements on form, function, and design in getting the e-cig experience in-line with a traditional cigarette.
  • We continue to see e-cig manufacturers favor the razor-razorblade model of a rechargeable unit and replacement cartridges to that of disposable e-cigs (NJOY is one big exception among major distributors in only selling disposables), with expectations that rechargables will be higher margin than disposables. 
  • We’ve heard a number of manufacturers quote gross margins for rechargables in the 40-50% range and well above traditional cigarettes around 13%-15%.
  • The higher margin opportunities in e-cigs versus traditional, especially if partially passed onto to retailers, should also help to accelerate growth in the category.
  • Blu, NJOY, Logic are the leading brands.
  • Current trends suggest that disposable sales are strong, and in some cases outpacing rechargables. As an example, Blu states that its current mix is 51% disposables, 23% cartridges, and 26% rechargeable kits.
  • Manufacturers are pricing a single disposable roughly between $5.99 to $9.99 and claim the number of puffs is equivalent to 1.5 to 2 packs of traditional cigarettes. [Note: an average pack of cigarettes in the U.S. is $6.00 and in New York City the minimum price for a pack is now $10.50, mandated by Mayor Bloomberg’s newly approved bill that raises the legal age to buy cigarettes to 21 from 18]
  • We believe the price discount of e-cigs to cigarettes remains attractive to consumers. Many top manufacturers continue to push the value of rechargables, especially when the discount on a price per replacement cartridge is factored in when buying multi-pack replacement cartridges (versus single replacements or disposables).
  • A defining trend within the category is companies’ strategy to broaden retail distribution, often at a lower margin to online, with recognition that the FDA could ban online sales.


Awareness, Adoption and the E-Cig User

  • Adoption rates remain quite low despite increases in trialing and awareness throughout the year.  However, we expect that to change as the category grows behind Big Tobacco’s involvement and innovative improvements.
  • Recently Blu cited that in Q1 2013, 57% of adult smokers had heard of Blu, and by Q3 2013, the number had increased to 82%.
  • Companies like LO and NJOY are advertising on television. LO has used celebrities such as Jenny McCarthy and Stephen Dorff to get their messages out. Our concern here is that such high profile advertising may adversely harm the e-cig image in the FDA’s eye.  As mentioned above, the FDA could well ban e-cig TV, print, and banner ads as it has with traditional tobacco.
  • The charts below from a recent RAI presentation suggest demographic trends are very similar between e-cig users and cigarette smokers.

E-Cigs at the Thanksgiving Table - zz. vap 1


E-Cigs at the Thanksgiving Table - zz vap 2



The Opportunity

  • Smoking causes 5-6 million deaths per year and kills over 400,000 in the U.S. each year. Smoking is also the first avoidable cause of death and disease in the U.S. and the second globally. The numbers alone indicate to us that there’s a huge opportunity for products that can lead to harm reduction.
  • We think e-cigs demonstrate truly disruptive and compelling innovation because the e-cig so closely mimics smoking behavior.
  • We expect that technical performance changes and enhancements of e-cigs, their price discount to traditional, and e-cigs’ perception as a healthier alternative to tobacco will accelerate growth in the category.
  • We’re bullish on the U.S. and global runways for the category: the global tobacco market is worth $800B annually.  While the industry is subject to the scope of the FDA’s regulation, we believe the category is here to stay. 

Vape on!


Matthew Hedrick


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