Walk The Line

“Because your mine, I walk the line.”

-Johnny Cash


Since we introduced it at the beginning of July as our intermediate term TREND line of bearish resistance for Q3, it’s no secret that the 1144 line on the SP500 has been our line. Now that the SP500 has rallied sharply (+9.8%) from what we called immediate term TRADE support (1040), it’s time for me to walk the line.


Will I be bullish? Will I be bearish? Or will I be neither? I don’t have to make a call; I make calls when the probability in my math tells me to. I already made my selling moves yesterday and I will be accountable to them.


It’s NFL season. This is a great time of year in America because it allows us to remind ourselves how real winners in this country behave. Professional athletes and their coaches like making calls too – unlike professional politicians of the Fiat Republic, they thrive on accountability.


Before the Monday Night Football game between the San Francisco 49ers and the New Orleans Saints, 49er head coach, Mike Singletary, made the call that “we will not try to stop Drew Brees – we will stop Drew Brees.”


After the game Brees said, “we won the game and that’s all that counts.”


Ultimately, this business is a lot like professional sports in that being right or wrong is really all that counts. This isn’t a charity. This isn’t a philanthropic venture. This is meat and potatoes bids versus asks. Take your position, and walk the line.


No matter where I go this morning, here I am. Here are the moves I made yesterday:


1.  09/20/2010 02:45 PM SHORTING XLY $33.34

We covered this short position on August 24th and now we'll put it back on as we are bearish on US Consumer Spending for the intermediate term TREND, from this price. Timing matters.


2.  09/20/2010 10:42 AM SELLING CAF $28.24

Chinese stocks have closed down for 4 consecutive days and have broken their immediate term TRADE line. Could Chinese growth slow in SEP vs AUG?


3.  09/20/2010 10:34 AM SELLING GLD $125.22

I said I was going to do it in this morning's Early Look, so I'm doing it - booking a gain here in gold as it is immediate term TRADE overbought.


4.  09/20/2010 10:28 AM COVERING HCBK $12.14

US Housing data this week won't be as much of a bomb (relative to expectations) as the AUG24th report was. We'll cover here and re-short later.


5.  09/20/2010 10:22 AM SELLING ASPS $27.48

Steiner remains bullish on ASPS for the intermediate term TREND, but it is finally overbought here from an immediate term TRADE perspective. Selling high.


6.  09/20/2010 10:16 AM SHORTING HOT $53.23

Jordan and I remain bearish on the market's intermediate term expectations for revpar growth. Shorting green.


In summary, one of the first takeaways you’ll have from these 6 position changes is how mixed the research reasoning is. That, Dear Fundamentalist Sir, is the hallmark of both chaos theory and how you apply it to a modern day risk management model. Managing risk has nothing to do with the certainty of your “valuation model” or your latest super-duper “one-on-one” with a company. It has everything to do with accepting uncertainty.


When I make a call, I immediately start trying to prove myself wrong. Each position in the Hedgeye Portfolio has to undergo a disciplined and repeatable line of examination every morning, afternoon, and night. If you want to have a position playing on my team, your research is mine.


Sounds hard core, because it is. We’re not here to sell our clients some broken Greek bond promise, CNBC advertising, or an investment banking fee. We’re here to win – and the best way to ensure that is to keep moving as the game does.


My immediate term and intermediate term lines of resistance (TRADE and TREND) are the same line this morning, 1144. It’s time to walk the line.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Walk The Line - cash

EARLY LOOK: Trojan Protection





“The best lightning rod for your protection is your own spine.”

-Ralph Waldo Emerson



EARLY LOOK: Trojan Protection - chart2






On Friday President Obama introduced Elizabeth Warren as the new head of the US Consumer Protection Agency. Sounds serious. We hope that she’ll be working vigilantly to protect us from more policy making ideas coming out of Larry Summers and Timmy Geithner.



EARLY LOOK: Trojan Protection - chart1



Hope, of course, is not an investment process. So the best we can do for your protection this morning is recommend you take your financial security into your own hands – in the face of government sponsored volatility, sell high - buy low.


If you thought last week was a big week for Government (Congress was back in session), this week is going to be a barn burner:  



1.   Monday - kicks things off with an “exclusive CNBC” town-hall meeting with none other than the President of the United States as 12PM EST today (I couldn’t make that up if I tried).


2.   Tuesday - Heli-Ben is going to save us all from the road that is US monetary policy perdition at the FOMC meeting that will be brought to you by Trojan’s NEW “Fire & Ice Quantitative Easing”, twice the turn on!


3.   Wednesday – both the Senate Banking Committee and weekend at Barney’s House Financial Service committee will be back in action.

Some people take the alleged Trojan horse protection Ben Bernanke provides us very seriously – if you think about it in terms of the world’s poor who are watching food prices rip higher again this morning, it’s very serious indeed.



EARLY LOOK: Trojan Protection - chart4



Bernanke’s “Warped Twenty Ten Tour” (Trojan) has been a battle. He started the year talking about US GDP growth accelerating into the back half of the year on the order of 3.5-4%. Now that US GDP growth is barely 2%, you can fully expect him to downgrade his growth estimates tomorrow. In modern day risk management speak, we call this chasing your own tail.


Protecting their own tail is what people in Washington do. This isn’t new, and you don’t need CNBC to provide the sponsor’s messaging to understand this either. Today is just another day in the Fiat Republic. Prices are a lot higher than where they were only a month ago, so now is not the time to be buying those inflated prices.


On a sequential basis versus August, inflation in September has re-reared its ugly head. Expect Ben Bernanke to mention none of this tomorrow. If he didn’t see inflation in 2008, he’s certainly not going to see it now. These things are very hard to see from a helicopter.


Interestingly, but not ironically, Bernanke’s counterpart at the Reserve Bank of Australia, Glenn Stevens, pre-empted Heli-Ben’s political pandering by saying the following in Victoria this morning: “If downside possibilities do not materialize, the task ahead is likely to be one of managing a fairly robust upswing. Part of that task will, clearly, fall to monetary policy.”


Now if you are part of the perma-Deflationista camp, you probably don’t like these trivial things like prices going up being mentioned as inflation. Heck, how should we expect one of the next alleged great leaders of the Fiat Republic like Republican Senate candidate, Christine O’Donnell, ever see anything but deflation in US home prices since she stopped paying her mortgage in 2007?



EARLY LOOK: Trojan Protection - chart5



Never mind 15 year highs in cotton prices this morning or all-time highs in the nominal price of gold – the deflation story-telling is entrenched – and Elizabeth Warren is going to protect all consumers from those evil-doer gold commercials anyway.


Last week saw further deflation in the US Dollar Index’s price. The US Dollar continued to look like the credibility of the government that backs it, losing another -1.6% of its debauched value week-over-week and closing down for the 13th week out of the last sixteen.


In response to the Dollar DOWN trade that Ben Bernanke has been hired to perpetuate, most asset prices inflated week-over-week, including short-term US Treasury bonds. As we look at 2-year yields dropping to generational lows this morning of 0.47%, Americans with hard earned savings accounts in this country must be wondering whether Elizabeth is going to protect us from Japanese style fixed income rates too…


As Emerson dares me to have the spine to sell my 6% asset allocation to Gold (GLD) this morning, I think I might just do it. That’s right - I have my own protection strategy against Government.


My immediate term support and resistance levels for the SP500 are now 1113 and 1137, respectively. On Friday, I sold 3% of our 15% position in the Chinese Yuan (CYB), taking our asset allocation to Cash up from 46% to 49%. Unlike prior bear market rallies, we have plenty more to sell into this one.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer




This note was originally published at 8am this morning, September 20, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.


After feeding at the trough of cheap commodities during 2009, restaurant operators are facing an increasingly difficult cost environment as food prices head higher.  Of all commodity cost inputs, corn speaks to this fact most lucidly.


Since the most recent low in prices (6/29, $3.25/bushel), corn prices have move sharply higher.  There are several reasons for the move; some are more transient than others.  Corn prices provide a highly accurate reflection of the cost environment facing restaurant companies since the commodity is used in soft drinks (high fructose corn syrup), bread, as feed for livestock and in the production of ethanol.  There is no restaurant company that I’m aware of that is immune to a sustained move higher in corn prices; it’s really a question of how exposed each company is. 


The United States produces more than twice as much corn as its closest corn producing competitor, China, according to USDA data.  Any factors impacting corn production on the United States have a strong impact on the direction of prices and, therefore, restaurant company margins. 


Regulatory risk is the most pertinent factor in domestic corn markets today.  In 2007, with the passing of the Energy Independence and Security Act, the U.S. government adopted an active role in the price of the grain.  The Renewable Fuel Standard (RFS) portion of the EISA pertains to bio-diesel and ethanol.  The RFS mandates that “applicable volumes of renewable fuel” must be produced with the majority of that renewable fuel to be ethanol to be blended in with gasoline.  The result has been gasoline E10: 10% ethanol mixed with 90% gasoline. 


As you can see in the chart below, as passage of this legislation became more certain, corn responded appropriately by gaining sharply over the next few months.  Recent agitation on the part of the Environmental Protection Agency to increase the ethanol blend to E15 (15% of the blend) has added further support to corn prices.  In conversation with our Energy sector head, Lou Gagliardi, he has made it clear that he expects this momentum to continue and for lobbyists in D.C. to seek higher and higher levels of ethanol in gasoline.  A recent study, touted by the EPA, “confirming” the safety of E15 for older vehicles (as well as new models) was just released late last week and is available on the Renewable Fuels Association website. 




Recent USDA reports have highlighted some interesting supply and demand dynamics in the corn market.  Firstly, the USDA revised its 2010/2011 U.S. corn yield forecast lower to 162.5 bushels per acre in the September World Agricultural Supply and Demand Estimates from 165 bushels per acre prior.  The higher 2009/10 use of corn for ethanol was incorporated in to this forecast.  Another pertinent factor is the excessive rain in corn-growing regions earlier in the summer coupled with high temperatures in August.   Weather has impacted grains heavily this summer with China and Russia experiencing shocks to their grain supply chains.  Irregular weather patterns can cause significant price fluctuations in corn – especially if top corn supplying countries are affected: The United States, China, Brazil, Mexico, Argentina, and India are currently the top six.  Investors seem to believe that national corn balances will tighten further, as is suggested by the chart below of net long contracts for corn.   If anything, the high level of net long speculative positions could impede further gains in corn prices if a significant portion of the positions are unwound.




Of course, since corn prices are denominated in dollars, it is important to consider the impact of foreign exchange on spot prices.  Our view on the U.S. dollar continues to be bearish in light of sharp down moves in recent weeks in response to rhetoric from Capitol Hill.  As long as the dollar continues to decline, it will continue to be bullish for corn price and negative for restaurant margins.


NO MORE ROOM AT THE TROUGH - us dollar corn


Howard Penney

Managing Director


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Where Is the Inflation? Just Like Politics, It’s Local

A number of our subscribers have rightfully pointed out the apparent contradiction in our call for slowing economic growth in the United States combined with a pick-up in inflation.   Not unlike politics, inflation is local.  In many local markets, we continue to see a pick-up in inflation, despite the increased likelihood of sequentially declining growth in the United States.


China is probably the best example of accelerating inflation globally.  Directly below we’ve posted the chart of Chinese CPI going back two years.  While we are not back to the year-over-year increases in CPI that we witnessed in late 2008, which neared 5%, CPI in China is accelerating.   From July 2009 of last year to the most recent data point for August, CPI growth year-over-year has increased steadily to 3.5%, which is a 22-month high.


Where Is the Inflation? Just Like Politics, It’s Local - 1


Another global inflationary signal relates to major food inputs.  Immediately below we’ve posted the CRB Foodstuff Index.  This index incorporates the following food inputs: butter, cocoa, corn, hogs, lard, soybean, steers, sugar, and wheat.  This index has accelerated dramatically off of its June lows and is up almost 35% on a year-over-year basis.  If a year-over-year price increase of the 35% doesn’t imply some form of inflation, then shame on us. 


Where Is the Inflation? Just Like Politics, It’s Local - 2


Our Retail team lead by Brian McGough and Retail COO Zach “The Hammer” Brown also highlighted another key inflation data point recently in a post on cotton titled, “Apparel: We Just Got More Bearish.”  As Zach wrote in the note:


“While we’re talking 3-Standard Deviation moves, look at the recent move in cotton. Yes, the recent spike puts it into the ‘statistical aberration’ bucket. Anomalies or not, it is an economic reality, and a 50% boost in the industry’s biggest cost input must be dealt with.”


Cotton is, obviously, one of the key inputs in making apparel; ultimately, inflation in cotton prices will be felt throughout the apparel supply chain. Either consumers will have to pay higher prices or retailers, apparel makers, and/or vendors will have to eat margin. In the U.S., this could not come at a worse time, as Consumer Confidence recently hit a 13-month low and unemployment continues to hover above 9%.


Where Is the Inflation? Just Like Politics, It’s Local - 3 


Currently, the primary driver of inflation is the continued debasement of the U.S. dollar.  As the U.S. dollar declines, the cost of goods and materials priced in U.S. dollars should increase. In our opinion, the main reason we are seeing all-time highs in gold is that investors and sovereign wealth funds globally are looking to protect their wealth from the debasement of fiat currencies. 


Even if we aren’t currently seeing inflation on a reported basis in the U.S., the rapid increase over the past few months in food costs, apparel costs, and reported CPI from China suggest anything but deflation to the team at Hedgeye.


Daryl G. Jones

Managing Director


In preparation for Carnival's Q3 earnings release on September 21 , we’ve put together the pertinent forward looking commentary from CCL’s Q2 earnings release/call.





General Comments:

  • “We are maintaining earnings guidance of $2.25 to $2.35 a share.”
  •  “Looking at bookings over the last six weeks by major trades for North American brands, Caribbean itineraries, which are more than 50% of North American capacity over the next nine months, continue to be strong at higher prices. Bookings for Alaska cruises however, ran behind the last six-week period but at substantially higher prices. But fortunately, there is very little Alaskan inventory left to sell. Bookings for North American brand Europe programs were also lower, but there’s also not much inventory left to sell in Europe for the reminder of the year.”
  • “Despite the brief slowdown in these trades, we are still expecting significant year-over-year pricing improvement for Alaska and Europe for 2010.”
  • “There may be a slight increase in fuel consumption because we have to navigate around what may be the worst areas, but the ships are being inspected every time they return to the U.S. We haven’t had to clean a hull once yet. We’ve seen no slowdown in booking pattern.”
  • “As we get bigger and bigger and bigger in our European brands, you become more and more seasonal. And so our advance ticket deposits at the end of 2Q is always going to be significantly higher than at the end of the year. As we grow the European brands, you can expect lower earnings in the first quarter and more earnings in the third quarter.”
  • [Booking curve] “The curve is about at the same levels as last year.”
  • “But typically for the next quarter, which in this case would be the 3Q, we’re always 85 to 95% booked. Two quarters out, which is 4Q, our historical range is 55 to 75% booked. And for three quarters out, which would be 1Q, traditionally we are in the range of 30 to 50% booked, and we’re still in those historical ranges.”

3Q 2010:

  • “For the third quarter, fleet-wide capacity is 6.2% higher than last year, 3.7% in North America, 8% for Europe brands. At this point, with very little inventory left to sell in the quarter, fleet-wide capacity is slightly ahead -- fleet-wide occupancy, I should say, is slightly ahead YoY, with local currency pricing well ahead.”
  • “We are expecting that third quarter ticket pricing for North American brands to increase in the low double-digit levels by the time the third quarter closes.”
  • “By the time the quarter closes out, we are expecting European brand pricing to be flattish YoY, which is a very good result given the 8% increase in capacity. We are forecasting third quarter fleet-wide revenue yields will increase in the 5 to 6% range on a local currency basis, flat to up slightly on a current dollar basis.”

4Q 2010

  • “Now turning to the fourth quarter, wide capacity is up 6.1% in the quarter, 1.7% in North America and 10.6% in Europe. On an overall basis, fourth quarter occupancy is slightly lower, with local currency pricing running nicely higher. North American brands in the fourth quarter are 50% in the Caribbean, with all other itineraries individually below 10%.”
  • “At the present time, pricing is running nicely ahead year-over-year with lower occupancies. Overbooking volumes for the fourth quarter for North American brands continue to be strong.”
  • “European brands are 73% in Europe in the fourth quarter, with all other itineraries individually under 10%. Europe itinerary pricing on a local currency basis is nicely ahead of last year with slightly better occupancy. Bookings continue to be strong for the fourth quarter, and we are forecasting that by the time the fourth quarter closes Europe brand local currency pricing will be higher YoY, which is a very good result considering the 10% capacity increase that we have during the quarter.”
  • “On a fleet-wide basis, we expect fourth quarter revenue yields to be up approximately 3% on a local currency basis.”

1Q 2011

  • “Our fleet-wide capacity is going to be up 6.6%--3.8% for North American brands and 11.7% for European brands.”
  • “1Q pricing is running higher on a YoY basis with occupancy running slightly behind.”
  • “North American brands are 66% in the Caribbean, 11% in Mexican Riviera cruises and the balance in all other itineraries. Presently, Caribbean pricing is slightly higher on lower occupancies and Mexican Riviera pricing is higher on higher occupancies. Pricing on virtually all other itineraries, mostly longer premium-price cruises, is higher on lower occupancies.”
  • “European brands are 25% in European itineraries, 23% in the Caribbean and 18% in South America with the remaining in various other itineraries. Local currency pricing for Europe and South America cruises is running higher on lower occupancies and pricing for European brand Caribbean cruises is higher on higher occupancies. Overall, pricing in local currency for Europe brand cruises is nicely higher at this time with occupancies, when you combine it all, at the same level as the prior year.”




Unless we we’re completely off base with the analysis behind our bearish industry call, the number of companies in the quadrant of our SIGMA framework that is most linked to stock blowups will double over 2 quarters. Our updated book is available for your enjoyment. Please let us know if you'd like a copy.


Sales/inventory spread drifting lower, gross margin improvement eroding, sg&a and capex starting to build. It’s all plain as day in the attached apparel supply chain SIGMA chart, and we just inked the fourth quarter of easy compares.  Mind you, this is completely retrospective, and does not account for the rise in input costs we’ve seen in just 3-weeks.  All this, and the consensus still has margins reaching new highs in 2011, and the market is sporting a 15x p/e on 15% forward earnings growth consensus expectations.  


Out of the 107 companies we track in this framework, 75 were in the ‘sweet spot’ (positive sales/inv spread with improving margins) last quarter, and that has since fallen to 53.  Conversely, the number of companies in the quadrant of our chart that is most often linked to stock ‘blowups’ went from 7 stocks last quarter to 26 in 2Q. Unless we we’re completely off base in our bearish industry call, the number of companies in the SIGMA ‘sweet spot’ will be cut in half over 2 quarters.







One of the cornerstones of our analytical process is our SIGMA (Sales Inventory Gross Margin Analysis). Once you take a minute to understand it, you see that this is not only a strong analytical tool, but also a way to monitor the behavioral changes of how a management team (or group of them) trades one line of the P&L or balance sheet against each other in the face of volatility in the Macro environment.


Here is a quick overview of how to read the chart:


  • The vertical axis illustrates the difference between sales growth and inventory growth, while the horizontal axis represents the year-to-year change in the operating margin.  We then plot the past 8 quarters of data to visualize the trend. The ultimate fundamental outcome for any company occurs when the data points line up in the upper right hand quadrant (sales outpace inventories and margins up).
  • The background of the SIGMA chart depicts the year-to-year changes in gross margin and SG&A margin, along with a line representing capex as a percent of sales on a trailing twelve month basis. This allows us to track margin and cash flow comparisons on a quarter-to-quarter basis.


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