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EARLY LOOK: A Heavier Crash


“The lofty pine is oftenest shaken by the winds; high towers fall with a heavier crash; and the lightning strikes the highest mountain.” 



EARLY LOOK: A Heavier Crash - Horace




I haven’t considered a heightening probability of a US stock market crash in an Early Look note since 2008. I’ll go there this morning.


Before I look forward, allow me to take a step back. To fully appreciate the risk that is getting baked into this US stock market cake, we should respect history’s lessons. If you believe that the professional politicians of the Fiat Republics of modern day America and Japan have as much to lose as those in the Roman Empire did in 49BC, you’ll find my using a quote from the leading Roman lyric poet of that era appropriate.


I’m not a poet. I’m a Risk Manager. In probability speak, I am registering signals in my global macro risk management model that would consider an abrupt 1-3 day US stock market crash in October probable. To be clear, I’m not saying it’s likely – but I am saying it’s probable. There is a difference.


Probable is proactively predictable. Likely would be a better than 50% chance. What I see here is a 33% chance this happens, so let’s strap the accountability pants on and take a walk down that path. For a Heavier Crash to occur during a compressed period of time, we still need a few more things to happen:

  1. We need to see the SP500 get squeezed one more time in the next few weeks to a price north of 1164.
  2. We need to see volatility (VIX) get oversold towards 20.
  3. We need to continue to see the world’s said “reserve currency” lose its credibility.

The bad news is that all 3 of these factors are already in motion, big time (since late August the SP500 is +10%, the VIX is down over -20%, and the US Dollar has been crushed to lower-intermediate-term-lows). If these 3 factors continue to travel the path of least resistance (SP500 up, VIX down, and US Dollar debauched), we could have a serious short term problem.


Measuring time and space is a critical aspect of my profession. As a chaos theorist, I don’t expect to be taken seriously by the gurus of buying cheap P/E’s, nor do I want to be. If the Ken Fishers of the world didn’t realize they were going to get smoked in 2008, I don’t see why they’d see it coming now. Evolving the risk management process is a dynamic exercise in and of itself. We all need to change as the market’s ecosystem does.


So what would a Heavier Crash look and feel like?

  1. The most probable scenario that the perma-bulls would consider improbable is a 1-3 day correction on the order of -5.4% to -6.9%.
  2. The least probable scenario in my model is an October 1987 type day (down -23%); I’d still consider that improbable, for now.


EARLY LOOK: A Heavier Crash - heute


Now isn’t that a correction rather than a crash? If we eliminated that one little critter that the market calls expectations, yes, it might be. But relative to the expectations in this market today (this morning’s Bullish to Bearish Survey from Institutional Investor is seeing a +2400 basis point swing to the bullish side since the week US stocks closed at their late August lows), this could feel like a Heavier Crash than it might be considered in nominal terms.


What immediate term bearish data and price information in the land of global interconnectedness am I staring at in my notebook?


EARLY LOOK: A Heavier Crash - Notebook Image Hedgeye


EARLY LOOK: A Heavier Crash - Notebook Bearish


  1. The SP500 is teetering on a critical line of support (my intermediate term TREND line of 1144); any slicing through that line on accelerating volume puts this bearish scenario back in play (again, that’s not what I would consider tail risk – it’s a probability to manage risk around)
  2. Volatility (VIX) continues to trade with an extremely high inverse correlation to the SP500 with TREND line support for the VIX at 20.96
  3. The SP500 is actually down for 4 out of the last 6 trading days and the market’s breadth is deteriorating
  4. Financials (XLF) remain the only sector in the SP500 (of the 9 we model top-down daily) that’s bearish from a TREND perspective
  5. Yield Spread (10s to 2s) continues to compress this week versus last and remains a bearish headwind for US Financial spreads and earnings
  6. High Yield is trading within 7bps of its April 2010 highs at 8.25%; this is a contrarian indicator, big time
  7. Levered Loan Index at 15.13 is 5bps away from its late April early May highs; another contrarian (bearish) indicator for equities
  8. Case-Shiller Prices (JUL) rollover again sequentially (month-over-month) and we forecast the October 26th Case-Shiller report to be a bomb
  9. US Consumer confidence comes in at a bomb, 48.5 for SEP versus 53.2 AUG, despite CNBC cheering the stock market higher
  10. “Republican House” finds its way onto the cover of Barron’s = consensus bullish catalyst now
  11. M&A rumors haven’t been this frothy since September of 2007 (we’ve counted 67 alleged “takeouts” that haven’t occurred)
  12. US Dollar Index continues to burn at the stake of QE hope; down now for the 15th of the last 18 weeks and Washington doesn’t care
  13. US Treasury Yields are in a Bearish Formation across the curve (2yr yield TRADE resist = 0.51%) = bearish signal for US economic growth
  14. Chinese stocks have closed down for 6 out of the last 8 days and the Shanghai Composite is now broken on immediate term TRADE duration
  15. Japanese stocks continue to be the armpit that is long term QE; Nikkei down 3 of last 5 days and down -10% for 2010 to-date
  16. Japanese exports (AUG) hammered sequentially down to +15.3% y/y vs +23.5% y/y in JUL; expect more Fiat Fool intervention from here
  17. Japan’s Bureaucrats calling for another 4.6 TRILLION Yen in stimulus and proposing to pay for it by raising taxes this time?
  18. Spain’s IBEX is breaking its immediate term TRADE line this morning (first time in months; support line could become resistance at 10,501)
  19. Italy’s CDS continues to push higher at 205bps and remains the country with the most downside relative to consensus (we’re short EWI)
  20. European CDS continues to push wider on the heels of Greek Equities getting smoked (down -13% since 1st week of September with SPY +9%)
  21. Russian deficit risk heightening in the face of Medvedev firing the longstanding (18 year) mayor of Moscow
  22. Romania’s Interior Minister resigns in the face of austerity implementation
  23. Sri Lanka is now issuing sovereign debt ($6B worth) and markets there are cheering it on?
  24. Dubai says “we are back”

Acknowledging that there are plenty of bullish data points on the other side of this ‘QE is going to save us all’ expectation (there better be with the SP500 up +9.6% in a straight line from its August 26th low), I can only count 15 of consequence this morning - and that’s less than what I’d need to see for me not to call for a buckling of your chinstraps.


Horace’s lightening has already struck some of the highest mountains of buy-side and sell-side exposures in the last 3 years, but the lofty pines of professional politicians and the highest ivory towers of academic dogma that support them are still in for their heaviest crash yet.


My immediate term support and resistance lines for the SP500 are now 1136 and 1155, respectively. It’s not October yet. The SP500 hasn’t touched 1164 yet. So I’m not short the SP500 yet. Measuring time, space, and probabilities matter.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


This note was originally published September 29, 2010 at 08:01am ET



Conclusion: PFCB is facing easy comparisons in 3Q10 on many fronts.  At the same time, trends are getting better at the Bistro, which should make for a strong third quarter.  Co-CEO Bert Vivian’s modestly positive comments today increase my conviction that PFCB will have a marginally stronger back half of the year.

To that end, PFCB should move up and to the right into the “nirvana” quadrant of our restaurant sigma chart (positive same-store sales and growing YOY restaurant level margin) during the back half of the year after starting out the year in the “deep hole” quadrant (negative same-store sales and declining YOY restaurant level margin). 

Risk: Despite the company’s modestly optimistic outlook for the industry, our Hedgeye view is that the consumer will continue to face increased pressure in the back half of the year.


Mr. Vivian gave a broad overview of his outlook for PFCB and the industry for the balance of this year and next year at an investor conference this afternoon.  Overall, he said that the year is progressing as management had expected going into the year.  Specifically, business travel trends, or the weekday business, improved during the first half of the year while the social side of the business, primarily driven on the weekend, has caught up to-date in 2H10.  To that point, the company is seeing fairly even activity across the week on a YOY growth basis; though Mr. Vivian called the growth “modest.”


In August, same-store sales growth was positive for the Bistro in 36 of the 38 states in which it operates, which Mr. Vivian said signals a real change in tide of the overall health of the business relative to last year.  Trends were negative in all 38 states in the year-ago period.


Regional performance:  Las Vegas is currently one of PFCB’s strongest markets.  Traffic has been consistently solid this year in Las Vegas, which is a marked change from last year.  California continues to be an extremely important state for PFCB as it drives about 16-17% of sales.  Trends in California need to stay positive in order for the Bistro to be positive (California turned positive for the Bistro a few months ago).  Trends in Arizona have bounced back and forth whereas Texas and Florida have shown modest positive growth.


Commodities: The company is locked in on its commodity needs for the balance of 2010.


Share repurchase: PFCB expects to buy back about $40 million in shares in 2010.




Currently, Mr. Vivian expects 4Q10 to be ok as he thinks consumers will be out and about around the Christmas season; though people will still be looking for great value.




“Unless the solar systems collide,” Mr. Vivian expects next year to be marginally better for PFCB and the industry.  For industry trends to come in better than ok, there would need to be a significant change in the jobless situation, which he views as unlikely.


Commodities: The company is locked in on a bulk of its commodity needs through the end of FY11, with the exception of beef (which he expects to move higher).  On balance, PFCB is locked in at prices that are fairly similar to 2010 levels.


Labor:  Mr. Vivian expects higher labor costs to put some pressure on margins in 2011 as a result of increased wage rates, a higher level of turnover and higher health care costs, which are expected to be up low double digits.  The company hopes to take some price next year to offset these higher costs as long as traffic trends hold up in the back half of the year.


New openings: Current development plans include about 4-6 new Bistros each year over the next 3-5 years and about 10-15 Pei Wei openings in 2011 (closer to the low end of that range) and 15-20 in 2012.


Share repurchase: PFCB expects to buy back about $60 million in shares next year.


Unilever and International businesses: Expected to add a small, high-margin royalty stream to PFCB’s P&L over time, which requires no capital on the part of PFCB.


EPS growth: Expects to achieve low double-digit EPS growth over the next 3-5 years.




Howard Penney

Managing Director

US Dollar: Ugliest Macro Chart In The World



No, I’m not telling you to short the US Dollar right here and now. It will finally be immediate term oversold within 50 basis points from today’s price.  That said, you should continue to short it with impunity on rallies to lower-highs until America changes its conflicted and compromised monetary policy.


I typically don’t short-and-hold. But in this case I am, at a bare minimum, evolving my investment style. I shorted the US Dollar on June 7th when consensus about “Euro Parity” was running rampant and the US deficit and debt ratios were about to cross the proverbial Rubicon of risk. Risk for anyone with a US Savings account (which yields ZERO percent) or anyone who cares about the US Dollar-adjusted-value of their wealth, that is…


CNBC executives won’t get this because they think that the America’s health should be solely measured by the daily tick of her stock market. Sadly, they cheer on things like “QE” and they buy-and-hope that a balding man in government will save their advertising revenues.


Debauching a citizenry’s currency for the sake of short term stock market returns never ends well for that currency’s society. The current inverse correlation between the US Dollar Index and the SP500 is -0.88. That’s alarmingly high, but at least the nature of the mathematical reading has a very high correlation with the complacency of the government that stands behind this currency’s value destruction.


The reflation trade in everything priced in US Dollars will be on until the music stops. And it will stop. We’ve all seen this movie before. This time is different only in that we won’t be able to blame Lehman or Madoff.


"To stand in silence when they should be protesting makes cowards out of men."
- Abraham Lincoln


Keith R. McCullough
Chief Executive Officer


US Dollar: Ugliest Macro Chart In The World - 1

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CRI: Back in the Book

The near-term cotton trade is done like dinner. But CRI is putting up –HSD EPS on +HSD sales with raw materials set before a quarter of CRI’s customers were even born. How can they do +7% sales and +6% EPS next year??? No Way.



Keith added Carter’s to the short side of Hedgeye’s virtual portfolio yesterday; revisiting a high-conviction call that we have that margins will unravel by 400bps in 2011. See our 9/16 post ‘CRI: One of the Worst Stories in Retail.’  Also as noted in that report, the next 1-2 quarters have numerous events to be cognizant of as it relates to timing and sizing a position.


In his words (plucked from our email exchange) “Pretty bullish volume/price move there today – either someone knows something we don’t or someone thinks they do. I’d be digging for what you don’t want to find if I were you. TAIL/TREND lines of resistance converging in the $27.06-$27.76 range = bearish. TRADE support = $25.01, bullish.”


CRI: Back in the Book - cri


So let’s think about this for a minute… What can go wrong for a short here? The catalyst calendar is a pretty good place to start.

1)      Same store sales next week. Will likely confirm upside to anyone who owns/operates boxes that sell apparel.

2)      CRI reports 3Q on Oct 19. 12 weeks ago they lowered comp expectations from 4% to 2%. It’s no secret to anyone that business in September across all of retail was strong. Carter’s won’t be left out of that dynamic.  The company stated outright on its last call that a better comp could mean upside from its $0.76 implied guidance (Street at $0.74). Sensitivity is high on such a low (and insufficient) cost structure.

3)      Then 2-weeks later, CRI is hosting an analyst meeting to show the fruits of the new design team at Osh Kosh (15% of sales and EBITDA). It’s unlikely that the company is inviting analysts in to show them ‘how horrible the product is.’


Here are some offsets to keep on your risk-management plate.

A)     Message to the Street: Cotton COGS is not Real Time: The Street has come down a couple pennies in 3Q to $0.74, which I’m willing  to bet is due to cotton shooting from $0.75/lb to $1.01 today. But here’s what gets me…  The company is selling product today based on cotton bought six months ago. It is competing with others at retail who have a cost of materials set when a quarter of CRI’s customers weren’t even born yet. Think about that for a minute.


B)     Timing Mismatch:In a ‘rebound’ quarter like 3Q could be, the company is looking at mid-high single digit sales growth and a double digit decline in EPS?!? On top of that, the Street is modeling 7% sales growth in 2011 along with 6% EPS growth!?!  Can someone – I mean anyone – please explain to me how this is mathematically possible given the confluence of Macro factors?


C)     ‘We get it’ that everyone understands the near term cotton risk.What we don’t think people have really thought through are the implications for the margin climate as the companies start to absorb the real cost, and get pushed by partners in the supply chain. This supply chain is extremely complex, and is the key factor in sparking irrational pricing behavior (which, to a company like CRI that has a 40% discount on its product the day it hits the floor, is untenable).


D)    If Everyone Waits For Prices To Decline, Will It Happen? Consider this…We met with HBI and VFC last week, and have since had conversations with 2-other major apparel companies. While hardly a representative sample, one factor all had in common is the view that 1) cotton prices will stay at elevated levels, and 2) they’re not locking in anything at a buck per pound. So if they all agree that there is a supply problem, but will wait until prices come down before locking in, then it begs the question as to whether price will really come down after all?


E)      Why did so many companies blow off the cotton issue at the GS conference – and others since?Aside from not wanting to beat up their partner’s CEO at the very start of back-to-school season, the reality is that they were having a good revenue month. Good revenue on product procured before input costs went parabolic is hardly a reason for any CEOs to sweat during their few dozen double-secret one-on-ones.


We outline the full CRI thesis in out 9/16 report, and if anything feel stronger today than we did then about the idea. But if there’s any one clarifying factor today vs. then it is duration. For those who are shorting names like CRI today based solely on the ‘cotton trade,’ then congratulations, you’re late.  Those fans who are chirping that strength in cotton provide an opportunity to get involved with a ‘high-quality’ growth idea like CRI. Then I wish them the best of luck. They’re gonna need it. 


We’re going to stick with our research, good 'ol fashioned math, and our process.  There might be near-term ‘Oohs and Ahhs’ around leverage to a good September and the cute little denim for Jr. out of Osh Kosh. But it can’t sidestep what is a very big problem lurking below the surface. Our team will continue to dig deeper into the story, and unless the facts change meaningfully, we’ll get louder with our call on any strength. As always, Keith will manage around the timing/sizing.



CoD driving strong Mass and VIP business. We’re well above the Street.



The “crew that couldn’t get their act together” appears to have gotten their act together.  We first highlighted the potential for sustained market share gains in late July.  MPEL gained significant share that month, gained even more in August, and is poised to take another step forward in September.  Gaining market share while the market grows 40-70% is impressive, particularly for a company held in such low esteem by the investment community.




Given the strong market growth in Macau this quarter as well as an estimated 250bp sequential increase in market share to 16.0%, we think MPEL can post EBITDA of $120 million.  Consensus is only $100 million.  Our Q4 estimate of $92 million is also higher than the Street at $88 million.


City of Dreams drives most of the company’s revenues and profits and has been the market share driver.  So what’s driving the market share gains?  On the Mass side, we believe the reconfiguration of the slot floor earlier this year has created a busier and more exciting feel.  Too much space can be a bad thing for a casino.  Also, management was very promotional in the first half, particularly in Q2, which seems to be paying dividends. 


On the VIP side where the market share gains have been more pronounced, aggressive junket commissions have certainly helped although we do not think Q3 commission rates and VIP promotional activity have increased.  Rather, we think MPEL may be advancing junket commissions for 3-4 months.  Essentially, they are providing more credit to the junkets.  This should have the impact of better margins than a straight commission increase, but may create longer term credit risk.  For now, we are not worried.


While 16% market share was probably aided by high hold, particularly in September, we think a 15%+ share is probably sustainable and is likely above investor expectations.  Sure the stock has moved up significantly off its sub $4 in late July when we first turned positive on the name.  However, MPEL remains discounted to the group--10.5x 2011 EV/EBITDA versus 12.5-14.5x, and EBITDA estimates could go higher.  There is still 25% upside to the low end of that range, without the benefit of higher numbers.


Updated sales guidance implies that Jack in the Box trends are at least stabilizing.


Management stated at an investor conference this morning that it does not expect to see a significant improvement in Jack in the Box top-line trends until the unemployment picture improves in its key regions.  That being said, with less than one week left in the company’s fiscal 4Q10, management said that same-store sales are tracking slightly better the company’s most recent quarterly guidance.  For reference, JACK guided to a 4.5% to 5.5% decline in comp sales at Jack in the Box.  A -4.5% comp implies two-year average trends that are relatively stable with 3Q10.  The company attributed the better-than-expected trends to its strong promotional calendar and better service execution.




Howard Penney

Managing Director

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