Sound Reasoning

“You are right not because others agree with you, but because your facts and reasoning are sound.”

-Benjamin Graham


That’s one of the concluding quotes in a great book I’ve been citing for the last few weeks, The Outsiders, by William Thorndike. It comes from the final chapter, “Radical Rationality – The Outsider’s Mindset” (pg 197). I love that mentality.


I also love getting big Macro Themes right. After beating myself up daily in this forum throughout February as inflation was having a counter-TREND bounce, I’m happy that March looks a lot more like January – Global #Deflation continues to dominate.


Was our early January reasoning on an intermediate-term TREND target for the Euro of $1.05 sound? Yes. In stark contrast to how many are describing US Dollar strength today, we started with the most basic premise of all – that Draghi would burn the Euro at the stake.

Sound Reasoning - bruning euro 08.25.2014 large


Back to the Global Macro Grind…


Burn baby burn. And now what? Now that they have centrally planned both their stock and bond markets to all-time highs (German DAX +20.2% YTD; German 10yr Bund Yield 0.21%), what’s next?


Our reasoning is mathematical, so bear with me:


1. European growth and inflation data will continue to slow well into Q3…

2. Draghi’s growth and inflation targets will be missed… and… drum-roll…

3. Then he’ll need to provide more #Cowbell, burning the Euro further


That’s been our intermediate-term TREND call. In the very immediate-term (i.e. this morning) the US Dollar is finally signaling overbought at 99.99 on the US Dollar Index (which is what implies our $1.05 EUR/USD target).


Meanwhile, the European “inflation” data remains deflationary:


1. Spain’s Consumer Price Index (CPI) for FEB was still -1.1% year-over-year

2. Germany’s CPI bounced to a whopping +0.1% year-over-year


That’s right. After the counter-TREND bounce in things like commodities in FEB, that’s all the Germans got out of Draghi in reported economic terms, a 0.1% inflation reading which isn’t in the area code of the 2% “target” most central planners are hoping for.


Hope, as we like to say @Hedgeye, is still not a risk management process. And with March’s reversion to the mean of #deflationary forces firmly intact, the Federal Reserve’s hope that #deflation in Oil and Energy markets is “transitory” is going to look wrong (again).


Being right with sound reasoning is one thing. Being wrong, over and over again, on both your growth and inflation forecasts – but representing yourself as right (using stock markets as your validation) is entirely another.


NEWSFLASH: centrally planned stock markets should not be confused with economic realities


That is, of course, how this gigantic and ideological experiment ends. With central planners attempting to bend and twist economic gravity and ending up right where they started – with both Global growth and inflation slowing.


“So”, with European equity and sovereign bond prices pinned up here this should be fun to watch.


It’s also been a hoot to watch the Weimar Nikkei, which took it’s inverse-correlation queue from Burning Yens and ramped another +1.4% overnight (+8.9% YTD) to a 15 year high. Yep, that’s crushing the SP500 (which is -0.9% YTD).


Oh, you don’t like when I contextualize the almighty US stock market that way? You mean you didn’t tell your clients you were buying the living daylights out of failed Abenomics and shorting the US stock market on the other side of that?


What is wrong with you? You definitely don’t deserve 2 and 20 unless you had that reasoning! #kidding


But I’m not kidding in telling you that I have my US equity asset allocation (see our dynamic and daily Hedgeye Asset Allocation model in the bottom of this note for how I’d be allocating capital or raising cash after macro moves) at YTD highs, on red.


From this time and price, I like US Consumer Discretionary (XLY), Housing (ITB), and the Russell 2000 (IWM) – in that order. I also like Healthcare (XLV) stocks, but in looking for a beta bounce on accelerating US consumption (US Retail Sales are going to be reported this morning), I think there’s more upside in the aforementioned order.


If everything that punishes those levered to commodity and/or debt #Deflation doesn’t pay the people in America who have been pulverized by US cost of living, my reasoning will prove to be wrong. Oh, and so will any US GDP forecast that doesn’t look recessionary.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.98-2.24%

RUT 1194-1235

Nikkei 189

USD 96.98-99.99

EUR/USD 1.05-1.08

YEN 119.35-121.91

Oil (WTI) 48.01-50.22


Best of luck out there today,



Keith R. McCullough

Chief Executive Officer


Sound Reasoning - Slide1


The Laws of Arithmetic

This note was originally published at 8am on February 26, 2015 for Hedgeye subscribers.

“They haven’t repealed the laws of arithmetic, yet, anyway.”

-John Malone


Malone wasn’t talking about economic-central-planning authorities, but he could have been. The American grandmaster of debt leverage, EBITDA, and equity value creation would probably be the best overlord of our markets, ever. It’s too bad he’s a libertarian.


Yep, the largest land owner in America (2.2M acres) not only founded Liberty Media – but he’s a libertarian. That makes some of the Yale alumni in the economic-gravity-smoothing department cringe. And I like it.


Born, raised, and educated in Connecticut, Malone is a Yale man. He’s rightly featured as one of the best CEOs in US history in the book I’ve been citing as of late, The Outsiders, by William Thorndike. If you want to be a hard core capitalist, you have to study John Malone.


The Laws of Arithmetic - 48


Back to the Global Macro Grind


Hard core capitalists who believe in things like arithmetic and second derivative math, meet your makers – these central planning “folks” are going to go to hell’s end until they get reported “inflation” – and guess what? For now they aren’t going to get it!


In today’s Chart of The Day we show what the Federal Reserve currently uses as its definition of “inflation” – something academic wonks call “Core PCE”, or the US Personal Consumption Expenditure Core Price Index.


Other than this chart going straight down for the foreseeable future (until at least Q3), here’s what this time-series means to me:


  1. Instead of using real-world inflation, Bernanke deferred to a made-up calculation that fit his policy narrative
  2. In 2011, the US Dollar hit its lowest-level since 1978 - that’s what perpetuated the highs in this chart
  3. But since, at $1900 Gold, “there was no inflation” (per the Fed); it said it was just about right at 2%


I can guarantee you that everyone Paul Krugman influences in the Yale and Princeton econ departments completely disagrees with the context I just provided you. So that means I’m probably onto something…


Taking this to a higher-level of an investor’s real-time education, why does this chart matter now?


  1. Both the 1 and 3 year “compares” (comps) for reported CPI are very difficult
  2. When the comps are hard, the central tendency of the current data is to the downside
  3. Janet is going to be waiting for Godot if she’s looking for this sucker to hit her +2% “target” again


As importantly, the European definition of “inflation” continues to be, well, #deflationary. This morning Belgium reported at -0.4% year-over-year Consumer Price Index (CPI). That’s both in line with other countries in the Eurozone and nowhere near the +2% “target.”


If you buy into our Global #Deflation Theme, you have been buying the living daylights out of Long-term Bonds on all pullbacks for the last year, and you’ve been getting paid. Here’s where Big Macro 10yr yields are falling to this morning:


  1. Germany Bund 10yr = 0.29% (record low)
  2. Japanese Government Bond (10yr) = 0.33%
  3. Dutch 10yr = 0.37%
  4. French 10yr = 0.60%
  5. US Treasury 10yr = 1.94%


Never mind that the Swiss have a 10yr yield of 0.01% for a minute and tell me how, on God’s good earth, that the US 10yr Yield isn’t going to mean revert lower… if I’m right on both Global growth and “inflation” slowing, that is…


As many of you who have followed me for a long-time know, I haven’t been a perma bull on the Long Bond. In fact, I was a raging Long Bond bear in 2013 when our modeling was signaling US #GrowthAccelerating.


But, newsflash: US growth didn’t accelerate in Q4 of 2014 – alongside Global growth, on both a sequential and year-over-year basis, it slowed. Unless they repeal the laws of arithmetic and change the “growth” definition too, that will be headline news on Friday morning.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.81-2.05%
SPX 2087-2121
DAX 11008-11302

VIX 13.39-16.71
USD 93.73-94.81
EUR/USD 1.12-1.14
YEN 118.16-120.46

Oil (WTI) 48.09-53.66


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The Laws of Arithmetic - chareal

March 12, 2015

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LEISURE LETTER (03/12/2015)

Tickers: RCL, CCL


  • March 16-19: Cruise Shipping Miami Conference
  • March 19: Galaxy FY 2014 results


Macau Legend- Macau Legend Development Ltd’s CEO, David Chow Kam Fai, expects the adjustment in Macau’s gaming market to last for two more years. Chow said Macau’s gaming industry has enough money to see it through the slump in business. Chow failed to answer directly when asked if the government was going to give his company its own gaming licence.


Takeaway: A bearish outlook from David Chow


Genting Singapore- repurchased 5.989 million shares totaling US$4 million, bringing its repurchases to more than 11 million shares. Genting Singapore has said it will repurchase up to 1.224 billion of its 12.084 billion shares.



  • Royal Caribbean's newest ship Harmony of the Seas will spend the start of the 2016 summer season in Europe.
  • Independence of the Seas will return to Southampton in 2016.
  • Also returning to the UK is Navigator of the Seas, having recently been through a £50 million pound makeover as part of Royal Caribbean's fleet-wide refurbishment programme.


Takeaway: It will be a busy time for the UK in 2016. Will higher supply affect pricing?


CCL  - CEO Arnold Donald has admitted the way the company cut commission in the UK in 2011 was executed poorly. But he suggested agents put customer service above earning potential when booking first-time cruisers.


Donald said the remuneration cuts to 5% were an “honest attempt” to respond to discounting but he conceded the lines, which include P&O Cruises and Cunard, hadn’t got it right.


He said the commission cuts were an attempt to help the trade eradicate discounting but the move had backfired. Now, he added, he was keen to build ties for the future to ensure the success of agents’ businesses and that of the Carnival Corporation brands.






Beijing-  The Chinese Security Ministry has continued its hardened stance against corruption in Macau, by warning mainland officials and Chinese business leaders that they would be monitored if they visited Macau gambling enterprises.


The hardened approach to Macau casino enterprises is part of President Xi Jinping’s wider ongoing effort to curve Chinese corruption through the ‘Tigers & Flies’ special taskforce. Xi Jinping wants officials to lead the fight by shunning away from practices associated with corruption (in particular money laundering) such as gambling,


To its financial detriment, Macau has suffered from the Security Ministry’s anti-corruption measures. Asian news sources have reported that the Ministry has the authority to carry background checks on all national gamblers visiting Macau casinos.


Takeaway: A followup to Li Gang's comments earlier in the week.


Las Vegas - Visitors to Las Vegas last year spent an estimated $723 each. Spending per visitor is also up by $33 compared to 2013 with convention-goers spending more than leisure travelers. Jeremy Aguero with Applied Analysis says 2014 represented the highest visitor spending the destination has ever seen on everything but gambling.



China February new yuan loans CNY1.02T vs consensus CNY700B and CNY1.47T in January

  • Loan growth +14.3% y/y vs +13.9% in January
  • Deposits +10.9% y/y vs +13.7% in January
  • Total social financing CNY1.35 vs consensus CNY1.100T and CNY2.05T in January
  • M0 +17.0% y/y vs (17.6%) in January
  • M1 +5.6% y/y vs +10.6% in January
  • M2 +12.5% y/y vs consensus +11.1% and +10.8% in January

Takeaway: A surprisingly positive loan data point. It may alleviate some pressure from the Central government to push for more stimulus. 


Hedgeye Macro Team remains negative Europe, their bottom-up, qualitative analysis (Growth/Inflation/Policy framework) indicates that the Eurozone is setting up to enter the ugly Quad4 in Q4 (equating to growth decelerates and inflation decelerates) = Europe Slowing.

Takeaway:  European pricing has been a tailwind for CCL and RCL but a negative pivot here looks increasingly likely in 2015.

HIBB – As Good As It Gets

Takeaway: This quarter should be as good as it gets for HIBB. Don’t get used to it.

We think that HIBB is one of the most structurally challenged retailers out there. But we’re definitely not counting on the company showing its true colors with the print this Friday. This quarter is literally as good as it can get for HIBB. 1) Wal-Mart, from which HIBB draws traffic in its core market, just printed the first positive traffic comp in nine quarters. 2) Athletic retailers like Dick’s and Foot Locker both printed solid comps in the last two weeks (DKS +3.4%, and FL +10%). 3) HIBB went against its second-easiest comp in over five years in the month of January. All-in, the comp for 4Q14 will more likely than not come in ahead of the Street’s 3.2% expectation. Somewhere in the mid-single digits is more likely, with EPS closer to the low $0.70s vs. the Street at $0.68.


So…what does this mean? It means that HIBB is our least favorite type of call. The kind where we say it’s a short, but where estimates in the upcoming quarter are too low. When we hear someone make that kind of pitch, it usually ends up being a really lousy call.  


So how and why can we stick with a short call on a name in the face of a likely positive event?  A few reasons... 


1) Smoking Required. HIBB absolutely positively has to smoke this quarter due to factors above (see charts below). Again, the climate has never been more favorable for a retailer like HIBB. The stock is up 10% relative to the market over the past month. If it does NOT smoke numbers, then it spells big trouble for this company.


2) e-Commerce Hit Inevitable. It’s no secret the company needs to install an e-commerce platform. It should be very expensive – costing 3-5 points in margin over 12-18 months before a dollar in revenue is recognized. Will HIBB announce that initiative on Friday? We don’t know. It will be some time this year. They’re just prolonging the inevitable.


3) Huge Estimate Gap. The gap in margin between our estimates and the Street’s are simply colossal. This year, we’re 7% below. That’s not huge. But in ’16 we’re at $2.06 vs the Street at $3.33. By the time we get to year 5 of our model, we have HIBB earning $1.35 vs the Street at $4.74.  The point here is that if we’re calling for estimates to come down next year by nearly 40%, we’re hardly going to be spooked by a few pennies on the upside.  


WMT Traffic – Key For HIBB Comp – Positive For The First Time In Nine Quarters

HIBB – As Good As It Gets - hibb wmt comp traffic


FL Comp Trends Are Off The Chart. Not Identical Businesses, But Close Enough.

HIBB – As Good As It Gets - FL Comp Trend


Ditto For DKS – Though Less Positive Than FL. Comp Driven By e-Comm (which HIBB does not have), Brick&Mortar Down

HIBB – As Good As It Gets - dks comp trends


HIBB Monthly Comp Trend Shows The This Quarter Goes Against Second Easiest Comp In Over 5-Years

HIBB – As Good As It Gets - hibb monthly comps


HIBB – Hedgeye Financial Summary

HIBB – As Good As It Gets - hibbfinancials



  • 5% of employees (450 positions) eliminated by end of 2014
  • Gaming consolidation underway in Las Vegas
  • Highly confident in seeing improvement in FCF starting in 2H 2015
  • Gaming ops:  Average daily revenue/footprint increased 10% YoY in 2014
  • Lower installed base: One single customer reduced slots by 259 in 4Q 
  • $18.5m not added to Attributable EBITDA -consisting of $6.2 million of impairment charges associated with the Monopoly Millionaires Club™ game (of which $5.7 million impacted cost of instant games and $0.5 impacted depreciation and amortization), $5.2 million of impairment charges related to inventory obsolescence (of which $3.1 million impacted cost of services and $2.1 million impacted cost of sales), $4.0 million write-down of certain receivables from international customers included in selling general and administrative expense and an incremental $3.1 million charge in earnings (loss) from equity investments related to the additional shortfall payment booked by the Northstar Illinois joint venture for the lottery's fiscal year ended June 30, 2014.
  • No significant maturities until 2018.  Paid down $18m in revolver to fund Bally acquisition. 
  • Currently liquidity of $538m
  • FCF: priority is to pay down revolver
  • 2015 Capex: $320-$350m (15-25m integration related capex)
    • Spending mainly on lottery side of business
  • SG&A:  $85m of charges previously described; $11m restructuring expenses ($1m WMS-related)
  • 7% increase revenue in UK installed base
  • 4Q: 228 IL VGT units shipped
  • 4Q replacement: 4,511 (848 units YoY increase)
  • Maintenance revenue virtually flat
  • Table revenue down $1m 
  • Lottery services revenue declined $5m (low performance of Powerball and MegaMillions). 2015 better start due to large Powerball in February.
  • Lottery: benefited from lower OpEx and lower termination expenses  
  • Interactive: $3m from Bally
  •  Key priorities:
    • 1) customers
    • 2) focused on integration initiative
    • 3) discipline in management of deployment of capital

Q & A

  • Feedback from customers: similar budgets as last year
  • Believe increased wallet share in Q4
  • Leverage:  Q4 included $135m of cash-based charges. Continue to invest wisely and get appropriate returns. 
  • 2015 Gaming:  relatively flat with a slight increase in share 
  • 2015 Lottery: Europe doing better
  • Gaming systems:  long lead time. Expect some big sales.  ALH rollout is very exciting - for the smaller-end market.
  • NOL balance at end of 2014: will be in the 10K (will be filed on Monday)
  • Cash taxes:  tens of millions from foreign results
  • Q4 Replacement units:  Bally had a stellar performance with Wave cabinet and Shuffle products. 
  • Gaming ops: customers are used to operating in 'new' environment. Mixture of luck, lower gas prices, and better weather also playing impact.
  • Salesforce integration:  training session. So far, so good.
  • Pro-forma 12mth ended: Cash based interest expense was $615m 
  • In purchase accounting, eliminated deferred revenues that Bally had ($27m). $5m of that $27m would have been in Dec Q. The other $22m will be impacted in 1H 2015.
  • Greece (OPAP):  contract being finalized now. SGMS was selected as a contractor. 
  • Can you get Interactive margins to 30-35%?  Rolling out mobile part of interactive.  Spending more there which has adversely impacted margins. 
  • Area of disappointment:  non-WAP premium units declined in 2014.  Customers had to reduce costs in that sector.  
  • Good performance with Wonder Woman and Flintstones 
  • S23 Cabinet will be launched this year and a couple of more products
  • The $15-25m of integration capex is in addition to the $70-80m disclosed previously
  • Low Gas price impact:  instant ticket sales are up but don't know definitely if there is an impact
  • Attributable EBITDA from Equity investments: $70.8m in FY 2014
  • Writedown in receivables:  related to Gaming business in Latin America


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