The Fed's Road

“The Road goes ever on and on… down from the door where it began.”



No, that is not from Janet Yellen’s testimony yesterday. It’s from J.R.R. Tolkien’s Lord of The Rings. It’s also the theme for a walking song that my favorite Tolkien character (Bilbo Baggins) cites in Chapter 19 of The Hobbit:


“Roads go ever ever on

Under cloud and under star,

Yet feet that wandering have gone

Turn at last to home afar.”


While Janet may have been pulled and pushed toward the path of “rate liftoff”, now she’s back to where she, Ben, and their fantasy novel has always been – back to the Shire of money printings and lower-rates-for longer, that is…

The Fed's Road - Deflation cartoon 02.24.2015


Back to the Global Macro Grind


To be clear, The Fed’s Road doesn’t end with green meadows that rest under shining stars. Policies to Inflate, ultimately end in #deflation. And that gets the Long Bond Bulls paid.


Long Bonds? Yes, as in the things that are at all-time highs in Europe and Japan (10yr German Bund and Japanese Government Bond Yields are trading at 0.36% and 0.33%, respectively) as long-term economic expectations there = #deflation.


While the USA’s 10yr Yield has dropped -14 basis points to 1.96% in the last 24 hours, it’s still trading at a +160-163 basis point premium to German/Japanese Long-term Bond Yields. Unless you think US inflation is pending, you’re long  the Long Bond (TLT).


So, thank you Janet – for pseudo telling the truth yesterday. My world needed that! What did she say?


  1. She kept the key-word “patient” in the Fed’s current policy vernacular
  2. She acknowledged inflation expectations being nowhere near the Fed’s “target”
  3. She reminded her fans that she is, allegedly, “data dependent”…


Why do these 3 things matter (in the same order)?


  1. Plenty of funds were pushing the idea that the “patient” language was going to be dropped
  2. Plenty of funds were trying to pull me into the narrative that the Fed “doesn’t care about inflation”
  3. Plenty of funds now realize that the next “data” points are really going to matter!

On the “data”, you need both a calendar and a forecast – here’s mine:


  1. Thursday’s CPI (consumer price inflation) report is going to slow (again) both sequentially and year-over-year
  2. Friday’s GDP report (for Q4 2014) is going to slow (again) both sequentially and year-over-year
  3. Next week’s US Jobs Report (for FEB) is going to do something that I have no edge on


While this game of front-running expectations isn’t easy, if I have 3 data points pending and I’m relatively certain about 2/3, I’d much rather see those 2 face cards first! I think both the bond and stock market see them the way I see them too.


In that regard, yesterday’s real-time market reaction to the Fed taking you right back down the road that they’ve always been on made complete sense to me:


  1. Bond Yields fell, and accelerated to the downside into the close (TLT +1.4% on the day)
  2. The US Dollar stopped going up – Burning Yens and Euros stopped going down
  3. Housing (ITB) and Consumer Discretionary (XLY) stocks led a stock market rally to all-time closing highs


Yes, all-time is a long-time – and that’s why I’ve been saying that it was more obvious to buy longer-term Bonds on the recent pullback than it was to buy the SP500. The 10yr US Treasury bond isn’t back to its all-time high yet = more upside!


But, for those of us who like to buy both stocks and bonds (I wouldn’t have an Independent Research business if I marketed one asset class over another, sorry), we want to be buying the parts of the US stock market that will go up the most.


We call these Sector Style Exposures. In Equities, the 2015 outperformance of the following sectors remains obvious:


  1. US Housing Stocks (ITB) were +2.5% yesterday to +8.8% YTD
  2. Healthcare Stocks (XLV) were -0.1% yesterday to +5.9% YTD
  3. Consumer Discretionary (XLY) stocks were +0.5% yesterday to +5.0% YTD


Whereas the Sector Styles we’d want to be net short (hedge funds) or underweight (mutual funds) like Energy (XLE) and Financials (XLF) are +1.6% and -0.9% YTD, respectively, are underperforming the SP500 (which is +2.7% YTD).


Don’t get me wrong, in a world facing both Global #GrowthSlowing and #Deflation headwinds, a +2.7% YTD gain is nothing to complain about. Being positioned on The Hedgeye Road of Long TLT, ITB, XLV, and XLY has simply been more fruitful.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.84-2.07%
SPX 2099-2125

ITB (Housing) 27.01-28.36
VIX 13.22-16.98
USD 93.70-95.18


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The Fed's Road - 02.25.15 chart




  • Wynn Macau and the Sands China properties discontinued the practice of accepting proxy phone betting in October 2014
  • As can be seen from the chart, it appears that about 2 and 1 points of market share were lost by Wynn and Sands, respectively, since the ban was implemented
  • Sands' share may have already been on the down slope but for Wynn the elimination of phone proxy betting seemed to reverse positive momentum
  • We think Wynn Macau may restart their phone proxy betting, possibly as soon as this month. Along with new junkets, the resumption of phone proxy betting could jump start its VIP business
  • Overall Macau trends are deteriorating further and Wynn cannot overcome the environment. However, on a relative basis Wynn's VIP business could hold up better over the near term.


CHART: MACAU PROXY PHONE BETTING - phone proxy betting


The short side of our Investment Ideas list is beginning to grow, despite strong industry sales trends.  If there is anything CAKE, PNRA, or NDLS has taught us recently, it is that struggling business models are not participating in what is oft-referred to as the “industry-wide” sales strength.  Alas, a rising tide cannot lift sinking boats. DFRG is a name that we see approximately 27-48% downside in over the next twelve months, given our $10-14 fair value range.

DFRG is a company we referred to last June as “the darling of Wall Street,” when we first tagged it as a short.  Since that time, the stock has had a tremendous amount of difficulty staying afloat, as management’s growth vehicle consistently defied aggressive expectations.  To wit, fiscal year ‘14 earnings estimates have declined more than 20% since January 2014.  Over this same period, fiscal year ’15 earnings estimates have declined more than 23%.  Despite these moves, we believe there are incremental negative revisions on tap.




The Bear Case

While we believe DFRG will miss estimates when they report 4Q14 earnings on 2/27, this is not solely a call on the quarter.  2014 was a year of pain for DFRG holders and we have little reason to believe 2015 will be any different.  The street is looking for 15% and 23% earnings growth, respectively, in 2015 and 2016 after two consecutive years of down-to-flat growth.  The leverage assumed in the operating model will prove more wishful than realistic.




To get at the heart of the matter, we have little confidence in the Grille as the company’s only growth vehicle.  This concept is proving much harder to grow than most anticipated.  The classes of 2012 and 2013 openings have been extremely disappointing; with restaurant level EBITDA in the 10-15% range, well below the 20-25% benchmark.  Only the class of 2011, which was only 2 restaurants, has achieved restaurant level EBITDA in this range.  This leads us to believe that 1) management is having a difficult time selecting quality sites 2) management’s targeted restaurant level EBITDA range is far too aggressive 3) the Grille shouldn’t be growing by 35-45% a year and 4) it is dilutive to the entire portfolio (leading to lower margins and returns).



Source: Company Filings




Our lack of confidence in the Grille, based solely on reported results, drives our distaste for the stock.  Management has successfully framed DFRG as a growth company, but the new unit returns are falling well short of estimates and, if this aggressive new unit agenda continues, will lead to more destruction of shareholder value.  The street is currently looking for seven new unit openings in 2015, a number we believe is at risk of being scaled back at some point throughout the year – keep in mind that management guided to 6-8 (one Double Eagle and 6-7 Grille’s).  Sullivan’s will not be growing anytime soon; right now, it’s a dead concept walking.


Tough Setup into the 4Q14 Print

  • Consensus is looking for an 80 bps sequential improvement in the two-year average of system-wide comps to +2.6%.
  • Consensus is looking for 13% EPS growth in 4Q14, after -5%, 0%, and -20% growth in 1Q14-3Q14, respectively.
  • Consensus is looking for cost of sales as a percentage of revenues of 30.24% in 4Q14, implying full-year cost of sales of 30.17%. Management guided this line to 30.1-30.4% of sales, suggesting estimates may be too aggressive at the low end of the range.
  • Consensus is looking for 29 bps of labor leverage in 4Q14; management has only levered this line once on the past 12 quarters (20 bps of leverage in 2Q14).
  • Consensus is looking for 29 bps of restaurant level margin leverage in 4Q14; management has only levered this line once in the past 12 quarters (9 bps of leverage in 2Q14).
  • Consensus is looking for 23 bps of operating margin leverage in 4Q14; management has only levered this line twice in the past 12 quarters (301 bps of leverage in 1Q12; 354 bps of leverage in 2Q12).
  • Guidance will likely be unfavorable.





Source: Company Filings, Consensus Metrix


Valuation and Sentiment

DFRG currently trades at 21x an (in our view) inflated next twelve months earnings estimate.  Neither the sell-side, nor the buy-side, shares our sentiment on the stock, which has a 100% buy rating and only 3.26% short interest.



Source: FactSet

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Got Reasons?

This note was originally published at 8am on February 11, 2015 for Hedgeye subscribers.

“The heart has its reasons, of which reason knows nothing.”

-Blaise Pascal


Leave it to a 17th century mathematician/physicist/philosopher (who was raised by a socialist tax collector in France) to nail what Mr. Macro Market thinks about your investment and risk management reasonings – he does not care.


Of course “he” could be a she – and if the market gods ever let me know on gender, I’ll let you know. The more important point I’m trying to make about markets is that they really don’t care about your political, social, or emotional leanings either.


They don’t care about your research, what school you went to, or your neighbor’s brother’s aunt’s dog. Macro markets care about what they care about – and those things are constantly changing.  Your #process needs to embrace that uncertainty.


Got Reasons? - complacency cartoon 02.10.2015


Back to the Global Macro Grind


Got reasons for what is moving the US Equity futures intraday these days?


  1. Is it another bailout or a blowup in Greece?
  2. Is it a counter-TREND move higher in US Treasury Bond yields?
  3. Is it the Correlation Risk relationship between US Dollars and Oil?


Your portfolio may be affected by one, none, or all of these reasons. If you can tell me which one of them is going to trump all of the others, please tweet me – because, in the very immediate-term, I do not know.


Here’s what Mr. Macro Market thinks about the upside/downside in what I call my immediate-term Risk Ranges:


  1. Greek Stock Market (Athens General Share Index) = 680-883
  2. UST 10yr = 1.62-2.05%
  3. WTI Oil = $45.04-54.78


In other words, what just happened in all 3 of these counter-TREND bounces (newsflash: Greece, Bond Yields, and Oil have been crashing for the last year) was that they all recently tested the top-end of their respective risk ranges.


Unlike who I affectionately call Chart Chasers, Mo Bros, etc., I’m a fader. I don’t chase prices – instead, I try my best to:


  1. Have an intermediate-term TREND research view
  2. Sell/Short at the top-end of the immediate-term TRADE range
  3. Buy/Cover at the low-end of the immediate-term TRADE range


The least complicated part about this research and risk management process are points 2 and 3. It’s just math. The math generates the immediate-term ranges. It’s both dynamic (changing alongside price, volume, and volatility) and non-linear.


The most complicated is point number 1. What is your trending research view? Does it whip around daily? Or do you have a Bayesian inference #process that helps you change both fast, and slow, as critical rates of change undergo phase transitions?


From an intermediate-term research TREND perspective, here’s what I think:


  1. Greece remains bearish and broken
  2. Long-term Bond Yields are bearish inasmuch as our 1H 2015 inflation forecast is
  3. Oil remains a bearish TREND susceptible to ongoing Global #Deflation risk


Yep, there are multiple factors and multiple research and risk management durations incorporated in what I think. And no, Mr. Macro Market doesn’t care about that. But I certainly respect what he/she thinks, and try to listen to him/her very carefully.


Our immediate-term Global Macro Risk Ranges are:


UST 10yr Yield 1.62-2.05%
SPX 2038-2085

DAX 10598-10990
Shanghai Comp 3026-3201

VIX 15.81-20.89
USD 93.67-95.49

Oil (WTI) 45.04-54.78


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Got Reasons? - 02.11.15 chart


Takeaway: 4Q EBITDA missed expectations due to higher costs and revenue mix. Jan/Feb performing better than market.


  • Visitation from Mainland has continued to grow
    • High end players have either less gaming budget or visiting less often
  • Do not expect V-shaped recovery in near-term
  • 2015 Wage increase: 5% across the board and some loyalty benefits
  • 5% of rooms will be out of service in the next couple of years
  • On schedule to open Lisboa Palace in 2017. Currently 600 workers there
  • 2015 capex:  $7.1bn ($5.8bn -construction for Lisboa Palace); will be funded from cash
  • Will consider financial options after completion of Lisboa Palace


Q & A

  • Staff retention:  3,600 subscribe to bonus accumulation program.  Will be $45m/ year
  • Dividend payout: 70% in-line with what they have said before
  • New Mainland China visitation restriction possibility: both HK and Macau concerned. May address it in upcoming CPCC meeting.  Impact may be minimal.
  • Grand Lisboa margins:  low because of revenue mix and statutory holiday payments
  • Why satellite RC volume up?  Solid junket operators 
  • Casino Lisboa:  hold rate - 3.26% in 4Q, up from 2.77% in 3Q
  • Jan market share: improvement in both vip and mass
  • Promotional $ as a % of revenue:  5.9%...want to keep in the 4-5%; have to reinvest in mass business
  • February CNY:  market fundamentals remain weak but SJM doing better than market

Hedgeye's Morning Macro Call with CEO Keith McCullough

On today's Morning Macro Call, Hedgeye CEO Keith McCullough shares his Top Three Things, welcomes Financials Sector Head Josh Steiner via phone to discuss the current housing setup, and takes questions from viewers. 





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