Education of A Bond Bull

This note was originally published at 8am on June 08, 2015 for Hedgeye subscribers.

“Education is what happens after one has forgotten what one has learned in school.”

-Albert Einstein


After rates rise, we learn that consensus hasn’t learned a whole heck of a lot about cyclical investing. It’s too bad they don’t teach that in school.


I don’t know about you, but I got schooled last week. Both stocks and bonds were down. With German Bund Yields doubling in 3-days, then US yields rallying on  another “good” jobs report, bond yields ripped.


No, I’m not capitulating on the Slower-For-Longer (lower rates) cycle call this morning. If US growth was accelerating, I would. On jobs, #history students know that Non-Farm Payrolls rising is what happens AFTER the US economic cycle has already peaked.

Education of A Bond Bull - Jobs cartoon 06.05.2015

*Click here to watch The Macro Show at 8:30am ET with special guest, U.S. macro analyst Christian Drake.


Back to the Global Macro Grind


As you can see in today’s Chart of The Day (it’s actually a rock solid table of historical labor cycle data), these are the facts about US labor metrics. I’d like you to zero in on the number of NFP months (+/-) vs. economic cycle peaks:


  1. DEC 1969 (economic cycle peak) = +4.9 months (# of months after DEC 69’ when NFP peaked)
  2. NOV 1973 =  +5.9 months
  3. JAN 1980 = +3.9 months
  4. JUL 1981 = +2.0 months
  5. JUL 1990 = +1.0 months
  6. MAR 2001 = +1.0 months
  7. DEC 2007 = +3.0 months


Yeah, I know – the Fed and its Old Wall research departments are all over it, reminding you about that this morning. But, unless it’s “different this time”, US non-farm payrolls are in the #process of peaking. And I’m not a big fan of capitulating at peaks.


Zooming into this #LateCycle (2015), here’s what the rate-of-change in Total Non-Farm Payrolls (NFP) has looked for the last year:


  1. JUL 2014 = +2.01% year-over-year growth (y/y)
  2. OCT 2014 = 2.04% y/y
  3. NOV 2014 = 2.11% y/y
  4. ***FEB 2015 = 2.34% y/y
  5. APR 2015 = 2.18% y/y
  6. MAY 2015 = 2.21% y/y


And if you want to data mine, Total Private Payrolls (PP) peaked in rate-of-change terms in FEB 2015 as well = 2.71% (vs. 2.53% in Friday’s jobs report).


In other words:


A)     The US economic cycle (see recent GDP report for details and/or April/May economic data) already peaked

B)      The latest of #LateCycle indicators (employment) is in the process of peaking, as it always does


“So”, Janet, what do you say you raise rates into that?


You know, with the almighty Dow down for 3 straight weeks (-1.6% in the last month) – why not give it a try, just to see what happens? Not that you care about the stock market, or any other asset bubble that your boy Bernanke perpetuated… give it a whirl!


While this note contextualizes the latest GROWTH cycle component of the Fed’s decision on June 17th, here’s a friendly reminder on the other big economic factor that some say bond yields are rallying on – INFLATION:


  1. CRB Commodities Index was down another -0.3% last wk and is still in crash mode at -26.9% year-over-year
  2. Oil (WTI) remained in TAIL risk mode (TAIL resistance = $67.92/barrel) -2.3% last wk and -36.7% year-over-year


Not to be confused with the counter-TREND bounce off the January 2015 #deflation scare lows (when the Long Bond tested all-time highs), year-over-year inflation’s TREND remains as bearish as the rate of change in US growth is.


I’m thinking that if the Fed raises rates in this environment, equity volatility (VIX) is going to start looking like FX and Fixed Income volatility (venti!). Don’t forget that horse has already left the barn (VIX +21.7% year-over-year) too.


If I’m wrong on US Treasury Yields from here, the re-education of perma stock market bulls is officially back-to-school.


Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:


UST 10yr Yield 2.02-2.44% (bearish)

SPX 2079-2109 (neutral)
RUT 1239-1267 (neutral)
Nikkei 20371-20679 (bullish)
VIX 13.04-14.99 (bullish)
USD 95.01-98.05 (neutral)
EUR/USD 1.08-1.14 (bearish)
YEN 123.76-125.81 (bearish)
Oil (WTI) 56.77-61.30 (bullish)

Natural Gas 2.52-2.75 (bearish)

Gold 1170-1200 (bullish)
Copper 2.62-2.78 (bearish)


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


Click to enlarge

Education of A Bond Bull - z 06.08.15 chart

CHART OF THE DAY: Buy Everything! (Well, Not Everything)

Editor's Note: Below is a chart and excerpt from today's Morning Newsletter written by Hedgeye CEO Keith McCullough. Click here to learn more and subscribe.


CHART OF THE DAY: Buy Everything! (Well, Not Everything) - z 06.22.15 chart


Actually let me take that back – not all “stocks” liked the Dovish Down Dollar + Down Rates move. Here’s how our two favorite S&P Sector Shorts and Global Equities did with the pin tucked in the front, and some USD devaluation tailwind:


  1. US Financial Stocks (XLF) down -1.2% week-over-week, taking them back to 0.0% for 2015 YTD
  2. US Industrial Stocks (XLI) down another -0.4% week-over-week to down -1.5% for 2015 YTD
  3. European Stocks (EuroStoxx600) down -1.0%, taking their 3-month correction to -3.8%


Chambers #Grind

“I really grinded over those four or five-footers – that was the difference.”

-Jordan Spieth


Love that quote. After acknowledging that “I didn’t have my best ball striking”, that’s how an impressively transparent and accountable young man boiled down his #history making win at the US Open yesterday.


In sharp contrast, Dustin Johnson (who 3 putted from 12 feet to lose the Championship) said “I did everything I was supposed to do. I hit the ball well – I just really struggled to get it in the hole – I wasn’t hitting bad putts, they just weren’t going in.”


Actually, getting the ball in the hole (under pressure) is what you are supposed to do, Dustin. I don’t care who you are. Nice ball striking is, well, nice. But If you want to be a Champion, you gotta #grind boy. #Grind, grind, grind.


Chambers #Grind - 44


Back to the Global Macro Grind


So you have “nice” short ideas and did all your bottom-up research but missed that A) the Fed was going to be Lower-For-Longer last week and B) that Greece was going to extend and pretend again this morning?


SP Futures +19 handles pre-open! #Fun


Or at least more fun than trying to stick some of those greens at Chambers Bay. No matter what conditions your game is best suited for, you need to play the macro game that is in front of you.


The “buy everything” call we’ve had into a prevailing consensus wind of “it’s just time for the Fed to hike” has a few very simple components:


  1. Down Dollar = asset price reflation
  2. Down Rates = #YieldChasing


And here’s how those 2 core factors off the tee box looked last week (golfers, think of them like wind and pin):


  1. US Dollar Index down for the 3rd straight week into and out of the Fed meeting, -0.9% week-over-week
  2. US 10yr Treasury Yield down for the 2nd consecutive week, -13 basis points week-over-week to 2.26%


US stocks enjoyed that (Dow Jones Industrials Index up for the 2nd straight week putting it back in the black for 2015 at +1.1% YTD), but the biggest recipient to Down Dollar + Down Rates = Up Gold, absolutely loved that, closing +1.8% on the week.


Actually let me take that back – not all “stocks” liked the Dovish Down Dollar + Down Rates move. Here’s how our two favorite S&P Sector Shorts and Global Equities did with the pin tucked in the front, and some USD devaluation tailwind:


  1. US Financial Stocks (XLF) down -1.2% week-over-week, taking them back to 0.0% for 2015 YTD
  2. US Industrial Stocks (XLI) down another -0.4% week-over-week to down -1.5% for 2015 YTD
  3. European Stocks (EuroStoxx600) down -1.0%, taking their 3-month correction to -3.8%


If you stayed out of those big performance pot-bunkers, you were probably pleased. That said, you still had to grind over those putts once you got on the greens. There were two holes in particular that had huge breakers:


  1. Chinese Stocks (Shanghai Composite) -13.3% week-over-week, but +25.1% in the last 3 months
  2. Greek Stocks (Athens Index) -11.3% week-over-week, taking them to -5% in the last 3 months


Sure, Greek stocks are up +8% this morning on whatever extension and pretension macro market players are going to have to deal with next, but they’re also still -11.3% in the last month so this isn’t for the faint of heart.


In terms of how we’re setup right now (you can see my tilts in the Hedgeye Asset Allocation Model every day), we have one of our lowest cash positions since April. I’d characterize our cross-asset class weights being as balanced as they’ve been in a while too.


If you’d like me to rank our Best Ideas in ETF terms, here’s what I’m thinking (Top 3):


  1. ITB - US Housing Stocks (they’ve corrected on rate fears)
  2. XLV – US Healthcare Stocks (they haven’t corrected, and should continue to outperform)
  3. GLD – Gold, yep – #grind


Japanese Stocks (DXJ) are still our favorite in the International Equity bucket. And I’d be a seller of European Equities on this morning’s Greek ramp. If you’re looking for a natural head-to-head twosome, I’d put Japan up against Germany, long/short.


I’m also thinking I should stop with the golf metaphors and just get ready to #grind. Today’s gap-up open in both European and US equities is going to provide for quite a day. Like the reasons or not – we still need to put the alpha ball in the hole.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.16-2.38%

SPX 2094-2126
Nikkei 20109-20609
USD 93.88-95.40
EUR/USD 1.11-1.14
Oil (WTI) 59.05-61.35

Gold 1185-1204


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


Chambers #Grind - z 06.22.15 chart

Early Look

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The Macro Show Replay | June 22, 2015


June 22, 2015

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Takeaway: All the conversations I’m having with investors about DRI are focused on the potential of an Olive Garden REIT.

DRI is due to report FY4Q15 earnings on Tuesday and it’s going to be a great quarter!


Three things to think about following the print:

  1. Are the margin trends sustainable?
  2. What is the stock discounting?
  3. What is management doing to fix Olive Garden?

The current street consensus has DRI FY4Q15 EPS at $0.93, up 150% year-over-year.  Personally, I don’t think it’s out of the question that the company can print $1.00 for the quarter.  The headlines will make for great press as the current management team is doing a great job realigning the cost structure of the company.  Like Bob Evans recent announcement, I also suspect DRI will formally announce it is looking to do a bigger deal in the real estate space. 


Other themes coming out of the FY4Q15 earnings call will be similar to the FY3Q15 themes:

  1. Management is attacking G&A and bringing it to the bottom line
  2. There is significantly less discounting in FY4Q15 vs FY4Q14
  3. Olive Garden sales trends have improved but signs of a renaissance remains elusive
  4. Restaurant margins will improve 130bps in FY4Q15 vs 66bps in FY3Q15
  5. Operating margins will improve 343bps in FY4Q15 vs 264bps in FY3Q15
  6. There will be an intense focus on Olive Garden’s real estate and the potential for a REIT


With the stock at $69 and trading at 11.12x EV/NTM EBITDA, the street is discounting that DRI is going to have a great quarter.  The question becomes how great is great and what is the upside from here?  The bigger question shareholders need to ask is with all the improvement in profitability are they starving Olive Garden of essential capital and the initiatives to be relevant again? 


All the conversations I’m having with investors about DRI are focused on the potential of an Olive Garden REIT. The potential for a REIT was a big focus of the Starboard presentation on value creation.  To be clear, all of the talk of a REIT is temporary as it’s the last financial lever the board can pull to create value. The REIT discussion is also distracting the conversation away from the real issue and that is the Olive Garden renaissance plan. 


I have no edge on the potential of a REIT, but the chances of a REIT seem very slim in the restaurant space.  Contributing to the heightened expectations for DRI REIT are Hudson's Bay, Bob Evans and others announcing plans to potentially monetize their real estate into separate publically traded companies?  Time will tell!


So what is DRI stock discounting?

Using the same price to Price/Sales analysis we used to determine that DRI was undervalued three years ago now shows that the company is overvalued.  At the very least, there is a significant component of the current value that accounts for the value of the real estate portfolio.


Referring to the Starboard presentation on the Darden real estate opportunity, the investors valued the DRI real estate portfolio (including Red Lobster) at $3.8-$4.2 billion.  Assuming Red Lobster was $2.2-$2.5 billion of the total, the remaining Olive Garden real estate is worth around $1.4-$1.7 billion (before tax leakage).


Our sum-of the parts analysis of DRI has the collective brands worth an enterprise value of $7.4 billion or approximately $49.74 per share.  This implies that the market is valuing the DRI real estate at $2.4 billion or more than 100% of the value of Olive Garden’s real estate. With the stock at theses levels there is significant pressure on management and the Board to come up with a creative real estate transaction that makes Olive Garden relevant again.


If a deal can’t get done does DRI run the risk of becoming the Sears holdings of the restaurant industry? Nobody wants to follow the example of Sears Holdings Corp, Eddie Lampert, who had been criticized for starving the retailer of the capital reinvestment needed to keep stores refreshed and relevant in the minds of consumers.


Once we get past the DRI financial engineering and cost cutting the ultimate value of this company will be driven by Olive Garden and right now it’s being starved of capital to be relevant to the consumer.







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