Mandelbrot Math

“He doesn’t spend months or years proving what he has observed.”

-Professor Heinz-Otto Peitgen, on Benoit Mandelbrot


Benoit Mandelbrot was one of the most important contributors to my multi-factor, multi-duration, global macro risk management model. After publishing “The Fractal Geometry of Nature” in 1982, Mandelbrot eventually landed in New Haven as a professor in Yale’s math department. He finally earned his tenure as I was leaving campus for Wall Street in the late 90’s. Over time, he’s been recognized as one of the forefathers of fractal math.


On October 14th of this year, Professor Mandelbrot passed away in Cambridge, MA.  He was 85 years old. A few days later, one of our analysts, Matt Hedrick, sent me a nice tribute that Jascha Hoffman wrote for Mandelbrot in The New York Times. That’s where the aforementioned quote came from and it was followed by this one (which is taped on the insert of my notebook):


“But if we talk about impact inside mathematics, and applications in the sciences, he is one of the most important figures of the last 50 years.”

-Professor Heinz-Otto Peitgen (“Benoit Mandelbrot, Novel Mathematician, Dies at 85”, by Jascha Hoffman, NYT, October 16, 2010)


Amen Professor Peitgen. And thank you Jascha Hoffman. Benoit Mandelbrot was no one’s yes man. He wasn’t academically dogmatic either. He kept learning and re-thinking. As a result, I think the principles of Mandelbrot Math will be applied by global macro risk managers for decades to come.


I call this out this morning as I just got back from an investor trip that took me to Western Canada. The contours of the Rocky Mountain tops would most certainly fascinate Mandelbrot inasmuch as they would the fractal dimension of the Pacific Ocean’s coastline. Anyone flying across this world attempting to consider its deep simplicity from a top down perspective probably gets what I mean. It’s what make this game fun.


When you wake-up every morning trying to make a global macro market “call”, you need a place to start from. In order to attempt to know where you are going with that “call”, you most certainly need to know where you’ve been. By the time that market’s bell rings, you don’t have “month or years to prove what you have observed.” You have minutes. This is the game.


This morning’s global macro game is confusing. The US stock and bond markets are sending completely different messages as Asian stocks and bonds continue to break down.  All the while European sovereign risk premiums continue to fluctuate like twitter.


Let’s look at US markets first:

  1. The SP500 had its 1st up day in the last 3, making a bullish comeback from an outside reversal on the day prior, hitting a new YTD high at 1228.
  2. The SP500 is now up +81.7% from its March 2009 lows and down -21.5% versus its October 2007 highs.
  3. The immediate-term TRADE range for the SP500 moves to 1, with the daily downside risk being about equal with upside reward.
  4. Volatility (VIX) at 17.74 is testing a breakdown towards its April lows; while this is a bearish contrarian signal, the VIX could easily test 16.
  5. US stock market Volume and Breadth studies continue to flash bearish, despite higher prices, there is a very negative skew.
  6. In our SP500 Sector Studies, 2/9 sectors are bearish (XLV, and XLU) and 7/9 bullish from an immediate-term TRADE perspective.
  7. The US Dollar Index continues to flash bullish on both our TRADE and TREND durations, with intermediate term TREND support at $79.49.
  8. US Treasury Yields continue to boom to the upside with 2s, 10s, and 30s all busting out into what we call Bullish Formations.
  9. The Yield Spread (10s minus 2s) continues to widen at +10bps for the week-to-date, supporting the rally in Financials (XLF).

Overseas, the immediate-term game is much less confusing:

  1. Chinese equities were down another -1.3% overnight and remain bearish from an immediate-term TRADE perspective at -14.3% YTD.
  2. Indian equities got tagged for another -2.3% drop overnight as the BSE Sensex broke its intermediate term TREND line of 19,655.
  3. Japanese equities are the only bullish immediate-term TRADE market in Asia as the POSITIVE correlation to the USD reigns supreme.
  4. Australia’s central banking guru, Glenn Stevens, continues to prove that raising rates and seeing unemployment drop can work together.
  5. Germany, Russia, and the Netherlands continue to flash bullish TRADE and TREND signals in both stocks and bonds.
  6. Spain, Italy, and Greece continue to flash bearish TRADE and TREND in both stocks and bonds.
  7. Brazil looks like India, as stocks on the Bovespa are down every day this week and now bearish on both TRADE and TREND durations.
  8. The Euro continues to flash bearish on both our TRADE and TREND durations with intermediate-term TREND resistance = $1.34.

Global Commodities markets continue to confirm what almost every country’s central banker who has real-time quotes sees – inflation:

  1. The CRB Commodities Index closed at 316 yesterday = +21% higher than Bernanke’s decision in Jackson Hole to Quantitatively Guess.
  2. Oil is in a Bullish Formation with immediate-term TRADE lines of support and resistance of $87.17 and $91.47, respectively.
  3. Copper prices are testing ALL-TIME highs again this morning = +29% since The Ber-nank opted to sponsor inflation.

Gold, meanwhile, looks a little bit less-like most commodities all of a sudden. To a degree, if real-interest rates continue to push higher, the gold bulls will have to compete with that yield. That’s new. Tops are processes, not points, but Gold will need to get back above its immediate-term TRADE line of $1390/oz to get me interested in getting long it again (I sold our GLD position on Monday).


Altogether, if you take the beginning and end of 2010, you can draw plenty of conclusions that are now crystal clear. From my global macro model’s vantage point, the deep simplicity of all of these global macro factors and what they mean prospectively to the global markets remains as follows: Growth Slowing, Inflation Accelerating, and Interconnected Risk Compounding.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Mandelbrot Math - mandelbrot


The Macau Metro Monitor, December 9th, 2010


Jorge Oliveira, Macau Gaming Commission's former legal affairs chief, said more casino regulation and an overhaul of the junkets are needed.  Mr Oliveira also opposed the concentration of more economic activities in the hands of casino operators and resists the idea that Macau should fully open its casino industry.



According to Reuters basis point, RWS is seeking to borrow around S$4.2 billion to pay off an existing loan.  The refinancing comprises a S$3.5 billion seven-year amortizing term loan and a revolving credit facility.  The term loan, which has an average life of 4.13 years, will pay an initial interest rate of 160 basis points over the Singapore dollar swap offered rate.  If the debt-to-EBITDA ratio falls to 2.5 times or lower, the interest will fall to 120 bp over SOR.  Bank of Tokyo-Mitsubishi UFJ, DBS, HSBC, Oversea-Chinese Banking Corp and Sumitomo Mitsui Banking are lead arrangers and joint bookrunners for the loan.



The Guangzhou‐Zhuhai Intercity Mass Rapid Transit (MRT) will come into operation by the end of December.  The train began trial operation last Tuesday.  The trial train runs four to eight times from Jinding to Guangzhou at a speed up to 350km. Construction of the Zhuhai Station in Gongbei is still under way and to be completed by the end of 2011.  The train from Zhuhai to Guangzhou will take 45 minutes.

Clever Enough

This note was originally published at 8am this morning, December 08, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The individual’s power to operate something with a deficit is very limited.”

-Ludwig von Mises


I think people who run their own companies (or lives) without government bailout support get this very simple point. It’s Darwinian.


Most modern day federal governments, however, don’t have to have any experience in the simple matter of balancing a budget. As the late Austrian economist, Ludwig von Mises, astutely pointed out, “for the government, conditions are different. The government can run a deficit, because it has the power to tax people.” (Economic Policy, von Mises’ 3rd Lecture, “Interventionism”, page 28)


Well what happens if a government that’s running a deficit doesn’t have the political spine to tax people? Simple answer. The risk associated with that government’s sovereign debt goes up. That’s the price of fiscal irresponsibility. Try this at home with your credit card debt and you’ll get the point.


Yesterday was a fascinating day in the US stock market. In risk management speak we call what happened an “outside reversal.” Essentially, outside reversals occur when some buy-and-hope event (extending the Bush tax cuts) sends US stock market futures soaring to fresh YTD highs… but then they fade intraday on heavy volume… and close below the prior YTD closing high. An outside reversal is a bearish immediate-term signal.


The 2010 YTD high for the SP500 is 1225. Intraday, the market registered readings as high as 1234 (on the open at 945AM EST when emotional decisions run rampant), but sold off hard into the close to settle down at 1223.


All the while, US Treasury yields were screaming higher. They were telling you, Mr. Shortermism of Political Career Risk Management, that CUTTING taxes when you have a massive deficit problem = sovereign debt risk.


So, if you are a government… and you have a debt financed deficit spending problem… and you can’t tax anyone… what do you do? This is not a trick question. There’s only one answer the Fiat Fools have for this – INFLATE.


In fact, it was the forefather of Big Government Intervention, John Maynard Keynes himself, who wrote in his 1936 manifesto, the General Theory of Employment, Interest and Money, that “if one devalues the currency and the workers are not clever enough to realize it, they will not offer resistance against a drop in real wage rates, as long as nominal wage rates remain the same.”


Sorry to Messrs Bush, Obama, and The Ber-nank. This Canadian American’s workers are Clever Enough.


If the ideological submission by the Keynesians is that:

  1. Markets are rational, and
  2. American workers are stupid…

I’ll comfortably sit on the common man’s side of that trade.


If the conclusion is that we can load American 301ks with bond fund allocations and no one will notice when they get ploughed, we’ll take the other side of that theoretical trade too. Inflation is bad for bonds.


Both US and Global Bond Yields are all of a sudden making a credible threat to break out into what we call a Bullish Formation (bullish on all 3 of our core investment durations: TRADE, TREND, and TAIL). The corollary to this is that sovereign bonds (including US Treasuries) are moving into a Bearish Formation. This is not what The Ber-nank ordered.


The following lines are the bullish intermediate-term TREND lines of support across the US Treasury Yield Curve:

  1. 2-year yields = 0.46%
  2. 10-year yield = 2.66%
  3. 30-year yields = 3.90%

In other words, bond yields are trading significantly above their intermediate-term TREND lines of support and bond funds are breaking down, hard, as a result. Maybe that’s why this morning’s ABC Consumer Confidence reading remains astonishingly low at -45 (that’s a minus 45, less than 10 points off its all-time lows) on the weekly print, despite the US stock market having a monster move of +2.9% to the upside in that week.


Maybe Americans don’t own as many stocks as they did when they had 401ks…


Maybe someone stuffed their 301ks with bond fund allocations at a bond market top…


Maybe Americans are Clever Enough to know what’s happening to their money when A) the government can’t tax and B) has chosen to inflate…


My immediate term support and resistance levels for the SP500 are now 1206 and 1239, respectively. I’ve dropped the Hedgeye Asset Allocation to Bonds to 6% in the last month and I remain short the SP500 via the SPY in the Hedgeye Portfolio.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Clever Enough - EL dec 8 chart

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Robust Germany

Position: Long Germany (EWG); Short Euro (FXE), Short Italy (EWI), Short Spain (EWP)


Germany’s fundamentals and capital markets continue to signal a positive divergence versus most of its European peers, however we caution that the DAX is approaching an immediate term TRADE overbought level (see chart below).  


Robust Germany - h1


From a fundamental standpoint we continue to emphasize just how important Germany’s fiscal conservatism is as a differentiating factor versus its debt and deficit laden peers, the PIIGS in particular, which we believe has contributed to its equity outperformance (chart below).


Robust Germany - h2


Germany’s deficit is projected at 3.7% of GDP this year, according to the German Finance Ministry, with public debt at 75.5%.  In comparison, most PIIGS are pushing deficit-to-GDP levels near low double digit figures with debt-to-GDP near or above 100%. As Reinhart and Rogoff examine in their work “This Time Is Different”, which examines sovereign default over the last 800 years, there are two important metrics used to indicate when a government is reaching the crisis zone of fiscal imbalance: debt-to-GDP north of 90% and deficit-to-GDP north of 10%.


It therefore comes with no great surprise that based on YTD equity performance alone, the market is rewarding those countries that have not violated these critical fiscal levels. Germany is certainly one standout. On the credit side, we continue to see elevated yields (though off their highs) for the PIIGS.  As we noted in previous works, despite the bailouts of Greece and Ireland, we expect yields to remain elevated over the intermediate to longer term as the Sovereign Debt Dichotomy plays out in Europe, which will further hamstring peripheral countries that require debt servicing to meet their fiscal imbalances.



German Data


Returning to German fundamentals, the data (while admittedly a bit stale), presents a positive picture.


German Industrial Production reported today showed a +11.7% year-over-year gain in October, or +2.0% gain over the previous month. Reported yesterday, German Factory Orders rose +1.6% in October month-over-month, or +17.9% year-over-year. Here we’d note the comp of -8.2% in October 2009, and caution that comparisons will get more difficult into year-end (see chart).


Robust Germany - h3


German Export and Import figures for October were also released today and showed a contraction in Exports of -1.1% in October month-over-month, while Imports rose +0.3% versus the previous month.  Despite the “wet Kleenex” for October exports, Germany’s exporting base looks poised to remain strong into year-end.


Further, German consumer and business confidence surveys have looked strong over recent months, as has Manufacturing and Services PMI, bolstered by an unemployment picture that has improved nearly every month over the last year. Unemployment currently stands at 7.5% in Germany versus 10.1% in the Eurozone or such extremes at 20.7% in Spain or 13.6% in Ireland. 


The German Economic Ministry recently revised its GDP forecasts up to 3.4% in 2010 and 1.8% in 2011. For comparison, the only other countries that will see growth in this area code in Europe are: Poland 3.20% in 2010 and 3.50% in 2011; and Sweden 4.35% in 2010 and 3.15% in 2011, according to Bloomberg estimates.


Today we shorted Spain (via the etf EWP) in the Hedgeye Virtual Portfolio with the IBEX 35 rebounding off another dead-cat bounce.  Spain remains broken on immediate TRADE and intermediate term TREND durations, and we believe will likely be the on the near horizon to need European and international assistance to contain its fiscal imbalances.


Matthew Hedrick








Global Pipeline and Owned Portfolio

  • 72-73 hotel openings this year
  • Building owner preference to own more hotels
    • HOT booking channels generate a large % of hotel room nights- especially corporate room nights
    • Yield management system
    • HOT marketing efforts
    • Brand recognition allows them to diversify the origin base of guests for hotels
  • Pipeline
    • 5.4% CAGR in operating rooms since 2004
    • Largest relative growth potential out of their competitive set.  Their pipeline represents 28% of their existing room base.
      • HLT's pipeline is 22% of their base
      • Hyatt's is 21%
      • MAR's is 16%
    • Four Points is well positioned as a conversion brand for Western Europe and NA.  This brand is also well positioned for primary and secondary cities in emerging markets
  • Owned real estate portfolio and strategy to maximize value
    • 21,000 room/ 62 hotels
    • 85% wholly owned
    • Remain committed to asset light
    • Mostly in NA, and in urban markets which protect them from supply growth as these are higher barriers to entry markets
  • Maximizing shareholder value - owned portfolio
    • 60% don't require a lot of capex and are relatively easy to sell
      • Sheraton on the Park in Sydney (considered offers for the asset in 2009 but prices didn't meet expectations and this year will achieve peak earnings levels)
      • St. Regis San Fran
      • St. Regis Rome
      • St. Regis NY
      • Park Tower
      • The Phoenician
      • W Chicago
      • Westin Excelsior Florence
      • Westin Excelsior Rome
      • Sheraton Gateway Toronto
      • Sheraton Centre Toronto
      • Sheraton Maria Isabel
      • Sheraton BA
    • 25% need a lot of capex
      • St. Regis Aspen which was just sold is a good example- needed a renovation - sold for $70MM to an owner that was willing to invest in the asset
      • Grand Florence
      • Gritti Palace
      • W New Orleans
      • W Chicago - Lakeshore
      • Westin Gaslamp
      • Westin St. John
      • Westin Cancun
      • Sheraton Kauai
      • Sheraton Steamboat
    • 15% of hotels are very large and would meaningfully benefit from a repositioning and redevelopment - may need a partner
      • Manhattan at Times Square is a good example (was Sheraton Manhattan) - unclear that a hotel is the highest and best use for this hotel
      • Sheraton Rio
      • Westin Peachtree
      • Westin Maui

Summary and Financial Update

  • Since 2000 they have sold 110 hotels for $7.5BN
  • For 10 years, 70% of their business came from the US; now 62% of their business is international
    • Added 338 mgm'd and franchised hotels (79k rooms) since 2000, 70% (55k rooms) outside the US
    • Expect to drive 80% of profits outside the US eventually
  • Launched new brands:
    • W in 1998
    • Westin Heavenly launch 1999
    • Sheraton Revitalization (2007)
    • Launch of Aloft and Element (2008)
  • Targets of their transformations:
    • Higher growth trajectory
    • Lower cyclicality
    • Higher margins
    • Higher capital efficiency
    • Superior cash flow generation
  • 50% of their Luxury brands are located outside the US and 52% of their UUP brands are internationally located.  This is very hard to replicate.
  • WHY HOT?
    • Largest international presence
    • Huge pipeline
    • High value owned hotel portfolio
    • Best global team
    • Secular demand growth in EM
    • Low supply growth in developed market
    • Cash flow generation ability
  • Value of their owned portfolio:
    • Cap rate using average (04-08 NOI)
      • 5.5% = $5.6BN
    • Using per keys: $275k/room = $5.7BN; $325k/room = $6.7BN
    • If they sold these hotels, they could still retain ~$80MM in fees, creating another $1BN of value
    • SVO can continue to generate $150-200MM of cash flow for them assuming one note sale per year
    • Bal Harbour is their largest non-cash flow generating asset on their balance sheet
      • 307 residential units
      • Have 141 contracts in place with 20% deposits
      • On track for certificate of occupancy by Oct 2011
      • Invested $450MM by YE 2010 and expect to spend an additional $200MM
      • Cash from deposits: $60MM, expect to net $550MM through 2013 in closing and an additional $165MM in cash flow post 2013
      • Then they will still own a 210 room St. Regis
    • Have 10,125 unconsolidated JV room, with $60MM of pro-rata share EBITDA
  • Assumptions 2011-2013:
    • RevPAR: 7-9%
    • Margin improvement: 450-600bps (cumulative)
    • Earnings growth: 16-20%
    • 1% (+/-) RevPAR CAGR: -/+ $35-40MM of owned/ leased earnings through 2013
    • Base mgmt fee growth: 7-9%
    • Incentive fee growth: 10-13%
    • Franchise fee growth: 7-9%
    • Net room growth:  3-5%
    • Total fee revenue fee growth: 10-12%
    • VOI: flat originated sales and flat operating income growth
    • Timeshare capital spend: $80-100MM and cash flow: $450-600MM [cumulative]
    • Bal Harbour net cash flow: $350-400MM [cumulative]
    • SVO/Bal Harbour Net Cash Flow: $800-1BN [cumulative]
  • So they think they can get to $1.25BN -$1.375BN EBITDA by 2013 and EPS of $2.70-$3.20
  • 2010 Ending Cash flow: $500MM
    • + 3 yr estimated hotel operating CF ($2.3-2.5BN)
    • + 3 year CF from SVO/Bal Harbour ($800MM-1BN)
    • - Capex ($800-$900MM)
    • - Cash taxes & Interest ($900MM-1BN) =
    • $1.9-2.1BN of cash flow + asset sales =
    • Funds for growth/ debt reduction/ returning cash to shareholders
  • Already received $140MM of tax refund money - and expect to get the remaining $90MM before year end
  • Goal is to get to 3.0x leverage from an estimated 4.4x at 12/31/2010 - that equates to about $1.2BN of debt reduction


  • Assumptions: 7-9% RevPAR growth with 6% coming from ADR why only 150bps of margin expansion?
    • There are inflation and cost pressure
  • Why such a low incentive fee recovery?
    • In international markets they are more tied to top line
    • In NA, F&B and other revenues lag RevPAR typically
  • In Asia, the demand for key money is a lot lower
  • Don't have to give as much key money in general now than they used to given their value proposition
  • Platinum SPGs visit 4 of their brands each year on average
  • Current transaction market?
    • Broad spectrum of buyers hasn't really returned yet
    • Think that for them a rifle shot approach to asset sales is the best approach for now.
    • They think a larger transaction is a little ways off just given the current environment. Most of the action are driven by large REITs looking for clean transactions with little required capex
    • Haven't seen the return of the leveraged transaction - but think asset values will move up a lot when and if the leverage market returns
  • Have 140 units under contract; prices are in the range of 1,000/psf.  Assume that they will not close all 140 units, but that sales will continue for a few years
  • Vast majority of hotel in the china pipeline are under construction - there is plenty of financing. In the rest of Asia - financing is also not really an issue. Owners are either high net worth or conglomerates.
  • In NA and Western Europe are where they are using more of their capital to support the pipeline. Have a lot of conversion opportunities.
  • 70% of customers in their Chinese hotels are Chinese
  • Think that any upside to their projections will come primarily from rate
  • Why no SVO growth?
    • Will only invest money where they are confident there is demand
  • With the hotels that require a large reposition (15% of rooms) they will wait until they find the right partner given the capex requirement
  • Their intent is to preserve their NOLs

Gold Break: Gold Levels, Refreshed...

POSITION: No position in Gold (GLD)


I sold our entire gold position in both the Hedgeye Asset Allocation Model and in Hedgeye’s Virtual Portfolio on Monday, December 6th at $138.55.  This was not a popular decision.


It was an especially unpopular position given that:

  1. It is year end and everyone is long Gold
  2. It is finally consensus to see gold as a replacement currency for the Fiat Fools
  3. I was presenting in front of investors in gold country yesterday (Vancouver, BC)

Now if I was a banker, my boss probably wouldn’t have allowed me to make a bearish call on Gold ahead of meetings in front of large holders. Oops, did I just write that?  


But all TIME, PRICE, and VOLATILITY factors that supported the sell decision aside, there is a very important shift in the Hedgeye fundamental global macro view that doesn’t support the gold price making higher-highs in the immediate-term. We are long of and bullish of the US Dollar.


That position, combined with the macro calendar catalyst that Ron Paul is going to have the right to subpoena the leader of the Fiat Fools (The Ber-nank) in January gives plenty of support for a continued bid to what was a the Burning Buck. The world’s reserve currency could simply have a credibility bid associated with Americans seeing a live, two-sided, debate about what debauching the dollar really creates – the inflation.


If the US Dollar Index can remain above its intermediate-term TREND line of support ($79.49), and the Gold price remains below its immediate term TRADE line of support (1389) like it is today, there will be a heightened probability that gold breaks $1376 (see chart), then makes a move down toward its bullish intermediate-term TREND line of support at $1313. That’s not a crash, but it’s a correction that could leave a mark.


Yours in risk management,



Keith R. McCullough
Chief Executive Officer


Gold Break: Gold Levels, Refreshed...  - gold png

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