Wealth And Power

“A true friendship develops on the basis of genuine human affection, not money or power. Of course, due to your power or wealth, more people may approach you with big smiles or gifts. But deep down these are not real friends of yours; these are friends of your wealth or power.”
- Dalai Lama
The Summit meeting between Obama and the Dalai Lama is all about WEALTH and POWER.  Taiwan needs weapons that will give them more POWER.  Will the Obama swagger with the Dalai Lama give us more POWER over the Chinese or just some needed income?  At best, the administration can hope that the damage will be limited.  
The Chinese already don’t like us and that was made clear at the climate talks in Copenhagen.  There is nothing simple about the US - China relationship, but it appears that we are headed for a rough patch.  The Chinese have made a series of moves to slow its market-oriented, economic reforms over the last year (CHINESE OX IN A BOX), which should raise some concerns for many businesses in the West and increases our conviction that the Chinese market will underperform in 1Q10.  

It now becomes a delicate balance on the part of the Obama administration to play hardball with the Chinese so the US is not perceived to be POWERLESS, while not making them angrier.   Obama needs to demonstrate that he is not “in a box” but instead, has WEALTH and POWER to navigate the issues with the Chinese.      
While hope is not an investment process, let’s hope that the administration does not make some irrational decisions in dealing with the Chinese given that Obama is losing POWER at home.         
Yesterday’s ABC consumer confidence number confirms what the polling numbers are saying about the Obama administration.  Poll after poll suggests that President Obama’s efforts to reassure Americans about the economy haven’t paid off.  According to the latest American Pulse™ Survey of over 5,400 people, 64.2% say the economy will worsen or stay the same in 2010 (29.7% think it will improve) and 43.7% plan to spend less this year than last.
Americans also remain uneasy about terrorism - 92.8% believe the U.S. is still fighting the war on terror, 40.8% feel less safe since President Obama took office (47.3% feel the same, 11.9% feel safer) and 68.9% are somewhat/very concerned that terrorists may infiltrate high-level elected positions or the military.
Overnight, Asian stocks rallied after Australian employment increased three times more than consensus expectations.  Even after the central bank in Australia raised interest rates in the middle of 2009, the December employment figure was up 35,200 vs. the consensus at 10,000.  The Central Bank in Australia has the POWER to make decisions that are right for the country.     
Ben Bernanke has the WEALTH (albeit leveraged) but appears to be “in a box” and can’t demonstrate that he has the POWER to lead.  At the time Bernanke last printed his “extended and exceptional” view of monetary policy the U.S. economy improved in 10 of the Federal Reserve’s 12 districts.  
Despite unemployment staying at 10%, the economic conditions in the USA continue to improve, putting our “RATE RUN UP” theme into play.  The evidence continues to mount that the FED will need to change its policy statement at the next meeting.  
Here is a thought that most people don’t believe could happen.  The Federal Reserve hints at a rate increase, maybe even raises rates slightly and the employment picture begins to improve in the US. Higher interest rates in the USA will instill confidence that the Administration and the Federal Reserve have the POWER to do what is right for the country, while helping put WEALTH back into the pockets of the average consumer.  At this point corporate America just might believe we have turned the corner and start hiring again.   
What does all this mean?  That’s right, the “BUCK BREAKS OUT.” America has vast amounts of WEALTH; we just need leadership that has the POWER to make the difficult decisions.     
Hedgeye Risk Management will be hosting its Q1 2010 quarterly themes strategy conference call this Friday January 15th at 11 AM EST.  Contact to request access to the conference call.
Function in disaster; finish in style.
Howard Penney
Managing Director
XLK – SPDR Technology
Buying back Tech after a healthy 2-day pullback. Next to Healthcare, this remains our favorite sector in the SP500.

UUP – PowerShares US Dollar Index Fund
We bought the USD Fund on 1/4/10 as an explicit way to represent our Q1 2010 Macro Theme that we have labeled Buck Breakout (we were bearish on the USD in ’09).

XLV – SPDR HealthcareBuying back the bullish position Tom Tobin and his team maintain on the intermediate TREND term for the Healthcare sector.

VXX - iPath S&P500 VolatilityThe VIX broke down to our immediate term oversold line on 1/6/10, prompting us to add to our position on VXX.

EWG - iShares Germany Buying back the bullish intermediate term TREND thesis Matt Hedrick maintains on Germany. We are short Russia and, from a European exposure perspective, like being long the lower beta DAX against the higher beta RTSI as well.

EWZ - iShares BrazilAs Greece and Dubai were blowing up, we took our Asset Allocation on International Equities to zero.  On 12/8/09 we started buying back exposure via our favorite country, Brazil, with the etf trading down on the day. We remain bullish on Brazil's commodity complex and believe the country's management of its interest rate policy has promoted stimulus.

CYB - WisdomTree Dreyfus Chinese Yuan The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP - iShares TIPSThe iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are mispriced and that TIPS are a efficient way to own yield on an inflation protected basis.


IEF – iShares 7-10 Year Treasury One of our Macro Themes for Q1 of 2010 is "Rate Run-up". Our bearish view on US Treasuries is implied.

FXE – CurrencyShares EuroWe shorted the Euro ETF on strength on 1/11/10. From an intermediate term TREND perspective we remains bullish on the US Dollar Index.

RSX – Market Vectors Russia
We shorted Russia on 12/18/09 after a terrible unemployment report and an intermediate term TREND view of oil’s price that’s bearish.

EWJ - iShares JapanWhile a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

SHY - iShares 1-3 Year Treasury Bonds If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.


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SKX: Breakout Considerations

In what appears to be one of ICR’s big news names today there is actually little by way of change to note here. Taking into account yesterday’s head fake, the stock is up a more pedestrian 5% prior to Tuesday’s preannouncement. That’s not to diminish the 30%+ top-line growth management announced for Q4, but it is worth noting.  


As I sit here in the presentation, here are a few highlights from the earlier breakout:

  • DC transition progressing - with the company expecting to break ground in March, the timing of the transition in 2H of F10 or 1Q of F11 unchanged
  • Backlogs remain strong with men’s up vs. ’08, but still below ’07 levels
  • Men’s Shape-Up sales beginning to take hold now roughly 15%-20% of women’s domestic sales
  • Expect to see low single-digit increase in G&A in F10 (most leverageable line in the model)
  • Shape-Ups hasn’t necessarily resulted in new channels of distribution or retail relationships, but it’s enabling SKX to gain significant penetration in key players (i.e. Foot Locker, FINL, DKS, TSA, etc.)
  • When asked if we’re going to see them during the Super Bowl, I got a smile - not a definitive ‘no,’ but my sense is the company is happy with their exposure during the College Bowls over the last few weeks


If Kentucky Grilled Chicken was helping to drive increased traffic and profitability for its franchise operators, I think they would be in full support of the product.


It was reported earlier this week that KFC franchisees have initiated court proceedings against YUM over a debate as to the current direction of the company’s marketing campaigns.  According to a Washington Post article published on January 9th, a coalition of franchisees is not happy with the company’s focus on the new grilled chicken platform and decision to devote the advertising budget to promoting Kentucky Grilled Chicken.


YUM rolled out its Kentucky Grilled Chicken product nationally in 2Q09, supported by advertisements that told consumers to “Unthink KFC.”  When YUM reported positive 2Q09 same-store sales growth for KFC, it seemed that the company had finally found a way to drive traffic back into KFC.  That positive growth, however, quickly turned negative during 3Q09 when KFC’s comparable sales declined 2% (And, KFC was lapping an easy comparison of -4% from 3Q08).  The initial success of Kentucky Grilled Chicken was actually even more short-lived than that with management citing an “unprecedented” 30-point swing in same-store sales growth at KFC during the first month of the launch versus pre-launch, followed by a flattening of sales immediately after the introductory launch.  YUM’s 4Q09 same-store sales in the U.S. continued to be weak with management guiding to -8% in early December.


I don’t know how many of the 4,000-plus U.S. franchised KFC units are included in the coalition that is taking legal action YUM, but this type of “noise” in the system is never good for business and does not convince me that the grilled chicken product is yet as successful as management has claimed.  On the 3Q09 earnings call, YUM management stated, “At KFC, Kentucky Grilled Chicken has been an unqualified success.”  If this statement was entirely true and the grilled product was helping to drive increased traffic and profitability for its franchise operators, I think they would be in full support of the product and the advertising spending being used to increase trial of the product. 


During the company’s 2Q09 earnings call (the first quarter of the new launch), management stated in regard to Kentucky Grilled Chicken, “another reason why it’s very popular, not only with our customers but with our franchisees is the margins are actually better on a grilled piece of chicken versus a fried piece of chicken.” As I stated before, during 2Q09, the grilled chicken launch helped to drive positive comparable sales growth so franchisees may have been happy with the product, but at this point, the franchise community does not seem to be in complete agreement with the company about the push behind grilled chicken. 


KFC’s sales have been weak for some time now so management had to do something to try to turn around the brand.  Broadening the menu seemed like a good idea to me, but I do think it is always somewhat risky for a concept to pursue a strategy that moves away from its core competencies and its core users.  Yes, chicken is KFC’s core product, but that chicken has always been fried in the past and when people think KFC, they still think fried chicken.  It will take a while to train consumers to think anything else, which explains why the company needs to spend behind the grilled chicken platform.  In the meantime, the company needs to be careful not to abandon its core users who continue to want fried chicken.  Even if the Kentucky Grilled Chicken launch has driven grilled chicken to become an impressive 30% of KFC’s sales mix, fried chicken still represents a bigger piece of sales.  And, the company’s campaign to “Unthink KFC” may not appeal to the concept’s current users who were perfectly happy with the brand.


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