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Enabling Success

This note was originally published at 8am on March 04, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“He is able who thinks he is able.”



When I started this firm, I had a simple goal – to democratize the risk management process of a hedge fund. What does that mean? That means showing the world exactly what it is we do, real-time, in a transparent and accountable way.


What does a hedge fund do? You’ll get a lot of different answers to that question – and as industry supply of hedge funds continues to expand, you’ll get more hedge funds who really don’t do what I do – hedge. Some strategies are simply levered-long versions of mutual funds that charge higher fees. Those hedge funds tend to blow up when markets stop going up.


Enabling Success in a hedge fund model is best achieved by having short positions that don’t hurt you when the market goes up. It’s a trivial exercise to buy something when everything is going up – that’s called beta. Managing losses is the key to this game – not chasing relative returns.


I don’t run money anymore, and a lot of people still ask me why. Three years ago, I thought I might eventually go back to doing it again – not anymore. I’m having too much fun building a real company with real cash flows. I absolutely love reading and researching so that I can put myself out there every morning. The challenge for me isn’t how much money I make, it’s how big of an arena I can play this game in.


I’m certainly not walking through these thoughts for any other reason than this is what I am thinking right now. I only have 45 minutes to write you these missives every morning – so I have to roll with what’s in my head. That requires a risk management process in and of itself – editors!


Enabling clients to look inside our risk management process seems to be the most empowering part of what we do. In order to Enable Success in this business, I think you need to let independent minds explain their research perspectives so that you can weigh them against your own. Whether our research is top-down, bottom-up, or quantitative – it seems to elicit plenty of feedback. Constant feedback enables success too.


How have we enabled this research platform to deliver an 81.6% batting average on the short ideas since inception in 2008? It certainly hasn’t been by sitting on my positions. Short-And-Hold isn’t a repeatable strategy across market cycles inasmuch as Buy-And-Hold isn’t. If you want to compound positive absolute returns on the short side over time, you have to keep moving.


Enabling Success on the short side of your portfolio is also driven by finding asymmetric opportunities. Since I attach the Hedgeye Portfolio at the bottom of this note every morning, you can monitor this real-time. But the upshot of it all is that you can witness a raging bull-run in US stocks and, at the same time, find ways to make money on the short side. If you broaden your scope, there’s always a short selling opportunity somewhere.


When I was younger, I was pigeon-holed into following US Retail and Restaurant stocks – so automatically, I was handcuffed to fishing in the creek that was in my area code. I was in the right place at the right time however, because 2000-2002 were bearish US stock market tapes, so there were plenty of names that were going down. Timing, like gravity, matters.


As I get older, I’ve simply broadened my horizons to fishing in oceans around the world across asset classes. At the same time, I’ve expanded my research team to 40 people (the largest team I managed at a hedge fund was 6).  


Enough about that. I just felt like writing about it this morning. I think it’s important to be transparent about what it is we do.


Since I only have 15 minutes left, here’s what I’ve been doing this week in the Hedgeye Asset Allocation Model:

  1. Reduced my cash position from 58% to 49%, taking advantage of some lower prices earlier in the week
  2. Expanded my invested position in International Currencies (Chinese Yuan and Canadian Dollars) as the Buck Burns
  3. Expanded my invested position in German Equities (EWG) where we remain bullish
  4. Bought back Gold on yesterday’s correction (GLD)
  5. Stayed long Oil and Grains (OIL and JJG)
  6. Stayed long US Healthcare (XLV) – my favorite US Sector alongside Energy

On the long/short side of the Hedgeye Portfolio, the main investment theme remains being long of The Inflation:

  1. Long Stocks with top line leverage to The Inflation (bought Petrobras (PBR) this week)
  2. Short stocks without pricing power whose margins get jammed with The Inflation (McDonalds (MCD), Target (TGT), etc.)
  3. Short Bonds and Emerging Markets – The Inflation is bad for them

Yes, there are some names in the Hedgeye Portfolio that aren’t working – there always are. There are also names that don’t always fit the top down and quantitative themes we’re focused on like a glove. These are names that my analysts like on either a turnaround or operating basis (SBUX, WEN, IGT, etc.).


Altogether, Enabling Success in terms of asset allocation, security selection, or net exposure is really best achieved managing your mistakes so that they don’t suppress your ability to generate repeatable absolute returns across market cycles.


My sincerest thank you to all of you who have enabled this platform to thrive. We don’t have to wake up every morning looking for some central planner in government to help us employ people. In an industry that is in dire need of evolution, you’ve enabled us to be the change we want to see in the world.


My immediate term support and resistance levels for the SP500 are now 1318 and 1342, respectively.


Happy birthday to my baby girl, Callie.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Enabling Success - yy1


Enabling Success - yy2


The Macau Metro Monitor, March 9, 2011


According to the US Department of State's International Narcotics Control Strategy Report 2011, illegal side-betting could total MOP 1.88 trillion, 10x the MOP 188.3 billion in Macau GGR in 2010.  Reiterating the junket concern in the August 2010 report, the 2011 report calls for "robust oversight of junket operators."  It classifies Macau as a “major money laundering” territory and a “jurisdiction of primary concern” and claims for the 1st time that local “financial institutions [are] engaged in currency transactions involving significant amounts of proceeds from international narcotics trafficking”. The reports stresses, “In addition to the existence of casinos, close proximity border with PRC [the People’s Republic of China] and Macau’s open economy, are factors that create a risk of money laundering and terrorist financing activities”.


However, the report does acknowledge that Macau continues to make considerable efforts to establish an anti-money laundering framework that meets international standards.  It states that the GIF (Financial Intelligence Office) should have access to all the currency transaction reports sent to the DICJ by gaming operators.



The consortium between Bombardier Transportation and China Road and Bridge Corporation (BT CRBC) has filed a new lawsuit in Macau’s Administrative Court to obtain the release of documents and additional information regarding the public tender for the supply of the rolling stock and the system for the first phase of the Light Rail Transit (LRT).  The BT CRBC consortium claimed it was barred from analysing several documents from the LRT tender process.  The new lawsuit, filed on March 2, suspends yesterday’s deadline for lodging an appeal against the result of the tender.


Sands Macao’s “Imperial Stadium” features live roulette and sic bo games with 100 individual electronic touch-screen stations, combining live dealers with electronic stations.

WMT: Virtual Portfolio Update


Keith shorted WMT in Hedgeye’s virtual portfolio with the view that inflation will become an increasing headwind for the company’s topline as well as for margins.   Independent of inflation, we’re already pre-disposed to be short WMT based the internal challenges the company faces to drive its domestic same store sales towards the first increase in seven quarters.  


The situation surrounding Wal-Mart’s internal execution in areas such as apparel and overall category management is nothing new.  Too much selection? Not enough selection?  Brands? Basics?  Management is hyper focused on turning things around, yet numerous strategy changes over the past year have yielded little in the way of tangible results. We do not see a meaningful and credible plan at this current time that suggest domestic sales can outperform an increasingly challenging backdrop for the company’s core consumer.  In fact, the company entered 2011 with total inventories up 11% against a 2.5% increase in sales.  Clearly not the “clean” start that instills confidence in the wake of rising costs and substantial volatility at the gas pump.


We remain concerned with the following near-term challenges:

  •  Management’s message now says the US goal of positive same store sales will “take time”.  The CEO acknowledged that issues facing sales (and their customers) were bigger than they “initially expected”.  Traffic is still a drag and likely to remain so given the law of large numbers that puts 1 in 3 Americans at a Wal-Mart each week.
  • The company cut capex by $1 billion for this year, after slightly raising it at the October analyst day.  While this is noteworthy because it shows some discipline towards capital preservation, we put the amount of the cut in perspective.  At today’s share price, WMT can buy an additional 19 million shares which represents a mere .005% of shares outstanding.  
  •  Inventories are high no matter how you slice it heading into this year.  Total inventories were up 11%, total sales up 2.4% at year end.  With a negative comp headwind, inventory pressure is likely to persist through the first half of the year leaving little chance for margin expansion.  From a timing perspective, this then rolls into the second half of the year which is the most uncertain time from an inflation and price elasticity standpoint.
  • The current four point plan aimed at fixing the US business is centered on price leadership, broad assortments, improved remodels, and focus on multi-channel.  None of this is revolutionary, but rather basic blocking and tackling.  Details surrounding these plans are also scant, at least as of 4Q reporting.  The first point of the plan is most telling however.  In order to maintain price leadership in a the wake of rising costs, we suspect WMT will be as aggressive as ever to protect its market share.  At best, this caps margin improvement in the near to intermediate term.

Eric Levine



What’s the chance that LVS gets prosecuted?



LVS shares continue to be pressured by the potential ramifications of the SEC/DoJ investigation into the company’s compliance with the Foreign Corrupt Practices Act (FCPA).  As Adelson wonders how much more hair and money he will lose over this matter, we checked in on stats from some of the past high-profile FCPA cases. 


In 2010, there were 23 FCPA investigations that resulted in enforcement actions.  This translates into a roughly 20% hit rate. 48%, 28%, and 18% of estimated ongoing FCPA investigations resulted in prosecution in 2007, 2008, and 2009, respectively.  The number of cases have more than tripled since 2007.


As the table below shows, the settlement payments for the largest FCPA cases have risen significantly since 2008.  The penalty multiple placed on the alleged illegal money varies widely, although the guideline for 2010 was around 2x.  Moreover, many senior management members, including CEOs, are serving prison sentences.  We’re not saying Adelson is going to jail but as we wrote in LVS: IT’S NOT JUST ABOUT THE FINE (3/2/11), we believe the FCPA fine for LVS could be high, and more importantly could have deeper ramifications (e.g. forced exit from NV,PA; lost opportunities in new markets).



Dr. Copper's Writing a Divergent Thesis


Conclusion: Price momentum is slowing in copper.  The industrial metal is now bearish on TRADE duration and that has our attention.  The fundamentals – supply and demand – confirm the price breakdown; thus, we do not see the pullback in copper as a buying opportunity


Dr. Copper's Writing a Divergent Thesis - copper price


China consumes ~40% of the world’s refined copper – 4x as much as the U.S.  Historically, copper prices and Chinese growth have been positively correlated.  However, just as at a point higher oil prices are bad for economic growth, so are higher copper prices.  The chart below illustrates this point.  The Chinese stock market and the price of copper closely mirrored each other for the first half of 2010.  But when copper crossed over $4.00/lb in October 2010, the two diverged meaningfully.  At a point reflation becomes inflation, and inflation hampers growth.


Dr. Copper's Writing a Divergent Thesis - shanghai


The method through which higher prices stymie growth is lower demand.  Consumption of copper in China peaked in early 2010, and has trended down since:


Dr. Copper's Writing a Divergent Thesis - copper3


As consumption slows, inventories build.   Here is what that looks like in China:


Dr. Copper's Writing a Divergent Thesis - copper4


What about the developed world?  After China, the largest consumers of refined copper are the US, Germany, and Japan.  Here’s what consumption of copper looks like in those countries:


Dr. Copper's Writing a Divergent Thesis - copper5


Obviously, developed economies cannot be relied upon to pick up the slack for a marginal slowdown in Chinese copper consumption.   And recently copper inventories at the largest copper warehouse in the world – the London Metal Exchange – have built aggressively.  When China slows, copper inventories build:


Dr. Copper's Writing a Divergent Thesis - copper6


Lending to the inventory builds, copper production (mining) is strong, increasing 7% in 2010 year-over-year:


Dr. Copper's Writing a Divergent Thesis - mine production


Inflationary pressures (copper included) have forced the Chinese to tighten monetary policy, leading to slower growth.  Slower growth has led to a decline in copper consumption, though we have to not seen the impact of that feed through to the price of copper until very recently.  We contend that copper traded away from the supply – demand fundamentals beginning in late 2010, and simply inflated.  After all, the correlation between the USD and the price of copper is -0.80 over the last year. 


If inflationary pressures subside and copper returns to the fundamentals, lower demand and higher supply will take the metal lower.  We will be watching the TREND line of support ($4.25/lb.) closely.  If that line breaks, look out below.


Kevin Kaiser


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