What We Don't Know

“Only when we admit what we don’t know can we ever hope to learn it.”

-Ed Catmull


That’s another fantastic leadership quote from a new book I introduced in yesterday’s Early Look – Creativity Inc. Overcoming The Unseen Forces That Stand In The Way of True Inspiration.


“The best managers acknowledge and make room for what they do not know – not just because humility is a virtue but because until one adopts that mindset, the more striking breakthroughs cannot occur… They must accept risk… and engage with anything that creates fear.” –Ed Catmull


I can tell you that I wake up every morning living in fear of one simple thing – losing. I hate losing. And I refuse to allow my team to lose for extended periods of time. If and when we are wrong, we either double down or change our mind. We get paid to take a line and be held accountable to it.


Back to the Global Macro Grind…


Being long slow-growth and #YieldChasing in 2014 (i.e. being long bonds and/or anything equities that looks like a bond) has not only been the winning position YTD, but it was yesterday too.


With SP500 busting out (on no volume – US Equity Volume -29% vs the 3mth avg) to all-time-bubble highs intraday, bonds reversed from opening down to closing at their highs of the day. The 10yr UST Yield has ticked down yet again this morning to re-test a fresh 2014 low of 2.49%. Bond bears are losing.


But, but, Biotech (IBB) +2.5% yesterday was winning. Yep, nice trade. I just hope you didn’t own it the whole way down, because that “growth” sub-sector of the SP500 has been a certified train wreck this year. Most things high-multiple, high-beta have been.


“So” do we buyem because they were up?


Let’s get real here folks. I left Career Risk Management Inc. in 2007 so that on days like this I could double-down on my team’s hard work and process. If you want to beat a monthly bogey, great – chase the wabbit. If you want to win a championship in 2014, stay with the fundamental trends.


In the US, here are the big intermediate-term TRENDs that have been winning for the last 5-6 months:


1. US #InflationAcclerating

2. US #ConsumerSlowing

3. US #HousingSlowdown


Winning being defined as the score:


1. CRB Commodities Index, Food, and Oil +8-22% YTD #InflationAcclerating

2. US Consumer Discretionary Stocks (XLY) = DOWN -2.1% YTD #ConsumerSlowing

3. US Housing Stocks (ITB)= DOWN -3.0% YTD #HousingSlowdown


That’s not to say that I didn’t feel like the NY Rangers last night. However magical a playoff run they’ve had, getting lit up for 7 goals in Montreal feels like I did at yesterday’s market close. Kreider went to de penalty box in the first minute of the game. Canadiens scored. He felt shame.


“So” why shouldn’t I change our entire Macro Theme Deck (6-12 month view) and positioning this morning?


1. Why isn’t it “different this time” (i.e. bond yields going down aren’t an explicit sign of US growth slowing)?

2. Why isn’t it time to giddy up and buy stocks like Facebook, Twitter, and Yelp that blew up into the thralls of April?

3. Why isn’t it time to pretend that no-volume and an 11 VIX doesn’t matter as a risk management signal anymore?


Why Mucker? Why can’t you just change everything you and your team have done YTD and join a crowded consensus long-growth US Equity Multiple Expansion (and bearish on inflation and bonds) view that almost everyone else on the sell-side has?


What would change my mind? That’s easy. Going back to what we loved about our US #GrowthAccelerating call in 2013:


1. #StrongDollar

2. #RatesRising

3. #DeflatingTheInflation


In fact the Swiss have some of that this morning. As the Swiss Franc ripped to new highs, Swiss Exports ramped +2% year-over-year and so did Switzerland’s GDP growth rate. Sound familiar, Mr. Krugman? Same thing happened this year in the UK. #StrongCurrency tax cuts for The People.


“So”, other than a lot, what else don’t we know that could be driving spooos higher with the Russell 2000 -1.9% YTD?


1. How many hedge funds came into 2014 levered long growth, got smoked, then shorted the April lows?

2. How many people have Yellen and Bernanke whispered to that if growth continues to slow, that they go Qe6?

3. How many one-legged ducks can avoid swimming in a circle?


What we do know is that with the VIX at 11.51 (testing YTD lows) and the II Bull/Bear sentiment spread at its YTD highs (58.3% Bullish, 17.3% Bearish = +4100bps wide to the Bull side) that the buy in May, chase performance, and pray thing is alive and well.


Our immediate-term risk ranges are now (12 Global Macro Ranges are in our Daily Trading Range product):


UST 10yr Yield 2.48-2.60%


RUT 1089-1144

VIX 11.09-13.79

WTIC Oil 102.99-105.27

Gold 1


Best of luck out there today,



Keith R. McCullough

Chief Executive Officer


What We Don't Know - Chart of the Day

May 28, 2014

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TODAY’S S&P 500 SET-UP – May 28, 2014

As we look at today's setup for the S&P 500, the range is 36 points or 1.25% downside to 1888 and 0.63% upside to 1924.                                                            














  • YIELD CURVE: 2.13 from 2.17
  • VIX closed at 11.51 1 day percent change of 1.32%


MACRO DATA POINTS (Bloomberg Estimates):


  • 7am: MBA Mortgage Applications (prior 0.9%)
  • 7:45am/8:55am: ICSC/Redbook weekly sales
  • 4:30pm: API weekly oil inventories
  • 9:30pm: BOJ’s Shirai speaks and holds press conference



    • House in session; Senate out
    • 10am: Northrop Grumman holds a briefing on state of global logistics in aerospace, defense industries
    • 10am: FDIC Chairman Martin Gruenberg holds briefing on bank and thrift industry 1Q earnings
    • 11am: President Obama to give commencement address at West Point
    • 2pm: House Veterans Affairs Cmte seeks testimony from three VA officials about Phoenix VA Health Care System
    • John Ratcliffe defeats Rep. Hall in Texas’ 4th district




  • GE’s Immelt strengthened offer for Alstom in Hollande meeting
  • GE said to pledge 1,000 new jobs in France
  • RBS to eliminate hundreds of U.S. jobs ahead of Fed’s new rules
  • Nestle to buy skincare rights from Valeant for $1.4b
  • Valeant hosts investor call; watch for change in Allergan bid
  • Citigroup’s head of centralized risk trading said to leave bank
  • Amazon says not optimistic on dispute with publisher Hachette
  • Hachette hoping to solve Amazon dispute in “few weeks”: CEO
  • China banks’ bad-debt ratio seen climbing to most since 2009
  • Microsoft touts new opportunities, unveils Skype translation
  • Google unveils company-designed driverless vehicle prototypes
  • Morgan Stanley sues convicted ex-broker to recoup legal fees
  • GM poised for more recalls as 2 million vehicles probed
  • President Obama to give commencement address at West Point
  • Credit Agricole said to accuse EU of bias in rate-rigging probe
  • Exchanges can ruin high-frequency trading benefits, study finds
  • Sands China falls as investor moves stake to parent company
  • Credit Suisse’s Dougan says he won’t quit over fine: L’Hebdo
  • Euro-area economic confidence climbs more than expected in May
  • German unemployment unexpectedly rises for 1st time in 6 months
  • Ukraine prolongs anti-rebel operation after dozens killed



    • Bank of Montreal (BMO CN) 7:30am, C$1.52 - Preview
    • Brown Shoe (BWS) 7am, $0.31
    • Chico’s (CHS) 7:31am, $0.28
    • Copart (CPRT) 4:45pm, $0.48
    • Cracker Barrel (CBRL) 7am, $1.22
    • DSW (DSW) 7am, $0.48
    • EnerSys (ENS) 4:01pm, $1.18
    • Michael Kors (KORS) 7am, $0.68 - Preview
    • Palo Alto Networks (PANW) 4:03pm, $0.10




  • Corn Extends Decline to 12-Week Low as U.S. Planting Accelerates
  • Brent Gains for First Day in Three on Libya, Ukraine; WTI Steady
  • Gold Sinking as ETP Assets Drop to Lowest Since ’09: Commodities
  • Palladium Climbs to Highest Since 2011 as Gold Near 15-Week Low
  • Copper Trades Near 11-Week High Amid Advancing Global Equities
  • Robusta Coffee Falls After USDA’s Vietnam Forecast; Sugar Climbs
  • Steel Rebar Drops With Iron Ore as China’s Steel Supplies Climb
  • Iraq Oil Revival Stalls Again as Violence Pinches Growth: Energy
  • El Nino Risk Seen Spurring Rice Importers to Advance Purchases
  • Ukraine Gas-Price Risk Premium Remains for Europe as Gap Widens
  • Gold Premiums in India Seen at 10-Month Low as Curbs Eased
  • Japanese Lawmakers to Lobby Abe for Russian Gas Pipeline
  • Weather, LNG Exports Pace Near-, Long-Term Gas Demand: Bull Case
  • West Australian Court Dismisses Organic Farmer Action in GM Case


























The Hedgeye Macro Team















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DRI: Fighting the Good Fight

Starboard Is Right

Starboard is doing the right thing.  They’ve officially taken on the task of saving the largest publicly traded casual dining company in the world.  From our vantage point, there is a high probability that Jeffrey Smith and his team will gain a majority position on Darden’s Board of Directors.


It will be a long, hot summer for the folks in Orlando and we want to be clear about what we think Starboard Value’s move last week means for the shareholders and employees of Darden Restaurants.  In our view, Starboard has assembled a highly qualified group of professionals that will be able to rebuild a broken company into one of the most admired, while making a lot of money for all constituents along the way.


We didn’t personally know the people at Starboard prior to their investment in DRI, but we’ve been impressed with how thoughtful they’ve been in their business endeavors.  Nobody is perfect, but we don’t view them as a stereotypical activist investor out to make a quick buck.  From what we’ve seen in their public presentations, it is clear that they see a significant long-term opportunity.


While Starboard has not formally put a price target on the stock, we believe there is an opportunity for them to make 2-3x their investment over the next three to five years.  As we’ve said before, Darden represents a “generational opportunity” that does not come around too often in the restaurant space.  In my twenty years as a restaurant analyst, I’ve only seen a similar type of opportunity three other times.


Knowing that Starboard is fully committed to getting control of the Board is critical to realizing any potential upside.  If Starboard is successful, which we believe they will be, it will send a loud and clear message to Darden employees and the Greater Orlando community: the future is bright.


Unfortunately, getting to that point is not going to be easy and we suspect some serious mudslinging is about to begin.  There is no doubt that Clarence Otis and his advisors will be working overtime to discredit Starboard and their slate of Board nominations.  We feel fairly confident that Darden will be specifically gunning for Brad Blum, because he represents the biggest threat to Otis’ job. 


After advocating for change at Darden for the past two years, we are more confident than ever that senior management and the Board must be replaced.  Darden continues to mislead shareholders and the investment community by telling a demonstrably fabricated tale of shareholder support. 


In fact, based on our conversations, this support nearly ceases to exist in any capacity.  We estimate that Darden only has support from 5-10% of the outstanding shares.  The Red Lobster fire sale has further enraged shareholders who explicitly demanded a Special Meeting to discuss the merits and motives of such an ill-advised transaction.  We believe the vast majority of outstanding shares are in the hands of what we consider to be Starboard advocates.

Starboard’s Slate, Darden’s Brass

Last week, in a letter to Darden shareholders, Starboard nominated 12 directors to stand for election at Darden’s 2014 Annual Meeting.  According to the release, the slate of nominees is a culmination of “experienced restaurant operators with expertise in Darden’s major business lines, and experts in real estate, finance, turnarounds, supply chain, and, critically, effective public company governance and compensation programs.”  Importantly, we believe these candidates, in aggregate, are more qualified to help orchestrate the biggest revival in the history of casual dining than the current Board.


Getting to the heart of the matter, by nominating 12 Board members, Starboard hopes to effectively gain control of the company.  Given management’s blatant disregard for shareholder rights and history of destroying value, we can comfortably say they’ve brought this upon themselves.


Shortly after the news hit, Darden released a press release in which it said: “by attempting to replace all 12 members of the Board with its own preferred nominees, Starboard is seeking effective control of the Company – representation which is disproportionate to Starboard’s recently acquired approximate 6.2% stake in Darden and which does not offer Darden shareholders a control premium for such change in control.”  Our initial thought was that the change of control premium would come when Starboard gets control of the company. 


Two things come to mind as it relates to this.  First, Starboard and its potential Board members own 2x the amount of stock that Darden’s management and current Board own, so their interests are more closely aligned with other shareholders.  Second, the current management team’s track record is so poor that most shareholders are begging for a major shakeup.


The other part of the Darden rebuttal was that “Starboard’s assertions continue to be based on incorrect and unrealistic analysis, which results in misleading conclusions regarding the value associated with the sale of the Red Lobster business.”  Having read Starboard’s letter several times, we’re having a difficult time seeing where Starboard is being misleading.  It makes us wonder if management can objectively read what the financial community is saying about the Red Lobster sale.  Did management see what happened to its stock the day they announced the Red Lobster sale?


Darden goes on to say “the recently signed agreement to sell the Red Lobster business and the actions underway to reinvigorate restaurant performance, reduce costs and ensure a sound financial foundation to support Darden’s dividend reflect the input we have received from shareholders.”  That statement is misleading in its purest form.  If management’s plan reflects the input from shareholders, why did they not allow shareholders to vote on the Red Lobster transaction?


Darden’s cavalier attitude toward shareholders has led to an unsustainable pattern of behavior that will result in wholesale changes at the company when the Annual Meeting comes around.


Starboard’s slate of nominees possess highly relevant and broad based expertise, including significantly greater restaurant operating experience.  Several of the nominees, in particular, have considerable experience turning around restaurant companies – something the current management team has proven incapable of doing.


Aside from Darden’s potential efforts to attack Starboard’s slate of nominees, the next big event for Starboard will come when they detail specific plans to fix Olive Garden and other operational issues at Darden.  We still contend that Darden should spinout LongHorn and Capital Grille into a separate steak company and explore an IPO of Yard House.  Olive Garden needs to stand alone and Starboard needs to communicate to the investment community how they plan to turn around the flagship brand.

The 180 Rule is in Effect

All told, Starboard’s recent actions ensure that our longer-term bullish thesis remains intact.  Despite the Red Lobster sale, we continue to see tremendous value that can be unlocked through various, highly feasible initiatives.  However, with the Annual Meeting four or five months away, we see downside in the stock over the immediate and intermediate-term due to the significant and abrupt loss in earnings power.


Starboard must replace the current Board in order to unlock Darden’s inherent value.  Barring a change of this nature, Darden would immediately become one of the best shorts in the entire restaurant space.  As always, our bear case remains Chairman and CEO Clarence Otis.


Starboard’s attempt to replace the entire Board may seem overly aggressive, but those intimately involved with the situation know that this is a legitimate, even likely, possibility.  The Board’s questionable practices have become increasingly egregious and its mockery of corporate governance has reached seemingly insurmountable levels.  Shareholders, collectively, must put this to an end.


Call with any questions.


Howard Penney

Managing Director


Fred Masotta


Poll of the Day Recap: 55% Think Gluten-Free Is Here to Stay

Takeaway: 55% said HERE TO STAY; 45% said FAD.

Within American health and wellness consumption trends, the Hedgeye consumer staples team is trying to tease out to what extent consumers will be drawn longer-term to gluten-free products beyond those suffering from celiac disease (approximately 1% of the U.S. population).

Today’s poll question was: Is the popularity in gluten-free products in the U.S. a fad or here to stay?

Poll of the Day Recap: 55% Think Gluten-Free Is Here to Stay - 2 

At the time of this post, 55% said gluten-free is HERE TO STAY; 45% said it’s a FAD.

In a sampling of those who said that gluten-free products are HERE TO STAY, voters explained:

  • “I know too many people who have said it makes a difference.”
  • “Not a fad when there is an autoimmune disease attached to it. Once the diagnosis process becomes more streamlined and efficient, the number of either gluten-sensitive or genetic Celiac victims will increase by the millions. Therefore, the products will be more of a necessity for people rather than being just a fad. It has also been linked to improving adolescent ailments leading to health-conscious mothers to scourer the market for GF products. Plus, many professional athletes swear by the diet's overall physical benefits.”
  • “Secular trend to healthier consumer choices continues as GMO purveyors $MON $MCD lose market share to $STKL and transparency demanding, enlightened, educated consumers!”
  • “The historical hybridization and genetic modification of wheat is irreversible, and our bodies are not equipped to handle modern wheat.”
  • “As the spouse of a doctor, I have been informed that it is absolutely not a fad; or, so speaketh the oracle.”

Conversely, one person who think it's a FAD said, “Gluten isn't even bad for you unless you're allergic.” Another agreed: “The Dr. who invented gluten free just recanted. The real problem is all the sugar they put in grain products.”


Non-Traded REITS: A Fool and His Money

As the Fed continues sucking yield out of the marketplace, individual investors are desperate for return.  This has fueled a moon-shot in a host of dicey instruments sold only on the basis of percentage returns. 


Hedgeye energy analyst Kevin Kaiser has written extensively on oil and gas Master Limited Partnerships, many of which are purely accounting exercises designed to lure investor money to pay management compensation.

Non-Traded REITS: A Fool and His Money - Atlas cartoon

Oil and gas aren’t the only sure thing in America today.  There’s also real estate, available in “non-traded REITS.”  These are illiquid private investments.  Since the function of the marketplace is price discovery, where real transactions establish a real-time market price, how does your brokerage firm price non-traded instruments on your statement?


Simple.  All non-traded REITs are priced $10 a unit, regardless of the value of the underlying portfolio.  Non-traded REITs are sold to the investor at $10 a share, and FINRA permits them to remain on brokerage statements at original sale price.   Since REITs are very long-term instruments, it will be a long time before the investors find out the actual value of their holdings – typically, only when the REIT goes bust because there is no residual value to the properties.


Non-traded REITS are marketed as being “stable” – because they’re not subject to market price fluctuations – and have become increasingly popular as investors grow desperate in a world without yield.


Even if they’re not so great for you, they are a great deal for the firms that sell them.


A typical non-traded REIT can pay a 7% sales commission, plus a 2.5% “dealer management fee” and 3% in offering expenses – all taken off the top.  You end up with 87.5 cents of every dollar actually invested: your REIT has to appreciate 14% in value before you are even.


The REIT managers also pay themselves ongoing fees.  One real-world example had managers taking a 4.5% annual management fee, plus 3% for leasing properties.


But wait – there’s more.  Because they are often blind pools, the REIT managers don’t buy real estate until all the money is in (there appears to be no rule barring managers from selling their own operating properties to the REIT they manage, a massive self-dealing loophole.)


During the process of acquiring the properties for the REIT, they make regular payments to the investors.  These payments are non-taxable (great!) because, since there are no operating properties in the portfolio, they’re just giving you back your own cash (oh… not so great).  And recording it as yield (how’s that?!)


In 2011 industry oversight body FINRA proposed a rule requiring disclosure of the actual value of these investments.  This month, over 2 ½ years later, FINRA says they aren’t ready to send the rule proposal to the SEC.  They are still mulling over the comments they received.


The comments appear to be overwhelmingly objections from the firms who market these instruments.  As with many other public comment exercises, if you want to know what the average retail investor thinks of non-traded REITS, don’t ask FINRA.  They don’t know.


As sales of these instruments swelled to $20 billion in 2013, the best FINRA could do was to issue Investor Guidance (Public Non-Traded REITs—Perform a Careful Review Before Investing)


The fecklessness of FINRA and its efforts at investor protection goes a long way towards explaining the explosion in these types of investments.  “You gonna listen to the regulators?!” says the salesman.  “They don’t know the first thing about the markets!”  While we generally can’t argue with that proposition, it does not logically follow that one is better off embracing the advice of a salesman who won’t tell you how much he’s getting paid on the transaction (if you ask, he is required by law to give you a full description of commissions, fees and charges.)


The Fed’s prolonged QE program is intended to boost asset prices, raising the price of securities by creating dollar inflation and praying that wealth will magically “trickle down” throughout the economy, a fairy tale Washington and Wall Street have been telling us for two generations. 


The Fed hasn’t learned two basic lessons of finance: the money business brings out the worst in people; and what goes around, comes around.  You can’t inflate forever.


Legendary former Bear Stearns head Ace Greenberg warned in the early stages of the 1980’s bull market that growth in the financial sector would attract criminals and scam artists in their legions.  While Ace was slugging it out in the trenches, Bernanke and Yellen were assiduously taking notes in their advanced Econ seminars. 


If you want to know why the store is in such rotten shape, you need only look at who’s minding it.

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