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Faith is taking the first step even when you don't see the whole staircase.

- Martin Luther King, Jr.


In general terms, faith is the persuasion of the mind that certain statements are true, belief in and assent to the truth of what is declared by another, based on his or her supposed authority and truthfulness. Faith in politicians around the world is certainly waning. Europeans, Americans, and Asians can’t see the whole staircase, but they don’t believe their representatives can either.


Yesterday the S&P 500 finished lower by 0.5%, with the financials as the only sector positive on the day. The Financials (XLF) sector was somewhat of a surprise outperformer despite headlines out of Washington that continued to feed into worries surrounding the bottom-line impact of financial reform. Specifically, yesterday the Senate failed to cut off debate on the financial regulatory bill as two key Democrats said it still did not sufficiently tighten rules.


The market was also unable to take advantage of a short-covering bounce in the euro. The euro has gone straight up from our oversold line of 1.21 and is currently trading at 1.23. The Hedgeye Risk Management models have the following levels for the euro – Buy Trade (1.21) and Sell Trade (1.25). Despite a brief reprieve for euro, the issues in Europe continued to be a drag on sentiment.


On the MACRO front, the Mortgage Bankers Association data showed that the mortgage delinquency rate rose in the first quarter to 9.38% of all loans outstanding, from 8.22% last year. Yesterday the Dollar Index gave back some of it recent gains, declining 0.88% on the day. The Hedgeye Risk Management models have the following levels for the USD – Buy Trade (85.48) and Sell Trade (86.97).


Currently, equity futures are trading below fair value as markets attempt to reconcile yesterday's decline and the more bullish FOMC minutes. The news in Europe is mixed and there is clear lack of direction coming out of Europe regarding the appropriate strategy for dealing with its debt crisis. As we look at today’s set up the range for the S&P 500 is 41 points or 1.4% (1,099) downside and 2.2% (1,140) upside.


The Hedgeye Risk management models have moved to 0/9 sectors on TRADE and 2/9 sectors positive on TREND - Industrials (XLI) and Consumer Discretionary (XLY).


Yesterday, the Industrials (XLI) was the worst performing sector, declining 1.3%. Year-to-date, the XLI has been the biggest beneficiary of the MACRO headlines that have been driving the bulk of the direction for global equities. In addition, although the sector has been a big beneficiary of a rebound in the manufacturing sector, May represents that first data point that was a disappointment as the Empire Manufacturing Index fell to 19.1 from 31.9 in April.


Consumer Discretionary (XLY) underperformed as stocks leveraged to the housing sector were mostly weaker today with the XHB down 1.5%. The building products names remained under pressure with USG (4.5%), AWI (3.7%) and OC (2.8%) all finishing down for a fifth straight session. The home builders were mixed on the day. As expected, the recent housing data points have come in ahead of expectations, doused by the reality that the stimulus measures have pulled demand forward. Today's MBA release offers some support for that thesis, as the purchase index fell 27.1% week-over-week.


Oil halted a six-day losing streak yesterday after stockpiles in the U.S., increased less than analysts forecast last week and supplies of distillate fuel unexpectedly declined. The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (69.99) and Sell Trade (74.63).


Gold declined 1.9% yesterday as did many other commodities on speculation that the recent rally is ahead of itself. The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,180) and Sell Trade (1,251).


Copper rose as declining stockpiles in warehouses monitored by the London Metal Exchange boosted speculation that demand for the metal may be increasing. The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.90) and Sell Trade (3.11).


Three month LIBOR ticked up to 0.48 from 0.46 yesterday. The TED Spread widened to 0.32, indicating that risk perception is heightening. Europe remains a factor for investors gauging global risk; the inverse correlation between the TED Spread and the euro is now -0.95.


On the MACRO calendar we have: 

  • Initial Jobless Claims
  • May Philadelphia Fed
  • April Leading Indicators
  • Fed Governor Tarullo testifies at a House Financial Services joint subcommittee hearing on The Role of the IMF and Federal Reserve in Stabilizing Europe 

Howard Penney

Managing Director













Friedrich vs. The Fiats

“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

-F.A. Hayek


Friedrich von Hayek isn’t who the Fiat Fools want to read about this morning. So let’s unite as a community of capitalists and pass this message around to the legions of Keynesians out there who need a wakeup call. We are running out of time. The Western world’s fiat currency system is failing.


I’d wager that 2 out of every 3 anchors on CNBC don’t even know who Hayek is, which is actually quite sad when you think about it. The group-thinkers of American finance cannot begin to respect the history of economics if they’ve never studied it.


Friedrich von Hayek is the father of the Austrian School of Economics. Unlike John Maynard Keynes, who was actually a currency trader before he realized how easy it was to grandstand against the British politicians of his time, Hayek had a multi-factor risk management model that hinged on marked-to-market prices.


Hayek won the 1974 Nobel Prize in Economics for his "pioneering work in the theory of money and economic fluctuations and [his] penetrating analysis of the interdependence of economic, social and institutional phenomena.” (Wikipedia; http://en.wikipedia.org/wiki/Friedrich_von_Hayek)


What’s most important about Hayek’s work is that it was built on the principle that market prices should clear freely and that we should stay as far away as possible from the tyranny of political power, socialist influence, and collectivist thought. In his day, his views provided the foundations for some of Paul Volcker’s actions, and the death bed for the Keynesian political pandering of then head of the US Federal Reserve, Arthur Burns.


Burns and Bernanke have a lot in common – both have pandered to the political winds of debauching their citizenry’s currency in order to artificially inflate prices. Some might even call marking the cost of bank capital to model like this, price fixing. I’m not sure I am willing to go that far yet, but I am willing to go on the record stating plainly that the Japanese, American, and European economic experiments of Fiat Fools has failed.


Getting right back to what’s happening out there in the market that’s in front of us this morning, we continue to witness an unbelievably blind belief that the US Federal Reserve and the European Central Banks know exactly what they are doing.


Ben Bernanke may indeed be a wonderful historian of the Great Depression, but when it comes to financial forecasting he is borderline incompetent. His inflation forecasting track record since he took over at the Fed in 2006 speaks for itself – it’s just plain ugly. On the growth side, his forecasts continue to be a, if not THE, lagging indicator.


In the Fed’s minutes yesterday, Bernanke’s boys upped their growth forecast for US GDP from a range of +2.8%-3.5% to +3.2-3.7%. The man has to be kidding me. AFTER calling this the greatest of “emergency” like depressions, cutting rates to ZERO, then acknowledging that Mr. Macro Market had it right and that US GDP wouldn’t be depressionary, NOW he is upping his forecasts right before US GDP is setting up to slow again sequentially!


Sorry Keynesian fans, this nonsense of piling policy mistake upon policy mistake as we pile debt upon debt has to stop. And soon, or this country is heading to at least as dark a place that some Western Europeans are heading to real-time.


Unlike during my 2008 criticisms of Bernanke and Paulson’s decisions to destruct America’s balance sheet for the sake of Groupthink Inc’s compensation structures, this time around we have an army of you who have the ability to forward this note to whoever has the spine to be accountable.  It’s time to stand up to the Fiat Fools. It’s time for a modern day enlightenment. It’s time to show them that there is a better way.


Saying that “no one saw it coming” this time around won’t cut it. The lack of leadership and accountability in our country has every opportunity to be righted. It always has. From New Haven to Omaha, please stand with us and continue to form the line. As George Washington said, it’s time to “guard against the impostures of pretended patriotism.” America’s legacy stands on the shoulders of competent giants. We know you are out there. Stand tall.


We remain short the SP500 (SPY) in order to protect our friends, our firm, and our handshake. We will not go down with the men who don’t  know what they don’t know “about what they imagine they can design.” Our immediate term TRADE lines of support and resistance for the SP500 are now 1099 and 1040, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Friedrich vs. The Fiats - DXY

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Who is going to stir the pot on WEN?


Over the years, Trian Partners has been extremely successful at creating value from mispriced securities.  In the almost two years since creating the Wendy’s/Arby’s Group, it has now created one of those mispriced equities.  Can Trian and senior management fix WEN again?  Our sum of the parts analysis concludes that WEN is right back where it was in 2005 – except this time, there is no value in the current security for the Arby’s brand.


In 2005, Trian and a host of other high profile hedge funds, put pressure on Wendy’s management to unlock value by allowing the market to value the separate parts of the company (resulting in the spinoff of Tim Horton’s).  Almost two years after the merger of the Wendy’s and Arby’s’ brands, the company finds itself right back in the same position.  In 2005, the Tim Horton’s brand accounted for more than100% of the value of the equity, as compared to today when the Wendy’s brand accounts for more than 100% of the value of the company. 


Over the past two years, management has done a commendable job restoring Wendy’s margins despite a very sluggish overall sales environment.  Ironically, at the time when Trian was pressuring Wendy’s management to spin off Tim Hortons’s, Trian pointed to the higher margins at Arby’s as proof of the company’s success as operators.  The relatively lower and declining margins at Wendy’s, at the time, acted as evidence of a concept that was being mismanaged. 


Given the quick turnaround in restaurant-level margin trends at Wendy’s, it would seem that Trian was correct in its conclusion that the concept was being mismanaged.  In the most recent quarter, the progress at the Wendy's brand was evident, but Arby's trends continued to decelerate and are overshadowing the company’s overall performance. 


Arby’s restaurant margin, which closed out 2007 at an impressive 19.7%, has since declined to 10.8% in the most recent quarter, not much higher than Wendy’s reported 10.1% restaurant margin in 1Q08, just before the two companies announced the merger.   The obvious conclusion would be that WEN management lost its focus on Arby’s while working to turnaround Wendy’s.  That being said, it is important to remember that Arby’s performance was already suffering when it merged with Wendy's in September 2008, and the economy has exasperated the declines at the concept.




The recent sales trends are somewhat disappointing.  Company-operated same store sales at Wendy's turned negative in April to -0.5% (excluding a negative fiscal month calendar shift from Mother's Day) from +0.2% in 1Q, while Arby's company-operated trends remained very negative, at -8.4%, albeit with traffic up 4% and check down about 12%.


This -8.4% and positive traffic in April marks a significant improvement from the first quarter when company-operated same-store sales declined 11.6%.  Management attributed the sequentially better trends to the systemwide launch of the Arby’s $1 Value Menu in April, combined with national advertising beginning on April 11.  During the weeks when the company advertised its $1 Value Menu nationally, transactions improved to +7%.    And, as management correctly pointed out on its 1Q10 earnings call, “getting more customers into [its] stores is the first step in successfully turning around the Arby’s brand.”   


The company expects that the everyday value offering will lead to continued improvements in the second quarter as awareness grows.  Investors seem less convinced as WEN is currently trading down nearly 8% since reporting 1Q10 results.  Arby’s business is in free fall, relative to same-store sales, AUV and margin trends (shown below).  The deteriorating trends at Arby’s are overshadowing the improvements at Wendy’s.  Based on my sum of the parts analysis (also shown below), which assumes continued margin expansion at Wendy’s in FY10 (though not to the same magnitude as we saw in 2009) and continued margin erosion at Arby’s, WEN is being undervalued.  In fact, at its current price, it would seem that investors are getting Arby’s for free.  Given the current trends at Arby’s, this might not seem like too much of a bargain, but my numbers also suggest that WEN’s current price does not reflect the true value of the Wendy’s concept alone.




As I said earlier, Trian Partners has been extremely successful in the past creating value from mispriced securities.  No, I do not think WEN will spin off Arby’s any time soon but the company will work to address the issues at Arby’s.  If Arby’s shows some sign that it has at least bottomed, WEN should reflect the full value of Wendy’s, which would suggest a move higher of nearly $2.  The potential longer-term upside is reliant on management’s ability to return Arby’s margins to peak levels.  I don’t think this will happen in the near future but we have seen what management has been able to accomplish at Wendy’s in a short amount of time.  Time will tell.








Howard Penney

Managing Director