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CMG: COSTS HEADED UP

Chipotle’s bottom line is highly vulnerable to a continued rise in food prices.

 

CMG is a popular brand and their management team has done a great job in many respects.  One significant factor buttressing the bottom line since the stock price troughed in 4Q09 has been food prices.  As I wrote in my June post, “CMG: WATCH MARGINS”, the favorable commodity environment enabled CMG to attain higher margins from 1Q09 onward.  The company is not locked into many of its ingredients and continued food inflation will likely impact CMG’s earnings potential significantly.  

 

CMG: COSTS HEADED UP - cmg food margins crb

 

CMG: COSTS HEADED UP - crb foodstuff

 

Maintaining comparable restaurant sales in this economic environment will be difficult for all restaurant companies.  There is virtually no pricing (one tenth of one percent) in Chipotle’s comp but it seems that management would be hesitant to carry out such a move with unemployment this high.  As the chart below shows, positive traffic momentum has been instrumental in driving Chipotle’s top line.  If the company can maintain high single digit comparable restaurant sales trends, margins will likely remain healthy.  Slowing comps, however, will amplify the negative effect of food inflation on margins and make leveraging other parts of the income statement more difficult. 

 

CMG: COSTS HEADED UP - cmg comp detail

 

Below is a rundown of Chiptole’s commodity setup.  While they are largely unlocked on some items such as proteins and dairy, smaller items like rice, tortillas, and corn are locked for the remainder of this calendar year.  Should prices in these contracted commodities continue to trend higher, margins could come under additional pressure when the contracts expire at year end.

 

Looking at Chipotle’s commodity setup:

  • Rice is contracted through at least two more quarters (through 4Q).   Clearly, this is a good thing to have contracted given recent climate events in Pakistan and China.  
  • Soy oil and corn are also contracted through two quarters while tortillas have also been locked in for the remainder of 2010.
  • Chicken prices in the second quarter were held lower because the company, due to supply issues, only served 80% naturally raised chicken.  The company is “optimistic” that they can return to 100%.
  • The inadvertent change in chicken sourcing was margin accretive (by 20 bps) and partially offset the higher year-over-year cost of avocados and beef, which are not currently contracted.
  • CMG has not locked in cheese or sour cream. 

 

Howard Penney

Managing Director


EARLY LOOK: Focus on Risk

This note was originally published at 8am this morning. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK in real-time, published by 8am every trading day.

 

 

____________________________________________________________________

“The best investors in the world do not target returns; they focus first on risk.”
-Seth Klarman

 

 

EARLY LOOK: Focus on Risk - Screen shot 2010 08 25 at 9.13.37 AM

 

 
Seth Klarman founded Baupost in 1982. He’s one of the best players who are left playing this game. He’s not your huckleberry if you are looking for someone to get levered up long. He’s conservative. He likes cash and he has no problem moving to a cash position greater than 50% of his assets.
 
I’m not Seth Klarman, but I like cash too. I currently hold plenty of cash in our asset allocation model. I get that some investors have (or think they have) leverage figured out. I have yet to see a levered long equity or commodity fund perform in a bear market, but that certainly doesn’t mean one may not exist. Please forward details if you know of one that’s generated absolute returns in both 2008 and 2010.
 
Yesterday we invested 6% of the Cash position in the Hedgeye Asset Allocation model, taking our recommended Cash position down from 61% to 55% (buying DJP and IHE). When we started getting bearish in April/May, our allocation to cash peaked at 79%. In bear markets like these, I fundamentally believe in managing a large cash position dynamically.
 
I’m not ready to say “buy-and-hold” is dead. I don’t think it will ever be. Whether it’s investing in Hedgeye in 2008 or buying Starbucks (SBUX) in early 2009, I doubt I’ll ever sell these positions. However, I will say that buy-and-hope is dead. Buying on valuation alone in a slowing growth environment is rarely a catalyst and hope is not an investment process.
 
Managing risk in an interconnected global ecosystem of colliding macro factors is a repeatable risk management process that we can all apply. If we are accountable to our investors in focusing “first on risk”, that is…
 
Every day the score is re-calibrated. I’m pretty sure that the triumvirate of Google, Wikipedia, and YouTube will be holding us all accountable to how we managed risk on both the downturns of 2008 and 2010. History will decide whether Hedgeye was useful to your investment process long after I am dead.
 
We’ve been bearish on US Equities and now we are accountable to our clients in recommending where they book gains in these bearish positions. Making calls on US GDP or housing slowing is only one part of the risk management process. The most critical part of the investment process is getting the timing right.
 
We had the timing right on the way down. The question now is can we get the timing right on the way out? Here’s how I thought this through yesterday as I was covering 5 of the 14 short positions in the Hedgeye Virtual Portfolio (SPY, XLI, HOT, IWM and XLY):


 
1.      Math: Immediate term TRADE support (our most immediate term risk management duration – 3 weeks or less) in my macro model for all of the aforementioned short positions was 2.5 standard deviations oversold. This is not to say that 3 and 4 standard deviation moves couldn’t occur this morning, but looking at the macro calendar of events today, I made a conscious decision to bet against those low probability events.

 

2.      Risk/Reward: For the sake of this illustration I’ll use the SP500 (SPY) short position – moving to a 3 standard deviation level of downside support I was coming up with 1040 (the 2.5 standard deviation level = 1053), and in terms of immediate term TRADE upside I was registering 1077 on a 2 standard deviation move. Net net, I saw 2.5:1 upside versus downside in getting longer and I thought that was worth taking.

 
3.      Volatility: The inverse relationship between the VIX and the SP500 continues to be a heavily weighted risk management signal in our 27-factor baseline model. It hasn’t always been – it just is now because the inverse correlation between the two remain very high on an intermediate term basis. At the same time as I’d call the SP500 immediate term oversold anywhere south of 1053, I was registering the VIX immediate term overbought anywhere north of 27.57. Since the VIX closed at 27.46, that was close enough for me to stick with my cover/buy signal.

 

Now all this starts and ends with risk management. I wasn’t trying to decide whether or not we should drop our net long exposure from 140% to 107% yesterday. I was risk managing how to A) get out of 1/3 of my short positions and B) get into some long exposure to US Equities. There is no rule saying I can’t re-short any of these positions at anytime today. This doesn’t make me bullish either.
 
Again, it’s a lot easier to think this through from a position of strength. I’m certainly not always in a position of strength either. Yesterday I was, and my risk management task was to focus on risk first. Don’t get squeezed on the short side and focus on investing cash when markets are oversold.
 
I realize that this is unconventional. I realize that sometimes it’s hard to read about my team’s wins. I am very aware of the confidence interval I have in this team’s risk management process, and I can assure you that the hardest part about all of this is how hard I am on both my team and myself. Showing you what we do, when, and why isn’t easy. Neither is modern day risk management.
 
As of last night’s close, our Hedgeye Asset Allocation portfolio had the following positions and weightings:
 
1.      Cash 55%

2.      International FX 21% (Chinese Yuan (CYB) = 15%, British Pound (FXB) 6%)

3.      Commodities 9% (DJUBS Commodity Index (DJP) = 6%, Gold (GLD) = 3%)

4.      Bonds 6% (all TIP)

5.      US Equities 6% (Utilities (XLU) = 3%, US Pharma (IHE) = 3%)

6.      International Equities 3% (Brazil (EWZ) = 3%)

 
Best of luck out there today,
KM


Focus On Risk

“The best investors in the world do not target returns; they focus first on risk.”

-Seth Klarman

 

Seth Klarman founded Baupost in 1982. He’s one of the best players who are left playing this game. He’s not your huckleberry if you are looking for someone to get levered up long. He’s conservative. He likes cash and he has no problem moving to a cash position greater than 50% of his assets.

 

I’m not Seth Klarman, but I like cash too. I currently hold plenty of cash in our asset allocation model. I get that some investors have (or think they have) leverage figured out. I have yet to see a levered long equity or commodity fund perform in a bear market, but that certainly doesn’t mean one may not exist. Please forward details if you know of one that’s generated absolute returns in both 2008 and 2010.

 

Yesterday we invested 6% of the Cash position in the Hedgeye Asset Allocation model, taking our recommended Cash position down from 61% to 55% (buying DJP and IHE). When we started getting bearish in April/May, our allocation to cash peaked at 79%. In bear markets like these, I fundamentally believe in managing a large cash position dynamically.

 

I’m not ready to say “buy-and-hold” is dead. I don’t think it will ever be. Whether it’s investing in Hedgeye in 2008 or buying Starbucks (SBUX) in early 2009, I doubt I’ll ever sell these positions. However, I will say that buy-and-hope is dead. Buying on valuation alone in a slowing growth environment is rarely a catalyst and hope is not an investment process.

 

Managing risk in an interconnected global ecosystem of colliding macro factors is a repeatable risk management process that we can all apply. If we are accountable to our investors in focusing “first on risk”, that is…

 

Every day the score is re-calibrated. I’m pretty sure that the triumvirate of Google, Wikipedia, and YouTube will be holding us all accountable to how we managed risk on both the downturns of 2008 and 2010. History will decide whether Hedgeye was useful to your investment process long after I am dead.

 

We’ve been bearish on US Equities and now we are accountable to our clients in recommending where they book gains in these bearish positions. Making calls on US GDP or housing slowing is only one part of the risk management process. The most critical part of the investment process is getting the timing right.

 

We had the timing right on the way down. The question now is can we get the timing right on the way out? Here’s how I thought this through yesterday as I was covering 5 of the 14 short positions in the Hedgeye Virtual Portfolio (SPY, XLI, HOT, IWM and XLY):

  1. Math: Immediate term TRADE support (our most immediate term risk management duration – 3 weeks or less) in my macro model for all of the aforementioned short positions was 2.5 standard deviations oversold. This is not to say that 3 and 4 standard deviation moves couldn’t occur this morning, but looking at the macro calendar of events today, I made a conscious decision to bet against those low probability events.
  2. Risk/Reward: For the sake of this illustration I’ll use the SP500 (SPY) short position – moving to a 3 standard deviation level of downside support I was coming up with 1040 (the 2.5 standard deviation level = 1053), and in terms of immediate term TRADE upside I was registering 1077 on a 2 standard deviation move. Net net, I saw 2.5:1 upside versus downside in getting longer and I thought that was worth taking.
  3. Volatility: The inverse relationship between the VIX and the SP500 continues to be a heavily weighted risk management signal in our 27-factor baseline model. It hasn’t always been – it just is now because the inverse correlation between the two remain very high on an intermediate term basis. At the same time as I’d call the SP500 immediate term oversold anywhere south of 1053, I was registering the VIX immediate term overbought anywhere north of 27.57. Since the VIX closed at 27.46, that was close enough for me to stick with my cover/buy signal.

Now all this starts and ends with risk management. I wasn’t trying to decide whether or not we should drop our net long exposure from 140% to 107% yesterday. I was risk managing how to A) get out of 1/3 of my short positions and B) get into some long exposure to US Equities. There is no rule saying I can’t re-short any of these positions at anytime today. This doesn’t make me bullish either.

 

Again, it’s a lot easier to think this through from a position of strength. I’m certainly not always in a position of strength either. Yesterday I was, and my risk management task was to focus on risk first. Don’t get squeezed on the short side and focus on investing cash when markets are oversold.

 

I realize that this is unconventional. I realize that sometimes it’s hard to read about my team’s wins. I am very aware of the confidence interval I have in this team’s risk management process, and I can assure you that the hardest part about all of this is how hard I am on both my team and myself. Showing you what we do, when, and why isn’t easy. Neither is modern day risk management.

 

As of last night’s close, our Hedgeye Asset Allocation portfolio had the following positions and weightings:

  1. Cash 55%
  2. International FX 21% (Chinese Yuan (CYB) = 15%, British Pound (FXB) = 6%)
  3. Commodities 9% (DJUBS Commodity Index (DJP) = 6%, Gold (GLD) = 3%)
  4. Bonds 6% (all TIP)
  5. US Equities 6% (Utilities (XLU) = 3%, US Pharma (IHE) = 3%)
  6. International Equities 3% (Brazil (EWZ) = 3%)

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Focus On Risk - risk


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THE M3: GALAXY MACAU STILL ON SCHEDULE

The Macau Metro Monitor, August 25th 2010


GALAXY MACAU 'AFFECTED' BY LABOR SHORTAGE Macau Daily Times

 

Galaxy's vice chairman, Frances Lui, said the 1:1 imported labor rule and the illegal workers cases have "slightly affected" construction for Galaxy Macau, pushing the project behind schedule. However, he reiterated the Galaxy Macau's opening for "early next year."  Lui also said Macau GGR will rise 50% this year.


THE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - August 25, 2010

As we look at today’s set up for the S&P 500, the range is 37 points or 1.13% (1,040) downside and 2.39% (1,077) upside.  Equity futures are trading modestly above fair value following Tuesday's sharp sell-off; the positive tone is being set by a steadier open in Europe.

Today's macro highlight will be July Durable Goods and July New Home Sales.

  • PERFORMANCE ONE DAY: Dow (1.31%), S&P (1.45%), Nasdaq (1.66%), Russell 2000 (1.17%)
  • PERFORMANCE MONTH-TO-DATE: Dow (4.07%), S&P (4.51%), Nasdaq (5.81%), Russell (8.50%)
  • PERFORMANCE QUARTER-TO-DATE: Dow +2.73%, S&P +2.05%, Nasdaq +0.69%, Russell (2.28)%
  • PERFORMANCE YEAR-TO-DATE: Dow (3.72%), S&P (5.67%), Nasdaq (5.12%), Russell (4.77%)
  • ADVANCE/DECLINE LINE: -1571 (-785) - continues erosion yesterday
  • VOLUME: NYSE - 1175 (+35%) - volume accelerated as stocks moved lower
  • SECTOR PERFORMANCE: XLU only sector positive and up the last three days; XLB breaks TREND
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: Southern Co +1.51%, Lennar +1.42% and Ameren +1.37%.  Medtronic -10.80%, Stryker -6.37% and Sandisk -6.04%

EQUITY SENTIMENT:

  • VIX - 27.46 +7.01%          
  • SPX PUT/CALL RATIO - 0.87 down from 1.78 (matching the 7/15 low)  

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD - 17.16 0.913 (5.621%)
  •  3-MONTH T-BILL YIELD .16% unchanged
  • YIELD CURVE - 2.00 from 2.11

COMMODITY/GROWTH EXPECTATION:

  • CRB: 262.46 -1.34% down 7 of the last 8 days
  • Oil: 71.63 -2.01%
  • COPPER: 326.20 -1.52% - biggest down day in a week
  • GOLD: 1,230 +0.34%

CURRENCIES:

  • EURO: 1.26728 +0.03%
  • DOLLAR: 83.146 +0.03%

 OVERSEAS MARKETS:

  • ASIA - Most markets closed lower. China closed down 2% following the move in the USA.  A pre-open report that the Bank of Japan is considering taking additional monetary easing steps before its scheduled policy meeting in early Sep provided a little support for Japanese markets but failed to counteract the effects of the strong yen. Yoshihiko Noda, Japan's finance minister, said he was considering “appropriate action” on what he described as “one-sided” moves in the yen
  • EUROPE - Most markets are flat to slightly higher; Ireland up 0.85% following S&P's downgrade of Ireland's sovereign rating to 'AA-' from 'AA'.  Germany's business confidence indicator has offered some support along with some solid corporate earnings. Construction sector outperforming, with oil & gas lagging.
  • LATIN AMERICA - Argentina and Mexico are down 3.1% and 2.4%, respectively.  Yesterday, in Mexico retail sales rose 1.5% in June from the same month a year earlier, the statistics agency said yesterday, below the median forecast in a Bloomberg survey for a 4.3% increase.
Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends

 

THE DAILY OUTLOOK - S P

 

THE DAILY OUTLOOK - VIX

 

THE DAILY OUTLOOK - DOLLAR

 

THE DAILY OUTLOOK - OIL

 

THE DAILY OUTLOOK - GOLD

 

THE DAILY OUTLOOK - COPPER


EARLY LOOK: Red Letter Day

This note was originally published at 8am this morning. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK in real-time, published by 8am every trading day.

 

 

_____________________________________________________

“You can sneer or disappear behind a veneer of self-control.”
-Pet Shop Boys

 

 

EARLY LOOK: Red Letter Day - Red Letter Day

 

 
We have our British electronic dance music playing this morning in New Haven as the bulls are forced to sneer at the tail that’s been wagging this US growth dog since US Housing saw its cycle peak in April. As one of our three Hedgeye Macro Themes for Q3, we’ve called this Housing Headwinds.
 
The aforementioned quote comes from the Pet Shop Boys 1996 top ten hit, “A Red Letter Day.” What an appropriate quote and song name for a day like today where expectations for a bomb of an Existing US Home Sales report are finally being baked into this bear’s cake.
 
This day in 410 (AD) was also a Red Letter Day for the Roman Republic. Historians refer to this day as “The Sack of Rome” when the enemy (the Visigoths) took over the city for the first time in 800 years. This was a bad day for the professional politicians of Rome.
 
The US stock market has had a bad day for the last 3 days in a row. While our 2011 estimate for US GDP growth is still approximately half of the Bloomberg consensus, the Street is finally taking down its expectations for Q3 and Q4 of 2010. In recent weeks we’ve seen both Goldman Sachs and JP Morgan cut their estimates. There will be more of that to come.
 
Combined, with the prospective outlook for US unemployment, housing, and GDP growth finally getting a reality check, it will be interesting to wait and watch today as the SP500 finally takes a good hard look at our immediate term TRADE line of 1059 support.
 
Last week we penned this Red Letter Day on the calendar with both The Catalyst and The Line. While we do not think that the Fiat Republic will fall today, we do think that members of the risk management community will most certainly get paid on the short side.
 
To be crystal clear on this, today is not the day to be shorting stocks. Today is a day to book your gains and increase both your gross and net exposure. If you don’t run an asset management firm and you’ve gone self-directed, in Hedgeye Risk Management speak that means today is a day to invest some of the 61% we have allocated to Cash in the Hedgeye Asset Allocation model.
 
In terms of asset allocation, there’s an emerging and healthy debate about what percentage of your assets you should have in US “bonds versus equities.” This, of course, is born out of the last bubble that remains in global markets today – that which the Fiat Republic perpetuates by marking short term Fed Funds rates to model rather than letting the world mark them to market.
 
There will undoubtedly be a Red Letter Day for US Treasury bonds, we just don’t know when that will be yet. However, what we are comfortable saying right here and now is that it’s relatively safe to start shorting short term US Treasuries. The long end of the US Treasury market is not where we’d be focusing short positions. The 10-year yield could easily drop another 40-45 basis points from here and retest its prior lows.
 
On the short end of the curve, this morning you are seeing record lows in 2-year UST yields. At 0.46%, this may not be the lowest level of confidence global investors have had in US growth in 800 years, but the lowest US Treasury yields ever is still, by our calculations, a very long time.
 
So why is this so? Isn’t this ok? Yesterday while I was debating him on this topic on Bloomberg TV, Dean Baker of the Center for Economic Policy Research said it’s perfectly fine for America to keep on borrowing. He went on to say that “the bond market doesn’t have a problem with it.”
 
Admittedly, I think I was too surprised to absorb his summary conclusion on the spot. But after a good night’s sleep and some googling this morning, I am reminded of the partisan nature of Mr. Baker’s view point. After all, he does work at the center of modern day Rome in Washington, DC.
 
Rather than have barbarians hold professional politicians in the Roman Republic accountable, modern day risk managers have YouTube. For more Dean Baker and Paul Krugman thoughts on why we need to jack up government spending by another $800 BILLION dollars, please peruse the web.
 
Back to the question of whether you should buy US Treasury Bonds or US Equities - I don’t think you need to accept the preface of the question. Why not Brazilian or Chinese or Peruvian Equities? Why US Treasury Bonds? Why not cash?
 
Since 1997 when Paul Krugman told the Japanese to “PRINT LOTS OF MONEY”, you can pull up a chart of Japanese Government Bonds versus Japanese Equities and you’ll start to answer some of these questions on “bonds versus equities.” Foreign direct investment has been leaving Japan altogether for a very long time and Japanese bureaucrats are still trying to do more of what hasn’t worked.
 
On this Red Letter Day of August 24th, 2010, Japan will sell another 1.1 TRILLION Yen (that’s a lot of yens) in 20-year debt in order to attempt to boost expectations for another broken promise of “stimulus spending” still being the answer to their structural economic growth mess.
 
After losing another -1.3% overnight, Japanese equities have crashed, again, losing -21% of their already “cheap versus bonds” valuation since April the 5th.  Japan’s bond market “may not see a problem with monster debt levels” yet Mr. Baker, but her stock market sure does!
 
Best of luck out there today,
KM


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