Force Rapid Learning

This note was originally published at 8am on June 02, 2014 for Hedgeye subscribers.

“There is nothing quite like ignorance combined with a driving need to succeed to force rapid learning.”

-Ed Catmull


With three kids, I’d say that quote pretty much sums up my life right now. It’s also the opening line to chapter 3 of the book I have my nose in these days – Creativity Inc., by one of the founders and leaders at Pixar Animation Studios, Ed Catmull.


When it comes to the market side of my life, it isn’t what it used to be. I have the dubious task of running both my mouth and a company. On the latter, I can assure you that there is no driving force greater than owning it. If Hedgeye isn’t constantly evolving, we’re failing. And that’s not an option.


We’ve built both the risk management process and firm on the same principles. We wake up every morning with our eyes wide open to the reality that we do not know what is going to happen next. Embracing uncertainty forces rapid learning. And we like that.


Back to the Global Macro Grind


If all you did at the start of last week was get rid of the most consensus short position on the planet (short SPX Index + E-minis),  and focused on expressing slow-growth #YieldChasing where at least 66% of hedge funds out there haven’t yet, you’d have liked that too.


With the net SHORT position (CFTC non-commercial futures and options contracts) in the SP500 dropping week-over-week from -114,248 contracts (1yr high) to a net SHORT position of -57,737 this morning, I still wouldn’t be using that consensus “hedge.” Use the Russell.


What is the Russell?


  1. The Russell 2000 is a much purer read-through on US domestic growth than the multinational Dow or SP500
  2. The Russell 2000 (IWM) was down -0.5% in an “up tape” on Friday (SPX closed +0.18% at an all-time bubble high)
  3. The Russell 2000 is down -6.1% from its March 2014 high and -2.5% YTD


The alternative to being levered long US growth and/or social bubble stocks (i.e. the alternative to being down YTD) is:


  1. Being long #InflationAccelerating (CRB Commodities and Food Indexes are +9% and +22% YTD, respectively)
  2. Being long slow-growth via the long bond (10yr yield down another -6bps last wk and -55bps YTD at 2.48%)
  3. Being long anything US Equity #YieldChasing that looks like a bond (Utilities up another +2.3% last wk = +12.6% YTD)


“So” why bang your head against the #OldWall shorting spooos and trying to pick no-volume-v-bottoms in bubble stocks that blew up in March-April, when you can just keep doing more of what’s been a relatively low volatility position to keep?


A: it’s not consensus (yet)


No worries though, as time, price, and economic data change, consensus futures/options positioning changes:


  1. SPX Index + E-mini net SHORT position of -57,737 contracts today (vs. -19,488 net SHORT 3 month avg)
  2. 10YR US Treasury bond net LONG position of +22,876 contracts (vs. -59,080 net SHORT 3 month avg)
  3. Gold net LONG position of 68,393 contracts (vs. +103,404 net LONG 3 months ago)


In other words, 3 months ago (on March 1st):


  1. Hedge funds started getting short the consensus SPX hedge  (after the JAN-FEB drawdown in the SP500)
  2. Consensus still didn’t think bond yields could go down in 2014 (so the 10yr yield crashed)
  3. And consensus momentum players chased being long Gold at $1350




Nothing forces rapid learning faster than doing precisely the same thing (at the same time) as thousands of other money managers and getting plugged.


But please don’t confuse consensus getting whipped around in an oversupplied asset management industry with the US or global economy. They are nowhere in the area code of the same thing.


And I suspect there will be nothing normal about the next three months in global macro risk management either. So have another coffee. It’s Monday June 2nd (Happy Birthday Dad!). Prepare to embrace the uncertainty of what tomorrow will inevitably bring.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.42-2.51%

SPX 1888-1932

RUT 1090-1154

EUR/USD 1.35-1.37

WTIC Oil 102.19-104.95

Gold 1240-1294


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


Force Rapid Learning - Chart of the Day

June 16, 2014

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TODAY’S S&P 500 SET-UP – June 16, 2014

As we look at today's setup for the S&P 500, the range is 37 points or 1.14% downside to 1914 and 0.77% upside to 1951.                                                              













  • YIELD CURVE: 2.12 from 2.15
  • VIX closed at 12.18 1 day percent change of -3.03%


MACRO DATA POINTS (Bloomberg Estimates):           

  • 8:30am: Empire Manufacturing, June, est. 15 (prior 19.01)
  • 9am: Net Long-Term TIC Flows, April, est. $37.5b (prior $4b)
  • 9:15am: Industrial Production m/m, May, est. 0.5% (prior -0.6%)
  • 10am: NAHB Housing Market Index, June, est. 47 (prior 45)



    • House not in session; Senate returns at 2pm
    • Treasury Sec. Jack Lew on trip to Abu Dhabi, UAE, Saudi Arabia, Jerusalem and Berlin
    • House Transportation Cmte’s panel holds meeting on role of financial sector in infrastructure, with JPMorgan’s Jamison Feheley, Macquarie’s Karl Kuchel, IFM Investors’ Tom Osborne, Barclays’ Steve Howard among participants
    • 10am: Supreme Court to issue decisions
    • Washington Week Ahead
    • U.S. ELECTION WRAP: Tea Party’s Reach; Coal Electorate              



  • Medronic agrees to buy Dublin-based Covidien for $42.9b
  • Williams buys control of Access Midstream Partners for $6b
  • Siemens said to prepare bid for Alstom’s energy unit
  • Mitsubishi offering to buy ~10% Alstom stake: Nikkei
  • Russell makes Egypt frontier mkt, lists Russell 3k changes
  • Intel, county in talks that may save $1b in taxes: Oregonian
  • American Express, Citi, others report May charge-offs
  • American Tower to buy BR Towers for $978m; sees $131m/y rev.
  • ‘22 Jump Street’ tops ‘How to Train Your Dragon 2’ in sales
  • Iraq attacks militants north of Baghdad; U.S. Emb. cuts staff
  • Russia, Ukraine fail to reach gas payment deal



    • Korn/Ferry Intl (KFY) 4:15pm, $0.39



  • European Gas Jumps Most Since March as Ukraine Faces Supply Cut
  • Gold Climbs to Three-Week High as Iraq Violence Boosts Demand
  • Hedge Funds Cut Crop Wagers the Most Since January: Commodities
  • Oil Topping $116 Seen Possible as Iraq Conflict Widens: Energy
  • Iraq Crisis: Basrah Output Holds the Key to Global Oil Prices
  • Copper Climbs as China’s Central Bank Moves to Support Growth
  • China Adds to Iron Ore Glut as Record Output Seen This Year
  • Wheat Rebounds From Weekly Slide as U.S. Rain Threatens Quality
  • Sugar Gains With Brazilian Mills Slowing Harvest; Coffee Drops
  • Iraq Oil Exports to Jordan Won’t Resume Soon on Security: Hamed
  • Coal’s Share of World Energy Demand at Highest Since 1970
  • Norwegian Oil Industry Faces Mediation to Avoid Output Halt
  • Iraq Uprising Draws In OPEC Nations, Boosts Oil Price: Bull Case
  • WTI, Brent Pare Gains as Iraq Unrest Seen Sparing Crude Supplies


























The Hedgeye Macro Team














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Messi Week

“Something deep in my character allows me to take the hits and get on with trying to win.”

-Lionel Messi


First and foremost, happy belated Father’s Day to all the Dads out there who do what they do when no one is looking. As most of the young men playing in the 2014 World Cup will attest, doing the best that you can do out there, every day, is a grind.


For those of you who didn’t know who Messi was until your Dad’s Day dinner last night, what a gem this guy is in the arena that is soccer. Selfless, hard working, and talented, he is everything that the largesse of Argentina’s government is not.


At 26 years old, Messi is the Captain of Argentina’s hopes in Brazil. Like many athletes who represent their country, his maturity and leadership are beyond his years. On money, he said it “doesn’t thrill me or make me a better player… I’m just happy with the ball at my feet.”


Messi Week - messi


Back to the Global Macro Grind


With both the NHL and NBA seasons officially over (congrats Kings and Spurs!), it’s time for some World Cup Soccer while you attempt to risk manage what are becoming very thinly traded all-time-bubble-highs in US Equities.


In order to look forward, let’s take a step back. Unless you were long #InflationAccelerating last week, it was messy:


  1. SP500 and Dow were down -0.7% and -0.9%, respectively, last week (Dow barely up YTD at +1.2%)
  2. Russell 2000 resumed its bearish intermediate-term TREND at -0.1% YTD and -3.8% since March
  3. Industrials (XLI) led losers at -1.5% on the week as energy prices (producer costs) ripped


US Consumer Discretionary stocks (XLY) are still -1.6% YTD and continue to eat #InflationAccelerating:


  1. CRB Commodities Index (19 Commodities) was up another +1.5% last week to +10.6% YTD
  2. WTI Crude Oil led inflation melt-up at +4.2% on the week to +10.8% YTD
  3. Natural Gas and Coffee prices were up another +1% last wk to +14.8% and +50.6% YTD, respectively


While Total US Equity Market Volume was down -34% (vs. the 3 month average) on Friday’s +0.3% SPX negative breadth up-day, we finally got some real equity and commodity market volatility last week:


  1. Oil volatility (Oil VIX) was +34.3% last week to 19.47
  2. US Equity volatility (VIX) was +11.8% last week to 12.18


From a risk management perspective, rate of change in our model always matters – but it really matters when that directional rate of change (2nd derivative) signal occurs off its most asymmetric long-term TAIL risk point.


That’s where US Equity Volatility (VIX) was when it closed at 10.73 on June 6, 2014. While the perma-bulls on US GDP growth may think “it’s different this time”, it’s not. The VIX has never stayed below 10 – ever. And, as you know, never-ever is a very long time.


As gas prices rage higher alongside an all-time high in US rents (34% of the country rents and shelter is their #1 cost of living), prepare for another messy week of Consensus Macro expectations meeting their maker (bond market signaling growth is slowing):


  1. TUESDAY: US Consumer Prices (unlegislated taxes) for May should continue to accelerate
  2. WEDNESDAY: The Fed should talk down its US Housing and GDP forecasts now that they’re wrong on growth (again)
  3. THURSDAY: Uruguay plays England at 3PM EST #WorldCup


If England plays like they did against Italy, that could get messy too. As Spain learned against the Dutch, at first risk happens slowly – then all at once.


UST 10yr Yield 2.45-2.64%


RUT 1124-1175

VIX 10.73-13.21

Brent Oil 109.87-113.11

Natural Gas 4.65-4.83

Gold 1


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


Messi Week - chartofday

LULU – Adding To Best Ideas List As A Long

Takeaway: Adding LULU to Best Ideas list as a Long. The story has gotten so bad that it’s good. 4 to 1 upside/downside. Conf Call and Deck to follow.

We’re adding LULU to our Best Ideas list as a long. As we articulated after the quarter (see below), we think that the risk/reward is too good to pass up.  There’s a massive bifurcation between the growth potential at this company, and the lack of a plan to execute on it. If management continues to execute in a sub-par way, we see downside to about $31 (stress testing our model at 10x EBITDA). Not pleasant (18% downside), but not the end of the world from its current price ($37.61). If the company/Board adds the operational depth that is necessary, then the discussion returns to this company doubling or tripling its top line, and realizing $3.00-$4.00 in earnings power.  Pick whatever multiple you want, but the stock price on $3.50 in earnings will push it through its all-time high of $82. LULU can make those decisions on its own, or we think that shareholders will emerge that will decide for them. Let’s also not rule out strategic buyers. That may or may not come to fruition, but it definitely lends valuation support to a stock trading at what we’d consider depressed levels relative to its realizable underlying growth potential.  There’s no questioning that there’s weakness in the company’s core, but everybody – including a $37 stock – already knows that. After all, we saw eight downgrades on Friday and the stock closed up on the news. Ultimately, the blow-up risk on this long idea (in the $30s) is very low, and if LULU adjusts the depth and caliber of management and process to the size of its 3-year market opportunity (vs the legacy $500mm team and process in place now), then we think we could see $4bn in value creation, compared to about $800mm risk if the company continues to mire in incompetency and no one steps in to change it.   


We’ll follow up with a conference call and accompanying deck outlining the steps that we think need to be taken to repair this company.  


06/12/14 07:09 PM EDT

LULU = Activist Candy

Takeaway: Things are getting so bad that it’s good. If no one goes activist, we might. Shareholders deserve it. Still solid acquisition candidate.


Conclusion: We think that things are getting so bad, that it’s almost good. This company is in worse shape than the quarter suggests. The good news is that every problem we see can be fixed with the right talent steering the ship. The bad news is that such talent is nowhere to be found in Vancouver. The reality is that someone will have to step up and go all activist on LULU. Valuation is at a point where we could see that happening, which could be facilitated by recent tension at the Board level.  And if it doesn’t happen, we might just lead the charge ourselves. Value needs to be unlocked. This is an amazing brand with solid global growth prospects. Management is too focused on recapturing Gross Margin that is a) lost forever, and b) something that investors won’t pay for without meaningful top line growth. If all else fails, there are no fewer than five public companies eyeing LULU, not to mention financial buyers.  



We said that the risk/reward for LULU would really shape up on a miss. We’re standing behind that statement. If we had to be long or short at this point, we’d be long. Fortunately, we don’t have to be either. But let’s make one thing abundantly clear. Our view that it is a more favorable risk/reward is not because we have confidence in management executing a sound growth strategy. Quite the opposite, actually. This is as close to a ‘no confidence’ vote as we’ve come across with a management team in a long time. If this was a weak brand with questionable growth prospects, then it’d be game over. But the fact is, this is what we’d consider one of only a small handful of truly defendable brands in retail. When there’s a great brand with bad management, it is a situation that can be easily fixed. When even the greatest of managers are in charge of marginal brands, they’re usually terminal. This is definitely the former.


If the play here is for a rebound in the business under the current regime, then it is an absolute coin toss as to whether they succeed. We don’t like flipping coins. Process = Good. Coin Flip = Bad.


That means we need major change inside the company. John Currie (CFO) getting pushed out is a start. He was terrific for LULU in its early years (when Chip was still relevant), and sales were sub $500mm. But so many of us forget just how fast LULU grew, as sales were a mere $275mm in 2007. The skill sets throughout this company today are broadly consistent with those of an entrepreneurial early-cycle company. The problem is that LULU is going through puberty. It is sitting at $1.6bn in sales, and is in need of a completely different range of skills. Unfortunately, we’re not convinced that CEO Laurent Potdevin has them either.


WINNING VS LOSING: (LULU should look 948 miles South to see how it’s done)

We think it’s so ironic that LULU reported earnings within 14 hours of Restoration Hardware (RH – our top long idea). Some similarities are striking. Both are $1.6bn in revenue, both serve a very high end consumer in a fragmented and hyper-growth piece of the retail space, and both can conceivably achieve $4-$5bn in revenue over a 5-year time period. The big difference is that the CEO of RH (who many people hate) got on the call, played offense, took control and set the investment narrative. He conveyed top to bottom what his vision is for the company, what it will mean for long-term revenue growth, what the margin implications are, and what kind of capital is needed to achieve those goals and maximize ROI. Laurent said…well…not that.


LULU, instead, was extraordinarily defensive. Granted, weak trends will put anyone on defense. But we did not listen to the call and think “hey, these guys really understand their business.” There was no talk about long term growth targets, no crisp delineation of key growth initiatives, with the only real numbers given around share repurchase and gross margin goals.


Let’s address the gross margin issue for a minute. The fact that this company leads in with recovery of gross margins to a mid-50s level is preposterous. If the company can recapture a few points in margin over time, then great. But there’s no way we (or most others) will pay up for that now. This is a mid-cycle growth company that is growing outside of an extremely profitable core (dresses, denim, men’s – fine, but not Gross Margin Accretive). There is one thing and one thing only that most investors will pay for with LULU – top line growth.  Yet the only top line growth drivers they really address on the calls are little near-term tactical patches that are irrelevant in the context of investing in Retailers.  



What this means for us, is that the problem is still…you guessed it…Chip (Wilson, Founder). As much as everyone likes to say that Chip stepped away last year, the fact is that the guy still controls 27% of the voting stock. Voting stock aside, his influence inside the hallways of Lululemon trumps that of the CEO that he hand-picked and pushed through the Board approval process. John Currie was Chip’s CFO, and when the Board decided to push him out over the past week, we think that’s what prompted Wilson to vote against the re-election of the two Board members who caused it (one of whom replaced Chip as Chairman).


What’s nice about this is that the Board is no longer uniformly ‘Chipped’.  The more the Boardmembers band together and show Chip that he’s no longer the boss, the better chance this company has of succeeding.


The reality with all of this is that someone will have to step up and go all activist on LULU. Valuation is at a point where we could see that happening. And if it doesn’t happen, we might just lead the charge ourselves. Value needs to be unlocked.



One consideration is whether the company’s troubles put it in play. The answer there, we think , is Yes.

  1. Nike is a perennial possibility. Though its strategy is to build instead of buy (and it passed when LULU was at $8) the fact is that it has been chasing LULU for years, and LULU still is far more authentic for Yoga than Nike is. Low probability. But something to consider.
  2. Kering is in print saying that it wants to broaden its portfolio of sports brands (the owner of Gucci also owns Puma, Tretorn and Volcom). Does not hurt that it is a French company and LULU has a French speaking CEO.
  3. VFC is possible. But VFC is rumored to be buying everything. It has Lucy, which is a poor-man’s version of LULU. It’d be interested at the right price.
  4. PVH is an interesting thought. It’s business is in trouble, and what does PVH do when its core weakens? It does a HUGE acquisition. Enter LULU.
  5. Here’s a dark horse…but GPS is not completely out of the realm of possibility. Granted, it’s eating LULU’s lunch with Athleta in markets where the brands overlap. But GPS could handle it financially, and it would give the company some organic growth.


LULU – Adding To Best Ideas List As A Long - LULU financial4

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.