He Who Sees No Inflation

“A perfection of means, and confusion of aims, seems to be our main problem.”
-Albert Einstein
Is there inflation on Main Street America? If you want the right answer to that question, don’t ask the willfully blind in Washington. They have enough political issues to deal with right now and can’t handle this ugly truth.
What’s ugly is what you don’t see on CNBC. The participants in the USDA’s Food Stamp Program has almost doubled since He Who Sees No Inflation (Bernanke) took the helm. A shockingly high 11% of Americans are now on food stamps. Almost 1 in 4 American children are in the program. Creating a high-low society by starving American savings accounts of fixed income yield, and plugging them with food, energy, and medical care inflation seems to be our main problem.
On Friday we saw US Consumer Price Inflation (CPI) reported at +2.7% year-over-year growth for December. That’s not only a 6-month high, but a massive +480 basis point move off of what Bernanke labeled a deflation problem of “Great Depression” proportions. You have to be kidding me Ben. I thought you were “data dependent”?
Plenty a political pundit and Washington academic who has been prognosticating a benign CPI here in the US is seeing their inflation forecast blown out of the water once again. This isn’t new. These guys didn’t see inflation with oil at $150/barrel either. Newsflash: for Main Street, $65-85/barrel oil is still inflationary.
Both the energy and medical care services components of the December CPI report came in higher than the CPI average of +2.7%. Energy was up +18.2% and Medical Care Services were up +3.4%. Again, we can be willfully blind to these realities, but it doesn’t change the fact that year-over-year price inflation is here to stay for the foreseeable future. Inflation is the nasty price a citizenry pays when their government clips the value of their coins.
This isn’t just an American problem. It’s a problem for countries who are levering up their balance sheets with debt and debasing their currencies. The United Kingdom reported a record one-month pop in inflation this morning. At +2.9% year-over-year CPI growth, the UK hasn’t seen inflation accelerate this fast in 13 years. That’s a long time.
When asked about the numbers, this is what the UK’s Prime Minister, Gordon Brown, told reporters in London this morning: “I don’t think you should read too much into one month’s figures.”
Oh, ok. We trust you Mr. Big Government bailout. Sure…
Now, even though her headline inflation is a good deal lower than that of the US or the UK, China still took a +1.4% year-over-year inflation reading quite seriously and went ahead and raised interest rates for the 3rd time in 3 weeks last night.
China raised rates on 1-year bills to 1.92% and continues to show that they are willing to manage the inflation risk their citizenry faces, proactively. After all, in a state-managed economy, you don’t have to come up with a political dance to solve for a mathematical reality.
Stock markets around the world have obviously weakened on all of this accelerating inflation data. In a perfect world, one could argue that this price reaction makes sense. Then again, this world’s western political leadership is far from perfect. Paying the bankers a Piggy Banker Spread at the expense of fighting Main Street inflation obviously has an implied “confusion of aims.”
My immediate term support and resistance levels for the SP500 are now 1131 and 1151, respectively.
Best of luck out there today,

EWC – iShares Canada
— We remain bullish on the intermediate term TREND for Canada. With a pullback in the ETF on 1/15/10 we bought Canada.
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 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 Japan
While 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 BondsIf 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.


Last week the S&P 500 traded down 1.08% on Friday and finished lower by 0.78% for the week.  The number of shares traded on the NYSE was the biggest so far this year and the decliners outnumbered advancers approximately 3 to 1.


No sector was up on the day, although six sectors did outperform on a relative basis.  Only one sector, Utilities, broke TRADE on the Hedgeye Risk Management quant models.   


As we look at today’s set up the range for the S&P 500 narrowed from 35 points on Friday to 20 points or 0.44% (1,131) downside and 1.32% (1,151) upside.  At the time of writing the major market futures are trading flattish on the day.  


On the MACRO front, the markets had a number of mixed economic data points to consider on Friday.  First, January preliminary University of Michigan confidence was slightly disappointing at 72.8 versus consensus 74.   Second, December Industrial Production was in line at 0.6%, while November was revised down to 0.6% from 0.8%. December Capacity Utilization was 72.0% versus consensus 71.8%; while November was revised up to 71.5% from 71.3%. Third, December CPI was 2.7% versus consensus 2.8% versus the November reading of 1.8%.  On the positive side of the MACRO data January Empire Manufacturing was 15.92, much stronger versus consensus 12.


Treasuries rallied across the curve on Friday and the dollar index was up 0.77% on the day; the Dollar index had its first up day in the last five trading days.  The increase in the dollar pressured commodities as Oil and Gold traded down on the day. 


The worst performing sector last Friday was Financials (XLF).  Within the XLF, the Banks lead the sector lower with the Bank Index (BKX) down 2.1%, with the investment banks weaker too.  While the Obama “responsibility tax” was front and center it was JPM earnings that were the key negative data point for the day.   As it related to JPM, revenues disappointed and there were lots of questions raised about the quality of the quarter with an outlook less robust.  Regional banks were also weak on the day. 


Technology (XLK) was the second worst performing sector on the day, as the Semiconductor index (SOX) declined 3.4% on the day.  INTC declined 3.1% despite reporting a good quarter last, although higher than expected inventory and unsustainable gross margin concerns were an issue.


On a relative basis, the best performing sector last Friday was the Consumer Staples (XLP).  The XLP benefitted from KFT as it improved 1.6% on the day.  Consumer Discretionary performed in line with the market, down 1.1%; the XLY was facing a bearish consumer confidence number. 


Yesterday, the CRB index closed lower 1.02% on the back of a decline in Energy commodities; nearly every other major commodity traded higher last Friday.   


In early trading Copper is trading up 1% after declining for the previous two days.  The Hedgeye Risk Management Quant models have the following levels for COPPER – buy Trade (3.32) and Sell Trade (3.48).


In early trading Gold is trading down about 0.2% to 1,131. GOLD continues to underperform especially when compared to other precious metals.  Gold continues to trade in a fairly tight range and consolidating around the 1,130 level.  The Hedgeye Risk Management models have the following levels for GOLD – buy Trade (1,118) and Sell Trade (1,153).


Last week crude oil traded lower for five straight days, declining 5.7%, and is trading down flat in early trading today.  The Hedgeye Risk Management models have the following levels for OIL – buy Trade (77.27) and Sell Trade (81.37).


Overnight most Asian markets traded to the downside, although China ended slightly higher on the day.  The Chinese market traded higher, despite the fact that China raised its yield on one-year bills for the second week in a row.  Europe is down across the board, after trading higher on Monday. 


Howard Penney

Managing Director














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The Week Ahead

The Economic Data calendar for the week of the 18th of January through the 22nd is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - HH1

The Week Ahead - HH2

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.









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