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Deeply Disturbing

"It is not the function of our government to keep the citizen from falling into error; it is the function of the citizen to keep the government from falling into error."
– United States Supreme Court decision in American Communications Association v. Douds 

Before I start getting into one of the most critical long term TAIL risks that I am currently seeing develop in my interconnected global macro model (analytically incompetent Congressmen starting an economic war with China), allow me to paint a few mathematical lines around the core of the issue – unawareness.

  1. US Dollar: for the week-to-date = DOWN -1.8% (just another week of the same debauchery)
  2. Chinese Yuan: for the week-to-date = UP +0.90% (its best week in 28 months)

Now President Obama has been crystal clear in rhetoric on making decisions “based on facts” so we, as citizens, should hold him accountable to that in order “to keep the government from falling into error.”


To be fair, maybe our immediate term TRADE duration (3-weeks or less) is too short term for the economic sophisticates managing America’s currency risk from Washington, DC. So let’s look at currency “manipulation” on our intermediate term TREND duration:

  1. US Dollar: has declined in 13 of the last 16 weeks, and has lost over -8% of its value since early June when CNBC started begging Bernanke for QE2.
  2. Chinese Yuan: has been stable, not losing more than 0.5% of its value in any given week for the last 3 months.

If the intermediate term TREND of US Dollar devaluation and Chinese Yuan appreciation doesn’t fit your partisan politicking, let’s blow the charts out to the longest of long term so that your local politician who is gasping for the over-compensation air of re-election at the mid-terms can get “smart” on the math.

  1. US Dollar: after Nixon abandoned the gold standard (1971) and endowed both the Fed and Congress with the inalienable right to manipulate the world’s reserve currency via the US Federal Reserve Fund Rate, the US Dollar has only made a series of lower-highs and lower-lows.
  2. Chinese Yuan: since China de-pegged its currency in 2005, the Chinese Yuan has only appreciated in value. This morning’s price is the highest price ever for the Chinese Yuan. By our math, ever is a long time.

For the mathematically challenged, we’ve provided a picture of the long-term US Dollar chart so that you can forward it to Chuck Schumer (Democrat – New York) and Sander Levin (Democrat – Michigan). Before we YouTube what these professional politicians had to say on this matter, here’s what the Chinese said overnight:

  1. “Large fluctuations in the US Dollar’s exchange rate may impede the global economic recovery.” –Chinese Central Bank
  2. “The appreciation of the renminbi cannot solve the trade deficit with China and can’t fix the US unemployment problem.” –Jiang Yu
  3. “Pressure cannot solve the issue, rather it may lead to the contrary.” -Jiang Yu (spokesperson for the Foreign Ministry in Beijing)

Back to America’s conflicted, compromised, and confused:

  1. “We have to figure out ways to change behavior” –Tim Geithner
  2. “The U.S. economy is trying to pick itself up off the ground, China’s currency manipulation is like a boot to the throat of our recovery.” –Chuck Schumer
  3. “Chinese practices have led to a staggering US Trade Deficit… and it’s deeply disturbing.”  - Sander Levin

You got that right Colonel Sander Levin – the comments coming out of your mouth are Deeply Disturbing on so many levels that are obvious to any educated American on global risk matters right now that I can end with that. If your objective is to fear-monger uneducated Americans into going anti-China, shame on you.


Chuck Schumer became a member of the New York State Assembly in 1975. Sander Levin assumed office in Michigan’s 12th district in 1983. If these two characters want to point fingers at China for US government spending, deficit building, and debt incursion rather than hold themselves accountable to zero US private payroll adds in the last decade, they can go ahead and try – maybe that gets the next lemming in line to vote for them again, but in the age of the internet, I don’t think Americans are that stupid. Gentlemen, you have been YouTubed.


What do the alleged “non-partisan” people in Washington have to say about all this? Eswar Prasad, Senior Fellow at the Brookings Institute, concluded that “as the US mid-term election nears, the temptation of grandstanding on China will be irresistible to most Congressman.”


Thank you, Mr. Prasad.


The fact of the matter is that US Dollar depreciation is aided and abetted by stock market cheerleading to keep the US Federal Funds rate at ZERO percent anytime this country has an economic problem. That horse has been beaten to a dead pulp and has only equated to a high/low society whereby guys like me get paid to trade the volatility of commodity prices born out of that Dollar Depreciation as America’s poor get jammed with higher prices.


Mr. President, you tell me who is lying here, because it certainly isn’t market prices. The price of oats are up +24% in the last month alone (I eat oatmeal for breakfast). On our immediate term TRADE duration here are the highest inverse correlations to the USD Dollar:

  1. Sugar = 0.90
  2. Oats = 0.88
  3. Cotton = 0.86
  4. Corn = 0.85
  5. Oil = 0.79

*note to Chuck – these are very high inverse correlations.


According to the US Census Bureau, there were 43.6 MILLION Americans living in poverty in 2009 and the latest reading on Americans who live off of food stamps is about that same number (which is at a 15 year high). Professional politicians who are pointing fingers at the Chinese this morning get one big fat middle one from me – their fear-mongering is Deeply Disturbing. It’s US monetary policy, stupid.


My immediate term support and resistance lines for the SP500 are now 1111 and 1134, respectively. With the US stock market being immediate term TRADE bullish, I have upped my asset allocation to US Equities to 6% this week and taken my position in cash down to 46%. With US Congress imposing this kind of systemic risk to our financial system however, I’ll be a net seller all day today.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Deeply Disturbing - usd

CHART: Sticking with our Yen Short


The chart was extracted from a note dubbed "Sticking With Our Yen Short" issued to Risk Manager Subscribers on  September 15, 2010 at 3:35pm ET.





We aren’t short the yen purely based upon the catalyst provided by the current batch of Fiat Fools leading Japan. We think the top in the yen is around yesterday’s pre-intervention level of 82-83 per dollar and we see downside on a 3-6 month go-forward basis around 6-9%.


The reasons for our bearish stance are: the potential for both waning upward Chinese pressure on the yen and U.S. dollar stability.



CHART: Sticking with our Yen Short - chart1




Subscribers and Free-trialers have access this and other Macro Select notes in their entirety, including access to Hedgeye's real-time portfolio positions. 


Loved by the street, management may have set the bar high for 4Q.


The sell-side analyst community loves PNRA with 65% of analysts recommending the stock as a buy (there are no sell ratings).  It is easy to figure out why with the company posting +10% comparable sales growth and north of 200 bps of YOY operating margin growth in the first half of the year.  The comparisons get more difficult from here, however, with the company lapping sequentially better same-store sales growth in the back half of the year - particularly in 4Q10.  Additionally, PNRA is facing its toughest YOY margin comparison during 3Q10. 


This is not new news as the company guided to lower, yet still impressive, comp growth of +5-6% growth in 3Q10 and +4-6% growth in 4Q10 with flat to 50 bps of margin expansion in the back half of the year.  Based on recent top-line trends, the +5-6% same-store sales guidance for the third quarter seems achievable as the high end of the range only implies a 20 bp acceleration in two-year average trends from the prior quarter.  The fourth quarter comp guidance is more concerning, however, as it implies a 125 to 225 bp acceleration in two-year average trends from the reported level in 2Q10.  Based on management’s guidance, this sequential improvement in trends is expected to be driven by a sharp increase in 4Q10 transaction growth on a two-year average basis while average check growth is expected to decelerate slightly. 


Transaction growth ran positive for PNRA during the first half of the year but average check growth has accounted for about 7% of the 9.8% comp growth.  Average check growth held steady on a two-year average basis during the second quarter whereas transaction growth decelerated 70 bps.


This recent level of average check growth is impressive but is likely unsustainable.  We have seen other restaurant companies in the past use pricing and average check growth to support same-store sales growth, but this often takes a toll on traffic growth (please refer to the charts below that highlight the similarity in trends between the relationship of average check growth and transaction growth for Panera and Chipotle).  Ultimately, restaurant operators need to get more people in their restaurants. 


Panera management attributed the 2Q10 average check growth to the strength of the company’s summer salads, its meal upgrade program (offers the customer the opportunity to get a baked good for $0.99 with the purchase of an entree and a beverage) and to its growing catering sales, which carry higher average check per transaction.  PNRA will begin to lap the increase in catering sales during 3Q10 as catering sales first turned positive in 3Q09 (+3.0%) and quickly accelerated from there (+14% in 4Q09, +20% in 1Q10 and +24% in 2Q10). 


This, combined with the fact that the company is lapping 4.2% average check growth from 4Q09, will put increased pressure on average check growth during the fourth quarter.  Management guided to 3.0% average check growth in 4Q10 relative to its expectation for 5-6% growth in 3Q10 and the reported 6.5% and 7.7% growth in 1Q10 and 2Q10, respectively.  The company expects to offset this lower level of average check growth with +1-3% transaction growth, which I said earlier assumes a significant increase in two-year average trends.  I am not convinced management will be successful in achieving this targeted transaction growth so I am currently modeling +3.0% comparable sales growth for 4Q10 (relative to management’s guidance of +4-6%).  My estimate still implies a 75 bp acceleration in two-year average same-store sales trends and a 110 bp improvement in two-year average transaction growth trends from 2Q10 levels. 


New MyPanera Loyalty Program:


Panera is rolling out its new loyalty program system-wide during the fourth quarter and expects the program to lift comp sales by +1-2% during the quarter.  Management’s comp and transaction growth guidance assumes this sales lift.  The company is confident in the success of this program after testing it in 23 markets where results have shown that it strengthens customer relationships and has a meaningful impact on frequency of visits.  I do not doubt that over time, this program will drive frequency, but a +1-2% lift in the first quarter it is rolled out seems like a stretch.  Like I said, I am assuming transaction growth will get better during the fourth quarter, but based on the deceleration in trends during the second quarter, getting to +1-3% growth in 4Q10 seems aggressive.  Time will tell.    






Howard Penney

Managing Director



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TODAY’S S&P 500 SET-UP - September 17, 2010

As we look at today’s set up for the S&P 500, the range is 23 points or -1.21% downside to 1111 and 0.83% upside to 1134.  Equity futures are trading above fair value as markets respond positively to earnings and guidance from RIMM and ORCL.

Today's macro focus will center on August CPI and the Michigan Consumer Sentiment survey.

  • Alkermes’ (ALKS) drug Vivitrol should be cleared as a treatment for opiate addition, outside advisers to the U.S. FDA said.
  • Arena Pharmaceuticals (ARNA) failed to win a U.S. panel’s backing to sell lorcaserin, the experimental diet pill that would be the company’s first drug.
  • Boeing (BA) said it would boost the production rate of 737s to 38/mo from 35/mo
  • Massey Energy (MEE) forecast a 3Q operating loss and 2010 operating results at the low end of its projections.
  • Oracle (ORCL) reported 1Q EPS that beat estimates.
  • Research In Motion (RIMM) reported 2Q revenue and profit that beat estimates.
  • Texas Instruments (TXN) boosted its dividend and said it plans to buy an additional $7.5b of its stock.


  • One day performance: Dow +0.21%, S&P (0.04%), Nasdaq +0.08%, Russell (0.72%)
  • Month-to-date: Dow +5.79%, S&P +7.18%, Nasdaq +8.95%, Russell +7.6%
  • Quarter-to-date: Dow +8.4%, S&P +9.12%, Nasdaq +9.2%, Russell +6.29%
  • Year-to-date: Dow +1.6%, S&P +0.86%, Nasdaq +1.5%, Russell +3.58%


  • ADVANCE/DECLINE LINE: -485 (-659)
  • VOLUME: NYSE - 906.14 (+0.55%)  
  • SECTOR PERFORMANCE: Mixed to poor performance - 3 sectors rose and 5 declined - Tech and Materials sectors outperformed; Financials and Energy led the decline. Economic data sent a mixed message, and limited corporate news flow on the day.
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: Ford +4.80%, Gamestop +4.36% and Expedia +3.86%/Helmerich -4.49%, Pulte -3.85% and Fed Ex -3.75%
  • VIX: 21.72 -1.72% - YTD PERFORMANCE: (+0.18%)            
  • SPX PUT/CALL RATIO: 1.03 from 1.53 -32.66%  


  • TED SPREAD: 14.94 0.812 (5.746%)
  •  3-MONTH T-BILL YIELD: 0.16% +0.01%
  • YIELD CURVE: 2.29 from 2.24


  • CRB: 278.69 -0.13%
  • Oil: 74.57 -1.91% 
  • COPPER: 349.35 +0.78%
  • GOLD: 1,272 +0.41%


  • EURO: 1.3074 +0.56%
  • DOLLAR: 81.241 -0.31% 



  • European Markets: FTSE 100: +1.00%; DAX: +0.88%; CAC 40: +1.29%
  • European markets opened higher and subsequently extended gains to currently trade close to session highs.
  • M&A activity again dominates with Johnson & Johnson (JNJ) negotiating to buy Crucell (CRXL.NA).
  • All industry groups trade higher with miners and technology shares amongst leading gainers. Defensive groups dominate the laggards. Mining shares were buoyed by higher metal prices whilst technology shares received a lift from Oracle (ORCL) results and guidance overnight, ORCL trading up over +4% in Germany.
  • A generally weaker US dollar also benefitted commodity prices that saw gold trade at a record high $1,280/oz.


  • Asian Markets: Nikkei +1.2%; Shanghai Composite (0.15%)
  • Most Asian markets followed Wall Street up today, despite some hesitation before pending holidays in Japan and South Korea.
  • Japan rose on a weaker yen
  • In South Korea, LG Electronics rose 5% after CEO Yong Nam resigned to take responsibility for poor management, to be replaced by Koo Bon Joon.
  • Banks rose slightly in Australia on successful bond issue by Asciano.
  • Taiwan rose when Beijing approved four banks including Chang Hwa Bank to open branches in China.
  • Declines in financials and heavyweights outweighed technical buying in individual stocks, taking China to a slight loss even though the central bank said it would keep monetary policy loose. 
Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends














One year expensing of capital purchases could be a boon to slot suppliers.



Casinos are about to get a new incentive to upgrade their slot floors.  HR 5297 would allow accelerated depreciation of new equipment for tax purposes, although not at the 100% proposed by President Obama last week.  Still, for slot floors that are aging fast and nearly fully depreciated, this bill could be the tonic to expedite that inevitable acceleration of replacement demand.


According to the Internal Revenue Code of 1986, slots are depreciated under a 7-year recovery period, though there is a pending proposal (HR 5465) to change the recovery period to 5 years.


On Sept 8, 2010, President Obama proposed increasing the bonus depreciation policy to 100% for 2011. The policy will allow firms for the first time to apply an immediate, full write off of the cost of new equipment purchased between Sept 8, 2010 and Dec 31, 2011. Expensing legislation has been enacted in the recent past.  In 2002, Congress passed a 30% bonus depreciation allowance through the Job Creation and Worker Assistance Act of 2002.  A year later, it raised the limit to 50% through the Jobs and Growth Tax Relief Reconciliation Act of 2003 for investments made before January 1, 2005.  The Economic Stimulus Act of 2008 and the American Recovery and Reinvestment Act of 2009 both renewed the 50% rule but that expired on 12/31/09.


The Small Business Jobs Act (HR 5297), which was passed in the Senate today, will allow firms to retroactively apply the 50% rule for equipment purchased before Sept 8, 2010.  HR 5297 will also increase Section 179’s depreciation limit from $250k to $500k for 2010 and 2011—Section 179 is a provision allowing taxpayers to expense 100% of certain types of acquired assets. Now, HR 5297 returns to the House for approval before being passed to Obama for his signature.


Let’s look at history.  As the following chart shows, the enactment of accelerated depreciation during 2002-2004 coincided with a big jump in replacement demand.  Of course, that was also in the middle of the Ticket In/Ticket Out (TITO) technology implementation so it is difficult to determine the direct impact.  What we do know is that for tax purposes, the current slot floors are pretty close to being fully depreciated.  Slots purchased pre-2004 will be fully depreciated by the end of the year.  Very little remains of the 2004 slots due to the accelerated depreciation in that year.  The 2005-2007 slots are still being depreciated over a 7 year life.  Due to 50% expensing, the 2008-2010 classes of slots have low tax basis.




We are not ruling out 100% expensing either.  The President wants it; it is politically feasible; and it could garner bipartisan support.  Accelerated depreciation alone is probably not enough to create a big replacement cycle but it could spark one.  The long-term dynamics are in place, however, which is why we are excited about the prospect of a spark.  Here are the reasons why replacement acceleration could be fast and big:

1.       Floors are not old yet but they will be soon – end of TITO was 6 years ago

2.       Operator balance sheets are in much better shape

3.       More certainty in the casino business – revenues are stagnant but at least the world isn’t ending

4.       More competition from new markets

Athletic Zigs While Retail Zags

Trends since August have turned decidedly more positive in the athletic industry since marking a near-term bottom from June through July during a period of declining trends in footwear and apparel. Here are a few noteworthy observations:

  • While the impact of BTS has occurred later than expected this year, it has also come in stronger than most expected as well driving the v-bottom and hockey-stick like move in August on the 1yr and 2yr trends respectively.


  • With trends moving sharply higher, it’s worth noting that footwear anniversaries its toughest comps over the next two-weeks – when sales came in +3.7% and 4.8% on a trailing 3-week basis before falling off sharply over the next 2-months – until we hit holiday driven December sales. Importantly, this period of favorable compares comes at a time when basketball begins to sell through on the heels of improving trends and new product is hitting the market.


  • While toning has contributed to athletic footwear sales particularly in the summer months, the recent improvement in trends is at a time when the contribution from toning is on a decided decline and driven instead by core categories like running as well as basketball.


  • Price still matters. After increases both in footwear and apparel heading into August, footwear trends have responded more favorably to less aggressive price increases over the last 6-weeks while apparel prices took longer to ease after which sales improved.


  • On a regional basis there are two key callouts since the beginning of August. First, the relative outperformance in the South Central, which coincides with recent commentary out of DKS on the strength of the Texas market relative to its core business. The second is the Pacific region, which is the only region to slow over this period of considerable strength in the industry.


  • With favorable Running and Basketball trends in footwear, Nike (both Brand and Jordan) and Saucony remain strong while Running, Compression, and Outdoor Outerwear have been the key categories of strength in apparel driving solid numbers at Nike, Under Armour, Columbia and VFC (The North Face).

Athletic Zigs While Retail Zags  - FW App Industry Data 1yr 9 16 10


Athletic Zigs While Retail Zags  - FW App Industry Data 2yr 9 16 10


Athletic Zigs While Retail Zags  - FW Core ExT 9 16 10


Athletic Zigs While Retail Zags  - AppFW regional trends 9 16 10


Athletic Zigs While Retail Zags  - App by Chan 9 16 10


Casey Flavin


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