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TODAY’S S&P 500 SET-UP - January 19, 2011

Equity futures are trading below fair value as European markets extend losses amid reports Greece may be looking at rescheduling its debt. Under the plan, reportedly being brokered in Berlin, Athens would be allowed to buy back its own debt using a euro zone crisis fund.  As we look at today’s set up for the S&P 500, the range is 18 points or -1.16% downside to 1280 and +0.23% upside to 1298.



  • MBA mortgage applications up 5% prior 2.2%
  • 8:30 a.m.: Housing starts, Dec. est. 550k, prior 555k
  • 8:30 a.m.: Building permits, Dec., est. 554k, prior 530k
  • 3 p.m.: USDA broiler eggs set, Jan. 14
  • 4:30 p.m.: API inventories, Jan. 14


  • Mosaic says it will be a “possible” takeover target as Cargill divests $24.3b stake in the co. over the next two yrs
  • Pimco’s Neel Kashkari, a former Treasury official, says U.S. may face a debt crisis without action to limit federal spending
  • Apple, IBM estimate-topping earnings bode well for results due in coming weeks from Hewlett-Packard, Microsoft, Dell and other cos. that supply corporations with computers and software
  • HSBC Global Asset Management’s Absolute Return fund favors stocks including Coca-Cola and Procter & Gamble to beat returns from gold this year as global economy recovers
  • Amgen (AMGN) agreed to sell its rights and assets at Fremont, Calif. manufacturing facility to Boehringer Ingelheim
  • Cree (CREE) forecast sees 3Q adj. EPS 38c-45c vs est. 58c
  • IBM (IBM) reported 4Q EPS $4.18 vs. est $4.08
  • Linear Technology (LLTC) forecast 3Q rev. ~$345.3m-$360.6m vs est. $371.6m
  • Mosaic (MOS): Cargill will spin off 64% MOS stake to Cargill shareholders, bondholders
  • NuVasive (NUVA): CIGNA, Humana change lumbar spinal fusion policy to include coverage for NUVA’s eXtreme Lateral Interbody Fusion
  • Western Digital (WDC) reported 2Q rev. $2.48b vs est. $2.35b, EPS 96c vs est. 59c


  • Bank of New York Mellon (BK) 6:30 a.m., $0.57 
  • US Bancorp (USB) 6:45 a.m., $0.47 
  • MGIC Investment (MTG) 7 a.m., $(0.46)
  • State Street (STT) 7:05 a.m., $0.86 
  • Amphenol (APH) 8 a.m., $0.73 
  • Hudson City Bancorp (HCBK) 8 a.m., $0.22 
  • Wells Fargo & Co (WFC) 8 a.m., $0.63 
  • Goldman Sachs (GS) 8:01 a.m., $3.79 
  • Northern Trust (NTRS) 8:01 a.m., $0.72 
  • AMR (AMR) 9:01 a.m., $(0.32)
  • Plexus (PLXS) 4:01 p.m., $0.59 
  • F5 Networks (FFIV) 4:05 p.m., $0.83 
  • Kinder Morgan Energy Partners LP (KMP) 4:05 p.m., $0.43 
  • Raymond James Financial (RJF) 4:12 p.m., $0.53 
  • eBay (EBAY) 4:15 p.m., $0.47 
  • Xilinx (XLNX) 4:20 p.m., $0.52 
  • SLM (SLM) 4:37 p.m., $0.71


  • One day: Dow +0.43%, S&P +0.14%, Nasdaq +0.38%, Russell flat
  • Last Week: Dow +0.96%, S&P +1.71%, Nasdaq 1.93%, Russell +2.51%
  • Year-to-date: Dow +2.25%, S&P +2.97%, Nasdaq +4.26%, Russell +3.05%
  • Sector Performance - (8 sectors positive and 1 down): - Energy +0.62%, Materials +0.55%, Industrials +0.72%, Healthcare +0.37%, Tech +0.11%, Consumer Disc +0.37%, Utilities +0.24%, Consumer Spls +0.06%, Financials (0.60%)


  • ADVANCE/DECLINE LINE: 250 (-211)  
  • VOLUME: NYSE 1227.72 (15.85%)
  • VIX:  15.87 +2.65% YTD PERFORMANCE: -10.49%
  • SPX PUT/CALL RATIO: 1.48 from 1.46 (+1.49%)


Treasuries were weaker with the better risk backdrop in focus.

  • TED SPREAD: 16.11 +0.304 (1.922%)
  • 3-MONTH T-BILL YIELD: 0.16% +0.01%     
  • YIELD CURVE: 2.79 from 2.76


  • CRB: 333.78 +0.22%  
  • Oil: 91.38 -0.17% - trading +0.58% in the AM
  • Crude Oil Supply Drops in Survey on U.S. Pipeline Shutdown: Energy Markets  
  • COPPER: 442.80 +0.36% - trading +0.24% in the AM
  • Copper Gains to Record on Speculation Demand to Outpace Supply on Recovery
  • GOLD: 1,372.68 +0.49% - trading +0.36% in the AM
  • Gold Climbs for Third Day as Dollar Weakens on Concern About U.S. Recovery


  • Container Ship Rates Rising as Fuel Prices Slow Vessels: Freight Markets
  • Japan May Cut 2011 Ethylene Output on Middle East Competition, Mizuho Says
  • Japan's Petrochemical Maintenance Closures to Drop This Year, Survey Shows
  • Rubber Futures Advance to Record as Thai Supply Concern Spurs Purchases
  • IEA's China Oil-Consumption Outlook Is `Too Conservative,' Bernstein Says
  • Precious Metals Make Up 76% of Commodity ETP Assets, Societe Generale Says
  • Alaska Pipeline System Boosts Crude Oil Flows, Exceeds Operator's Target
  • Mosaic Might Become Takeover Target as Cargill Divests $24.3 Billion Stake
  • Barclays Forecasts U.S. Natural Gas Prices Will Remain Around $4 This Year
  • Thailand Says It May Complete Nation's First LNG Import Terminal by June


  • EURO: 1.3360 +0.49% - trading +0.77% in the AM
  • DOLLAR: 78.962 -0.47% - trading -0.45% in the AM


  • FTSE 100: (0.37%); DAX: -0.03%; CAC 40: (0.14%) (as of 06:30 EST)
  • European markets saw session's highs early before paring gains to trade mixed.
  • Strong results from Apple and IBM overnight up +0.1% and +1.9% respectively in Germany failed to help tech shares in Europe as ASML Holding's reversed early gains and the sector is lower.
  • Kesa Electronics update highlighted the potential impact of the recent VAT increase in the UK as sales softened post the rise.
  • Ireland PM survived a vote of no confidence by his party yesterday, though a national election is expected as early as Mar.
  • Declining sectors lead advancers 10-8 as autos and retail lead fallers and basic resources lead gainers.
  • UK Nov ILO unemployment rate +7.9% vs consensus +7.9% and prior +7.9% - UK Dec Claimant count (4.1k) vs consensus +1.5k and prior revised to (3.2k) from (1.2k)
  • German economy ministry raises 2011 growth forecast to +2.3% from previous forecast of +1.8%  - Sees 2011 export growth of +6.5%, import growth of +6.4%
  •  ECB officials are back from a threat to raise interest rates, saying markets have over-reacted to their change in tone on inflation. ECB governing council “sees present rates adequate,” for the “foreseeable future,” council member Ewald Nowotny said at an event in Budapest yesterday.
  • Spanish home sales fell 6.2% Y/y in Nov., third month of declines.


  • Nikkei +0.36%; Hang Seng +1.10%; Shanghai Composite +1.81%
  • Asian markets were mixed, with tech stocks leading the way on the back of strong results from Apple and IBM.
  • China went up strongly on reports that the CPI rose 4.6% y/y in December, above expectations of 4.4%, but below November’s 5.1% rate. The official figures are to be published tomorrow.
  • Property developers led Hong Kong higher on improved risk appetite after Wall Street’s advance. On higher oil prices, Sinopec and Petro China rose 4% and 2%, respectively.
  • High techs lifted South Korea up 0.92%, but construction plays fell on profit-taking.
  • Australia rose 0.18%. Kathmandu Holdings soared 16% after upgrading its profit forecast.
  • Boosted by China’s gain, Japan edged up on a positive start to the US earnings season.
  • Japan November tertiary industry activity index +0.6% m/m.


Munis: Another Short Selling Opportunity



If it doesn’t make you laugh, it will make you cry – but the sell-side’s probability of defending anything that starts to go down these days is as predictable as, well, US Municipalities and States running deficits. Sadly, very few risk management lessons from the 2007 MBS market seem to have been learned. And yes, there was another side to the Bush Tax cut trade!


We’re on the transparency/accountability tape getting bearish on Munis on February 24th, 2010 in a note we titled “Domestic Pigs.” We’re also currently on the tape with a short position in MUB in the Hedgeye Portfolio. It’s not a position we intend on covering down here because “munis are cheap.” If you’re already long them, we know why you are bullish on “cheap”. If you aren’t short them, we know why you aren’t Bearish Enough.


Barron’s Randall Forsyth wrote an article this weekend titled “Yields Soar on Overpunished Munis”, and I can’t help myself but to highlight a few of his lowlight reasons to be bellying up to opacity’s next sketch bar. 

  1. “Last week saw wholesale selling”
  2. “A technical situation caused by heavy liquidations”
  3. “Smart managers are buying munis, not the hysteria” 

First of all, he actually did the outflow math ($16.5B out of open-end muni funds in the last 9 weeks over a base of a $2.8T market), but failed to acknowledge that this means this selling party has barely started. This is not “wholesale” selling yet. This is not “heavy” liquidation either. This is simply the beginning.


It’s also the first born problem child of The Ber-nank’s 3D Risks that are associated with keeping US interest rates unsustainably low.


As a refresher – what the Fed staying at ground ZERO percent means in terms of 3D Risk is: 

  1. Dares investors to chase “yield” (including munis)
  2. Disguises financial risk (what will municipalities do when borrowing costs go Greek?)
  3. Delays financial restructuring 

How many of America’s Domestic Pig governments need to be restructured? What’s a revenue bond worth if the municipality can’t generate its required tax revenues? What do rising bond yields tell risk managers about default risk?


These are simple risk management questions that should be answered by risk managers before we let an 8th grader hit <bond yield go> on a Bloomberg terminal and analytically deduce a bond is “cheap” when it’s yield is higher than another.


Our refreshed TRADE and TREND lines of resistance for MUB are outlined in the chart below.



Keith R. McCullough
Chief Executive Officer


Munis: Another Short Selling Opportunity - 1

Asian Trade Data Exposes Facade of US Growth

Conclusion: The slowdowns we are seeing across Asia’s trade-heavy economies continue to flash bearish signals as it relates to the direction and amplitude of global growth.


Position: Short US equities via the etf SPY.


This morning, we saw some more negative economic data points out of Asia. Signs of a regional economic slowdown, which have largely been ignored by US investors for much of the last two months, are highlighted today by Thailand’s December trade data. Thailand’s YoY Export growth slowed sequentially by (-970bps) and YoY Import growth slowed sequentially as well, falling (-2,380bps). On the prospects of an economic slowdown, Thailand’s Commerce Minister, Porntiva Nakasai, affirmed today what we at Hedgeye have been saying since November:


“It is hard to replicate last year’s exceptional growth. China’s economy, which is the main growth driver in the region, is slowing, while Europe is still having financial problems.” 


Asian Trade Data Exposes Facade of US Growth - 1


Thailand’s share of world exports are roughly ~2.6x its share of global GDP, so Thailand could potentially be used as a proxy for the health of global trade. On a standalone basis, however, Thailand isn’t responsible for moving the needle on global growth or international trade. Considering, we’ve compiled an aggregated, weighted index of Asian trade data that does serve as a good proxy for the direction of global demand.


Asian Trade Data Exposes Facade of US Growth - 2


Asian Trade Data Exposes Facade of US Growth - 3


Further, upon considering that these ten economies’ share of global exports is nearly 25% larger than their share of global GDP, we posit that a slowdown in this region is a leading indicator for a slowdown in the inventory cycle of advanced economies. Positive inventory adjustments have accounted for 63% of U.S. GDP growth in the three quarters through 3Q10, so a slowdown across Asia may be a stealth leading indicator for inventory adjustments being a drag on U.S. GDP growth in 2011.


Asian Trade Data Exposes Facade of US Growth - 4


In simple terms, consumption accounts for ~65-70% of the US economy and if factories in China and across Asia aren’t pumping out and shipping the apparel, harware, etc. that we buy with the same velocity, it means we aren’t buying it with the same velocity either. This leads to a building up of inventory and reduced demand for restocking domestically.


Lastly, it’s important to keep in mind the following stats, when considering the merits of Asian trade data:  

  • Exports account for roughly 40-45% of Asia’s GDP;
  • The U.S. and E.U. combine for roughly a third of Asia’s export destinations; and
  • 40-50% of intra-regional trade within Asia is basic and intermediate goods meant for re-export outside of the region. 

All told, the slowdowns we are seeing across Asia’s trade-heavy economies continue to flash bearish signals as it relates to global growth. Given the recent run-up in US equities, we feel most of the opportunities for alpha will be found on the short side throughout the next 3-6 months, as growth bulls are awoken by the pungent stench of global economic fundamentals.


Darius Dale


Europe’s Smorgasbord

Position: Long Germany (EWG); Short Italy (EWI) and Euro (FXE)


As two days of EU meetings conclude in Brussels today it appears that nothing definitive was decided on by the 27 ministers short of renewed discussions following last week’s rumors that the region’s bailout fund could be increased, possibly from €750 billion to €1 Trillion. While the Germans continue to flip-flop on the issue (depending on who you talk to) our bet is that if the funding were to increase (very likely) you'd see a pot far greater than €1 Trillion to meet the peripheral debts, especially the bigger exposures of Italy and Spain.


In any event, all eyes are turned to bond auctions again this week. On a bullish note, Spain sold €4.5 Billion of 12 month bills at 2.947% today, versus 3.449% on December 14th. 


Tomorrow:  Portugal issues short term bills

Thursday: Spain issues long term debt maturing in 2020 and 2024, a critical gauge for investor demand and yield premium offered


Rumors flew around today that Russia could buy European bonds, following commitments from China and Japan earlier this month.  While Russia has impressive FX and gold reserves (3rd largest in the world at $480.7 Billion), given the economic and political instability in Russia we think this rumor could be off base. Yet over the near term the rumor (like the increased funding talks in Brussels) offers another support mechanism for European equities and the EUR. 


In contrast, the credit markets of the PIIGS + Belgium have seen little arrest with yields continuing to rise since last Friday (see chart). Of note is that Portugal's 10YR yield is now above 7%, a level that proved an important upward momentum line for both Greece and Ireland.


Europe’s Smorgasbord - t1


Below we give our levels for the EUR-USD.  We’d be short the EUR-USD with impunity at $1.35, its intermediate term TREND level of resistance.


Europe’s Smorgasbord - t2



UK Inflation Punctuating


UK CPI registered 3.7% in December year-over-year, versus the previous month of +3.3%.  We’ve been hitting on the risk of rising inflation in the UK for months, however with this huge jump in December there’s even more pressure on the BOE to act.  Gains came from food and fuel prices and statements out of PM Cameron today suggest just how mainstream the inflation issue has become:


“I tend to be a ‘now man’ because we’ve had constant reassurances that inflation will fall and it hasn’t fallen… I’d rather see them start moving up gradually than go up in a huge jump, perhaps in the autumn.”


Europe’s Smorgasbord - t3


Considering that we’ll likely see more inflation pressure in January given that VAT was increased from 17.5% to 20% into the new year, we believe the BOE will have to bite the bullet over the next few months and raise rates (despite the threat of further choking off growth) to contain inflation. 


A rate hike should bolster the Pound versus major currencies. As the chart below shows, and given that we think the BOE will raise rates before the ECB, we like the GBP versus the USD above its intermediate term TREND line of $1.57, which it has currently broken through.


Europe’s Smorgasbord - t4



German ZEW Gains


Germany continues to impressive regarding the majority of the fundamentals we track.  The chart below of the ZEW economic survey shows a significant gain in the Economic Sentiment survey, from 4.3 in December to 15.4 in January, with a more mild gain in the Current Situation, from 82.6 in December to 82.8 in January. (We’ve noticed that Economic Sentiment has been a much more predictive gauge than Current Situation).


We continue to like Germany as the sovereign debt dichotomy plays out in Europe. We're currently long Germany via the etf EWG in the Hedgeye Virtual Portfolio


Matthew Hedrick



Europe’s Smorgasbord - t5


The only story surrounding earnings is that they shouldn’t be an issue.



IGT is scheduled to kick off the earnings season for us next week when they report F1Q11 earnings next Thursday after close.  We don’t expect many surprises on the call and our estimate is in-line with consensus at $0.20.  The near and long-term story will be driven by the main themes of re-acceleration of replacement demand and new domestic and international markets – near-term headlines and long-term actual earnings contribution. 


There are other areas of interest that should be addressed on the call:


Top line

1. Replacement Cycle… when will things pick up?

2. Gaming Operations… can they really grow?

3. How much juice is there in the international business?

4. Will systems get a lift from SbX? We’re waiting for the killer applications.

5. Online and mobile applications… when will it become material?


Bottom line

6. ROI – better return on capital deployment - consolidating platforms or allocation of R&D dollars,  all of which should yield better cash flow

7. Will they take out the convert which would add over a dime in EPS?

8. Quantify the benefit from the reinstated R&D tax credit

9. Accelerated depreciation rules that recently passed should result in a decrease in deferred tax liability and provide a benefit to working capital

a. 50% retroactive to [mid-2010]

b. 100% retroactive to [September 2010]

Details on FQ1:

We are projecting revenues of $502MM and EPS of $0.20 when they report on F1Q11 results on Jan 20th. 


We estimate that IGT will report $237MM of product sales at 51% gross margins

  • Domestic product revenues of $134MM and gross margin of $69MM (51%)
    • Domestic box sales of $77.5MM: 5k domestic unit sales--comprised of 2,700 replacements and 2,300 new units at an ASP of $15.5k
      • December is usually and should be a better quarter for replacements for the industry since it’s the G2E quarter and many buyers must either use or lose their budgets.  However, this is usually not the case for IGT, given that their fiscal year ends in September.
      • New units should include: Cosmo units – roughly 750 units; Perryville units which were subject to a 90 day acceptance clause - ~600 units; at least part of the shipments to Gun Lake
    • ASP’s should be higher than the last few quarters with the expiration of the Dynamix promotion
    • Domestic non-box sales of $57MM, up 10% YoY
  • International product sales of $103MM and gross margin of $51MM (51%)
    • $77MM of box sales: 6.3k international unit sales at an ASP of $12.2k
    • Non-box sales of $26MM
  • Gaming operations revenue of $265MM at 59% gross margins
    • We expect the install base to stay constant from last quarter at 57k units and we expect average win per day to be $50.5

Other assumptions:

  • SG&A of $87MM
  • D&A: $20MM
  • R&D: $49MM
  • Net interest expense: $21MM
  • Tax rate: 37% (lower than guidance due to the reinstatement of the R&D tax credit)


Conclusion: Knapp Track comparable restaurant sales trends in December indicate that the casual dining recovery has slowed down somewhat.  For the wider casual dining space, the fragility of the underlying economy warrants caution.


Knapp Track preliminary results for December suggest that the casual dining recovery seen in the third quarter has slowed over the past couple of months.  December comparable restaurant sales of -0.8% signifies the first year-over-year decline in results since June.  On a two year basis, comparable restaurant sales sequentially declined by 55 basis points.  Adjusting for bad weather, December's comparable restaurant sales number would have been +0.2%, which would imply a 5 basis point decline in two-year average trends excluding the impact of weather. Q410 saw a sequential slowdown in comparable restaurant sales to +0.5% from +0.8% in 3Q10.  On a two-year average basis, however, quarterly comparable restaurant sales trends accelerated by almost 90 basis points.


Comparable guest counts in the casual dining space saw a sequential decline from a revised -1.6% result in November, according to the most recent Knapp Track report.  December’s preliminary decline of -2.9% shows that the “recovery” is far from secure, especially as companies look to pare back their use of discounting as a driver of traffic.  On a two-year basis, December’s result implies a sequential deceleration of 95 basis points. 


In this month’s report, Malcolm Knapp highlighted several interesting factors that he believes are key to consumer behavior.  Firstly, the effects of the financial crisis persist with mortgage defaults and high levels of unemployment burdening attitudes.  Another interesting point is that increases in consumer confidence are consistently due to a view that “things will be better in 6 months” from the date of the report.  Expectations have dramatically outperformed current views. 


Howard Penney

Managing Director

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