Eye on Macro – Obviously Obvious


"Things always become obvious after the fact.”


- Nassim Taleb


Cygnus Atratus, or the Black Swan, hit us three times in the past week with the combination of an earthquake, tsunami, and nuclear disaster in Japan.  Nassim Taleb popularized this term after writing a book titled “The Black Swan,” which analyzed the misconception of investment risk.  His conclusion was that the highly improbable is much more probable than standard measures of risk suggest. 


Alongside the disaster in Japan, Obviously Obvious continues to prevail globally as tensions accelerate in the Middle East with the recently imposed no-fly zone in Libya; deficits increase and consumer confidence wanes in the United States; and sovereign debt issues continue to rear their ugly heads in Europe.



With the SP500 down for 3 of the last 4 weeks and the peak-to-trough correction being -6.5%, the call-out this week is more of a question. Was that it, or is volatility in US Equities signaling that there is more downside to come? With Global Growth Slowing and the VIX in what we call a Bullish Formation (bullish TRADE, TREND, and TAIL), we definitely need to see a re-test of the SP500’s 1256 close for an answer.



Bullish on Chinese Equities and/or US Treasuries? We’ve been bearish on Chinese Equities for well over a year now and have been working our Q1 Global Macro Theme of “Trashing Treasuries” since Q4, so we get the bear cases in both. But can we be mentally flexible enough to make the turn on either? Early signals in our quantitative setups are telling us that it’s time to focus our work on the long side of both.




Longs – China (via CAF); Healthcare (via XLV); CORN (via CORN); GOLD (via GLD); Canadian Loonie (via FXC); Energy Producers (via XLE); Chinese Yuan (via CYB); Yield Curve Flattener (via FLAT)


Shorts – Spain (via EWP); Italy (via EWI); Industrials (via XLI); Homebuilders (via XLB); Treasuries (via SHY); Transports (via IYT)



  • US Deficit – Expenses ran up +5% year-over-year in February to their highest level ever.


  • US Home Prices – Corelogic’s reading on US Home Prices fell -5.7% for the month of January (y/y) and are now running at a -18% annualized pace.


  • US Consumer Confidence – despite the US stock market rallying +98% in the last 2 years, the Michigan Consumer Confidence reading had its 8th largest drop since the data started getting tabulated in 1978 (falling -12% in March to 68.2 versus 77.5 in February).


  • The Japanese stock market lost -17% of its value in 2 trading days (biggest drop since 1987). If you go back to Feb. 14th, the week that fund flows into “Developed” Equity Markets peaked, the Nikkei is down -20.7%.


  • In 18 years of Keynesian experimentation, from 1992 to 2010, Japan had on average +0.85% year-over-year GDP growth.  Over the same period, the Nikkei 225 returned -55%.


  • After the January 17, 1995 Kobe earthquake, Japanese equities lost (-24.7%) before bottoming out nearly six months later on July 3. The Nikkei 225 did not break even until nearly 11 months later on December 7 of that year.


  • For 2011 YTD, the average and median percentage change in the 65 global equity markets and nine S&P sectors we track has been (-1.3%) and (-1.1%), respectively. Only 38% of countries currently register a positive gain.


  • The EU Summit on Competitiveness agreed that the temporary European Financial Stability Facility (EFSF) will be able to access its full funding (from the member states) of €440 Billion, versus the approximately €250 Billion previously available; funding for the permanent bailout fund, the European Stability Mechanism, starting mid-2013, is pegged at €500 Billion.


  • Eurozone leaders agreed to lower Greece’s bailout interest rates of about 5% by 100bps, and extend the repayment period of the loans to 7 1/2 years from 3 years.  Greek PM George Papandreou estimates the moves would save about €6 billion over the life of the loans.


  • Currently, according to the Real Clear Politics Presidential Approval poll aggregate, 47.4% of respondents approve of President Obama and 48.0% disapprove.  While this rating has gone the wrong way over the last few weeks in conjunction with accelerating gasoline costs and a U.S. equity market selloff, it is still well improved from the 51% disapproval rating on September 27, 2010, which was the worst reading of the Obama Presidency.


  • According to the Real Clear Politics poll aggregates, President Obama leads a generic Republican by 2 points, but leads Huckabee by 5.5 points, Romney by 5.2 points, Ron Paul by 9 points, Gingrich by 14 points, and Palin by 15.2 points.


  • The ZEW reported a month-over-month decline in its German Economic Sentiment survey, a 6-month forward-looking assessment, registering 14.1 in March versus 15.7 in February.


  • Chancellor Angela Merkel’s has decided to shut-down 7 of the country’s aging nuclear reactors for 3 months pending a safety review in light of the events in Japan. The Swiss followed the Germans saying they will suspend the regulatory process for 3 nuclear power stations because safety remained the first priority.


  • Portugal faces a hefty schedule of debt (principal + interest) that comes due in the months of March, April, and June (or ~ €16.1 Billion), accounting for nearly two thirds of its debt obligations for 2011 (or ~ €25.4 Billion).  So far the country has sold ~ €7 Billion in bonds of its €20 Billion target this year.


  • Last year, during the peak of the Sovereign debt crisis, the VIX traded at 45.79.  The average of the peak VIX levels during the past 6 major crises that impacted global financial markets comes to approximately 50, which would represent 48% upside from here.


  • Both the Swiss National Bank (SNB) and Norway’s Central Bank (Norges Bank) kept their main interest rates on hold, at 0.25% and 2.00% respectively. Both decisions are represented of the recent pause in global economic sentiment. Trichet may well elect to push out a rate hike decision, despite his latest hawkish stance.


  • Oil has a long term inverse correlation to the U.S. dollar, which for WTI is (-0.78) over the past three years. This has become more pronounced in the last six weeks.  In the prior six weeks, WTI’s correlation is (-0.88) and Brent’s correlation is (-0.86) to the U.S. dollar.

The Week Ahead

The Economic Data calendar for the week of the 21st of March 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 - cal1

The Week Ahead - cal2

Japanese Yen: Be Careful What You Wish For, Consensus...

Conclusion: History shows us that G7 intervention to weaken the yen has resulted in a significant uptick in inflation within Japan. In fact, if the G7’s plan to weaken the yen is “successful”, we expect the inflationary impact to be even greater this time around, particularly given Japan’s current staggering sovereign debt load and easy monetary policy.


Positions (TREND duration): Bullish on the yen and bearish on equities; OR bearish on the yen and JGBs. Getting ahead of the whims of central planners will be key to isolating the winning strategy here.


After just over a decade of inactivity on a collective scale, the G7 jointly intervened in the global currency market to help the ailing Japanese economy by weakening the yen, which is down nearly (-2.3%) on the day. In addition to today’s centrally-planned intervention, the G7 promised additional support as needed:


“We will monitor exchange markets closely and will cooperate as appropriate.”


In spite of yet another round of Almighty Central Planning perpetuating unprecedented volatility in yet another market, we remain positive on the yen over the intermediate-term TREND for now. That could change. While today’s intervention may have cooled off the speculative bid for yen appreciation (net yen shorts of Japanese households dropped -30% day/day), the fundamentals – repatriation and compressing interest rate differentials leading to unwinding of carry trades – remain supportive.


The expected acceleration in JGB issuance in the wake of this crisis (which, coincidentally, pushes Japan’s sovereign debt load above one QUADRILLION yen) has to be financed somehow, which is one of the supportive factors for the repatriation case (in addition to risk aversion and the need to finance rebuilding efforts).


Of course, the Bank of Japan could continue to provide “powerful” and “massive” stimulus, as pledged by BOJ governor Masaaki Shirakawa. They are currently already monetizing JGB debt at a rate of ¥21.6 TRILLION ($267.2B) yen annually, so what’s another ¥10-20 TRILLION yen in perpetual debt monetization?


The last time the world’s Almighty Central Planners decided to collectively intervene to weaken the yen as on August 15, 1995 (about a half a year after the Kobe earthquake). The yen went on to weaken (-29%) over the next three years until a reversal of that intervention scheme on June 17, 1998 sent the yen sharply in the other direction.


As with any Fiat Foolery throughout the course of history, the resultant yen weakness was accompanied by unintended consequences, as the deliberate currency devaluation resulted in a sharp spike in reported inflation on the island economy. As always, there are two sides to every trade.


The chart below shows YoY growth in Japanese Import Prices swung +1,860bps in the year following the initial intervention (July ’95: -3.5% YoY vs. July ’96: +15.1% YoY). In the 18 months beginning in Jan ’96, Japanese Import Price growth averaged +10.4% YoY. Eventually, these higher input costs manifested their way into reported inflation throughout the Japanese economy, with Japan’s Nationwide CPI peaking at +2.5% YoY in Oct ’97 vs. a deflationary (-0.6%) YoY just two years prior – a +310bps swing.


Japanese Yen: Be Careful What You Wish For, Consensus... - 1


This history lesson begs the following questions with regard to the current round of intervention:


Can the Japanese government’s stained finances handle backup in interest rates? Debt Service already consumes ~45% of the central government’s revenue.


Japanese Yen: Be Careful What You Wish For, Consensus... - 2


Can the Japanese consumer, after many years of price and wage deflation handle higher prices?


Japanese Yen: Be Careful What You Wish For, Consensus... - 3


Can Japan, which will need to procure raw materials from abroad to rebuild in the wake of the current disaster, afford an acceleration of imported inflation brought on by currency weakness?


Japanese Yen: Be Careful What You Wish For, Consensus... - 4


Can Japanese economy handle higher inflation, period? We don’t think so. This is why we stand counter to the current sell-side storytelling about “accelerated growth driven by construction and yen weakness”. The playbook for where Japan may be headed as a result of this current round of Big Government Intervention has a lot more factors than consensus’ simple two-factor, “buy the dip” model.


In fact, BOJ governor Shirakawa agrees, saying today that the government wants to avoid abruptly weakening the yen because it may bring about a back up in JGB yields. “That’s naturally the biggest fear for the government”, he says.


A worthy fear indeed.


Darius Dale


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Good Nugget For PSS


Another good nugget out of the family footwear channel, which bodes well for our call on PSS. Consistent with our note earlier this week, we expect the comp diversion that has been present between PSS and the rest of its peers to continue to converge again in Q1 a positive for the company near-term.


Interestingly, in looking at the aggregated SIGMA chart of the four companies, the Sales/Inventory spread improved for all but one – BWS. With an additional ~$50mm of inventory related to the acquisition of American Sporting Goods added to the mix equating to a -4% impact to the Sales/Inv spread next quarter, Brown Shoe is going to be challenged to improve its spread near-term. PSS starts to go against very favorable SIGMA comps.


Good Nugget For PSS - FamFWComp Chart 3 11


Good Nugget For PSS - FamFWComp Table 3 11


Good Nugget For PSS - FamFW SIGMA 3 11


Casey Flavin



Explosive slot revenue growth in Macau is a trend that has gone unnoticed.



We wrote a rather negative note on Macau slots a couple of years ago (“ASIAN SLOTS: SELLING HAGGIS TO VEGANS?” on 07/08/08).  At the time we were data dependent and the data didn’t show that the Chinese liked slots very much.  Since we’re still data dependent, we’d like to point out the huge growth in slot revenue and win per day per slot (WPD) generated in Macau since Q3 2009. 




It seems the trend of Macau as a slot market has gone largely under our and the Street’s radar screen.  However, this trend has very positive long-term implications for the operators and the slot suppliers. 


Not only are slots the highest margin revenue stream in Macau but there are no government caps on number of slots like there is for tables.  It’s not like slots aren’t already important. We estimate that LVS and WYNN will generate $190 million and $175 million, respectively, in EBITDA (before fixed cost allocation) from slots in Macau in 2011.  That represents over half of the total EBITDA generated by LVS and Wynn at their properties in Las Vegas.


In Macau, there has been virtually no replacement cycle given the youth of the properties.  That will change in the next few years.  For the suppliers, that means a double boost for revenues:  replacement slots and satiating the increased demand from patrons.


In addition, win per day per slot (WPD) generated in Macau since Q3 2009 has soared.  The following chart compares WPD in the Macau and Las Vegas Strip markets.  After trailing the Strip by a wide margin, Macau finally caught up in 2009 and then separated big time to the upside.  It is clear that 14k slots is not sustainable in Macau.  The number of slots in Macau could almost double and still maintain the Strip average for WPD – and that’s without any growth.  With visitation up 15%, GDP up almost 10%, and growing Chinese penchant for the slot product, we don’t see why slot revenue won’t continue to grow well into double digits.




Short-The-Rip: SP500 Levels, Refreshed...

POSITION: no position in SPY


This email may or may not make people happy, but 30 handles higher in the SP500 from what we called a Short Covering Opportunity, I’m going to call this for what it is – an opportunity to Short-The-Rip.


It’s probably ok to call it that… kind of like “Buy-The-Dip”… but on the other side…


It’s been a long week and I am running out of jokes and the SP500 should run out of immediate-term TRADE steam as it hopes for 1292 on anemically low volume.


PRICE/VOLUME/VOLATITY readings in my model remain bearish, but from a price. Manage your risk in this new bearish trading range of 1253 to 1292 for now and if the facts change, I’ll try my best to signal it if I’m so lucky to see it when it matters.


Have a good weekend,



Keith R. McCullough
Chief Executive Officer


Short-The-Rip: SP500 Levels, Refreshed...  - 1

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