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Excessive Storytelling

This note was originally published at 8am on February 16, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Epidemics are sensitive to the conditions and circumstances of the times and places in which they occur.”

-Malcolm Gladwell


Epidemic might be the right word to describe the environment in the USA that has ensued since Bernanke’s speech in Jackson Hole and the 96.3% move in the S&P 500 since March 2009.  There are many corners of the world that are looking at the USA and the policies of the Federal Reserve and clearly believe that we are pouring gasoline on a blazing hot fire.


The past month’s protests in North Africa and the Middle East were partly linked to surging agriculture costs and according to the UN, countries in Latin America are most at risk of food riots as prices continue to head higher.  According to the World Bank, rising global food prices have pushed 44 million more people into “extreme” poverty in developing countries since June.  Yet the USA and the S&P 500 continue to power forward like they are impervious to these issues. 


Not so fast….  The question is when, not if, Chariman Bernanke will pull the punch bowl on the current liquidity binge.  The increased civil unrest that ensues around the world will continue to put incremental pressure on him to alter the current policy.  The scary part is he needs to do it sooner rather than later and chances are it’s going to happen at exactly the wrong time.


Just by chance, what if we get a hint of a FED exit strategy today at 2 pm just as the “storytelling” is reaching a feverish pitch?  I’m hearing people talk about stocks, saying, “This time it’s different!”  Or how about this one, “margins don’t matter!” Or better yet, “consumer companies are impervious to rising input costs!” Over the next 12-months we are going to be able to produce some serious You-Tube moments that will last a lifetime. 


Of course margins don’t matter – until they do.  Consumer companies are impervious to rising input costs – until they are not.  And we are at the tipping point! 


It seems like yesterday that Malcolm Gladwell published The Tipping Point: How Little Things Can Make a Big Difference.  Gladwell describes a tipping point as “the moment of critical mass, the threshold and the boiling point.”  In nearly every situation there is that moment in time when the world is ready to follow the leader or “the trend.”  Right now, that leader is Chairman of the Federal Reserve, Ben Bernanke and the trend is excess liquidity that is leading to higher inflation and higher stock prices.   


The critical element of the U.S. economy that is not benefitting from the Federal Reserve’s actions, in real terms, is the consumer.  I believe that the consumer is reaching a tipping point.  Accelerating demand is critical to maintaining profitability in an accelerating cost environment.  What we saw yesterday from the retail sales data was perhaps an indication that the consumer is beginning to slow down. 


In the face of non-confirming data, observers with a conflicted or biased view often look for any other metric, or any other narrative, to justify a prior perspective.  Revisionist versions of the truth are offered with adroit semantic maneuvering and frantic searching for the comfort of a confirming thesis. 


One narrative being promoted at the moment is that consumers are willing to pay above market for “green” products from “socially responsible” companies. This may be true to a degree, but deflecting the clear truth behind the data, be it Retail Sales or otherwise, with qualitative narratives that are entirely subjective, is not a practice I subscribe to.  If consumers see raising prices in the absence of a corresponding growth in personal disposable income, there is likely going to be a change in consumer behavior. 


As Gladwell wrote, "Ideas and products and messages and behaviors spread like viruses do.”  At present, it is clear that many ideas and messages have spread rapidly around investor circles.  Sectors of the market are trading at premium multiples largely because of the free-money policy of the Federal Reserve.  The confidence that this instills in investors seems to trump any concern about companies’ ability to control their input costs from now on.


For many companies, the cost of raw materials is rising at a faster pace than revenue and we have only just begun to see the impact on margins.  Rising costs take time to flow through to the bottom line.  Rhetoric from management teams, against all of their incentives, has been decidedly cautious with respect to their commodity cost outlook.   As we move through the balance of 2011, the squeeze on profit margins will be more pronounced than most analysts expect. 


The Empire Index' Prices Paid index, which climbed to a two-and-a-half-year high of 45.8, was supportive of my theory yesterday.  Quoting directly from the press release, "The prices paid index climbed to a two and-a-half-year high in February, but the measure for prices received was little changed, suggesting some pressure on profit margins."  That’s right – margins are contracting, not expanding. 


How the consumer reacts to increased inflation pressures will be the tipping point for the market.  Across a wide spectrum of the S&P 500, companies are seeing margins contract, and some are more confident than others in their ability to pass on price to customers.  A growing percentage of companies will be unable to increase price at all, or fast enough to offset margin contraction, without hurting top line trends.  The economic recovery is in its embryonic stages, unemployment remains high, and consumers are keeping a tight rein on spending.  How much inflation can they take before spending begins to suffer?


I heard some supposed experts on CNBC say that $5.00 gas will not affect consumer spending.  It’s this kind of storytelling that is sign of pure excess.


Perhaps yesterday’s Retail Sales was the first glimpse of this trend.  Retail Sales growth missed Street expectations.  The trajectory of 4Q10 sales trends cannot continue with inflation accelerating and job growth proving to be highly inadequate as an offset. 


Over the next two days we will be getting more inflation readings from the PPI and CPI.  While these two numbers are conflicted calculations, they will both point to accelerating inflation.  For proof of this trend, last night in an interview on Bloomberg, Richmond Fed President Lacker (non-voting FOMC member in 2011) said that US inflation may accelerate in H2 of 2011 as firms seek to recoup higher commodities and health care costs. 


And Joe six pack is going to roll over and say thank you very much!




Function in Disaster; finish in style


Howard Penney


Excessive Storytelling - howard11


Excessive Storytelling - howard22


In preparation for MPEL's Q4 earnings release Tuesday morning, we’ve put together the pertinent forward looking commentary from MPEL’s Q3 earnings call.




  • “As we’ve said in the past, the improvement in our mass market whole percentage is intangible, sustainable, and reflects operational improvements in our business. The improvement indicates that we are providing a better experience for our customers, and they are staying longer at our tables as a result. We believe our mass market hold percentage at City of Dreams will remain between 20% and 22% going forward, with the bulk of our mass market gains coming mainly from increased volumes.”
  • “Looking forward, we expect our growth at City of Dreams to come from a combination of the introduction of new amenities over the next few quarters, and from tactical initiatives designed and implemented by the new management team. These include leveraging The House of Dancing Water in our marketing campaign and broadening our geographic reach into China, as well as into the Asia-Pacific region. We’re also improving our relationships with tour group operators and asking companies in China to help us to drive more traffic through the property at attractive customer acquisition cost.”
  • “Looking forward, we expect to continue to participate in the growth of the growing chip market in Macau, while maintaining our disciplined approach to junket pricing and avoiding unsustainable commissions.”
  • “More specifically, fourth quarter got off to a good start, with the business generating record monthly levels of consolidated rolling chip volume, mass table drop and mass win in the month of October. Standalone, City of Dreams is also hitting new records on each of these operating metrics. From a balance sheet perspective, our first financial covenant test commences with our 4Q results and we remain comfortable with our ability to meet these tests.”
  • [4Q] “Depreciation and amortization cost is expected to be approximately 84 million, which reflects a full quarter of depreciation from The House of Dancing Water. Net interest expense in the fourth quarter is expected to be approximately 29 million. We do not expect any pre-opening expense or capitalized interest for the fourth quarter.”
  • [Singapore impact] “And as we predicted, I think Singapore took some of the Southeast Asian VIP business, because from a geographical and traveling standpoint it’s just a lot easier and a lot closer to go there. But I think with the amount of quality resorts and hotel in Macau right now, Macau has its own appeal. So, I think at 60% year-on-year growth, there’s been very little impact.”
  • “Over the medium to longer term and beyond Macau in some of the major jurisdictions like Japan and Taiwan, we have quietly done some study trips and some lobbying work. So, we will continue to keep an eye on those markets as well.”
  • “And the expansion area will be around 20 tables. Hopefully, we will be bringing two to three junket operators before Chinese New Year, that’s the plan.”
  • [Unused land adjacent to CoD] “I think more likely than not it is probably going to be a hotel tower.”
  • “So, I think when sites five and six and Galaxy opens up, that will certainly appeal to their visitors, and will certainly draw some traffic into our property.”
  • [Junket market] “So, we’ve stuck very firm on our pricing since over a year ago, and also, on credit support as well. So, I think if you look at some of our receivable is actually going down.”
  • “In terms of Altira, the majority of junkets on the turnover basis.”
  • “In COD, the revenue share and turnover basis ratio is 50-50.”

The Week Ahead

The Economic Data calendar for the week of the 21st of February through the 25th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - jj1

The Week Ahead - jj2

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CNBC VIDEO: Cash-Strapped States Could Face Downgrades

Exhausted? SP500 Levels, Refreshed

POSITION: no position in SPY


Exhausted yet? I know the US stock market bears are exhausted with the bulls who sold at the exhausted March 2009 lows. As you can see in the chart below, that was 98% lower. The “flows” argument notwithstanding, US Equity market volume, breadth, and volatility readings finally look exhausted too.


Here’s another way to look at the exhaustion of immediate-term TRADE and intermediate-term TREND price momentum:

  1. Immediate term TRADE’s 3 standard deviation overbought line = 1340
  2. Intermediate term TREND’s 3 standard deviation overbought line = 1346

Interestingly, these lines are converging around the same price level. That multi-duration price momentum factor combined with an immediate-term TRADE breakout this week in volatility (VIX) and continued deterioration in our TREND duration volume studies has me exhausted looking at this.


What could go wrong from here to inspire a garden variety mean reversion correction of -7.7% to 1242 over the intermediate-term? Away from a potential crisis in US bond and currency market prices, probably nothing …


I guess the positive news for the bears who had it in them to short today’s highs in the SP500 (I haven’t yet), is that next week doesn’t have a merger Monday. Feels like a February in 2008.


Enjoy your weekend,



Keith R. McCullough
Chief Executive Officer


Exhausted? SP500 Levels, Refreshed - S P 021810

Civil Unrest In . . . Wisconsin?

Conclusion: We may be seeing the early stages of union busting in Wisconsin, which, if successful, could be a marginal positive for the municipal bond market.


Position: Covered our short position in the etf MUB on 2/16 in the Hedgeye Virtual Portfolio


The last couple of days have seen large scale protests on the Capitol in Wisconsin.  As much as they are likely disgruntled, Wisconsin natives aren’t protesting the fact that Yale (the alma mater of Keith and myself) is ranked ahead of the University of Wisconsin in Division 1 hockey.  Rather these are protests by government unions, in large part teachers, who are upset with the deficit cutting proposals currently set forth by Governor Walker to limit the ability of many public employees to negotiate their contracts on a go-forward basis. In effect, this would end 50-years of collective bargaining rights.


Governor Walker’s proposals are seen as aggressive by many on the left and, in fact, being called union busting tactics by much of the prominent union leadership in Wisconsin.  The key proposals include:


-          All public employees will be required to contribute 5.6% of their pay to their pensions (much more than now);

-          All public employees will be required to pay 12.6% of healthcare premiums, up from 6% now;

-          Public employees will only be able to negotiate pay raises that are on par with annual increases in CPI;

-          Contracts will be established with a duration of one year; and

-          Union fees will become optional and each year public employees will have the right to vote via a secret ballot to decide whether they want to stay in the union.


While the Republicans currently hold a majority in the Wisconsin Senate, with 19 seats of the 33 seat house, they are actually one short of a quorum needed to conduct business.  So, while the debate on Governor Walker’s bill was set to begin yesterday, the Democratic caucus responded by, literally, leaving town.  In fact, according to Democratic State Senator Jon Erpenbach, the Democratic State Senators had actually all left Wisconsin and assembled in Rockford, Illinois.  According to Erpenbach:


“The plan is to try and slow this down because it's an extreme piece of legislation that's tearing this state apart.”


No doubt leaving Wisconsin and refusing to debate is a sure fire slow down tactic, albeit a theatrical one.  Despite these theatrics in Wisconsin, the reality remains that heading into fiscal 2012, which starts for most States on July 1, 2011, States are collectively facing a ~$134BN budget deficit.   


In the past couple of fiscal years, the stimulus program has paid almost $200BN to the States, which has allowed them to fund their budget gaps.  As such, which we outline in the chart below, we have seen a very limited drop off in State and local government employment over the past three years compared to the dramatic drop off in private employment.  No doubt, this is set to change and change dramatically in the coming quarters as State governments will be forced to make cuts. According to some studies, employment costs are as much as 50% of State budget expenses, so it is likely that the battle we are seeing in Wisconsin spreads nationwide.


Civil Unrest In . . . Wisconsin? - djchart


The extent to which these new plans can be passed will be a function of the strength of the unions, and the extent to which they are willing to battle.  Over the course of the past 40 years the unionization of State and local governments has gone up dramatically, while unionization in the private sector has declined steadily.  Currently, more than 1/3 of these employees are unionized.  So, this lobby is large and motivated.


We called this out in our Q1 Theme Presentation, but the risk of these large and well organized unions is that they delay much needed fiscal reform.  Only time will tell the extent to which unions can impeded these fiscal reforms, but the gauntlet is being thrown down as highlighted by some recent quotes:


-          Randy Weingarten, president of the 1.5 million-member American Federation of Teachers (January, 2011):


“ Governor Christie’s vilification of teachers and their unions is a cloak for all of the cuts that have been or about to be visited upon public education.”


-          Gerald McEntee, President of the American Federation of State, County, and Municipal Employees (January 19, 2011):


“The stakes have never been higher… We’ll be running ground operations, hitting the airwaves and taking on the forces allied against us.”


The battle lines have been drawn and the future of fiscal reform at the State and local level is in the crosshairs.  But the reality remains, fiscal deficits loom and perhaps Governor Walker of Wisconsin summed it up best in a recent article in the New York Times:


“I’m just trying to balance my budget. To those who say why didn’t I negotiate on this? I don’t have anything to negotiate with. We don’t have anything to give. Like practically every other state in the country, we’re broke. And it’s time to pay up.”




Daryl G. Jones

Managing Director