Asia’s Power Struggles Part I

Conclusion: A potential record power outage looks to incrementally slow growth and marginally quicken inflation in China. Even still, we welcome these developments to the extent we may eventually be able to buy one of our favorite long ideas on sale when our models signal to us that it’s once again “safe” to significantly increase our exposure to equities in the Hedgeye Asset Allocation.


In yet another manifestation of our once out-of-consensus call that Growth Slows as Inflation Accelerates, China faces a power shortage that may incrementally slow economic growth and marginally quicken inflation. Multi-year high coal prices (+36% since Jan. ’10) driven largely by a significant pullback in Australian supply (the world’s largest producer) is causing Chinese utilities to slow electricity production, in addition to causing them to demand and receive higher prices.


Furthermore, the worst drought in a half a century is threatening to exacerbate the current reductions in aggregate power generation by limiting the capacity of China’s hydropower stations – particularly the Three Gorges Dam in the Hubei province (the world’s largest). Anecdotally, silicon makers and aluminum & copper smelters in the region are slowly suspending activity due to a lack of electricity on the margin.


The decline in hydropower output (22% of total power generation) in Hunan and Hubei is placing incremental pressure under coal prices (70% of total power generation) and exacerbating the energy supply situation across the country broadly.  At an 11-month low of 8.6M metric tons, coal inventories in China are around nine days’ supply vs. a normal range of two weeks. In an attempt to incentivize utilities to reaccelerate electricity production amid rising costs, China just raised electricity prices for industrial, agricultural, and commercial users in 15 provinces for the first time in over a year by +2.2%, with further increases not being specifically ruled out. This is following a +2.7% increase to power tariffs in 12 provinces on April 10. Interestingly, in a bid to limit consumer price inflation, the National Development and Reform Commission held residential rates flat.


Still, we feel the recent hike has the potential to be passed through the supply chain to Chinese consumers and could put upward incremental upward pressure on China’s CPI – a sharp fundamental reversal (recall that we had been and continue to be bearish on the slope of Chinese inflation over the intermediate-term TREND). The NDRC believes the recent increase could indirectly add +5bps to headline CPI. Obviously any further increases in producer’s energy costs will skew the surprise risk here to the upside.


All in, the combination of lower coal-fired and lower hydropower electricity output is estimated to leave China 30-40 gigawatts short of its energy supply needs this summer (down roughly 4-5% from the full-year total) according to the State Grid Corporation of China. From a glass-half-full perspective, a government-imposed energy use reduction plan implemented last summer that helped slow YoY GDP growth -230bps from 1Q10 to 3Q10 should limit any potential YoY drop-off in economic output some. That said, however, should the current blackout target be hit or breached, this summer’s electricity shortfall will surpass the previous record set back in 2004 when YoY GDP growth slowed -130bps from 1Q to 3Q as the chart below indicates. With Chinese equities demonstrably broken from a TREND perspective, the risks to growth appear to be indeed significant. On a marginally positive note, charting the Shanghai Composite’s 2004 performance vs. 2011 YTD, we don’t see much of a difference in trajectory mid-way through the year, which suggests the magnitude of the slowdown could be similar.


Asia’s Power Struggles Part I - 1


Asia’s Power Struggles Part I - 2


Asia’s Power Struggles Part I - 3


All told, we prefer to continue waiting and watching before re-exercising our bullish thesis on China in the Virtual Portfolio. As the data behind the research call we made continues to play out in spades (China’s May Input Prices PMI ticked down overnight to a 10-month low of 60.3 vs. a prior reading of 66.2), we maintain our conviction that China will once again present itself as one of the best markets to invest in across the globe – particularly as consensus unwinds the incredible cognitive dissonance associated with being levered-long of US equities amid 1970’s-style Jobless Stagflation.


Asia’s Power Struggles Part I - 4


For now we’ll continue to ride the bullish wave in the bond market over the nearer term until our models signal to us that it’s “safe” to significantly increase our exposure to equities in the Hedgeye Asset Allocation. And as consensus slowly figures out that the US has a structural growth problem, we think the multiples paid for unlevered, elevated Chinese growth rates will expand on both an absolute and relative basis going forward.


Darius Dale


SP500 Levels Refreshed: Equities Are Broken

Keith is on the road on the Left Coast (i.e. San Francisco) meeting with Hedgeye subscribers, but just called in his updated levels for the SP500.  The key trend line of support is 1,324, which is currently broken with the SP500 at 1,318 (3:15pm).  From the perspective of the Hedgeye quantitative models, closing prices are ultimately what matters, but this price is an important flag intraday.


In the first chart below, we’ve highlighted our current levels for the SP500.  The key takeaway is that if the 1,324 trend line of support is broken then 1,214 is legitimately in play as the next stop for the SP500.  This is 9% downside from current levels.


SP500 Levels Refreshed: Equities Are Broken - 1


The deluge of data that we’ve received over the last two days has confirmed a thesis that we’ve been postulating for most of the year, which is that Accelerating Inflation will lead to Slowing Growth.  Yesterday, Chicago PMI, housing prices, and consumer confidence were all worse than expected.  Today, ISM Manufacturing hit 53.5, which was worse than the expected and a sequential decline from 60.4.   In addition, the ADP employment number came in at +38K, versus an expectation of +175K.  Thesis confirmed.


As a further confirmation of slowing growth, we’ve also highlighted a chart of the yield on 10-year Treasuries, which are currently yielding 2.96. This is down from 3.28% a month ago, and its year-to-date high of 3.74% on February 8th.  There is a reason that one of our top ideas is the etf FLAT, which is a bet on the flattening of the yield curve.  Simply put, as growth slows, the yield curve flattens.


SP500 Levels Refreshed: Equities Are Broken - 2


In the Early Look today we highlighted NYSE margin debt being at an extreme of 1.5 standard deviations above its long-term mean.  As another proxy for equity froth, or the potential for a froth correction, we would highlight the IPO pipeline, which currently stands at 165 companies filed.  The last time the IPO pipeline was this substantial was in 2000.  In the last chart below, we’ve highlighted the recent IPO of LinkedIn, which emphasizes how quickly the speculative appetite of the equity market can adjust.  LinkedIn is down -20% in the last week.


SP500 Levels Refreshed: Equities Are Broken - 3


The next major catalyst for the equity market will likely be the jobs report on Friday.  The only potential positive ahead of that report is that expectations have been cut dramatically in the last couple of days led by Deutsche Bank, who cut their estimates for non-farm payrolls from 300,000 to 160,000 in the last two days alone. 


Hukuna matata!


Daryl G. Jones

Managing Director

R3: JOSB, Tweens, KKR, & AFA



June 1, 2010






  • The latest retailer to crack, JOSB not only came up shy on the top-line, but also margins with higher than expected SG&A expense driven by higher shipping costs and occupancy deleverage. The real callout here is inventories up +18% on +9% sales growth resulting in a sharp negative SIGMA turn. This isn’t the first-time JOSB has struggled with inventories and chances are it's not likely to be a one-off event with inventory compares getting even tougher next quarter.
  • While we aren’t going to have the regional trends for the last week in May until tomorrow, if the first three weeks are any indication, expect the Northeast to be a common negative highlight on tomorrow’s sales calls.

R3: JOSB, Tweens, KKR, & AFA - R3 6 1 11




Simpson to Take on Tweens - With an assist from her younger sister Ashlee, Jessica Simpson is tapping into the tween category. The Camuto Group, which holds the master Jessica Simpson license, has signed an agreement with The Jones Group Inc. to design, develop, produce and distribute Jessica Simpson tween apparel as part of its lifestyle offering of the Jessica Simpson Collection. This agreement expands the business the two companies are already doing with Jessica Simpson Jeanswear and Jessica Simpson Sportswear, both of which are licensed to Jones. The new collection, which will be available in stores in the fourth quarter, will be geared to the fashion-forward tween, sizes 7 to 16. According to Camuto, the tween offering will include footwear (licensed to Stride Rite) and outerwear (licensed to Fleet Street), in addition to the sportswear, jeanswear and activewear. The sportswear line will be available at about 400 doors of specialty and department stores in the fourth quarter. The company has already lined up orders with Dillard’s, Lord & Taylor, Macy’s, Belk, Von Maur, Bon-Ton and The Bay in Canada. Wholesale prices are $15.50 for core jeans; $15.75 to $18.25 for fashion bottoms; $8.50 for graphic Ts; $10.75 to $14.75 for fashion knits, and $14.75 to $20.75 for sweaters, fur vests and pleather jackets. Jones launched Simpson’s jeanswear collection last June (650 doors), and will introduce sportswear at retail this fall (450 doors). Jack Gross, chief executive officer of the Jones Jeanswear Group, projected sportswear and jeanswear combined to ring up $150 million to $200 million at retail annually by next year, evenly split between the two categories. Down the road, sportswear is forecast to outpace jeanswear. The tween line is expected to generate $20 million in retail sales in 2012, said Gross. <WWD>

Hedgeye Retail’s Take: While the tween line is projected to be only a fraction of the size of Simpson’s core lines initially, the key callouts here are 1) it’s yet another line extension (which JNY desperately needs), 2) it targets an entirely untapped consumer for Simpson and one that we’d suspect she still resonates with from her pre-fashionista music days, and 3) if done right, this segment could actually challenge if not surpass the meteoric growth rate realized in the jeanswear and sportswear businesses. Given the success of previous lines, this will be one to watch in 2012.


Hilfiger to Launch Tommy Girl - The Tommy Hilfiger Group, wholly owned by Phillips-Van Heusen Corp., will launch Tommy Girl, a sportswear collection for young women. Tommy Girl, which is licensed to RVC Enterprises LLC, will be available at 150 doors of Macy’s in the U.S., beginning in July. The collection, aimed at 12- to 18-year-olds, will be housed in its own shop environment in the junior area of Macy’s and will reflect Hilfiger’s preppy with a twist heritage. The line features oxford cloth shirts, polos, peacoats and denim jeans. “Younger audiences have shown a strong demand for the brand,” said Gary Sheinbaum, chief executive officer of Tommy Hilfiger North America. “In leveraging our relationship with Macy’s to distribute Tommy Girl, we are able to offer product to this younger consumer and in more locations than we would through our retail business model.” "I am [pleased] about the new Tommy Girl collection,” said Tommy Hilfiger. “Tommy Girl is our response to consumers wanting quality clothing at affordable prices.” Tommy Girl’s retail prices will range from $32 for T-shirts to $129 for outerwear. <WWD>

Hedgeye Retail’s Take: It appears that competition within the young girls segment is heating up with Simpson and Hilfiger both announcing their respective entries into the space. While the target consumer is decidedly different with Simpson going edgy compared to Hilfiger’s classic prep style and price points at Tommy nearly 2x, both lines will be carried at Macy’s. Following the launch of Material Girl last fall, Macy’s is proving to be a key destination for the tween’ish’ demographic.


WMT South African Deal Approved - The South African Competition Tribunal on Tuesday ruled that the Wal-Mart and Massmart merger can proceed. The tribunal accepted the conditions proposed by Wal-Mart and Massmart, including a 100 million South African rand ($15 million at current exchange) supplier development fund, no merger-related staff reductions for two years and continued recognition of the South African Commercial, Catering and Allied Workers Union for three years after the merger. The tribunal also said preference should be given to hiring 503 workers that were let go prior to the merger proposal’s announcement. Wal-Mart Stores Inc. in November acquired 51 percent of the Johannesburg-based retailer for 17 billion South African rand, or $2.36 billion. The Massmart board unanimously approved the transaction and the deal in January was approved by the necessary 75 percent of shareholders. All it needed to proceed was approval by the South African competition authorities. With the last obstacle removed, Wal-Mart said it intends to provide Massmart with increased financial stability and support to continue strengthening its presence in Africa. The combined Wal-Mart-Massmart entity is planning “significant new store openings that will create thousands of union jobs in South Africa,” Wal-Mart said. In addition, the Massmart food business is expected to grow more than 50 percent over a five-year period. <WWD>

Hedgeye Retail’s Take: Completing its biggest deal in more than a decade, Wal-Mart is now truly global penetrating the last remaining continent without the leading EDLP player. While upfront investment is considerable, we suspect it will be some time before we see this deal move the needle.


KKR Acquires Academy - Academy Sports & Outdoors is under new ownership. The Katy, Texas-based retail chain announced Tuesday it was acquired by New York private equity firm Kohlberg, Kravis, Roberts & Co. in a move that Academy President Robyn Faldyn said would accelerate growth for the athletic and outdoor-focused retailer. The current owners, the Gochman family, will retain a minority stake in the 131-door chain, which operates primarily in the southeastern U.S. and saw $2.7 billion in revenue last year. Terms of the deal were not disclosed. KKR is an international private equity firm with $61 billion in assets. As part of the agreement, Faldyn also will take on the CEO role, currently held by Chairman David Gochman, when the deal closes in six to eight weeks. Faldyn said the chain plans to open 12 stores in both new and existing markets in 2011, and he expects KKR’s involvement will facilitate even more expansion. “The transaction with KKR will give the company more flexibility and access to capital to more aggressively pursue additional store growth along with our focus on upgrading our technology and distribution infrastructure,” he said. <WWD>

Hedgeye Retail’s Take: Another sporting goods retailer falls into the hands of private-equity. With only 131 stores, 12 store growth in ’11 is on the more aggressive side relative to its peers – something we’d expect to accelerate as KKR looks to drive sales ahead of an eventual IPO. With DKS having missed the opportunity to grab the Academy when it could, it will be forced to compete with KKR over real estate out west and perhaps revisit the potential for a strategic deal down the line albeit at higher prices.


Barneys Expands e-Commerce Reach - Barneys New York says the e-commerce channel is the fastest growing part of its business and wants to keep the momentum going by playing on its international recognition. The luxury retailer has ramped up shipping online orders off to 90 countries including Canada, South Korea, the U.K., Australia and China, from just the U.S. at the beginning of the year. “We did a phase-in process beginning at the tail end of February, with 20 countries at a time, to make sure we were up and running and could handle it,” Daniela Vitale, chief merchant and executive vice president of Barneys New York, told WWD. Asked what countries are generating the most orders, Vitale replied: “Canada is very big, and we’ve had a lot of interest from Australia due to the beneficial exchange rate.” She also cited France, Germany, Italy and Mexico, which is “quite shocking considering the huge tax issues there....There’s been pretty much a great mix, but no real activity from South America aside from a little bit from Brazil but not much else yet. We haven’t done anything yet in terms of marketing. We would partner with Google to do some search-related things that apply to Brazil” and other countries. Vitale said international tourists represent one-third of Barneys’ active customer base, and that in some flagships, like Madison Avenue and Beverly Hills, it’s closer to a 50-50 split. With the increase in foreign shipping, Barneys is building up inventories but Vitale assured it’s an increase commensurate with sales projections. <WWD>

Hedgeye Retail’s Take: At some point, it becomes more economic to establish global POD to handle volume and mitigate cost, but with well over 1/3 of its business tied to tourists, Barney’s retention cost is considerable. Strong demand out of Canada and Germany are no surprise, but Mexico? Perhaps there’s some truth to ‘if you ship it, they will come.’  


AFA Introduced to Senate - The Affordable Footwear Act has been introduced in the US Senate by Senator Maria Cantwell (D-WA) and Senator Roy Blunt (R-MO) in a bid to reduce costs for outdoor industry footwear makers and their customers while supporting US production of outdoor shoes and boots. The Act would create a four-year suspension of many of the disproportionately high import tariffs, some as high as 37.5 percent, that are assessed against outdoor footwear. The bill also ensures US manufacturing that is currently underway in this area remains globally competitive by excluding any product with American production and preventing tariff engineering that undermines US footwear producers. The bill is also temporary so that domestic production can be reevaluated after four years and products removed where appropriate. It is estimated that $800 million in duties on children’s and low-cost shoes will be eliminated should the bill be passed. The goal is to ease the tax burden on families hurting in the current economy. <FashionNetAsia>

Hedgeye Retail’s Take: Back for another go attempt, but this time the Affordable Footwear Act has been introduced to the Senate – a step further than it’s ever been. This would undoubtedly help the lower end footwear retailers that are more price sensitive if passed. While unlikely to result in lower prices, we suspect that retailers will be less apt to pass increasing material costs through if cost relief in the form of lower tariffs comes to fruition.




get free cartoon of the day!

Start receiving Hedgeye's Cartoon of the Day, an exclusive and humourous take on the market and the economy, delivered every morning to your inbox

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.


In preparation for ISLE's FY4Q11 earnings release tomorrow, we’ve put together the pertinent company updates since its FY3Q11 earnings call as well as a FY3Q11 earnings call YOUTUBE.




  • "We recently closed our properties in Caruthersville, Missouri, and Lula, Mississippi.  Moving south, we have been working closely with officials from the City of Natchez and plan to close our casino on Sunday, May 8 unless circumstances change. We continue to face pressure in Vicksburg and we are continually monitoring conditions there. We have been in contact with our insurance carriers regarding property and business interruption claims."
  • “On Sunday, May 1 the Company reopened its Davenport, Iowa facility after a 15 day closure as water levels receded there.”


  • $50MM project cost; 600 slots, 28 table games 
  • PA combined licensing fee $12.5MM
  • Hopes to open the Lady Luck Casino within 12 months


  • The New Credit Facility is comprised of a $300 million revolving credit facility, maturing in 2016, and a $500 million term loan facility, maturing in 2017.


  • [Spend per visit]: “We’re starting to see this level off and maybe inch back up a little bit recently. But, right now people are very news driven or event driven. So if there’s good economic data that comes out, home prices stabilize wherever they are, if unemployment news comes out that’s good, we’ll see a lift for a while.  The converse is true as well.”
  • “We have started to see retail play tick back up recently.  We’ve seen about a 60% correlation between changes in unemployment and changes in retail revenue. The important part about this is that this is also the highest margin business we have, because these people aren’t getting the coin coupons, they’re not getting the room offers, the free buffets, so the things that go along with that, the marketing costs to a retail customer is really about 5%. In the last quarter, we saw seven of our properties have increases in retail play, and all of the minimum flow through at those properties to the EBITDA line was about 45%.”
  • “What we generally look for when we look for acquisitions or for growth is a state that either has limited licenses or a low tax rate, one of the two”
  • Cape Girardeau, Missouri:
    • “Awarded in December the last gaming license that’s available in Missouri and have started this project, some of the infrastructure work and street repairs and stuff like that or building that needs to be done”
    • “We’re in the final stages of selecting a contractor. Now, we hope to have that wrapped up probably by the middle of May. We’ll break ground officially this summer on the construction of the building and hope to be open by the end of calendar 2012.”
    • “It’s about a $125 million investment, 40,000 square feet of gaming space, 1,000 slot machines, 28 table games.”
    • “The closest competition to Cape Girardeau will be 80 miles in any direction, with the Pinnacle property, River City to the North. 80 miles South is our property in Caruthersville and sort of Southeast of us is the Caesars property or Harrah’s property in Metropolis.”
  • Nemacolin Woodlands Resort: 
    • “Our deal with the resort is that we pay them a fixed fee plus a certain percentage of revenues once revenues hit $30 million. And the market study for this would suggest that the market is about $60 million. And then we would receive 100% of the EBITDA after we paid what essentially is the rent.”



  • “In the fourth quarter, we expect about $15 million in capital expenditures, $10MM of which would be maintenance capital and $5 million related to Cape Girardeau.”
  • “Houston is generally a pretty robust economy, but Houston is not our primary market. We would consider Houston a secondary or tertiary market. So I think that while there may be a little bit of benefit from increased oil prices as it relates to the Houston market, it obviously puts pressure on the rest of our portfolio because of increasing gas prices.”
  • “We’ve had some significant pressures in the south from continuing unemployment rates at all of our Mississippi properties. I think that Lula, which is considered the north Mississippi market has just experienced its 20th consecutive quarter of decline in gross gaming revenues. Natchez is basically under pressure as well from the outer market which would be considered actually the Vicksburg market because of the high promotional activity there and we’re still seeing some significant pressure, pretty much across the entire Southern portfolio because of the high unemployment rates.”
  • “If you look at the corporate costs for the year, they’re going to right in-line with what we sort of guided to at the beginning of the year. It’s sort of in this mid-30s on a cash basis and then plus or minus whatever the stock comp is. So it may bounce around a little bit from quarter-to-quarter because of reserve adjustments and stuff like that, but by and large, I don’t think much has changed from what we talked about at the beginning of the year.”
  • [Stock comp] “Somewhere in that range, $1.4 million to $1.7 million or $1.8 million is probably what we would expect it to be the next quarter.”
  • “We’re seeing some increased promotional activity in the Quad Cities as other regional casinos in both Iowa and Illinois target the Quad Cities markets as well as Jumer’s promotional activity as well. We’re seeing a pretty intense promotional environment as I said in Biloxi but that’s pretty much steady state there. We are seeing an intense promotional environment in Vicksburg as everybody tries to compete for the same customers and deal with the effects of the economy, and a pretty good promotional environment in Lake Charles as well.”

The Big Red: European Manufacturing PMI

Positions in Europe: Long Germany (EWG); Short Spain (EWP)


In the chart below we present May European Manufacturing PMI figures according to Markit Economics. The May numbers show a major downward inflection from April, and confirm a negative trend over the last three months. We think declining factory production is largely in line with our Q2 Theme of Growth Slowing and Inflation Accelerating and consistent with eroding business and consumer sentiment and spending as headline risk surrounding peripheral sovereign debt contagion moves further to the forefront. With the EU-area the largest trading partner of most EU states, it comes as no great surprise that the majority of the countries are moving (downward) in tandem. [On the PMI survey, 50 is the line in the sand, with figures above 50 indicating expansion, and below indicating contraction. Spain is firmly in the latter camp.]


The Big Red: European Manufacturing PMI - zeechart


As we noted yesterday, statements from Eurogroup head Jean-Claude Juncker that a total restructuring of Greece’s debt is out of the question and that EU leaders will decide on a new aid package for Greece by the end of June may give some level of respite to European capital markets and the common currency in the near term. However, European equity markets are selling off today after a sizable rally yesterday, bond yields across the PIIGS are back up day-over-day, and a debt auction today from Portugal of €850 Billon of 3M bills yielded an elevated 4.967% (versus a previous auction of 4.625%).


As the high-frequency data slows, so too does our conviction. While Germany (via the etf EWG) has been a strong position for us in the Hedgeye Virtual Portfolio over the last two years, the data is slowing on the margin, and we’ll be managing our position accordingly.


Matthew Hedrick

Hakuna Matata

This note was originally published June 01, 2011 at 08:24

“It means no worries,
For the rest of your days,
It's our problem-free philosophy,
Hakuna Matata.”


-The Lion King


Hakuna matata is a Swahilli phrase that means, literally, there are no worries. The term was first popularized by 1980s rock band, Boney M, but gained most of its popularity in the 1994 Disney animated hit, Lion King. Yesterday, the U.S. equity markets closed solidly to the positive with the benchmark SP500 closing at 1,345 near the highs for the day. Hakuna matata! Right?


Certainly, yesterday’s stock market action reflected a care free / hakuna matata type of attitude, especially given the backdrop of the economic news of the day. There were actually three data points out that caused your grumpy old risk managers at Hedgeye a little concern. They were as follows:


1)      Chicago PMI - The ISM’s Chicago business barometer dropped from 67.6 in April to 56.6 in May, which was its lowest reading since November 2009. This was the largest one-month deceleration since October 2008. Clearly ominous, although perhaps somewhat attributable to the region’s exposure to the auto industry and shortage of auto components from Japan (at least, that’s the spin). The comments from the recipients of the survey were fascinating and can be found here:

The common themes were price inflation and slowing growth.


2)      Case-Shiller Index – According to the Case-Shiller Index, U.S. home prices fell for the 8th straight month and were down 4.2% for Q1 2011 versus Q4 2010. This is an accelerated decline versus Q4 2010, a quarter in which home prices fell 3.6% quarter-over-quarter. Declining home prices are negative for the financial sector, as banks have to adjust residential mortgage loan books accordingly, and negative for the outlook for consumer spending, especially on the low end.  According to the Case-Shiller report, home prices have now fallen as much as they did during the Great Depression. In that period, it took 19 years for the prior peak to be revisited.


3)      Consumer Confidence Index – The Conference Board’s index of consumer confidence dropped 5.2 points in May and is now at its lowest level since November. The Hedgeye Optimism Spread continues to contract, as the expectations component led the decline falling to 75.2 from 83.2 (previously 82.6). The present situation component dipped to 39.3 from 40.2 (previously 39.6). Overall, the assessments of future business and labor market conditions fell in May.


As we noted at the outset of the note, the equity markets completely shrugged off the economic data points above and closed at, or near, the Hakuna Matata Highs of the Day. Now to be balanced, these data points are mostly backward looking, except for perhaps the consumer confidence reading, so it is, maybe, understandable that the market looked through the news. 


That said, speculating on the meaning of market price moves is just that - speculation. To reduce speculation, we incorporate a quantitative process around looking at market prices. As Keith and I learned in our early days in the hedge fund industry, markets or stocks going up on bad news is an important signal, but it does need to be confirmed. That is, one day a trend does not make.  As well, short term price action needs to be placed into the greater context of market sentiment and psychology. 


To the last point, we have posted in the chart below a look at NYSE margin debt versus the SP500 going back to January 1997. The takeaway from this analysis is that when margin debt has reached an extreme of 1.5 standard deviations above the mean, the SP500 has seen a 50% correction in the ensuing 18 months.  We are certainly not calling for a crash or correction to that degree, but wanted to highlight this context, which is simply that stock market operators are leaning levered long - in a large way.


Over the course of the past couple of quarters, there is no doubt most stock market operators have experienced some level of cognitive dissonance. Yesterday’s action likely accelerated those experiences.  On the positive side of the ledger yesterday, a Greek default seems to have been punted, which is positive on some level for some time frame, and the economic data suggested, to our Q2 Theme, that The Bernank has continued clearance to stay Indefinitely Dovish. Therefore, if fixed income earns you little, or at least historically low rates of return, then perhaps equities are marginally more appealing? Thus the equity markets reacted accordingly yesterday . . .


We certainly understand this line of reasoning, but remain concerned that the “valuation” case for the U.S. stock market may not be what it is cut out to be. As inflation accelerates and growth slows, corporate margins contract, and earnings growth becomes challenging. Recall that at the end of 2007, the SP500 was trading at 17.3x forward earnings of $84.67 per share, except for the fact that the real earnings number was actually $60.57, or 28% lower than expected. There was little cognitive dissonance by the end of 2008.


Hakuna matata!


Keep your head up and stick on the ice,


Daryl G. Jones

Managing Director


Hakuna Matata - Chart of the Day


Hakuna Matata - Virtual Portfolio

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.