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Leaders At The Front

“Disaster was caused by errors committed by the leaders at the front.”

-George McClellan, 1861

 

I’m in the middle of reading an outstanding US history book that one of our star analysts, Allison Kaptur, recommended: “Team of Rivals – The Political Genius of Abraham Lincoln”, by Doris Kearns Goodwin.

 

The aforementioned quote comes from Chapter 14 which is titled “I Do Not Intend To Be Sacrificed.” As I was reading it last night, I couldn’t help but think about the parallels between America’s political leadership, then and now…

 

McClellan was a Major General in the American Civil War who served a very short term as Lincoln’s General-In-Chief of the Union Army (from November 1), before ultimately falling on his own sword of accountability.

 

Whether on the ice of athletic competition or in the arena of professional asset management, I’ve seen plenty of McClellans in my day. Their biggest problem is one of perception. However talented and resume’d up they may be, they don’t quite get what it means to lead people – by example.

 

Consider the following contrast between McClellan’s public representation of himself: “You have no idea how the men brighten up, when I go among them.” (“Team of Rivals”, page 378)…

 

And how he behaved when he thought no one was looking: “The whole thing took place 40 miles from here without my orders or knowledge… it was entirely unauthorized by me and I am in no manner responsible for it.” (“Team of Rivals”, page 383)…

 

It’s both sad and pathetic to think that the said leaders of this world, both then and now, think that they can fool history into believing not only the facts, but their intentions in representing their version of the “truth.”

 

McClellan’s finger pointing and excuse making came on the heels of a big mistake he made that led to a Union loss at Ball’s Bluff. This wasn’t a one-off event. To the contrary, if you follow a man’s behavior long enough – the leadership methods he employs, the decisions he makes, and the reactions he has to wins/losses – you’ll figure him out. That’s the point, in principle, that I want to make this morning about risk management.

 

Back to the Global Macro Grind

 

I’m certainly not suggesting I don’t make mistakes. But I’ll be one of the last guys who goes to war with you who will be accused of being gutless. And no, that doesn’t mean I’m the prettiest player in this game – neither the most polite. It just means my friends call me Mucker.

 

We’ve created a culture here at Hedgeye that resembles that of the 4-wall dressing room we fostered at the Yale Whale in 1995. We are accountable to our performance in real-time. Everyone faces each other. There is nowhere to hide.

 

No matter where you go this morning, there it is – the score. As we push into both month and quarter end, however “light the volume” has been for the last week in Global Equity market trading – the price performance has been up into the right. Thankfully, I’ve drawn down my cash position in the Hedgeye Asset Allocation Model by 18% (to 43% from 61%) in the last 6 weeks.

 

While I made the right “Short Covering Opportunity” call on March 16th, I’ve made the wrong call in not holding the line on a very net long position (16 LONGS and 4 SHORTS in the Hedgeye Portfolio) until the very end of the month. That would have made our navigation of the last 2 weeks of Q1 2011 perfect – and perfect we are not.

 

We do have a risk management process however. That’s what guides us in asking questions as to where we could be right or wrong next. The #1 question on my mind right now is can we see a DEFLATION of The Inflation?

 

On that score, there are two scenarios I see playing out – they are both US Dollar based:

  1. US Dollar UP  - through an end to the unaccountable outcomes of QG1 and QG2 (The Bernank Perpetuating The Inflation), I think this would relieve a huge consumption tax on the American people. With 72% of US GDP being tied to Consumption, we have to get this right.
  2. US Dollar DOWN - through a continued Debauchery of the Dollar, Americans will face either a currency or bond market crisis (or both). This will be a massive headwind for all US capital markets (currency, stocks, and bonds) as it was in the 1970s.

On the short side of US Equities, I’m not brave enough to fight a bullish breakout in the US Dollar again. Been there, tried that in December of 2010. And I don’t think those who have been as bearish as we have on US stocks since Valentine’s Day should be testing bravery-to-the-death on that front (if we see it again) either.

 

As is always the case when fighting the proverbial Fed War, our risk management process defers to the highest probabilities embedded in the math. That is, in the correlation risks we see developing between our most heavily weighted Global Macro Factor (US Dollar Index) and everything else.

 

As of the last 6 weeks, it’s critical to note that the long standing 2-year inverse correlation between the USD and the SP500 has changed (DOWN Dollar = The Reflation trade). Whether you look at it on a 3 week or a 6 week duration, this is the latest math:

  1. 3-week TRADE: USD versus SP500 = +0.29
  2. 6-week TREND: USD versus SP500 = +0.67

Don’t fight the truth. Embrace it. This means that our ultimate strategy for the President of the United States holds true where it matters most. On the battlefield of American currency.

 

Dear Mr. President, if you strengthen the US Dollar, you will DEFLATE The Inflation – and stocks will go up. Alternatively, if your General-in-Chief of the US Federal Reserve continues to point fingers at everyone in this global market system other than at himself, your currency will burn and your citizenry will lose confidence in whatever confidence they have left in our Leaders At The Front.

 

My immediate-term TRADE lines of support and resistance for WTI Crude Oil are $104.09 and $108.03, respectively. My immediate-term TRADE lines of support and resistance for the SP500 are 1306 and 1328, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Leaders At The Front - Chart of the Day

 

Leaders At The Front - Virtual Portfolio


CHART OF THE DAY: Up or Down, The US Dollar is Exhibiting Leadership at the Front

 

 

CHART OF THE DAY: Up or Down, The US Dollar is Exhibiting Leadership at the Front -  chart


GALAXY F4Q/FY2010 CONF CALL NOTES

More records broken

 

 

"StarWorld has consistently outperformed the market during this and previous years, and today we report its tenth straight quarter of EBITDA growth. The property is fully capitalizing on the surging demand in Macau and delivering one of the strongest returns of any major casino in the world.  We believe that Galaxy Macau will be the only major new property to open in Macau in 2011, in what continues to be surging market conditions.  This game-changing property officially opens on Sunday May 15th, and we are now preparing for an extraordinary grand opening ceremony.”

 

-Dr. Che-woo Lui, Chairman of Galaxy Entertainment Group

 

 

HIGHLIGHTS FROM THE RELEASE

  • GEG 2010 record EBITDA HK$2.23BN (+92% YoY) and HK$625MM in Q4 (+76% YoY)
  • Starworld
    • Record EBITDA of HK$585MM in Q4
    • Q4 EBITDA margin: 23% (US GAAP)
    • Record VIP RC of HK$147BN in Q4
      • Q4 Hold: 2.8%
      • Net win: HK$4.1BN
    • Q4 Mass drop: HK$1.8BN
      • Q4 Hold: 17%
      • Net win: HK$320MM
    • Electronic Gaming: Q4 slot handle HK$ 869MM; Q4 Hold: 7.6% & win of HK$66MM
    • ROI of 61%
    • 2010 Occupancy: 97%; Q4 Occupancy: 99%
  • City Clubs: HK$158MM in EBITDA for 2010
    • 4Q EBITDA of HK$44MM
  • Construction Materials reported HK$348MM of EBITDA in 2010, a 38% YoY increase
    • 4Q EBITDA of HK$116MM
  • Galaxy Macau - Day one and eventual offereing
    • 450 tables and 1,100 slot machines (can expand to over 600 tables and 1,500 slot
      machines if needed)
    • 1,400 rooms and suites (of total 2,200 rooms and suites)
    • 50 F&B outlets
    • Grand Resort Deck with the world's largest skytop wave pool
    • As at 31 December 2010, the Group invested HK$9.0 BN (HK$14.9BN total investment estimates)
  • Galaxy Macau HK$600MM entertainment offering
    • Under construction; open by September 2011
    • 15k sqm
    • Macau's only modern Cineplex, a 9-screen, 3D-compatible, multifunction cinema theatre with a total
      capacity of 1,000 seats, as well as a 1,000 square metre multipurpose event plaza.
  • Cash: HK$ 4.4BN
  • Debt: HK$9.426BN
  • Closed 13x oversubscribed and upsized RMB1.38BN bond offering
    • 3-yr fixed unsecured notes at 4.625%
    • Cost of debt currently below 5% from 8%.
  • "Subsequent to year end 2010, all of the HK$1.3 billion/US$165 million convertible notes were converted into 173 million common shares, further strengthening the balance sheet and increasing the free-float of shares"

 

CONF CALL/Q&A

  • Starworld - what is the reason for the margin expansion?
    • Even though they held lower, the mix of RevShare and R/C VIP business helped them
  • Is the Q4 margin for construction materials sustainable?
    • They are shifting towards higher margin products for this business.  Also given the change in the way that they are reporting their results, you can't just look at topline and margins.  More business is in JVs.
  • HK$80-100MM/Q is a good run rate for corporate expense
  • Expect pre-opening expenses to increase significantly in 1H2011
  • Anticipate that they will be just about fully occupied in the hotel from the day that they open
  • Believe that the entertainment offering will be successful because it will be Macau's only cineplex. Adds value to being a fully integrating resort and also has a event plaza.
  • As the share price appreciates, there is a non-cash charge as a result of the convert
  • They have HK$5.5BN to spend plus the HK$600MM to spend on the entertainment offering - majority of which would be spent in 2011
  • Total staff they need to hire for Galaxy Macau?
    • 7600 upon opening
  • Starworld: Mix is 50.50 between Mass and VIP
  • Galaxy Macau table mix: 2/3 Mass 1/3 VIP

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.64%
  • SHORT SIGNALS 78.57%


Obama’s Foreign Policy . . . Bush Doctrine Take Two?

Conclusion:  Last night President Obama began to define his foreign policy in more detail following the U.S. military’s involvement in the Libyan no-fly zone.   Ironically, the Obama doctrine sounds a bit like the Bush doctrine, albeit a little less granular.  The fiscal risk is that we could be entering a phase whereby military spending ramps up with ambiguous goals, which is negative for the deficit and U.S. dollar.

 

“Well, this is a new Obama doctrine that you act on threats, remember that’s what George Bush did.”

- Dennis Kucinich (D-Ohio)

 

President Bush’s foreign policy wasn’t fully defined until certain events helped him define it.  Specifically, the events were the terrorist attacks on U.S. soil on September 11th, 2001.  Shortly thereafter, President Bush began to outline the Bush doctrine in a speech to a joint session of Congress on September 20th, 2001 with this statement:

 

“We will pursue nations that provide aid or safe haven to terrorism. Every nation, in every region, now has a decision to make. Either you are with us, or you are with the terrorists. From this day forward, any nation that continues to harbor or support terrorism will be regarded by the United States as a hostile regime.”

 

The Bush Doctrine was eventually codified in a document, the National Security Strategy of the United States, which was published on September 17, 2002 and stated:

 

“To forestall or prevent such hostile acts by our adversaries, the United States will, if necessary, act preemptively in exercising our inherent right of self-defense. The United States will not resort to force in all cases to preempt emerging threats. Our preference is that nonmilitary actions succeed. And no country should ever use preemption as a pretext for aggression.”

 

While Bush’s speech to the joint session more broadly defined enemies and threats to the United States, the National Security Strategy of the United States took the Bush Doctrine to the next level and emphasized the concept of preemptive action against threats.

 

Based on his speech yesterday, President Obama appears to be maintaining the concept of preemptive activity, though he frames the preemptive actions in Libya with a humanitarian justification, rather than a specific threat to the United States. Specifically, the “refusing to wait” language in his speech from last night, which is quoted below, is a preemptive doctrine by another name.  As President Obama said last night:

 

"To brush aside America's responsibility as a leader and — more profoundly — our responsibilities to our fellow human beings under such circumstances would have been a betrayal of who we are.  Some nations may be able to turn a blind eye to atrocities in other countries. The United States of America is different. And as President, I refused to wait for the images of slaughter and mass graves before taking action."

 

This is an about-face from the views of Senator Obama, while a candidate for the Presidency, when he stated on the campaign trail in 2007:

 

“The President does not have power under the Constitution to unilaterally authorize a military attack in a situation that does not involve stopping an actual or imminent threat to the nation.”

 

Of course it is somewhat trite to “YouTube” candidate Obama.  Obviously, being President has different rules and responsibilities versus being a candidate.  In a campaign, the objective is to get elected, while as a President, in theory, the objective is to make the best decision for your nation.

 

While no doubt President Obama and his cabinet will further clarify the Obama Doctrine and their collective foreign policy actions in the coming weeks and months, a key risk, both with our allies and for that matter with our enemies, is that the Obama Doctrine remains ambiguous.  In aggregate, the key questions of:  when, where, and why the United States will intervene in foreign conflicts still need to be clarified.

 

(In fact, the name of the operation in Libya is itself ambiguous:  Operation Odyssey Dawn.  Whether you disagreed or agreed with President Bush’s foreign policy, the objectives of Operation Iraqi Freedom were, at least, obvious.)

 

While the speech last night was certainly a step towards clarity on the Obama administration’s foreign policy objectives, Romesh Ratnesar probably summed up the last couple of months of Obama’s foreign policy best when he wrote on March 21st in Time Magazine:

 

“He supported pro-democracy forces in Egypt and nudged out a regime the U.S. had backed for decades, but has been unwilling to do the same in Bahrain or Yemen. In Libya, his Administration was against armed intervention to stop Muammar Gaddafi before Obama was for it. American warplanes carried out the initial wave of strikes on Tripoli, but Obama's aides insist that Washington is merely following the Europeans' lead. U.S. officials were reticent for days as the nuclear crisis in Japan worsened, then declared the situation to be even direr than the Japanese government had let on.”

 

To be fair to President Obama, the popular unrest and regime change in the Middle East, as we’ve written, has accelerated at a pace no one could have anticipated.  Over the coming weeks and months, President Obama and his cabinet will have the opportunity to refine and clarify their foreign policies, but if the Obama administration is indeed adopting the preemptive philosophy of the Bush doctrine, it will come at a cost.

 

In the chart below, we’ve outlined defense spending as percentage of GDP and as a percentage of the federal budget going back to the early 1970s.  The Clinton presidency was relatively peaceful with limited overseas conflict and therefore defense spending dropped dramatically during that era.  Coincident with this drop in spending, although obviously not the only factor, the federal deficit dropped from -$290BN in 1992 to a surplus of +$125BN in 1999.  In that same period, defense spending dropped in real dollars from $319BN to $276BN.

 

With the advent of the wars in Iraq and Afghanistan, defense spending accelerated dramatically under President Bush and by his last year in office was $612BN.  In Obama’s first year in office, 2009, defense spending accelerated again to $655BN.

 

The risk of an ambiguous and increasingly proactive foreign policy, as evidenced by adding troops to Afghanistan, leading the no-fly zone in Libya, and announcing a foreign policy that is predicated on “refusing to wait”, is that President Obama will continue to grow defense spending during his Presidency.  Increasing defense spending, will only lead to an accelerating deficit and with a growing deficit come associated implications.

 

Daryl G. Jones

Managing Director

 

Obama’s Foreign Policy . . . Bush Doctrine Take Two? - 1


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