“Silence is a true friend who never betrays”
As was so often the case, Confucius boiled things down to the deep simplicity associated with making sense of this world. At the end of the day, that is the basis for chaos theory – when you have multi-factor models colliding within a dynamic system, simple patterns govern outputs. That’s most certainly an investment thought that I have applied to my global macro model over the course of the years. Sometimes waiting in silence is the best decision you can make.
Unfortunately, for me at least, I have to make some level of noise with this Early Look note, every day. As I was driving up to Boston last night, reflecting upon the short squeeze rally that perpetuated itself into an up +4.4% day for the SP500, I couldn’t stop thinking about how the Street’s narrative would shift from the prior day’s swoon.
The reality is that the rally wasn’t about Obama – it was about the US Financials having a +15% day. Yes, they were up less than they were down the day prior. Yes, at -27% for the year to date, they have still crashed in 2009. But this reminds the Depressionistas out there that bear market bounces can quite often be more powerful than those in bull markets. Our models must always respect that every ticker has both timing and price to consider. Buy low, sell high.
Tim Geithner’s hearing yesterday reminds us that the US Financial system has already been politicized. This is not new, but never underestimate the impact of socialist policy on a capitalist’s mental model. Nationalization and Socialization are bad – by late 1935, the US stock market started to figure this out, and the FDR love-fest ended badly. America crashed again, and you all know the rest of the story…
When we reference FDR, we are referencing a political climate – that’s it. In a situation like the US finds herself today, the only factor that remains is effectively hope. While hope is what we all aspire our children to embody, it is not an investment process. That, of course, does not mean it governs the emotions and minds of many market participants. That, fully loaded, is the only other explanation that I can give you as to why the US Financials can crash -17% one day and recover +16% on the next. Everything has a time and a price. Waiting in silence, is not a process that the market as a whole tends to abide by.
China’s silence in releasing their economic statistics for Q4 has finally ended. Did the numbers rollover sequentially? You bet your Madoff they did! Does anyone legitimately think that the -70% peak to trough decline in the Chinese stock market wasn’t discounting some level of a slowdown? Hopefully not… but again, that doesn’t mean people don’t hope to believe whatever it is that they need to.
China’s GDP for Q4 came in at +6.8% year over year growth, which is down significantly from the double digit growth rate that the bearers of the “I love Chindia” 2007 thesis levered themselves up long with. This was the worst quarterly print in 7 years and implies that China’s GDP ended up being 9% in 2008. Why wasn’t it 8.9 or 9.1 percent? Well, it’s because the Chinese make up numbers, a lot like some Americans did. Get over it.
So why was the Chinese stock market up another +1% on this “news”? If the apocalypse cometh, at 2,004 why is the Shanghai Stock Exchange +10% since December 31st? These are simple questions, with a simple answer. Stock markets are stealth leading indicators of future events, not trailing ones.
China could conceivably accelerate GDP growth sequentially in Q4. I don’t have to make that call yet – their stock market is doing it for me. No, not everything Asia is China, so don’t straight line that bullish thought across the expanse of the economic region. I am still amazed when I drive into work that the US media says “Asia was up or down XXX” and all they are referencing is what the Nikkei did in Japan. Hello, McFly – watching Japan and not China in 2009 is the equivalent of the horse and buggy whip operators of Britain’s last great century not paying attention to that emerging economic situation called the United States of America.
So far in 2009, I have been short Korea, India, and Japan against my 6% allocation to China (see our Asset Allocation Model at www.researchedgellc.com). Being short Japan has been a thesis I have been aggravating the “value buyer” of Japan with for a year, so I won’t rehash that or the India part of “Chindia” – that joke is getting stale.
In sharp contrast to China, where 2009 GDP will outpace year over year inflation growth, both Korea and India are going to likely see inflation outrun their GDP growth rates in 2009. That’s an economic cocktail that even the bravest of bailout socialistas won’t be able to swallow. The Korean Development Institute said this morning that they think Korean exports are running down something on the order of -30% in the first 20 days of the month. That’s bad!
The nationalization of a capitalistic systems is bad too – but that doesn’t mean they can’t bounce. Ireland, which move to nationalize banks and saw their stock market lose -20% in less than 10 days as a result, is trading up +4.7% overseas this morning for example. Everything has a time and a price. So do patience and silence.
I have taken my US Cash position up to 65%. On balance, that’s definitely not a bullish signal. For the immediate term “Trade”, I see -5% downside to the SP500’s closing price of 840, and +2% up.
Best of luck out there today.
“Silence is a true friend who never betrays”
Vaclav Klaus—More Theoretical Than Practical
Vaclav Klaus’s son recalled in an interview that when he was 13 his father told him to read Aleksandr Solzhenitzyn to better understand Communism’s oppressiveness. Those not familiar with Solzhenitzyn should note that the Russian novelist, dramatist, and historian exposed the Gulag, the Soviet Union’s forced labor camp system, which he himself served in and became the basis for his book One Day in the Life of Ivan Denisovich.
Suffice it to say that 67-year-old president of the Czech Republic Vaclav Klaus, who recently assumed the rotating presidency of the European Union, is a man shaped by his communist upbringing. In an interview Klaus said, “if you lived under communism, then you are very sensitive to forces that try to control or limit human liberty.”
It is this point about communism’s “repressive” nature that has become the crux of Klaus’s outlook, as a politician and economist. He is an economic liberalist that demands personal and state individualism. Without question, Klaus has provoked strong reactions from the international community.
For one, he is a fervent critic of the environmental movement, calling global warming a dangerous “myth,” arguing that the fight against climate change threatens economic growth. He went so far as to call out Al Gore as an “apostle of arrogance” for his role in the fight against global warming. Additionally, Klaus is a zealous eurosceptic. He claimed that the Czech Republic’s accession to the EU would reduce Czech sovereignty, and said in 2005 to a group of visiting US politicians that the EU was a “failed and bankrupt entity” that should be “scrapped”. He has most recently blamed the banking crisis on too much regulation, rather than too little, which some say display his dogmatic devotion to the free market economist Milton Friedman, who deeply influenced him when he was obtaining his economics degree.
So it should have come as no big surprise—although it played out as a big PR disturbance—that Klaus refused to fly the EU’s flag over Prague Castle on the 1st of January, the day French president Nicolas Sarkozy handed the presidency of the 27-member union to Klaus and the Czech Republic.
Yet while much of the European community is outraged the Klaus represents the “face” of the EU, Klaus garners appeal by Czechs. His credentials certainly speak for themselves: he became finance minister after the Velvet Revolution in 1989, founded the center-right Democratic Party to become prime minister between 1, and has been President since 2003 (reelected in 2008). He is credited with presiding over the peaceful 1993 split of Czechoslovakia into two states and helping to transform the Czech Republic into one of the former Soviet bloc’s most successful economies.
Yet Klaus has also been credited with what Vaclav Havel has called “gangster capitalism”, referring to his radical privatization strategy in 1992—including a voucher scheme that was later emulated in Russia—that led to the amassing of wealth by a few oligarchs. Klaus was also forced to resign as prime minister in November 1997 after a government crisis caused by a party financing scandal. Finally, he espouses friendly ties with Russia and criticized Georgia for causing war with Russia in August.
Klaus’s position as leader of the 6-month European Union presidency begs the question of his possible influence (and to what degree) on Europe and the Czech Republic. Critics say given the largely symbolic function of president in the Czech Republic he will wield little power. Yet Bohumil Dolezal, a leading commentator who once advised Klaus, said Klaus’s greatest talent—and therefore appeal—is his ability to appeal to average Czechs.
While Klaus’s role as President could be written off as strictly ceremonial, Klaus’s popularity and stature could sway the Czech “majority”. While we cannot substantiate this point, fact is that Klaus has an affinity for Russia (at least to the extent that he sided with the Russians in their attack on Georgia), and with the Czech Republic’s geographic location closer to Russia it is worth considering that the former “East” could have more influence Europe now that the “capital” has move to Eastern Europe.
Conversely this geographic shift from Paris to Prague will encourage Central and Eastern European countries not in the EU, or not using the Euro, to join. If Russia hasn’t put a bad taste in their mouths already, its recent stranglehold on natural gas may just tip the balance.
We’ll be looking more closely at the Czech Republic’s balance sheet as we considered our investment strategy in Europe.
Howard W. Penney
Declining inflation is a solitary bright point on a gloomy horizon…
The December German PPI number was announced today, registering at -1.20% month-over-month or +4.31 year-over-year, the lowest Y/Y rate since March of last year. This is positive, on the margin, as input costs for manufacturers’ contract - with the heavy industrial and chemical segments particularly helped by collapsing commodity costs. On balance, any benefits from this will do little to offset the contraction of global demand for pricey German exports.
Chancellor Merkel is attempting to push a €50 Billion stimulus package (counting tax cuts and other incentives –including a tax benefit for new car buyers) through the lower and upper houses of parliament this week in the face of increasingly negative employment and production data with the shadow of upcoming elections looming large over all decisions.
Projected 2009 numbers don’t appear to provide relief for incumbents. Today the Economy Ministry said Germany may contract by as much as 2.25% in 2009 - the biggest contraction since 1975, with the jobless rate projected to rise to 8.4% on average this year from 7.8% in 2008.
We’re neutral on Germany respecting that, on a relative basis, it has the strongest of any of the large EU economies. As we see it, being the strongest member of the EU is looking more and more like being the tallest man on a sinking ship.
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The incredible volatility in LVS’s stock should provide levels for long and short traders. We’re on the sidelines at this level waiting for the volatility coach to give us an opportunity to jump in the game. In the meantime we’d like to throw out some plays for both bulls and bears.
LVS is likely to breach the leverage covenant of its Macau credit facility in Q2 2009 unless drastic steps are taken
The Macau Rolling Chip environment may be decimated by the credit crunch over there.
In 2007, Venetian Las Vegas promotional spend was 18% of casino revenues, YTD promotional expenses are running at 33% of casino revenues. LVS has just recently started using promotional dollars to lure in slot players, so we believe that promotional spend will probably be around 40% in 2009. Same goes for Palazzo - In absolute dollars, promotional spend at Venetian & Palazzo was $76MM in 2007 and $146MM YTD 2008
ADR at the Venetian was $259 in 2007 vs. approximately $242 YTD in 2008. Given the weekly STR #s and the offer’s we’ve been getting from Vegas casinos, we believe that ADR will be down about 15% in 4Q08 and deteriorate further in 1Q09. The opening of City Center in 4Q09 isn’t going to help ADR’s recover. We estimate that the cost of cleaning a room is about $70-75, so you can guess where our hotel EBITDA margins are heading
While the Venetian Macau has been ramping up well during the last 3 quarters, we believe that they will experience significant cannibalization with the opening & ramp up of the Four Seasons
In 3Q08, Venetian Las Vegas held about 10% and Palazzo held about 16% on table games, costing these two properties about $33MM of lost revenues & EBITDA. Assuming normal hold next year, this easy comparison should soften the blow of lower drop
LVS has implemented a cost savings program that should save them an incremental $50MM or so in 2009
We believe that in 2Q-4Q08, LVS had one of the higher commission rates in Macau set at 45% (all-in for F&B credits). With the commission potentially capped at 1.25% or 40% currently, this could provide some margin relief for their properties in 2009
Sands 1H08 results experienced massive cannibalization as Venetian Macau ramped up and have seen some decent recovery in 2H08 which provides an easy comparison
With most of LVS’s debt linked to LIBOR and other floating rates, LVS will benefit from the massive drop off in rates -3 month LIBOR rates were 1.09% on 1/16/2009, down from average of 2.9% in 2008
LVS should have positive working capital in both 4Q08 and 2009, generating an estimated $175MM of cash over the next 5 quarters
o Construction Payables should begin to ramp down
o Accounts receivable should also ramp down as LVS has tightened credit extension to players
LVS’s credit troubles are with the banks, which are more incentivized to provide the company covenant relief at a “price” than would bondholders.
o Banks have $9.5BN of credit exposure to LVS
o Gaming licensing requirement provide a huge deterrence to banks taking the keys in an event of default
o Lack of a transaction market means that even if Banks took the keys, they probably couldn’t sell the properties
More Easing from Bank Negara Malaysia didn’t won’t accomplish much…
December consumer inflation data released by the Malaysian Department of Statistics today came in at +4.39% year-over-year, well below last summer’s high when CPI seemed poised to enter double digit rates. The central bank took this cue as justification for further rate cuts, lowering the overnight rate by 75 basis points to 2.5% and slashing the statutory reserve rate from 3.5% to 2% effective Feb 1.
But… the benchmark KLSE traded down almost -1% for the day as the investors weighed the prospects of a second government stimulus package.
The big picture for Malaysia is negative, if not awful. As a net exporter of oil and other commodities, the receding inflation figures are a double edged sword –lower prices at the pump come hand in hand with lower prices at the docks. Cooling demand for electronics from developed world economies is weighing heavily on the manufacturing sector.
A second stimulus package or further easing at this stage will likely not do much offset external demand retraction, although further declines by the Ringgit spurred by the rate cut may help shore up some sectors.
See the chart below, which largely reflects the dynamics of stock markets as stealth leading indicators. The “re-flation” rallies we saw in December were largely pricing in the expectation of aggressive rate cutting that we are now seeing here in January. By the time this aggressive rates cutting news is hitting the tape, the marginal buyer has already turned to selling on the news.
Today’s math reveals a downside support level in the SP500 of 788, and a magnified bearish intermediate term “Trend” – we show immediate term “Trade” rally resistance at 855, and intermediate term “Trend” line resistance overhead (thick red line) up at 879 in the chart below.
Keith R. McCullough
CEO & Chief Investment Officer