Conclusion: This market is as cheap as consensus wants it to be – if you use the wrong forward EPS assumptions.


Position: Zero Percent US Equity Allocation.


When stocks get tagged like they are today, the fall back for equity investors is to point to valuation as a reason to remain positive on the outlook for equities.  While this can have credence at times, whether equities are truly a good value depends on the reliability of the forward earnings projection.


Currently, the S&P500 is broken from across all three of our key risk management durations, which is confirming our fundamental call for Growth Slowing on an intermediate-term basis. Although it is now morphing into consensus, we have held this contrarian view since the start of the year and both our bottom-up macro models and our top-down quantitative models continue to validate this conclusion.


Speaking to 2H11 specifically, Bloomberg Consensus (78 buy-side and sell-side institutions) forecasts for 3Q11 and 4Q11 GDP growth are still at +3.2% apiece on a QoQ SAAR basis. Our models continue to point to rates of U.S. economic growth that are half, or less, of those consensus estimates. We expect the consensus forecasts to once again be revised down intra-quarter, but to likely still be too high when it’s all said and done. If 1Q11 and 2Q11 have taught us anything about the merits of consensus growth forecasts, it’s that they are not to be trusted.








Perhaps the largest problem with consensus growth forecasts is that they are trusted. Be it corporations in their inventory planning, entrepreneurs in their plans to start businesses, consumers in their plans to lever up or spend, or bottom-up/fundamental equity investors in their EPS models, consensus estimates for U.S. GDP are pervasive throughout our economy. Given this construct, the biggest risk to this market and the U.S. economy at large remains that consensus assumptions for U.S. (and global) economic growth could continue to be way off the mark.


What if 2012 U.S. GDP growth is not in the area code of the +3% YoY rate currently forecasted by Bloomberg consensus? What if consensus’ +3.2% YoY assumption for 2013 U.S. GDP growth is equally as far off as their +3.2% YoY assumption for 2011 GDP growth has been? We would submit this scenario analysis would materially adjust the 2012 and 2013 EPS targets embedded in many bottom-up company models to the downside.




We’ve been vocal YTD on our call that the Street’s earnings assumptions are simply too rich.  With an S&P 500 NTM EPS forecast $99.73, consensus is clearly expecting a rebound in U.S. economic growth in their current modeling assumptions. We arrive at this conclusion based upon the conviction we have in our call for historically overstretched U.S. corporate margins to compress on a go-forward basis. Simply put, if margins are compressing, a company needs topline growth to outpace the rate at which its operating performance is deteriorating in order to drive earnings growth. We do not see that happening. 




In fact, slowing or declining GDP growth can lead to dramatically decelerating earnings. In the last decade we have seen this in spades as noted by the -21.5% decline in SP500 TTM earnings from March '01 through June '02 and -44.0% decline in S&P 500 earnings from September '07 through September '09. Going back the last thirty years, there have been five periods in which earnings for the S&P 500 broadly have declined.  On average, the decline has been a peak-to-trough decline of -25%.  In a scenario analysis where we assume we are entering a period in which earnings are on decline and they decline by the average of the five declining periods over the last thirty years, the implied earnings of the S&P 500 over the next twelve months is ~$74.79.  Based on the current price of the S&P 500, this is a ~16.2x earnings multiple.  Not exactly cheap.


With U.S. debt/GDP at 91.6% per the IMF (2010), we’d contend that consensus estimates for U.S. GDP growth over the next 2-3 years are as pollyanish as the Congressional Budget Office’s +2.9% average projected GDP growth over the next decade. Not only is the long-term trend of U.S. GDP growth over the last ten years far below that at +1.7% YoY, our 18-month-old work on the Sovereign Debt Dichotomy leads us to believe that U.S. economic growth may be more structurally impaired than not (email us for the relevant presentation materials).




Given the price action in the S&P 500, with the index crashing through its former long-term TAIL line of support (now resistance), we think the quantitative setup of this market is telling you that the above scenario analysis is now in play. Obviously Big Government Intervention in the form of additional easing out of the Fed could stand to limit any potential downside, but we’d be remiss to blindly trust our client’s hard-earned capital in the hands of the Central Planning Elite.




At a point, we think no amount of Quantitative Guessing will be powerful enough to overcome the likelihood that consensus (both buy-side and sell-side) has their 2011-13 EPS assumptions substantially off the mark. Again, the market can look as cheap as consensus wants it to look if they remain content with using the wrong denominator in their valuation studies.


Net-net, we need to do more work before explicitly making the call that both economic and earnings growth are going to come in substantially lighter than expected over the next couple of years, but, as market prices are signaling, it is a realistic possibility. And should that be the case, we’d expect the market to pay a lower multiple for that – QG3 or not.


Darius Dale



Expectations are for a miss and we would have to agree.  With sentiment where it is, there may not be much of a reaction.



We expect that Genting Singapore will miss the mark on both revenues and EBITDA when they report their 2Q results on August 12th.  MBS likely gained significant share in Q2.  Here is the detail.


2Q Detail

We estimate that Genting will report net revenue of S$737MM and EBITDA of S$368MM.

  • S$615MM of gaming revenue, net of rebates and Goods & Services Tax
    • We estimate that total market Gross Gaming Revenues (GGR) will be down QoQ and that RWS market share slipped significantly in the quarter.  In 1Q11, RWS market share benefited from high hold, which makes this quarter’s comparison difficult out of the box.
    • Slot win of S$132MM
      • Slot handle of S$1.9BN (39% market share) and average win per day of S$1k
  • Mass win of S$224MM down 25% QoQ due to 12% QoQ decline in drop and a difficult sequential hold comparison.
    • Drop of S$1,226MM (47% market share – in-line with the last 2 quarters) – mass drop has been fairly stagnant since 2Q10 when MBS opened.
    • Hold of 18.3%
  • VIP gross win of S$574MM and net win of S$282MM
    • RC volume of S$20.1BN (57% market share vs 59% in 1Q11; up 22% YoY)
    • 2.85% hold
    • 1.35% rebate rate
    • $121.5MM of non-gaming revenue, up 11% QoQ
      • S$27MM of room revenue and F&B  and other equal to 100% of room revenue
        • RevPAR: S$231
  • USS revenue of S$67MM
    • 8.5k daily visitors
    • S$86.5 spend per visitor
    • S$370MM of total operating expenses compared to S$376MM in 1Q11
      • S$80M of gaming taxes – down S$16MM sequentially
      • S$289MM of fixed and other expenses compared to S$280MM in 1Q11


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Drawdown Risk: SP500 Levels, Refreshed

POSITION: no position SPY


It’s getting a little gnarly out there now – as it should now that the SP500’s long-term TAIL line of support has been broken. So far, the April peak-to-today drawdown has been right around 10%. At my immediate-term TRADE line of support (1219) it will be -10.6%.


As a reminder, across all 3 of our core investment durations (TRADE/TREND/TAIL), the SP500 is now broken/bearish: 

  1. TRADE and TAIL resistance = 1256
  2. TREND resistance = 1319
  3. TRADE support = 1219 

When the TAILs in my model break, that’s really bad. I see zero irony in the SP500 and WTIC Oil having broken their TAILs this week in the face of a TREND line breakout in the US Dollar Index ($74.69 = TREND line support).


When the TAILs are broken, it’s critical to remember that’s an explicit signal of a heightening probability of lower-lows in the coming days and weeks (i.e. I’ll be giving you a lower-low of support than 1219 next week).


The entire global marketplace is highly correlated on an inverse basis to the US Dollar Index. If you get the US Dollar right, you’ll get a lot of other things right.


I actually just sold my long US Dollar position and covered some shorts. At 1219, I’d do more short covering. Then, on any rally back towards 1256, I’m a seller again.


Keep moving out there,



Keith R. McCullough
Chief Executive Officer


Drawdown Risk: SP500 Levels, Refreshed - SPX

Pick Your Poison


Pick your poison.


There were definitely some interesting call outs from this mornings sales reports. The biggest is that true underlying demand is far less variable than the spreads between beats and misses would otherwise suggest.


The point is that the majority of companies that beat on the sales line did so at the expense of margins. Those that missed sales big (GPS, KSS) kept margins in the stratosphere.  There was not much in between.


What does all this mean?


As for the month, we'd characterize this as an in-line month relative to expectatons with 14 companies coming in better than expected compared to 8 misses, with a slight deceleration in overall spending. That said, at better margin rates, the flow through impact to the companies made up the slack.


One consideration is that Retailers have been touting the 'sell less at higher prices' theme for the better part of nine months.


They're selling now what they ordered 6-9 months ago when they hunkered down on their unit deflation cause.  Thats when cotton was over $2 and there was nothing but fear in their eyes.


Now fast forward, and in 2H the industry starts to sell the goods they ordered at 20%+ higher prices, which is something that will last for 9-12 months. That is the crux of our '4.5 below' call as this cost pressure will start the domino effect causing companies to react irrationally as their supply chain partners and competitors chase incrementally over margin dollars.


And another thing...we all know how these retailers think...'Hey, if I can sell a thousand shirts at $11 instead of $10, next season I bet I can sell 2,000 shirts at the same price.'. Add on the fact that cotton has dropped by a buck, and this will almost certainly add to their confidence.


The point here is that these numbers reported are 1H. That's water under the bridge. It's time to look forward. The market is not. We maintain our negative view on the space.


Shorts: JCP, JCP, and JCP. HBI, GIL, COH



Pick Your Poison - SSS Total 8 11


Pick Your Poison - SSS 1yr 8 11


Pick Your Poison - SSS 2yr 8 11





In preparation for WMS's Q2 earnings release tomorrow, we’ve put together the pertinent forward looking commentary from WMS’s Q1 earnings call and subsequent conferences/releases.


  • “The $8 million of orders were not canceled but they shipped in early April rather than by March 31st. Our production and distribution teams were simply unable to fulfill these orders in time as they were received after our normal cut-off dates which created challenges and stresses related to logistics of an already compressed order fulfillment period.”
    • This implies 450-500 units at WMS’s average ASP that were pushed into 4Q
  • “As we look forward over the next 12 to 24-months, WMS is planning new product introductions that we believe could be game changers and thus we would begin to monetize the potential value we’ve created through investments, intellectual property and R&D initiatives during the past several years. These include the expected launch of our portal applications and other network solutions, the introduction of our first participation games to be powered by our third generation operating systems CPU-NXT 3, and new category creating form factors yet to be announced”
  • “We expect that the further roll-out of these products and the approval of additional new products  in the June quarter will help us improve gaming operations momentum”
  • “Today we reiterated our revenue guidance of $210 million to $220 million for the June 2011 quarter. And with expectations for an improvement in product sales margin further strengthening of growth in gaming operations and our focus on cost containment, we expect operating margins will improve on a quarterly sequential basis to a range of 22% to 23.5%.”
  • “Initial outlook for fiscal 2012 to be consistent with the growth level achieved in fiscal years 2009, 2010 and 2011. We are still in the midst of our budgeting process, but we expect annual growth of 3% to 7% to be driven by continued market share penetration, especially in international markets, stronger new casino openings and expansion opportunities domestically and internationally, growing revenues from new networked gaming and online gaming products and services and increased participation revenues. Our operating margin guidance range of 21% to 22% anticipates improvements in product sales margin and operating expense growth at a rate less than our revenue growth”
  • “We now have received GLI approval on our core WAGENET system including remote configuration and download functionality and Jackpot Explosion. This now allows us to begin the commercial launch into Native American casinos, in California initially, and then expand to other travel casinos as well as certain riverboat and other commercial casino jurisdictions as secondary approvals for those jurisdictions are received.”
  • “In our for-sale business, we’re also beginning to break through the regulatory logjam. During the last 90 days, we’ve launched multiple new game themes in our G+ deluxe series and launched our first themes in a new line of Real Boost games, which is part of our innovation series of products. While still early in their rollout, these games are amongst the best performing games we have ever commercialized.”
  • Q: “What kind of ship share assumptions do you have for the fiscal 4Q and for fiscal 2012?
    • A: “I would say in a high 20s to the 30% range”
  • “We have modeled our guidance today on flat demand for fiscal ‘12, replacement demand.”
  • “I don’t think pricing really entered into our issues in Q3. Pricing comes up every now and again. It didn’t use to come up hardly at all. It comes up a little bit more frequently now but we still believe that we have pricing leverage and if our content continues to perform at the levels of the G+ Deluxe and the Real Boost product, we’re not going to continue to see pricing as an issue.”
  • 2012 guidance: “No, we’re not counting on any new markets. I believe there might be a little bit of Italy in there but I think that for the most part we’re not assuming any new market openings. It’s really flat demand and us continuing to drive penetration internationally and domestically as well as our gaming operations business and margin improvement. That’s where you’re going to see the up ticks.”
  • “Battle Stations, we got the Pirate Battle and we have Leprechaun’s Gold that have essentially moved from Q2 and Q3 in our original fiscal ‘11 planning into Q4, Q1 and Q2. So, you’re going to see the games that we launched in Q3 are going to help suffice through Q4 and the games we’re launching in Q4 are going to help build our footprints slightly and our average win per day should see a nice up tick over the next couple of quarters. So, you are going to see some accretion in the footprint and the rate over the next call it two quarters.”
  • 2012 growth will come from:
    • Greater market penetration [internationally] …margin improvement, ASP and Network gaming,… online revenues”

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