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Useless Sleep

“There is something in the New York air that makes sleep useless.”

-Simone De Beauvoir


I’m not known as a big sleeper. I’ve been krolled (not to be confused with being trolled on Twitter) a few times during the due diligence process for different ownership/partnership stakes and positions, and “irregular hours” always comes up as a “flag.”


Back when we started the firm in 2008, that’s why I called this morning rant the Early Look. And so my amateur writing career began… with the promise of only one repeatable competitive differentiator: getting up early and writing to you at the top of the risk management morning.


Last night we hosted a small group dinner in NYC to talk about how everything has “bottomed.” While the feedback (and fear) is that most don’t want to “miss” the next move up, I couldn’t sleep last night thinking that fear itself might just be the biggest #Bubble of them all.


Useless Sleep - EL chart 2


Back to the Global Macro Grind


When someone uses the word “fear”, it tends to have negative connotations. And, to be clear, I am thinking very negative things could happen if I am correct in calibrating that many got longer of #bubble exposures on the equity and junk bond market’s most recent bounce.


Sure, they may have sold short indices and overpaid for volatility, protection, etc. in the heat of last week’s melt-down, but they A) didn’t sell all of their crashing small/mid cap equity exposures and/or B) their junkie “high-yield” positions either.


In risk management speak, in bear markets we call this cardinal sin “selling what you can, not what you should”… and while my calibration might be wrong, I can’t see that in the market’s futures/options positioning (which is getting longer of beta, not shorter).


To review where some of the hardest core #Bubbles are in this interconnected world:


  1. Central Planning
  2. Carry Trading
  3. Complacency
  4. Small Cap Illiquidity
  5. Fixed Income Junk
  6. Hedge Fund Levered Long Beta


To me, a lot of this is one and the same thing. And it really starts with the 1st #Bubble (Central Planning) because that’s what drove macro markets to inheriting the mother of all interconnected risks (see exhibit 52 in the Q4 Macro Themes Deck) – the #Bubble in Spread Risk (see Chart of The Day):


  1. All-time Low in Spreads (Investment Grade over Treasuries)
  2. All-time low in Volatility (across asset classes)
  3. All-time high in Debt Outstanding (globally)


What’s fascinating about this 3D risk picture is that almost every equity only PM we meet with agrees with it much more adamantly than any of my US stock market centric #bubble charts (like the one that has Russell 2000 at 55x earnings with low liquidity).


There’s obviously confirmation bias in that, but reality is that unless you think it’s different this time (almost every “the bottom is in” thesis has something to do with markets not being able to go down anymore), this is how The Waterfall of Spread Risk works:


  1. Global Growth continues to surprise to the downside
  2. US Long Bond Yields continue to fall in kind (mean reverting to what Japan and Germany’s did)
  3. Both volatility and spread risk continue to break-out from their all-time lows


You see, the core differentiator in our call this year has always been fundamental – that growth slows and starts to get priced into expectations.


“So”, instead of living in fear of your own performance and/or what the “other funds” did last week when the Russell was -15% from its July #bubble high, why don’t I hear most people focusing on what was causal to the gap down in bond yields and equity markets to begin with?


You can lose sleep over what everyone else is doing, or you can focus on what you need to do to get the fundamental research right. And this early riser humbly submits that if you get the rate of change in growth and inflation right, you’re going to get both bond yields and your exposures right.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.09-2.25%


RUT 1040-1106
VIX 15.15-28.82

WTI Oil 79.97-83.95

Gold 1


Best of luck out there,



Useless Sleep - Chart of the Day

Exorbitant Privilege

This note was originally published at 8am on October 07, 2014 for Hedgeye subscribers.

“The Dollar is our currency, but it’s your problem.”

-U.S. Treasury Secretary John Connally, 1971


When charged with getting up early and working against the clock to produce a daily strategy missive, sometimes you throw up some duds.  You are, however, afforded the “exorbitant privilege” of serving as creator, curator and editor-in-chief of your own content. 


With KM in London, alongside a general dearth of domestic economic data this week, we’re afforded the opportunity to hit the Macro rand() button and survey some broader, top-down topography.


Exorbitant Privilege - 4


So, on with the binary dud or stud content creation....


Valéry Giscard d’Estaing, the French Finance Minister in 1960, coined the term “exorbitant privilege” in rebuking the U.S.’s ability to issue external liabilities (ie cheap treasury debt) at a discount to the global cost of capital while earning higher returns on foreign equity, debt and FDI holdings. 


Simply, as venture capitalist to the world and sole beneficiary of dollar hegemony – we get to borrow low and lend high. 


…and borrow we have. 


Over the last 34 years, on our way to becoming the biggest debtor nation in history, we have borrowed some $10.4T, with an average annual deficit-to-GDP ratio of ~3.2%.


What does that mean exactly and what are the consequences of such a massive imbalance in the global flow of goods, services, income & assets?


In short, it means we’ve borrowed and/or sold accumulated wealth to finance consumption in excess of income – with the tailwinds of globalization and financial integration helping us do so in unprecedented magnitude.   


To review: 


The global flow of commerce and capital can appear complex and convoluted but, in large part, the same dynamics and constraints that drive spending and borrowing decisions for the individual or household apply to sovereigns as well. 


If national expenditures (C+I+G) are greater than domestic output (GDP) – if spending is greater than income – that difference is financed by borrowing from abroad;  either by direct issuance of debt or via dissaving and the selling of domestic and external assets. 


A creditor/surplus country whose expenditures are less than its income lends that difference to a deficit country by buying the deficit country’s debt/assets.  From the opposite perspective, a debtor/deficit nation finances consumption expenditures in excess of income by selling assets or issuing debt to a surplus nation.


Such trade balances have important implications for national wealth because a country’s net investment position with the rest of the world (ie. how many foreign assets a country owns vs. foreign claims on domestic assets) defines a nation’s external wealth – and, in the (very) long run, it’s a country’s level of wealth plus its level of income (ie. GDP) that determines its long-run capacity to spend.    


Since ~1980, the U.S. has incurred a persistently negative trade balance, financing current consumption by dissaving and borrowing from abroad. 


Interestingly, however, U.S. external wealth has declined disproportionately less than the cumulative trade deficit.   Indeed, we have been a net exporter of assets to the tune of ~$600B per year via the trade deficit but our external net wealth has declined only modestly, even risen significantly in many years.  


How can a country increase its net wealth?  Again, the same as an individual or household:


  1. Save more (ie. the trade balance:  reduce/reverse the trade deficit)
  2. Be the beneficiary of gifts of assets (ie. the capital account: not really a factor for the U.S.)
  3. Benefit from capital gains (ie. high positive ROI on external assets)


For a country that is a net debtor, the singular path to earning positive net interest income is by receiving a higher rate of interest on its external assets than it pays on its liabilities. 


For the U.S. a few primary factors have driven this:


  1. The US gets to borrow low:  reserve currency, deepest/liquid market, risk-free rating, etc
  2. The US exports a significant amount of capital to foreign markets:   EM and developing market risk premiums are higher but, longer-term, returns are better also.  For the U.S., the benefit comes in the form of higher relative capital gains
  3. EM & Developing Countries borrow high and lend low:  This is an oversimplification but it's broadly true.  Cost of capital for EM and developing countries is comparably higher and, to the extent a higher proportion of investment capital flows to US/DM treasury debt (vs equity or FDI), the returns are comparably lower.


How do the above factors impact net external wealth and play to the benefit of the U.S.?  


Here’s the textbook equation for change in external wealth over a given period:  


Change in External Wealth = Trade balance + interest paid/received on prior period external wealth + interest rate differential + capital gains


It’s the two terms on the far right side of the equation that have provided an incremental net benefit to the United States and have underpinned her Exorbitant Privilege for nearly a century.


The data is somewhat mixed and open to debate, but the BEA estimates the US has been the beneficiary (due to the confluence of factors highlighted above) of a positive interest rate differential of ~1.5% and a positive capital gain differential of ~2% for the last 3 decades. 


In other words, Exorbitant Privilege has provided an  ~3.5% offset to the trade deficit. 


In recent years, global central bank policies aimed a lowering interest rates and inflating financial asset prices have served to further perpetuate that privilege.


Indeed, recall the circular flow of QE mechanics:  


The Treasury issues debt --> the Fed buys the debt --> the Treasury pays the Fed interest --> the Fed gives the money back to the Treasury.     


In addition to directly lowering the cost of U.S. external liabilities via large scale asset purchases, remittances from the Fed – at ~$80B/yr and equivalent to  ~35% of federal net interest expense – takes the effective cost of capital for the Treasury further towards 0%. 


#FreeLunch…for now


Since 1450 the mean length of dominance for a particular global reserve currency = 94 years.


The current duration of reign in US dollar supremacy?  Yup…94 years.


$USD correlation risk in markets currently is acute and for the investible future, the dollar will remain the Fx alpha male.


But alongside the fledgling internationalization of the renminbi and accumulating bilateral swap agreements across the BRIC and Asian axes, the anti-dollar coalition is ascendant.     


The dollar is our currency, and the cost of cumulative excess afforded under a century of privilege will be our problem during its descendancy. 


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.38-2.49%

SPX 1937-1978

RUT 1079-1108

VIX 14.09-17.54

USD 84.85-86.71

Brent Oil 91.18-95.16 


To free lunches, perpetual short-termism and blissful ignorance,


Christian B. Drake

Macro Analyst


Exorbitant Privilege - FED Remit

CAT: Game Time (Earnings Preview, Revised)



Thursday’s earnings report should shift attention to 2015 expectations, with the market likely to focus on backlog and preliminary 2015 revenue guidance.  While we expect management to provide a very wide guidance range for the segments, we also expect 2015 EPS to eventually come in near or below 2014 EPS.  Last year's initial 2014 revenue guidance took a significant bite out of both consensus sales and EPS estimates.  CAT will be giving initial 2015 guidance following a period of weakness in key energy, mining, and construction end-markets.  As a result, we think there is a heightened likelihood that 2015 estimates resume their march lower in the near-term.


CAT:  Game Time (Earnings Preview, Revised)  - asj1



Key Points


Wind Changing Directions?  Dealer inventory builds, a short-lived surge in coal production, and Tier 4 pre-buy activity supported 1H 2014 results, but the environment going forward looks far less supportive.  Commodity prices, particularly in iron ore, oil and gas, and coal are generally much lower than 1H 2014 or 2H 2013.  Dealers are expected to reduce inventories in 2H 2014 at a similar painful pace to that of 2H 2013, with guidance for drawdowns of ~$1.6 bil vs. ~$1.3 bil in 2H 2013.  Construction equipment demand may also have slowed, as preannouncements from TEX and MTW suggest.  It is hard to see order rates improving sequentially, pointing to either weak revenues or, more likely, further draws on the order backlog into 2015. 



CAT:  Game Time (Earnings Preview, Revised)  - asj2


CAT:  Game Time (Earnings Preview, Revised)  - asj3



Expect Wide Guidance Range:  While we do not know where management will place 2015 revenue guidance, we do expect that guidance will provide plenty of flexibility.  A wide guide would likely allow management to avoid another 2013-esque series of credibility damaging guidance cuts.  CAT’s markets have weakened in an increasingly uncertain global economy and recent growth concerns should provide a good pretext for incorporating ‘wide-ness’ into the 2015 outlook.  Of course, a wide guidance range may be interpreted as the market as ‘we don’t know, but it doesn’t look all that good’, anyway.


Energy & Transportation Exposed:  Increasingly, we expect the ‘action’ to shift into the Energy & Transportation (E&T) segment.  Of course, mining capital spending has declined to more normal levels, and may worsen a bit given commodity price weakness and equipment pricing trends.  Over time, we would look to the credit side of CAT for incremental interesting negatives in mining equipment.  With oil prices near the lows of recent years and Tier 4 Final implementation in large engine in 2015, we expect to see pressure on E&T order rates and margins.  


CAT:  Game Time (Earnings Preview, Revised)  - asj4



Tier 4F Beyond Locomotives:  While gas compression is likely to remain robust, the other energy end-markets may be less so into 2015.  CAT does not have a Tier 4 compliant US locomotive offering, and does not expect one, last we checked, until about 2017.  Prime power gensets frequently go into off-grid applications like mining, oil  production, rail, coal, steel, and agriculture.  Reciprocating engine sales to other oil and gas applications, like rig engines, may also soften amid lower energy prices.  


CAT:  Game Time (Earnings Preview, Revised)  - asj5

Source: Hedgeye Call with Jeff Leigh, Former Head of Finning Power Systems April 11, 2014



Our Expectations:  We think a more reasonable 2015 EPS and E&T revenue expectation is at or below 2014.  We expect an E&T downshift leading the decline on a softer energy market and Tier 4 Final implementation.  We also see pricing in mining equipment continuing to weaken, with credit developing into a more relevant factor.  Construction Industries may continue to perform on the top line, but faces record margin compares in 1H 2015.  That doesn’t sound to us like a recipe for the 5% ($55.1 bil to $57.8 bil) sales growth or 13% 2015 EPS growth ($6.26 for 2014 to $7.08) implied by consensus estimates. 


Where We Could Be Wrong:  CAT could have a larger cost reduction program than we currently expect.  Share repurchases boost EPS, and large or numerous acquisitions can impact reported sales and EPS.  Significant stimulus, particularly in China, could help re-inflate commodity prices.  Dealer inventory changes can also be a bit of a wild card, and may help 2015 after years of mostly destocking.


Some Questions on the Quarter and Guidance

  • What oil price is baked into the 2015 outlook?  Crude oil prices may be down on the Saudi’s trying to disrupt U.S. shale oil, or in an effort to pressure Russia over Ukraine, or steeply lower Chinese demand, or some combination of those factors, or none of those factors.  In any case, 2015 end use demand by ‘petroleum’ has a less clear outlook than it did a few months ago.
  • How much impact will Tier 4 Final have on E&T in 2015?  Interestingly, the company took a pass on a version of this question in the last conference call, with the analyst confessing that he “should have sent it before”.  Staged conference calls aside, the T4F standards matter for other high horsepower engines beyond locomotives.
  • Given the recent pressure in iron ore and coal, how are you managing the credit risk at CAT financial and are there any noteworthy trends?  It seems widely expected now that many coal and iron ore miners will be forced to exit. 
  • What is happening with mining equipment pricing in the market today relative to what is being recognized from backlogged orders in revenue?  Last we heard, pricing was slipping at a slow rate. 
  • How much of change in Construction Industries sales related to changes in dealer inventories (destock) vs. so-called end user demand?  The company has been doing a much better job with the disclosures around dealer inventory changes. Destock may overstate end-market weakness. 


CAT:  Game Time (Earnings Preview, Revised)  - asj6




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TODAY’S S&P 500 SET-UP – October 21, 2014

As we look at today's setup for the S&P 500, the range is 105 points or 3.89% downside to 1830 and 1.63% upside to 1935.                                                             













  • YIELD CURVE: 1.85 from 1.84
  • VIX closed at 18.57 1 day percent change of -15.55%


MACRO DATA POINTS (Bloomberg Estimates):

  • 7:45am: ICSC weekly sales
  • 8:55am: Redbook weekly sales
  • 10am: Existing Home Sales, Sept., est. 5.10m (prior 5.05m)
  • 11:30am: U.S. to auction 4W bills
  • 4:30pm: API weekly oil inventories



    • Senate, House out of session
    • Sec. of State John Kerry travels to Berlin
    • 10:30am: American Petroleum Institute media briefing
    • 11am: Foreign Policy Initiative briefing call on Ebola policy
    • 11:30am: Michael Lewis speaks at Mortgage Bankers Assn
    • 12pm: Gov. Chris Christie, R-N.J., speaks at U.S. Chamber of Commerce’s Legal Reform Summit
    • 12:15pm: SEC examinations dir. Drew Bowden luncheon interview at Natl Society of Compliance Professionals conf.
    • U.S. ELECTION WRAP: Comparing Sen. Models; Fundraising Reports



  • Total CEO De Margerie Dies in Moscow Plane Crash
  • Actavis Said to Bid for Omega Pharma Joining Sanofi, Perrigo
  • AbbVie Scraps $52 Billion Shire Deal on U.S. Tax Changes
  • Paulson Said to Urge Shire-Allergan Merger as AbbVie Talks End
  • Apple’s Forecast for Holiday Quarter Tops Analyst Estimates
  • Texas Instruments Quarterly Profit Outlook Exceeds Estimates
  • Staples Says It’s Probing Potential Customer Credit-Card Breach
  • Yahoo Said to Be in Talks to Buy BrightRoll: TechCrunch
  • Tudor’s Jones Said to See U.S. Stocks Beating Globe Rest of Year
  • China’s GDP Growth Bolsters Case for Stimulus Restraint
  • Guardrail Maker’s Faulty Secret Changes Cheated U.S. Government
  • Pimco’s Former Parent Pacific Life Switching Accounts to Janus
  • FBI Warns of Hacks by Moonlighting Foreign Government Agents
  • Dudley Warns Banks to Fix Culture or Be ‘Dramatically Downsized’



    • Allegheny Technologies (ATI) 7:30am, ($0.06)
    • AO Smith (AOS) 7am, $0.57
    • Apollo Education (APOL) 7:30am, $0.27
    • Brinker Intl (EAT) 7:45am, $0.50
    • Canadian Pacific Railway (CP CN) 7:30am, C$2.36 - Preview
    • Carlisle Cos. (CSL) 6am, $1.22
    • Coca-Cola (KO) 7:30am, $0.53 - Preview
    • Graphic Packaging (GPK) 7:30am, $0.20
    • Harley-Davidson (HOG) 7am, $0.59
    • Illinois Tool Works (ITW) 8am, $1.23
    • Kimberly-Clark (KMB) 7:30am, $1.54
    • Lexmark Intl (LXK) 6:30am, $0.91
    • Lockheed Martin (LMT) 7:25am, $2.72 - Preview
    • Manpowergroup (MAN) 7:30am, $1.50
    • McDonald’s (MCD) 7:58am, $1.37 - Preview
    • Omnicom Group (OMC) 7am, $0.90
    • Pentair (PNR) 7am, $0.94
    • Regions Financial (RF) 6am, $0.21
    • Reynolds American (RAI) 6:58am, $0.91 - Preview
    • Synovus Financial (SNV) 7:47am, $0.37
    • Travelers (TRV) 6:57am, $2.26
    • United Technologies (UTX) 6:59am, $1.81 - Preview
    • Verizon Communications (VZ) 7:30am, $0.90 - Preview
    • Waters (WAT) 7am, $1.29



    • ACE (ACE) 4:05pm, $2.33
    • Broadcom (BRCM) 4:05pm, $0.84
    • Canadian Natl Railway (CNR CN) 4:01pm, C$1.05 - Preview
    • Celestica (CLS CN) 4pm, $0.24
    • Cree (CREE) 4:01pm, $0.34
    • Cubist Pharmaceuticals (CBST) 4pm, $0.08 - Preview
    • Discover Finl Services (DFS) 4:05pm, $1.34
    • E*TRADE Financial (ETFC) 4:05pm, $0.22
    • FMC Technologies (FTI) 4:01pm, $0.74
    • Fulton Financial (FULT) 4:30pm, $0.20
    • Interactive Brokers (IBKR) 4:01pm, $0.03
    • Intuitive Surgical (ISRG) 4:05pm, $3.81 - Preview
    • Nabors Industries (NBR) 5:30pm, $0.36
    • Pinnacle Finl (PNFP) 5:15pm, $0.50
    • Robert Half Intl (RHI) 4:02pm, $0.58
    • Sonic (SONC) 4:01pm, $0.34
    • VMware (VMW) 4:01pm, $0.83
    • Waste Connections (WCN) 4:05pm, $0.55
    • Yahoo! (YHOO) 4:05pm, $0.30 - Preview



  • Codelco Puts Faith in China to Resolve Metal Collateral Case
  • Gold Buying Rebounds in India as Diwali Sales Shine: Commodities
  • Oil’s Plunge Snares Nigeria Seeking to Defend Naira: Currencies
  • Palm Oil Reserves in Indonesia Seen Shrinking Most in 19 Months
  • Aluminum Rebounds as Copper Extends Gains in London Trading
  • Brent Crude Rises as China’s Growth Exceeds Estimates; WTI Gains
  • China’s ‘Aggressive’ Electric Car Ambitions to Boost Aluminum
  • Soybeans Rise From 1-Week Low as Investors Assess Harvest Pace
  • Rebar Drops to One-Week Low on China Economic Growth Concerns
  • WTI Crude Seen Supported Near $75 a Barrel on Drop Below $80
  • Arabica Extends Biggest Slump in Five Weeks as Sugar Declines
  • Palm Growers Raised by Hong Leong to Neutral as Worst Seen Over
  • Codelco Not Affected by China’s Metal Collateral Case (Video)
  • Codelco to Sell $8 Billion Bonds for Record Copper Mine Spending


























The Hedgeye Macro Team


















October 21, 2014

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CMG: Dip Presents Buying Opportunity

CMG continues to be on our Investment Ideas list as a long.


CMG: Dip Presents Buying Opportunity - 1


Brief Analysis: 3Q14 marked another impressive quarter for Chipotle, which managed to grow same-store sales by nearly 20% at a time when the majority of quick service and fast casual restaurants would be pleased to deliver a low-single digit comp.  The company continues to thrive amid what appears to be a secular shift in the way people, and particularly Millennials, eat out.


The stock traded down after hours, however, as low to mid-single digit comp guidance for 2015 came in well below the street's 7.2% estimate.  We believe this was a concerted effort by management to temper aggressive expectations.  This guidance may very well prove to be conservative, but CMG will be lapping the strongest period of comp growth since being spun out as a public chain in 2006.


Underlying food inflation was up +8% in the quarter, which is quite possibly the only red flag we could find in the quarter.  The fact of the matter is, this is an incredibly strong company, with strong management, best-in-class unit economics, a robust balance sheet and unparalleled momentum.  We believe any sell-off today would be a nice buying opportunity.


Comps: CMG delivered 19.8% comp growth in the quarter, beating estimates of 17.2%, led by traffic growth and, to a lesser extent, an +8.5% increase in average check.  Management guided to low to mid-single digit comp growth in FY15.  Revenues of $1,084 billion (+31.1% y/y) beat consensus estimates by 2.34%.


Margins: Despite an accelerating top line trend and a price hike, cost of sales squeezed profits in the quarter, coming in at 34.31% of sales (+75 bps y/y) vs. expectations of 33.58%, as beef, avocado and dairy inflation persists.  Fortunately, Chipotle benefitted from sales leverage throughout the rest of its P&L as labor costs, other restaurant expenses, and general & administrative costs all came in well below expectations.  Operating margins came in at 19.13% (+255 bps y/y), beating estimates by 55 bps.


CMG: Dip Presents Buying Opportunity - 2


Earnings: Adjusted EPS of $4.15 (+56% y/y) beat expectations of $3.83 by 8.26%.


What We Liked:

  • Revenues of $1,084 billion (+31.1% y/y) beat estimates by 2.34%
  • +19.8% same-store sales growth; +13.0% two-year average
  • Restaurant level margin expanded 201 bps y/y
  • Operating margin expanded 255 bps y/y
  • Adjusted EPS of $4.15 (+56% y/y) beat estimates by 8.26%
  • Throughput continues to improve; this quarter by 6 transactions at peak hour lunch and 6 transactions at peak hour dinner
  • AUVs for restaurants in the comparable base reached an all-time high of $2.4 million
  • Strong transaction growth with minimal price resistance and trade-downs
  • Only repurchased $13 million of stock in the quarter; $127 million remaining on current share buyback program
  • Comps momentum in September has continued into October
  • Brand and food continues to resonate with consumers; particularly with Millennials who are increasingly rejecting traditional fast food


What We Didn't Like:

  • Management guided to low to mid-single digit comp growth in FY15 vs. current consensus estimates of +7.2%
  • Cost of sales ratio (34.31%) came in 73 bps above estimates and continues to march higher; beef remains an issue, while avocado could moderate, and dairy has likely peaked
  • ACA costs will hit the P&L next year; impact unknown, but costs unlikely to exceed 1% of sales
  • Catering took a step back from a favorable, in-season 2Q; only 1% of sales in 3Q


CMG: Dip Presents Buying Opportunity - 3


Call or email with questions.


Howard Penney

Managing Director


Fred Masotta