Channeling Hammy

“Those who stand for nothing fall for anything.”

-Alexander Hamilton


Keith is out this morning teaching a Risk Management class to MBA students at New York University’s Stern School, so I’ve been handed the quill on the Early Look.  I was fortunate to enjoy a week off last week, which afforded me some time to clear my head and do a little pleasure reading.  The first book I knocked off the list was Ron Chernow 856 page tomb, “Alexander Hamilton: A Biography”.


The story of Alexander Hamilton’s, or Hammy as his close friends affectionately called him, rapid rise from a dysfunctional family in the West Indies to becoming a confidant of General Washington during the Revolutionary War, to publishing the Federalist Papers, to finally becoming the first Secretary of the Treasury, is as rapid an ascension to influence that will likely ever be recorded in the annals of American history.


Hammy certainly had his faults, as we all do, but he was a learning machine that devoured books.  He also had a strong sense for right and wrong.  That is, he knew what he stood for.  In fact, he was so convicted in some of his beliefs that he ultimately died prematurely in a dual defending his honor against Aaron Burr.


Anyone that reads the missives coming out of the Hedgeye Research Juggernaut certainly understands very quickly that we know where we stand on our processes and our investment positions.   The goal in the investment business, though, is to be right, not obstinate.  The equivalent in our business of losing a dual is bad performance and client loss, so having conviction is fine if you are alive to trade another day.


While we have strong opinions, we aren't wedded to them and I think our track record speaks for itself on this intellectual flexibility. Since inception we've recommended 978 stock and ETF positions, 499 longs and 479 shorts, and have been right 85.6% on the longs and 83.9% on the shorts. But, I digress. Back to Hammy.


As Secretary of Treasury, Alexander Hamilton’s first objective was to pay back the heavy debt incurred to win the Revolutionary War.  As Hammy said, “The debt of the United States . . . was the price of liberty.” So, while this debt had its purpose, Hamilton also quickly realized that paying the debt back was critical in establishing confidence among other nations in the economic future of the United States.  This confidence would lead to support of the new American currency and a willingness of other nations to become trading partners.


We have been quite vociferous as to our thoughts on some important metrics relating to the national debt of a nation, specifically debt as percentage of GDP and deficit as a percentage of GDP. Another metric we would like to introduce today is debt as percentage of revenue. On a go-forward basis we will call this the National Coverage Ratio. That is, what is the ability, based on revenues generated, of a nation to both pay down its debt and cover its interest and principal payments, or cover these financial commitments.


In the chart below, we've highlighted the National Coverage Ratio for some relevant global economies.  While the United States screens negatively on the other debt ratios, especially on a projected basis, on this ratio it is actually an extreme outlier to the negative.  This tells a few things about the economic future of the United States from a policy perspective.  First, given current debt balances and revenue projections of the United States, it will be very difficult for the nation to support higher interest rates.  Second, and while we don't necessarily support this from an economic growth perspective, it seems likely that government revenues, i.e. taxes, will have to go higher. Neither of these points are very encouraging.


There is of course another option, an aggressive cut in future entitlements.  This is  perhaps what former Senator Alan Simpson, who is the co-chair of President Obama's Bi-partisan Debt Commission, meant when he described Social Security as a "milk cow with 310 million tits!" in an email.  Indeed.


As it relates to the shorter term though, over the past couple of days we have been covering our shorts and adding long exposure to the Hedgeye Virtual Portfolio.  This is not because we have become overly bullish on equities, but rather the market has sold off dramatically over the past seven weeks and our key economic catalyst is now behind us, which was the abysmal housing numbers of the past couple days.


While we aren't wedded to our bearish views, both the fundamentals and quantitative set up continue to support this stance. So, perhaps the best way to think of it is that we've gone from being Growling Loud Equity Bears to Cuddly Bears.  As a result, we currently have 14 longs and 8 shorts in the virtual portfolio, which is great positioning for a Cuddly Bear.


If you are looking for an equity Bull to support your investment positioning through year end, look no further than Lazlo Birinyi.  This morning he is out with the call that the S&P500 will rally 16% into year-end to the level of 1,225.  Interestingly, that is below his March target of 1,325. Since this morning we are being Cuddly Bears, we aren't going to challenge Lazlo to a Hamiltonian Macro Economic Dual. Albeit we do question any process that produces a round target for an equity index through an arbitrary time frame, but perhaps that is just us.


As we look forward though, we are not sure how cuddly we will remain.  The combination of initial jobless claims this morning at 830 a.m., Chairman Bernanke speaking at Jackson Hole tomorrow, and the second release of GDP for Q2 tomorrow will all combine to set the stage heading into September.  While we are not convinced these events will have a negative impact on the market in the short term, they will provide incremental data to inform our view through year-end.


And who knows, if the data is bad enough, perhaps we will drop our SP500 target by EXACTLY 100 points, just like Lazlo.   That is unlikely, however, given our macro models don't have a factor which incorporates licking your finger and holding it up to see which way the wind is blowing.


In the chart of the day, we have inserted a cute picture that shows President Obama inadvertently giving Treasury Secretary Timmy Geithner the middle finger.  This is not what President Obama really thinks of Timmy, but the President would probably like to Channel Hammy.


Yours in risk management,


Daryl G. Jones


Channeling Hammy - hamm2


The Macau Metro Monitor, August 26th 2010


Galaxy said 7,700 workers will be recruited for the new opening of Galaxy Macau next year.  Recruitment will mainly be in gaming, F&B and hospitality sector.


According to China News Service, Zhang Ping, head of NDRC, said the nation will further implement property measures to control the real estate market and curb speculation. Zhang also believes home supply will continue to rise and that some real estate prices are still too high.


Although RT’s momentum may continue into fiscal 1Q11, the balance of the year looks less promising.


Fiscal 2010 (ending May) was a transformational year for RT.  The company was able to maintain its top-line momentum from late fiscal 2009 with same-store sales declining only 1.3% for the full year versus -7.9% in FY09.  Comp trends improved sequentially each quarter of the year on both a one-year and two-year average basis and turned positive in 4Q10 for the first time in 15 quarters.  Despite the company’s promotional tactics, restaurant-level margin increased slightly for the year while operating margin improved about 130 bps to 6.5% (before reported closure and impairment charges).  Earnings grew about 30% (again before the closure and impairment charges) after declining for three consecutive years.  Free cash flow was up 44% and the company paid down $204 million in debt, leaving the company with a much healthier balance sheet at the end of fiscal 2010.


Given these sharply improved results, RT’s stock price has climbed 53% since the end of the company’s fiscal 2009.  And, investor sentiment has shifted with short interest declining to just under 8% currently, from 10% in May 2009 (end of RT’s fiscal 2009) and as high as 13.5% in February 2010.  Sell-side love for the name has also grown with about 50% of analysts now recommending the stock as a buy relative to only 10% at the end of the company’s FY09.






Although RT seems to be doing a lot of the right things to increase the number of people in its restaurants, I don’t think the company will be able to maintain this momentum in fiscal 2011.  Given the current economic backdrop, I am expecting sales trends to slow across the industry.  To that end, RT’s full-year same-store sales guidance of flat-to-plus 2%, which implies a fairly steady improvement in two-year average trends throughout the year, seems unrealistic.  For now, I am modeling a 0.5% decline in same-store sales for the full year, which still implies some improvement in two-year average trends so it could prove aggressive.  On an earnings basis, I am at $0.78 per share for FY11, lower than the street’s $0.84 per share estimate and at the lower end of management’s full-year EPS guidance of $0.76 to $0.86.


Getting the timing right on this name will be important, however, because despite my bearish view on RT for fiscal 2011, the first quarter could potentially show further improvement.  This is how we view the set up for RT next quarter, based on my numbers right now:

  1. Same-store sales could improve again on one-year and two-year average year basis in 1Q11 (I am modeling +0.5%).
  2. Restaurant-level margin and operating margin could once again be up YOY (so potentially in Hedgeye Nirvana for the second consecutive quarter in 1Q11, as shown below).
  3. However, I have them missing on an EPS basis…I am at $0.14 per share versus the street at $0.16 per share.


For reference, RT held its fiscal 4Q10 earnings call on July 22 and the company’s fiscal 1Q11 ends in August so management had relatively good visibility on quarterly trends and they sounded quite bullish, which is why I would not be surprised to see the company post another quarter of positive same-store sales growth.


From there, I see momentum slowing for RT.  It will get increasingly difficult for RT to continue to achieve stronger comps on a one-year basis and my full-year same-store estimate of -0.5% implies negative comps for the remainder of the year.  I would also expect restaurant-level margin to come under pressure after the first quarter and decline for the balance of the year as the company laps its improvements from the prior year and food costs as a percentage of sales likely move higher in the back half of the year.   I am modeling a nearly 80 bp decline in full-year restaurant-level margin relative to management’s guidance of a slight decline YOY.  Based on my assumptions, which include negative same-store sales and declining YOY restaurant-level margin after the first quarter, RT could be headed for the Hedgeye Deep Hole as early as its fiscal second quarter of 2011.





Howard Penney

Managing Director

Early Look

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Bear Market Macro: SP500 Levels, Refreshed...

Position: longer, for now.


Maybe now I’ll pretend I am bullish, beg for QE3, and then sell into it.


In all seriousness, the last 48 hours have definitely tested the this market’s immediate term TRADE pain thresholds. I outlined these levels in this morning’s Early Look, but they are worth revisiting - anything sub 1053 would be 2.5 standard deviations oversold on our most immediate term risk management duration (TRADE, which is 3-weeks or less) and 1040 would be a 3 standard deviation event, which rarely occurs.


Fundamentally, we are chaos theorists. Therefore today’s intraday low of 1041 being a point away from the line we’d consider max-immediate-term-pain isn’t entirely surprising. We’ll call today’s action proactively predictable.


My immediate term support and resistance lines for the SP500 are now 1046 and 1074, respectively. Manage risk with a bearish bias around that range.



Keith R. McCullough
Chief Executive Officer


Bear Market Macro: SP500 Levels, Refreshed...  - 1

Japan - The World's Easiest Layup

Conclusion: The Japanese government is under pressure to artificially weaken the yen. Regardless of any potential action that may be taken, it is not likely going to be enough to prevent growth from slowing on the island economy.


Position: Short the Japanese yen (FXY).


Japan’s exports slowed sequentially for the fifth consecutive month in July, furthering concerns that the Japanese central bank will intervene in the currency market to stem the yen’s recent rise to a 15-year high against the dollar and a nine year high vs. the Euro. Exports came in at +23.5% Y/Y vs. a 27.7% increase in June and the data looks to continue to weaken from here in the face of the yen’s 12% advance vs. the U.S. dollar since its April 5th cycle low.


Japan - The World's Easiest Layup - 1


Japan - The World's Easiest Layup - 2


Of course this is absent any intervention by the Bank of Japan in the currency market, a tool that has not been used by Japanese policy makers since March of 2004 when they sold 14.8 trillion yen in 1Q10 after record sales of 20.4 trillion yen in 2003. The gloomy backdrop for global growth and waning final demand from Western consumers suggest 3Q10 to be potentially as ominous from a decision-making standpoint and both the Japanese and American bond markets have been signaling slowing growth for months.


Japan - The World's Easiest Layup - 3


Just today, Japan sold 4.8 trillion ($57 billion) of three month treasury bills at the lowest yield (0.1123) since the Bank of Japan ended its QE policy over four years ago (April 26, 2006), which indicates investors are likely speculating that Japan will ease its monetary policy to stem the recent gains in the yen. Japanese Finance Minster Yoshihiko's recent change in tone supports such speculation, saying today, “We have to take appropriate action when necessary, though I plan to continue to watch currency movements very closely with great interest.”


This statement follows similar commentary out of Japan’s Trade Minister Masayuki Naoshima, who said Friday, “The yen is too strong against the dollar and should weaken about 6% to help the country’s exporters.” Officially, the government has not yet outlined a response to the yen’s surge, though last week Prime Minister Naoto Kan ordered his ministers to submit plans for additional economic stimulus (how shocking). The Nikkei Newspaper reported today that the Bank of Japan’s funding program which provides funds to lenders at 0.1% may be expanded to 30 trillion yen ($356 billion) from 20 trillion and the duration of loans may be increased to six months from the current three. To date, Kan has been tight lipped on government intervention in the currency market, though that could change by the next Bank of Japan meeting, which is scheduled for September 6-7.


All told, we continue to be bearish on Japan’s economic health for the long term as a result of unfavorable demographics (ageing population), burgeoning sovereign debt (way past the Rubicon of 90% Debt/GDP), and trade exposure to a deleveraging, jobless U.S. consumer (~16.5% of exports). Regarding that exposure, Toyota, the world’s largest carmaker, has said every one-yen gain against the U.S. dollar reduces their annual operating profit by 30 billion yen. Sony, which generates over 70% of its sales outside of Japan, echoes similar sentiment, claiming it loses about 2 billion yen of annual operating profit for each one-yen gain vs. the dollar.


Japan - The World's Easiest Layup - 4


Company commentary like this is particularly valuable as it relates to timing central bank action. According to the central bank’s Tankan survey released July 1st, Japan’s large manufacturers expect the yen to average 90.16 per U.S. dollar in the fiscal year ending March 2011. Currently, the average is slightly stronger for the fiscal year-to-date, averaging 90.06 per USD. With the negative barrage of economic data we are likely to receive from the U.S. and W. Europe in the next 6-9 months, the yen will have further upward pressure as investors flock to “safety” globally (we disagree that holding a bag full of yen is safe, but that is the subject of another debate).


It appears that Japanese policy makers will be under increasing pressure to artificially weaken the yen or risk economic stagnation and rising unemployment from declining export competitiveness in the face of what is already slowing consumer demand from western economies. Regardless of any potential action that may be taken by Japan’s central bank, it is not likely going to be enough to prevent growth from slowing on the island economy. The Japanese equity market agrees with our assessment on both a short term and longer term duration, down 22% from its YTD peak on April 5th  and down 77% since its January 1990 peak. Ironically, April 5th is the same day the yen put in its YTD low vs. the U.S. dollar. In the end, the deep simplicity that is Chaos Theory always wins in the land of Macro investing.


Simple is as simple does, at least according to Ichiro Ozawa (the former No. 2 official in the ruling Democratic Party of Japan) when referring to his American counterparts. For the sake of U.S. equities, let’s hope the Fed keeps it simple and avoids getting too cute with stimulus going forward, or else stocks in the U.S. will continue to be “cheap vs. bonds” for the foreseeable future.


Hope, however, is not an investment process.


Darius Dale


MACRO: Where are the housing bulls now?

This post was available to RISK MANAGER SUBSCRIBERS in real-time.



Conclusion: New homes sales in July were the lowest ever reported (excluding May’s downward revision).  Our street low 1.7% GDP estimate for 2011 is officially under review by the Hedgeye Research Committee, and will be going lower. Call us dogmatic if you will, but it looks like we nailed our Housing Headwinds Q3 theme call.

It’s no secret, Hedgeye has been very bearish on housing.  Our Financials Sector Head Josh Steiner presented his seminal work on this topic in a 101 page presentation about two months ago (if do not have that presentation and are not yet subscribing to our Financials vertical please email  The presentation boiled down to one key point: home prices have anywhere between 15 – 50% more to fall nationally based on the supply and demand dynamics we see in our mathematical models.
New home sales reflect contact signings and deposits, which is more real-time than yesterday’s Existing Home Sales release (which reflect activity from 1-2 months prior).  The chart below shows New Home sales fell off a cliff in May, which are post tax-credit.  The July number reported today is not positive.  More aptly, it is a disaster.  (And this low-key Canadian isn’t prone to hyperbole.)
Specifically, purchases fell 12 percent from June to an annual pace of 276,000, the weakest initial release prior to revision since data began in 1963.  As it relates to price, the median price of $204,000 was the lowest since late 2003 and down 4.8% year-over-year.  We’ve outlined new home sales data going back 18 months in the chart below.  Not surprisingly, consensus estimates were off large with the range being 291,000 to 355,000.




MACRO: Where are the housing bulls now? - Screen shot 2010 08 25 at 1.41.50 PM



We obviously have had many debates on the housing topic with the bulls. The key push back we get is in regards to the longer term tail of demand and reversion to the mean of housing.  That is, over time household formation will, sooner rather than later, drive the market back into balance.  That, of course, assumes that household formation is positive.  Fortunately our proprietary census research shows just the opposite. The following chart shows household formation data. It shows new household formation rates through June 2010. The first half of this year saw negative household formation rates in the US, which is unprecedented.



MACRO: Where are the housing bulls now? - Screen shot 2010 08 25 at 2.01.42 PM



To conclude, and to quote our Financials Team from earlier today:
“New home sales came in at just 276K, near their record low.  This anemic level is consistent with our cumulative displacement theory, published on 7/13/10 and republished below.  To summarize, there was an epidemic of overbuilding during the bubble, which will take a very long time to work off.  Using a sales rate of 300K, we calculate that sales would have to continue at this level for ten years for the cumulative displacement from the mean to return to zero.  Yes, new home inventory is very low, but we don't see sales rebounding anytime soon.”  
The question now is of course: where are the housing bulls?  We hope renting.
Daryl G. Jones
Managing Director

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