What do you do, Madame?

What do you do, Madame? - asset allocation010809

"As the facts change, I change... what do you do, Sir?"
-John Maynard Keynes

To be clear, I am no Keynesian. However, I think this may be one of the best one-liners in the economic dialogue - it is a process.

I have my investment process, and you have yours - together, we can learn from one another and test, implement, and evolve. That's what the most successful dynamic multi-factor systems on this planet have always done. There is no reason to believe that macro economics will end up any differently. When the Street or your boss tells you they "don't do macro", I humbly suggest you challenge that received wisdom from the heavens of non-transparency, and ask well "what is it that you do, Sir?"

Don't forget that the 1st Nobel Prize in Economics wasn't awarded until 1969 - there are plenty a precedent waiting to be set in this profession; plenty of processes to be tested and tried; and plenty of winning and losing investment strategies that will emerge from the facts.

Of course, this isn't a gender thing, so THE question could very well be "what do you do, Madame?" In fact, neuroscience is starting to uncover The New Reality that women are actually predisposed to make better portfolio decisions than men, on balance, when under stress. Sorry guys!

One of our sharpest female clients jumped right on my suggestion from yesterday's Early Look ("Crisis In Credibility",, 1/7/09) and effectively peppered me with questions as to the implications. She, as usual, was all over the pin with THE questions she was asking. Given the facts that have revealed themselves over the course of the last 3 months, THE question remains: why doesn't Wall Street understand that there is no longer a "Liquidity Crisis" and that all we have left is a "Crisis in Credibility?"

Whether it be Satyam Computer's Indian fraud announcement that continues to rock Asian equity markets or Chinese computer giant Lenovo trading down -26% last night on missing expectations, it's all one and the same - we have ourselves a crisis in both the credibility of the financial system's leadership and the research process embedded therein. If we didn't, expectations from Madoff to the "Made-Up" wouldn't be creating so much heartache in your 401k's.

"Expectations" are indeed "the root of all heartache", and to be clear, I am not a Shakespearean student in creative writing either, but his point lines up very appropriately with the Keynesian one. When the facts change, you better make moves in your portfolio, or your investors will soon be expressing heartache of their own.

Why does this process gospel according to Keith matter to the market this morning? Well, because it matters every morning. When I started selling our position in Commodities and Equities into the peaks of pessimism caught off sides, I was doing so because the facts in my macro model were changing. I didn't do it to be cute. I didn't do it to pander to a core constituency. I simply did it because I thought I was going to be right.

There are 3 things that have changed in the last 72 hours of global macro fact gathering: 1. Prices, 2. Expectations embedded in those prices, and 3. Timing of macro catalysts.

Of those 3, price and expectations are correlated functions of one another. As prices rose, so did expectations - so I started selling into them. We sold all of our "re-flated" Commodities, all of Brazil, and all of Hong Kong - prices in the two latter equity markets had risen over +40% since we started getting bullish, while the price of oil had raced +46% higher in less than 9 trading days. As prices and expectations change, I change... what do you do, Madame?

When it comes to understanding markets, Madame Speaker, Nancy Pelosi, is not in the same league as my aforementioned client. Yesterday, Pelosi, and Congress at large changed the point #3 in what mattered most to my macro model on the margin - TIMING. I sent out 2 separate intraday macro notes to our top tier Macro clients yesterday titled "Beware of Congress" and "Obama Having a Rougher Day" - so I won't rehash those notes in full, but I will say that the facts were changing yesterday - real time - and markets wait for no one.

The bottom line is that Congress is pushing out the timing of the catalysts associated with Obama's inauguration. On the margin, these pending catalysts are mostly positive... but their duration was being pushed out, at least rhetorically. I actually think this is great for the US stock market in general, because it creates a longer dated tail of positive announcements - in the face of a dreadful pending employment report tomorrow, and Q4 earnings season right around the corner, God knows we need that.

I don't need to be bullish or bearish. Neither do you. We have to be right. This is going to be a dog fight in 2009 as to who has both the best investment processes and returns. We will never, ever give up. We have your back. We appreciate your business and feedback - without it, we wouldn't be aware of as many facts changing in this globally interconnected market place as there are.

My buy/cover range for the SP500 is now 885-900. I proactively cut my asset allocation to US Equities in half over the course of the last week. Now I am open to buy more, lower.

Best of luck out there today.

What do you do, Madame? - etfs010809


We will soon see how much of an impact the flood of junket credit had on the Macau market in 1H 2008. The following chart shows the quarterly Rolling Chip (RC) volume in 2008 and the 2009 volume assuming a Q4 2008 run rate. Sure there may be some seasonality associated with Chinese New Year in Q1 but the underlying credit situation is deteriorating sequentially. Yesterday, LVS President Bill Weidner commented that junket operators have been unable to collect a lot of the money they lent their VIP players.

RC volume could be down 20-25% in 1H 2009. MPEL will be impacted the most as 96% of its revenues were from RC in 2008. However, Wynn Macau and Galaxy were not far behind, each generating around 80% of their respective 2008 revenues from RC. Granted, the mass market profit margin is roughly double that of rolling chip but rolling chip generates more dollar profits than mass market. That is certainly true for most of the properties in Macau, including Wynn Macau.

Macau estimates certainly look like they need to come down.

1H 2009 Rolling Chip will be impacted by tough comparisons and deteriorating credit environment


Some quick comments from Keith:

PFCB looks better than CBRL on the pullback

WEN still looks best at 4.35 and that’s where I want to buy it … DRI is 2nd, then SBUX, then PFCB… EAT broke like CBRL did today, not sure why….

HP - Fundamental comments

I was not hearing any new fundamental news yesterday. Just the standard “the stocks have rallied to far too fast.” EAT and DRI are the two in the group that had big December performance, albeit from oversold levels.

More to come….

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RT – Better than toxic

In FY2Q09 RT, RT’s total revenue declined 9.7% driven by a 10.8% decline in same-store sales. On a monthly basis same-store sales were down 9.4% in September, 10.4% in October and 12.7% in November. Keeping on trend with recent quarters, same-store sales in the Northern markets out performed those in Southern markets. In the quarter, the South’s same-store sales declined 13.9% compared with a decline of 7.7% in the Northern markets. The company’s weakest states are Florida, Alabama, Georgia, Virginia and Tennessee. I would note that things improved slightly since the end of the quarter. In December same-store sales were down 9.1%. The decline in Northern region was 6.5% while the decline in the South was down only 11.7%. At the peak of the decline in August, same-store sales were down 15%.

Turning to the balance sheet, total debt including operating leases, guarantees and letters of credit was $852 million. RT remained in compliance with their covenants at the end of the quarter. RT’s DEBT/EBITDAR ratio was 4.22x versus the maximum requirement of 4.5x. The fixed charge coverage ratio was 2.48 versus the minimum requirement of 2.25. Not surprising, the principle concern with RT is the step down in the leverage ratio going forward. The DEBT/EBITDAR ratio declines to 4.25 in the current quarter through FY1Q10. The debt/EBITDAR declines again in FY2Q and 3Q of 2010 to 4.0x and then goes down to 3.75x at the end of FY2010.

I was somewhat disappointed that the benefit from the store closings was not greater. In FY3Q09 average restaurant volumes should increase approximately $40,000 per year and pre-tax income should increase approximately $10 million. In FY09 RT will generate free cash flow (cash from operations less capital expenditures) between $68-78 million. The combination of the free cash flow as well as proceeds from the sale of other assets will enable RT to pay down $80-90 million in FY09, including the $40 million repaid in the first half of the year.

It’s a bit on the speculative side, but the RT story is one I like to tackle. There is a core RT business that will survive and we are much closer to seeing that core business. Sales comparisons get much easier in the Southern region as we head into the summer and the costs are much better aligned with current sales trends. Any improvement in sales will quickly flow through to the bottom line.


Once again, rumors of a visa loosening have surfaced. We’ve gotten conflicting opinions from our myriad of sources in Macau. The majority, however, believe that there has been no real change in visa policy for the masses. As we pointed out in our 12/21/08 post “MACAU VISAS: NO MAJOR CHANGES”, Beijing has allowed casinos to target certain direct customers for frequent visitation, but not on a mass basis. This could be causing a lot of the confusion.

Our contacts did indicate a busy New Year’s (western) celebration in Macau. Some of that was due to a big bash at MGM Grand. However, most of the incremental visitors appeared to be from Hong Kong and not mainland China.

We continue to believe that real change in the visa situation may not occur until late 2009, when the new Macau Chief Executive is getting ready to take over. In the meantime, the bigger issue is the lack of credit available to players, especially relative to 1H 2008 when the junkets flooded the market. Visa changes primarily impact the mass market business. As can be seen in the following chart, the Rolling Chip business suffered significantly more than mass market in the back half of 2008.

Lack of credit a bigger issue than visa restrictions as evidenced by the underperformance of RC

SP500 Levels Into The Close

A lot of people expressed difficulty in agreeing with my view that we could very well see a -4% pullback in this tape. That’s probably why we are correcting.

After refreshing our model, here’s how the math flushes out. Be patient – this is turning into a very predictable and trade-able range. Volatility is shooting up today, like we thought it would from those oversold immediate term lows. Next line of resistance for the VIX is $45.83, but as we climb towards that line and see the SP500 fall into the buy zone, this tape sets up very bullishly. For the SP500 my levels are:

BUY “Trend” = 895-901 (see chart)
SELL “Trade” = 951

Keith R. McCullough
CEO & Chief Investment Officer

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