Taking Sanity Seriously

This note was originally published at 8am this morning, November 01, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Everything is changing. People are taking their comedians seriously and the politicians as a joke.”

- Will Rogers


This weekend during his 200,000 plus people “Rally To Restore Sanity And/Or Fear”, Jon Stewart joined the ranks of calling the press out as the Manic Media. “If we amplify everything, we hear nothing,” he said. “The press is our immune system. If it overreacts to everything, we eventually get sicker.”


I don’t think he was precluding the financial media from that statement either. At least in politics there’s a core competency in being raging Republican or Democrat. In the arena of finance, the incompetence of academic dogma and Keynesian policy is pervasive. What sell-side lovers amplify as “news” becomes a contra-indicator that we make money from. Thank God for that.


This week brings us the Super Bowl of market hope:

  1. Tuesday = Midterm Elections
  2. Wednesday = Federal Reserve’s Decision to Debauch The Dollar
  3. Thursday = European Central Bank and Bank of England Fiat Fool statements

Then on Friday, everyone will come back from their mid-term election and Dollar debasement parties in Washington DC to be hung-over by Hedgeye reminding them that neither Republicans or Quantitative Guessing will result in anything more than what we already have in this country, Jobless Stagflation.


Jobless Stagflation? What’s that? Don’t ask Barron’s – they decided to title this weekend’s cover story “Bye-Bye, Bear”…


No, I couldn’t make that up if I tried… and no, I don’t think the probability is very high that Barron’s is a leading indicator on the US stock market’s next major move either.


Let’s start Taking Sanity Seriously and understand what’s occurred since Ben Bernanke exercised his conflicted and compromised right to give the perma-bulls and financial media alike something to cheer on since the Jackson Hole Groupthink Summit on August 27th:

  1. The SP500 is up +13%
  2. The CRB Commodities Index is up +14.5%
  3. The Input Price component of Chinese manufacturing is up +15.5%

Seriously? Yes, this is a very serious level of expedited inflation folks.


But what does it mean? Doesn’t this mean that Burning The Buck at the stake is a credible, everybody-wins, strategy? Or does the Manic Media on the Western side of the world get paid to suspend disbelief and take the Groupthinker’s word for it that this is going to end in jobs?


The Manic Media doesn’t do buy-side equations, but we’ll give them another one to chew on now that our clients have their positions on:


QG = COGS inflation


Seriously. It’s sort of one of those IF/THEN equations that they can build upon using the equation we gave them a few weeks back:


QE = i


Take these equations very seriously.


If, Quantitative Easing (QE) = inflation, and QE = QG (Quantitative Guessing), then QG = COGS (cost of goods) inflation. I know, I know. This is as brilliant a mathematical revelation as Morgan Stanley cutting its US Dollar forecast this morning “As The Federal Reserve Sets To Ease.” That and “Thirty Three Hour Race May Induce ECB Surrender on Weak Dollar” are top Bloomberg headlines this morning, fyi.


Notwithstanding the analytical incompetence of the political media on financial matters, this turns Jon Stewart into a very savvy politician, of sorts. Or is he a politician? Maybe he’s just simplifying the common sense signals that normal human beings have in their heads as Washington attempts to fear-monger you into believing that there is only deflation and, as a result, you should earn 0.17% on your hard earned savings in perpetuity?


Here’s what the Chinese think about this American style Burning of the Buck this morning:

  1. “US Dollar depreciation exacerbates currency war” –China Trade Ministry
  2. “China should buy gold, oil, to avoid US Dollar losses” –Chinese Business Reports
  3. “Yuan deposits rise as Hong Kong currency peg debate heats up” –Bloomberg Asia

Seriously? Yes, the Chinese  are seemingly sane folks.


Oh, and they have the real-time price data to support it. There was a creepy little Halloween critter in China’s better than expected PMI reports last night (54.7 OCT vs 53.8 SEP) called COGS (cost of goods) that showed input prices rise to 69.9 in October versus 65.5 and 60.5 in September and August, respectively. At the same time, South Korea released a new high in their inflation report of 4.1% overnight versus 3.6% in September.


If you’re taking the global interconnectedness of markets and prices seriously, you’re seeing inflation rise, globally, as joblessness stagnates locally. This is called Jobless Stagflation. And we don’t think the Manic Media’s stock market cheerleaders will make that go away by the end of this week.


My immediate term support and resistance lines for the SP500 are now 1169 and 1192, respectively. In the Hedgeye Portfolio, I remain short both the US Dollar (UUP) and the SP500 (SPY). I’ll be a seller of all buy-and-hope oriented strength this week.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Taking Sanity Seriously - SERIOUS

Bear/Bull Battle: SP500 Levels, Refreshed...



Fortunately, I didn’t waver this morning. All I did was sell. While I’m running out of long positions to sell, the bulls are running out of time.


Bearish intermediate term TREND signals have been developing since October 13th. In the last few trading days we’ve picked up some very bearish immediate term TRADE signals. Today’s intraday reversal in US equities only adds to a growing list of market risks.


The most problematic risk factors in the immediate term are: 

  1. TIME – the bulls have no time left on the bullish catalyst clock (Midterms and Quantitative Guessing)
  2. PRICE – both from an immediate term TRADE and RANGE perspective, signals are bearish (TRADE line resistance = lower-high of 1188)
  3. VOLATILITY – last week’s bullish immediate term TRADE breakout in VIX (+12.8% w/w) is being confirmed by another +3% rise today 

For the rest of my reasoning (Growth Slowing, Inflation Rising, and Interconnected Risk Compounding) please see my EL note from Friday titled “Drowning in Sweat.”


Immediate term TRADE support is now 1167. Today was a great day for risk management.




Keith R. McCullough
Chief Executive Officer


Bear/Bull Battle: SP500 Levels, Refreshed...  - 1


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



  • "So, I think we’ve been looking at every segment of the market and we’re finding some modest improvement, and we’re able to actually start to improve our rates. We become less dependent on the Leisure business and the Promotional segment, that’s the segment where we’re aggressively out there marketing and stimulating demand, and we’re trading that business for a little stronger kind of Convention and Group business, which last year averaged somewhere around 12.5% of our mix, and is trending closer to 17, 18% now."
  • [Asian business in  LV] "I think Asian business has decreased, but probably has sustained the best
    among all segments of the business."
  • Any improvement in spend per occupied room outside of room rates? "No material change. I think we’re just going to see just the benefit of a better mix. So, we’re displacing promotionally oriented, or leisure, more kind of value conscious customers with people that hopefully spend a little bit more. So, we’re not seeing by segment an increase in spend per room night. But we’re going to see some improvement just because of the shift in mix."
  • [Convention bookings] “We're booking through anywhere from 6 to 8 quarters. So, there’s a long tail on that. But we’ve had good, healthy bookings in the year for the year. Not what we would have liked to have seen coming into the year. But in the Convention segment, particularly, we’re seeing some strengthening going into next year.”
  • [Cotai] “We’re going to have 500 tables and 1,300 slot machines…we’re going to just build the most amazing hotel that anybody’s seen. And it will accommodate a lot of people, it will have 1,500 or between 1,500 and 1,600 rooms...We’re going to open before [MGM and SJM]...We’re not going to be any bigger than we are in the Peninsula in terms of gaming."
  • "Higher customer acquisition costs and table drop being down will continue into the second half of the year."
  • "We’re seeing good solid lift in the food and beverages outlets over at Encore. La Cave will open in early November."
  • "Wynn Macau generates 25% of the EBITDA in the market and 40% of the net income."
  • [Wynn Las Vegas remodel] "It will cost 99--45 for the typical room, 46 for the suites, and for the villas, another 10." 

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Conclusion: As we illustrated during our 4Q 2010 Macro Themes call on October 5th, consumption trends are under pressure as government supports subside and taxes increase.  The data released today shows this occurring in September and we expect this dynamic to continue in the fourth quarter and into 2011.


First, the ISM prints beats at 56.9 in October (the highest since May) from 54.4, that’s good news.  The contradicting and not all completely good news is that the upside appears to be completely driven by exports having increased 6 points in October while inventories dropped in October.  Not really a positive sign given that exports are such a small part of the economy and that the inventory builds accounted for 1.5% of the 2% GDP in 3Q10 (prior to the upcoming revisions).


What about the part of the economy that does matter, domestic consumption? A few bullet points:

  1. Both personal income and spending weakened in September.  Personal income fell 0.1%: the first decline since last September.
  2. The decline in income was driven by a $25.5 billion reduction in emergency unemployment insurance benefits.  Emergency benefits had boosted transfer income by $20.5 billion in August.
  3. Interest income (due to the Federal Reserve emergency interest rates fell 0.9% for the third straight month.
  4. Tax payments are up, driving disposable income down 0.2%.
  5. Real spending was up 0.1% driven by consumers diving into the savings rates which fell to 5.3% - matching its lowest level in over a year.

The Hedgeye consumer cannonball theme suggests that the next several quarters will be very taxing for the US consumer.  The thesis is based on very difficult year-over-year comparisons as Uncle Sam runs out of crutches and can no longer prop up the consumer.  A key takeaway from today’s data from the BEA is that transfer income is fading and taxes are on the rise.


While corporate profits are strong, the lack of confidence in the direction of the economy is holding back job growth as the unemployment rate will hit 10% before it will hit 9%.  The data continues to bolster our conviction; the private sector cannot make up the slack in income and the economy is experiencing Jobless Stagflation.


Howard Penney

Managing Director


Q4 2010 THEMES UPDATE - CONSUMER CANNONBALL - personal income taxes up tp down


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




  • “We continue to see growth in our mass market business in July and we are very comfortable predicting sequential volume growth in the third quarter of this year that is not dissimilar to that in the second quarter.”
  • “While we’ve grown with the market in the second quarter and third quarter, we are targeting to take some share in the fourth quarter of this year.”
  • “Depreciation and amortization cost is expected to be approximately 78 million US. Net interest expense in the third quarter is expected to be approximately 30 million and pre-opening expense will be approximately 4 million, which is primarily related to the House of Dancing Water.”
  • [CoD mass vs VIP breakout] “I mean the best way to look at that is to break it out in terms of split of EBITDA. And we are, at the moment, we’ve up to around about 50%, at theoretical hold rates on VIP, with roundabout 50% of our EBITDA coming from our mass activities and about 40% coming from our VIP business, the rest of it is non-gaming related. Do we think that we can move that mix to near a 60% coming from mass? Yes.
  •  "We would like to think that we would be able to do that. And clearly that would come from a step-up in overall mass volumes, associated with the amenities as we’ve suggested we’re aiming for.”
  • [Restricted cash] “We have part, 133 million of those proceeds in a restricted account, and that money will be applied against repayment on the bank loan that happened in the first three quarters. The first one being in December of this year (~$35MM) and then March of next year (~$35MM) and June of next year (~$63MM). In other words, we have no repayments under our bank loan until September of 2011 that need to be funded out of free cash generated from the business.”
  • “As far as our maintenance CapEx is concerned, it’s probably around about 30 to US$35 million across our portfolio of assets, on an annualized basis.”
  • [Macau growth rate] “So I think for the last quarter of the year, we should see in excess of 30% growth”
  • [House of Dancing Water] “It’s going to be three tiered, with the lowest tier being around US$50 per ticket and the highest tier being close to US$200… day-to-day maintenance cost is US$100,000 a day.”

We Are Calling For A Tie In The Senate And 65+ Republican Seats Gained In The House

Conclusion: It’s not politics for us, but simply math.  The turnout measures for Republicans are very positive and should drive a big Republican win to the tune of a net gain of 9 seats in the Senate and more than 65 seats in the House.


We’ve been pretty consistent in our call that the Republicans will do better than even most conservative prognosticators have been touting in the midterm elections coming up tomorrow.  The primary reason that we believe this is so is because of Republican turnout and enthusiasm, which is as high as it has been in generations.  Conversely, Democratic enthusiasm and turnout and enthusiasm seems markedly low versus more recent elections, particularly the 2008 election.


Our favorite poll to highlight broad sentiment is the Generic Congressional Vote poll.  Based on the Real Clear Politics poll aggregate, which looks at all of the major polls by all major polling organizations, the Generic Congressional Vote poll is the widest it has been in this cycle on the eve of the election.  We have posted a chart of this poll below, but currently the Republicans receive 49.8% of the generic vote versus Democrats receiving 41.8% of the generic vote for a spread of 8.0 points.  Interestingly the most recent four polls show an even wider spread with a spread that averages +11 in favor of the Republicans (this is using Likely Voters).  Momentum matters in elections, and the Republicans are clearly exhibiting momentum in this key poll.



We Are Calling For A Tie In The Senate And 65+ Republican Seats Gained In The House - Chart1



The secret sauce of any poll is, of course, its internals.  As we review many of the Generic Congressional Vote polls, the key measures we are analyzing are enthusiasm measures, which are a likely leading indicator for turnout.  While the spread in favor of the Republicans on the Generic Congressional Vote polls outlined above are incredibly significant as it relates to an advantage favoring the Republicans, the internals are even more so.  To wit: 

  • In the Pew poll taken from October 27th to October 30th, 70% of Republicans had given a lot of thought to the election versus 55% of Democrats for a spread of +15 favoring the Republicans.  In 1994, this internal favored the Republicans by only +5; and 
  • In the Gallup poll taken from October 28th to October 31st, 68% of Republicans have given a lot of thought to the election versus 54% of Democrats for a spread of +14 favoring the Republicans.  In 1994, this internal favored the Republicans by only +9. 

The fact that these enthusiasm measures are broader than in 1994 is quite telling as it relates to what will happen tomorrow.  In 1994, the Democrats lost 54 seats in the House.  As we will outline below, we think the losses this year will be more substantial than 1994.


As it relates to the Senate, we think that the when the dust settles on Wednesday, we could see a 50 – 50 tie. Currently, if we look at the seats that are not up for election, the Senators that may be independents but typically vote with one party or the other, or the polls that gives us a clear indication of who will win . . .the race for the Senate looks to be 48 seats for the Democrats and 45 for the Republicans with the remain 7 races currently registered by many poll aggregators as “Too Close To Call.”


As we look at the “Too Close To Call” races, it is clear that certain races have momentum towards one party or the other.  As a result, we will cede California to the Democrats at it seems Boxer will beat Fiorina.  On the Republican side, we will cede Colorado, Illinois, Nevada and Pennsylvania to the Republicans as the Republican appear to have the momentum in these races.  This leaves us with two races which will decide the balance of power in the Senate – West Virginia and Washington.  On the margin, it looks like Democrats might have a slight advantage in both of these races, but we believe at least one of these races will swing to the Republicans.  Most likely it will be West Virginia, which is historically more Republican (McCain won here by 13 points in 2008) and the polling has been less accurate and consistent over time.  In summary, we see the Senate coming in at 50 – 50, with Washington and West Virginia being the key races to watch in the Senate.  (Incidentally, in a 50 – 50 tie, the Vice President gets the deciding vote so the Democrats would still have control.)


In the House, a Republican majority is all but a foregone conclusion.  Based on the polls that are leaning or safe as it relates to either party, the Republicans are at 224 seats and the Democrats are at 168 seats, which suggests a net 46 seat gain for the Republicans.  Outside of this are the remaining 43 seats that are “Too Close To Call”.  While we could easily make the argument that these seats too will go on a high percentage basis to the Republicans, we will make a more conservative projection and suggest that half of the “Too Close To Calls” will go Republicans.  So, this is an incremental ~21 seats going Republican, which makes for a net Republican gain for 67 seats.  A Republican gain of 70 seats seems to be in the realm of mathematical reality as well. We have to go back to 1938 when the Democrats lost 72 seats to find a point in electoral history when a party has lost this many seats.


As former Congressman from Minnesota Walter Judd famously said:


“People often say that, in a democracy, decisions are made by a majority of the people. Of course, that is not true. Decisions are made by a majority of those who make themselves heard and who vote - a very different thing.”


In this election, nothing more could be true as, for better or worse, the Republicans seems overwhelming ready to make their voices heard by voting. 


Daryl G. Jones
Managing Director

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