The Case of the Missing Stimulus

This note was originally published at 8am on April 20, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The case has, in some respects, been not entirely devoid of interest."

-Sherlock Holmes


Sherlock Holmes is the fictional detective created by Scottish author and physician Sir Arthur Conan Doyle.   Doyle based the character of Sherlock Holmes on a number of prominent physicians of the late 1880s.  Indeed, criminal detective work certainly has parallels to a medical examination.  The role of the physician is to provide a diagnosis after thoroughly collecting information both from and about the patient.  Great investment research incorporates a similar process.


In our daily morning research process, each Sector Head provides relevant facts in our internal research meeting, which underscores our moves in the Virtual Portfolio that day (in combination with our quantitative models).  Quite often, which makes sense when you get enough”Type A”  Hedgeyes in a room, we have much broader discussions.  A few weeks back our Financials Sector Head Josh Steiner asked, effectively, whether the federal budget deficit could be narrowed by just reversing the stimulus.  That is, shouldn’t compares on stimulus spending get much easier, which would effectively narrow the deficit?  As usual, a great question.


To back up, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was passed by the 111th U.S. Congress in February 2009.   According to many reports, the act was nominally worth some $785 billion to the economy.  Roughly 1/3 of this came in the way of tax cuts, while almost 2/3s came in the way of increased government spending. 


The philosophical rationale for ARRA, according to our friends at Wikipedia, was as follows:


“The stimulus was intended to create jobs and promote investment and consumer spending during the recession. The rationale for the stimulus comes out of the Keynesian economic tradition that argues that government budget deficits should be used to cover the output gap created by the drop in consumer spending during a recession.”


Seems simple enough, even for a hockey head like myself. 


Interestingly, if we look at government spending in the 2008 – 2010 period we can actually see the impact of the stimulus act on government ledgers.  In fact, according to the U.S. federal government spent $2.98 trillion in 2008 and $3.59 trillion in 2010.  So, the net increase over this period was just over $600 billion, which roughly equates to the spending portion of The Stimulus.


In theory, Dear Watson, there then should then be a step down in spending as ARRA, or The Stimulus, winds down and begins to compare against itself. Interestingly, in 2011 federal government spending is actually expected to step up to $3.61 trillion!


The long run compounded annual growth rate of federal government spending from 1990 to 2007 is 4.47%.  If we apply this growth rate to the 2008 – 2011 period, 2011 normalized government spending on that basis would be $3.42 trillion, almost $200 billion less than what the government will actually spend and roughly one-third the size of ARRA, or The Stimulus. So, where did the stimulus go? Confused? I certainly am, but it seems that cutting government spending is not as simple as favorable compares against a “one-time” spending program.


But on to a more interesting case, that of today’s global macro investment outlook.  While Keith is enjoying Disney World with his two little risk managers, Jack and Callie, the Hedgeye Research Juggernaut continues to grind.  Three key data points to call out this morning are as follows:


1.  Europe – Overseas on the continent, equity indices are rallying hard this morning up almost 2% across the board with the FTSE and DAX leading the way.  Interestingly sovereign bond market are flashing a different signal as bond yields continue to rise in the PIIG nations and both Spain and Portugal are selling debt at much higher rates than even three weeks ago.


2.  Asia – Asian equity markets are also positive across the board, with China the clear negative divergence up only 27 basis points.  The noteworthy callout from Asia is the following report: “A senior Hong Kong monetary official told The Wall Street Journal on Tuesday that China's central bank is "actively considering" new rules that would make it easier to bring yuan funds raised offshore back onto the Chinese mainland.” This is positive for the long position we are holding in the Chinese Yuan in the Virtual Portfolio.


3.  Technology earnings – We are long the technology sector in the Virtual Portfolio via the etf XLK and are seeing serious fundamental support this morning from a number of key technology bell weathers.  In fact, Intel, IBM, Juniper Networks, and VMware all exceeded analyst expectations.  The results suggest that businesses are spending again. That said, IBM is trading lower as contract signings, an indicator of future demand, were less than expected.


Before I let you get back to your detective work this morning, I’ll leave you with one last quote from Sherlock Holmes:


“How often have I said to you that when you have eliminated the impossible, whatever remains, however improbable, must be the truth?”




Keep your head up and stick on the ice,


Daryl G. Jones

Managing Director


The Case of the Missing Stimulus - Chart of the Day


The Case of the Missing Stimulus - Virtual Portfolio

Indefinitely Dovish

“The dove descending breaks the air with flame of incandescent terror.”

-T.S. Eliot, Little Gidding (1942)


“Little Gidding” was the final of four brilliant poems in T.S. Eliot’s “Four Quartets” which helped him win the Nobel Prize for Literature in 1948. Each of the four poems considers the lessons of history within the context of one of the four elements: air, earth, water, and fire.


The element of fire in the aforementioned quote is an important metaphor to consider when watching what the US Government is doing to the US Dollar. Through a deliberately dovish monetary policy to inflate, the US Federal Reserve is Burning The Buck.


Since the unaccountable bureaucrats at the Fed and their friends who are working for Groupthink Geithner at the US Treasury will be the last to call up a chart of the US Dollar Index (career risk management), we’ll do it for you, weekly, until this Currency Crash looks less likely:

  1. Week-over-week, the US Dollar Index was down another -0.91% last week to close at $74.11 = a fresh 2-year low
  2. Closing down for 13 out of the last 17 weeks, the USD Index has lost -8.6% of its intermediate-term value in the last 4 months
  3. Since President Obama and Treasury Secretary Geithner strapped on the accountability pants in 2009, the US Dollar is down -16.8%!

So who cares?


Evidently our Almighty Central Planners don’t. They don’t even talk about it… and neither do the kowtowing “blue chip” economists who allegedly analyze their Keynesian policies.


But, The People do…


With the US stock market up +97.8% from its March 2009 low, you’d think that the policy to get us paid with some equity market performance would make this country really happy about all of this. Not.


Why not?


Alongside last week’s Crashing Currency, here’s what the price of other things that trade predominantly in US Dollars did last week:

  1. Oil = +2.1% to $112.29/barrel
  2. Gold = +1.1% to $1503/oz
  3. CRB Commodities Index (19 Commodities) = +1.4% to 367

Nice. If you are long of The Inflation, that is…


If you aren’t, well – I guess the message for you from The Bernank is too bad. Take it in the pump – and like it.


Ben Bernanke’s incompetent forecasts will be center stage on this week’s Macro Catalyst Calendar with following events:

  1. Tuesday – New Home Sales (trending at record lows despite Bernanke begging you to lever yourself up with a “cheap” mortgage)
  2. Wednesday – FOMC interest rate decision (Indefinitely Dovish); and Case/Shiller Home Prices for FEB (train wreck)
  3. Thursday – Q1 US GDP (running at least 30% below Bernanke’s initial forecast - almost all of Wall St has cut their estimates)
  4. Friday – Michigan Consumer Confidence for April (making lower-highs); and April month-end markups (US equities)

How will The Bernank spin alchemy’s free money spool into an Indefinitely Dovish message on Wednesday?


He’ll flip the switch from saying there is no inflation to worrying the world about Growth Slowing As Inflation Accelerates. At $112/barrel oil (up +180% since Obama and Geithner took office in 2009), The Inflation at the pump is almost 2x that of the US stock market. Meanwhile, gold and silver are trading at all-time highs this morning (all-time is a long time) – so he’s going to admit he sees that, I hope…


And while hope is not an investment process, watching marked-to-market expectations in both the US currency and Treasury markets is. Both the US Dollar crashing and UST yields breaking intermediate-term TREND support of 0.71% this morning are signaling Bernanke will remain dovish. He’ll blame growth slowing (Q1 GDP report Thursday) and US housing being the train wreck that he and Greenspan helped perpetuate.


In terms of asset allocation, this still leaves me long of The Inflation (Gold and Oil), and long of relatively unlevered growth where I can find it (China and US Tech). Since the week of March 28th, I’ve taken down my Cash position from 52% to 40% - the updated Hedgeye Asset Allocation Model has the following composition:

  1. Cash = 40% (down from 43% week-over-week)
  2. International Currencies = 30% (Chinese Yuan, Canadian Dollar, British Pound = CYB, FXC, and FXB)
  3. International Equities = 9% (China = CAF)
  4. Commodities = 9% (Gold and Oil = GLD and OIL)
  5. US Equities = 6% (Technology = XLK)
  6. Fixed Income = 6% (US Treasury Flattener = FLAT)

Understanding full well that the US Dollar correlation-risk to just about everything that I am long is surreal at this point, I’ll just call this positioning out for what it is – an explicit bet that the Fed remains Indefinitely Dovish until the US Government is forced to face a US Currency Crash and all of the understood consequences embedded therein.


My immediate-term support and resistance lines for oil are now $109.12 and $112.91, respectively. My immediate-term support and resistance lines for the SP500 are now 1319 and 1339, respectively.


My personal thanks to Big Alberta for riding shot-gun for the team last week, and best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Indefinitely Dovish - Chart of the Day


Indefinitely Dovish - Virtual Portfolio


We knew IGT had more levers to pull than the other guys and was regaining some share but a beat and raise of this magnitude was a surprise. 



IGT had been our favorite supplier heading into earnings season because we felt it was the safest pick.  Despite our longer term concern with participation share, we felt IGT had more near-term margin levers to pull and ship share was on the rise over the next few quarters.  What we didn’t bank on was a big beat and raise.


For the first time in a really long time IGT not only beat consensus but also raised guidance.   The beat was across the board – higher product sales, better game operations, and better margins.  IGT’s guidance raise was due to a combination of cost efficiencies and reduction in borrowing costs.  IGT also appeared to gain ship share this quarter in North America (NA).



Q2 Detail

  • Product sales of $215MM beat our estimate by 3%, while gross margins were $18MM above our estimate
    • Total units recognized were in-line with our estimate but once again NA units beat our estimate while international units fell short of our estimate
    • ASP’s were below our estimate – decreasing 4% YoY and over $1k QoQ.  While IGT did not elaborate on the call – nor did any analysts bother to ask, part of the reason for the depressed ASPs was due to a new promotional launch, which we wrote about in our preview.  The other reason for depressed ASPs was due to the conversion of 1,200 leased units to for sale units at very low prices.  Leases often have buyout options so this is not that unusual but would also explain the depressed ASPs in the quarter.  We estimate that the sale of the leased units could have depressed ASPs by about $600.
    • Domestic gross margins were also a lot higher than we estimated although IGT guided that a more normalized margin should be around 52%.  We suspect that some of the margin lift has to do with growth of high margin software included in non-box sales.
    • While international units were weak, margins of 56% were the best that IGT has had in at least 10 quarters.  We assume that normalized margins are lower (low 50’s).
  • Gaming operations revenue of $267.5MM beat our estimate by 4% and gross margins were 5% above our estimate
    • The install base was 300 units better than we estimated
    • Daily yields were 3% above our estimate
  • Other stuff:
    • Excluding the $1.7MM restructuring charge, SG&A was $7MM higher
    • D&A was $3MM lower than we estimated.


  • IGT increased the midpoint of its guidance range by 5 cents. 
    • We estimate that the interest savings from the new credit facility and the swap accounted for $0.02
    • This quarter was a beat – we estimate it contributed at least 2 cents to the guidance raise
    • Also, better gaming operations results and lower D&A, offset by higher SG&A

Hedge Fund Advisor Long China, Gold; Short US Stocks, Treasuries, Dollar



TODAY’S S&P 500 SET-UP - April 25, 2011

The Inflation trade remains in place; US Dollar down (down 13 of the last 17 weeks); continued signs of growth slowing with copper down -1.2% this morning (bearish TREND); while monetary inflation skyrockets (gold and silver hitting new highs).  As we look at today’s set up for the S&P 500, the range is 20 points or -1.37% downside to 1319 and 0.12% upside to 1339.



The Financials remain the only sector broken on both TRADE and TREND.    




THE HEDGEYE DAILY OUTLOOK - daily sector view








  • ADVANCE/DECLINE LINE: 952 (-1033)  
  • VOLUME: NYSE 812.78 (-15.44%)
  • VIX:  14.69 -2.52% YTD PERFORMANCE: -17.64%
  • SPX PUT/CALL RATIO: 1.60 from 2.17 (-26.33%)



  • TED SPREAD: 22.30
  • 3-MONTH T-BILL YIELD: 0.06%
  • 10-Year: 3.42 from 3.43
  • YIELD CURVE: 2.74 from 2.74 



  • 10 a.m.: New Home Sales, est. 280k (up 12%), prior est. up 250k (down 16.9%)
  • 10:30 a.m.: Dallas Fed Manufacturing, est. 13.4, prior 11.5
  • 11 a.m.: Export inspections, grains
  • 11:30 a.m.: U.S. to sell $29b 3-mo., $27b 6-mo. bills
  • 4 p.m.: Crop progress (winter wheat, cotton, corn)


  • Average pump price climbed 11.5c to $3.88 thru April 22: Lundberg survey. Obama said last week a task force will examine if oil, gas prices driven higher by market manipulation. 
  • Nike (NKE) may be poised to climb as it works to control rising materials and labor costs, Barron’s
  • China’s 2011 trade surplus may narrow to 2% of GDP because of rising commodity prices, Reuters says, citing a report from the State Council’s Development Research Center.


THE HEDGEYE DAILY OUTLOOK - daily commodity view




  • Silver Surges to All-Time High as Investors Seek Protection From Inflation
  • Crude Oil in New York Rises a Fourth Day as Middle East Violence Escalates
  • Copper Drops in New York on Signs of Ample Supplies in China, Biggest User
  • Palm Oil Declines as Lower Malaysian Exports Threaten to Boost Inventories
  • Corn Advances as Rains Delay Seeding in U.S.; Wheat Jumps to 2-Month High
  • China's Corn Imports May Expand This Year to 2 Million Tons, Baize Says
  • Rubber in Tokyo Declines as Demand May Weaken on Reduced Car Production
  • Hedge Funds Bullish on Natural Gas as Nuclear Output Falls: Energy Markets
  • Corn, Soybeans May Rise as Cold, Weather Slows U.S. Seeding, Survey Shows
  • India Gold Imports May Fall for Third Month on Prices, Industry Group Says
  • Tsunami Quickens ‘Terminal Decline’ of Northern Japan’s Fishing Industry
  • Most China Aluminum Capacity Lacks State Approval, Business News Reports
  • Corn Seen Topping Wheat on Demand, Raising Tyson's Costs, Helping Syngenta  




THE HEDGEYE DAILY OUTLOOK - daily currency view




  • European markets are closed in observance of the Easter holiday







  • Asian stocks were mixed overnight on earnings concerns and China declined on increased inflation concerns.
  • Japan March corporate services price index +0.4% m/m, (1.2%) y/y.
  • Japan March supermarket comps +0.3% y/y.
  • Hong Kong’s market is closed for a holiday.












Howard Penney

Managing Director

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