“Nothing is more obstinate than a fashionable consensus.”
Most stock market operators, particularly those trained in the dark art of short selling, have an understanding of the concept of herd mentality. The expression “herd mentality” describes how people are influenced by their peers to adopt certain behaviors. Herding around perceived fundamentals has led to some of the most spectacular bubbles of the last fifteen years – the internet, real estate, uranium, and so on. Interestingly, we may be at the beginning of the end of the most spectacular financial bubble of our lifetimes: sovereign debt.
Just over two years ago, on April 8th, 2009, Keith and I attended a guest lecture at the Yale Law School by former Treasury Secretary Robert Rubin. For better or worse, Keith and I have never worshipped at the Church of Rubin, though many current and former U.S. policy makers are considered his protégées - including the venerable Timothy Geithner and Larry Summers - so his philosophy certainly influences current U.S. policy. At that time two years ago, the Hedgeye team was digging deep into sovereign debt issues and were naturally struck by one specific quote from Rubin’s lecture:
“There is no risk of any defaults on sovereign debt globally."
In hindsight, Rubin pretty near top ticked the global sovereign debt markets with his Fashionable Consensus.
Last week, we introduced Policy Pong as one of our three Q3 2011 investment themes. On a global level, Policy Pong refers to the batting back and forth of Keynesian monetary and fiscal policies between Europe and the United States. Our view on the world’s two key reserve currencies, the Euro and the U.S. Dollar respectively, is directly influenced by the intermediate outlook for policy from each region.
In the U.S., the policy debate over the debt ceiling is critical to watch, but the U.S. Treasury market is telling us emphatically that no default is imminent. In fact, yields on 10-year treasuries are near year-to-date lows at 2.92%, while credit default swaps for 10-year treasuries are trading at 64 basis points versus 59 basis points on December 31, 2010. Despite heightened rhetoric, it is likely that the Republicans and Democrats will reach a Fashionable Consensus, which in the intermediate term is positive for the U.S. dollar versus the Euro.
There is no doubt that the herd is negative on European sovereign debt. In fact, with Greek 5-year CDS currently trading at 2,568 basis points and recent media reports suggesting that Greek debt could be written down by 80%, the case could be made that investors are too bearish on Greece. As it relates to the outlook for Europe more broadly though, Greece, at less than 2% of European Union GDP, is not the best indicator for contemplating the next move in the Euro currency or the Eurozone economy. So, the question remains, is the herd bearish enough on the Euro and European sovereign debt issues?
We are currently short of the Euro / USD via the etf FXE in the Virtual Portfolio. The key component of this thesis is that we believe that the ECB will be forced to shift its monetary policy stance due to both slowing growth in Europe and accelerating sovereign debt issues, primarily in Italy. Currently, credit default swaps on 5-year Italian bonds are trading just north of 300 basis points, which is slightly better than Lebanon at 358 basis points and Vietnam at 344 basis points.
This acceleration in the price of Italian credit default swaps has been underscored by the rapid increase in yields on Italian government debt. As an example, the yields on Italian 10-year bonds are currently at 5.79%, an increase of almost 100 basis points from the start of July. Rapidly accelerating interest costs are an issue for Italy because it has debt-to-GDP of north and 110% and interest-payments-as-percentage-of-GDP are north of 4.8%, according to recent ECB reports, which is second only to Greece at 6.7%.
Rather than viewing the European Union holistically, sovereign debt investors are rightfully evaluating each sovereign issuer on its own merits. Conversely, the ECB is seemingly evaluating the next interest rate move on what is best for the healthy economies in Europe, in particular Germany. Unfortunately for the one size fits all policy makers at the ECB, the GIPSIs (Greece, Ireland, Portugal, Spain, and Italy and so named for their wandering fiscal policies) are collectively more than 25% of Eurozone GDP and have credit default swaps government debt yields that are saying “No Más” to Trichet’s hawkish stance.
(For those sports fans, the best analogy is Sugar Ray Leonard versus Roberto Duran when Duran quit mid-fight, which occurs at 1:35 of this video: http://www.youtube.com/watch?v=HPoWrWwwi8M)
The second derivative issue of sovereign debt in Europe relates to the European banking system and the impending collateral call on European banks. Our ever insightful Financials Team lead by Josh Steiner wrote a note yesterday titled, “European Debt Crisis: Where the Bodies Are Buried (The 13 Most Exposed EU Banks), with the following key takeaway:
“We find that there are numerous European banks with over 100% of their Core Tier 1 Capital committed to either PIIGS commercial loans or PIIGS sovereign debt holdings. For example, we found that 18 of the 40 largest European banks held 100% or more of their Core Tier 1 Capital in PIIGS sovereign debt or commercial loans. In 13 of these cases, the banks held more than 200% of their Core Tier 1 Capital in PIIGS sovereign debt or commercial loans.”
Is it Fashionable Consensus to be short of the Euro? Perhaps, but our research, risk management, and obstinance are telling us to stick with it.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
Even the “greatest wet blanket” couldn’t dampen another blockbuster quarter at Wynn Las Vegas. Oh, and Macau helped too.
“And I'm saying it bluntly, that this administration is the greatest wet blanket to business, and progress and job creation in my lifetime.”
– Steve Wynn
WYNN blew away our Q2 EBITDA estimate by 10%, and we were way ahead of the Street. Despite the “the weird political philosophy of the President of the Unites States”, Steve managed to put up another blockbuster quarter in Las Vegas. Then again, Steve had Lady Luck on his side this quarter – not sure about Obama and his Keynesian plan to revive the economy. We estimate that hold favorably impacted the quarter revenue and EBITDA by $39MM and $28MM, respectively.
Overall, we’d say this was a terrific quarter. While Macau EBITDA didn’t beat us by much, we were high on the Street. After numbers go up, the question will be, “what’s next?” We think Wynn Macau is a market share retainer at best and will likely lose share over time. Market growth remains incredibly strong, but that benefits everyone. What is the next catalyst? MPEL for instance has many more catalysts, is cheaper, and probably has higher upcoming earnings revisions.
Below are some observations and takeaways from the quarter.
Wynn Macau generated $977MM of net revenue and $314MM of EBITDA, which were in-line with our estimates.
- VIP net table win was $12MM below our estimate
- Direct play was only 8% vs our estimate of 10%
- The rebate rate was 30.5% (vs. our estimate of 30%) or 88bps
- Mass revenues were $6MM above our estimate
- Drop increased 26% YoY vs our estimate of 44%; however, hold was 27.8% vs. our estimate of 23.5%. Wynn’s hold since 2Q10 (when they opened Encore) has been 25.5% if we include the current quarter
- We estimate that high hold benefited Mass revenues by $16MM and EBITDA by $10MM
- Net non-gaming revenue was $3MM below our estimate due to higher comps
- Fixed expenses were $93.4MM – in-line with our estimate
Las Vegas results of $391MM of net revenue and $133MM of EBITDA blew away our estimates by 10% and 41%, respectively.
- Casino revenues came in $24MM above our estimate, entirely due to high hold on Wynn’s baccarat business
- Table drop of $535 million was right in-line with our estimate, but hold of 27.6% was materially higher
- Using the mid-point of Wynn’s normal range of 22.5% - we estimate that hold benefited the quarter by $27MM on net revenue and $21MM on EBITDA. If we use the trailing 5 quarter hold rate of 23.8%, the benefit on revenues and EBITDA would have been $20MM and $16MM, respectively
- Slot revenue was $1MM below our estimate
- Casino discounts were 15.9% of gaming revenue or $30MM
- Non-gaming revenues were $10MM better than we estimated due to better F&B results
- Total operating expenses of $258MM declined $5MM sequentially and only increased 2% YoY
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“If you can’t convince them, confuse them.”
On the recommendation of my good American friend whose first daughter was born on the 4thof July, I have embarked on reading what my son Jack called the “heavy book” last night – “Truman”, by David McCullough. Whether you are a Republican or Democrat (or neither), you have to love that quote - purely and professionally political.
After Truman’s 2ndterm as President of the United States, there was a French storyteller by the name of Charles de Gaulle who suckered the French people into believing that a deficit spending and currency devaluation strategy was the best way to national prosperity.
De Gaulle became the 18thPresident of France in 1959 and quickly printed a fresh new fiat currency (issued in January of 1960) that was allegedly going to control ze inflation and spur ze economic growth. Sound familiar?
Of course it does.
Professional politicians have been obfuscating facts about their policies to devalue their currency and inflate asset prices for eons. By the time the French franc was flipped for another fresh new fiat (the Euro) in 1999, De Gaulle’s Fiat Fool money was worth just north of 10% of the “value” embedded in it at prevailing market prices of 1960.
Savvy American politicians introduced this political strategy of “Confusing Them” in the 1970s. Like Bush and Obama, both Nixon and Carter had one thing in common – a modern day Ben Bernanke in Arthur Burns (good ole Art was the last US Federal Reserve Chief to attempt to “monetize” the US Debt, fyi).
So from Truman printing US Dollars to finance war (WWII, Korea), to Charles de Gaulle, Richard Nixon, and back again – what have we learned about money printing being a policy to inflate?
Obviously a lot.
And with this sad and pathetic political reality, like they used to say on my favorite Soap Opera while playing Junior Hockey in Canada, “these are the Days of Our Lives.”
Back to the Global Macro Grind…
Yesterday, the US Dollar Index got hammered for a down -1.1% move as Gold was raging to the upside. Meanwhile, La Bernank (changed from The Bernank in the spirit of his 1960s France) got put on the spot by Ron Paul when asked whether “Gold is money”?
Notwithstanding Paul’s marketing challenges in asking concise questions of the Chairman, this one was as simple as simple gets. You can check out La Bernank’s answer to the question on YouTube. Suffice to say, with Gold ripping to a new all-time high in the face of Bernanke Burning The Buck, he didn’t want to tell us he was levered long Gold futures contracts.
Rather than listening to card carrying members of the Keynesian Kingdom attempt to explain what the value of money is, I highly recommend reading Niall Ferguson’s “The Ascent of Money.” Give it 30 years and La Bernank will be remembered by the history of money about as kindly as Arthur Burns has been.
Qu’es ce qui se passe avec Le QG3?
Well, Le Quantitative Guessing Part III caught a bid yesterday as La Bernank opened the door for more of what he’s been doing since becoming the Chairman of the Federal Reserve in 2006 – compromising the credibility of American currency.
After about a 3 hour rally, US stocks got tired of the nonsense and sold off aggressively into the close. Why? The People get it – Le QG1 and Le QG2 = Le Inflation Policy, not La Employment.
Fool me once, fool me twice…
Les Fiat Fools aren’t fooling anyone this week:
- Real-time Inflation (CRB Commodities Index) = UP +1.7% for the week to-date
- Real-time Stock Market Inflation Returns = DOWN -1.9% for the week to date
Since Obama, Geithner, and Bernanke can no longer convince markets that Quantitative Guessing is the best path to long-term American prosperity, the only strategy that remains is to attempt to confuse them.
Good luck with that.
My immediate-term support and resistance ranges for Gold, Oil and the SP500 are now $1536-1592, $96.54-100.03, and 1305-1331, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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