The Rivalry

“One friend in a lifetime is much; two are many; three are hardly possible.  Friendship needs a certain parallelism of life, a community of thought, a rivalry.”

-Brooks Adams


As many of you may have noticed already, my colleagues and I have a bit of a fascination with the sport of hockey.  In particular, Ivy League hockey, since many of us played at Yale (and our firebrand energy analyst Kevin Kaiser played at Princeton).  So, if you will, please tolerate my enthusiasm for just a minute here as this weekend is effectively our Super Bowl.


Specifically, this Saturday at 8pm Yale will be playing Harvard at Madison Square Garden.  In as much as I would like to wish my friends at Harvard good luck this weekend, I would, honestly, not really mean it.  But I sincerely do hope the Crimson don’t totally embarrass themselves, or next year we will have to invite Cornell to play us on the world’s biggest hockey stage. 


Now admittedly Harvard did once win a NCAA championship, albeit it was more than three decades ago.  On the other hand, Yale is the defending NCAA champion and over the last five years has amassed a record of 111 – 53 – 12.  Over the same period, Harvard hockey is 53 – 87 – 24.  As if having Larry Summers on their team wasn’t bad enough... ;)


In Malcolm Gladwell’s new book, “David and Goliath”, he digs into the idea that underdogs do disproportionately well in competition.  He cites a study from political scientists Ivan Arreguin-Toft that looked at all wars between small countries and much larger countries over the past two hundred years.  He found that the much larger country only win 71.5% of the time.  Further as Gladwell writes:


“What happens in wars between the strong and the weak when the weak side does as David did and refuses to fight the way the bigger side wants to fight, and instead uses unconventional or guerilla tactics.  The answer: in those cases the weaker party’s winning percentage climbs from 28.5% to 63.6%.  To put that in perspective, the United States population is ten times the size of Canada’s.  If the two countries went to war and Canada chose to fight unconventionally, history would suggest you ought to put your money on Canada.”


So, who knows, if Harvard hockey were to do something totally unconventional, like say put their football team on skates, maybe they will have a chance this weekend!


Back to the Global Macro Grind...


Yesterday, Keith presented our top three global macro themes for Q1 2014.  Like clockwork, we’ve been doing these themes for the last five years.  Those three themes are as follows:

  • #InflationAccelerating – CPI comparisons globally are easy and commodities are basing, as a result we are expecting a re-acceleration in reported inflation.  From a sector perspective, the three sectors we like in this scenario are technology, healthcare and energy;
  • #GrowthDivergences – This could be the year in which global growth divergences increasingly matter for stocks, especially as rates begin to normalize, and Europe looks set up to see accelerating economic growth.  Conversely, we are starting to question whether Japan’s recovery is losing steam; and
  • #FlowShow – In a world in which 75% of the global financing stock outstanding is in debt, there is a lot money that can flow out of bonds and into equities.  In the Chart of the Day below, we again emphasize that the ratio of debt-to-equity was 50/50% in 1999.

One key supporting point for the idea that Europe could well be the global growth leader, at least on a percentage change basis, is the fact the European sovereign debt markets have all but recovered.   Remember that sovereign debt crisis from a few years ago? Well, the European credit markets barely do.


This morning the Spanish 10-year yield is trading at 3.70%.  This is a mere 74 basis points wider than the U.S. 10-year yield.   In fact, last night Spain kicked off its funding program and raised $7.2 billion in five year debt, overshooting its target.  Further, this debt was sold at 2.411%, which was the lowest funding rated of the Euro era for Spain.


Now in the long run, the Spanish economy still has excesses built up from the parabolic housing bubble it experienced.  Nonetheless, in the short run as the likes of Spain, Italy, France and Portugal are able to sell debt at reasonable rates, this is both a real positive for their governments and their governments’ ability to spend, but more importantly for banks.  As broad borrowing rates go down, this will eventually filter back to corporations who can then borrow at low rates to more aggressively fund capital expenditures and expand. 


Since we are on the topic of housing, I should flag that the U.S. housing market is at the top of our list for worries as it relates to the U.S. economy.   In fact, mortgage applications are down 22% from their 2014 peak reading.


Even if it’s not clear yet that housing headwinds will derail the U.S. economy, it is setting up for some interesting short ideas.  In particular, our Financials team just added Nationstar Mortgage (NSM) to our Best Ideas list this week.  Previously, this had been a top long idea for us, which played out well as our earnings estimates were higher than the consensus.


Conversely, our view is now that the consensus earnings estimate of north of $5 for 2014 could come in as low as $1. 


Now, how’s that for a downside surprise? 


We are doing a deep dive on the name and will outline the thesis this Monday at 11am EST. (Email to subscribe for access.)  NSM trades more than $30 million in volume per day, so there’s lots of stock out there to short, especially if you believe our Financials team that the best case scenario is that the stock will get cut in half.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


The Rivalry - Chart of the Day


The Rivalry - Virtual Portfolio



In light of yesterday’s downgrade, we’d like to reiterate our LONG call on YUM.


It is our belief that the vast underperformance of its China Division in 2013 was largely driven by circumstantial issues (food supplier incident and Avian Flu) rather than structural issues.  In fact, we believe YUM continues to have a material opportunity to capitalize on a growing consumer class in China that is expected to double from 300mm+ in 2012 to 600mm+ by 2020.  While China same-store sales could remain volatile in 2014, we believe they will accelerate meaningfully over the prior year. 


The trend in both sales and margins in China suggest that the company has made significant progress restructuring the business, setting the stage for improved profitability in 2014.  We believe there is enough pessimism around a potential recovery in China (as evidenced by yesterday’s downgrade) that there is upside to estimates in 2014.



YUM is currently our favorite LONG in the big cap QSR landscape fueled by a substantial long-term growth opportunity, including a strong and growing presence in China as the country transitions from a producer to a consumer economy.  We believe China same-store sales will not only benefit from easy comparisons, but will also be driven by incremental sales from menu innovation and daypart expansion in the region.  In addition to China, YUM has positioned itself well for the future through considerable penetration in other developing markets. 


YUM has been strong in the U.S. for the past couple of years, led primarily by an innovative Taco Bell business.  We believe the company has the correct drivers in place to capture additional market share and drive incremental sales at this concept.  The breakfast daypart is a huge opportunity for Taco Bell and, if successful, could drive incremental gains.



YUM: CHINA WILL BE KEY IN 2014 - 1 9 2014 4 38 00 PM


YUM: CHINA WILL BE KEY IN 2014 - 1 10 2014 7 16 26 AM




Easy same-store sales comparisons in China, improving margins across the major divisions, and a potential acceleration in domestic consumer spending could all lead to multiple expansion in 2014.  Investors punished the stock on bad news for the majority of 2013 and, as such, we expect them to reward the stock on good news throughout 2014.  As it stands, we see approximately 16-30% upside in the stock (depending on the trajectory of profitability in China), implying a stock price between $87 to $100 per share.



YUM: CHINA WILL BE KEY IN 2014 - 1 9 2014 4 54 38 PM



In the series of annotated charts below, we run through our bull case from a fundamental perspective.  It quickly becomes clear that operating margins are set to accelerate and that a turnaround in China would have a considerable impact on the profitability and earnings of the company.



YUM: CHINA WILL BE KEY IN 2014 - 1 10 2014 7 43 08 AM

YUM: CHINA WILL BE KEY IN 2014 - 1 10 2014 7 43 45 AM

YUM: CHINA WILL BE KEY IN 2014 - 1 10 2014 7 44 17 AM

YUM: CHINA WILL BE KEY IN 2014 - 1 10 2014 7 44 54 AM

YUM: CHINA WILL BE KEY IN 2014 - 1 10 2014 7 45 27 AM

YUM: CHINA WILL BE KEY IN 2014 - yum cost of sales

YUM: CHINA WILL BE KEY IN 2014 - laborrrr china

YUM: CHINA WILL BE KEY IN 2014 - other expppppeppepe

YUM: CHINA WILL BE KEY IN 2014 - 1 9 2014 3 18 46 PM

YUM: CHINA WILL BE KEY IN 2014 - us rlmnsjpg

YUM: CHINA WILL BE KEY IN 2014 - intl rlmns

YUM: CHINA WILL BE KEY IN 2014 - 1 9 2014 3 17 06 PM

YUM: CHINA WILL BE KEY IN 2014 - gagagaga

YUM: CHINA WILL BE KEY IN 2014 - 1 9 2014 3 14 52 PM

YUM: CHINA WILL BE KEY IN 2014 - 1 9 2014 3 21 37 PM

YUM: CHINA WILL BE KEY IN 2014 - yum intl op margins

YUM: CHINA WILL BE KEY IN 2014 - chinappp



Feel free to call with questions.



Howard Penney

Managing Director


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International Entertainment, the company controlled by the family of Asia’s fourth-richest man, Cheng Yu-tung, agreed to pay as much as HK$7.35 billion ($948 million) for a 70% stake in Sun City Gaming Promotion Co, a junket operator. Cheng owns a 10% stake in closely held Sociedade de Turismo & Diversoes de Macau SA (STDM) - the 10% stake in STDM gives him control of 293 million shares of SJM.


Sun City expects its credit facilities offers to customers will be no less than HK$12 billion during 2014 and 2015 while the rolling turnover at its VIP rooms across Macau will be no less than HK$1.68 trillion, it said in the statement.



According to multiple industry sources on Thursday, the Korean government plans to announce its new tourism strategy later this month, which, among other things, would relax financial rules for foreign bidders to earn casino licenses in the nation’s economic zones.  “We are considering easing the bidding standards after receiving complaints that it is too difficult to meet the criteria of BBB credit ratings,” said a government official. “But we have yet to decide on detailed plans.”  Caesars and Universal are potential bidders. 


Korea’s casino operator Paradise Group, together with Japan’s Sega Sammy Holdings, has already launched an 11,190-square-meter resort project, with its construction planned to start in April for completion by 2017. 


TODAY’S S&P 500 SET-UP – January 10, 2014

As we look at today's setup for the S&P 500, the range is 25 points or 0.71% downside to 1825 and 0.65% upside to 1850.                                                   










THE HEDGEYE DAILY OUTLOOK - 10A                                                                                                                                                                  



  • YIELD CURVE: 2.54 from 2.54
  • VIX  closed at 12.89 1 day percent change of 0.16%

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Nonfarm Payrolls, Dec., est. 196k (prior 203k)
  • 8:30am: Unemployment Rate, Dec., est. 7% (prior 7%)
  • 8:45am: Fed’s Lacker speaks in Raleigh, N.C.
  • 10am: Wholesale Inventories m/m, Nov., est. 0.4% (pr 1.4%)
  • 10am: IBD/TIPP Economic Optimism, Jan., est. 46 (pr 43.1)
  • 11am: Fed to purchase $2.5b-$3.5b in 2019-2020 sector
  • 1pm: Fed’s Bullard speaks in Indianapolis
  • 1pm: Baker Hughes rig count


    • 9:30am: Joint Economic Cmte holds hearing on Dec. employment, w/ testimony from BLS Commissioner Erica Groshen
    • 9:30am: House Nat. Resources Cmte panel hearing on seismic exploration of Atlantic outer continental shelf
    • 10am CFTC holds closed meeting on enforcement matters
    • 12:30pm: Amtrak President Joseph Boardman delivers address on passenger rail issues; National Press Club


  • Dec. job gain in U.S. probably capped best year since 2005
  • Debt rule faces dilution as regulators heed bank warnings
  • ICE said to hire Evercore to sell NYSE technology divisions
  • Google X staff meet w/FDA pointing to possible medical device
  • Apple cuts China iPhone online, store price for holiday sale
  • Goldman Sachs denies Singapore stock dump, countersues Quah
  • LightSquared awaits regulatory approval; funding deadline near
  • YRC may drop after Teamsters reject accord tied to refinancing
  • Aegerion gets U.S. subpoena on rare-disease drug marketing
  • Chevron says 4Q net income fell as energy production declined
  • Bazaarvoice PowerReviews deal can be blocked by U.S.: judge
  • PCs mark steepest drop in 2013 with 10% decline in shipments
  • U.K. industrial output unexpectedly stagnated in Nov.
  • China’s imports rise to help nation claim trade crown
  • NTT Docomo adds most Japan users for first time since 2011
  • U.S. Funding Deadline, Retail Sales, GE: Wk Ahead Jan. 11-17


    • No earnings expected from S&P 500


  • China’s Ore to Coal Imports Reach Records in ’13 as Demand Gains
  • Amazon Soy Route Seen Extending Brazil Lead on U.S.: Commodities
  • Nickel Surges After Report Indonesia Detained Chinese Vessels
  • WTI Crude Rises From Eight-Month Low on Signs Losses Excessive
  • Gold Moving-Average Oscillator Returns Most Through 2013 Plunge
  • Gold, Silver Imports by India Tumble as Government Keeps Curbs
  • Wheat Futures Head for Longest Weekly Losing Streak in Two Years
  • Chalco Says Has Enough Bauxite Stored Ahead of Indonesia Ban
  • Rubber Posts Biggest Weekly Drop Since April on China Demand
  • Red Kite Says Copper Outlook Turns Positive With Glut Delayed
  • LNG Export Surge Boosting Prices for Australian Buyers: Energy
  • Sugar Traders Turn Most Bearish in Four Months on Indian Exports
  • OPEC Outages Propping Up Oil Price Mask Weak Demand: Bear Case
  • American Water Expands Military Business With $288 Million Deal
  • Gold Rises Before Jobs Data as Investors Weigh Demand, Tapering


























The Hedgeye Macro Team















This note was originally published at 8am on December 27, 2013 for Hedgeye subscribers.

“Difficulties are just things to overcome, after all.”

 -Ernest Shackleton


Even though many of us thoroughly enjoy our jobs, most work years are still typically a bit of an endurance test.  Luckily, as I wrote yesterday, the U.S. stock markets had a very healthy year and returns were up and to the proverbial right.  So, for stock market operators, 2013 wasn’t all that much of an endurance test.


I recently finished reading a book called, “Endurance: Shackleton’s Incredible Voyage”, which tells the story of Ernest Shackleton and his failed attempt at being the first person to cross Antarctica from sea-to-sea via the pole.   Shackleton’s ship was named the Endurance and endure is exactly what he and his shipmates did.


The Endurance departed from South Georgia for the Weddell Sea on December 5th, 1914.  Two months later the Endurance was frozen in an ice flow and Shackleton ordered the abandonment of the ship and her conversion into an ice station.  For the next 8 months, the crew lived on the ice floe in the middle of the Antarctic Sea until the ship was finally broken in half by ice pressure.


At that point, Shackleton order his crew to another ice floe and for the next six month, until March 1916, he and his crew shifted between various floes.  By April, their current flow was becoming too small and Shackleton and his crew jumped into the remaining life boats to make a five day harrowing trip to Elephant Island. 


After a couple weeks on the deserted Elephant Island, Shackleton selected a crew of six to sail with him across the Drake Passage back to South Georgia Island, the nearest point of civilization more than 600 miles away.


The Drake passage is widely considered the most challenging water to sail on the planet. According to Wikipedia:


“There is no significant land anywhere around the world at the latitudes of the Drake Passage, which is important to the unimpeded flow of the Antarctic Circumpolar Current which carries a huge volume of water (about 600 times the flow of the Amazon River) through the Passage and around Antarctica.”


Shackleton and his crew sailed the Drake Passage in a 20-foot wooden sail boat in the middle of a hurricane and eventually made it to a whaling station on South Georgia Island (only after crossing the Island on foot, something no man or men had done to that point).  So, after almost 20 months of being stranded in the Antarctic, Shackleton and his crew made it to civilization.  And that, my friends, is endurance!


Back to the Global Macro Grind...


After a relative tame investing year in 2013, the question for all of us is: what will we have to endure in 2014 to generate outperformance? There are a few things that potentially come to mind, specifically:


1)      Debt Ceiling – The debt ceiling is set to expire on February 7th, though the Treasury Department has the ability to extend this via the use of extraordinary measures for about another month.  Treasury Secretary Jack Lew, and thus the Obama administration, has already sent the opening volley in a letter to Congress last week.  As Lew wrote in the letter:


“The creditworthiness of the United States is an essential underpinning of our strength as a nation; it is not a bargaining chip to be used for partisan political ends.”


In part he is of course correct, the debt ceiling shouldn’t be used as a bargaining chip, but in reality 2014 is an election year and it is a very good bargaining chip for the Republicans. In particular the Tea Party, who need a win to go back to their constituents with after the recent budget compromise.


In the Chart of the Day, we show the return of the SP500 in the summer and early fall of 2011.  As you may recall, while it wasn’t as difficult as sailing the Drake Passage in a wooden row boat, the last major debt ceiling debate was a difficult and volatile period for U.S. equities.


2)      Interest rates – As we’ve noted, the U.S. interest rate market has basically already front run the beginning of tapering.  The 10-year yield has close to doubled from the lows of May of this year to the recent high of around 3.0%.  Certainly increasing rates has its positive implications, especially as it relates to supporting U.S. dollar strength, the challenge of course is controlling the speed at which rates normalize.   An accelerated increase in interest rates will undoubtedly serve to stymy economic growth.


In the short run, the most significant impact that rising rates will have is on the housing market.  In part, the impact on the mortgage market is already being seen.   According to the Mortgage Bankers Association, mortgage applications fell 6.3% on a seasonally adjusted basis last week to their lowest level in 13-years.  National home prices are unlikely to continue climbing if mortgage demand and affordability are falling.


3)      Chinese growth – The Shanghai Composite is having a positive morning up more than 1.4% as Chinese Interbank rates fell for the fourth day in a row.  While the spike in Chinese interbank rates has garnered headlines over the last few weeks, our Asia Analyst Darius Dale has been quick to note that much of this recent spike relates to a liquidity crunch going into year-end and is likely to be short lived. The broader question for Chine relates to economic growth.


Certainly, managing growth lower will be important for Beijing in reigning in domestic credit growth and rebalancing the economy, but what of the implications globally?  A Chinese growth rate potentially slowing from 7.5% to 6-7% will definitely have implications on global economic activity.  Some may be positive, such as a decline in demand, and thus price, for certain commodities.  Conversely, a lower than expected Chinese growth rate may be a shock to barely recovering Western countries and companies that depend on Chinese demand.


In aggregate, the three points above may actually not provide an endurance test for stock market operators in 2014, but merely be “icebergs” that we easily sail around.  Only time will tell on that front.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.91-3.02%

SPX 1810-1855

DAX 9234-9563

VIX 11.35-13.94


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Endurance - Chart of the Day


Endurance - Virtual Portfolio


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