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Government Interference

This note was originally published at 8am on May 31, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Is it just or reasonable, that most voices against the main end of government should enslave the less number that would be free?”

-John Milton


John Milton was an influential 17th century poet who “wrote at a time of religious flux and political upheaval in England” (Wikipedia). His most famous writing was “Paradise Lost.” His most enduring life lesson was to challenge the Perceived Wisdoms of the State.


F.A. Hayek cites Milton’s aforementioned quote in “The Road To Serfdom” (page 210) in order to introduce Chapter 14, “Material Conditions And Ideal Ends.” Hayek goes on to remind us that: “Though it is natural that, as the world around us becomes more complex, our resistance grows against the forces which, without our understanding them, constantly interfere with individual hopes and plans…” (page 211).


In the face of Global Macro Markets waking up to further Government Interference in the free-market pricing of Greek risks this morning, considering Milton and Hayek’s thoughts on the matter seems just and reasonable to me.


BREAKING (#1 Headline on Bloomberg this morning): ”Greek Aid Package To Be Decided By June”


Ok. So what does that mean? Does it mean that the first 110 BILLION Euros ($158B US Dollars) allocated to the Greeks was a success? Does it mean that socialist bailout policies have gone global? Why don’t they throw another 30-60 BILLION at this sick puppy and see?


Obviously, this gargantuan global experiment in Fiat Fool policy has crossed its proverbial Rubicon – or I wouldn’t be in a position to ask such ridiculous questions. I do not think doing more of what isn’t working is a good idea. I do not think Greece’s structural economic implosion will end by June either.


So don’t get upset about it – capitalize on it.


Here are the 3 things that matter most in digesting this morning’s Global Macro Grind:

  1.  Greece’s ATG Stock Market Index: up +3.8% on “news”, but is still DOWN -25% since FEB and broken on both TRADE and TREND durations
  2. Euro: making its last charge to overcome its newly minted TRADE line of resistance at $1.44 (versus USD)
  3. USD: throwing a little fear into the US Currency Crash scenario again, but should hold Hedgeye’s critical $74.41 line of TRADE support

In other words, while it’s nice and tidy to tell ourselves stories that our long positions are all off to the races again, we’ll stop, take a breath, and remind ourselves that all this Government Interference in Europe means is that we’re going to have heightened market volatility in June.


Market volatility? Big time. As a reminder, our base long-term TAIL case is that that’s what Big Government Intervention does:

  1. It shortens economic cycles
  2. It amplifies market volatility

In order to capitalize on that thought, all you really have to do (for now) is stay ahead of the next big moves in the US Dollar Index. This morning, with the Euro up at $1.44, the USD Index is down at $74.59, if this US Dollar Index level holds, I’ll make LONG US Dollar (UUP) at least a 9% position in the Hedgeye Asset Allocation Model.


As you know, being long the US Dollar isn’t exactly what my Canadian craw should be considering – given my “long-term” view. And that’s exactly why I think the position makes so much more sense from this price. If the Europeans are actually serious about “ruling out restructurings”, what is going to be bearish for Euros in the intermediate-term is going to be bullish for Dollars.


Taking a step back, looking at last week’s US Market Macro Moves, the US Dollar has already set itself up to recover:

  1. US Dollar Index = DOWN -1% last week to $74.89 (down for the 2nd consecutive week)
  2. US Equities (SP500) = DOWN -0.2% last week (down for the 4th consecutive week)
  3. US Treasury Yields (30-year) = DOWN -1.4% last week to 4.24% (testing fresh YTD lows)

The summary risk management point embedded in currency, equity, and bond markets here in the United States of America is that Growth Is Slowing. This isn’t a new Hedgeye view. But it is becoming a consensus one.


Lower prices in US Equities had me cover our short position in the SP500 last Monday (time stamped @Hedgeye at $131.95 SPY on 5/23/11) and take up my US Equity exposure from ZERO percent last Monday to 3% this morning (I know – call me a horned up bull!).


The complexion of the Hedgeye Asset Allocation Model to kick off this week is now:

  1. Cash = 49% (down from a 61% last week – my peak Cash position for Q2)
  2. International Currencies = 24% (Chinese Yuan and US Dollar – CYB and UUP)
  3. Fixed Income = 18% (Long-Term Treasuries and US Treasury Flattener – TLT and FLAT)
  4. International Equities = 3% (Germany – EWG)
  5. US Equities = 3% (US Healthcare - XLV)
  6. Commodities = 3% (Gold – GLD)

Is it “just or reasonable” to have not lost money in the month of May? Is Government Interference the best path to long-term economic prosperity? These are simple questions for a complex macro market – and it’s our job, as your Risk Manager, to answer them in real-time.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1512-1543, $99.65-101.89, and 1323-1340, respectively.


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


Government Interference - Chart of the Day


Government Interference - Virtual Portfolio


The Macau Metro Monitor, June 3, 2011




The Director of the Maritime Administration, Susana Wong Soi Man, said the Macau govt will not renew the concession contract with Sociedade de Turismo e Diversões de Macau (STDM) regarding the control of the Outer Harbour Ferry Terminal after the contract expires on December 20.  Meanwhile, she also said that the fare increase applications submitted by four ferry operators--Far East Hydrofoil Company Limited, Hong Kong Macao Hydrofoil Company Limited, New World First Ferry Services Limited and Shun Tak-China Travel Ship Management Limited will be authorized but some may not be at the rates requested.



Starting June 15, Singapore's Casino Regulatory Authority (CRA) will have a new chief executive, Mr. Lau Peet Meng, who is the senior director of the Policy & Operations Division in the Ministry of Home Affairs and Assistant Commissioner of Police.

The current CEO of the CRA, Mr. T Raja Kumar, will return to the Singapore Police Force where he will be appointed Deputy Commissioner of Police (Policy).

SP500 Levels Refreshed: Dazed and Confused

Yesterday with Keith on the road, I wrote our intraday market note and highlighted that the stock market was broken on the intermediate duration based on our quantitative models.  As always, closing prices dominate and the SP500 closed below yesterday’s trend line of support, which was at 1,324.  Thus, until further notice, the SP500 is broken based on our quantitative models.


Today’s action is indicative of a dazed market that is having a difficult time finding real buyers, despite how “cheap” it is.  Interestingly, the market is flat despite a substantial sell off in the USD.  Currently, the EUR is up 1.17% versus the USD, while the U.S. dollar index is down over 0.60%.  The fact that U.S. equity markets are flat to down, despite this sizeable selloff in the USD market today, is a noteworthy observation, even if just for one day.


Over the past couple of years if there has been one tried and true correlation, it has been dollar down and most everything, particularly equities and commodities, up, with the 1-year r-squared between the SP500 and U.S. dollar index at 0.71.  We’ll have to wait and watch to determine whether this correlation is changing, but it is certainly confusing price action for those market operators that had been playing this correlation.


Undoubtedly part of the confusion in the markets today is born from Moody’s “update” on U.S. debt and deficit negotiation in which they stated:


“If the debt limit is raised and default avoided, the Aaa rating will be maintained.”


So, to paraphrase Moody’s, if the U.S. is allowed to issue more debt, that is deemed a positive and the Aaa credit rating will be maintained.  It’s shocking that the rating agencies have lost their credibility . . .


Below we’ve refreshed our current levels for the SP500. TRADE support is at 1,302 and TAIL support remains down at 1,214.  If the TRADE line holds, then maybe, just maybe, Morgan Stanley will get that Groupon IPO they just filed out the door, though we have our doubts if this market remains broken, as it is.


Daryl G. Jones

Managing Director


SP500 Levels Refreshed: Dazed and Confused - 1

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ISLE beats handily and numbers need to go higher.


"While we are seeing signs that the economic conditions for our business are slowly beginning to improve, we are cautiously optimistic that the positive changes we have made during the past two years will soon begin to have a more dramatic impact on our bottom line."

- Virginia McDowell, the Company's president and chief executive officer




  • "Across our portfolio, we have been introducing new entertainment options through our Jester's Jam concert series, new dining options with the popular Otis & Henry's concept, and we have also streamlined our marketing to benefit from the synergy created by more centralized promotional and branding programs. As a result of these targeted investments, we have been able to maintain a reasonable mix of rated and retail business, even through tough economic times, and believe that this is an area of further opportunity for fiscal 2012. Further, we have recently put in place new marketing programs in Colorado and management in Vicksburg that we believe will positively impact our results in periods to come."
  • "Flooding along the Mississippi River resulted in the closures of five properties including: Davenport, Iowa; Caruthersville, Missouri; and Lula, Vicksburg and Natchez in Mississippi. At this point, three properties have reopened with Lula and Natchez remaining closed. We hope to reopen Lula this weekend, pending regulatory approval; however Natchez will remain closed until the Mississippi River recedes further."
  • Development updates: 
    • Cape Girardeau, Missouri: 
      • $125MM budget
      • broke ground on March 31, 2011
      • in final phase of contractor selection
      • planned to open late in 2012
      • 1,000 slots/ 28 tables
    • Nemacolin Woodlands Resort, Pennsylvania:
      • Through a development agreement with the Resort, ISLE will develop & manage Lady Luck Nemacolin
      • 600 slots/ 28 tables
      • Assuming no appeals filed by 6/19, construction should commence late summer 11' and the casino will open 9 months later (May 2012 or F1Q13)
  • As of 4/24/11, ISLE had non-restricted cash of $75MM and $1.2BN of total debt w/ $175MM of R/C availability
  • "Fiscal Year 2011 capital expenditures were $58.6 million, of which $13.0 million related to Cape Girardeau, $0.3 million related to Nemacolin and $45.3 million related to maintenance capital expenditures, including conversion of approximately 2,600 slot machines to the Bally's slot system technology."
  • FY12 guidance for non-operating items:
    •  D&A: $89-91MM
    • Cash income taxes: less than $5MM (primarily state income taxes)
    • Interest expense, net of capitalized interest: $83-86MM
    • Corporate and development expenses: $43MM, including $6MM of non cash stock comp
    • Maintenance capex: $50MM
    • Project capex: $90-100MM


  • They continue to see signs of a recovery in half of the properties in their portfolio.
  • Hope to have a new COO within a month
  • Interest in the Q included a $2.2MM write-off related to their former credit facility
  • $33MM drawn on R/C; $500MM on new T/L, $357MM sub notes, $4MM of other debt
  • Flooding & claims: Deductibles are around $250k/location. They expect the first report filed for Davenport in the next few weeks. Timing of settling the claims depends on when the properties reopen and what happens elsewhere like Tunica.


  • If anything happens in Florida, then they expect to get parity treatment
  • Volumes in Vicksburg were healthy when they reopened
  • Mechanics of recognizing insurance proceeds.  Business interruption comes through as revenues. It's still to be determined whether they will have any write-offs from property damage.   You get reimbursed for certain costs as well like payroll.
  • Customer behavior in impacted regions - In Vicksburg, the results have been in-line with prior expectations.  Caruthersville is also in-line with prior expectations.  Not that many people live in the flood plains at their properties. Don't think that there will be much of an adverse impact on their customers.
  • Why was corporate expense so low and why is the guidance for next year so high?
    • They spent a lot of money earlier this year to get licensed in PA & MO
    • Claim that the corporate number for the year was $42MM
  • They plan to have a GMP order on the Cape Girardeau project - generally speaking around $50-65MM is covered by that 
  • If there are appeals filed by June 19th at Nemacolin, it's unclear how long the delay would be, but don't think it will be that long.  They don't think that they will get appeals. They pay $150,000 per year in base fees to the resort and a % of revenues over $30MM. They expect that the fee that they will pay will be about $400,000 per year.
  • Even with the flood impact, they expect to be in compliance with their covenants
  • Capex spend throughout the year? Assuming everything is on time
    • 10% in 1Q; 15% in 2Q and balance is in the back half - either equal or 4Q loaded
  • Blackhawk numbers in the 4Q are actually masking a very positive trend.  The last quarter's numbers include some impact from renovations and management/ marketing/ dining/ hotel yield changes.  The trends are positive there, though.
  • KC market - competition in advance of Kansas speedway?
    • They are happy with their performance there; they have been gaining market share. They are not going to market into the Kansas Speedway opening.
  • Thoughts on IL proposal?
    • Still unclear on how the governor will respond.  Veto is still a possibility.
    • It will likely come down to a negotiation between the governor and the mayor

JCP: Covering TRADE


Booking a nice gain on the short side of JCP on the sales miss. Brian McGough remains bearish on JCP for the intermediate-term TREND. -KM



JCP came in well below expectations this morning citing weather for the second consecutive week as well as a shift of promotional mailers into April - a factor the company failed to mentioned as a positive driver last month. After a handful of brand highlights in April, Sephora was the only callout in May with Liz Claiborne noticeably absent. Additionally, internet sales remain underwhelming contributing only +2.8%. However, the most notable callout (and red flag) is the absence of any comment on inventories. Last month the company dropped the verbiage that inventories were “in-line with sales trends,” this month they failed to mention inventory altogether.


With the least attractive sales/inventory spread among its peers (KSS, M, JWN – see chart below), it looks like JCP is likely to maintain its laggard status over the near-term. We remain bearish on the deparment stores and are still convinced that JC Penney is in the center of the bulls-eye as it relates to the erosion in retail margins in 2H.


JCP: Covering TRADE - JCP 6 2 11


JCP: Covering TRADE - SSS Dept SIGMA 6 2 11

Liberalizing in Latin America

Conclusion: We continue to believe that the short-term scare ahead of a close Fujimori victory or the long-term capital flight that is likely to follow a Humala victory in Peru’s upcoming presidential election will serve as a warning notice for bureaucrats throughout the region to steer clear of further Big Government Intervention and instead opt to increasingly lean on the private sector as vehicles for economic growth.


As Peru’s financial markets brace for Sunday’s presidential elections, we wanted to use this as an opportunity to restate our long-term thesis on the implications of this historic election – which is that we’re likely to see increased economic liberalization throughout the region. As we wrote in an April note titled: “Peruvian Crystal Ball”, we think the potential for measured international capital flight from Peru will serve as a wakeup call against incremental socialism to the region’s leaders:


Such incremental sell-offs have the potential to destabilize the Peruvian economy and should be viewed as a warning sign to politicians throughout the region. Gone are the days of simply parlaying the poor vote into election victories – particularly at the highest office. As we are seeing currently, Latin American politicians must pay increasing attention to the desires of international investors, as well as the needs of the region’s growing middle class.


As resource-rich Latin American countries continue to capitalize economically from elevated commodity prices, we expect this trend to continue. This should put incremental pressure on regional leaders like Dilma Rousseff of Brazil and Cristina Fernandez de Kirchner of Argentina to open up to investor calls for additional privatization of the region’s vast investment opportunities in the coming years.

-Peruvian Crystal Ball, April 19, 2011


At a bare minimum, the surge in volatility we’ve seen across Peru’s equity, currency, and bond market has been noteworthy to say the least. In the YTD alone, Peru’s Lima General Equity Index has seen a -25.3% decline and a subsequent +27.3% melt-up; its currency, the Peru Nuevo Sol, has seen a -2.3% decline and a subsequent 3% gain; and its sovereign 5Y CDS has seen a +71bps melt-up followed by a -50bps decline.


Liberalizing in Latin America - 1


All of the volatility has been centered on the projected outcome of Sunday’s Presidential elections, in which the socialist Ollanta Humala goes head-to-head vs. the younger, more right-leaning Keiko Fujimori. We’ve written extensively about the credentials and policies of each candidate in previous reports, so we’ll spare you the details here. For more background, refer to the aforementioned “Peruvian Crystal Ball” and our April 27 report titled: “Everyone’s A Winner – Except Peru”.


As of yesterday’s close, various sources had shown that Fujimori’s lead in the polls was slipping: -100bps in the latest Datum poll and -270bps in the latest CPI poll (both released on May 29), while the larger Ipsos Apoyo poll showed both candidates in a statistical tie. The Lima General Index is up nearly +6% today on rumblings that Fujimori has gained +100bps in a private Ipsos poll (official polling is prohibited in the week prior to the election), which would give her the lead heading into this weekend’s election. An official Fujimori victory will likely be a further tailwind for Peruvian assets.


Shifting gears to the region at large, we continue to believe that the short-term scare ahead of a close Fujimori victory or the long-term capital flight that is likely to follow a Humala victory will serve as a warning notice for bureaucrats throughout the region to steer clear of further Big Government Intervention and instead opt to increasingly lean on the private sector as vehicles for economic growth.


We’ve already seen signs of this with Brazil selling controlling stakes at a few of its major airports in an effort to spur much needed infrastructure investment ahead of the 2014 World Cup and 2016 Olympic Games. This is following the announcements of a potential pullback in Petrobras’ “aggressive” capex plans and a possible fuel & energy tax cut. On the flip side, the ouster of former Vale CEO Roger Agnelli is a red flag that reeks of the government’s old ways of trying to promote domestic job creation through its state-owned enterprises. He was replaced with essentially a puppet of the Rousseff regime, Murilo Ferreira, who regularly clashed with Agnelli’s overly capitalist management style.


Net-net, time will tell whether or not Brazil and the other countries in the region learn the following very important lesson the easy way or the hard way: Big Government Intervention shortens economic cycles and perpetuates volatility. In some cases (see: US, Japan, PIIGS), too much government in the form of burgeoning debt and deficits has a funny way of structurally impairing growth. As consensus currently reminds you that they lack the Global Macro process to actually get ahead of slowing growth, keep these very important long-term TAIL themes front and center.


Darius Dale


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