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Contemplating Slow Growth . . . Bad for Equities and Natural Gas

Conclusion: The math is pretty simple – debt at extreme levels equals slow growth which negatively impacts equity and natural gas returns.


While we are encouraged to see a savvy firm like Goldman Sachs take their GDP estimates down closer to our street low estimates for 2011 GDP growth of 1.7%, it is likely that our estimate continues to have negative bias.  The key current factor driving our view of slowing growth is debt on the balance sheet of the United States.


The future downward risk to our GDP growth estimate will likely hinge on two key factors: housing prices and inventory.  If housing prices unravel quicker than we expect, it will have a direct impact on consumer spending, which is ~70% of GDP.  Additionally, if inventory building were to slow, which was a major contributor to last quarter’s GDP growth number, it would create a major economic growth headwind on a reported basis.


Currently, our estimate for debt-as-a-percentage of GDP for 2010E is 93.2% and 96.1% for 2011E.  The wild card variable for this number is that it assumes no further stimulus (though with yesterday’s “quantitative easing light” this ratio will grow), which would obviously step up the ratio dramatically in the short term.  Leaving future stimulus out of our projections is appropriate given the momentum that Republicans have in polls, and the potential austerity measures that are associated with such.


In our 40+ page sovereign debt presentation from early August (email us at if you want a copy), we highlighted a piece of long term analysis from Professors Reinhart and Rogoff from their recent paper titled, “Growth in a Time of Debt.”  In the paper they look at 220 years of data comparing debt levels of countries to their underlying growth.


The key take away from their paper is that as sovereign debt balances accelerate and eventually reach the 90% debt-to-GDP level, which we have coined the Rubicon of Sovereign Debt, growth slows dramatically.  In fact, the analysis of 2,317 observations has a statistically significant 352 observations at, or above, 90% debt as a percentage of GDP.  Collectively these observations show us that growth averages at 1.7% beyond the Rubicon of Sovereign Debt , which is almost three standard deviations below the collective growth rates at lower debt levels.


The second derivative of this analysis is, of course, equity returns.  In effect, how do equities perform in periods of slower growth?  We looked at the annual returns for the S&P500 for the last 30-years versus the GDP growth in each period.  The conclusion was that in low growth periods, equity returns lag.  The key conclusions of the analysis were as follows: 

  • In the five years with the lowest GDP growth of the past 30-years, the average return of the S&P500 was 2.5%; and 
  • In the five years with the highest GDP growth of the past 30-years, the average return of the S&P500 was 19.8%. 

The question of course is: what else is impacted by slow economic growth? 


We also took a quick look at the returns of natural gas, the commodity which is priced domestically and most directly impacted by U.S. economic growth.  Not surprisingly, the results were very similar.  For this analysis we were only able to look at the past 10-years of data, but in the four years with the highest GDP growth in that period the average year-over-year price gain for natural gas was +16.8%, while in the four years with the lowest GDP growth prices declined an average of (-3.4%) year-over-year.


The math is pretty simple – debt at extreme levels equals slow growth, which negatively impacts equity and natural gas returns.


Daryl G. Jones
Managing Director


Here is a look at 2Q guidance ahead of earnings on Thursday.


The trends at MCD are making it nearly impossible for any of the big (mature) hamburger chains to post better that expected results.  In addition, higher commodity prices (especially beef and pork) will make it difficult to maintain margins in 2H10.


The recent introduction of salads has been well received, but not enough move the needle at this point. 


The stock trades at a significant discount to its assets values, but being “hopeful” that the majority shareholders can create value (by spinning-off Arby’s) is not an investment process.  The $1 menu at Arby’s helped transactions, but will penalize margins for the time being.


I look forward to the day when Wendy’s can just be Wendy’s!



  • Wendy’s - To maintain or sequentially improve two-year average company-owned same-restaurant sales trends for the Wendy’s concept must see same-restaurant sales grow by at least 1.7% in 2Q.  Per StreetAccount, the Street estimates that company-owned same-restaurant sales for Wendy’s will come in at -0.1%, which would result in a 91 bp sequential decline in two-year average trends.
  • Arby’s - To maintain or sequentially improve two-year average company-owned same-restaurant sales trends for the Arby’s concept must see a same-restaurant sales number of at least -13.8% in 2Q.  Per StreetAccount, the Street estimates that company-owned same-restaurant sales for Arby’s will come in at -7.6%, which would imply a 310 bp sequential increase in two-year average trends.



  • For the year, we continue to expect positive same-store sales and further margin expansion at Wendy’s, and negative same-store sales at Arby’s but improving on a year-over-year basis.
  • Expecting adjusted EBITDA growth in the low to mid-single digits for 2010. This excludes the effect of the 53rd week in 2009 of approximately $14 million and incremental investment spending to expand breakfast menu in 2010.
  • We believe that the new salads will drive transactions and sales.
  • In 2010, we plan to remodel up to 100 company-owned Wendy’s restaurants
  • We will begin to introduce the new menu into our three existing breakfast markets in the second and third quarters, expanding in the fourth quarter (franchise and additional company markets) and finally a national rollout in 2011.
  • Internationally, we expect franchisees to open 35 to 45 new international Wendy’s restaurants.
  • We would expect the Wendy’s system unit growth to be flat this year.
  • For Arby’s we plan on having 75% of system as Pinnacle Image restaurants by the end of 2012 – stronger sales and margins.
  • On track to remodel 100 Arby’s company-owned restaurants in 2010.  Investing $100 million over the next three years.


Howard Penney

Managing Director

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EARLY LOOK: The Point of Collapse

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“Perfection of planned layout is achieved only by institutions on the point of collapse.”
-Northcote Parkinson
Parkinson was a well known British scholar who specialized in naval history. Before he passed away in 1993, he authored 60 books, including “The Devil to Pay”, “Dead Reckoning”, and “So Near, So Far.” His writings recognized patterns of behavior in administrations and institutions in a way that makes we modern day chaos theorists proud. Patterns repeat.
The point of collapse is generally crystal clear in the rear-view mirror. Professional politicians in Japan have been telling stories for 20 years as to why they can prevent economic stagnation. In the US, the storytelling started in 2007. All the while, stock market and real-estate prices have every opportunity to rally to lower-highs, then collapse to lower-lows.
Despite all of the dissimilarities between Japan and the US, there is one similarity that continues to matter most in our risk management model – debt as a percentage of GDP. Now that the US can’t cut interest rates any lower, the “perfection of planned layout” to quantitatively ease, is also similar. We agree with Reinhart & Rogoff that crossing the 90% debt/GDP threshold is the equivalent of crossing the proverbial Rubicon of economic growth.
On July 2nd, as part of our Q3 Hedgeye Macro Themes presentation, we cut both our Q310 and full year 2011 GDP estimates for the US to 1.7%. At the time, these US economic growth estimates were about ∏ the Bloomberg consensus estimate. Now we’re starting to see both the sell-side and the Fed gradually cut their estimates, but not by enough. Our estimate for 2011 is still too high.
Growth slowing, both domestically and in China, is core to our bearish views on both the US Dollar and US Equities. There will be a downward bias to our US growth estimates as long as debt-financed-deficit-spending continues to remain the answer to the Fiat Fools prayers.
Markets trade on expectations. Yesterday’s setup in the SP500 was unlike most Augusts in America. That’s because the ‘government is good’ crowd leaked an idea to the Wall Street Journal that QE2 was coming, and that Ben Bernanke was going to solve for buy-and-hope begging.
To think that we have institutionalized market expectations in this great country to this degree is downright frightening. All things rallies start and end with rumors about what a humble looking man of government will represent at 215 PM EST on an August afternoon. Sadly, this kick starts thoughts of what another thoughtful European mind, Alexis De Tocqueville, warned about American style democracy in the 19th century.
So now what?
What do we do with this big Keynesian intervention that has delivered the fear-mongering national marketing message? Have we sufficiently scared the horses? While we’ve been getting paid, has this “perfectly planned layout” of telling Americans that this is a “great depression” worked?
With 40.8M Americans on food stamps (record high) and 45% of the unemployed having been seeking employment for 27 weeks or more (record high), now what?
Should we start begging for QE3? Should we cancel the bomb of an Existing Home Sales report for public release on August 24th? Or should we get back on TV after checking our I-pads and drinking our $5 mocha-frap and tell Americans to bite the bullet on ZERO percent returns-on-savings while we pay Washington to continue to lever-up our future to the point of economic collapse?
Before the Fiat Fools run out campaigning for QE3, never mind decisions made in 1997 Japan, maybe they should analyze some real time market results to yesterday’s announcement of QE Light:
1.      The US Dollar is battling for resuscitation after 9 consecutive down weeks at $80.80 (down -9% since June)

2.      US Treasury yields are making record lows on the short end of the curve, with 2-year yields striking 0.49%!

3.      The Yield Spread (10yr minus 2yr) continues to collapse, down another 4bps day-over-day to 223bps

4.      US stock market futures are diving below the beloved 200-day Moving Monkey line of 1115

5.      US Volatility (VIX) is spiking from its intermediate term TREND range of support (22-23)

6.      QE Specialist (Japan) got smoked overnight, closing down -2.7% to down -11.9% YTD

Now what?
De Tocqueville’s answer: “The American Republic will endure until the day Congress discovers that it can bribe the public with the public's money.”
My immediate term TRADE lines of support and resistance for the SP500 are now 1099 and 1138, respectively.
Best of luck out there today,

R3: GIL: Ammo for Q3


August 11, 2010


In preparation for Gildan’s print after the close, here are the puts and takes to help navigate the quarter.





For Q3, we are a penny above the Street at $0.49, but starting in Q4 headwinds get considerably more challenging – we’re $0.04 below consensus at $0.42. Assuming management is looking to get paid this fiscal year, they can take down SG&A to make it happen.  But, looking out into next year is when the deviation from Street estimates gets big.  Our model is at $1.46 (down -5% yy) versus the Street at $1.94 (up +27%!). Here are a few assumptions to note:


  1. They’re already at full utilization in their Activewear biz (80%) of total and are building out capacity, but this is not overnight.
  2. It is precisely 1Q11 when higher cotton/labor costs start to kick them where it hurts. With cotton prices up over 10% since the end of June and back at peak levels upwards of $0.85 /lb. last seen in early 2008, this delta is turning sharply starting in Q4.
  3. Can SG&A stay at 12% of sales forever? Especially if they need to kick start top line at a point when HBI is getting more competitive?
  4. One positive offset is that we took incremental cash flow and slapped on an 8% return. Not through any kind of financial product. But they’ll probably buy something, and we assume they will realize a nominal 8% return off the top. They’ve had mixed results in the past. This assumption is batting down the middle.


Following a decent quarter that laps significant Broder related disruptions this time last year, we’d consider adding GIL to the short list in a few months one the dust settles after the quarter and as 2011 approaches.


R3: GIL: Ammo for Q3 - GIL Q3 Prev 8 11 10 





- In another sign that online and offline sales are essentially one in the same, Piperlime is opening a pop-up shop in NYC this September. The Gap-owned footwear site will represent the brand’s first ever attempt at having a physical presence. The opening coincides with Fashion Week.


- In an effort to boost its east coast image and drum up some marketing buzz, word has it that Vans is leasing a 15,000 warehouse in Brooklyn to create an indoor skate park. The site is expected to be used for promotional and marketing events and NOT for locals to use.


- Kmart gets added to the list of discounters looking to make a fashion splash, several years AFTER Target pioneered the concept. This Fall the retailer will launch Kmart Design, an apparel collection created by a team of 250 international designers. The fashion campaign will also launch with an ad campaign in Vogue.





Skechers Defends Toning Footwear - Skechers said that the two recently filed civil class actions disclosed in its Form 10-Q for the quarter ended June 30, 2010 each have only a single plaintiff and both are completely baseless. The complaints, Tamara Grabowski v. Skechers USA, Inc. and Sonia Stalker v. Skechers USA, Inc., allege that the company’s advertising for Shape-ups violates California law. The complaints, which were filed respectively on June 18 and July 2, are in the early stages and that the company will mount a vigorous defense. Skechers claims the lawsuits are inconsistent with numerous scientific studies, including studies cited in one of the lawsuits. Links to key studies, including two published in peer-reviewed journals, are available at www.ToningShoeStudies.com. The company also said that the popularity of its toning shoes provides convincing evidence that customers are pleased with the product.  <sportsonesource.com>

Hedgeye Retail’s Take:  Baseless or not, the volume of studies supporting and refuting the “toning” shoe claims is increasing.  If anything, we expect the media attention to increase here as “consumers” begin to realize walking in a certain type of shoes may not actually be a replacement for going to the gym and eating healthy. 


American Apparel Will Miss SEC Filing Deadline Due to Previous Auditor Resigning After Finding Material Weakness in Internal Control - American Apparel Inc. has informed the Securities and Exchange Commission that its numbers will neither be punctual nor profitable. Its new independent auditor, Marcum, needs more time to work through the figures for Q2, as well as Q1, which have yet to be filed. The summary of Q2 offered by American Apparel was not positive: Q2 loss against a net profit last year, net sales declines from lower retail sales only partially offset by increased wholesale, and gross margin declines from shift in business towards wholesale coupled with higher production costs. Deloitte & Touche LLP resigned the account last month after identifying “material weaknesses in internal control” with respect to the closing and reporting of its figures. Additionally, American Apparel told the SEC, Deloitte became aware of certain information “that if further investigated may materially impact the reliability of either its previously issued audit report” or the financial statements made regarding fiscal 2009. <wwd.com/business-news>

Hedgeye Retail’s Take:  Maybe the clamp down on the company’s dress code was the leading indicator that things weren’t exactly as advertised. 


GSI Commerce Expands to Asia; Appoints Vice President of Japan and Asia Pacific - GSI Commerce Inc. has opened its office in Tokyo, Japan and has appointed a VP of Japan and Asia Pacific. They will open the Japanese office and lead the operation of the company’s existing client commitments in Asia Pacific as well as the development of new clients. <sportsonesource.com>

Hedgeye Retail’s Take:  With more and more retailers taking on their own e-commerce efforts, we wonder if the expansion is purely offensive or a bit of defense. 


JCP Introduces MNG by Mango Shop in Shops - J.C. Penney juices up the contemporary side of its fashion business next Wednesday with MNG by Mango shops inside 77 of its department stores and online. By February, Penney’s intends to have Mango shops in 600 doors. MNG by Mango is one of only three brands in the store with dedicated built-out shops, including Sephora and Call It Spring footwear. The influx of goods will be speedier as Mango collections will arrive every two weeks, differing from other labels which may ship as rapidly, but in limited quantities to supplement what’s already on the selling floor. The speed to market is made possible by Mango’s superior sourcing and design capabilities coupled with Penney’s advanced logistics and planning and allocation systems.  <wwd.com/retail-news>

Hedgeye Retail’s Take:  One of the more exciting collaborations that we’ve seen in a long time.  We do wonder how aggressive the Mango fashion will be for the JC Penney customer however. 


7 For All Mankind Expands into Berlin - The premium jeans label opened a 970-square-foot store last month in Berlin’s tony Quartier 206. The store design features a slick zebra-wood interior, similar to many of its U.S. boutiques, and houses the brand’s current men’s and women’s wear collections as well as perennial best-selling items such as leather and denim jackets and skinny jeans with a low rise. The Berlin opening marks the first of several slated in Germany. A 1,938-square-foot shop will open in Düsseldorf early in September and further units are planned for Hamburg and Frankfurt. <wwd.com/retail-news>

Hedgeye Retail’s Take:  While the US premium denim market appears to have peaked, it’s time to look elsewhere for growth.  We wonder if Seven can be one of those American brands that was born stateside but ultimately becomes a bigger brand outside of its domestic roots.


Puma Appoints New Retail VP - Puma North America announced the appointment of John Trott as Vice President of Puma Retail, who will oversee all Puma North America retail divisions, including Puma Stores, Puma Outlet Stores, and Shop.PUMA.com.  <sportsonesource.com>

Hedgeye Retail’s Take:  An acceleration in growth on the horizon or perhaps a revamp of the store base that seems to have grown lockstep with popularity of low profile footwear?  For those keeping track, Puma is missing the boat at the moment with the resurgence in technical/performance footwear.


Target Brings Back John Derian for Home Line - A new John Derian for Target collection will hit stores this fall, featuring more than 100 exclusive home décor and accessories. The new line will include decorative trays, wall art, coasters, stationery (mini journal sets and paper organizers), fabric-covered storage bins, ceramic mugs and melamine dinnerware.In 2008, Derian partnered with Target for a line of stationery and home décor products. <licensemag.com>

Hedgeye Retail’s Take: Given that the first collection was sold out immediately, this expanded assortment makes sense. 


Perry Ellis International Launches PGA TOUR Collegiate Apparel Program - Perry Ellis International announced the launch of PGA TOUR Collegiate Apparel at retail accounts nationwide, offered through a licensing agreement with The Collegiate Licensing Company (CLC), a division of IMG Worldwide, and the PGA TOUR. <sportsonesource.com>

Hedgeye Retail’s Take:  All of a sudden the college market has become a big source of growth.  Long a sleeper in the world of retailing, we now see BKS, HBI, COLM, and UA tapping the college market in one way or another.   After all, for every graduate there is a freshman needing new gear- year after year.


MACRO: An Employment Gong Show




Conclusion: Employment “growth” is anemic and looks weak going forward, which will be a negative catalyst for equities.
Today’s underwhelming Employment report was no doubt made worse by Goldman Sachs Chief Economist Jan Hatzius’ lofty forecast of +600,000 payrolls for the month of May (a +100,000 increase from his previous estimate). While being “a little low on the census contribution” was his chief reason for upping his forecast far above the median consensus estimate of a 536,000 gain, our Hedgeye estimate was that he (and consensus) was “a little too high” on the private contribution. Jan’s estimate was for an incremental 150,000 private payrolls to be added in May vs. 180,000 consensus.
Private payrolls added for the month of May was reported at an anemic 41,000 – first marginal deceleration since December of 2009. After a 9% drop in the S&P throughout the month, and a near 11% drop from the highs of April to the end of May, it was proactively predictable that the rate of job growth would slow on the margin. For clarification, the S&P 500 and Net Private Payrolls have a 0.72 positive correlation over the last three years. That’s an r-squared of 0.53, which suggests some level of statistical significance.
Interestingly, if we normalize for the birth-death adjustment, which we admit is the fodder of conspiracy theorists, and exclude the 215,000 birth-death adjustment, the economy actually lost 226,000 jobs.  Even if you aren’t willing to accept that dire of a claim, those unemployed longer than 27 weeks hit a new record coincident with this report at 46%.  The likelihood that people just give up hope and drop out of the workforce increases every week with that statistic.
We shorted the QQQs into the close yesterday based on the view that this payroll number was going to be worse than expected.  While Hatzuis’ took the shot, and we admire him for that at least, by inflating the whisper consensus number, he actually increased the probability that we would be right on our short call and that payroll additions would be worse than expected by implicitly increasing consensus expectations.
While consensus hiring is boosting over all payroll additions and, temporarily, decreasing the unemployment rate, this payroll report should be framed for exactly what it is . . . a disaster.  As we’ve highlighted in the chart below, this is a sequential decline in the addition of private sector jobs and highlights two critical points: a) this is a jobless recovery at best and b) the stimulus package has failed to stimulate any real sustainable jobs additions.
With the stimulus behind us and census hiring also primarily in the rear view mirror, it is likely that the payroll additions will continue to be anemic, and that the actual unemployment rate ticks back up.  And that, as they say, is not good.



MACRO: An Employment Gong Show - Screen shot 2010 08 11 at 6.47.34 AM


Daryl G. Jones
Managing Director
Darius Dale