American Bliss


“There are two ways of being happy: We must either diminish our wants or augment our means - either may do - the result is the same and it is for each man to decide for himself and to do that which happens to be easier.

-Benjamin Franklin


American Bliss - Ben Franklin




It is nearly impossible to get away from talking about QE – believe me, I tried.  But the quote below from Ben Bernanke is the first story that caught my eye today. 



American Bliss - Bernanke 2



"Raising the inflation objective would likely entail much greater costs than benefits.  Inflation would be more volatile, bring more uncertainty and possibly create destabilizing moves in commodity and currency markets that would likely overwhelm any benefits arising from this strategy."


Am I missing something or is this just another case of watch what I do, not what I say?


Mr. QE is doing nothing but destabilizing commodities and currency markets.  Our contention has been for some time that quantitative easing leads to reflation, which can lead to inflation.  Gold continues to signal high inflation expectations among investors.   The Hedgeye math says: QE =Reflation = Inflation


Pick your duration of one day, one week, one month, or three months; as quantitative easing expectations have ramped higher, so has the outperformance of commodity-driven equities and the global recovery-leveraged Materials and Industrials sectors.  Yesterday was no exception.  With the S&P trading flat on light volume, the best performing sectors were Energy (XLE), Materials (XLB) and Industrials (XLI).  The worst performing sector yesterday was Consumer Discretionary (XLY).  Yes, inflation is bad for consumer spending!



American Bliss - Federal Reserve


Rhetoric from Federal Reserve officials on the need for quantitative easing may affect the markets but consumer behavior, and confidence, remain impervious to Washington, DC Groupthink.  Downturns such as the one we are living through today (41m Americans on food stamps) deeply affect consumer confidence and attitudes towards debt accumulation in the name of consumption. 


As I said on our 4Q10 themes call, the Consumption Cannonball implies that consumers will continue to save more and are “reconsidering” their living standards; the policies of the FED and the Obama administration are perpetuating this trend.  While creating windfall returns for paper assets and financial institutions, quantitative easing has not met the expectations touted by many of its initial proponents.  By failing to improve the unemployment picture (as was promised), the administration’s policy of quantitative easing is a failure as far as Main Street is concerned.   The effect on the dollar (and commodities) of this policy is further hampering a consumer recovery.


The lack of traction in the labor market was reinforced yesterday after ADP reported that private payrolls fell 39,000 last month following a 10,000 gain in August, while consensus expectations were for a 20K increase. 



American Bliss - Chicago Federal Reserve



Charles Evans, President of the Federal Reserve Bank of Chicago said because unemployment is not coming down nearly as quickly as it should, his conclusion is that “we need more monetary accommodation than we’ve put in place!”  Yet there is no connection between QE and the ability to reduce unemployment!  As Albert Einstein said, “The definition of insanity is doing the same thing over and over again and expecting different results.”   


Despite the S&P 500 being up 8.7% in September, the consumer macro factors were mixed as confidence, employment and housing data all added further to our conviction that recent governmental policies are failing to produce a real consumer recovery.  


For all the valuation junkies that will tell you that the market is cheap on a P/E basis, that metric will be fighting the gravitational pull of slowing growth.  Despite all of the QE talk, 3Q10 will likely represent the last double digit EPS growth quarter for the S&P 500 for the next one, maybe two years.  Which begs the question, have you factored in enough of a slowdown in earnings growth? 


American Bliss - 1


Looking out over the next 6 quarters, consensus is projecting S&P 500 earnings growth of 20% in 3Q10, dropping to 11.8% in 4Q10 and sub 10% for the balance of 2011.  In a slowing growth environment, how do you manage risk around the fact that these estimates might be too aggressive?  This is the question every portfolio manager/analyst needs to be thinking about as we head into the current earnings season. 


As it relates to our 4Q10 Consumption Cannonball theme and the implied year-over-year deceleration in discretionary spending, Brian McGough asked the question: are management teams being conservative enough?  How do you manage risk around 2011 guidance that companies might throw out to the Street before they know; (1) what will happen to the consumer, and more importantly, (2) how will they behave when desperate competitors react in a weak consumer environment?  


How will you manage risk around this?


We are likely to get a small preview of these trends with today’s retails sales data.  Most retailers are expected to meet estimates that are not viewed as overly aggressive; although difficult comparisons will also play a role as September 2009 was the first month of positive comps in some time for many retailers.


For the time being many American will be forced to diminish their wants in order to be happy. 


Howard Penney


Conclusion: Ruby Tuesday has seen a solid start to their fiscal year; time will tell how the new business pans out. 


RT’s fiscal 1Q11 top-line and bottom line results came in better than I was expecting, but relatively in line with street estimates.  Same-store sales grew +1.2% during the quarter, which implies a 50 bp acceleration in two-year average trends from the prior quarter.  This performance is impressive given that Knapp trends decelerated 10 bps on a two-year average basis during the same timeframe.  During the quarter, RT widened its gap to Knapp to +2.5% on a two-year average basis versus -1.8% in the year ago quarter.




Restaurant-level margin improved 210 bps YOY to 18% (excluding the $1.7 million in accounting gains from franchise partner acquisitions).  I was expecting restaurant margin to improve in 1Q11, but this growth exceeded my expectations, largely as a result of better-than-expected comp growth and “lower levels of promotional activity.” 


Given this positive margin and comp growth, RT operated in the Nirvana quadrant of our restaurant sigma chart for the second consecutive quarter.  Going into the quarter, I thought the company could fall out of Nirvana as early as 2Q11, but given the strong current trends, RT could potentially remain in Nirvana in the next quarter (if the company can sustain its current sales momentum).  The margin comparisons, however, do get more difficult in the back half of the year.  For reference, RT is now guiding to flat full-year restaurant-level margin versus its prior guidance of a slight YOY decline.  This flat guidance implies that the company will have to give back some of the gains achieved in fiscal 1Q11 as it progresses through the year.




Management maintained both its full-year same-store sales growth guidance of flat to +2.0% and its EPS outlook of $0.76-$0.86 (street is at $0.85).  Although RT got a head start during the first quarter in achieving this comp goal relative to my expectations, I continue to believe that this target, particularly the high end of the range (street is at +1.9%), will be difficult to accomplish as it implies a continued improvement in trends on a two-year average basis for the balance of the year.  The Hedgeye view is that the consumer will face increased pressure in calendar 4Q10 and into calendar 2011.  At the same time, RT will face increasingly more difficult comparisons as it progresses through the year, particularly in the back half of fiscal 2011. 


RT seems to be doing all of the right things to increase its guest satisfaction scores, add sales layers and improve operations within its four walls.  The company has made a lot of progress in growing same-store sales and started the year with a lot of momentum.  To that end, my concern around the company’s ability to achieve the high end of its comp guidance, as expected by the street, is more a function of the economic environment and the potential for a further slowdown in top-line trends for the casual dining industry as a whole.



Howard Penney

Managing Director

People lie, and so do Governments: Contemplating Greece's Deficit

Portfolio: Long British Pound (FXB), bullish on EUR-USD; Short Italy (EWI)


Conclusion: citing a senior government source, Eurostat is expected to revise Greece’s budget deficit and debt in 2009 significantly upward. This announcement puts further question into the validity of Eurostat data and by extension the data from member countries. Greece’s likely upward revision ties into our forecast for continued sovereign debt risk in Europe, and underlines our call for a divergence, especially among Europe’s fiscally weaker countries.  Today we sold Germany (via the etf EWG), our one bullish position in Europe. We caution on slower growth across the region into year-end. 


The Eurozone’s sore thumb, Greece, could look a lot more black and blue if in fact Greece’s budget deficit and debt for 2009 are revised higher. Sources suggest the country’s deficit could be revised to 15.1% of GDP from 13.8% and the debt could be revised to 127% of GDP versus a previous calculation of 115.1%.


Clearly, a revision of this magnitude is not inconceivable given the country’s years of fiscal mismanagement, including improper book keeping.  If substantiated, the revision further erodes Greek PM’s George Papandreou’s credibility and his targeted debt and deficit reduction plan over the next three years. 


Our view is that Greece (and debt and deficit-laden countries like it) will remain the EU’s baby in the sense that European commissioners and heads of state will do everything in their power to prevent the immediate term failure (default) of member states for fear of the associated volatility (contagion).


Euro-crats had a good taste of contagion fears and currency destruction in the first half of the year, which led to the decision on May 9th to issue a €750 Billion package of medicine to contain it. Politics are generally local, but recently the EU’s political scene has gone global. Surely politicians in Brussels can ill afford talk of the destruction of the Eurozone!


While we don’t see an outright default by member countries over the intermediate term, what is clear is that capital markets are signaling the distressed outlook for fiscally weaker nations.  For instance, Greece’s Athex Composite is the worst performing equity market in the world YTD, down -29.3%. And as the charts below display, 5YR Sovereign CDS spreads have not abated significantly over recent weeks, with Portugal and Ireland holding above the 400 bps level, a critical break-out level (Shark Line) based on our analysis.  Also, as the final chart shows, sovereign bond yields also remain elevated particularly for Portugal and Spain, a reflection of the risk premium investors demand to hold the country’s debt (see charts below).


Certainly there are a number of headwinds for investors to be aware of in Europe.  We’re currently short Italy in the Hedgeye Portfolio and very cautious on the region as a whole. Please see our post on 9/28 titled “Why We’re Short Italy” for our fundamental view on Italy.


Matthew Hedrick



People lie, and so do Governments: Contemplating Greece's Deficit - t1


People lie, and so do Governments: Contemplating Greece's Deficit - t2


People lie, and so do Governments: Contemplating Greece's Deficit - t3

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Dollar Stores & Food Stamps

Is it me, or does Family Dollar have stellar timing in hosting their analyst meeting on the day that government reports that a record number of Americans are receiving food stamps? The longer this trend continues to climb, the better it is for the dollar stores.  This comes in the form of increasing penetration of EBT as a % of sales as well as overall growth in the demographic that NEEDS to shop at deep-value discounters.  Keep in mind that this is through July, but nonetheless anecdotal evidence suggests the overall trend is still positive from the dollar store perspective.


Eric Levine


Hedgeye Retail




“With all of the talk about record highs (Gold) and record lows (Japanese interest rates), it’s important to focus on another record-high number that Americans on Main Street really understand. 


Whether the NBER says so or not, the recession persists for many Americans.  A record 41.8 million participants received food stamps in July as part of the Supplemental Nutrition Assistance Program, according to government data.  Furthermore, the White House estimates that an average of 43.3 million people will get food stamps each month in the twelve months that began October 1st, 2010.  The rising costs of food and energy (dare I say it, “inflation”), and the lack of job creation, continues to hurt the consumer – especially those at the low end of the spectrum.” 


Howard Penney

Managing Director

Hedgeye Macro



Dollar Stores & Food Stamps - FoodStamps 10 6 10



Sports Apparel: Negative Turn – Except NKE

Yes, we’d been prepping for a very tough comp. But even looking at the true underlying trend (2-year on a smoothed 3 week run rate) it still rolled. Still sitting at about +2-3% -- so it’s not the end of the world. But it marks the second week in a row that we saw this magnitude of erosion. 1 week is relatively meaningless to us. 2 weeks makes us raise an eyebrow. 3 weeks is a trend. Nike is the only brand to post a positive growth number for the week.


Sports Apparel: Negative Turn – Except NKE - FW App Ind Total Table 10 6 10


Sports Apparel: Negative Turn – Except NKE - FW App AppChan 1yr 10 6 10


Sports Apparel: Negative Turn – Except NKE - FW App AppChan 2yr 10 6 10


Sports Apparel: Negative Turn – Except NKE - FW App Reg 10 6 10


Sports Apparel: Negative Turn – Except NKE - NKE Apparel T3W 10 6 10


Sports Apparel: Negative Turn – Except NKE - UA Apparel T3W 10 6 10



Eye On Latin America: Callouts from Brazil and Argentine

Conclusion: Depending on the result of the Brazilian Presidential election, the Brazilian economy may see an incremental boost in private sector investment, as a Serra victory is bearish for Brazilian interest rates. Also, Argentine CDS are at two year lows – this could potentially be a contrarian indicator.


Brazilian Presidential Election


As anticipated, Lula successor Dilma Rousseff won the initial election on October 3rd, though she failed to garner the 50% necessary to immediately emerge as Brazil’s new political leader.  That leaves her and her main rival Jose Serra, who lost to Lula in the 2002 presidential election, to go head-to-head in a runoff election scheduled for October 31st.  As it stands now, Rousseff has 46.9% of the popular vote and Serra has 32.6%; the wild card will be what happens with now-eliminated third place candidate Marina Silva’s 19.3% of voter support.


Assuming that a large percentage of Silva’s 19.6 million supporters show up at the ballot box in the runoff election, her followers will have a large voice in determining Brazil’s next president. Her supporters are typically university-educated young professionals, environmentalists, and a group of Evangelical Christians who oppose Rousseff because of her stance on legalizing abortion. Because of these qualities, many expect a large portion of her following to favor Serra over Rousseff, which could potentially push Serra over the top in the next round. Of course, this would assume that Rousseff’s fails to garner incremental votes from any potential non-participants during the first election.


As we called out back in July, a Serra victory is more bullish on the margin for Brazil’s private sector, as he is in direct contention with Brazil’s high interest rates and wasteful government spending. Rousseff, on the other hand, is essentially a Lula pawn and is expected to continue the social programs and heavy government spending that has made Lula such a popular president among the masses (~75-80% approval rating).


 Considering the dichotomy between their fiscal positioning, a Serra victory may be incrementally bullish for the real, which the government has had trouble containing of late (up 12% vs. the U.S. Dollar since late May). While it may seem at first glance that Serra’s desire to lower the Selic rate would be negative for the real, his reputation for fiscal austerity and his support for Brazilian private sector growth may prove to be the deciding factors in the real’s pace of appreciation, should he become elected.


Elsewhere in the Brazilian economy, in the latest attempt to stem the real’s gains the Brazilian government will double to 4% the tax it levies on foreigner’s investment in the nation’s bonds. The tax was first introduced a year ago in October and was greeted with near-term success (the real declined 3.5% from mid-October through the start of November). It, however, resumed appreciation back to its original high one week later, only declining substantially after the U.S. Dollar bottomed out early December. Considering the intermediate and long term outlook for the fiscal health, economic growth, and interest rates in the U.S. and Brazil, we don’t see the real’s bullish fundamentals eroding anytime soon.


Eye On Latin America: Callouts from Brazil and Argentine - 1


Eye On Latin America: Callouts from Brazil and Argentine - 2


Argentine CDS Head Fake?


By now, it’s no secret that Argentine is doing well economically as evidenced by the government’s 9.5% GDP growth projection for 2010 and the S&P’s Sept. 13th upgrade of Argentina’s debt rating one notch to B (five levels below investment grade). What does come as a slight surprise to us is the market’s positive reaction to the Argentinean government’s decision to use FX reserves to pay down debt – an action that is typically frowned upon because of its propensity to stoke inflation.


Currently, Argentine President Fernandez de Kirchner is avoiding selling bonds internationally to service debt despite the lowest yields in two years (~8%). Rather, she and central bank President Mercedes Marco del Pont have elected to finance debt service with FX reserves, which have grown to a record $51.2 billion as a result of dollar purchases and strong export growth. YTD, Argentine has spent $5 billion of reserves this year and plans to use an additional $7.5 billion next year to service debt (TRANSLATION: Piggy getting hooked on the trough). Never mind that the former central bank president Martin Redrado was fired for refusing to back the plan because of its inflationary potential.


On the inflation front, many Argentinean economists have gone on record to publicly contest the government’s reported 11.1% inflation rate, suggesting that consumer prices may be growing at more than twice the rate. Moreover, a September 15 survey by Buenos Aires-based Torcuato Di Tella University showed that consumer prices are expected to rise 25% over the next 12 months, further supporting inflation skeptics’ views on the economy. To sterilize recent sales of the peso, the government is issuing short term local debt that pays about 12 to 14% interest. So effectively, the government is taking a loss on the dollars it is buying which yield ~40bps on 2-year U.S. Treasuries. The total supply of central bank debt maturing in one month to three years has grown 77.1% since June ’09 to 60.4 billion pesos. We interpret that as Argentina’s liquidity risk just increased by some fraction/multiple of 77.1% in the last 15 months.


Also, we’d be reckless to not callout the potential for Argentine’s export tailwinds to deteriorate, creating directional headwinds in the process. The Argentinean economy has benefitted YTD from record export tax revenue (+92% YoY in September) fueled by a record 55 million ton soybeans harvest.  Soybeans (prices up +21.1% YoY) have an inverse correlation of 0.80 to the U.S. Dollar on a three-month basis, which has lost 12% of its value since its high on June 7th. Similar to company analysis, we callout peak revenue and peak margins on the country level as potential inflection points that are not to be streamlined into the future estimates of valuation.


To some extent, the Argentinean CDS market may be pricing in such peak revenues, as evidenced by Argentinean CDS hitting lows not seen since August 2008. Of course, two months later, the spread widened to over 4,000bps in the heart of the financial crisis. While we’re not suggesting a repeat performance, we are keen to highlight asymmetry of the current risk setup, considering the overwhelming positive investor sentiment regarding the Argentinean economy.


Darius Dale



Eye On Latin America: Callouts from Brazil and Argentine - 3

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