Client Talking Points
With the Wall Street Journal's Jon Hilsenrath passing along the "super duper" secret information that the Fed isn’t one and done on the whole #taper thing, the US Dollar and Rates are up this morning (versus down Friday, which meant stocks down). You already know that I like the Fed tapering. It's long overdue. Yes - it's bearish for bonds and bullish for stocks (see our #FlowShows Macro Theme for Q114).
The 10-Year Treasury yield is up 3 basis points this morning to 2.85% after testing and holding our Hedgeye TREND support of 2.76%. Higher-lows are bearish form bonds, but the broader breakout to higher-highs in yields over 3.05%? It isn’t in the cards. Yet.
Well, Gold certainly loved the down bond yield move last week (and year-to-date for that matter) and does not like bond yields up this morning. This is how Gold is trading... with rates. The risk range is now $1220-1267 with the 10-year yield range of 2.76-2.89%, immediate-term.
|FIXED INCOME||0%||INTL CURRENCIES||27%|
Top Long Ideas
Darden is the world’s largest full service restaurant company. The company operates +2000 restaurants in the U.S. and Canada, including Olive Garden, Red Lobster, LongHorn and Capital Grille. Management has been under a firestorm of criticism for poor performance. Hedgeye's Howard Penney has been at the forefront of this activist movement since early 2013, when he first identified the potential for unleashing significant value creation for Darden shareholders. Less than a year later, it looks like Penney’s plan is coming to fruition. Penney (who thinks DRI is grossly mismanaged and in need of a major overhaul) believes activists will drive material change at Darden. This would obviously be extremely bullish for shareholders and could happen fairly soon driving shares materially higher.
Hedgeye's detailed and constructive view on the improving fundamentals in the M&A market with a longer term perspective is a contrarian idea at odds with the rest of the Street which is overly focused on short-term results. From an intermediate term perspective, M&A is poised to break out in 2014. We are witnessing record amounts of cash on corporate balance sheets, continued low borrowing costs and the first positive fund raising round for Private Equity in four years. Moreover, a VIX in secular decline (this has historically benefited M&A), recent incrementally positive data points from leading M&A firms that dialogue has improved, and an improving deal tally from Greenhill & Company (GHL) themselves coming out of the summer all bode favorably for GHL. So is a budding European economic recovery that would assist a global M&A market that has been range bound over the past three years. GHL stands out as a leading beneficiary of these developments.
We remain bullish on the British Pound versus the US Dollar, a position supported over the intermediate term TREND by prudent management of interest rate policy from Mark Carney at the BOE (oriented towards hiking rather than cutting as conditions improve) and the Bank maintaining its existing asset purchase program (QE). UK high frequency data continues to offer evidence of emergent strength in the economy, and in many cases the data is outperforming that of its western European peers, which should provide further strength to the currency. In short, we believe a strengthening UK economy coupled with the comparative hawkishness of the BOE (vs. Yellen et al.) will further perpetuate #StrongPound over the intermediate term.
Three for the Road
QUOTE OF THE DAY
"Confidence comes not from always being right but from not fearing to be wrong." - Peter T. McIntyre
STAT OF THE DAY
The poorest half of the world’s population—3.5 billion people—control as much wealth as the richest 85 individuals. (Businessweek)
“Conquering of fear produces exhilaration.”
I don’t know about yours, but in my life the aforementioned statement definitely holds true. My fellow Canuck, Malcolm Gladwell, cited MacCurdy’s psychological work in David and Goliath (pg 148) to explain the resilience of the British during the London Blitz.
Do you need a psychiatrist? How many days after 2008 did it take you to conquer your fear about growth? The earlier in 2009 (or 2013) the better, obviously. But some of the savants sipping on Champagne in Davos this week are just starting to get bullish now. #Exhilarating
While Gladwell’s latest book is a little too thick on sociology for me, I loved a few of his stories simply because they spoke to me personally. Unfortunately, Mr. Macro Market couldn’t care less about me as a person. Whatever speaks to me this morning has very little place in my risk management process. The easiest way for me to conquer my market fears is to grind through the process and get on with my day.
Back to the Global Macro Grind …
With a day off here in the US, it’s a good time to take a step back and review what the score is for 2014. From a performance divergence perspective, it’s been an exhilarating start to the year!
In the land of Global Equities, here are the world’s Top 3:
- Greece +9.2%
- Argentina +8.7%
- Portugal +8.5%
In other words, the markets that some of the fear-based advertising blogs talked most about for the last 3 years are your portfolio’s top money-makers. After all, who in Davos didn’t tell you to buy Greece?
And here are the world’s 3 dogs (YTD):
- China -5.3%
- Brazil -4.5%
- Japan -3.4%
Yep, remember the ole “BRICs” long-term investment theme from Davos before they had Davos? #Mint, that was. Brazil in particular has been just sad to watch – and who isn’t long Japan, after it being one of the world’s best performers in 2013 btw?
To summarize what we think will be a glaringly different year for asset allocation in 2014, we called one of our Top 3 Global Macro Themes for Q114 #GrowthDivergences. This theme should not only make for winners and losers in what we call Country Picking, but sector and stock picking within those countries too.
Speaking of #GrowthDivergences, check out the Sector Divergences in the US Equity market for both last week and 2014 YTD:
- Consumer Discretionary (XLY) -1.9% w/w to -2.60% YTD
- Healthcare (XLV) +0.5% w/w to +2.85% YTD
Yep, that’s a +545 basis point performance spread between two of the most widely held US stock market sectors. So much for Sector Variance (see our Q413 Macro Themes deck and Chart of The Day) hitting all-time lows. Mean reversion is #exhilarating, indeed.
And what’s driving that? In our GIP (Growth, Inflation Policy) model, the traverse from:
A) Quadrant #1 in our GIP Model (Growth Accelerating as Inflation Decelerates), to
B) Quadrant #2 in the same model (Inflation Accelerating alongside Growth Accelerating),
… shows you that Consumer Sectors are two of the worst sectors you can be in (makes sense because, on the margin, #InflationAccelerating (another Q114 Macro Theme), slows real consumption growth), while Healthcare and Tech are two of the best.
Technology (XLK) and the Nasdaq (QQQ) are up +0.03% and +0.5%, respectively, for 2014 YTD (versus the Dow and SP500 -0.7% and -0.5%, respectively).
Looking beyond US Equities, you can see the same performance divergence taking hold in Global Equities that you are already seeing in the world’s top and bottom 3:
- EuroStoxx600 = +1.8% last week to +2.3% YTD
- MSCI Latin American Index = -1.5% last week to -4.6% YTD
So, maybe this year at Davos they put Captain Pie-Chart on “global emerging market equity diversification” in one of the breakout rooms. He’ll have plenty of time and space to hear himself talk. Maybe his government will pay for his psychiatrist and post meeting masseuse too.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.79-2.89%
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
To summarize our current thesis on CAKE, we believe the company’s three year run of improving margins is coming to an end. Specifically, we believe the decline in food costs, labor costs, and other costs have run their course.
To what extent has the decline in these expense lines since fiscal 2010 contributed to the recent traffic declines? That question is difficult to answer and even more difficult to pin on one factor. But, we do know that, collectively, all three can have an impact. We point to DRI and PNRA as other current examples of companies needing to reverse course.
The declining traffic trend suggests that we could see an increase in food, labor and other costs as the company reinvests in store operations. Below are a series of CAKE operational observations from a consultant within the Hedgeye restaurant industry network.
From these observations, there is a lot the company can do to improve traffic, but it will take some time and incremental investment which could pressure operating margins over the near-term.
FOOD AND BEVERAGE
- Food menu hasn’t really changed in 10 years so the restaurants are unlike others who adjust seasonally and can offset certain food cost increases with new less costly items.
- Also no limited time only items that can be used to move people to less costly food items.
- Beverage is not promoted and the drink menu is too confusing.
- Labor is high because meals and drinks require too many steps to complete.
- No call ahead seating (different than reservations) allowed – costing them potential customers.
- Trouble seating large parties because of too many booths.
MARKETING AND LOYALITY
- No marketing at all!
- No focus groups.
- No loyalty programs.
- They don’t market their “to go” menu.
- They are not engaged at all at the local level.
- Mall locations mean they are very dependent on mall traffic.
- Overton is a tyrant who doesn’t listen to anyone and makes all the decisions.
- Potential health concerns and close to 70.
- Struggles to travel.
The last point about management is certainly not lost on us. David Overton, Chairman, President and CEO, controls and owns 6.6% of the company. As a result, he could decide to sell the company at any given time. But with the stock currently trading at 9.0x EV/EBITDA, we view that possibility as highly unlikely.
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