My Bubble's Birthday!

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

“Today you are you! That is truer than true! There is no one alive who is you-er than you!”

-Dr. Seuss


On this day in 2007, my first of three children, John Henry McCullough (we call him Jack) was born. It was the most humbling, yet inspirational moment of my life. While he won’t quite get what that means until he reads this many years from now – I’ll give him a big hug when he wakes up this morning and thank him for it anyway.


At the time, I thought Jack inspired me to say goodbye to a life in the hedge fund business that was very good to me. Little did I know that my goodbye (to the head hunter community) was more like a “top of the risk management morn” hello to all of you.


So I just wanted to thank all of you this morning too. I started building this company 7 years ago with only 1 thing in mind – being true to who I am. To do that, I could only build alongside teammates and business partners who share the same principles and purpose. While we may not get everything right, today I can still say that we are who we are, truer than true.


My Bubble's Birthday! - 80


Back to the Global Macro Grind


Today is also my bubble’s birthday. Shortly after Jack was born, the US stock market #bubble of 2007 stopped going up. It actually started to go down fast, closing down 6.6% in November of that year – and didn’t bottom for 16 months after that.


Today’s all-time #bubble high in the SP500 is approximately +30% higher than that one was…


And while I haven’t been explicitly bearish on the SP500 this year (my focus has been much more on the small/mid cap illiquidity #bubble that was the Russell 2000, which is still -3.1% from its all time high), I’m obviously getting there!


What a long, strange, but thoroughly enjoyable trip…


What’s the same between now and November of 2007?


  1. They were both all-time SPY highs – and in both cases, all-time was/is a very long time
  2. As we hit all-time highs, in both cases, both local and global growth was already slowing
  3. In both cases, there were/are a myriad of “it’s different this time” perma bull cases being made


Away from that – this day of November 2014 versus that in 2007 are entirely different.


How so?


  1. This time, every major central planning agency considers itself some version of a gravity bending god
  2. There are fewer hedge funds that are actually hedged for a crash (hedge fund correlation to SP500 beta = +0.9)
  3. Where I am most bearish (Russell 2000), this market is way more expensive (55x trailing earnings) and illiquid


I’m also grayer and fatter, but you already know that.


What we don’t know now is similar to what they didn’t know then (with they being those who bought them at the all-time high). There is a buyer and seller at every cost basis don’t forget.


I am the way I am, partly because I am a Canadian hockey player, but largely because I’ve never lost money in a down US stock market (2000, 2001, 2002, 2008).


While I think I was as bullish as anyone on small/mid cap US growth stocks in both 2009 and 2013, but I’m definitely not the guy who is going to give you reasons to buy #bubbles. At least 90% of the Old Wall can get you that call this morning (for a brokered fee!).


So don’t expect that from me today and/or on Monday if the jobs report is magically “better than expected” this morning either. The main reason for that isn’t an ideology or a marketing model – it’s a risk management process.


My catalyst in both 2007 and 2014 was/is the same. It’s called the economic cycle. Whether naval gazing US stock market consensus is forced to acknowledge it today, next week, or next month isn’t the point.


Long-term Bond Yields, Oil, Gold, Japan, Russia, Brazil, Europe, Emerging markets, Russell 2000, etc. have already confirmed it.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.22-2.40%

SPX 1967-2046

RUT 1121-1181

Nikkei 14602-17378

VIX 13.29-17.14

WTI Oil 76.23-79.92


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


My Bubble's Birthday! - 11.07.14

DRI: Still Lacking Direction

As promised, the “new” Darden is cutting costs and streamlining the organization.


Unfortunately, the recent press release reads like the “old” Darden.  It lacks conviction, enthusiasm, new thinking and a new strategic direction.  We do recognize, however, that the new board was recently elected and that we are in the early innings of an overhaul.


While “winning market share, improving same-restaurant sales and achieving best-in-class profitability” are the right things to say, these objectives pale in comparison to the other strategic changes that must be made at Darden, which includes fixing the broken culture of the company.


Commensurate with the changes at the board level, the company needs an entirely new strategic direction.  We understand the company is in the midst of a CEO search, and now in need of a new CFO, but FY15 is rolling on and there appears to be little sense of urgency.  With the stock up 13% and 17% over the past one and three months, respectively, it appears as though there is anticipation of better times ahead.


The company needs a new strategic plan that addresses the issues brought forth by Starboard in its 297 page activist presentation.  Until then, the move in the stock is premature.


Since Starboard’s impressive victory in early October, the “new” Darden has issued four press releases:

  • October 14, 2013 - Darden names Gene Lee Interim CEO
  • October 16, 2014 – Darden’s Board Appoints Additional Director
  • November 5, 2014 – Darden Retains Korn Ferry for CEO Search
  • November 13, 2014 – Darden Announces Corporate Governance Reforms and Sets Second Quarter Earnings Release for December 16, 2014.
  • November 18, 2014 – Darden Announces Leadership Changes and Strategic Actions


These are important steps, but we’re still waiting for the big one.  We will likely not reach an inflection point in the business until we see a press release that reads:


“Darden to Hold Conference Call for New CEO to Outline a New Strategy for the Company.”


The plan would need to include:

  1. A new strategic direction for Olive Garden - DRI’s future valuation depends on this brand being fixed.
  2. A plan to improve LongHorn’s relatively low AUV’s and below average returns.
  3. Significant changes to capital allocation strategies, including limited new unit growth and the potential sale of real estate and other non-core assets.
  4. Strategic priorities for improving the cost structure of the enterprise.


Our point is that the majority of Darden’s announcements over the past month are insignificant relative to what needs to take place for this company to turn the corner.  Importantly, the list of executives that have left the company since interim CEO Gene Less was appointed COO back in September 2013 is staggering:


Dave Pickens, Drew Madsen, Clarence Otis, Michael Barnes, Leonard Berry, Odie Donald, Christopher Fraleigh, Victoria Harker, David Hughes, Charles A. Ledsinger Jr., William Lewis Jr., Senator Connie Mack III, Michael Rose, Maria Sastre William Simon, Brad Richmond, Daisy Ng and Bob McAdam.


Importantly, zero new executives have joined in order to breathe new life into the company.  It seems like more of the same – a “trust me” mentality that got Darden into trouble in the first place.


Recall that during the past year, the current management team said they could not fix Red Lobster.  So what did the company do?  They promptly sold the business.  Following the sale, there was some very conflicting commentary about the Red Lobster opportunity.  We feel it could have been ‘saved’ under the right leadership and ultimately sold for a significantly better return for shareholders.  In other words, we believe the company was in need of some new leadership and oversight. 


While Darden has a new board in place, we must recognize that this is only the beginning and further changes are needed.


Now the same management team says they have a plan to fix Olive Garden.  Again, why should we play the “trust us” game?  We believe that a new CEO-CFO team will be central to any strategic turnaround plan.


We continue to believe that DRI, with a healthy Olive Garden (positive same-store sales and guest count growth), would have the potential to be a tremendous investment over time.  Like all great restaurant turnarounds, DRI would likely go on a multi-year run of shareholder value creation if this is achieved.


Here’s our takeaway from the news flow since October:

The $20 million in cost cuts announced is underwhelming relative to the $216 million Starboard thought was possible.

  • Hedgeye: Since there was no indication that more cost cuts are on the way, is this $216 million number still a relevant benchmark?


There are only a few days left in the quarter, meaning management knows what the numbers look like. If the company’s core brand, Olive Garden, was participating in the industry upturn in sales wouldn’t they have given shareholders the good news?

  • Hedgeye: The Company was making progress on the Renaissance Plan in 1Q15. Has there been any follow through into 2Q15?


There has been no indication the company will cut spending on new units and stop the egregious spending on Olive Garden remodels.

  • Hedgeye: This is a must.  Why was this not a part of the strategic actions revealed in the November 18th press release?


Even with the current round of cost cutting, 2015 EPS guidance is aggressive.

  • Hedgeye: If I’m the interim CEO, and trying to become the full-time CEO, there’s no way I’m cutting guidance this quarter.  I’d rather push it out three months from now.


We suspect that the last time Darden issued earnings guidance; they assumed a recovery in the Olive Garden business.  While there may be an industry upturn, there is no renaissance happening at Olive Garden.  There is a chance the company makes 2Q15 numbers, but the hockey stick improvement the street expects in 2H15 is far too aggressive.


DRI: Still Lacking Direction - 894949


As we’ve said many times DRI can be a great company once again.  We just don’t see the path to prosperity yet!


Feel free to call, or email, with questions.


Howard Penney

Managing Director


Fred Masotta


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It's Still an Illiquid Small Cap Bubble | $IWM

Editor's note: This is an excerpt from CEO Keith McCullough's morning research. For more information on how individuals can subscribe click here.


After dropping another -1% yesterday, the Russell 2000 (IWM) is right back into the red for 2014 year-to-date (down -4.2% from its all-time #bubble high of 1208 in July).


It's Still an Illiquid Small Cap Bubble | $IWM - ben11


Stay with:

  • #GrowthSlowing Long Bonds (TLT, EDV), 

  • Consumer Staples (XLP) 

  • Healthcare (XLV) and 



Takeaway: Existing Home Sales joins the bullish housing party, alongside NAHB (Tuesday) and Housing Starts & Mortgage Apps (Wednesday).

Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume. 




Today's Focus: October Existing Home Sales 

EHS topped off three-days of strong housing data with a sequential gain of +2.5% up to 5.26M units SAAR – the third consecutive month of gains and the highest level in 13 months. 


Generally, there's limited usefulness in the EHS report on the sales side since the data is well-telegraphed by the Pending Home Sales report a month earlier.  However, we’ve seen EHS diverge from the more modest gains in PHS the last couple months – a trend we’re seeing on the new home side as well with New Home Starts positively diverging from Permits in Sept/Oct.  The two series are tethered, so unless we see a positive revision and/or sizeable increase in PHS for October, its unlikely we see a gain of similar magnitude in existing sales next month.


Looking at the recent historical data, the direction of convergence between EHS and PHS after a period of divergence isn’t consistent.  As can be seen in the 2nd chart below, EHS re-coupled to PHS to the downside in 2H13 while, conversely, PHS played catch-up to EHS mid-year this year. 






TOTAL EHS:  Total EHS rose +2.5% MoM to 5.26M Units SAAR, marking a third month of gains and the highest level since September of last year.  Notably, sales turned positive on a YoY basis (+2.5% YoY) for the first time in 12 months.  As we’ve been highlighting, we continue to expect improvement in rate of change measures on the volume side as we traverse the peak collective impact (ie. easiest comps) of weather, QM implementation and FHFA loan limit reductions into 2H15. 


REGIONAL:  All regions except the West reported both sequential gains and positive year-over-year growth in sales.  All regions reported positive YoY growth in median prices with all except the Northeast registering accelerating price growth. 


INVENTORY:  Inventory remains relatively tight and should help buttress the moderation in prices.   On a Unit basis, inventory declined -2.6% MoM to 2.22M, the 3rd month of decline and lowest level since March.  The confluence of rising sales and lower inventory took months supply down -4.1% sequentially to 5.06 months.  


DISTRESSED/CASH/1st-timers:  First-time homebuyers held at 29% of sales for the 4th straight month and, on an annual basis, remain at the lowest level in three decades.   All-cash sales increased to 27% from 24% prior while Distressed Sales declined to 9% vs 10% in October and 14% a year ago. 















About Existing Home Sales:

The National Association of Realtors’ Existing Home Sales index measures the number of closed resales of homes, townhomes, condominiums, and co-ops. Existing home sales do not take into account the sale of newly constructed homes. Existing home sales account for 85-95% of all home sales (new home sales account for the remainder). Therefore, increases in existing home sales tend to signify increasing consumer confidence in the market. Additionally, Existing Home Sales is a lagging series, as it measures the closing of homes that were pending home sales between 1 and 2 months earlier.



The NAR’s Existing Home Sales index is published between the 20th and the 22nd of each month. The index covers data from the prior month.


Joshua Steiner, CFA


Christian B. Drake


Keith's Macro Notebook 11/20: Yen | Europe | Russell 2000


Hedgeye CEO Keith McCullough shares the top three things in his macro notebook this morning.

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