GS downgraded WMS and trashed the sector. Their slot estimates are factually wrong but are their concerns warranted?
Goldman Sachs sent shock waves through the gaming investment community yesterday with the release of its annual slot survey. Smaller than expected slot budgets, waning Wide-Area Progressive (WAP) demand, and more competition were cited as reasons to be cautious on the stocks. The firm was particularly negative on WMS and actually downgraded the stock to sell.
While we are not sure WMS is a sell given the favorable long-term outlook for this sector, we’ve articulated the view that the company is in danger of losing some share in calendar 2011. GS’s survey corroborates that to some extent. However, we must take the slot company responses with some caution. Firstly, the number of participants and the participating operators in the survey change each year, so the results each year aren't exactly apple to apple comparison of sentiment changes within the same group. In last year’s survey, WMS was cited as the clear winner in the survey, yet from Q4 2009 to Q4 2010, its market share was essentially unchanged. IGT was considered somewhat of a loser in last year’s survey, yet its market share only dropped 1%. In terms of stock performance, WMS has dropped 24% since last year’s GS survey was released up until the day before this year’s survey while BYI and IGT only fell 7% and 5%, respectively.
The reaction yesterday may have been extreme but we’re still a little wary of WMS over the near term. We do like IGT and BYI – IGT is a better near-term story because it’s safer (margin levers) but BYI is a better 12-18 month story. Both should be sequential market share gainers as we move through the year.
In terms of Goldman’s industry conclusions, we would caution investors on putting too much stock on operator responses regarding budgets. We stand by our 55k estimate for calendar 2011 replacement demand versus GS at 47k. More importantly, we are pretty sure GS’s slot estimates for new casinos and expansions are just flat out wrong. They appear to be off by 10k units in 2011 and 20k units in 2012. Here are the discrepancies:
The other important issue is wide area progressive where GS seems to be overly focused. Yes that business is waning but they ignore that a big reason for that is the growth in other pricing models such as fixed daily fees and straight revenue participation. These are actually higher margin pricing schemes because there is no jackpot expense.
We continue to believe that replacement demand is uncertain but priced in to the stocks. IGT seems to be the best positioned over the near term because they maintain the most margin levers should replacement growth fail to materialize. BYI seems to have the most upside over a 12-18 month time horizon given the likely technology-driven, sequential pickup in ship share off of a low base and low valuation. WMS is well-positioned long term but could continue to hit bumps in the road as market share normalizes at a lower level.
This note was originally published at 8am on March 03, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“So our virtues Lie in the interpretation of the time.”
This morning Global Equity markets are begging for Libyan resolve. The Chinese and Russians talking down a US no-fly zone notwithstanding, fidgety bulls are trading on a tick with the direction of the price of oil. That is “the interpretation of the time.” That price volatility is also becoming this market’s greatest risk.
The longer term risk management question as to the pace of Global Inflation Accelerating remains – if peace and love were to breakout across the Middle East tomorrow, will that stop the world’s reserve currency from being debauched?
Looking at the Global Currency market’s real-time vote on money printing, Ben Bernanke’s 2-day Semi-Annual Storytelling on US Monetary Policy was a disaster. Whether The Ber-nank chooses to be willfully blind to this or not, the US Dollar Index is now down for 8 of the last 10 weeks and collapsing to lower-lows.
Proving that petrodollars are indeed affected by the dollar’s price or that US Dollar priced inflation at the pump is a consumption tax on US growth is a trivial exercise. What isn’t trivial to the American public is the math. And that’s not because the math isn’t trivial. It’s because we have allowed an Almighty Central Planner to garner so much political power that he can not only obfuscate things like math – but make up his own interpretations of the times.
Before I get into Bernanke’s definition of what the US Dollar is (Ron Paul asked him for it yesterday), here’s the math on the inverse correlations between US Dollars and things that are inflating:
*Note to Fed: this correlation risk is running extremely high
And if you want the R-squares on these relationships they run between 0.74-0.82, so the correlation between what the US Dollar is doing and inflation is doing is crystal clear. Now some academic brainiac who is defending the Keynesian Kingdom of thought is going to quickly say something in response about “causality versus correlation” and, while there may be differences in certain scientific exercises, it’s a crock when it comes to analyzing the Fed’s mandate.
The Fed’s official marketing mandate is “price stability.” Whereas the Bernanke Fed’s operative has been to print money and inflate. He has only raised interest rates ONCE (2006) and he has overseen the highest levels of PRICE VOLATILITY that modern day markets have ever seen. Ever is a long time.
What is causality? What are the root causes of inflation? Is the global market place or The Bernank going to resolve this debate? Mr. Macro Market all but evaporated the Keynesians with The Inflation of the 1970s – are we looking to roll the bones to see if we get one of those again? (see the chart below of long-term median price inflation going back to the year 1500 from Reinhart & Rogoff’s This Time Is Different, page 181)
First, to attempt to briefly address some answers to these questions, let’s define what the US Dollar and Causality are:
Now, since Bernanke says there is no inflation, he says the “price stability” and buying power of the US Dollar are just fine. And every American who doesn’t have a car service take them to work will tell you that’s the most ridiculous conclusion they’ve ever heard. In fact, most Americans think Bernanke is simply part of the government lying to them about real-world inflation – and you know what, most Americans aren’t as stupid as Bernanke must think they are – they are right.
Back to causality - to understand the cause of inflation, one must study the history by which The Inflation is priced – fiat currencies:
Do we need to bring back a great American leader (Herb Brooks) to line The Bernank up on the blue line and repeat – “Again”… “Again”… “Again”? Or do we need a Miracle? Developed economies (including our own) have tried this over… and over… and over again with the cause (politics) and effect (inflation) being the same.
To make matters worse, it appears that the Big Government Spenders of longstanding European and modern American ilk haven’t learned a damn thing from all this. Bernanke seems readily prepared to blame any unintended consequences associated with this US Dollar Crisis on either Congress or someone in the Middle East. Gotta love the accountability in that. ‘Congress needs to stop spending, but I need to keep printing’ – he said it, not me.
My bearish view of Bernanke’s process isn’t a new one. Neither is managing the systemic risk that the Federal Reserve imposes on global market prices. Anyone who has been managing market risk for the last decade has been paid to accept and understand that the Greenspan/Bernanke interpretations of the times have not worked. As the late Murray Rothbard (distinguished Austrian School of economics professor) wrote in “The Case Against The Fed” in 1994:
“The Federal Reserve System is accountable to no one; it has no budget; it is subject to no audit; and no Congressional committee knows of, or can truly supervise, its operations… and this strange situation, if acknowledged at all, is invariably trumpeted as virtue.”
Maybe it has become the virtue of the few who hold centralized power in the palm of their hands – but this is not the virtue of the American Constitution. Neither is it the virtue of this Canadian who thought he was building an American family and firm under a President’s marketing pitch about Transparency, Accountability, and Trust. This virtue is a lie.
My immediate term support and resistance lines for the SP500 are now 1291 and 1319, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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TODAY’S S&P 500 SET-UP - March 8, 2011
As we look at today’s set up for the S&P 500, the range is 19 points or -1.00% downside to 1297 and 0.45% upside to 1316. The futures are trading higher as Oil falls for the first day in three. Most Asian stocks climb on speculation Chinese regulators will stop measures to cool lending and European markets are mixed as German factory orders rise more than expected in January.
MACRO DATA POINTS:
WHAT TO WATCH:
For the second day we have 5 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND.
CREDIT/ECONOMIC MARKET LOOK:
Treasuries finished weaker following some intraday strength
Conclusion: The growing divide in monetary policy relative to the US suggests current FX trends may continue and perpetuate crude oil prices beyond their summer ’08 peak. At the bare minimum, elevated prices are here to stay over the intermediate-term TREND – irrespective of the turmoil in the Middle East and North Africa.
Position: We remain long of inflation via crude oil, gold, agricultural commodities, and energy stocks. We remain short bonds, emerging markets, and US consumer and industrial stocks.
Perhaps the most important piece of economic data to hit our screens in recent weeks is ECB President Jean-Claude Trichet’s hawkish comments following the latest ECB policy meeting last Thursday. Regarding those comments, Matt Hedrick, our European Analyst writes:
“In a Q&A session after the ECB announced no change to its key interest rates this morning, ECB President Jean-ClaudeTrichet said that an “increase of interest rates in the next meeting is possible… but not certain.” Despite all attempts by Trichet to be close-lipped on future actions by the governing council, the sentence was largely interpreted by the market as proof that the ECB will hike in the near-term.
And both the EUR and European equity markets cheered on the news. The EUR-USD rose to an intraday high of $1.3966 and European equity indices gained to close up +50 to 150bps today.
Trichet also made it clear that today’s decision was based on data taken from mid-February, and therefore did not include the recent move in crude prices, which created further speculation that greater inflationary readings next month may boost the probability of an interest rate hike.”
Regarding these rising inflation expectations, Matt writes:
“In comments today, Trichet said the range for Eurozone inflation (CPI) has shifted upwards to between 2.0% and 2.6% in 2011 and between 1.0% and 2.4% in 2012, mainly due to “the considerable rise in energy and food prices.””
It has long been our stance that Bernanke & Co. will continue to be willfully blind to inflation pressures, as neither $100-plus crude oil or world food prices at all-time highs directly manifest themselves in the Fed’s preferred “Core” CPI reading. While refraining from the debate on the analytical merits of “core” vs. “headline” inflation, the key takeaway here is that the ECB just confirmed that they’ll be quicker than the Fed to react to rising inflationary pressures resulting from commodity inflation.
The ECB now joins the Bank of England, the Bank of Canada, Sweden’s Risbank, and the Swiss National Bank as key constituents of the US dollar basket that are exhibiting hawkish monetary policy on a relative basis to the Fed. Together, these currencies make up 86.4% of the US Dollar Index.
As we often say, “everything that matters in Macro occurs on the margin”, and, on the margin, the foreign central banks most important to determining the value of the US dollar are moving away from Bernanke & Co. on monetary policy.
As a result of this collective marginal shift in monetary policy, these currencies are appreciating relative to the US dollar:
Understanding that currencies can only appreciate/depreciate relative to each other, it’s no coincidence that the US Dollar Index is down (-7.7%) over the same duration. The effect of monetary and fiscal policy on currencies does not happen in a vacuum; all deltas and inflection points must be considered relative to competing currencies.
Up until last week, it can be strongly argued that the dollar’s decline has been aided by a confluence of dovish US monetary policy (QE2) and incredibly lax fiscal policy (the CBO revised up the US federal budget deficit by +46% through FY13). With this news largely baked into the cake, we argue that incremental US dollar weakness (down -2.7% since it rallied to a lower-high in mid-Feb) is being driven largely by strength in the dollar’s counterparts, rather than incrementally-weak policy home:
The chart below shows the inverse relationship between the US Dollar Index and strength/weakness in its constituent counterparts (ex-Japan):
It’s no coincidence that mid-Feb corresponds with the latest jump in global crude oil prices, which have an incredibly high inverse correlation to the US Dollar Index:
This price action underscores a developing trend we see picking up steam over the near term: increased hawkishness relative to the Fed out of the central banks within the US dollar basket as a result of rising crude oil prices will put upward pressure on their currencies and incremental downward pressure on the US Dollar Index – in addition to the USD’s own dovish fundamentals. Perhaps the most alarming part of this trend is that it has a self-perpetuating tendency:
Indeed, this self-perpetuation of global FX trends vividly reminds us of early 2008, where the monetary policy backing each of these currencies was hawkish relative to the Fed (with the notable exception of Canada, which was more impacted by the US’s burgeoning recession). Even the Bank of England, which was cutting rates at the start of 2008, was more hawkish than the Fed by cutting at a significantly slower pace. The ECB and the SNB were on hold after hiking rates in mid-to-late 2007 and the Riksbank was outright raising rates until September of 2008.
This collective hawkishness relative to the Fed from mid-to-late ‘07 through mid-2008 contributed to widening interest rate differentials across the board, as the spread between German, British, Canadian, Swedish, and Swiss 2Y bonds each increased vs. 2Y US Treasury bond yields (using German bunds as a benchmark for EU yields). This widening of spreads supported the appreciation of each currency (Euro, Pound, Canadian Dollar, Swedish Krona, and Swiss Franc) vs. the USD.
Understanding full well that the Fed did its best to debauch the dollar during this period, the US dollar would not have declined much without the aid of this relative hawkishness out of competing central banks – the buck can’t truly burn without help. Thus, as each currency appreciated relative to the USD, the US Dollar Index correspondingly depreciated. Given, we argue that much of the run-up in crude oil prices from late-2007 to mid-2008 was, in fact, due to strength in the USD’s counterparts as much as it was due to Bernanke Burning the Buck.
Fast forward to 2011, and we have a very similar scenario whereby competing central banks are getting tighter on the margin relative to the Fed by a combination of hawkish rhetoric and rate hikes. This marginal hawkishness is supporting each of their currencies to varying degrees (excluding Japan, which continues to hint at additional easing, but is handcuffed by rising import prices) and keeping the selling pressure on the US dollar, which keeps buying pressure on crude oil and other commodities.
While the US Dollar Index may be oversold on an immediate-term TRADE basis, the broader intermediate-term TREND suggests that this self-perpetuating cycle is already underway and will only be alleviated by some combination of dovishness out of the aforementioned foreign central banks or hawkishness out of the Fed from a policy perspective – which is unlikely given that Bernanke was unable to see inflation at $150/bbl. crude oil; nor could he hike rates when GDP growth was at +5% on an annualized basis.
We know QE2 is ending in three months; will the Fed be tempted to step on the gas pedal some more? Reasonably strong US GDP growth forecasts of around +3.5% for 2H11 suggest that QE3 is not consensus – yet. If, however, we are correct in our call for a measured rollover in consumption growth and expedited housing deflation over the intermediate-term TREND, calls for additional monetary easing in the US will indeed become consensus – making US monetary policy incrementally dovish vs. competing central banks, as well as giving the US dollar an incremental push to the downside relative to its counterparts.
Of course, the Eurozone continues to have its sovereign debt issues, so we’ll be acutely focused on their monetary policy as well, measuring the slope of any hawkishness or dovishness on the margin. For now, their relative hawkishness combined with that of the BoE, BoC, Riksbank, and SNB is supporting the price of crude oil, which, ironically, supports additional hawkishness.
Will the cycle extend itself as it did in early 2008? As always, time and space will tell.
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