“We shall not cease from exploration, and the end of our exploring will be to arrive where we started and know it for the first time.”
Yesterday we held our quarterly firm meeting in Stamford, CT. It was by all accounts a very successful day. We introduced new employees, celebrated recent wins and also contemplated strategic shifts to keep Hedgeye moving forward.
As an aside, it also coincided with my personal favorite day of the year, April Fool’s Day. Unlike those April Fool’s days of prior years, like when I fired Keith one year, this year’s joke was more benign, though we did manage to “suck” a few people in again. For those that didn’t see the faux press release about Wall Street 2.0: Hedgeye the Movie, it can be found here.
So at the company meeting, a key topic of discussion was how to generate contagious content / ideas. For those that didn’t know, the term, “content is king”, was first used in 1994 and then popularized by Bill Gates in an essay about two years later. So, as ideas go, the idea of content is king is not new, but it is certainly contagious.
Back to the Global Macro Grind...
In my mind, activist investment ideas are examples of ideas that need to become contagious before they become successful. Yesterday activist Starboard filed a presentation outlining the potential for Darden Restaurants ($DRI). A key take away from the presentation is that the Company’s EBITDA margins are at 7.4% versus the industry median of 10.3%.
As many of you know, Darden is also currently a favorite of Restaurant Sector head Howard Penney and is on our Best Ideas list. As a result, Starboard was kind enough to reference our work on Darden in their presentation. Specifically, they referenced a recent poll that we did:
“According to a recent poll conducted by sell-side research firm Hedgeye Risk Management, 84% of respondents said that they did not believe that management’s plan to spin-off Red Lobster would create value.”
We actually have created a polling product to specifically gauge sentiment and opinion in a more quantified fashion, which has, obviously, also had the derivative impact of creating contagious content.
Included in the Starboard presentation as well was this tweet from Penney:
“$DRI management shuts me out of another earnings call. Running out of time is not an excuse. @jannarone article on #CNBC was $$”
This point goes to the crux of Penney’s thesis on Darden, which is that management operates in a vacuum and is totally unwilling to listen to new ideas, especially from analysts that may disagree with them. Ignoring great ideas is the death knoll for any company. If you’d like to learn more about our thesis on Darden before it goes too viral, please email .
While we are on the topic of contagious content, I thought it would be worth highlighting an essay that Warren Buffett wrote for Fortune in 1977 (back when periodicals like Fortune still published essays):
“There is no mystery at all about the problems of bondholders in an era of inflation. When the value of the dollar deteriorates month after month, a security with income and principal payments denominated in those dollars isn't going to be a big winner. You hardly need a Ph.D. in economics to figure that one out.
It was long assumed that stocks were something else. For many years, the conventional wisdom insisted that stocks were a hedge against inflation. The proposition was rooted in the fact that stocks are not claims against dollars, as bonds are, but represent ownership of companies with productive facilities. These, investors believed, would retain their Value in real terms, let the politicians print money as they might.
And why didn't it turn but that way? The main reason, I believe, is that stocks, in economic substance, are really very similar to bonds.”
As you can see this basic concept that we have been pounding on, which is that when a currency is devalued that devaluation naturally creates inflation in dollar denominated asset classes, is not new. Neither is the idea that at a point, this inflation begins to negatively impact economic growth, which has the potential to have a negative impact on the returns of those assets classes levered to economic growth.
Certainly, of course, we aren’t suggesting we are in the midst of 1970s style inflation. Or, frankly, on the path to that any day soon, but commodity inflation is here, is persistent and is likely to be sticky. Most notably on the inflation front is what is happening to food (you know that stuff we eat).
In the chart of the day below, we’ve compared the performance of consumer discretionary stocks in the year-to-date versus the CRB Index versus the BLS Foodstuff Index. For those that can’t read the fine print, I’ll give you the punch line. The CRB commodity index is up more than 7% in the year-to-date, the BLS Foodstuff Index is up more than 20%, and consumer discretionary stocks are down on the year.
As Warren Buffett might say, you don’t need an economics PH.D. to see that correlation!
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.66%-2.80%
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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TODAY’S S&P 500 SET-UP – April 2, 2014
As we look at today's setup for the S&P 500, the range is 32 points or 1.57% downside to 1856 and 0.13% upside to 1888.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.33 from 2.32
- VIX closed at 13.1 1 day percent change of -5.62%
MACRO DATA POINTS (Bloomberg Estimates):
- 7am: MBA Mortgage Applications, March 28 (prior -3.5%)
- 8:15am: ADP Employment Change, March, est. 195k (prior 139k)
- 9:45am: ISM New York, March (prior 57.0)
- 10am: Factory Orders, Feb., est. 1.2% (prior -0.7%)
- 10:30am: DOE Energy Inventories
- EU finance ministers, central bankers continue Athens meeting
- 12:30pm: Fed’s Lockhart speaks in Miami
- 4pm: Fed’s Bullard meets reporters in St. Louis
- 10am: Supreme Court hears worker stock plans case arguments, may issue opinions
- 10am: GM CEO Mary Barra, NHTSA Acting Administrator David Friedman at Senate Commerce, Science and Transportation panel on defective ignition switch recall
- Budget panels/hearings:
- 10am: House appropriations panel: Energy Dept’s Sec. Ernest Moniz; Treasury Sec. Jack Lew
- 10am: House Energy and Commerce panel: EPA Administrator Gina McCarthy
- 10am: House Armed Services Cmte: Navy Adm. Cecil Haney, commander of the U.S. Strategic Command, Army Gen. Curtis Scaparrotti, commander of U.S. Forces Korea
- 10:30am: House appropriations panel: Labor Sec. Thomas Perez; U.S. Ambassador to United Nations Samantha Power
- 10:30am: House Energy and Commerce hearing on Obama’s plan to give up control of system for assigning website addresses
- 2:55pm: Obama speaks on minimum wage in Ann Arbor, Mich.
- U.S. Election Wrap: Camp Replacement; Scott Brown Visits Senate
WHAT TO WATCH:
- Amazon said set to debut TV-viewing device
- Netflix plans to target French mkt from Luxembourg: Les Echos
- Virtu said to delay IPO amid furor over Michael Lewis book
- GM CEO Barra, NHTSA Acting Admin Friedman at Senate on recall
- Microsoft executives speak at “Microsoft Build 2014”
- Energy Future plan said to almost wipe out owners KKR to Goldman
- House sends Ukraine aid bill to Obama rebuking Putin
- Russia pressures Ukraine to disarm “radicals” as NATO mulls response
- Greece said to plan EU2b bond sale in 1H
- British nuclear submarine joins search for missing Malaysian jet
- Malaysia sees possibility cause of MH370 loss won’t be known
- SAC asks managers to sign 2-yr deals to prevent departures: NYT
- GE to bid for part of Investec’s Australian ops: Australian
- ADM says it may seek to raise GrainCorp stake: WSJ
- Univar exploring IPO that may value co. at $6b: Reuters
- BNP Paribas sells Miami private bank to Santander: Les Echos
- Cofco to pay initial $1.5b cash for Noble Unit stake
- Bouygues says earlier offer for Vivendi’s SFR remains valid
- Acuity Brands (AYI) 8:47am, $0.83 - Preview
- Monsanto (MON) 8am, $3.06 - Preview
- Resources Connection (RECN) 4pm, $0.05
- Texas Industries (TXI) 6:21pm, ($0.58)
- UniFirst (UNF) 8am, $1.39
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Copper Pares Gains as Chile Earthquake Leaves Mines Undamaged
- Brent Falls Below $105 for First Time in Five Months; WTI Slides
- Billionaire Amazon Bet Vindicated as Apple Buys Tin: Commodities
- Gold Rises on Speculation Drop to Seven-Week Low to Spur Demand
- Sugar Falls With Coffee as Investors Review Brazil Drought Risk
- Soybeans Climb Third Day to 9-Month High as U.S. Stocks Dwindle
- Copper Surplus Seen by Study Group Growing to 595kt in 2015
- California Mountain Snow Pack Improves While Drought Persists
- Louis Dreyfus Commodities Readies for Possible IPO or Stake Sale
- MORE: Europe Would Need $215B Capex to Cut Russia Gas: Bernstein
- U.S. Joins EU in Seeking New Gas Supplies for Europe, Ukraine
- South Africa’s Platinum-Belt Economy Crippled by 10-Week Strike
- Powder River Coal Grabs Market Share in North Asia, South Korea
- Rebar in Shanghai Falls 1st Time in 4 Days on Ore Price Outlook
The Hedgeye Macro Team
This note was originally published at 8am on March 19, 2014 for Hedgeye subscribers.
"I am sometimes a fox and sometimes a lion. The whole secret in government lies in knowing when to be one or the other."
The old farm yard analogy of a fox licking its chops and entering the proverbial hen house can likely be applied to many current situations. On the global macro front the situation in the Ukraine and stand-off, of sorts, between the West and Vladmir Putin is likely the most relevant.
Certainly, the foxes in the Kremlin are licking their chops since annexing the former Soviet territory of Crimea. Is this the beginning of another Cold War? It is likely not. But the ineffectiveness in combating the Russian move certainly increases the likelihood of additional and more aggressive moves by the Russians. (By ineffectiveness, I read yesterday that the current, proposed sanctions by the U.S. would freeze the assets of a mere seven Russian citizens.)
Late yesterday, the first fatality occurred as a Ukrainian military base in Crimea was overtaken by Russian / Crimean troops. Albeit only one serviceman was shot, and reports are still conflicted as to how and by whom, the response by the leadership in the Ukraine is to now allow their military to use force as needed in Crimea.
Perhaps most telling yesterday was Vladmir Putin’s hour long speech, specifically this excerpt:
“Our Western partners headed by the United States prefer not to be guided by international law in their practical policies, but by the rule of the gun. They have come to believe in their exceptionalism and their sense of being the chosen ones. That they can decide the destinies of the world, that it is only them that can be right.”
Clearly, the old Russian fox Putin is licking his lips.
Back to the Global Macro Grind . . .
Assuming hostilities don’t accelerate in Crimea, the most significant impact from the annexation of Crimea by Russia is likely to be on the upcoming midterm elections. The media has been very clearly painting President Obama and his administration to have been ineffective in dealing with the Russians and Obama’s approval rating is starting to reflect as much.
According to the RealClearPolitics approval aggregate, Obama’s disapproval rating is now 52 and his approval rating is 43, for a spread of 9. Gallup runs the longest running approval poll and the spread in that poll is even wider. Currently, according to Gallup, Obama’s approval is at 41. This is the worst approval rating of Obama’s Presidency and lower than President George W. Bush at the same time in his Presidency.
The fact that President Obama’s approval rating is in free fall is likely to be felt by the Democrats in the upcoming midterms. In fact, the generic congressional poll aggregate, which effectively asks the respondent to say whether they would vote Republican or Democrat in congressional races, is basically tied (with the Republicans actually leading in some polls). This is an inflection point as the Democrats have led in this generic poll very consistently since the last mid-term elections.
Speaking of polls, yesterday our daily Hedgeye poll asked, “Are you feeling the price pinch at the breakfast table?” More than 75% of the respondents responded, yes. This obviously shouldn’t be a surprise given the fact that coffee, orange juice and lean hog prices have had almost parabolic moves in the year-to-date. Of course, for those consumers who don’t eat breakfast (or eat for that matter), they may yet be immune to food based inflation!
As my colleague Christian Drake highlighted yesterday in an intraday note, inflation is also percolating in other parts of the economy. Specifically, CPI Services growth continues to hold above 2% and the growth trend looks similar even if you strip out the Shelter and Energy components of the Index.
Even as most consumers are seeing inflation, the bigger question will be whether the Fed sees it. Fed Chair Janet Yellen will get a chance to address this in her first news conference today at 2:30 pm (following the Fed statement at 2:00 pm). Certainly the stock market is seeing the consumer getting squeezed as well, as the consumer discretionary and consumer staples sectors are both down on the year.
Speaking of the stock market, despite the somewhat tepid return in the year-to-date, (the SP500 is only up just over 1% in the year-to-date and most major markets are down on the year), the latest US Investor's Intelligence poll shows that a predominance of investors remain bullish.
According to the poll:
- Bearish sentiment is unchanged at 17.4%;
- Those expecting a market correction increases to 30.6% from 27.5%; and
- Bullish sentiment decreases to 52.0% from 55.1%.
To be fair, it is likely difficult to envision much of a correction when the stock market is barely up on the year, but nonetheless investor complacency, at least based on this polls, seems noteworthy to say the least.
Our immediate-term Global Macro Risk Ranges are now (we have 12 ranges in our Daily Trading Range product):
UST 10yr Yield 2.62-2.74%
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
Takeaway: A Starboard investor presentation was deservedly highly critical of Darden’s current management team and is a must-read.
Starboard released an investor presentation this morning, detailing its analysis of Darden management and the proposed Red Lobster spin-off. Starboard believes Darden’s real estate portfolio is worth approximately $4 billion and that separating Red Lobster and its real estate from Darden’s portfolio would destroy approximately $850 million in value.
The presentation was deservedly highly critical of Darden’s current management team and is a must-read for interested parties. Below, we highlight what we believe are the most important quotes from the 100+ page deck.
A Perpetual Self-Serving Agenda
- “It appears that the Red Lobster Separation was designed to benefit management, not shareholders.”
- “We believe Darden has historically shown a blatant disregard for shareholder concerns, a propensity to silence critics, and is similarly now trying to avoid shareholder concerns and input when it comes to the Red Lobster Separation.”
- “It appears the Board is going to great lengths to ensure that shareholders DO NOT have a say in the Red Lobster Separation.”
- “We question whether compensation decisions are motivating management to rush the separation of Red Lobster.”
- “We believe the current management team and Board have a long history of self-interested behavior and disregard for shareholders’ interests.”
Shareholder-Unfriendly Corporate Governance
- “Darden maintains shareholder-unfriendly corporate governance provisions.”
- “We do not believe the Board would sanction what we would view as an egregious violation of good corporate governance, like proceeding with the Red Lobster Separation in direct opposition to a clear shareholder directive, especially just months before a potential election contest.”
- “Despite significant criticism from leading governance firms and shareholders regarding Darden’s poor governance practices, the Company has actually taken steps to further disenfranchise shareholders.”
- “Darden’s corporate governance is unacceptable and recent Bylaw amendments have made things even worse.”
- “Darden’s new Bylaw amendments serve to exacerbate Darden’s already alarming corporate governance concerns.”
- “Rather than look out for the best interests of shareholders, it appears that Darden's Board has taken steps to further entrench themselves.”
Premeditated, Misleading Statements
- “Management’s arguments in support of the Red Lobster Separation are highly misleading.”
- “Management has misled shareholders regarding customer demographics at Red Lobster and Olive Garden.”
- “Management has misled shareholders regarding potential debt breakage costs.”
- “Management has misled shareholders regarding their own performance.”
The Ill-Advised Wall of Silence
- “We are troubled by the Company’s continued attempts to avoid open discussion on what we believe to be the most important and difficult issues facing the Company.”
- “Darden has a long history of silencing critics and trying to avoid an active dialogue on the key issues facing the company.”
- “Management refuses to share key supporting assumptions to demonstrate how the Red Lobster Separation will create value.”
- “Management has not adequately addressed Darden’s real estate value.”
- “Despite repeated inquiries, management has refused to disclose the key valuation assumptions used for Red Lobster in the analysis that led management to conclude that the Red Lobster Separation is the best alternative available to create value for shareholders.”
This research note was originally published April 1, 2014 by Hedgeye Restaurant Sector Head Howard Penney (@HedgeyeHWP).
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