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Conduct Unbecoming

“The amount of money in both these pots may not be enough to solve the problem”
-Alan Greenspan (February 2009)

What has become of American Capitalism when the only thing market pundits and former maestros alike can find as a solution is government handouts?

While I can write depressing books about being as bearish as I was at this time last year, or point fingers and whine about yesterday’s reaction to the US government’s stimulus plan, don’t expect either from me. I am a capitalist, and I will not stoop to this shameless level of manhood. It is unbecoming, irresponsible, and un-American.

Fortunately, I proactively prepared for this final selloff, and had our clients in a recommended 76% cash position going into yesterday’s open. So what? What does that do for me today McCullough? Well… For one, it allows us to stay in the game here – it also provides us the unique opportunity to buy low – and that’s what real American capitalists who have a repeatable investment process have always done. So let’s roll up our sleeves here and be accountable. Blaming Obama for all of this is a loser’s excuse.

Loser? Yes folks, if you haven’t noticed, there are a lot of world class losers out there who are pretending to be fiduciaries of the American economic system. I am tired of hearing their excuses. The time has come to stop putting our country in the hands of their horrendous judgment.

There are plenty of American Capitalists out there who still understand the value of their principles, and trust their counterparty’s handshakes. They don’t need leverage to earn a return, and they certainly would rather roll over into a hole 6 feet under than attempt to socialize the losses associated with their personal mistakes.

Capitalizing individual profits and socializing losses is not the America I want to raise my son in. It’s a pathetic Code of Conduct, and it’s time to stop being charitable to these people who have proven to have behaved willfully blind. Between Rick Wagoner at General Motors asking for another $17B, the government of California looking for $14B, and some billionaire loser by the name of Allen Stanford in Texas committing another $43B Madoff yesterday, we have no reason to trust what was … what was is behind us now… and we have to find the right people who can step up, be accountable, and move this country forward.

If you don’t want to read the rest of my riff, you should probably stop here. On this topic of Code of Conduct, one of our consultants in the field, Dirk Blum, made an important observation this past weekend. Without paraphrasing his words, I’ll give them to you in full. After interviewing a retired US Army Officer, this was what Dirk had to say about his discussion with one of America’s finest:

“It seems like any decision get’s consideration so long as it is legal… at which point the US Army Officer jumped in and said “well that’s why we had conduct unbecoming”.

He was referring to Article 133 of the Uniform Code of Military Justice, which states that: “Any commissioned officer, cadet, or midshipman who is convicted of conduct unbecoming an officer and a gentleman shall be punished as a court-martial may direct.”

The essence of this article is that, only because an officer doesn’t violate any of the other Articles of the UCMJ, that doesn’t mean that he is displaying the conduct expected of a uniform officer of the United States.  You get cute or passive aggressive with another officer, guess what, that’s conduct unbecoming.  You shame the uniform in any way, guess what, that’s conduct unbecoming.

According to a reference to the Navy-Marine Corps Court of Appeals (check the Wikipedia entry), Article 133 refers to an officer and gentleman, because a gentleman is understood to have a duty to avoid dishonest acts, displays of indecency, lawlessness, dealing unfairly, indecorum, injustice, or acts of cruelty.

How many of the executives that we have all gotten to know so well over the past year can truly say that about themselves?”
-Dirk Blum

Now Dirk graduated from Dartmouth, worked in Washington and Baghdad, and now lives in China. He has one of those simple attributes that a lot of Americans appreciate – global perspective. What America has been doing over the course of the last 12 months has been You Tubed by the world, and guess what, we are now ALL accountable for it.

So let’s stop pointing fingers this morning and step up and conduct our respective businesses in a way that is becoming of this great American flag.

Yesterday, I invested 9% of that 76% position I was carrying in US Cash, taking my Asset Allocation Model’s Cash position down to 67%. I bought American and I bought Chinese. On the International Equity side, we now have a 3% position in the Morgan Stanley China Fund (CAF) and a 3% position in Brazil via the EWZ etf. Being a successful American Capitalist in 2009 and beyond will require us to fortify partnerships with foreign buyers. We need to make our handshakes mean something again. That is The New Reality. Protectionism has always been a loser’s game.

With the SP500 closing at its lowest level since the November 2008 capitulation, the US market has yet to make lower lows. My call has been, and continues to be, that we will not close below that 752 low.

I don’t want bailout money. I don’t need a politicized Washington “economist” to tell me what to do with my family’s hard earned capital. All I want is the economic freedom to succeed or fail. My name is Keith R. McCullough, and I am accountable for every call I make.

Best of luck out there today,

Conduct Unbecoming - etfs011809


Regional gaming revenues (excluding new racino markets) only fell 3% in January. A favorable calendar and low gas prices no doubt contributed, but the trend is positive on the margin. As seen in the chart below, comparisons get tougher, but only slightly, until the summer when they ease considerably. Assuming continued depressed gas prices and no further deterioration in the economy, we could actually see some growth in the back of 2009.

Dare I say 2009 consensus estimates are beginning to look reasonable for the first time in over a year? If so, valuations are very attractive for all the regional operators, particularly BYD, PENN, and PNK. Free cash flow yields of 20-40% and EV/EBITDA multiples of 5-6x with numbers one can believe in? Very compelling, indeed.


Louisiana posted a 10% increase in gaming revenues in January, mostly of the same store kind. While an extra Friday and Saturday probably contributed almost half of that gain, the results are very impressive. Low gas prices certainly helped and more than offset any economic weakness associated with plummeting oil prices.

Aside from the weather and calendar impacted September, Louisiana gaming revenues have consistently grown in a range of -5% to +10%, decent enough but outstanding relative to other consumer sectors.

PNK and BYD were the big winners with gaming revenue up 16% each. PNK and BYD generate 72% and 16% of their EBITDA in Louisiana, respectively. PENN’s Baton Rouge property was up 7% but is only a small contributor to PENN’s arsenal.

I like this trend

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At the end of the day ugly fundamentals overruled the “hidden assets” and takeover parts of the long thesis. We called this initially way back in June 2008 (“OEH: IT LOOKS LIKE KOPIN TAN MISSED THE BOAT”) in response to a Barron’s article pumping the stock.

OEH’s dual super voting class stock structure surely disenfranchises shareholders and without a remedy here the focus will be on the fundamentals. As we approach the company’s Q4 earnings release, the following “Youtube” shines the spotlight on some of management’s prognostications from last quarter’s call, provides our thoughts on some of those comments, and also poses some questions for the call.

Management comment 1:
“As I have said, in many areas bookings for 2009 as of the 30th of September are showing signs of stabilizing, with overall bookings for the portfolio already sitting at the same levels as this time last year, despite everything we have seen in the world.”

Our thoughts:
We expect management to drastically revise this assertion. It’s tough to proactively manage one’s business with expectations so far removed from reality.

Management comment 2:
“The impact of the September revenues, coupled with revising our expectation for the fourth quarter, sees us keeping RevPAR guidance in the 6-8% range.”

Our thoughts:
RevPAR likely fell 15-20% in the 4Q08. This is partly due to a 9% decline in the Euro which has been a tailwind for OEH’s RevPAR during the last 2 years.

Management comment 3:
“A simple fact is that some of our properties in the high season achieve a 40% to 50% RevPAR premium on the nearest competitor, therefore pricing, you know, drops in pricing do not come, do not sort of produce immediate returns.”

Our thoughts:
Exactly, that’s why they are in such rough shape. This is a big, big issue for OEH. We're not sure what they can do since reducing the rate from $1200 to $800/ per night is still too rich for most of us that didn’t get a bonus in 2008.

Management comment 4:
“And our focus has been very much and will be very much on preserving cash to enable this company to capitalize on what we believe are investment opportunities that will come its way.”

Our thoughts:
Preserving cash to pay down debt and remaining a going concern should be their priority since RevPAR is taking a nose dive.

Management comment 5:
“In Venice, the Cipriani has seen revenues drop back to 2006 levels as a combination of the weak dollar, the U.S. recession, and the decline in U.K. short break business have hit the city. Some reports show Venice over 30% down in 2008 versus 2007. Similar numbers are coming out of Florence... Our properties are phenomenal properties, well-run, and this winter we continue the works planned at the Cipriani, which will see the property with 16 new suites, adding to the 10 which came online in 2008.

In Italy, we have reduced operating days at all properties next year, thereby compressing demand and reducing variable costs and bookings that are actually stronger by 17%”

Our thoughts:
If demand is down 30% and the company is reducing operating days, why does it make sense to add 26 rooms to the Cipriani? Ok the 10 rooms have already been added but why continue with the 16 other additions?

Management comment 6:
“So what of our current action plans that we have? We have outlined the key items in our press release issued last night. I have implemented significant SG&A reductions, which we currently have quantified in constant dollars at between $20 million and $22 million.”

Our thoughts:
$20-22MM amounts to a whopping 14% reduction in overhead. SG&A has grown 140% from $70MM in 2000 to 169MM in 2007, a CAGR of 13.5%. For the 9 months ended 2008, SG&A grew 14.5%. Not exactly leveraging overhead? With the further erosion of fundamentals, OEH needs to make much more progress here.

Anna Massion

Buying/Covering: SP500 Levels Into The Close...

Finally, the stars have lined up to start investing some of that 76% Cash position we had in our Hedgeye Asset Allocation Model this morning. The US Dollar is up another +1.25% on the day at $87.60, and the gold etf (GLD) is up another +3.1% at $95.46 – I just shorted both the US$ and gold in the Hedgeye Portfolio as a result.

The VIX is putting in an immediate term top at 48.23, trading +12.4% on the day, and the SP500 is effectively oversold anywhere below that dotted green line shown in the chart below at 795.

Keith R. McCullough
CEO & Chief Investment Officer

“You Tubing” David Axelrod on Meet The Press

Below, I have paraphrased (not quoted verbatim, but my best shot using my laptop and DVR recorder) this past weekend’s Meet The Press interview with Obama’s Man, David Axelrod, who was his key strategist throughout the Presidential campaign. Now he’s Senior Advisor to President Obama, and we’re going to hold him to the ‘YouTube’ rules of accountability.

DA: David Axelrod - Senior Advisor to President Obama
DG: David Gregory – Host of NBC’s Meet The Press
KM: Keith McCullough – CIO Research Edge LLC

DG: What will this stimulus plan do to ease the recession, this year?
DA: Well… I think that there will be some immediate activity… you know… let’s understand that this is the worst economic downturn since World War II… so our first mission is to slow the trajectory of it and turn it around… this will help do that – we believe that this will create 3.5M jobs… Ultimately we are going to put people to work doing the work that America needs done in energy, in healthcare, in education, rebuilding our bridges, roads… a lot of those projects are going to begin soon… but let’s be clear, it’s not going to be an overnight turnaround… it took us a long while to get into this mess, it’s going to take us a while to get out of.

KM: Axelrod is already pushing out expectations on the duration of the fix… and trying to insulate the new President’s room for error by using the same Bush fear mongering verbiage of “worst since World War II” – C’mon man, America didn’t hire Obama to make excuses – let’s step up to the plate and show some confidence in your plan.

DG: Will this stimulus plan prevent 10% unemployment?
DA: Well, that’s our hope… there is no doubt that’s what we were looking at, double digit unemployment… this should help put the brakes on that and slow it down.

KM: David, hope is not an economic process. At least say it like you mean it. You definitely did during the Presidential campaign – now it’s time to give Americans something to believe in. Or do you actually believe it?

DG: Mark Zandi at Moody’s Economy.com thinks the stimulus will create only 2.2M jobs by 2010, leaving unemployment hovering around 10% and probably forcing lawmakers to undertake another stimulus plan? Another stimulus plan?
DA: Look, let’s see how this works out… I respect Mr. Zandi, but there are all kinds of analysis by different economists saying different things… we believe the 3-4M number is an accurate number, a good guess… but there are some unknowns here… let’s give this a try.

KM: “Lets see how this works out”… “a good guess”… are you kidding me?

DG: But is it ambitious enough? Other economists like Paul Krugman say the economy is under-producing to the tune of $2.9 trillion dollars?
DA: Well… let’s see how it goes… we think this spending will have a multiplier effect and that ultimately this will pay off… this will break the hard edge of this recession… we believe this stimulus is where it should be, and we want to move forward.

KM: “Lets see how it goes”? and hope and pray that John Maynard Keynes was right – because if his economics aren’t (and Irving Fisher’s are), we’re definitely going to need to have to ask Congress for a whole lot more of them stimulus moneys come summer time… Axelrod does rhetoric – he doesn’t really do math. This is now very clear.

DG: The President said his metric is 4M jobs. If you have benchmarks along the way that are not being achieved, will you go back to Congress and ask for another stimulus?
DA: I am not going to presuppose that David. That’s a hypothetical that I am not going to deal with. We have great confidence in what we are doing here… and that’s the assumption we are making.

KM: I, David Axelrod, do not manage proactively for tail risk. I manage toward the assumptions embedded in a conclusion that I want to see… not all of the risk and scenario analysis stuff… “I am not going to deal” with those…

DG: Government outlays pay out rather slowly… do you run the risk of losing precious ground as the economy worsens day by day?
DA: Look… obviously this is a complex task administering this program… but there are a lot of projects all over this country that are ready to go, that have been vetted and cleared… and we are just waiting for funding that will begin very quickly.

KM: There is a lot of risk in the Axelrod rhetoric of “shovel ready”… it’s something that he is going to be taken to task on – but since his view is that this has all been “vetted”, he probably has nothing to worry about, right?

DG: You wanted this to be a bi-partisan package. It is not… do you think this was principle opposition, or calculated efforts by the Republican Party to rebrand themselves?
DA: I don’t know.. I think they have a point of view… the point of view was expressed in the economic policies of the last 8 years – those economic policies have not worked… that’s one of the reasons why we are in the mess we are in.

KM: Good answer by Axelrod here – this is his go to line, and the one that gave him his position of power. If he said that same line, and had Obama repeat it, for the entire 2008 campaign, how could he lose? He didn’t… but what do we do with that one liner now? Show us the change big man – show us the change we can believe in.

DG: Are you creating more permanent government spending in a debt environment, which is very dangerous for the economy of the US?
DA: Well… I think it’s sort of late in the game for folks to be raising the debt issue after doubling the debt over 8 years… most of this spending is going to be spent very quickly… rebuilding 10,000 schools is going to have a short term and long term benefit… for decades we have been deferring investments in energy, healthcare, education – let’s put people to work doing the work that America needs done…

KM: The work that America really needs done is in Financial Services. I get the politics associated with the Energy, Healthcare, Education platform… that won an election. But now that gas prices are under $2 at the pump, I don’t think it matters like it did then. Why isn’t Obama focused on getting people to rebuild Wall Street?

DG: So the lack of bi-partisanship in this bill is not a major concern to the President?
DA: First of all bi-partisanship isn’t just measured by the number of votes you get… its measured by the dialogue you have…

KM: Now, for a politician… that was a classic answer! Welcome to Washington team Obama – welcome to Washington!

DG: What does this tell you about how to approach your agenda and how you approach Republicans?
DA: Look, we’re faced with an economic emergency here, and were going to have to move forward quickly… there are a range of things that we to have to do because the country is in trouble right now… we want to move deliberately, thoughtfully… but we can’t drag our feet because people are counting on us to act in the face of this crisis…

KM: This is true. But be careful to not manage this reactively, like the Bush Administration did – as the US stock market flails, we will see if you will succumb to the pressures associated with not being popular. Being a populist won’t get you to where you ultimately need to get – move “deliberately, and thoughtfully”, if you can – I agree.

DG: The “buy American” provision… this survived in the package… the President said he didn’t want protectionist measures – what is this?
DA: First of all we want to promote American businesses, we all agree on that… there was language added to that provision that respects our international agreements… the last thing we need is a trade war…

KM: You may not want a trade war, but you are being protectionist… on the margin.

DG: But China and India are excluded?
DA: We believe that it achieves our goals without risking the kind of trade war we can’t afford right now…

KM: You may not want a trade war, but if you exclude the Chinese like this – you will get one…

DG: Was it a mistake for Geithner to issue principles and not specifics?
DA: First of all, I understand Wall Street’s reaction… they would have preferred he wheel barrowed down the center of that room with cash and say were going to take care of all of your problems – that wasn’t a practical answer… he planned to lay out a strategy – the strategy is set, and we believe it will help lead us out of the morass… and were going to fill in the details in the next few weeks…

KM: I like this answer. It’s patient and it, ostensibly, implies they have a proactive plan. Only time will tell if this is a New Reality, or simply rhetoric.

DG: So nationalization of banks is not something you anticipate?
DA: Well, we will do what we need to do… but our long term goal is to have a strong private financial sector…

KM: That didn’t sound like a no to me. I think Obama is going to let more banks fail.

DG: Is the Administration prepared to offer more bailout money to at least 2 of the Big Three (auto)?
DA: Well, of course, we need to see what they come up with this week… one thing is clear, really two… we need an auto industry in this country… but it’s going to require a major restructuring …

KM: They are going to bailout big auto, but not big shareholders or big executive comp of big auto.

DG: Can the economy withstand a bankruptcy at GM?
DA: Well, I am not going to … as I said… were going to need a major restructuring of these companies… it’s going to be something that requires sacrifices not just from the auto workers, but from creditors, from shareholders, and executives who run the companies…

KM: A simple no would have sufficed here… if the other part of the answer is that we are going to have a Big Auto “Czar”, God help us all…

DG: Senator Judd Gregg steps down – what happened here?
DA: He had second thoughts and he withdrew… and we’re going to move on…
KM: Let’s hope that the first 4 weeks of Team Obama was the low point – having second thoughts via tax evasion or guys just not wanting to be on the group hug bus of the new, new Washington DC, is not what voters in this country signed up for.

Keith R. McCullough
CEO & Chief Investment Officer

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