The People’s Seat

“Well, with all due respect, it’s not Ted Kennedy’s seat, and it’s not the Democrats’ seat, it’s the people’s seat.”

-Scott Brown, Republican candidate for United States Senate


A few days ago we posted a note on President Obama and touched upon the special election for the late Senator Kennedy’s seat.  We noted that Republican candidate Scott Brown seemed to be making some decent headway in the liberal bastion of the Commonwealth of Massachusetts. 


Polls out in the last 48 hours seem to further support the potential for Brown to surprise the punditry.   In fact, a poll out this morning from Suffolk University suggested that Brown had the support of 50 percent of the voters, while Democrat Martha Coakley had the support of 46 percent. 


The implications of this race obviously goes far beyond just the fine Commonwealth of Massachusetts.  This race, in fact, is important for the balance of the power in the United States Senate.  With this loss, the Democrats would no longer have the filibuster proof majority of 60 votes.  This of course has implications for some of the President’s primary agenda items.


From an investment theme perspective, the idea of less control for the Democrats is positive for the U.S. Dollar and supports our call for a Buck Breakout in Q1 2010.  This isn’t a political point, but with less than 60 votes in the Senate it becomes more difficult for the Democrats to move forward with their agenda, which is naturally more left wing in nature, and realistically more expensive.  Perversely, a government that can do less, is probably positive for the U.S. dollar.


One of our Hedgeye contacts on the ground in Massachusetts sent us the following note as it relates to this race:


“I just read your piece from yesterday.  It is insane up here in socialism land.  I think many still have the fear in the back of their mind that it is a Democrat’s seat and always will be but polls have this guy winning now.  Most feel he caught her and the lead will grow.  The state has been engrossed in this race for a couple of weeks now and he’s not picking up steam, that horse left the barn last week, it is like a tidal wave of support up here for Brown.


This race is the topic of every conversation and the Scott Brown support is overwhelming.  It is strange, it feels like you are an interloper heard round the world type of deal.


I think he is going to win this thing and even if he does not win, the damage has been done.“


There are potentially some serious investment implications based on this race and the potential for a shift of power in the Senate.  Implications for the Buck Breakout, but also specific sectors.  As our Financials Sector Head noted when I forwarded him the above note:


“Wow, I had no idea this guy had that much momentum …. This would be HUGE for financials if this guy won.”






Daryl G. Jones
Managing Director


The three biggest unknowns in the quarter relative to my estimates are, most obviously, top-line trends, the margin impact from current promotions and the level of investment needed to support changes at Chili’s (any change under the new direction at Chili’s). 


EAT is scheduled to report fiscal 2Q10 earnings next week on Wednesday, January 20th before the market opens.  My ESP estimate of $0.22 is in line with the street and my comparable sales expectations of -4% at Chili’s and on a blended basis are only slightly better than consensus estimates of -4.2% and -4.3%, respectively.  It is important to remember that Todd Diener, the former president of Chili's Grill & Bar and On The Border Mexican Grill & Cantina left the company in the middle of the quarter.  The timing of his departure was odd and may have caused some dislocation within the Chili’s and On The Border systems during the quarter.


The three biggest unknowns in the quarter relative to my estimates are, most obviously, top-line trends, the margin impact from current promotions and the level of investment needed to support changes at Chili’s (any change under the new direction at Chili’s). 


Sales: Management did not provide any comments on how the quarter started out from a top-line perspective on its last earnings call and did not reiterate its prior full-year same-store sales guidance of -2% to -4%. 


Although we have not learned too much from Brinker, specifically, we have gotten a few industry data points that give us some idea of how the casual dining industry fared during calendar 4Q09 (EAT’s fiscal 2Q10).  We know that through November, casual dining same-store sales, as measured by Malcolm Knapp, improved by nearly 90 bps, on a 2-year average basis, from calendar 3Q09.  Brinker outperformed the Knapp benchmark during its last reported quarter by 80 bps on a 1-year basis (reversing the two prior quarter of underperformance) and by nearly 90 bps on a 2-year average basis.  Since November, we have heard a few companies talk about challenging weather in December.  We have also heard quite a few comments about recent regional underperformance in Texas, which is an important market for Brinker, representing about 18% of the company’s restaurant base (about 17% for Chili’s and 25% for On The Border).  Much of this weakness in Texas can be attributed to tougher YOY comparisons as Texas held up much longer than other parts of the country in late 2008, but it will have an impact on EAT’s trends, nonetheless.


Brinker management did not provide a quantitative look at October on its 1Q10 earnings call, but it did say that it was again running its 3 Courses for $20 promotion at Chili’s in October after taking a brief pause from offering it in September.  For reference, Chili’s first started offering 3 for $20 in late July, continued it through August and then stopped offering it in September so that the company could make some adjustments to the promotion.  Brinker’s same-store sales in July were -8.8% (from down low double digits prior to the promotion), -3.1% with the offering in August and -5.4% in September.  The sequential improvement in trends in 1Q10 and subsequent fall off seem to be driven largely by the timing of the promotion (though July was a rough month for much of the casual dining industry) as EAT’s year ago comparisons in the July through September timeframe were not too different and actually got slightly easier in September by about 100-150 bps. 


Based on the better performance with the promotion in place in 1Q10, my -4.0% 2Q10 same-store sales estimate for Chili’s does assume about 40 bps of sequential improvement on a 2-year average basis.  Again, Mr. Diener’s leaving may put my numbers at risk, particularly if his leaving was not by choice and signals that business trends may not have been improving under his direction.


Restaurant-level margins:  EAT’s restaurant-level margins declined more than30 bps during the first quarter after improving in the prior two quarters.  The company’s promotions, particularly 3 for $20 at Chili’s and Today and Tomorrow at Maggiano’s, were largely responsible for the increased pressure on margins.  Helping margins in 2Q10 relative to 1Q10 is the fact that management guided to less food cost inflation during the quarter and had relatively good visibility on these costs as the company was locked in on a significant portion of its costs through the end of the calendar year.


Although the margin impact of 3 for $20 could be greater during fiscal 2Q10 due to the fact that the promotion was available for most of the quarter, management did say that the second introduction of the promotion (after stopping the offering in September) would yield better margins.  EAT’s CFO Chuck Sonsteby said, “Well, we are trying to get a little bit smarter after having the experience of going through it one time. So we are working hard on getting the labor back in line. This is the second time our operations team has had a chance to go through this promotion. So that replication is going to help them a little bit more trying to gain that back. So we would anticipate both some changes to the menu and also some labor efficiencies will help us a little bit more in terms of profitability this time around.”  Specifically, management stated that Chili’s will not require the same level of incremental traffic to hits its margin targets as compared to when it offered the promotion during the first quarter.  So the question is to what extent Chili’s will become more efficient with its execution of the 3 for $20 offering during the second quarter and mitigate pressure on margins.


Revitalization at Chili’s:  Management stated that as the next phase of menu enhancements at Chili’s start to roll into the system that the company would incur approximately $0.01-$0.02 of one-time investment costs for “things such as training, small pieces of equipment needed to efficiently produce certain products, and other smaller items utilized in the preparation or delivery of the new menu items.”  These costs are expected to primarily hit the P&L during the second quarter, with a small amount in 3Q10 as well.  The exact timing of these costs will matter to the bottom line in 2Q10, but more important, I question whether the level of investment will remain unchanged under the direction of Wyman Roberts, the new president of Chili's Grill & Bar and On The Border Mexican Grill & Cantina.









1Q10 Theme: RATE RUN-UP

Essentially we have traversed the nasty part of the “GREAT RECESSION” and we are on the path to recovery.  We have moved from a 3Q09 theme of “REFLATION ROTATION” to “RATE ROTATION” in 4Q09 and now we believe that interest rates are headed higher.  One of our key themes headed into 1Q10 is “RATE RUN-UP”:


(1)    The FED is behind the curve and the next few data points on the US economy and employment will drive interest rates higher. 


(2)    Inflation is evident in a number of places, but primarily reflects the effects from higher energy prices.


(3)     Feeding the rich at the trough of the Yield spread.


The consensus believes (and it is likely true), that there are some factors supporting the USA economic recovery that are of temporary nature.  There is no denying that the financial “crisis” is behind us and that the economy is on more solid footing.  SO why does the Fed maintain rates at a “crisis” level?


Current street expectation for an increase in the FED funds target rate is not until 3Q10.  Our view is that FED will likely be changing its policy statement at the next meeting and that an actual interest rate increase is not far behind.


One of the biggest issues with the current interest rate policy is that it is feeding the rich and starving the poor.  The yield spread (10-year minus 2-year Treasury yields) is trading at 281 basis points wide and peaked out at +288 basis points wide on January 11, 2010.  The spread is killing the average American’s saving account and is providing the best ever environment for Investment Banking Inc. to print money. 


While the next few data points on jobs and the economy will point to improved growth, the underlying pace of growth is still in question.  Clearly manufacturing is getting a boost from inventory corrections and pent up demand; the upward trend in industrial production, ISM, capacity utilization, and new orders for nondefense capital goods all look strong. But consumers sentiment is not improving and his/her balance sheets are not financially sound.  


All in, the net-net  impact has been to stem the pace of job losses and, if temporary help and the census hiring trends is a leading indicator, set the stage for and improvement in the unemployment rate and the potential for actual gains in nonfarm payrolls in the months ahead.   In the short run, interest rates are headed higher, but all of this is setting the stage for a challenging 2H10 given the likelihood that growth slows as government stimulus will eventually come to an end. 


Howard Penney

Managing Director


1Q10 Theme: RATE RUN-UP - hp11


1Q10 Theme: RATE RUN-UP - hp12


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 80.46%
  • SHORT SIGNALS 78.36%


For the eight day this year the S&P was up on the day, rising 0.24%.  Volume was very light on the NYSE, declining 8% sequentially and 54% below the average daily volume for 2009.  With INTC reporting earnings last night and JPM expected shortly, earnings season is about to get into full swing. 


On the MACRO front the market largely ignore bad news, as yesterday’s performance came despite an unexpected decline in December retail sales.  In fact the Consumer Discretionary was the third best performing sector yesterday.  Within the XLY, retail stocks underperformed with the S&P Retail etf down 0.82%. 


The MACRO calendar was the headwind for the group after retail sales fell 0.3% month-to-month in December vs. consensus expectations for a 0.5% increase.  The big category decliners included autos (-0.8%), general merchandise (-0.8%), food/beverages (-0.8%) and clothing (-0.6%). 


The best performing sector yesterday (for the second day in a row) was Healthcare (XLV).  Within the XLV, managed care was a bright spot with the HMO +1.4%, despite reports of progress in terms of merging healthcare reform legislation from the Senate and the House.


Surprisingly, the XLF (the second best performing sector yesterday) was able to shake off the formal announcement from the Obama administration regarding its bank tax proposal.  Within the XLF, the bank stocks extended its two day rally up 1.64%. Also, the regional bank names continued to outperform with the KBW Regional Bank etf up 3.05%.


While not one of the top three performing sectors, Technology (XLK) outperformed the S&P 500 for a second straight day.  A big chunk of support came from the software group, with the S&P Software Index up 1.69%.  Outside of software, the SOX declined 0.6%.  INTC rallied 2.5% ahead of its Q4 results and is trading 3% higher in early trading after blowing out 4Q numbers. 


Parts of the RECOVERY trade underperformed yesterday.  Yesterday, Energy (XLE) outperformed, but the Materials (XLB) was the worst performing sector on the day.  Metals, mining and Chemical stocks were the worst performing stocks in the etf. 


The range for the S&P 500 is 10 points or 0.6% (1,141) downside and 0.2% (1,151) upside.  At the time of writing the major market futures are trading lower on the day.    


Yesterday, the CRB index closed lower 0.25% on the back of a decline in Energy, Grains and Precious Metals.  Livestock and Industrial commodities traded higher on the day.     


Copper stockpiles advanced 1.8% in Shanghai this week to the highest level in almost a month, according to the Shanghai Futures Exchange.   In early trading today Copper is trading lower, after declining 0.37% yesterday.  The Hedgeye Risk Management Quant models have the following levels for COPPER – buy Trade (3.33) and Sell Trade (3.49).


In early trading Gold is trading down about 1% to 1,131.  The Hedgeye Risk Management models have the following levels for GOLD – buy Trade (1,119) and Sell Trade (1,154).


Yesterday, crude oil traded lower for the fourth day in a row and is trading down 1% in early trading today.   Oil has traded down about 5% this week.  The Hedgeye Risk Management models have the following levels for OIL – buy Trade (77.10) and Sell Trade (81.72).


Howard Penney

Managing Director















We’re a little above the Street for FQ2 but a little below for FQ3 and FQ4 owing to a dearth of new casinos and expansions in 1H CY2010. New market timing may be the important take away from the call.



WMS will report FQ4 (December) earnings on January 26th.  We are projecting $0.44 in EPS, a touch above the Street at $0.43 on a slight revenue beat.  We do think there is some risk to the March and June quarters so we remain a few pennies below in each of those quarters.  The shortfall from the Street stems from lower new casino and expansion slot sales.  We believe our replacement expectations are pretty much in-line.


New Market Discussion

  • Italy timing – we wrote about Italy in our 12/10/09 post, “THE ITALIAN BIRD”
  • Australia - Will likely finish field trials by year end of first week of January so they will be able to say whether or not they can start shipping.  They are shipping to New South Whales (100,000 unit market) but they are only targeting the larger casinos in that market.  This is definitely a source of upside for WMS.  Total international sales in fiscal 2009 were less than 10k units.  We’ve gotten positive feedback on WMS’s opportunity there.
  • Mexico – WMS should be able to give an update on this potential new market for WMS.  As we wrote about in our 1/6/10 note, “WHAT DO WE DO WITH THESE PESKY SLOT STOCKS”, Mexico was a class II market - 35-50k games.  During the summer time, one of the large operators got its license reissued with games closer to Class III.  Early results on the "Class III" games are much better than Class II so operators now want to put more Class III product on their floors.  In the September quarter, WMS sold its first games to that market, less than 100, all to that first operator. 


On the domestic front it’s really all about replacements since there are very few new casinos and expansions the rest of FY2010.  We project total industry unit sales to new/expanded casinos to decline 80% and 41% in the March and June quarters, respectively.  WMS is probably getting around 30% share of the replacement market.  Management has only provided a breakout of the last 2 Q’s which came in at 25% & 35% replacement ship-share, respectively.  For WMS, replacements usually pick up “dramatically” from the December Q to the March Q and they typically get another smaller lift into the June Q.  They will need a nice acceleration to offset the new and expansion degradation.


Internationally, between Mexico & Australia, all else being equal, there can be 20-25% upside from what was shipped in FY2009.  Assuming that organic shipments are down y-o-y, it’s likely that WMS will still grow international shipments by around 5% if not more.  Depending on how quickly Mexico and Australia ramp, there could be upside to our projections.

The Chinese Chiefs

"That's not a bad thing. I'd take a bleeding nose for a win, wouldn't you?"
-Dave Tippett
That was Dave Tippett’s quote after beating the 1st place New Jersey Devils last night. Tippett is the head coach of the Phoenix Coyotes. He’s what hockey players call a ‘guy’s guy.’ There is no sugar coating on what the tough do when the tough gets going. As my Dad likes to say, they just focus on getting the job done.
The Chinese have started to face the fiddle on some of the tough issues they face economically. My only hope is that American policy makers start to face theirs. Hope, unfortunately, is not an investment process.
In 2009, China had a bubble developing in money, loan, and real estate growth. Since November, the Chinese government has been explicit in articulating it’s goal to limit debt leveraged asset price speculation, and focus on what they consider “quality growth.” Chinese property stocks have been going down since July of 2009. For those who are calling for a bubble to pop in China, waky waky out there, they’ve been popping for 3 months.
Unlike America’s super smart Piggy Bankers, the Chinese are willing to take the short term bloody nose in order to get the long term win. In the last 3 weeks, China has raised interest rates twice and raised the reserve requirement on Chinese banks. They haven’t sugar coated this. They are getting the job done.
For the year-to-date, inclusive of last night’s +0.27% up move, the Shanghai Composite Exchange is down -1.6%, underperforming both the SP500 (+3% YTD) and the Brazilian Bovespa (+1.8% YTD) by a considerable margin. This is what Hedgeye Risk Management calls a negative country divergence. China is slowing sequentially in 2010 because The Chinese Chiefs are slowing money supply and loan growth.
For centuries countries have not measured their economic, political, and military power via the daily tick tock of their nation’s stock market price. That’s what a modern day monkey on CNBC does. China gets this. America has already provided her the historical example. The stability of a country’s currency and balance sheet are what drive a country’s long term wins.
Let’s look at China’s latest balance sheet and money growth stats (reported overnight):
1.      Year end Foreign Currency Reserves +23% year-over-year to $2.4 TRILLION

2.      2009 Chinese Loans 9.59 TRILLION Yuan

3.      December Money Supply (M2) growth +27.7% year-over-year

Now, if you are in the Jim Chanos camp and you think they are making these numbers up, that’s fine. I see his point but, remember, from Madoff to Alan Stanford and tricky Dick Fuld, I can show you plenty of Americans that made them up too. For now, let’s roll with what we have and put these 3 reported numbers in context:
1.      FX Reserves: that’s an increase of $453 Billion dollars year-over-year, which is huge, but the rate of FX Reserve growth slowed from Q3 to Q4

2.      Loan growth: that’s an increase of +131% year-over-year (versus 4.15T for all of 2008), which is monstrous, but again slowed in December (month/month)

3.      Money Supply: again, that’s a beast of a number, but M2 growth slowed in December versus a record monthly growth rate of +29.7% in November

So, what does this all mean? Quite simply, I think it means that the Chinese Ox is putting herself in the penalty box. Yes, for a few minutes (or months) those who bought Chinese stocks AFTER an +80% year-over-year move on December 31, 2009, will also be put in the penalty box – and yes, Charlestown Chiefs fans (Slapshot), they will “feel shame.” But make no mistake, de goalie, Dennis Lemieux, is not running this country.
China is coaching themselves through this interconnected game of geopolitical risk much more like Dave Tippett coaches his Coyotes. There is no crying or groveling in front of Washington’s willfully blind (can you name me a Chinese banker?). Nor do the Chinese appear to look like used-car salesmen in Piggy Banker suits. These guys understand that, over the long haul, there will be blood – and now is the time to rid themselves is Greenspan/Bernanke-style speculative growth.
After being bullish on China since December of 2008, we pulled de goalie (in early December of 2009) for the intermediate term. My team and I will be wearing our newly issued Hedgeye Risk Management jerseys at 11AM EST time this morning as we host our Quarterly Macro Investment Themes conference call. If you’d like tickets to the game, please email . We don’t do trading huddles, so all are welcome to hear what we think in real-time.
My immediate term support and resistance levels for the SP500 are now 1141 and 1151, respectively.
Best of luck out there today and have a great weekend,



XLK – SPDR Technology
We bought back Tech after a healthy 2-day pullback on 1/7/10.

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).

VXX - iPath S&P500 Volatility The 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 Brazil As 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 TIPS The 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 Euro
We 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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