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TODAY’S S&P 500 SET-UP – July 1, 2014

As we look at today's setup for the S&P 500, the range is 29 points or 1.13% downside to 1938 and 0.35% upside to 1967.                                             













  • YIELD CURVE: 2.09 from 2.07
  • VIX closed at 11.57 1 day percent change of 2.75%


MACRO DATA POINTS (Bloomberg Estimates)               

  • 7:45am: ICSC weekly sales
  • 8:55am: Redbook weekly sales
  • 9:45am: Markit US Manufacturing PMI, June final, est. 57.5 (prior 57.5)
  • 10am: ISM Manufacturing, June., est. 55.9 (prior 55.4)
  • 10am: Construction Spending m/m, May, est. 0.5% (prior 0.2%)
  • 10am: IBD/TIPP Economic Optimism, July, est. 48.0 (prior 47.7)
  • 4:30pm: API weekly oil inventories



    • House, Senate on recess until July 8
    • President Obama holds cabinet meeting, speaks on economy
    • 8:30am: Treasury Sec. Jack Lew speaks at U.S.-China Business Council event ahead of his trip
    • *U.S. ELECTION WRAP: McAllister to Seek Re-Election; Obamacare



  • U.S. June vehicle sales starting ~8:30am - Preview
  • Iraqi lawmakers meet amid rifts on Maliki’s political future
  • China June Purchasing Mgrs at 51.0, matching estimates
  • BNP agrees to pay $8.97b to End U.S. sanctions probe
  • BNP Paribas seen rerouting dollar clearing to retain customers
  • Macau casino revenue falls 3.7%, first drop in 5yrs
  • Job gains fail to lower U.S. office-vacancy rate stuck at 16.8%
  • Global equities may rise 8-9% in 12 months, UBS’s Haefele says
  • Russell offers final member lists for Russell 1000, Russell 2000
  • U.K. manufacturing unexpectedly strengthens on demand surge
  • German joblessness unexpectedly increases for second month
  • Poroshenko says Ukraine ends cease fire in Eastern regions
  • U.S. foreign account tax compliance act takes effect



    • A Schulman (SHLM) 4:30pm, $0.66
    • Acuity Brands (AYI) 9:15am, $1.12
    • Paychex (PAYX) 4:01pm, $0.40



  • Iraq’s Kurds Vow to Keep Kirkuk Oil Fields Until Referendum
  • Gold Rally Obscures Fund Outflow as Investors Target Shares
  • Raw Materials’ Resurgence Follows Record Fund Exit: Commodities
  • Zinc Drops From 16-Month High as Rally Is Judged to Be Excessive
  • Soybeans Extend Slump on USDA Data as Corn Drops to 5-Month Low
  • Cocoa Drops as Supplies From Ivory Coast Increase; Sugar Falls
  • Gold Investor Index Falls to 4-Year Low as Rally Spurs Selling
  • Steel Rebar Extends Quarterly Slump as China Steel Output Climbs
  • Europe’s Seven Months of Warm Weather Set to Finish in July
  • South Africa Close to Starting Yellow-Corn Exports to China
  • Fuel Oil Shipments to Asia for July Arrival Increase to 3.3M Mt
  • Uganda Seen Boosting Sugar Production 32% With New Factories
  • Shutdown Threatening to Cost U.S. Ports $2 Billion Spurs Talks
  • Gold Trades Near Three-Month High as Holdings to Economy Weighed


























The Hedgeye Macro Team
















Expert Call: Geopolitical Outlook in The Energy Space -- Summary and Replay

Takeaway: Dr. O'Sullivan outlined three geopolitical pressure points in the global energy space along with potential scenarios that could manifest.

Last Friday we hosted a call featuring Dr. Meghan O’Sullivan, Kirkpatrick Professor of the Practice of International Affairs and Director of the Geopolitics of Energy Project at Harvard University’s Kennedy School. A replay link is included below along with a brief summary:


Link to Replay


Prior to her current position as professor of the Practice of International Affairs and Director of the Geopolitics of Energy Project, Dr. O’Sullivan has held a number of posts including but not limited to the following:

  • Special Assistant to George W. Bush and National Security Adviser
  • Senior Director for Strategic Planning and Southwest Asia at the National Security Council
  • Political Adviser to the Coalition Provisional Authority Administrator and Deputy Director for governance in Baghdad.

On a high-level, Dr. O’Sullivan outlined three major geopolitical pressure areas in the energy space. She provided potential implications and forward-looking points of interest in her discussion:

  1. Iraq – The current situation with the ISIL advancement and implications for Middle-Eastern energy security moving forward
  2. Russia – Details and events that have unfolded in the last week
  3. Unconventional Oil & Gas- Geopolitical impact of North American capacity


ISIS has made a substantial advance in Iraq and currently controls more than a third of Iraqi territory. Most of the Western and Northern Provinces outside of Kurdish control have fallen. Mosul and Iraq’s largest oil refinery, Baiji, have been overtaken. ISIS’ goal is to continue diminishing the border between Syria and Iraq. For all practical purposes, the border between Syria and Iraq has already merged in the northwest part of the country.

Iran has initiated support and advice, with the unconfirmed existence of special forces within Iraqi borders. Syria has conducted air raids within Iraqi airspace against ISIS. Finally, Russia has sold Iraq jet fighters. Throughout escalation of the conflict the US has been hesitant to provide support militarily, but rather has called for political reform.

The current Iraqi government has failed to maintain Sunni support. Many Sunni-based groups have sided with ISIS because of their growing disillusionment with the current regime. Pressure is now being applied for Iraq to form a new government that would be more inclusive to the Sunnis, Kurds, and Shiites.  All parties remain hopeful that steps will be taken within the coming weeks to form a new government.

O’Sullivan provided probability-weighted scenarios moving forward:

  1. 25% - A new government, new Prime Minister, more robust military, and involvement of Kurdish forces in the fight.
  2. 35% - A continued political stalemate with an extensive civil war in Iraq and close involvement from neighboring countries.
  3. 40% - Something in between these two.

These three scenarios will be easier to forecast depending on several events concluding in the near future:

  1. What happens in parliament over the following weeks
  2. What religious leaders convey about political change
  3. How the U.S. intervenes
  4. ISIS exacerbation of their rule
  5. Iranian political stance

Energy implications:

  • Unlikely any production interruptions as most of Iraq’s exports move out of the Persian Gulf
  • Possibly an increase in exports near-term due to the Kurds exporting their own oil for the first time
  • Medium-term production expectations could be an issue; 45% of future OPEC production expected to come from Iraq (IEA estimates)


Over the last weeks and months we have seen this constant ebb and flow of confrontation between Russia and the West. The world is waiting to see if a new round of sanctions will be imposed on Russia. Despite a cease-fire proposal from Kiev, Russian backdoor involvement is likely fueling the violence.

Putin’s strategy when dealing with the EU and U.S. seems to be twofold:

  1. He’s provided encouragement and support for the Eastern separatists in a way that allows him plausible deniability when faced with scrutiny from the international community, mainly the West and EU;
  2. He then takes conciliatory measures to signal cooperation and his desire to end the violence.


His strategy points to the likely goal from Moscow: keep Ukraine weak and vulnerable without being directly involved in a war in the global spotlight.

For the first time, the US and EU have been more specific about what they want to see. These measures would target the exploration and production of natural gas. These sanctions however, would not be a tough as people think; Global leaders are cognizant of the situation in Iraq and the corresponding global price impact of short-term supply disruptions.



Dramatic changes in North American production capacity have shifted the domestic landscape. The U.S. has gone from importing tens of billions of dollars of LNG to self-sustainability.

Possible economic benefits of self-sustainability:

  • GDP increase
  • More employment opportunities
  • Trade deficit reduction
  • Lower prices

Prior to the boom, every time an intelligence assessment was made of the US, it was recognized that America’s dependence on external energy was one of its prime vulnerabilities. This movement from energy as an Achilles’ heel to energy as an asset relative to other countries globally is a monumental benefit moving forward.



Sticky Wages, Pricey Meat

Sticky Wages, Pricey Meat - USD vs. LH and LC Chart YTD


A sign notifying customers of “conventionally raised” steak has been up for two months. Chipotle is either seeing outright supply scarcity or experiencing supply shortages at a price it’s willing to pay. Granted this is only one location, prices have recently increased +8.3% for steak and 11.1% for guacamole at New York locations… And for “conventionally raised!” 

With the exception of a -3 bps correction in front-month live cattle futures during the week ending June 20th, Livestock prices closed in positive territory every week this month:


June 6th: Live Cattle: +1.7%; Lean Hogs: +1.1%

June 13th: Live Cattle: +5.3%; Lean Hogs: +1.2%

June 20th: Live Cattle: -0.3%; Lean Hogs: +10.3%

June 27th: Live Cattle: +3.2%; Lean Hogs: +2.4%


Sticky Wages, Pricey Meat - chart 2 Performance Table


Rather than making a call on the direction of agricultural and soft commodity prices on a daily basis, we accept that the speculation of supply shortages can whip prices for a number of reasons outside our control. What we choose to dissect is the consumer and outlook for the U.S. dollar. For the first half of 2014, the consumer slowed and will continue to face similar headwinds in 2H:


  1. A Fed revision for 2014 full-year GDP from 3.0% to 2.1 - 2.3% at the last FOMC meeting will likely face a further downward revision after a -2.9% Final Q1 print last week
  2. The Fed gets more dovish with the data
  3. The bond market adjusts for growth expectations and the prospect for future dollar devaluation perpetuates the yield spread compression
  4. Commodities, which are priced in U.S. dollars, face continued pressure to the upside


Unfortunately this headline commodity inflation is not considered the kind of inflation that concerns the Federal Reserve formula. Forgive us on the repetitive call-out, but the Hedgeye Macro team felt the following article from Reuters last week was an epic interview with Yellen on the linearity of the Fed’s model.


Full Article 


Every FOMC meeting in the last several years precedes an abundance of financial media punditry that dissects the sequential change in the language of each statement. Although rare, we enjoy this direct commentary in the Reuters article for insight into the assumptions made by the fed machine:


"My own expectation is that, as the labor market begins to tighten, we will see wage growth pick up some to the point where ... nominal wages are rising more rapidly than inflation, so households are getting a real increase in their take home pay," she said last week, adding: "If we were to fail to see that, frankly, I would worry about downside risk to consumer spending."


Janet Yellen is, in this quote, referring to her belief in what is called “money neutrality” which is basically the idea that prices and wages move together without harm over the intermediate to long-term. In our opinion, she sounds rather nervous in her assessment of this “reality".


To further quote the Reuters reporter in this article:


“Over the last year Fed staff changed their main model for forecasting wage and price inflation to reflect evidence that companies were adjusting prices more slowly than in prior years. That implies the Fed has more time to allow wages to rise and employment to expand before having to be concerned about inflation accelerating.”


This seems like a convenient way to make room for an extension of accommodative policy as wage growth has stagnated against a flat dollar and skyrocketing cost of living…


Sticky Wages, Pricey Meat - chart 3 wage growth vs. livestock and USD


Income earners save less and spend more with an increase in cost-of-living:


Sticky Wages, Pricey Meat - chart 4 savings rate vs. USD and CRB


Our process points to Fed and consensus full-year growth and inflation estimates that are still too optimistic. Yellen’s comments point to the predictable FOMC policy response that we have continuously highlighted as a catalyst for further dollar devaluation. With the CRB Index up 10% in 2014, both the dollar and ten-year treasury yield remain in @Hedgeye bearish formations. 



Ben Ryan








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Poll of the Day Recap: 51% Are Bullish on U.S. Equities

Takeaway: 51% voted BULLISH, 49% voted BEARISH

In today’s Morning Newsletter Keith McCullough wrote, “While it might work in disruptive technologies, devaluing history, time, and cycles rarely works in Macro…  ‘so’, let’s embrace the uncertainty born out of these measurable risk factors and get on with Q3.”


As Q2 month-end markups end today and as June stands as one of the lowest equity volume months in U.S.  we wanted to know what your thoughts were heading into the third quarter.


Today’s Poll Question Asked: Are you bullish or bearish on U.S. equities for the third quarter?


In the video below Director of Research Daryl Jones highlights the top three reasons why he is decidedly BEARISH on U.S. Equities for the third quarter.



At the time of this post, 51% voted BULLISH, 49% voted for BEARISH.


Those who would are optimistic about what the third quarter holds and are BULLISH on U.S. Equities had this to say:

  • Hard to be bearish on the equity market as a whole. There are certain sectors that are significantly outperforming. Record amount of assets under management, easing Fed, life is good when investing with other people's money. I'll buy all the stocks with VIX at 10, as long as I get paid. Greed is good.
  • Consumer spending compares get easier in 2H (the second half of the year). The worst performing stocks in the market through six months have almost all been consumer discretionary. If this group simply ceases to be putrid, it should be positive on the margin for the broader market.
  • Until the Fed stops propping up the market, I can't bet against it. I don’t want to fight the Fed.


Voters who are BEARISH on U.S. Equities for 3Q reasoned:

  • Bearish for a 10% reversion to mean without hurting major uptrend.  Reasons: XLY:XLU ratio trending sideways to downward on 1 month, 4-6 month and 1 yr period, all while JNK:TLT outperformance has slowed on those same periods.
  • Too much complacency out there, no volume, inflation cutting into consumer spending, growth forecasts being revised downward with room for consensus to continue to chase growth to the downside with future revisions...
  • Inflation creeping up, economy slowing down, jobs being created are not permanent, increasing disconnection between stock prices and economic reality... see and increasing movement of funds to commodities.
  • The third quarter contains September which historically is the worst month for the markets - so sideways trading in light volume until the tick down in Sept.


Takeaway: We lack conviction on the intermediate-term direction of the Abenomics Trade and we think investors should remain on the sidelines for now.

I know. The only thing worse than an offensive lineman who can’t block is a sell-side strategy note that lacks conviction. But don’t take our lack of conviction as the absence of conviction altogether; rather, we have conviction in the view that it makes little sense for investors to have conviction in either direction of the Abenomics Trade (SHORT Japanese yen + LONG Japanese equities) with respect to the intermediate term.


Consider the following arguments that are in favor of this investment strategy:


  1. A likely transition from Quad #3 (i.e. growth slowing as inflation accelerates) in 2Q14 to Quad #1 (i.e. growth accelerating as inflation decelerates) in 3Q14: Not exactly the hardest call to make. Japanese growth has certainly stabilized here in the back half of 2Q and that is very supportive in the context of an easier GDP compare and tougher CPI compares.
  2. A re-risking of the GPIF portfolio: Per Japanese Prime Minster Shinzo Abe, a review of GPIF’s target allocation is due anytime in the next 1-3M. He has gone on record to suggest that the portfolio rebalancing will “benefit the insured and also bring investments that foster growth”. The general consensus among the investment community is that GIPF will likely reduce its JGB holdings from 60% of its $1.2T in assets to 40% and increase its allocation to Japanese equities to 20% from 12% currently.
  3. Favorable micro tailwinds: Japanese companies have announced a record $25B in share repurchases as of the last week of JUN and are sitting on a record $3T in cash to the extent they will look to continue engineering an optical improvement in ROE over the intermediate term. Per Bloomberg, TOPIX companies posted an 8.6% ROE in the year through 1Q14, the most since the 12M ended 1Q08. That’s well in advance of the trailing 10Y average of 6.2%  – which is the 2nd lowest reading of the 24 developed markets tracked by Bloomberg and less than half that of the S&P 500.





JAPAN POLICY VACUUM PART II? - Japan High Frequency GIP Data Monitor






Now, consider the following two arguments that are particularly unsupportive of the aforementioned investment strategy:


  1. Abe’s “Third Arrow” is more talk; less walk: In an op-ed this weekend, Abe defended the “Third Arrow” of his economic reform agenda, claiming that it will “fell Japan’s economic demons”. While time will ultimately tell on that front, we do not share Abe’s bullish conviction with respect to the current plan.
    • We like that he remains committed to lowering Japan’s corporate tax rate to sub-30% “over the next several years” (after a -240bps reduction in the effective rate in FY14), but we do not think it’s particularly helpful to ensure that the measure will be “revenue neutral” in the context of long-term fiscal consolidation targets. That likely equates to even more pressure on Japanese households from a tax perspective. Moreover, it’s unclear how promoting marginal growth in corporate profits will benefit Japan; if the US experience is any indication, the only growth Japan will see from rising corporate profits is growth in socioeconomic inequality.
      • The Third Arrow is woefully short on ameliorating Japan’s core economic issue: woeful demographics. Specifically, a policy to promote mass immigration is conspicuously absent from the Third Arrow as it stands currently. Per StreetAccount:
        • Kyodo cited government data that indicated Japan's population fell 243,684 YoY to 126,434,964 as of 1-Jan. 
        • Deaths hit a record high of 1,267,838 last year while births were up modestly YoY to 1,030,388.
        • Those 65 or older increased to 31,582,754, and those under 15 hit 16,489,385, a twenty-year low.
        • 39 of 47 prefectures experienced a fall in population, with Hokkaido seeing the largest decline.
        • Elderly people accounted for 24.98% of the population, and the number of foreign residents declined 2,347 YoY to 2,003,384.
  2. Easier Fed + Japanese monetary policy vacuum = stronger JPY: We continue to be the bears on the USD because we continue to be the bears on domestic economic growth and the latter supports our contrarian view that the Fed will continue to ease monetary policy, at the margins, as we progress throughout the year. We put out a deep-dive on this topic last week; CLICK HERE to access that report. While down from the trailing 3Y reading of +0.98, the Japanese equity market remains tightly correlated to the USD/JPY cross (+0.73 over the TTM). We expect that correlation to tighten (in a manner that is negative for Japanese stocks) as consensus is forced to review its lazy expectations for US monetary policy, at the margins.


Net-net, we do not think it’s appropriate for investors to gross up their exposures here in either direction. Our call for investors to cover Abenomics shorts ~1M ago was highly appropriate, but the outlook from here is less than clear.


As such, we think it makes sense to hold tight through 3Q so that we can finally be 1-2M striking distance of a likely expansion of the BoJ’s QQE program. Again, that is the approximate timing of the next major pro-Abenomics Trade catalyst according to our Hedgeyes, as the resiliency of the Japanese economy post the consumption tax hike should continue to keep Kuroda and Co. at bay for at least the next 3-4M.


Specifically, given the large amount of “hay” that the LDP has promised to bale on the growth and inflation front, we continue to see no reason why long-term investors should bail on the Abenomics Trade (i.e. they should remain involved on the long side of Japanese equities). Policies to Inflate out of Tokyo aren’t going anywhere anytime soon; that’s more than we can say for the Japanese consumer, however.






Email us if you have any further questions and we’d be more than happy to follow up. Best of luck out there!




Darius Dale

Associate: Macro Team

Dollar General: Our Take on the Chairman and CEO's Resignation

Takeaway: The resignation of DGs chairman and CEO likely signals either a slowdown in the growth trajectory or simply that growth is hard to come by.

(Editor's Note: Here is an excerpt from a note our Retail Team published to institutional subscribers earlier today.)

DG - Dollar General CEO Announces Retirement Plans (PRESS RELEASE)



"Dollar General Corporation announced that its chairman and chief executive officer, Rick Dreiling, 60, has informed the Board of Directors of his intent to retire as CEO effective May 30, 2015 or upon the appointment of a successor. Dreiling has agreed to serve, at the discretion of the Board, as chairman during a transition period following the appointment of a new CEO."


"Dreiling has served as CEO since January 2008 and was named chairman of the Board in December 2008. Under his leadership, the Company's annual sales have increased more than 80 percent to $17.5 billion in 2013 and store count has increased by 38 percent to more than 11,000 stores in 40 states."


Our Takeaway:

Dreiling was critical in leading DG in the two years leading up to its (re) IPO in December 2009.


Since that point, he's executed on the real estate growth strategy, but also in a meaningful shift into consumables. We've been vocal about the category shift being largely played out at DG (and FDO).


And although there is admittedly still room for the company to expand (and fill out) its footprint, we can't imagine that a CEO switch at this point does not signal either a change in the growth trajectory, or the likelihood that growth is simply harder to come by.


That's a similar theme these days in retail -- DG, TGT, JCP, KSS.

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