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Einhorn's Objectivity

In this morning’s Early Look I said that I would post David Einhorn’s full rebuttal.


David does his own work, and I have a great deal of respect for his independent research process. I have not edited any part of his reply to my Early Look note from January 29th, titled “Red Light Risk.”


This is one of the most even-handed and intellectually objective replies I  have had since I started this firm. Some people get very emotional when I stand on the other side of their timing in a position. There is zero emotion in this rebuttal.


Many thanks to DE for letting me pass this along to you, unedited (his comments are in red, within the body of the original text).




"As investors, we can't change the course of events, but we can attempt to protect capital in the face of foreseeable risks."

-David Einhorn


Admittedly, when "bottom's up" we are bottom up investors, but bottom’s up drinkers hedge fund manager David Einhorn proclaimed his new macro mystery of investing faith at the 'Value Investing Congress' on October 19, 2009, I was smiling. Our Hedgeyes call this proactively managing macro risk and I do support Mr. Einhorn's message thanks.


Einhorn and I are about the same age. We both grew up in a hedge fund bubble. For a decade, we were probably both overpaid I can’t speak for you, but even though I have started a valuable business that has created high paying jobs and provided a good value to my customers, I would agree with this.  I feel very fortunate. He still runs money and sometimes my mouth and I run my mouth, so I am thinking that he's probably worth a lot more than me. But what does that mean?


To some in this business, that means a lot. To others, it means nothing at all put me in this group. We all wake up early every morning with a passion to play this game. David's Greenlight Capital now has its macro views. I have mine. Game on much less conflict here, than you think.


The global macro risk manager's job in this business is to acknowledge amber flashing lights, before they go red. It's also being keenly aware of when one of your big "ideas" is everyone else's too. Measuring consensus is part of any repeatable Red Light Risk Management process.


Embedded in our macro risk management process are 3 dominating Global Macro Themes. We change them quarterly, because the math changes daily. As a reminder, my team's current Macro Themes for Q1 of 2010 are:


1.       Buck Breakout (bullish on the US Dollar; bearish on gold) We are bullish on the dollar vs. the yen, euro, & pound.  We like the dollar more than most everything but gold at the moment.  Or maybe we just hate it less than the other currencies.  We are long various European sovereign CDS.


2.       Rate Run-up (bearish on government bonds)  agreed at some point, but no real view on this quarter.


3.       Chinese Ox In A Box (bearish on Chinese equities; bullish on Chinese currency) I would tend to agree, but have no position and no real conviction.  It seems to be working.


I do not know what Einhorn thinks on Macro Themes 2 and 3 but, now that he does macro, he obviously better have a view. That said, I do know that he stands on the other side of me with regards to both the US Dollar and Gold.


In that same speech, Einhorn made the following conclusions about gold:


1.       "Of course, gold should do very well if there is a sovereign debt default or currency crisis."


2.       "I subscribed to Warren Buffett's old criticism that gold just sits there with no yield and viewed gold's long term value as difficult to assess."


3.       "Gold does well when monetary and fiscal policies are poor and does poorly when they are sensible."


After being bullish on gold since 2003, and vehemently bearish on what I labeled the "Burning Buck" in early 2009, I do think I have the credibility associated with understanding the bearish dollar/bullish gold case Agreed. There are many aspects to Einhorn's conclusions that I agree with, but not at every price and every duration. My guess is your current quibble is more about duration than price.  I’d be willing to bet there will come a time where you will like gold at a substantially higher price.


Now, if you really want to manage Red Light Risk in global macro, you better manage those two things dynamically  - price and duration. I have written about this before, but it's worth mentioning again. Duration Mismatch is one of the top 3 risks that has hurt me over the course of my risk management career. We need to monitor it systematically and measure it scientifically. Just as I am still trying to learn and improve (like incorporating more macro thinking), I am hopeful to improve here, as well.


Back to Einhorn's points on gold. On an immediate (TRADE) to intermediate term (TREND) duration (3 weeks to 3 months), gold has not done well in the face of sovereign debt default risks rising. I don’t know.  I wouldn’t say my speech was an important date….but since then gold is up a little and the S&P is down a bit.  It was about 3 months ago. (Since our actual entry, the results have been much more decisively in our favor) Gold is up a lot in Euros, where the sovereign crisis appears to be at the moment  Now maybe he meant a sovereign debt default crisis in the USA it would do very well in a US crisis and that was my point.  My guess is that such an event, if it ever happens, is quite a ways away and would not fit into the thinking of someone investing for 3 months or less and, to be fair, we should give him the benefit of the doubt the benefit of the doubt is always appreciated here until he replies to this. But, so far, with CDS (credit default swaps) in Greece blowing out to 414 basis points last night, gold is still going down not relative to the place where the crisis exists.


Gold is going down because I am right on the Buck Breakout. Yes, as Mr. Buffet pointed out to David We didn’t discuss this.  I was relying on his public statements. way back when, there are many risks embedded in evaluating the gold price. But those difficulties work both ways! Today, in terms of measuring the risks of being long gold, the r-square is highest relative to up moves in the US Dollar. I haven’t done the math, but it feels more correlated to equities than the dollar to me at the moment.  I suspect that that correlation will break down in gold’s favor at some point.


Managing Red Light Risk is just that. You have to accept that there are many types of investors telling many different types of qualitative stories about what it is that they are bullish on. You also have to accept that Mr. Macro Market's math will rule the day over all the storytelling I strongly agree with this.


This morning the US Dollar is making a 5 month-high at $78.94. Gold is trading down another -1% for the week to-date at $1083/oz. I am long the US Dollar and short Gold via the UUP and GLD etfs, respectively, and I have a zero percent allocation in our Asset Allocation Model to Commodities.


The long term TAIL of resistance for the US Dollar Index is up at $80.21, and I think it's going to test that line this year. My long term TAIL line of support for the gold price is down at $997/oz. That's another -8% of Red Light "foreseeable risk" that these Hedgeyes are calling out for you Mr. Einhorn. I do think we have a different view on duration.  I have no idea which way the next $80 in gold will be.  If I had a strong view, I would modify my position, as I’d rather buy it back cheaper.  Sadly, I don’t and you may well be right.  I do have a strong view as to which way the next $500+ will be and I don’t want to give that up just because I might have to temporarily give up a fraction of our gains to date to the volatility gods in the meantime.  Welcome to the game of proactively managing macro risk. It's a full contact sport. I don’t see it as full contact.  I am still not betting these things big enough to look at it that way.


Best of luck out there today, and have a nice weekend  (de)




Keith R. McCullough
Chief Executive Officer

R3: RL: Big Enough?


February 3, 2009


A big beat by RL, and the company gave the bulls plenty to chew on here. But a miss vs. our model, and let’s face it…expectations were high. Retail looked solid, and the balance sheet continues to improve, but wholesale definitely turned down. We’ve been waiting for a pullback to get involved – but we need to get clear on wholesale earnings to be certain that $5.75 next year is still a reality.





A big beat by RL, and the company gave the bulls plenty to chew on here. But a miss vs. our model, and let’s face it…expectations were high. Retail looked solid, and the balance sheet continues to improve, but wholesale definitely turned down. We’ve been waiting for a pullback to get involved – but we need to get clear on wholesale earnings to be certain that $5.75 next year is still a reality.


“Footwear cited as primary positive driver of wholesale, first such call out suggesting traction there perhaps modestly ahead of expectations. That perhaps explains away part of the wholesale margin decline as footwear is lower margin at this stage, but it flies in the face of a wholesale top line miss (or suggests that apparel and accessories failed to show up)."


R3: RL: Big Enough? - RL SIGMA


R3: RL: Big Enough? - RL Comp 1 10




  • Despite increased traffic and the weak economy, Rent A Center just reported a 2.3% skips and stolen rate as percentage of per store revenues, its best rate in 6 years. Additionally, management noted that the average income of its customer base continues to trickle higher.
  • According to a Harris Interactive poll, the NFL continues to widen its lead as the most favorite sport in America amongst fans who follow more than one sport. Pro football posted a 400bps increase in popularity in 2009, widening its lead over baseball. Approximately 35% of fans say football is their favorite, while baseball is favored by 16%. College football, auto racing, and the NBA round out the top 5.
  • After an incredible run of outsized same store sales gains, Japan’s deep value, fashion retailer UNIQLO reported a 7.2% decrease in January sales. Interestingly, the company warned that the sales shortfall was entirely due a shortage in inventory after the company sold out of its Heattech baselayer products during December. This marks the first retailer that definitively cited inventory shortage as the root cause of weakness in sales. Definitely not a bad problem if rectified quickly, but something to watch as retailers are faced with the decision to increase inventories or continue to run lean.




Walking Co. Files Reorganization Plan - The Walking Company Holdings, Inc. filed a reorganization plan under which the company intends to keep 207 of its 214 (over 96%) current store locations open and pay off all of its debts and future obligations to trade creditors. It plans to exit Chapter 11 protection "sometime this spring." In a court filing on Monday, the company said it had negotiated new lease agreements with landlords of about 90 of its 210 stores and that the move will generate annual cost savings of about $3 million. The retailer had filed for bankruptcy protection in December, with a plan to close almost half of its stores. The Walking Co said it has obtained a commitment from an investor group led by Richard Kayne of Kayne Anderson Capital Advisors LP to invest $10 million to recapitalize the company. Wells Fargo Retail Finance has agreed to provide $30 million as exit financing. "Today our company took a major step forward in the process of emerging from chapter 11. I want to commend all of the professionals working on behalf of the company -- the unsecured creditors committee, landlords, financial institutions, and otherwise -- on their diligence in achieving this result," said Andrew Feshbach, CEO of The Walking Company, in a statement. <sportsonesource.com>


Nike and Others Form Sustainability Coalition - Ten organizations, including Nike and the Outdoor Industry Association, announced the launch of the GreenXchange (GX), a Web-based marketplace where companies can collaborate and share intellectual property (IP) which can lead to new sustainability business models and innovation. The remaining eight are: Best Buy, Creative Commons, IDEO, Mountain Equipment Co-op, nGenera, salesforce.com, 2degrees and Yahoo. Announced at a CEO breakfast at the World Economic Forum in Davos, Switzerland, the organizations called on other corporations to join them in committing to opening up their IP to fast-track the development of innovative solutions to sustainability challenges. "Nike is today committing to placing more than 400 of our patents on GX for research, demonstrating our belief that the best way to stimulate sustainable innovation is through open innovation," said Mark Parker, NIKE, Inc. president and CEO. "Our hope is this will unleash new innovation to help solve current obstacles to sustainability issues." <sportsonesource.com>


PPR Eyeing Rentabiliweb Stake - French retail-to-luxury group PPR is set to join rival French luxury player LVMH Moët Hennessy Louis Vuitton as a minority shareholder in Rentabiliweb, which provides payment platforms for Web sites, market sources said on Tuesday. Belgium-based Rentabiliweb, whose subsidiary, Mailorama, made headlines in November after a cash handout it had planned in Paris turned into a riot, last week unveiled plans to raise funds and transfer from the Alternext to the Euronext market in Brussels and Paris. Rentabiliweb said it planned to raise around 18 million euros, or $25 million, in funds by increasing capital by roughly 6 million euros, or $8.3 million, and selling 12.2 million euros, or $16.9 million, worth of existing shares. Dollar figures are calculated at current exchange. “In the context of this capital increase, PPR could take a stake equivalent to roughly 2 percent of the firm’s capital,” said one source. “This stake reflects PPR’s strong belief in the growth prospects of the online sector, in particular e-commerce.”  <wwd.com>


Loft Gift Cards for Bloggers Stir Buzz - A new Loft blogging strategy has created some buzz, but not entirely the kind intended. A group of bloggers was invited to preview Loft’s summer collection on Jan. 26 and each received a free gift card, ranging from $10 to $500. But Loft executives insist it wasn’t a ploy to insure favorable reviews about the collection, just to generate some blogging action. “They could write whatever they want. Obviously, there’s freedom of speech,” said Gary Muto, president of Loft, which is a division of AnnTaylor Stores Corp. “These are independent bloggers, not affiliated [with] any publications. We invited them to come in and write something. We treat bloggers more as potential clients. We don’t believe bloggers to be the same as the editorial community. We don’t incentivize the press. We would never do that.”  <wwd.com>


Dick's SG Set to Move Into New Findlay Headquarters - Dick's Sporting Goods plans to fully occupy its new corporate headquarters by the end of February. The $150 million, 670,000-square-foot complex occupies 116 acres of land beside the main runway at the Pittsburgh International Airport in Findlay, PA.

About 1,200 employees will occupy the space, according to The Pittsburgh Tribune. The center is the first phase of what eventually could be a 2 million-square-foot complex. The complex, which is pursuing LEED certification, is seven stories tall at its highest point, with 675,000 square feet of space. There's a separate, 60,000-square-foot aviation center to accommodate five corporate aircraft. The new site features a waterfall-like fountain and a large sports complex.  <sportsonesource.com>


CIT Veteran Breuer Joins R&R -  Sydnee Breuer has joined Rosenthal & Rosenthal as senior vice president for business development. A 20-year veteran of CIT Group, where she was most recently senior vice president for business development and underwriting, Breuer will work from R&R’s offices in Woodland Hills, Calif., and report to Harry Friedman, executive vice president. < wwd.com>


Americans Leery of Too Much Gov't Regulation of Business - At a time of increasing debate over the optimal relationship between government and business in the U.S., new Gallup polling shows that 57% of Americans are worried that there will be too much government regulation of business, while 37% worry that there will not be enough. Half of Americans believe the government should become less involved in regulating and controlling business, with 24% saying the government should become more involved and 23% saying things are about right.

R3: RL: Big Enough? - G1

Two questions Gallup asked on Jan. 26-27 measured the American public's overall views toward government regulation of business. The first asked directly about government regulation of business. The second asked Americans if they worried more about the prospect of too much or too little government regulation. Responses to both questions indicate that Americans remain leery of too much government regulation and control over business. This sentiment persists despite a significant loss of the public's confidence in banks and skepticism about the honesty and ethics of bankers over the last two years, and with increased focus on the negative impact of the actions of some big banks and other businesses on the nation's financial crisis. These results are generally consistent with a slightly different question that Gallup last updated in late August and early September of last year. Those results showed that about a quarter of Americans felt there was too little government regulation of business and industry. The majority of Americans believed that there was either too much regulation, or about the right amount. The current "worry" question measures these attitudes in a different way, but shows the same basic pattern of results. Given a choice, a little more than a third of Americans say they worry more about not having enough regulation of business, while 57% say their worry is that there would be too much regulation. <gallup.com>

Volcker's Soul

“I may not be alive to see the crisis, but my soul will come back to haunt you.”
-Paul Volcker (February 2nd, 2010)
Hearing Paul Volcker speak his mind is always both a pleasure and a privilege. The man didn’t win any Washington Groupthink points while testifying to the Senate Banking Committee yesterday, but who really cares?
As the old battle axe of the American Financial System’s credibility-lost was attempting to beat some very basic points about how the conflicted and compromised business model of a “full service” investment bank works into the melons of paid off politicians, the US stock market rose like a phoenix.
At one point, Volcker told one financially illiterate politician, “my soul will come back to haunt you”, and the Bubble Boy who missed proactively preparing  for the recent financial crisis actually snickered. At the same time I was being pinged by a few market players that “this Volker Rule is dead.”
Well folks, as our American patriot admitted yesterday, he may very well be dead by the time these reactive short term Washington decisions come home to roost. But as sure as you are waking up to a nice two-day pop in your 401k this morning, Bank of America is paying their bankers $4.4 Billion in bonuses. If you don’t know those bonuses were partly financed by a government sponsored Piggy Banker Spread – now you know.
The Stickler (Bank of America’s spokesperson, Robert Stickler) is seemingly empathizing with the 11% of Americans who are now on the USDA Food Stamp Program (up from 6% when Bernanke took over from Greenspan) saying this morning that, “we attempted to balance the need to pay competitively with our understanding of the general concern.”
Nice Stickler. Nice.
Again, for those incompetent political lemmings who don’t get the trade. Bernanke’s academic background (Great Depressionista) is being used as a political backboard to fear-monger this country into buying that we need an “emergency level of zero percent” interest rates on our hard earned savings accounts for an “extended and exceptional” period of time…
Then, the government supported bankers borrow moneys on the short end of the curve at zero percent, plug the citizenry with a higher lending rate, and keep the spread between what American citizens would have ordinarily kept as fixed income in their savings accounts.
Americans aren’t stupid, but most of the elected politicians using their short term job security duration to judge Paul Volcker’s long term wisdom must be. This morning’s ABC/Washington Post weekly consumer confidence reading dropped from minus -48 to minus -49. Nice Stickler. Nice!
Since no one running this country really gets paid to proactively prepare our children for the long term, let’s just go back to our immediate to intermediate term market views. Pavlov, if you are still out there, at 930AM, will you please ring the bells?
As the fleeting momentum of the “Volcker Rule” faded, so did the price momentum that was being built behind the buck’s credibility. After having a bang up week of +1.7% last week, the US Dollar is down for three straight days this week, and I am feeling the immediate term TRADE shame. Both Gold and the SP500 were up yesterday. I am short both.
I remain bullish on a continued Buck Breakout here in Q1 of 2010. A three-day -0.8% correction from the 5-month high the US Dollar reached on Friday certainly has my attention. So does a +3.4% bounce in the gold price. For now, irrespective of Volcker being put back in the closet, I am maintaining my intermediate term (3-month) view and the positions implied therein. The Fed needs to raise rates.
On US Dollar weakness yesterday, I upped my position in the US Dollar (UUP) to a 12% position in our Asset Allocation Model. Having had sold some into Friday’s strength, this is what I do. It doesn’t always work, but the idea is to buy on red and sell on green, actively managing exposures to my core positions.
On Friday, I titled my Early Look, “Red Light Risk”, and shorted the SP500 (SPY) when it was up a full percent on the rally associated with the Q4 GDP report. That made me look smart for a day, and not so smart yesterday.
I also highlighted the risk associated with what we call Duration Mismatch, using David Einhorn’s long position in gold as an practical example of a difference in opinion on duration. David kindly sent me a note in reply on Saturday morning, and it turns out the only thing we really disagree on is timing.
Einhorn wrote, “We are bullish on the dollar vs. the yen, euro, & pound. We like the dollar more than most everything but gold at the moment. Or maybe we just hate it less than the other currencies. We are long various European sovereign CDS.” My name is Keith McCullough, and I support that message.
I’ll post David’s full rebuttal on our Macro portal sometime today. It was one of the most even-handed and intellectually objective replies I think I have ever had since I started this firm.
If only America’s political leadership had the economic and financial understandings of the real players who wake up to play this game every day like David Einhorn does. Maybe one of the most thoughtful leaders of an American generation of finance wouldn’t have to threaten some crackberry politician with his soul…
My immediate term support and resistance lines for the SP500 are now 1071 and 1116, respectively.
Best of luck out there today,


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).
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.


USO – United States Oil
FundWe have been waiting, patiently, to short the US Oil Fund on an up day, which we got on 2/2/10. We are bullish on the Buck and bearish on China right now. These factors contribute to our multi-factor (bearish) intermediate term stance on the oil price.

EWJ – iShares Japan
We shorted Japan on 2/2/10 after the Nikkei’s up move of +1.6%. Japan's sovereign debt problems make Greece's look benign.

UNG – United States Natural Gas
Fund Macro DJ (Daryl Jones) and I remain bearish on Commodities. Natural Gas had a healthy price pop on 2/1/10, prompting us to short it.  

XLE – SPDR Energy
The Energy ETF was up +1.7% on 1/29/10 and we remain bearish on both oil and commodity prices for the intermediate term. Shorting green.

SPY – SPDR S&P 500
The SP500 broke our intermediate term TREND line earlier this week and remains broken. The 4Q09 GDP report confirms that Bernanke has to raise interest rates. ZERO is not a perpetual policy unless the USA wants to become Japan. We shorted SPY on 1/29/10.

GLD – SPDR Gold Shares
We re-shorted Gold on a bounce on 1/25/10. We remain bullish on the US Dollar and bearish on the intermediate term TREND for the gold price as a result.

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.

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. Russia’s GDP fell 7.9% in 2009.
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.

Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.


Yesterday we sold our position in Healthcare; shorted the US Oil Fund and Carnival Corp (CCL).  Todd Jordan doesn't see what consensus sees coming for Carnival in 2010. We think demand will continue to languish as the supply and debt issues refuse to go away.


Yesterday, the move in the S&P 500 to the upside was impressive.  The S&P 500 closed up 1.3% on 13% day-over-day improvement in volume.  The two-day move in the S&P 500 is now 2.73%.  The SAFETY trade would be the overriding catalyst for the two-day move as Healthcare (XLV) and Consumer Staples (XLP) are the only two sectors back to positive on both TRADE and TREND. 


Yesterday we sold our position in Healthcare.  As Keith said yesterday, “As the Pelosi factor creeps into our craws, we are mindful of political risk. Healthcare is up +1.6% here, so Tom Tobin and I will get off the bus, for now.”


In addition, RISK AVERSION was fashionable for a second straight day with a positive data points from Greece (the European Commission's is expected to back a deficit reduction plan); the VIX declined 4.91%, to 21.48 and is now broken on TRADE and TREND.  The Hedgeye Risk Management models have the following levels for VIX – buy Trade (20.63) and Sell Trade (22.26).  With the earning season more than half over the trends from machinery, AG-products, personal care selected industrial groups are providing additional support to the market. 


On the MACRO front, an improvement in December pending home sales coupled with better-than-expected earnings out of DR Horton set a more constructive macro tone to the housing sector and the RECOVERY trade.  Pending home sales increased 1% month-to-month in December, in-line with expectations, but significantly better that the downwardly revised 16.4% plunge in November.   It should be noted that consensus expectations are for pending home sales to strengthen into the spring on the back of low prices and mortgage rates and the extension of the homebuyer tax credit.


The Industrials (XLI) was the second best performing sector yesterday and Hedgeye Risk Management models have the XLI moving back to positive on TREND.  A strong earnings number out of Emerson Electric (EMR) took the stock up 10.1% on the day.  In addition, the machinery group outperformed for the 2nd straight day with the S&P Machinery Index up 1.9%. It also should be noted that there were better-than-expected January auto sales from F and GM. 


The Financials (XLF) was the 3rd best performing sector yesterday, improving 1.7%.  The improvement can be attributed to the belief that banking regulation will get severely diluted if it is ever passed into law. Within the XLF, the money-center banks (JPM, C and BAC) outperformed the regional’s. 


Yesterday, Consumer Discretionary outperformed by 10bps and moved to positive on the TREND duration.  The retail group was a contributor to the outperformance; the S&P Retail Index rose 1.35%.  Department stores outperformed for a 2nd straight session day and Barnes & Noble was up 7.78% after Ron Burkle is looking to acquire a significant position in the company.  The lower-beta names like the discount and dollar-stores underperformed.


As we look at today’s set up the range for the S&P 500 is 45 points or 2.9% (1,071) downside and 1.1% (1,116) upside.  Equity futures are trading above fair value after yesterday’s strong performance.  Today performance will likely be driven by more earnings which continue to be better than expectations.  


The Dollar Index decline for the second day in a row and the Hedgeye Risk Management models have the following levels for DXY – buy Trade (77.94) and sell Trade (79.56). 


In early trading Copper is extending its gains for a 3rd day, as the rally in RECOVERY trade and a weaker dollar is helping the demand outlook.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.96) and Sell Trade (3.21).


In early trading Gold is up for the 4th straight day as the dollar has weakened.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,076) and Sell Trade (1,119).


Crude oil rose in New York for a 3rd day before data that is expected to show that U.S. supplies of distillate fuels shrank last week.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (72.21) and Sell Trade (78.31).  Yesterday, we shorted the US Oil Fund.  We have been waiting, patiently, to short the US Oil Fund on an up day.


We continue to be bullish on the Buck and bearish on China. These factors contribute to our multi-factor (bearish) intermediate term stance on the oil price.


Howard Penney

Managing Director















The Macau Metro Monitor.  February 3rd, 2010.



HOME PRICES GOING UP macaubusiness.com

According to a Savillis report published January 27th, home prices are projected to rise as much as 15% in Macau in 2010. In 3Q09, the average transaction price of residential units rose by 27.6% q-o-q to MOP24,154 per square meter of usable area in Macau and by 35.8% to MOP24,158 psm on the peninsula.  Prices rose by 29.6% in NAPE to MOP51,296 psm and by 6.8% in Taipa to MOP23,897 psm.

YUM - until the cows come home

Will growing “until the cows come home” come back to bite em in the butt?


I want to be clear:  Yum will continue to grow in China for years and years.  What I’m focused on is the rate at which Yum is growing in China.


On the surface, it does not follow that a country where the economy is growing by 10% and consumer confidence is on the rise, that concepts like KFC would be having problems.  I have been told many times by senior management at YUM that taking a traditional U.S. restaurant analyst approach to analyzing China business is just wrong.  Call me stubborn, but here I go.


I’m trying to understand why Yum’s same-store sales in China have been coming down on a 2-year average basis throughout 2009 (and guided to come down again in 2010) when the MACRO backdrop is seemingly so positive.  Why are the issues that KFC faces in China any different from any other country in the world?  We see three major issues facing YUM in China: increased competition, over-building, and deteriorating brand perception among consumers due to health-related isses such as obesity.


As the chart below indicates, macro factors are providing somewhat of a tailwind.  Overall consumer confidence is improving (though not reflected in sentiment towards fast food) and GDP is growing, yet YUM’s China same-store sales have gone in the opposite direction.


YUM - until the cows come home - yumchinapod1


COMPETITION - Our contacts on the ground in China suggest that in the older, more mature cities where KFC has been for years there is significantly more local competition from smaller local players that can compete effectively on price.   Not to mention that McDonald’s has made great strides in increasing its pressence in those cities as well.  We have also heard that because the KFC brand is now much better known in China, when KFC opens in newer cities it has what I call the “Cheesecake” problem.  The new units are so big and glamorous that they operate at peak volumes and then subsequently, struggle to  grow same-store sales thirteen months later.  This is not a bad problem to have until a chain begins to canabilize sales by increasing capacity in order to achieve economies of scale.


It is interesting to take our propietary comments in the context of what we heard from McDonald’s management on its most recent earnings call.  “I think on an overall basis the pricing relationships in China in the quick service restaurant industry are in an interesting dilemma because of who you are competing against which is a very low price menu on the street from the non sort of chain restaurants and food available. We are not necessarily discounting but what we are doing is getting our price right in relationship to the economic time that we find ourselves in which is an ongoing pricing relationship as compared to a discounting of our food.  And it moves up and down the scale depending on where we find ourselves in the consumer spending. As we’ve said, I think the environment of China which basically fell off a cliff after the 2008 Beijing Olympics. We’ve adjusted accordingly along the way to be relevant with our consumers and it’s worked well for us.”

MCD’s comments highlight that despite improving consumer confidence, YUM is not the only QSR player in China facing a slowdown in demand.  The defining factor for YUM, however, is that the company is more leveraged to performance in China as management likes to point out that it continues to widen its lead in the Western QSR category with its approximately 1,700 KFC units in Mainland China relative to MCD’s 1,150 units.  In 2009, MCD cut back on growth in China in response to what it called a marketplace that was not growing while YUM maintained the pace of growth it had outlined at the beginning of the year (500 new units).


SUSTAINABILITY - Sustainability issues are looking to be a big red flag in China.  The issues stem not from growth alone, but rather from the company’s rate of growth.  For the past three years, YUM has raised its level of capital spending in China (forecast to grow another 9% in 2010) to roughly 10% of sales in 2009.  Over the same timeframe, operating margins in China have declined to close to 16%, based on my estimates, from nearly 18% in 2006.  And, return on incremental invested capital (ROIIC) has come down every year since 2006, albeit from a very impressive level.  In 2009, ROIIC should come in just better than 30%, but that compares to nearly 50% in 2007 and about 45% in 2008.  Based on my numbers, both margins and ROIIC will continue down on their current trajectory in 2010.  Focusing too much on same-store sales and on the fact that 2-year average trends will continune to come down in 2010 may be the U.S. centric way of analyzing trends in China (as management likes to talk about system sales growth), but I can’t disregard declining margins and returns.


YUM - until the cows come home - yumchinaroiic


YUM’s mentality in China is to grow “until the cows come home” - no matter what.  When a majority of management’s compensation is dependant on “system-wide sales” growth and comps are negative, the only way to get a bonus it to grow units.  Over the past four years YUM has taken its total number of units in China from about 2,300 in 2005 to almost 4,000 today , with the company first talking about canabilization in 3Q05.  At the time, CEO David Novak was quoted as saying that the company was cannibilizing units because four years previously, in 2001, “we thought we were starting to see some potential cannibilization in China and…we put the pedal to the metal and look at the business we’ve built”. 


While YUM has taken down its total capital spending in 2009, it is forecast to grow its spending in China by about 9%.  This 9% rate of growth expected in both 2009 and 2010 is toned down from the 40%-plus growth in the prior two years, but it appears that current trends should dictate further slowing in the coming years. 


The likelihood of YUM slowing growth in China any time soon is low as management has publicly stated, “We could drop our sales 20%-25% and open restaurants until the cows come home - so that's what we plan on doing.”  I contend that if the issues of over capacity are real and YUM maintains an accelerated pace of growth, it will exacerbate the problem. 


Think SBUX!


YUM - until the cows come home - yumchinacapex


CONSUMER PERCEPTION - In the late 90’s and early 2000’s, McDonald’s had a major problem in the U.K. dealing with consumer perception, particularly around health related issues.   Based on recent performance by both YUM and MCD in China, it appears that QSR in general is facing some consumer backlash in China.  Concerns about obesity preoccupy Chinese citizens and authorities alike and an awareness campaign has been launched by the government to highlight the dangers of fast food with vivid images of children playing among oversize food laced with glass and scorpions.  The article, posted on france24.com, was entitled, “China scaring kids out of fast food chains”.


YUM - until the cows come home - yumchart4


Obesity is a growing concern in China, and it is clear that the association between U.S.-style fast food and child-safety is being emphasized by the government. 


YUM - until the cows come home - yumchart5


Even if consumer confidence and GPD numbers are rising, there appears to be some MACRO related issues at play in China, too, as McDonald’s made perfectly clear on its 4Q09 earnings call.  


 “Now China, although their economy is improving and we delivered an increase in comp sales and guest counts in December, we expect it will still be sometime before consumers regain confidence and are willing to spend more.”  NOTE: this contradicts a study that we referred to earlier in this post.

MCD’s management also went on to say - “Regarding China, a couple of things, yes we did report positive sales and guest count movement in December.   You won’t see that in January though because we have the shift of the Chinese New Year so last year that was in January and this year it will be in February so by comparison that will be a little bit choppy.   But, we’re optimistic in what we’re seeing with the trends. We’ve talked about China in the south, and the central and the north so we saw all three of those areas improving in December and are kind of cautiously optimistic as the consumer starts to spend a little bit of money there that we will then be able to get a little bit more out of price and get a little more traffic moving there so that’s a perspective for you.”

Another potentially important MACRO focus-point is the urban youth of China.  While I have been advised by YUM’s management not to apply American logic to Chinese scenarios, I would hazard a guess that younger people are a somewhat important demographic for fast-food chains.  A telling piece on France24.com entitled “Beijing graduates crammed into slums like ‘ants’” shows the harsh reality for graduates living in urban China.  It is clear that these graduates are not frequenting western fast-food chains.  


The photo (shown below) is followed by a comment by one such graduate living in Beijing, “This is a place to eat.  It’s cheaper than in the rest of Beijing.  But people only eat out for breakfast – the rest of the time we cook in our bedrooms.”  Local players, whether operating out of premises or off the street, are providing formidable competition for YUM. 


YUM - until the cows come home - chinateen


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