"He who will not economize will have to agonize."

For those of us moving upward and onward in The New Reality, this past week was a fantastic one. We spent time with our families, rang in a New Year, and made some serious weekly returns!

However, getting all excited about the "Re-flation" call, AFTER deflated balloons found their first blast of air is not what I am in the business of doing. So don't expect me to be buying high in hopes of "selling higher" this morning. Hope is not an investment process. We'll let them buy what we have readily available for sale. Sell high, buy low.

The pundit patrol tends to mistake the definitions of "inflation" and "re-flation" for one and the same. They aren't! In sharp contrast to 1970's style inflation, this melting up the wall of consensus worry is simply a form of asset class mean reversion. Over the course of October/November, as US Treasury Bonds and US Cash became inflated kings, global equities in Brazil to global commodity markets were primed to see their dose of a fresh tire pumping.

While I do my fair share of tire pumping, my goal in 2009 is to keep pumping yours. We want to "pump you up!" If you weren't into the bearish notes that I had to painstakingly post at this time last year, here's my gift to the bulls out there who ended up being too bearish - after the worst stock market deflation since 1931, the SP500 raced higher for another +6.8% weekly gain last week, taking its cumulative "re-flation" from the freak-out "de-leveraging" November 08' lows to a whopping +24%. Aren't we allowed to be bullish, at a price?

This bullish stock market party that's been rocking since November isn't just local - last week the booty cam juiced it up and took it global! On Friday, the Brazilians jacked their market's music up to 40,244 decibels, closing up +7.2% on the day, taking its cumulative ascent to +37% since it's October 27th low. Last night, in Hong Kong they too rang the proverbial bullish gong, taking the Hang Seng up another +3.5% on the session, adding to its cumulative +41% "re-flation" run since October 27th! We remain "long of" both Brazil and Hong Kong via the EWZ and EWH etfs.

No, no, no... this is not inflation - this is "re-flation"... and it was all signaled by the solid gold album we've been signing to you via the artists formerly known as "prop desk" traders. As they were busy getting fired in November/December, the US Dollar and Hank Paulson were as well. These bullish American agents of change, alongside the largest rate cutting party in global history, continue to provide the backbone for my bullish stance on both global equities and commodities. That said, right here and now, don't forget that every investment thesis has its time and price.

Last night's "inflation" news in both Asia and Europe had deflationary trends. This continues to prove that if you hold a ball of negativity under water long enough, any hint of a release of that sentiment-oriented pressure is going to create a rather explosive move to the upside. Most, but not all of, Asian and European stock market strength this morning is being buoyed by deflationary Consumer Price Inflation readings in Italy, Spain, Thailand, and Indonesia. Consider Thailand's year over year CPI reading for December falling to +0.40%. That's not inflation folks - that's a bullish macro data point - one that shot the stock market in Thailand up +6.4% overnight!

Considering what's going on in the Gaza strip, one might have expected the regional stock markets in the Middle East to be concerned... not so much. Egypt is trading up +8.7% right now, Saudi Arabia +2.6%, and the United Arab Emirates +7.8%. As sad as it may sound, war is the mechanism that gets this region's most relevant currency (oil) higher. Oil, incidentally, "re-flated" right past our price target of $45.53 last week, closing up +23% on the week at $46.34.

Enough of all this "re-flation" stuff, let's turn the dial to growth... because that's where I am having a heck of a time trying to figure out who was bearish at this time last year that is dance party bullish this morning. Our pals over at Goldman are on the tape this morning reiterating their "view" that "there is no obvious drivers of growth" here in the USA. That was Jan Hatzius, their US Strategist, who was cited in the #1 Bloomberg article under "Economy" this morning titled "Engines of Recovery Flame Out." Were there plenty of compensation structures on Wall Street that "flamed out" in 2008? You bet your Madoff there were.... But, Jan, "C'mon Man" - it is 2009 this morning!

Our call has been, and remains, that there is going to be a "MEGA Squeeze" in the land of the US Consumer Discretionary stocks into and out of the "no drama" Obama inauguration and stimulus plan events (see my Partner, Howard Penney's, US Strategy note "Got MEGA" for more). MEGA not only represents the quantitative reality of the squeeze that we have already taken advantage of (the XLY, the SP500 Sector etf for Consumer Discretionary, is up +39% since the November 20th capitulation low), but it stands for Mortgages, Employment, Gas, and Assets. Don't underestimate that the last of the letters in that acronym, Assets, is THE DRIVER of US Consumer Confidence, and US growth. US stock prices are some of the most relevant Assets on the US Consumer's balance sheet - again, they are up +24% since November!

Can someone do me a favor and send this note, alongside Howard's Strategy piece, to the fine folks at Goldman. Jan needs to be aware of the "obvious drivers of growth", and we'd like to throw the guy a bone.

Don't buy the SP500 at 931. Wait for a correction. Our buying range remains what it has been (884 on the SP500 or lower). 
Buy low, sell high, and remember what Confucius says, "he who will not economize" and be patient on price, will ultimately "agonize."

Have a great week.


Chinese Chart Of The Day: PMI Accelerates, Sequentially

For the better part of the last three months, the bears have been stuck with a thesis we were flashing them 9-12 months ago – that China is “slowing”…

Well, like all great stories, there is an ending… and then, a new narrative finds new beginnings. This morning’s Chinese PMI accelerating sequentially (see chart) may not be a huge move on a nominal basis, but the point is that on the margin, the move was finally higher. Since the month of November couldn’t have been worse in terms of global trade, December was bound to be better than toxic – and it was…

Everything that matters most in our macro models occurs here – on the margin. This data point is now old news, and surely one that the China bears will have a tough time getting “unstuck” in their models; that’s if they have them, of course…

We remain long both China and Hong Kong via the FXI and EWH etfs.

Keith R. McCullough
CEO & Chief Investment Officer

Eye On Korea: Equities, Currencies, Reserves...

Korean stocks and The Won are trading up, we are not a buyer… waiting to re-enter the game on the short side, rather.

Bank of Korea announced the first increase in foreign currency reserves in 9 months today, spurring the Won higher against the dollar and Yen and lifting stocks higher. The won was the worst performing major Asian currency in 2008 and the KOSPI was a complete disaster at -40% for the year , but the glass half full crowd is now starting to buy again based on the thesis that the worst is over. We disagree.

The increase in currency reserves does not necessarily indicate as large a bullish turn as it might look at first blush. After the central bank spent 65 billion dollars trying to prop up the Won it appears to have finally found a bottom 25% lower than the dollar for the year and about 35-40% lower than both the Yen and Yuan. The good news is clearly that Korean exports will be more competitive in China, which now accounts for over 20% of total sales abroad. The bad news is that -even with resilient Chinese buyers for semiconductors and cell phones, the heavy concentration of Korean industry on large machinery; nautical and automotive manufacturing will probably mean that the real economy won’t bottom out until later in the year at best when the government’s $11 billion stimulus package focused on public works (hopefully) gets under way.

Additionally, despite the improvement in regulation and oversight since the financial crises a decade ago, the Korean banking sector is more levered than other Asian institutions and is still far from done working through the bad real estate debt that it gorged on over the past 5 years. Despite currency stability and lower nominal rates the credit market, Korea remains frozen, as evidenced by the Korean Development Bank’s recently announced Dollar and Yen denominated debt issuance –needed to shore up short term working capital.

We will keep our eye on Korea carefully and as always reserve to right to change our mind as soon as the data changes, but for the time being the bad there continues to outweigh the good.

Andrew Barber


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As positive as I am on MGM and most of the gaming operators as a trade, a dose of reality is in order. The market is powering gaming stocks higher, particularly those with Las Vegas exposure. Apparently, visitation to Las Vegas and Atlantic City was strong over the Christmas/New Year’s holiday week. However, one must consider the type of customer attracted to room rates slashed by 30% and lowered table minimums.

Heavy discounting is the reason Las Vegas was able to fill its rooms. The flow through on negative room rates is around 90%. Gaming revenues should be significantly lower, assuming normal hold, due to a lower end average customer and lower table revenues. From a profitability standpoint, this past New Year’s will not be viewed as a success.

However, with such bearishness surrounding the beaten down gaming sector heading into 2009, any superficially positive data point can have an impact. We pointed out as much in our bullish 12/26/08 post “A TALE OF TWO YEARS” which called for a January rally. The January Effect is indeed alive and well in this sector but keeping a short leash on this long trade probably makes sense.


December was a tough month in Macau and even tougher for Wynn Macau. Following a fairly strong start to Q4, Wynn Macau has struggled and lost share in a declining market in November and December. For Q4, on a year over year basis, we estimate Wynn is flattish in both its mass market and rolling chip business (revenue). However, the month of December was likely down around 10% in both segments. Obviously, this is not a favorable sequential trend. The downturn appears to be related mostly to volume and not hold percentage.

The consensus Wynn Macau EBITDA estimate is around $115 million for Q4. I believe the property could miss this number by $15-20 million. I doubt Wynn Las Vegas will make up the difference. Rather, Wynn Las Vegas may also miss the consensus projection of $65m. Only abnormally good luck at Wynn Las Vegas over the New Year’s celebration can save the quarter.

Eye On Volatility: Time to Sell Vol. On Small Caps?

Overall market volatility is declining, but less rapidly for small cap stocks…

This week marked the first decline of 30-day realized volatility on the S&P 500 below 60 since the first week of October and the first time the VIX has closed below 40 since October 1st. As both real and expected volatility on the SPX decline closer to the upper edges of historical averages they remain significantly higher for small cap names. Although the volatility levels implied by options on smaller capitalized stocks are normally higher than that of larger cap names, the current level of divergence remains wider than it has been for years prior to last fall.

From an options standpoint, the traditional liquidity issues facing small cap stocks are exacerbated by the demise of well capitalized “upstairs” trading desks at investment banks and other financial risk intermediaries who used the listed markets as virtual crossing networks for thinner names in years past. Now, with fewer and less well capitalized market makers increasing focused on large cap names expect volume to decline significantly in small cap option land.

The still-rich premiums in small cap names make strategies involving selling options look attractive here, but keep these factors in mind if you are considering any.

1) Need For Patience: Although the premiums for options sellers on small cap names may be attractive, volume is light. It makes no sense to chase the market; pick a price that you deem attractive for the risk involved and stick with it.
2) Fundamental Conviction: In no way, shape or form is this an endorsement of arbitrage or so called “relative value” dispersal strategies – selling options in the current market without a fundamental directional conviction is not advised. For now, tactical equity investing is best kept in the cash market, with any options selling confined to strategic enhancement.
3) Rates: Any long term option will derive a portion of its value from prevailing interest rates since an option seller is providing the buyer with leverage. Any options seller that is using long dated contracts should consider this factor carefully.
4) Duration: the absence of liquidity is a major driver of current high implied volatility. Anyone that is stepping up to sell options in this market to take advantage of this must be prepared to stay to the bitter end. As we said earlier, volume may be lighter by the time options with 6 to 12 month durations expire so don’t count on trading out in advance on that.
As always, feel free to contact me with any questions about any options strategies that you are considering.

Andrew Barber

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