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Nonrandom Patterns

“All fixed patterns are incapable of adaptability. The truth is outside of all fixed patterns.”

-Bruce Lee


For those of us who embrace the non-linearity and uncertainty of Global Macro markets, how good is that quote? I can’t believe it took me this long into my career to find it. The more I read, the less I realize I really know.


Non-fixed market patterns. They are dynamic and constantly testing consensus narratives. Some of the best Bayesians in our profession get this. While they aren’t in the business of providing us their #process, they do make a lot of money front-running market truths.


“In 1993, Renaissance Technologies hired away from IBM a Bayesian group of researchers… searching for nonrandom patterns that will help predict markets, RenTech gathers as much information as possible. It begins with prior knowledge about the history of prices and how they correlate with eachother…”The Theory That Would Not Die (pg 237)

Nonrandom Patterns - 99


Back to the Global Macro Grind


What an excellent start to 2015! It’s been years since I’ve seen so many great long and short ideas across the Global Macro universe. If your portfolio mandate is diversified and flexible (across asset classes), I think you can have a crusher of a year!


Pardon? Yep, those who have been chasing single-factor #MovingMonkey models aren’t quite down with my optimism. But hey, I’m an optimistic guy – I’ve always thought that those who evolve their #process and adapt the fastest will ultimately win.


At 1PM EST today I’ll review our Global Macro Themes for Q1 of 2015 (ping if you’d like access). In customary hash-tag style, our current themes are as follows:

  • Global #Deflation: Amidst a backdrop of secular stagnation across developed economies, we continue to think cyclical forces (namely #StrongDollar driven commodity price deflation) will drag down reported inflation readings globally over the intermediate term. That is likely to weigh heavily upon long-term interest rates in the developed world, underpinning our bullish outlook for U.S. Treasury bonds (TLT, EDV, ZROZ, etc.)
  • #Quad414: After DEC and Q4 (2014) data slows, in Q1 of 2015 we think growth in the US is likely to accelerate from 4Q, aided by base effects and a broad-based pickup in real discretionary income. We do not, however, think such a pickup is sustainable, as we foresee another #Quad4 setup for the 2nd quarter. Risk managing these turns at the sector and style factor level will be the key to generating alpha in the U.S. equity market in 1H15.
  • Long #Housing?: The collective impact of rising rates, severe weather, waning investor interest, decelerating HPI, and tighter credit capsized housing in 2014.  2015 is setting up as the obverse with demand improving, the credit box opening and 2nd derivative price and volume trends beginning to inflect positively against progressively easier comps. We'll review the current dynamics and discuss whether the stage is set for a transition from under to outperformance for the complex. 

While commercializing my research and risk management process will continue to take time, after 7 years of doing this from an independent research provider perspective, I think we’ve made significant progress.

They key word in that statement is we.


Our Macro Team is not only up to 6 analysts at this point – they have matured into a very cohesive unit of selfless grinders who not only work very well together, but question one another’s premise, so that we keep finding ways to front-run consensus market truths.


As legendary Macro maven Ray Dalio likes to ask, “what is the truth?”


Well, on yesterday’s US stock market bounce:


  1. Healthcare (XLV) led the rally +2.4%
  2. Consumer Staples (XLP) wasn’t far behind at +1.7%
  3. And Energy Stocks (XLE) continue to suck wind (+0.2%)


And, if all you do is US Equities, that’s precisely the Macro Playbook (ask sales for our daily note on that with Top/Bottom 5 ETFS, long/short) we have for you while we are still in #Quad4 reporting season (December and Q4 GDP data all gets reported in January).


As we roll out of that into Q1, we think you should be tilting to early-cycle (LONG) and late-cycle (SHORT). I’ll explain both asset-class-rotation and catalysts/timing as best I can on our 1PM call today. We hope you can find the time to dial in.


If I’m wrong on the timing and patterns of behavior born out of my macro calendar catalysts, I’ll do the only thing a humble servant to Mr. Macro Market knows – adapt to the prior, so that I can best position for the next posterior.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.91-2.12%

SPX 1195-2046

Nikkei 168

YEN 118.11-121.27

Oil (WTI) 47.22-52.63

Gold 1195-1225


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Nonrandom Patterns - 01.08.15 chart

SBUX: Why We Think It's a Short

We first laid out our bearish thesis on a conference call back in September 2014.  Let us know if you’d like a copy of the slide deck.


This note is accompanied by an updated, condensed slide deck that visually runs through the bear case.  CLICK HERE for access.  We encourage you to read the note prior to running through the deck.



Point #1: ‘Big Bets’ Carry Risk

As we see it, the “biggest bet” the company is making is on its food strategy and the implications for overall performance of breakfast and lunch.  SBUX is investing a substantial amount of time and effort into building food sales, without the benefit of having equipment or a process that allows them to produce the food fresh.  Food is the biggest risk to the DNA of the company because, in our view, it will never be on-par with the quality of beverages consumers have come to expect from Starbucks.  Handcrafted beverages and food served wrapped in plastic are not complimentary.  It’s also difficult to imagine that other QSRs and fast casual restaurants will idly sit by and let SBUX scoop up incremental market share.


Point #2: Signs of Domestic Maturation

There’s no two ways about it.  The business is steadily decelerating in the U.S.  Two-year average same-store sales have decelerated 250 bps from the recent highs of 4Q11.  Even more concerning, two-year average traffic has decelerated 300 bps from the recent highs of 3Q13 and, last quarter, was up a measly +1%.  The recent composition of comps has been weak, yet the street expects the company to produce 5%+ comps throughout 2015.  If comps come in below cheery estimates, Starbucks will not hit its earnings numbers. 


SBUX: Why We Think It's a Short - sbux chart 1


Point #3: Menu Proliferation Rearing Its Ugly Head

Our short call argues that the proliferation of new menu items is in fact slowing service times and traffic trends.  Management was hard pressed on this issue on the 4Q14 earnings call and was in complete denial about the possibility of a throughput issue.  In fact, they attributed the entire slowdown to the macro environment and a shift in consumer shopping patterns.


SBUX: Why We Think It's a Short - chart2


Point #4: CAP & EMEA Are Irrelevant

We often hear pushback from bulls that Starbucks has an enormous growth opportunity in CAP and that EMEA has turned the corner.  Look, we get it – the company has plenty of international expansion ahead.  But, the fact of the matter is, this is irrelevant to the business today.  EMEA only contributed ~3% to operating profits in Fiscal 2014.  CAP, where same-store sales and traffic trends have been in freefall, only contributed ~10%.  This business, for now, is about the U.S. – a market which is undoubtedly showing signs of maturation.


SBUX: Why We Think It's a Short - chart 3


Point #5: Japan Acquisition Reeked Of Desperation

Shortly following our bearish conference call back in September 2014, Starbucks announced its intentions to acquire the remaining 60.5% share of Starbucks Japan in a two-step tender offer process that should be fully completed in the first half of this year.  To be frank, this acquisition makes strategic sense over the long-term as it will allow the company to capture the significant growth opportunity left in that region.  It’s a large market for Starbucks ($1.2 billion in revenues), boasts high store-level profit margins (20-25%), and should be immediately accretive to EPS. 


The timing of the deal, however, is what really raised some eyebrows.  In our view, this transaction was completed, at this specific point in time, in attempt to mask a slowing core business.  The company could've done this deal at any time in the past three years, but did not need to given strong sales trends and a significant commodity tailwind.  With these trends reversing, expectations for 17% EPS growth in FY15 still look aggressive, despite the transaction.


Point #6: DNKN Debacle & Parallels

Mid-December, Dunkin’ guided to disappointing full-year 2014 comps of +1.4%, below the +1.8% consensus estimate.  The read-through was quite discouraging, as it implied 4Q comps in the range of +0.5-0.8%, well below the +2.2% consensus estimate.  The company also guided down full-year 2015 EPS by $0.11-0.14 to $1.88-1.91.  This made us consider whether or not Starbucks is seeing similar pressure in their business.


While it pains many people to compare Starbucks to Dunkin’ Donuts, the reality is that the correlation between the two company’s same-store sales is an alarming 0.75 since the beginning of calendar 2011.  It’s difficult for us to sit here and pretend Starbucks is fully immune to the softness Dunkin’ is facing.


SBUX: Why We Think It's a Short - 4


Point #7: Hyped Up Holiday Season

Let’s face it – Starbucks 4Q14 print was not a pretty one, resulting in multiple downward revisions in 2015 EPS estimates.  Despite this, it’s been clear to us that the street has given management “a pass,” for now, opting instead to wager that holiday promotions and “Starbucks for Life” will drive accelerated traffic in 1Q15.  If there’s one thing we’ve learned over the years, it’s that the holiday season is almost always overhyped – and, this year, we’re not buying it.


Point #8: Operating Leverage Is Gone

The core of our thesis is playing out exactly as expected.  This is a business model that is completely lacking incremental leverage.  If sales and traffic continue to surprise to the downside, Starbucks will continue to miss its numbers.  Management is currently struggling to find additional leverage in the model in order to offset a reversing sales trends and a commodity headwind.  Efforts to pull labor from stores come with the massive risk of exacerbating recent comp and traffic deceleration.  With the cadence of comps already weak (fueled by unsustainable average check growth), management has suddenly found itself between a rock and a hard place.


SBUX: Why We Think It's a Short - 5

SBUX: Why We Think It's a Short - 6


Point #9: Sentiment Is Shifting

We’ve been the lone bear on Starbucks since our initial call back in September.  Even with the overwhelmingly majority of the street bullish (80.6% Buys; 1.62% Short Interest), we feel the tide is slowly turning.  In fact, last week a competitor downgraded the stock to Neutral in a note which cited multiple factors, including concerns about near-term comp trends.  Analysts are hesitant to take on an unfavorable view of the restaurant industry’s darling, and we get that, but the good news is sentiment can only get worse from here.


Point #10: Fundamental Disconnect

While our thesis is playing out to a tee, the stock has yet to move in our favor.  Consider this:  since the end of October, FY15 EPS estimates have been revised down by $0.04 while the stock has traded up nearly 7% to $81.18 per share.  While these aren’t substantial moves on either account, they are notable – and they certainly shouldn’t be ignored.  If comps come in below the street’s estimates at all in 2015, there will almost certainly be another leg down in the red line below.


SBUX: Why We Think It's a Short - 7 

Cartoon of the Day: It's All Greek to Me

Cartoon of the Day: It's All Greek to Me - Greek cartoon 01.07.2015

Greece's crumbling economy and its potential impact on the EU is roiling global markets. Again.

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"Draghi Has No Plan": McCullough Talks Europe, Japan, and U.S. Dollar


In this excerpt from today’s Morning Macro Call, Keith answers questions about today’s $SPX trading ranges and describes the different durations.

Keith also discusses the likelihood of a dovish Fed and what impact that will have on the three main currency players (Yen, USD and Euro).

Subscribe to Hedgeye's Daily Trading Ranges product to receive Keith's proprietary ranges for the S&P 500, U.S. Dollar, Euro, and more every morning before the market opens: 

Keith's Macro Notebook 1/7: #EuropeSlowing | UST 10YR | SPY

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

Retail Callouts (1/7): JCP, KSS, M, PVH, NKE, UA

Takeaway: JCP Nov/Dec sales - marketshare gains from KSS to continue. CK adding the Biebs, far cry from Marky Mark. NKE e-mail promos.



Thursday (1/8)

FDO - Earnings Call: 10:00am

BBBY - Earnings Call: 5:00pm




JCP - November/December period up 3.7 percent



Takeaway: Optically the number looks solid for JCP, though we could argue that a 3.7% comp isn't good enough for a retailer who ceded $5bil in sales and has productivity levels 45% below peak. But in light of the expectations it was enough to get the stock moving +20% after hours. The only other point of contention we'd flag here is the lack of commentary on gross margins - though for JCP it's less of an issue with GM 1000bps below historical levels. Any way you slice it, it's a big improvement from the "pleased with its performance for the holiday period" press release from LY.

This marks 5 quarters now where JCP comps have been better than negative and it also is the first quarter where it laps market share gains from both M & KSS. Over the past 4, JCP has outperformed M and KSS on the comp line by an average of 0.7% and 3.4% respectively (see chart below). Our research, which includes a number of surveys on the topic, shows that KSS was the biggest beneficiary of JCP's lost market share gaining over $1bil in sales. JCP is just starting to take that back – they’ll either earn it, or they’ll buy it (through discounting). Either way it’s bad for KSS.

Lastly on January - we did that math to see what the implied comps looked like for each of the three retailers during the month and there is no question comps look easy. The scorecard looks like this: JCP -3.8%, KSS -7.8%, and M -10.2%. But it's important not to lose sight of 1) the month represents ~15% of the top line in the quarter and 2) M & KSS were comping against 11.7% and 13.3% comps respectivley in January of FY12.

Retail Callouts (1/7): JCP, KSS, M, PVH, NKE, UA - 1 7 chart1


PVH - Calvin Klein Signs Justin Bieber, Baby



Takeaway: The 2 or 3 Bieber fans left out there that The Bieb did not alienate and/or offend can sleep well knowing that he'll be synonymous with the CK Brand. Seriously, what is PVH thinking? There is very likely a large number of potential male CK Underwear consumers that won't touch the brand given Bieb's affiliation. The teeny-bopper crowd has grown out of him. Adult women generally don't find him appealing. Men hardly view him as being 'masculine' or fashion-forward. And his music is no longer relevant.  We hope that PVH did a lot of market analysis on this one and has enough data to prove us wrong. But this sounds like a really bad idea. If all else fails, maybe CK can sell a lot of underwear and jeans in Canada.

Retail Callouts (1/7): JCP, KSS, M, PVH, NKE, UA - 1 7 chart2


NKE - Rare Email Promo


An extremely rare promotional email directly from Nike with many items on the site on sale. The company is in the process of transitioning out of Holiday and into Winter, so this makes sense. But the point is it previously used its outlets as the primary clearance channel. For what it's worth, Nike's promo emails look tight and brand-relevant -- which is a far cry from the emails of its wholesale partners.


Retail Callouts (1/7): JCP, KSS, M, PVH, NKE, UA - 1 7 chart3





UA - Under Armour Launches UA Record™, the Latest Addition to the Definitive Digital Health and Fitness Network



Chris Burch Shutters C. Wonder Operation



Federal mediators join West Coast ports dispute



GME - GameStop swaps customer gift cards



SWY - Safeway to pay $9.87 million for environmental violations


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.51%
  • SHORT SIGNALS 78.32%