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Observable Theories

This note was originally published at 8am on August 08, 2014 for Hedgeye subscribers.

“It is the theory that decides what can be observed.”

-Albert Einstein


I have a theory about performance that I developed running my own fund: it’s the score in your P&L that counts. I also have a theory about market theories: your positions reflect your theories.


We can theorize about the relationship between inflation and growth. We can highlight immediate-term market observations within their longer-term trends. We can write and rant too – but, at the end of the day, taking your position in macro is what matters.


In 2014, we’ve had a contrarian theory that as US growth expectations slow, US interest rates will fall, and both Gold and Long-term Treasury Bonds will rise. We’re not changing that theory this morning. We’d like you to keep that position.


Observable Theories - EL chart 2


Back to the Global Macro Grind


But, but… you said that if the Dollar goes up and inflation expectations fall, the consumer gets a tax cut and consumption growth can accelerate. Yep, but I said that before we were 62 months into an economic expansion (in 2009 and again in 2013), not at the end of it.


Year-over-year, the US Dollar is down -0.4%. With US cost of living barely coming off her all-time highs, that isn’t going to make me tell you to run on out there and buy-the-damn-bubble in US stocks. Sorry.


If the US Dollar were to breakout from here, and crude oil were to drop to $80/barrel – now that might get me interested. But there’s this thing called #timing that we need to consider when we theorize about getting long.


In the meantime (we’re net short in Real-Time Alerts terms) and here’s the score:


  1. US Dollar Index stopped going up this morning (because the Euro stopped going down)
  2. US 10yr Yield of 2.36% is hitting a fresh YTD low of 2.36% (crashing -22% YTD)
  3. US Equities (SPX) have only had 1 up day in the last 11 (dip buyers #underwater)


Bull market, baby (in the Long Bond)! 2014 Score: Long Bond (in TLT terms) +15.1% vs Gold +9.6% vs Russell 2000 -3.9%.


Digging into the Sector Style performance of the SP00:


  1. Consumer Discretionary (XLY) leads losers at -2.2% YTD
  2. Industrials (XLI) aren’t far behind at -1.6% YTD
  3. Financials (XLF) are 3rd worst (of 9 Sectors) at +1.4% YTD


Digging deeper, you can see the real wins and losses (sub-sectors within the S&P’s major sectors):


  1. Housing (ITB) is -10.6% YTD
  2. Regional Banks (KRE) are -7.4% YTD
  3. REITS (VNQ) are up +15.3%


REITS are a way to be long A) slow-growth #YieldChasing and B) US Rents hitting all-time highs. Yep, we have a theory that you can check with your landlord on that too: he’s not reducing your rent tomorrow due to Russia or ebola.


You see, in theoretical-land, as our #InflationAccelerating theme from Q114 stops going straight up into the right (Coffee prices dropped -3.6% yesterday, but are still +66.2% YTD), real-world inflation still sticks. Starbucks (SBUX) isn’t cutting prices today.


Inflation (especially the cyclical stuff like wage inflation and rent), is a late-cycle economic indicator. So is unemployment. Got early cycle? That’s easy. Consumer, Housing, some Industrials, and Regional Banks.


The reason on Regional Banks is really simple. As the bond market prices in slower growth, the long-end of the bond yield curve falls, and net interest margins (i.e. how banks make money off your deposits - long-term rates minus shorter-term ones) compress.


This is called Yield Spread Compression. And it’s part of this fancy theory called gravity. I have a perverse theory that as the Q3 US Growth data slows, the Fed will get easier (on the margin), and that the long-end of the curve will perpetuate moarrr compression.


As growth slows, not only do net interest margins at banks compress, but equity market multiples do. All the while, you’ll see multiple expansion on long-term Treasury bonds.


Since there’s no long-term support to 1.70% on the 10yr, maybe we should all start theorizing about that. The observable score says that’s more likely than seeing the consensus theory of 3.25% anytime soon.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.35-2.51%

SPX 1891-1927

RUT 1105-1128

VIX 15.45-18.89

USD 81.06-81.73

Gold 1298-1323


Best of luck out there today and have a great weekend,



Keith R. McCullough
Chief Executive Officer


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God, Country, Notre Dame (and Under Armour) $UA

Takeaway: At $199, it’s the most expensive authentic college football jersey on the market.

Notre Dame And Under Armour Unveil 2014 Football Uniforms


Excerpt from Notre Dame's press release:


NOTRE DAME, Ind. -- Inspired in large part by Notre Dame's tradition, and specifically based upon the University's iconic Golden Dome atop the Main Building, Notre Dame and Under Armour officially unveiled the Fighting Irish football team uniforms for the 2014 season. All three versions of the uniform -- home, away and Shamrock Series -- were on display Tuesday afternoon during head coach Brian Kelly's Notre Dame Football Media Day press conference inside the Isban Auditorium at the Guglielmino Athletics Complex on the Notre Dame campus...



Takeaway from Hedgeye Retail: Under Armour (UA) unveiled the crown jewel from its 10-year, $100 million deal with Notre Dame. (The most expensive deal in collegiate athletics.) At $199, it’s the most expensive authentic college football jersey on the market. Starting to see a trend here? Nike's retails for $135.


UA has very little artistic liberty, and we can't see anything that differentiates it from Nike and Adi other than a small embroidered text on the front that reads "God, Country, Notre Dame." Our resident ND alum (Hedgeye macro analyst and former Notre Dame ice hockey captain Ben Ryan) is unimpressed, but we don't doubt that this will be a hit with the masses. Notre Dame has arguably the most loyal fan base in America - last year it was the 3rd highest grossing university in licensed goods sales. Behind UT and Alabama.


While you can't argue with the UA mojo right now, at 75X earnings, it's not a stock we're comfortable buying here.


God, Country, Notre Dame (and Under Armour) $UA - ND1


God, Country, Notre Dame (and Under Armour) $UA - ND2

Retail Callouts (8/21): UA, NKE, DG, FDO, DLTR, TGT

Takeaway: UA - close to deal with KD, unveils ND jerseys. FDO says no thanks to DG. TGT - Canada strategy was a mistake.



Thursday (8/21)

  • GPS - Earnings Call: 4:00pm


Friday (8/22)

  • ANN - Earnings Call: 8:30am
  • FL - Earnings Call: 9:00am
  • HIBB - Earnings Call: 10:00am




UA, NKE - Ball in Nike's court for Kevin Durant



  • "Kevin Durant's representation Roc Nation Sports informed Nike on Wednesday that he has a deal on the table with Under Armour worth between $265 million and $285 million over 10 years, sources told ESPN.com. The deal includes Under Armour stock and other incentives, such a community center built in his mother's name, whose exact worth will not be known for some time."
  • "Nike's last offer, sources said, would have given Durant a base and a minimum royalty guarantee that would equal no less than $20 million a year."


Takeaway: Looks like the Durant to UA talks had some teeth after all. The ball's in NKE's court now, and we doubt they step up to the plate. Over the past few weeks NKE has made some extremely rational decisions on the cost side, saving upwards of $100mm per year by passing on ManU and KD - one of the reasons we moved it to our long bench. Currently UA's basketball business is ~$30mm, and it's marquee athlete, Steph Curry, won't have a signature shoe line until February. Clearly a lot still needs to be done in order to support the type of revenue stream KD is capable of creating, and we have a tough time believing UA is ready. Our original thoughts on the deal below.


We'll play along with the conspiracy theory on this one as it pairs nicely with the note we published last night looking at endorsement obligations for both NKE and UA (Link - CLICK HERE). If the KD deal closes with UA at the reported $30mil per, the company would have to generate an incremental ~$275mm in sales to make that margin accretive. Not outside of the realm of possibility, but consider two things. 1) In 2013 the KD grossed $175mm, 2nd only to the Lebron at $300mm. 2) That $275mm is a 75% premium to what UA has done in all of footwear over the past 12mnths. At NKE that's just 1.1%. It may be a brand builder for the company, but without a Nike-esque product and marketing engine behind KD, it's tough to see this benefiting margins in the short term.


UA - Notre Dame And Under Armour Unveil 2014 Football Uniforms



Retail Callouts (8/21): UA, NKE, DG, FDO, DLTR, TGT - Chart3 8 20 2014

Retail Callouts (8/21): UA, NKE, DG, FDO, DLTR, TGT - chart4 8 20 2014


Takeaway: UA unveiled the crown jewel from its 10 year, $100mm deal with Notre Dame. The most expensive deal in collegiate athletics. At $199 it’s the most expensive authentic college football jersey on the market. Starting to see a trend here? Nike's retails for $135. UA has very little artistic liberty, and we can't see anything that differentiates it from Nike and Adi other than a small embroidered text on the front that reads "God, Country, Notre Dame." Our resident ND alum is unimpressed, but we don't doubt that this will be a hit with the masses. ND has arguably the most loyal fan base in America - last year it was the 3rd highest grossing university in licensed goods sales. Behind UT and Alabama.


FDO, DG, DLTR - Family Dollar Board of Directors Rejects Proposal from Dollar General Based on Antitrust Issues



  • "Family Dollar Stores, Inc. announced today that its Board of Directors has unanimously rejected the non-binding proposal made by Dollar General Corporation on the basis of antitrust regulatory considerations. In addition, the Family Dollar Board unanimously reaffirmed its recommendation in support of the merger agreement with Dollar Tree, Inc."
  • "The Family Dollar Board, after consultation with its financial and legal advisors who have conducted an extensive antitrust analysis, determined that the Dollar General proposal fails to satisfy this requirement."
  • "Mr. Levine continued, 'I would also like to note that Dollar General’s letter, sent late last night, contained blatant mischaracterizations and did nothing to address the antitrust issues in Dollar General’s proposal.'”


Takeaway: We can debunk FDO's reasoning with just one word: Walmart. DG's bid was light at just a 5.5% premium. We have a feeling this is more than just dollars and cents. If FDO truly thinks there are anti-trust issues there is no price tag in the world that would allay those concerns. But, we have a hard time seeing how the FTC would be overly concerned with a dollar store monopoly. First, dollar stores sell things for a $. Second, anything above a buck is a consumable and that market is un-monopalizable. We think this is still far from over.


TGT - How Target strayed deep into the red in Canada



  • "Instead of opening 124 stores in this country last year, the second-largest discounter in the United States should have launched just five to 10 outlets and 'refined' the operations before rolling out more, chief financial officer John Mulligan said on Wednesday."
  • "'We bit off way too much, too early,' Mr. Mulligan said in a frank assessment of the company’s first foray outside its U.S. home base."


Takeaway: We still don't see how TGT makes money in Canada - ever. Consensus estimates are now 35% below the $6bil revenue estimates for 2017 and we are another $1bil+ below that. To get to the company's updated Canada guidance for 2014 calling for just over $2bil in revenue and a -25% EBITDA margin; we have to assume that 2H comps hit 6%, gross margin improves sequentially for the balance of the year (+375bps and +1500bps in 3Q and 4Q respectively), and SG&A declines by over 3%. At the same time as the company tries to fix operations and attract new or lost customers.




DG - Dollar General Sends Letter to Family Dollar's Board of Directors



  • "As you are aware, we continued to express our interest in exploring a combination into June of this year. During the June 7, 2014, phone call referenced in the background section of the Form S-4, our representative reiterated Dollar General's interest in potentially acquiring Family Dollar and stated our preference to negotiate directly with the Board of Directors and not in the public media, as might be the case with an activist investor involved, and suggested a meeting with the Dollar General CEO as soon as possible."
  • "That meeting was held on June 19, 2014, just days before the Family Dollar Board decided to enter into exclusive negotiations with Dollar Tree. During the June 19 meeting, although noting that the timing was not optimal for Dollar General, our representatives expressed more than once our interest in exploring a combination with Family Dollar. At no time during this meeting did Mr. Levine indicate that there was a process, that there was any urgency to act or that there were discussions with another potential buyer. In fact, Mr. Levine's response to specific questions posed by our representatives gave us quite the opposite impression. Had we left the meeting with the belief that a sale of Family Dollar was imminent, we assure you that our course of action would have been different."


AMZN - Amazon.com Coming to Shanghai's Free-Trade Zone



  • "Amazon.com Inc. said it plans to set up operations in Shanghai's new free-trade zone, a move that will allow it to sell more merchandise from abroad in China and help boost competition against rivals like Alibaba Group Holding Ltd."
  • "The Seattle-based Web retailer said Wednesday it signed a deal with authorities in the free-trade zone to open the company's global platforms to Chinese consumers, enabling them to import bags and books normally available for delivery only in other countries."


Toms Sells Half of Company to Bain Capital



  • "The brand announced today the sale of a 50 percent stake in its company to Bain Capital LLC, a Boston-based global private investment firm. The transaction is expected to bolster the footwear label's commitment to supporting its global charitable programs."
  • "Financial terms of the private sale have not been disclosed. Founder Blake Mycoskie will retain a 50 percent ownership of Toms."


M - Macy's Settles Profiling Cases for $650K



  • "Macy’s Inc. has reached an agreement with the New York State Attorney General resolving more than a dozen recent complaints of profiling and false detentions at the Macy’s Herald Square flagship in Manhattan."
  • "Under the settlement, Macy’s will pay $650,000 in costs, fees and penalty to New York State, and has agreed to take several steps to help prevent cases of profiling in the future at Macy’s 42 stores in the state."

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