The chart was extracted from a note dubbed "HOPE FADING BUT ON ITS HOLD UNTIL DECEMBER" issued to Risk Manager Subscribers earlier today, September 8, 2010.




The chart below details where the unemployment rate would be if the labor force participation rate was at its ten-year average level of 66.1%; for the year-to-date, it has been averaging 64.8%.  This implies that many folks are losing heart and dropping out of the job hunt.



CHART: HOPE FADING... - chart1


Easy comparisons and a beneficial cost environment should translate into strong fiscal 1Q11 results.


Darden is scheduled to report its fiscal 1Q11 earnings after the market close on September 21st.  The company is lapping extremely easy blended same-store sales comparisons in the first half of the year of -5.3% and -4.7% in 1Q10 and 2Q10, respectively.  Of the three larger concepts, the comparisons are particularly easy at Red Lobster as comps declined 7.9% and 8.4% in 1Q10 and 2Q10, respectively. 


These easier comparisons should allow Darden to report positive comps during 1Q11 even if trends slow slightly on a two-year average basis.  That being said, given the current macroeconomic backdrop, I continue to think the company’s full-year same-store sales guidance of +2% to +3% could prove aggressive.  Lower food costs in 1H11, lower YOY labor costs as a percentage of sales, expected incremental cost savings initiatives of $10 to $15 million and accelerated share repurchase during fiscal 2011 leave me less concerned about the company’s ability to achieve its 14% to 17% EPS growth target.


For reference, casual dining same-store sales trends on a two-year average basis, as measured by Malcolm Knapp, slowed about 50 bps through the first two months of Darden’s fiscal 1Q11 (June and July) from the prior quarter.  Darden’s reported results will provide the first real glimpse of casual dining trends in August and insight into whether or not the industry was able to sustain the sequentially better results from July on a two-year average basis after posting declines for the prior three months.


Increased leverage from positive same-store sales growth, combined with the expected beneficial cost environment, should lift margins during the first quarter and for the entire first half of the year.  The company guided to continued food costs favorability during fiscal 1H11 but expects costs to level out during the second half of the year.  To that end, management has good visibility on its food costs through the first half of the year as it has contracted most of its commodity needs through December.


Also helping YOY margin growth during fiscal 2011 is the fact that the company is lapping significantly higher labor expenses as a percentage of sales from fiscal 2010, largely in the first half of the year.  Management attributed these higher labor costs in fiscal 2010 to sales deleveraging, increased benefit costs, wage rate inflation and higher manager bonuses.  For fiscal 2011, the company guided to lower labor costs as a percentage of sales and I would expect the biggest YOY benefit to come during 1H11.


Darden’s cash flow story remains intact.  The company recently increased its quarterly dividend 28% to $0.32 per share and expects to repurchase about $300 to $350 million of shares during FY11, up from $85 million in FY10. 


Howard Penney

Managing Director



With the current administration playing defense ahead of midterms in November, a positive bias to the jobs picture is all but assured as we head into the elections.  To be clear, the fudging of government data happens whatever party is in the ascendency, but politics will play a particularly significant role in government-reported statistics over the next few months.  This is the reality for GDP, inflation, and jobs.


This point has been made by various sources over the past few days but I think it speaks further to the theme of opacity, if not outright bias, in government numbers that we have been highlighting ad nauseum.  


There are two ways (maybe more) the government can manipulate the jobs data to make things look better than they appear.  The first way was highlighted in a post entitled, “FRIDAY MACRO MIXER: THE PAYROLL FUDGE FACTOR”, I discussed the implications of the Birth/Death model on the credibility (or lack thereof) of the payroll data.  As I wrote on Friday, the last benchmark revision released by the BLS indicated that the Birth/Death model numbers were grossly understating job losses and, as such, is not reliable. 


The second way the BLS distorts the numbers is through the headline unemployment rate, which is being deflated by changes in the Labor Force Participation Rate. 


Since BLS unemployment data begins, 1948, the proportion of the civilian population working or seeking work has generally been growing.  This is largely as a result of women entering the workplace and long-term growth in the U.S. economy through the 20th century.  The 1950’s saw year over year increases in the labor force participation rate of 210 bps – more than three standard deviations from the mean of all available data (January 1948 to present).  Recently, there has been a period of precipitous decline in labor force participation rate, peaking at a year-over-year decline of 120 bps – two standard deviations from the mean – which is important to note. 


The chart below details where the unemployment rate would be if the labor force participation rate was at its ten-year average level of 66.1%; for the year-to-date, it has been averaging 64.8%.  This implies that many folks are losing heart and dropping out of the job hunt.




An early indication the surprisingly positive labor market report from last week will not continue.  The ISM purchasing managers nonmanufacturing (services) survey for August showed a plunge in its employment component.  As seen in the chart below.




With the November elections right around the corner, the “spin” from both parties will reach fever pitch.  With respect to government data, we expect the numbers to remain close to consensus ahead of midterms.



Howard Penney

Managing Director

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The Greek Canary in the European Coal Mine

Conclusion:  Sovereign debt issues in Europe have not gone away.  In fact, Greek CDS are approaching the highs of June, which we believe are a leading indicator for more issues to emerge on the debt front from Europe.


Just when we thought things were settling down in Europe, credit default swaps in at-default-risk nations continue to increase.  In the chart below, we’ve highlighted Greek 5-year CDS.  While we are not quite at the parabolic highs of late June, when insurance for 5-year Greek bonds reached almost 1,150 basis points, we are well off the lows of May.  In fact, CDS are up almost 50% from their lows this summer.  Interestingly, the lows were put in literally the day the EU bank test results were released. 


The Greek Canary in the European Coal Mine - 1


Back in March 2010 in our theme presentation entitled, “Where Does the Sovereign Debt Cycle End?”, we highlighted a few points related to Greece. Specifically, 

  • Greece is typically a leading indicator for defaults in Europe;
  • Debt in Europe is very interconnected, so one nation defaulting could have an impact on the balance sheet of many banks in other nations that hold that debt (we’ve posted a graphic highlighting this at the bottom of the note); and
  • The unreliability of Greek numbers as noted by the fact that in late fall of 2009 they reported their budget deficit was 3.7 percent of GDP and two weeks later that number was revised upward to 12.5 percent. 

The point is, Greek could be worse than we know and there will be a domino effect if Greece unravels.


To the lack of understanding the numbers point, the Wall Street Journal wrote an article yesterday criticizing the efficacy of the recent stress tests. The key point from the article was that the stress tests potentially understated the debt levels of many banks.  To highlight this point, we’ve posted a chart from this article directly below. If the analysis is in the ball park of reality, the stress tests missed the mark by a staggering margin. 


The Greek Canary in the European Coal Mine - 2 


Not surprisingly, the Council for European Banking Supervisors released a statement attempting to rebuke this criticism. The key points from the statement, which defended the tests, are highlighted below: 

  • The “gross exposures” disclosed were on-balance sheet exposures net of impairments but gross of collateral and hedging. 
  • CEBS notes that comparison with other sources should be treated with caution as a result of different reporting dates and reporting methodologies. For instance, data provided by the Bank for International Settlements (BIS), is aggregated in a way which makes comparison with the data disclosed by banks during the CEBS exercise impossible. 

Maybe it’s just me, but with a defense as non-transparent as that, it is really no surprise that the market is once again losing confidence in the at-risk European sovereigns.


Chirp, chirp says the Greek Canary.


Daryl G. Jones

Managing Director


The Web of European Debt


The Greek Canary in the European Coal Mine - 3

EARLY LOOK: Someone Gets to be Canadian

This note was originally published at 8am this morning, September 8, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.




“Somebody gets to be smart and somebody gets to be dumb. If we win, it'll be because of the President. And if we lose, it'll be because of me.”
-Karl Rove



Yesterday afternoon at our offices in New Haven, CT, Daryl Jones and I hosted former White House Deputy Chief of Staff and Senior Advisor to President George W. Bush, Karl Rove, for a political strategy conference call.
For the record, before you call me a raging Republican, remember that I am neither a Democrat nor a Republican. I am Canadian (with a green card and an American son who has much better chances of wearing his country’s Olympic hockey jersey on this side of the border!).
I, like most immigrant small business owners in this country, fundamentally believe in doing the best I can to provide for both my American family and American employees. This includes analyzing and understanding US political policy as it is going to affect markets and my firm’s future.
If I couldn’t stand Karl Rove’s politics, I’d still have invited him to our offices to meet with us. How else would a Risk Manager of both global market strategy and local payroll-punching get to the right answers?
It turns out that Rove was perfectly analytical and proactively prepared with plenty of math. The data, after all, doesn’t lie as much as some of America’s current politicians do. That said, the data can still change before the mid-term elections in November.
Daryl Jones will publish a more in depth research note later on today that covers some very interesting intermediate to long term US political strategy topics that we dug into with Mr. Rove in our Q&A session (the changing US electorate, small business healthcare spending, taxes, etc.).
For now, I’ll spare you having to watch the DVR version of this weekend’s Meet The Press where CNBC’s money-honey-mini, Erin Burnett, espoused her unqualified US political strategy thoughts about how the economy has seen the “stimulus really work” and give you some proactive political predictions that you can hold Karl Rove to:
1.      The Republicans will win the House by a wider than expected margin.

2.      The Democrats will cede at least 8 seats to the Republicans in the Senate.

3.      The anti-incumbent vote in America will be pervasive theme.

“Anti-incumbent” means anti any professional politician in Washington who sold you a bill of dry heaves in the most recent election, or as Mr. Rove called them, incumbent politicians with a “D” after their name who are perceived to be easiest to blame. Shock-and-awe, eh? A Republican strategist concluding that the Democrats are going to get rolled over in the mid-terms!
Well, take it from one Canadian with an American family looking to be on the right side of this immediate term TRADE rather than get stuck in the partisanship of being wrong and blaming someone else’s politics for it – I think Rove’s got this one right.
If you’d like the slide deck that backs Rove’s analysis and the replay of the conference call, please email <> . I’ll be happy to print the most analytical rebuttal to Mr. Rove’s conclusions, provided that you let me print your name on the analysis like he did with his. This is the only way I know to strap on the accountability pants folks. I’d much rather be proven wrong here than remain wrong…
Whether we like politics or not, we all have to play the risk management game that’s in front of us. To spend or not to spend more taxpayer moneys on “stimulating” the economy, remains the question.
The SP500 was down -1.2% yesterday to 1091, taking its cumulative decline since its YTD high on April 23rd to -10.4%, and its YTD loss for 2010 to -2.2%. Was yesterday’s weakness related to an expectation mismatch associated with an alleged “better than expected” employment report on Friday? Or was it based on another partisan “spending plan” of $50 BILLION that Americans don’t buy into?
Plenty more questions remain for the Fiat Spending Bulls this morning than there are answers. I don’t need Karl Rove to remind me of that. My immediate term support and resistance levels for the SP500 are now 1086 and 1107, respectively.
Best of luck out there today,


The analysis below is taken from this morning's Healthcare First Look, a daily piece that marries top-down macro and bottom-up fundamental analysis with the intent of delivering actionable investment ideas within the Healthcare sector. Institutional subscribers and trialers, please email if you'd like to hear more about the work Tom Tobin and Christian Drake are doing within the Healthcare sector at Hedgeye.



Karl Rove was a little taller than I expected.  He was also more analytical than I expected in his prediction of the midterm elections.  While his analysis has political underpinnings, those views were not the core of his call.   His primary source of data was simply available polls with some colorful anecdotes from meetings that come from having Karl Rove’s rolodex.  At the end of the day, it was a familiar process to which just about every Wall Street fundamental analyst subscribes.


Whether it is Karl Rove’s analysis of publicly available polls, or Professor Ray Fair’s national data analysis (Bloomberg 9/8/2010), or the current $70 price on the Intrade contract, Republicans will likely resume control of the House of Representatives.  This has implications for real policy changes, or the minimum, the lack of progress.


For Healthcare the important themes that fall out of a Republican House of Representatives are as follows.


Deficit Reduction/Spending Cuts

Healthcare spending is the key contributor to long run federal and state spending.  With the political discussion having already moved to “paying for” new spending with budget reductions, the policy shift is already in place. 



Longer term, the election implications extend spending pressure from a Republican election advantage for many years to come from redistricting.  The trends in support for Republicans retaking the House are affecting Governor races as well.  With the 2010 Census being implemented through redistricting, and key states led by Republican Governors and Legislatures, there may be a long term Republican advantage.


Policy Implementation:


Public Hearings:  Karl Rove suggested Republican Committee Chairman would use hearings to affect change.  He specifically mentioned the idea of calling Dr. Berwick, who was President Obama’s recess appointment to head CMS.   Based on Dr. Berwick’s record and public comments (also easily found with a browser) political pressure from a Socialist label, while politically valuable, may also handcuff him administratively.


Health Reform Rules:  Investigating the affect of Health Reform on employer sponsored health insurance seems another likely topic.  Both a contact of Karl Rove’s and one of mine, both of whom run small businesses, will likely drop coverage for their employees saving money by paying the smaller penalties set up by the legislation.  Again, an easy political point to raise, but one that may also impact HHS decision making as specific policy rules and guidelines are written.


The market seems like it should get this, as all of the analysis is based on data readily available with a browser.   The Intrade contract crossed 50% odds at the beginning of July and made a massive move in August.   But looking at the performance across Healthcare subgroups since July 1 and August 1, there is not a clear pattern across individual stocks.  


The only standout has been Managed Care, which has led across both periods and clearly would benefit from moderation in Health Reform implementation, or the long odds of Health Reform repeal.






The low-volume action continued yesterday as broader healthcare and the XLV dropped 120bps & 60bps, respectively.  Internals were mixed with the A/D across our aggregate index at 14%/86%  while total volume held 12% & 21% below the 10-day and 30-day averages.  The XLV currently sits positive TRADE & TREND in the HEDGYEYE Sector Model closing 2 cents above the TREND line.  The next level of TRADE resistance remains north at $29.31


Generics outperformed yesterday on the back of BVF which ran for 10% following positive P&L news out of VRX.  Generics currently sits as the lone subgroup flashing positive divergence across durations in our 1 STD subsector divergence model.


BMY’s string of pearls strategy got its next pearl in the form of ZGEN as the company made a $885M move to consolidate its HCV product line and further buttress its pipeline with mid-to-late stage prospects.   


Insurer’s are back in the headlines with Aetna & the Blue plans announcing the need to raise individual & small business rates to offset reform related provisions.  According the WSJ (Here) the reform provisions, including “letting children stay on their parents' insurance policies until age 26, eliminating co-payments for preventive care and barring insurers from denying policies to children with pre-existing conditions, plus the elimination of the coverage caps” relate directly to the premium growthInterestingly, its these same provisions that continue to score well in Kaiser’s Health Tracking Poll (you can find the latest Kaiser poll results Here). Managed Care dropped 1.0% to start the week, but has outperformed over the past two weeks and is the best performing subgroup since July 1st.


Meanwhile, healthcare continues to take baby steps towards a consumer based model as consumer reports (NYT article Here) has begun rating surgical groups based on heart bypass surgery.  This coincides with a push by federal and local agencies to increase transparency & price discovery through online posting of surgery/therapy costs by insurer’s and providers.






Thomas Tobin

Managing Director


Christian B. Drake


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