• run with the bulls

    get your first month

    of hedgeye free


Measuring Time

“Observe due measure, for right timing is in all things the most important factor.”



On Monday I titled my Early Look “Timing Matters.” It still does.


If you are proactively prepared to play this game, you will capitalize on opportunities while your competition freaks out. Yesterday was a good example of that. If you were watching La Bernank back-pedal on QG3 (Quantitative Guessing III) real-time, you knew exactly what to do. Buy US Dollars, Short Euros, and cut your gross (and/or net) exposure to US and European Equities.


Or at least that’s what I did.


No, that’s not being overly “confident.” It’s called seeing the play develop and capitalizing on it. I’m not sure if it’s this industry’s very low expectations of sell side research or whether it’s just easier to universally accept mediocrity in “not being able to time markets”, but whatever it is, I like it. Championship teams have championship processes. They make calls when calls need to be made.


That’s just modern day risk management with a Global Macro overlay. Measuring political timing, as Canadian Prime Minister Elliott Trudeau once said, “is the essential ingredient of politics.”


Timmy Geithner’s message on timing yesterday was that there is “no way to give Congress more time.” Really Timmy? Thanks – we appreciate the fear-mongering about a debt position you’ve spent 47% of your born life helping create.


Assuming America’s political panderers abide by Geithner’s timing signal, you can bet your Madoff that this weekend sees an acute level of Congressional respect paid toward their own career risk management.


Rather than waking up to these embarrassingly timed notes out of Moody’s and S&P on US credit risk, what if you wake up on Monday to the thundering Squirrel taking a victory lap on a debt-ceiling compromise?


Perversely, that could be bad for stocks – in the very immediate-term. Why? Because that’s both US Dollar and US Treasury Bond bullish! In the long-run, that’s what America needs – a strong US Dollar, as opposed to a debauched one; a confident leadership-line drawn in the sand, as opposed to a politically obfuscated one; and a progressive American resolve, as opposed to a backward looking one.


Back to the Global Macro Grind

  1. I am long the US Dollar (UUP)
  2. I am short the Euro (FXE)
  3. I am Canadian

If you can’t have any fun with this game, don’t play it. Or at least we recommend not playing it against us. Hedgeye likes to stir the pot. And in case you missed our notes earlier this week on China – Big Alberta and his Chinese Cowboys in the Haven have brought out the mandarin ladle.


Despite La Bernank sending US stocks lower for the 4th day in the last 5, Chinese stocks closed up another 0.35% last night (they were UP for the 4th day out of the last 5). Good timing.


Meanwhile, European stocks are sucking on a Europig’s nipple this morning hoping that the rest of the real-time risk managing world doesn’t realize that the European Bank “Stress Test” Part Deux isn’t a joke. Hope, and “stress testing” banks using their 2010 numbers, is not a risk management process.


In terms of European positioning:

  1. I sold my Sweden (EWD) yesterday because we don’t like/trust their banks’ exposures
  2. I am long Germany (EWG), and I’m worried about it
  3. I am short Italy (EWI), and I like it

Conan O’Brian said that “early on, they were timing my contract with an egg timer.” And that sounds just about right in terms of the shortest of short-term durations that we’re talking about when we consider these Eurocrat and Congress market catalysts…


But, when Measuring Time in macro market moves, you have to be Duration Agnostic. Market catalysts can be short and/or long term in nature. Mr Macro Market doesn’t particularly care about our individual investment styles or durations.


I’ll walk through how we Measure Time with our all-star Global Macro team of analysts on a conference call at 11AM EST this morning. This is our Q3 Macro Themes call, and we’re right fired up to grind through it and get to the best part of the game – your Q&A session. Please send an email to our Sales Deck () if you need call-in info.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1, $94.68-97.34, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Measuring Time - 222. USD EL


Measuring Time - Virtual Portfolio


Best operator in the top performing market in the world – you bet it will be another beat.



We expect Steve Wynn will be grinning from ear to ear next Monday when WYNN presents its Q2 results.  Q1 was a stand-out quarter as EBITDA and EPS came in 28% and 89% above consensus.  We think Q2 will be another big beat, particularly on EPS—we’re at $1.30, 34% above the Street.  We’re also 12% higher on Adjusted EBITDA and 7% higher on net revenues.


While we remain confident in our Wynn Macau estimates, Las Vegas, as always, is a bit of a wild card.  Our Q2 Wynn LV estimate is above the Street, owing to a very strong May on the Strip and Wynn’s recent outperformance.


Macau surprised everyone again in Q2 as market revenues rose 46% YoY and even 13% sequentially.  WYNN will be the 1st gaming operator in Macau to report Q2 earnings but, despite the upside, may not even have the best quarter of the bunch.  We think top Q2 honors will go to MPEL.  However, a big WYNN beat on July 18th should sustain the positive momentum for the group.


Here are the details:



WYNN Macau

We project Q2 Wynn Macau net revenue of $985MM and EBITDA of $310MM, 6% and 8% ahead of Street, respectively

  • We estimate net gaming revenues will be $929MM or 38% YoY growth
    • VIP net win of $669MM
      • Assuming direct play of 10%, Rolling Chip of $33.4BN and hold of 2.9%
      • Rebate rate of 86bps
  • Mass table win of $191MM
    • Table volume of $789MM and hold of 24%
  • Slot win of $74MM
    • Handle of $1.43BN and win % of 5.2%
  • Non-gaming revenue, net of promotional expenses of $56MM
  • Variable expenses of $555MM ($474MM of gaming taxes and $75MM of incremental junket commissions above the rebate)
  • $25MM of recorded expenses for non-gaming revenues
  • Fixed expenses of $94MM

WYNN Las Vegas

We estimate that Wynn Las Vegas will report $355MM of net revenues and $94MM of EBITDA, 4% and 10% above the Street, respectively.

  • We estimate net casino revenues of $134MM, representing 14% YoY growth
    • Table win of $118MM, up 21% YoY: table drop of $534MM and 22% hold
    • Slot win of $42MM, up 3% YoY: slot volume of $699MM and 6% hold
    • Discounts and other as a % of Gross Casino Win: 16%
  • $266MM of non casino revenue and $44MM of promotional expenses
  • $49MM of SG&A and $4MM of doubtful accounts

Other stuff:

  • Corporate expense: $19MM
  • D&A: $101MM
  • Stock comp: $8MM
  • Net interest expense: $58MM

the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

Tale of Two Deficits


Conclusion:  While the long term negative nature of both the U.S. trade and budget deficits is negative for the U.S. dollar, in the short term incremental improvement on the budget deficit should be positive for the U.S. dollar, especially as European sovereign debt dysfunction accelerates.


Positions: Long U.S. Dollar via UUP; Short the Euro via FXE

“We must always take heed that we buy no more from strangers than we sell them, for so should we impoverish ourselves and reach them.”


         -  Discourse of the Common Weal of this Realm of England, 1549


In the past couple of days, the U.S. government has released the most recent information on both the trade and budget deficits.  Interestingly, the trade budget, which generally garners less attention than the fiscal deficit, was much worse than expected and in fact came in a level not last seen since 2008.  In the chart below, we’ve highlighted the trade deficit going back nine years.


Tale of Two Deficits - d1


In simple terms, of course, the balance of trade is the difference between a nation’s exports and imports.  A country has a trade surplus if it exports more than it imports and trade deficit if the opposite occurs.   Since the 1980s, the United States has consistently had a growing trade deficit.  This is both because of the low U.S. savings rate and low cost production capabilities (labor primarily) of many Asian nations.  The net result of this, particularly due to the second factor, is that many foreign nations hold large amounts of U.S. government debt to fund the trade deficit with the U.S.


There is much debate over whether a negative trade deficit is actually positive or negative for an economy.   On the positive side of the ledger, many economists point to the case of the United States where in periods of more rapid GDP growth, and perceived economic prosperity, trade deficits have expanded.  Conversely, in periods of slower GDP growth, trade deficits have narrowed. 


Regardless of the long term implications, in the short term a trade deficit is negative in the sense that it is a drag on overall GDP growth.  In May, the U.S. trade deficit was -$50.2 billion, which was a sequentially increase from the April deficit number of -$43.7 billion.  The U.S. dollar basket was down ~-9.5% over the 12-month period ending July 1st, which grew exports to the second highest quarterly on record, but this was largely offset by increased input costs, especially oil which costs the most since August 2008.  In part, this expanding trade deficit underscores our below consensus GDP growth range for the next two quarters of 1.7 – 2.1%.


While the economic implications associated with a trade deficit is subject to debate, most economists, even Keynesians, would argue that a federal budget deficit eventually becomes negative if not kept at a manageable level.  The long term budget deficits in the United States are currently front and center, especially given the debt ceiling deadline looming in early August.  Interestingly, though, the June federal budget deficit actually came in at a better than expected level, at least on face value.


In June, the estimate for government revenue is $248BN and the estimate for expenditures is $294BN, which equates to a budget deficit of $-45BN.  They key delta, as outlined in the table below, is a dramatic decline in expenditures year-over-year.  In June 2010, U.S. federal government outlays were $319BN and they declined to $294BN in June 2011.  At face value this appears positive, though according to the Congressional Budget Office literally all of this improvement was attributable to net reduction in estimated cost of loan and loan guarantees and lower outlays for equity injections in to Fannie Mae and Freddie Mac. 


Estimates For June (Billions of dollars)


Tale of Two Deficits - d2


For the year-to-date, which is the first nine months of the government’s fiscal year, the Federal budget deficit has seen limited improvement.  Based on the reported government numbers, revenue is up 8.5% and expenditures are up 4.0%, so the deficit has improved by $31BN for the first nine months to -$973BN according the government’s numbers.  That said, if expenditures are adjusted for various one-time charges (primarily payments to GSEs), the deficit is basically flat year-over-year.  Currently, the budget deficit is on pace to be just under $1.3TN for the full year and is trending just above the 9% deficit-to-GDP level.


Obviously, given this massive budget deficit, the federal government will continue to have to aggressively borrow absent a long term deficit reduction plan being passed by Congress.  The financing expense is literally being seen in the deficit results.  Net interest on public debt has grown 17.8% year-over-year in the first nine months to $202BN. So, 11.6% of federal government revenue is going just to servicing debt.


Tale of Two Deficits - d3


While both the trade and budget deficits have different long term implications, there are both critical to watch and understand as it relates to having a perspective on the direction of the U.S. dollar and U.S. interest rates.  Longer term, both suggest the case for weak U.S. dollar, though in the short term positive news flow out of the debt and incrementally positive action on the deficit should support a strong U.S. dollar, especially versus the Euro.


Daryl G. Jones

Director of Research


Stress Test Results Tomorrow Will Dramatically Understate Risk

We don't think it's too great a stretch to call tomorrow's EU "Stress Tests" absurd. Why? Consider the following.  The stress test results to be released tomorrow.  are based on balance sheet data from the banks at December 31st, 2010. No changes in exposure since then are reflected.  Furthermore, the macro assumptions work off of a baseline of what the world looked like at year-end 2010.  This means that the current state of the world is actually much worse than the so-called "adverse" scenario in many cases.  


The charts below look at what the EU considered for its "adverse" scenario, namely the backup in sovereign bond spreads relative to German Bunds, compared with what has actually occurred in the market.


The starting point for the tests is YE2010. This is the date when the stress test scenario analysis begins. In the charts below we show the amount by which the stress tests assumed sovereign spreads would widen vs. the amount they have actually already widened by. Let's do a quick case study on Portuguese 15 year sovereign bonds, as these are the bonds the stress test assigns the biggest haircuts to under their adverse scenario. Looking at the 15 year bonds of Portugal, the EU stress test assumes the bonds widen by 251 bps against German bunds in an adverse scenario. In reality, however, Portuguese 15 year bond spreads have already widened by 612 bps since YE2010. Under the 251 bps scenario, the EU estimates that the haircut on those bonds would be 30.6%.  You can do the math on what a 612 bps scenario means for the haircut.


Performing the same analysis on the 2-year Portuguese bonds, the stress test assumes 201 bps of spread widening, when in reality 2-year spreads have widened by 1,860 bps. Under the EU stress test adverse scenario, their 201 bps assumption triggers a 5.5% haircut on those bonds. Given the actual widening is closer to 9x what they've assumed it seems reasonable to conclude that the stress tests will quite materially understate the real risk in the system.


This profound ignorance of reality repeats across durations and countries. As such, it will be hard to take seriously the EU's conclusions tomorrow when they announce which banks are adequately capitalized and which banks are not. Portugal, Greece & Ireland are all trading well in excess of the adverse scenarios. Italy is quite close to their adverse scenario assumption.







Assumptions of the 2011 Stress Tests

If the lead-in section of this note hasn't dissuaded you from the Stress Tests' relevance, here's some additional lunacy to consider. 


The "Adverse Scenario" in the stress tests makes assumptions around GDP growth, unemployment, home prices, exogenous shocks, and other macro variables.  Let's skip straight to the big question: What are the assumptions about sovereign default?


- No sovereign defaults.  (No, really.)  The adverse scenario does not contain a default of any sovereign issuance. Instead, sovereign "shock" is purely a function of higher interest rates on sovereign bonds and higher credit spreads.    


- No assumption of any change in ratings.  (Coincidentally, the EU is considering banning ratings agencies.)


- Valuation haircuts are only applied to held-for-trading bonds for each bank - that is, those that are already marked-to-market.  



GDP Assumptions

The chart below, from the European Banking Authority, shows the assumptions around GDP growth in the 2010 and 2011 stress tests.  





For those interested in the overview of the stress tests, take a look at the following document, which describes in greater detail what we have summarized in this note.





Detailed Disclosures Will Be Forthcoming

One thing the stress tests will provide is a great deal of data for individual banks' exposures (or at least what those exposures were at December 2010).  Refer to a disclosure template at the following link:


One side note is that the stress test data will not be comparable to the BIS data that many investors have used to get a handle on exposures.  According to the EBA, the data is aggregated in a way that makes reconciliation "impossible."



Market Reaction to 2010 Stress Tests

The chart below shows the Euro STOXX Bank Index back to 2009.  The market was in an uptrend at the time of the stress test release, and in the 7 trading days immediately following the July 23rd, 2010 release, the index squeezed 9.2% higher. Today, the index is 24% lower than its level on the day of the release. We think this is probably a good way for thinking about how the stocks will trade again this go-around. Remember, it was clear to everyone last summer that last year's stress tests were also a complete joke. Somehow, this time around, the market seems to think that this round of stress tests is much more serious. While that is clearly wrong, the market may well use it as an excuse to move higher in the short-term.






Based on the fact that it relies on assumptions that border on disbelief, we think clients should treat with extreme skepticism the likely bullish conclusions of tomorrow's EU Stress Tests (Round 2). While it served as a catalyst for the market to go higher in the short-term last summer, those gains proved short-lived as the market went on to retrace all that and more.



Joshua Steiner, CFA


Allison Kaptur






Yum! Brands reported strong EPS growth last night on the back of blockbuster China comps and a lower-than-usual tax rate. 


Depending on what you assume for a “normalized” tax rate, the 16.7% tax rate YUM reported for the second quarter helped EPS by $0.07-$0.08.  


Needless to say, such a tax impact calls into question the quality of the company’s earnings but the strong growth in China cannot be discounted.  That said, there are serious issues to be addressed in the U.S. and those issues took up a significant proportion of the discussion during the earnings call this morning. 


Earlier this year, management highlighted four goals as its “2011 Focus”:

  1. Build Leading Brands in China in Every Significant Category.
  2. Drive Aggressive International Expansion and Build Strong Brands Everywhere.
  3. Dramatically Improve U.S. Brand Positions, Consistency and Returns.
  4. Drive Industry-Leading Long-Term Shareholder and Franchisee Value.


On points 1 and 2, YUM is powering ahead as usual.  Point 3 is completely missing and the situation seems increasingly dire.  Point 4 is intact, for now, but they will need to show more solid operating profits (not lower tax rates) in the back half of the year to convince investors that long-term shareholder value is secure.  If the back half of the year produces better quality earnings, it would go a long way toward reassuring investors.  The stock is up today following incredible comps out of China, albeit with down margins.


Below we run through management’s commentary on each of the three business divisions and provide our own thoughts on how things are likely to transpire over the intermediate term.



YUM China


China remains the jewel in the crown for YUM, providing 18% same-store sales versus 4% growth in 2Q10 and 13% growth in the first quarter.  On a sequential basis, two-year average trends accelerated by 250 basis points in 2Q.  Management highlighted several key initiatives that are attracting traffic to its China stores.  24-hour operations, delivery service, and a growing breakfast business are all helping to increase AUVs. Breakfast is available in almost all of the KFCs in China (3,378 as of June 11, 2011) and accounted for 13% of transactions versus ~10% beforehand.  24-hour operations are now the norm for over 1,300 units and delivery service is available for 1,600 restaurants.  During the second quarter, KFC China continued to offer a 6 RMB Breakfast promotion and began offering a 15 RMB weekday lunch promotion also.  These promotions helped drive transactions, which gained +21% during 2Q.


While it is tough to imagine for U.S.-based investors, Pizza Hut is a very popular brand in China and continued to perform strongly in 2Q.  Continued expansion of Pizza Hut into new cities should provide strong returns for YUM China.


Inflation is an issue in China and management is likely to take price as the company’s full-year inflation guidance is now +9% for commodities and mid-to-high teens for labor.  Despite this, management anticipates full-year margins to remain above 20%


Hedgeye:  YUM faces markedly easier margin compares over the next three quarters.  While same-store sales compares also increase in difficulty, I would expect momentum to continue (obviously not at the same rate at 2Q).  Management is guiding to double-digit same-store sales growth in the third quarter.






YRI continues to represent a bright spot for YUM as the company positions itself to grow in emerging markets.  YRI continues to see positive same-restaurant sales growth and margin expansion, despite the impact of inflation.  The company set out its stall regarding YRI at the Analyst Meeting in NYC earlier this year when management explained that the expected growth in “consuming class population” between 2010 and 2020 in “YRI Emerging Markets” is expected to far outstrip the impressive forecasted growth in China over the sale period.  Nevertheless, there are clearly opportunities in developed nations also.  France, for instance, was highlighted today by management as being a significant opportunity.  As of year-end 2010, YUM had 117 Pizza Hut restaurants and 117 KFC restaurants in France. McDonald’s, YUM management pointed out today, has almost 1,200 restaurants in France and makes more money from them than YUM does from the entire YRI division.  Clearly there is plenty of white space, even aside from the obvious emerging market targets, for YUM to grow. 


Hedgeye: YUM has shown itself to be an anomalous restaurant company in its ability to build the infrastructure necessary to manage multiple brands over multiple geographies.  We wouldn’t bet against the company succeeding in other international markets as well.  We were critical, after the Analyst Meeting, of claims by the company that Africa offers the next big source of growth for YUM, and will continue to monitor the returns the company sees on its investments, but for now the accelerating comps and expanding margins bode well for the division’s profitability.


YUM – 3 OUT OF 4 AIN’T BAD - yri




Last, and by almost every metric least, the U.S. division is a disaster and, as good a management team as YUM has, I’m not sure they are going to come up with the answers any time soon.  The company’s frustration came across during the earnings call and prior statements that 2011 would be a “transition” year for YUM U.S. are clearly euphemisms in retrospect.  Same-store sales for the U.S. division declined -4% and Operating Profit declined by 28% year-over-year.  During the conference calls, participants and listeners were informed of a relaunch of last year’s disastrous Kentucky Grilled Chicken product but it was clear that no real solution is forthcoming.  During the Analyst Meeting earlier this year, in NYC, management distributed materials that showed YUM’s path to becoming a truly global company.  In 1998, 78% of YUM’s profits were from the US and management stated that, by 2015, the goal was to reach a 25% U.S./75% international split in operating profit source.  It seems they have gotten there much faster than they had wished, due to the U.S. profit declining so much.  We expect the U.S. to become more and more insignificant as YUM’s international store count continues to grow.


Hedgeye:  One has to wonder if they would be better off taking drastic measures with their domestic business, KFC in particular.  Taco Bell may have been hurt by the bogus lawsuit and time will likely fix that issue, but KFC and Pizza Hut are two brands in indisputable decline and I believe something bold has to be done to change their fortunes.  Even with an infrastructure as vast as YUM’s, however, there are only so many tasks that a management team can execute on and the international markets are simply more important.





Howard Penney

Managing Director


Rory Green





Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.