What's Going On?

This note was originally published at 8am on January 06, 2014 for Hedgeye subscribers.

“If you really don’t know what’s going on, you don’t even have to know what’s going on to know what’s going on.”

-George Goodman


Sadly, one of my favorite authors and financial writers, George Goodman, passed away this weekend. He was 83 years old. After graduating magna cum laude from Harvard and winning a Rhodes Scholarship, Goodman published his first novel, The Bubble Makers – then went onto to join the “US Army Special Forces in 1954 in the intelligence group known as Psywar.” (Wikipedia)


“Goodman’s first non-fiction book, The Money Game (1968), was a number one bestseller for over a year. In the book he memorably introduced the catchphrase “assume a can opener” to mock the tendency of economists to make unjustified assumptions.” (Wikipedia)


Over the years, I’ve cited The Money Game many times. Today’s quote comes from that book and my Early Look is dedicated to Goodman who taught me a great deal while he wasn’t watching. Taped on the insert of one of my notebooks is that “a man is really at his best, his most fulfilled, when he’s on his way to becoming what he is going to become…” I’m grateful for that opportunity, every day.


Back to the Global Macro Grind


If you really don’t know what’s going on in markets for 2014 YTD, now you know. It’s sitting right there in front of you on your screen. That is the score. That is Mr. Macro Market’s Game. And we’re all tasked with playing the game that’s in front of us.


On the heels of Asian Equity markets getting banged up last week, Japan opened 2014 for stock market trading overnight and got smoked for a -2.4% drop in the face of a barely up Japanese Yen. Get the Yen right, and you’ll get the Nikkei right – for now.


China reported yet another #GrowthSlowing data point last night as well. Its Services PMI print for DEC slowed to 50.9 versus 52.5 in NOV and Chinese stocks dropped another -1.8% on that. For 2014 YTD, the Shanghai Composite is already down -3.3%.


With Japan and China -2.4% and -3.3%, respectively, what other big Equity indices are down so far for the YTD?

  1. SP500 -0.9%
  2. MSCI World Index -0.9%
  3. MSCI Emerging Latin American Index -2.1%
  4. MSCI Emerging Market Index -2.3%
  5. MSCI Asia ex-Japan Index -2.4%

This shouldn’t be a huge conceptual surprise given that the US Dollar is +0.9% YTD. Emerging Markets in particular do not like #StrongDollar. But those of you who embraced that reality into the USD’s 2013 highs (July) know what’s going on there too.


Can the US Dollar continue higher? With Janet Yellen being confirmed tonight, I doubt it. But my doubts are often wrong, so we’ll deal with whatever Mr. Macro Market decides on this front. Is there any other way to accept what’s really going on?


From a long-term @Hedgeye TAIL risk perspective, where the US Dollar Index is at is significant in that it’s a principal and directional driver for other massively interconnected global macro risks. Check out the last price of the following Big 3 Macro levels vs. our TAIL lines:

  1. US Dollar Index long-term TAIL line = $81.12
  2. Copper’s long-term TAIL line = $3.33/lb
  3. WTIC and Brent Oil long-term TAIL lines =  $98.26 and $108.89, respectively

While Dollar UP, Oil DOWN doesn’t yet have the correlation risk in our model that we’d jump up and down about (30 day and 180 day USD/Brent Oil correlations are +0.21 and -0.45, respectively), that doesn’t mean the Mr. Macro Market won’t change that.


On last week’s +0.5% move in the US Dollar Index:

  1. WTIC Oil was down -6.3%
  2. Brent Oil was down -4.7%
  3. Oil Volatility (VIX) was +30.9%! to 20.60

As I am sure Goodman would agree, volatility in an “asset class” that everyone and their brother is net long of breeds contempt. A breakout towards 30-40 Oil VIX would most certainly wake up consensus – because consensus is big time long of oil.


Looking at last week’s closing CFTC Futures/Options consensus positioning, here’s what I mean by that:

  1. BULLS: Crude Oil is the biggest net long position in Global Macro right now at +381,392 contracts
  2. BEARS: Japanese Yen is the biggest net short position in Global Macro at -143,384 contracts

In other words, if you are long Oil and the Nikkei on Down Yen expectations, join the club.


I don’t feel like we need to make a call for the sake of making a call right here and now on things like Oil and Yen. Going into last week we weren’t short Oil, so I missed that – but won’t miss shorting it on the bounce if it fails at TAIL resistance again. If Brent or WTI crude oil recapture TAIL supports, so be it.


That’s what’s going on in macro. The game is constantly changing. And it’s our job to change alongside it.


Our immediate-term TRADE Risk Ranges are now:


SPX 1817-1852
USD 80.52-81.12

Brent 106.99-109.40


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


What's Going On? - Chart of the Day


What's Going On? - Virtual Portfolio


Takeaway: Current Investing Ideas: CCL, DRI, FDX, FXB, GHL, HCA, RH, TROW, WWW and ZQK


Below are Hedgeye analysts' latest updates on our high-conviction stock ideas and CEO Keith McCullough's refreshed levels for each stock.




Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers. 

  • "Trade" is a duration of 3 weeks or less
  • "Trend" is a duration of 3 months or more
  • "Tail" is a duration of 3 years or less


The latest comments from our Sector Heads on their high-conviction stock ideas.


CCL – Hedgeye Gaming, Lodging & Leisure analyst Todd Jordan reiterates his bullish thesis on Carnival. Next week, his team will have visibility into "Wave Season" and will update their take accordingly. CCL is up 15% since being added to Investing Ideas, while the S&P 500 has gained 2.5%.




DRI – Hedgeye Managing Director Howard Penney has been calling Darden’s "strategic plan" woefully inadequate since Day One.  Needless to say, people have clearly been listening to the veteran Restaurants analyst.  Earlier this week, Barington Capital publicly came out and called for a broader breakup of DRI, which would include spinning off the Olive Garden brand.  The activist group plans to host an online presentation on January 30, 2014 to provide more color around their plan to enhance shareholder value.


If these activists are successful in forcing change, Penney sees significant upside to the stock. Mind you, the near-term fundamentals of the business are ugly and current trends in the casual dining sector don’t do much to allay these concerns.  We are bullish on DRI, but acknowledge it may not be the smoothest ride. Darden is a name you want to hold over the long-term.



FDX – Shares of FedEx weakened a bit on UPS’s pre-announcement of disappointing earnings.  Much of the UPS miss appears related to the challenges of excessive, close-in volume in the holiday season.  While there may be some read through to FDX’s costs, we do not expect the holiday challenges to have an ongoing impact on either company.  If anything, excess demand from e-commerce could be seen as a long-run positive.  We will need to see UPS’s report to confirm the full nature of the preannouncement, but we do not expect it to impact our bullish thesis on FDX.



FXB – We remain bullish on the British Pound versus the US Dollar, a position supported over the intermediate term TREND by prudent management of interest rate policy from Mark Carney at the BOE (oriented towards hiking rather than cutting as conditions improve) and the Bank maintaining its existing asset purchase program (QE).




UK high frequency data continues to offer evidence of emergent strength in the economy, and in many cases the data is outperforming that of its western European peers, which should provide further strength to the currency. Notably this week the UK reported strong retail sales, up 5.3% in DEC Y/Y vs expectations of 2.5% and 1.8% in NOV. CPI also moderated 10bps to 2.0% in DEC Y/Y versus the previous month – we expect this cut in the consumption tax to continue to boost business and consumer confidence and with it consumption.


The British Pound is holding its Bullish Formation, which we expect will continue to be supported by prudent monetary policy from the BOE and strengthening economic fundamentals.



GHL – Bulge bracket bank earnings season shed some light on where the growth was to finish 2013. The earnings releases of JP Morgan, Goldman Sachs, and Bank of America were all consistent in that mergers and acquisitions or M&A had excellent finishes to the end of year which bodes well for the boutique M&A firms (they specialize in M&A versus these larger banking operations where M&A is only 5-10% of total revenues).




The largest banking operation in the sector, JP Morgan, had a 35% increase quarter-to-quarter from 3Q13 in M&A with Goldman Sachs putting up 38% higher revenues q-o-q and even Bank of America (more of a trading and underwriting specialist) which had M&A revenues up 42% from last quarter.


The across the board validation of much improved M&A results in the fourth quarter is a good indication for Greenhill (GHL)’s result on Thursday, January 23rd.  While GHL’s quarterly earnings result will likely be less important than management’s assessment of the state of the industry, with the past 3 years having been flat to down in global M&A volumes, any sort of positive indication that things are improving should be well received by investors (GHL is still an unpopular stock with only 1 buy recommendation out of 11 and hence having low expectations).  


We estimate that 2014 will be the first positive year of M&A volume improvement since 2010.



HCA – The concern over admission growth in the hospital sector has been growing all quarter.  Citi's team wrote a headline-grabbing note saying Q413 was the "worst ever" for hospitals.  But it's important to separate the headline (which is frightening) from the fundamentals which continue to look good to us and that we published.


Over the last week, we saw a lot of evidence that we will continue to be right.


First, HCA Holdings pre-announced that Q413 came in better-than-expected. In addition, Tenet Healthcare Corp (THC) which is HCA's closest peer, said something very similar. 


Meanwhile, the companies that supply the hips and knees and other devices that drive profits at hospitals?  We saw a host of companies announce or indicate their sales trends are improving, while our macro work continues to tell us the trend will continue.  



RH – We remain extremely bullish on Restoration Hardware. Our fundamental thesis remains unchanged, and we think it’s important to remember that 2014 will be the first year of square footage growth after a number of years of store closings. Store openings/expansions in Greenwich, CT, Los Angeles, New York, and Atlanta starts phase-1 of the real estate transformation. Couple that with increased sales productivity, robust dot-com growth, new category extensions, and GM improvement – you get, in our opinion, the best 5-year growth story in all of retail.


So... what’s the reason for the pullback?


In the absence of news on RH, we have to defer to conjecture and experience to help explain investors’ behavior. At and prior to the ICR conference in Orlando, FL you had a whole slew of retailers (everyone from Pier1 to Gap) miss holiday sales numbers. The key reasons for the lackluster holiday season: mall traffic, a highly promotional environment, and weather. In light of the current state of retail, investors have drawn the conclusion that RH will be the next to preannounce disappointing holiday earnings. Let’s be clear about one thing – we think it’s highly unlikely that RH preannounces.  As it relates to the Holiday season, RH, unlike many other retailers is not tied to the Holiday shopping period.


Over the past 12 months of reported data 55% of sales have been furniture, and of the remaining 45% a negligent amount of that is related to holiday specific inventory (which we might add was completely gone from the one store we visited on Christmas Eve). Do people buy sofas as presents…they might…but we don’t see that as a gift giving category sensitive to the ‘highly promotional’ holiday sales environment. Weather may have a minimal impact when it comes to the 10% of items that are actually sold and taken home from a retail store, but will it stop you from buying a couch? Our answer to that is no as well, the furniture buying is event driven (i.e. home remodel, move, etc) and is stretched over  5-8 store visits. Lastly, RH sales are essentially booked for this quarter (Nov. – Jan.), remember that 90% of orders are fulfilled from the company’s distribution centers. Order fulfillment at this time takes 6 – 9 weeks currently depending on demand, and is not booked as revenue until it arrives at the customers homes. If we do see a weather induced pullback, it’d most likely be felt in Q1 not Q4. It’s hard to even entertain the weather argument with RH, since nearly 50% of its sales come from the .com channel.


We understand that it’s often difficult to remain positive during pullbacks – but the logic in the bear case is less than convincing. Under a worst case scenario, could we see a 5% hit to RH’s top line? Perhaps – given the horrific results we’re seeing at other retailers. But that means that sales grow 30% instead of 35%.  The consensus whisper is for a comp of 10%, which we find to be ridiculous.


RH remains our top long idea in retail by a country mile. Nothing that is happening in the current climate could affect our $11 earnings power thesis.



TROW – Shares of T Rowe Price continue to remain attractive as the firm should benefit from a strong finish to 2013 from an equity flow standpoint. Industry equity mutual fund flow totaled a $46 billion inflow in the 4th quarter of 2013 compared to $55 billion which was redeemed within bond funds. T Rowe Price, as largely an equity only manager with the best equity mutual fund performance in the industry, should have benefited from this dynamic in the last quarter of last year. In a recent conversation with TROW management, the firm also referenced that its Asian sovereign wealth clients which have been in redemption the past two quarters, have been less active in the 4th quarter which could remove one major negative catalyst within the story. 





WWW – Prior to their presentation at the ICR conference on Tuesday, Wolverine Worldwide reaffirmed the top end of its EPS guidance and took down its revenue estimates by $20 mm. While some took this as an excuse to get even more beared up on WWW, we did not. The holiday selling period was abysmal for many reasons and for practically every brand/retailer on the planet, so for WWW to come through that environment virtually unscathed was a testament to the company’s strong portfolio and diversity (both brand and geographic).


The bearish view was centered on the company’s lighter than expected FY14 revenue guidance and the reported weakness in the Sperry brand. As it relates to revenue it’s important to remember that WWW is the master of tempering the street’s expectations. On its Q4 2012 Conference Call the company guidance called for FY13 Adjusted EPS to be in the range of $1.25 to $1.33. Guidance has risen 7% to where it currently sits today. So we take the company’s conservative targets with a  grain of salt - especially when you consider that 2013 was an investing year. This will be the first year where the PLG brands will be able to leverage the global distribution capabilities of its parent company moving from their current 5% of sales outside the US towards the 40% company average. It won’t happen in one year, but that type of opportunity gives us comfort in our double digit sales growth target for FY14. Sperry, on the other hand is not a concern to us in the slightest. The weakness is Sperry was related to inventory of key winter boot styles, not the impending slow down of the boat shoe category in the US that we’ve been assured was looming for four straight quarters. Even if that trend were to decelerate, we’d happily trade 5% growth in the US for 30% growth in International.


The punchline is that we think management’s ‘msd top line and dd bottom line guidance will ultimately result in 10% sales and 20%+ EPS growth. Our estimates remain well above consensus.



ZQK – Quiksilver announced this week that it sold the Tony Hawk brand to Cherokee Inc for $19 million. Tony Hawk was classified as a non-core brand and was sold exclusively at Kohl’s (definitely not on par with the likes of the namesake Quiksilver line, Roxy, and DC footwear). The cash will help the company clean up their balance sheet and fuel investments in core brands.




There are still three assets left to go (Surfdome Shop, Moskova brand, and Maui and Sons) to get ZQK from its prior 11 brand portfolio to its core 3. We view 2014 as a year of cost-cutting and reorganization, which does not really get us too excited. But that still gets ZQK from a loss of $1.53 last year to a modest profit in 2014.  But 2015 and beyond is a much different story.


Our long-term model has ZQK adding $600mm in revenue as the company’s new, 12 month old, management focuses its attention on growing the Quiksilver, Roxy, and DC brand free of the distraction of low grossing non-core brands. In the end, this is a 40%+ EPS grower that’s a double if we use a 20x p/e, which we think is more than fair based on the soon-to-be-realized growth profile. 


*  *  *  *  *  *  *


Macro Theme of the Week: #GrowthDivergences

In our first Investing Ideas of 2014, we introduced Hedgdeye’s 1Q14 Macro Themes, three key global macro forces that we believe will play a dominant role in shaping the markets in the near term. 


The themes are:

  • #InflationAccelerating
  • #GrowthDivergences
  • #FlowShow

This week, we elaborate on the second theme, #GrowthDivergences, as Darius Dale, Hedgeye’s resident expert on all things Asia, focuses “All Eyes on Japan” in this HedgeyeTV video.



Hedgeye CEO Keith McCullough has been chanting a mantra of “Buy The Darned Bubble!” since December.  While the current rise in US equity prices may not be sustainable as what economists call a “secular” trend, meaning a long-term trend that is not seasonal or cyclical in nature, McCullough says there is still money to be made before prices pause or meaningfully correct. 




In the Q1 call, Hedgeye’s Macro team tracked the world’s major markets and identified significant divergences in growth rates among national markets, and in the stages of our proprietary Growth / Inflation / Policy four-quadrant model.  For Japan, the headline was “Recovery Losing Steam?” with indications that the economy is heading towards Quad #3: “Growth Slowing and Inflation Accelerating.”  This is a dicey setup, as both monetary and fiscal policy find themselves in a box.  On the monetary policy side, in a growth-slowing environment it will take more and more quantitative easing, to achieve less and less impact in the financial markets.  This concern was voiced in the recently released minutes of the latest meeting of the US Federal Reserve board, and seems to have contributed to the decision to finally announce a taper.


But tightening fiscal policy in a weak growth environment will exacerbate the forces acting as a brake on the economy.  Thus, the central bank is damned if they do (QE – which will continue to damage their currency, but to diminishing effect on the markets) and damned if they don’t (slowing economic growth risks turning back the equation, hurting both the currency and the financial markets).  What’s a central banker to do?    Dale’s work focuses on Japan’s currency.  If you want to get Japanese markets right, you’ve got to get the Yen right – a correlation that has proven out very consistently over longer periods.


Bubble Downgraded From “Buy” To “Hold”???


Dale’s models flashed high conviction on the long side in Japan a little over a year ago.  Dale says Japanese equities still make sense for now, but his conviction going into the first half of 2014 is not so strong as in the first blush of Abenomics-driven market euphoria.


With Abenomics policies continuing to trash Japan’s currency, Dale’s call remains bearish on the Yen.  This should be correspondingly bullish for Japanese equities over the intermediate-term TREND and long-term TAIL durations.  Dale believes Japanese economic growth could slow through the first half of this year.  Therein lies one uncertainty, because deflationary concerns could ripple through to corrections in Japanese equities.


Governments purposely weaken their own currencies – if you live in the Bernanke-ed States of America, you certainly get that – on the theory that, as the value of the currency goes down, the price of stuff goes up.  This has certainly worked for US equities.  So far, it has worked well for Japanese equities too, which is why Dale thinks a deflationary trend could be seen as negative in the Land of the Rising Equity Markets.


Dale suggests that intermediate and long-term investors in the Japanese markets might look to hedge against the possibility of an intermediate-term TREND correction.  And for the first time in a long time, near-term pullbacks in the Nikkei may not be points to add to long-term positions.  This is the first time in the life of the “Abenomics trade” that we’ve said wait and see on pullbacks.  Dale says the markets need to hold at key long-term support levels for the bubble in Japanese equities to keep expanding.


The Land Of Falling Expectations?


For much of 2010-2012, US equities responded positively to negative economic news, as investors preferred hearing the shoes, rather than waiting for them to drop.  Dale thinks this could replicate in Japanese markets.  “There is a rising possibility that Japanese equities start to actually cheer on bad economic data,” he says.  While the consensus is that Japanese economic growth will slow in the second quarter, Dale’s work indicates the slowdown may already be upon us in 1Q14.  “Considering that Japanese economic growth data has been white-hot,” says Dale, “it’s not exactly going out on a limb to call for it to cool.”  #InflationAccelerating in a low-growth environment could further dampen Japan’s consumer-aided recovery.  And economic data comparisons year-over-year will naturally get tougher on the back of 2013’s strong showing, making the economic situation appear still more daunting.


Finally, Dale believes Japan’s corporations have not fully bought into Abenomics as a sustainable long-term driver of the economy.  This was exactly the same set of concerns that held back growth in the US, as companies and banks alike hesitated to undertake new projects in an atmosphere of regulatory and policy uncertainty, and resulting unclear messages from the financial markets.  If the major companies at the core of Japan’s economy are hesitant, then a growth slowdown could become a self-fulfilling prophecy.


A Closely-Watched Bubble


Dale says the next 6-9 months could be the first real test for the economy since Japanese central bank governor Haruhiko Kuroda materially changed the Bank of Japan’s monetary policy. 


For now, Japanese markets express faith that the BoJ will continue its program of “Quantitative and Qualitative Easing,” with 80% of economists surveyed by Bloomberg expecting additional stimulus.  But if the impact of that stimulus dwindles – or if the bank switches course – near-term weakness in the Nikkei could turn into a rout for investors.  Dale says the Bank of Japan’s recent public statements “suggest the BoJ stands ready and willing to react to any confirmation of lost momentum on either the growth or inflation fronts in the interim.”


For investors in the Japanese markets, the big question is: how long is “the interim”?  Here at Hedgeye we’re keeping our eye on the Bubble.


- By Moshe Silver

Moshe is a Hedgeye Managing Director and author of the Hedgeye e-book Fixing A Broken Wall Street



The Economic Data calendar for the week of the 20th of January through the 24th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.



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Ackman At the Herbalife Gate, Again

Take-away: We’re buying the dip in HLF as we think that the news about Chinese officials investigating Nu Skin is a separate issue from HLF, despite both businesses sharing risk on pyramid scheme claims. 


What’s going on with NUS and HLF?

  • Chinese regulators yesterday said they’d investigate accusations from The People’s Daily, the Communist Party’s main propaganda organ, which called Nu Skin, a skin-care and nutritional products company, a pyramid scheme.
  • Nu Skin (NUS) is trading down -45% since 1/14 (looks like someone had some inside info ahead of the announcement).  NUS earns ~ 31% of its revenues from mainland China.
  • Herbalife (HLF) is getting hit on pass-through fears that it could be the next target of an investigation (either abroad and/or in the U.S.). HLF has ~ 11% net sales from China, according to Q3 2013 results.
  • As background, the debate around the business practices of HLF took flight late in 2012 when Bill Ackman of Pershing Square Capital presented a 334 page PowerPoint at the Ira Sohn conference (on 12/20/2012) calling HLF a pyramid scheme, and announcing that his fund would take a short position in HLF with a $0 price target.
  • Rival activists, including Carl Icahn and Dan Loeb (and others), were quick to take the other side of Ackman’s short bet. 
  • Since Ackman’s presentation the stock has soared as high as 212%. As of December 2013, Ackman has lost as much as $500M in the position.
  • If you’re unaware of the intense animosity and scorn that these rival activists have for Ackman, see Vanity Fair’s April 2013 article The Big Short War.


Today we added HLF as a buy in our Real-Time Alerts

  • Today, it was announced that Ackman plans to claim in a public presentation next month that HLF operates illegally in China.
  • Yesterday’s Nu Skin news along with Ackman’s announcement today have sent HLF down -12% in the past two days.
  • We view Ackman’s decision to claim HLF operates illegally in China as an effort to talk up his book.
  • We think this position is supported by a number of factors:
    • As we’ve stated before in our research, we do not know whether HLF is or is not a pyramid scheme. A Federal agency (SEC, FDA, FTC, or IRS) would have to make this determination (not a money manager) and we’ve yet to see any interest in an agency to open Pandora’s Box on the questionable business practices and accounting of multi-level-marketing companies.
    • In his original presentation Ackman was unable to convince investors that HLF is a pyramid scheme (based on the stock’s move). He’s now trying to augment his claim, but now the target is China, a country steeped in opacity’s vine when it comes to transparency.  Remember, Ackman wasn’t able to equivocally show how the pyramid scheme worked in the U.S., with the aid of geographic proximity and the ability to communicate in his mother tongue.
    • We cannot underscore more how vehemently the rival activists want to bury Ackman on this position – even if they believe HLF is a pyramid scheme. We expect this rival camp to continue to drive the debate, and the stock.
    • The company has also done all it can to insulate itself and protect the stock price, from hiring the high profile David Boies of the law firm Boies, Schiller & Flexner LLP to issuing aggressive stock buybacks and dividend raises. 
    • Finally, HLF has a lot less skin in the game in China compared to NUS, as we note above.  While there’s the risk that a decision in one country can tumble weed into other regions, our investment approach with HLF is simply to take advantage of the stock that is oversold on fear.

Ackman At the Herbalife Gate, Again - zz. hlf


Matthew Hedrick


Takeaway: While our conviction over the next 3-6M is unlikely to be anywhere near where it has been, we think it pays to #BTDB in the Abenomics Trade.

This note was originally published January 13, 2014 at 16:19 in Macro




  1. We remain bearish on the Japanese yen and bullish on Japanese equities with respect to the intermediate-term TREND and long-term TAIL durations.
  2. With respect to the former duration, however, our conviction is dramatically lower than it was 12-15M ago.
  3. Specifically, we think Japanese economic growth is likely to slow throughout 1H14. To the extent that catalyst results in declining inflation expectations, we’d expect to see a [continued] correction in the USD/JPY cross and concomitant correction in the Japanese equity market.
  4. A immediate-term TRADE breakdown in the aforementioned currency cross (TRADE support = 102.68) will likely result in the exchange rate testing its intermediate-term TREND line of support at 100.06. An immediate-term TRADE breakdown in the Japanese equity market (TRADE support = 15,698) will likely result in the index testing its intermediate-term TREND line of support at 15,045.
  5. The aforementioned TRADE lines a good levels to buy protection to the extent you are looking to hedge for more noteworthy downside in your existing SHORT yen or LONG Japanese equity exposure(s). The aforementioned TREND lines would be a good place(s) to add to existing positions – to the extent you have pared them back or have plans to do so.
  6. Furthermore, there is a rising probability that both the USD/JPY cross and Japanese equities start to actually cheer on bad economic data; that would represent a material inflection from trends observed in years past, but very much akin to what we’ve all observed in the US over the course of 2010-12.



The consumption tax hike (scheduled for APR 1st) has likely been the most over-analyzed fiscal policy catalyst in the world over the past 6-12M, so we’re not going to waste your time adding to the slew of analysis. Japanese growth is a near-lock to slow in second quarter.


Where we are divergent from consensus is that we think Japanese economic growth slows in 1Q14E as well (i.e. sooner than the market might expect; Bloomberg consensus forecasts currently call for an acceleration to +3.1% YoY real GDP growth in 1Q14).




Considering that Japanese economic growth data has been white-hot in recent months/quarters, it’s not exactly going out on a limb to call for it to cool off, at the margins. Tough comps and #InflationAccelerating are threatening to suppress Japan’s consumer-aided recovery from currently elevated growth rates.










ALL EYES ON JAPAN - Consumer Confidence


ALL EYES ON JAPAN - Retail Sales


Moreover, despite marked improvement in domestic industrial production, manufacturing, capital goods orders, business sentiment, exports, etc., we believe that Japanese corporations have yet to fully buy into the sustainability of Abenomics – as evidenced by their forecasts for the USD/JPY cross and CapEx guidance that remains well off the peaks of previous economic cycles.


As such, the growth rates/index levels of the aforementioned indicators is at risk of slowing from currently-elevated levels until Japanese corporations get substantially more color on the much-anticipated “Third Arrow” of Abenomics (allegedly to be detailed in JUN).


ALL EYES ON JAPAN - Industrial Production


ALL EYES ON JAPAN - Manufacturing PMI


ALL EYES ON JAPAN - Capital Goods Orders


ALL EYES ON JAPAN - Economy Watcher s Survey




ALL EYES ON JAPAN - CapEx Guidance


ALL EYES ON JAPAN - Tankan JPY Forecast



To the extent a noteworthy slowing of Japanese economic growth results in declining inflation expectations, we’d expect to see a [continued] correction in the USD/JPY cross and concomitant correction in the Japanese equity market. It’s worth noting that the USD/JPY cross has a +0.85 correlation to Japan’s 5Y breakeven rate over the trailing 3Y.


ALL EYES ON JAPAN - Breakevens


ALL EYES ON JAPAN - JPY vs. Breakevens

Source: Bloomberg L.P.


That said, however, it’s hard to have a high-conviction view on that relationship at the current juncture. The next 6-9M is likely to present Japanese policymakers with their first real test on the economic growth front since Kuroda materially altered the way the BoJ conducts its monetary policy operations.


If Shirakawa were still in charge, we’d actually think about shorting the USD/JPY cross and shorting the Nikkei on a TRADE breakdown in the respective markets. Recall that Japanese capital and currency markets were constantly testing Shirakawa’s will to implement the necessary measures to overcome deflation – a task he ultimately failed miserably at.


Haruhiko Kuroda is a different animal altogether, however. It remains to be seen how much faith the market will have in his willingness to add to the BoJ’s “Quantitative and Qualitative Easing” program and how quickly they anticipate him doing so (80% of economists surveyed by Bloomberg expect additional stimulus measures by SEP). Faith, as evidenced by the net length in the futures and options market remains high – for now at least.




We too think Kuroda & Co. will continue to fight hard to achieve “+5% monetary math” and that expectation underpins our respective long-term TAIL biases on the yen and Japanese equities as outlined at the onset of this note. Moreover, the preponderance of recent commentary suggests they stand ready and willing to react to any confirmation of lost momentum on either the growth or inflation fronts in the interim.


ALL EYES ON JAPAN - 5  Monetary Math


Furthermore, there is a rising probability that both the USD/JPY cross and Japanese equities start to actually cheer on bad economic data; that would represent a material inflection from trends observed in years past, but very much akin to what we’ve all observed in the US over the course of 2010-12.


These views lead us to conclude that the current correction in the USD/JPY cross and the Japanese equity market are just that – corrections. As such, while our conviction over the next 3-6M is unlikely to be anywhere near where it has been in months and quarters past, we still think it pays to #BTDB in the dollar-yen and Japanese equities if and when the opportunity presents itself.


Feel free to ping me with follow-up questions if you’d like to dig in further on a specific topic(s).




Darius Dale

Associate: Macro Team


Takeaway: From Bull to Bear, we briefly run through our short thesis following our conference call.

We added CAKE to the Hedgeye Best Ideas list as a SHORT yesterday at $47.51 per share.


Click here to access the presentation: NEW BEST IDEA: SHORT CAKE




We have been bullish on CAKE for the better part of the past two years, but in this industry nothing lasts forever.  In full disclosure, CAKE is a strong company with a good management team, so we will be disciplined with this short call.


The bottom line is that 2014 is setting up to be a difficult year for the company.  To summarize our thesis, we believe the company’s three year run in improving margins is coming to an end.  Specifically, we believe the declines in food costs, labor costs, and other costs have run their course.


Traffic has declined for four straight quarters, a trend that management must address soon.  This suggests that 2014 could see an increase in labor and other costs as the company reinvests in store operations.  Factor in the minimum wage increases and the ACA, and it is clear that incremental pressure is beginning to build.




CAKE is scheduled to report 4Q13 EPS on 2/12.  Current consensus estimates suggest the company will report 2.0% same-store sales at the Cheesecake brand and 1.9% on a consolidated basis.  This would represent a slight slowdown in 2-year same-store sales trends of 30 bps.  We believe that those estimates are aggressive and have not been adjusted lower during the quarter despite sluggish industry sales trends.


On the 3Q13 earnings call, the company gave fairly aggressive guidance for 4Q13, due to the easy comparisons from a year ago.  The 0.9% comp from last year was the lowest of the 2012 and was impacted by the Presidential debate, Election Day, and Hurricane Sandy. 


Management commented on the 3Q13 call: “The housing market continues to recover, the stock market is up, there really doesn’t appear to be any negative calendar issues or holiday shifts that are impacting the fourth quarter.  I think that Thanksgiving and Christmas, there’s one less week between Thanksgiving and Christmas.  We don’t really think that’s going to impact us.”


However, one less week seemed to have an impact on a number of retailers this holiday season.  We are unsure why CAKE would be immune to these trends.


Consolidated revenues are expected to grow 4.1% in 4Q13 vs 3.5% in 3Q13, but we believe these numbers may also be aggressive given slower than anticipated 4Q13 trends.


Furthermore, the company is guiding to EPS of $0.57-$0.60 in 4Q13, based on a range of same-store sales between 1.5-2.5%.  The street is assuming the company delivers at the high end of the EPS range, currently registering at $0.59.  The current guidance for 2014 is for EPS of $2.29-$2.41, based on a range of same-store sales growth between 1-2%. 




In our opinion, the largest issues the company will face in 2014 is food inflation.  This becomes an even bigger issue considering management has limited pricing flexibility given the decline in traffic over the past four quarters.  Can they protect margins without perpetuating the recent decline in traffic?


Management is guiding to food cost inflation of 4-5% in 2014, driven primarily by shrimp and, to a lesser extent, salmon.  The company estimates this could impact 2014 by as much as $0.07-$0.10. 


As management stated on the 3Q13 earnings call: “We believe that we will be able to offset some of this pressure with slightly higher pricing, balancing our need to protect guest traffic and protecting our margins.  As a result, we factored in a net of about $0.04 to $0.07 into our 2014 earnings per share sensitivity.”


However, management failed to account for the spike in milk and cheese prices we are seeing early on in 2014.  In our opinion, this will add significant incremental pressure to the food cost line and will force management to lower their 2014 earnings guidance.  We run through this thesis in our presentation, including more thoughts on the topics, our earnings sensitivity analysis and the notion that management will be “in a box” in 2014.


If you haven’t already, we encourage you to read through the slide deck.  As always, we are available to talk.  Please feel free to call any questions. 













Howard Penney

Managing Director

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