CHART OF THE DAY: Questionable Mathematics


CHART OF THE DAY: Questionable Mathematics - Chart of the Day

Questionable Mathematics

“Common sense is not so common.”

-Voltaire (quote used at the end of David Einhorn’s Q2 2011 letter)


This morning has nothing to do with legitimate credit risk in America’s sovereign debt. US Treasuries would be collapsing if it did. Instead, stocks are as Treasuries are making new 2011 highs!


This morning has everything to do with analytical incompetence. If watching the analytically incompetent chastise the analytically incompetent yesterday didn’t remind you that both S&P and the US Government have issues, you need to replay the tapes. The People don’t trust either ratings agencies or governments’ risk management processes anymore. And they shouldn’t.


As outgoing Chairperson of President Obama’s “Council of Economic Advisers”, Austan Goolsbee, told Meet The Press yesterday that S&P had “Questionable Mathematics”, I literally started laughing out loud. This is AFTER the US government revised their Q1 2011 GDP estimate for the US by 81% to the downside to 0.36%!


With all due respect to my fellow Yalie (Goolsbee was Yale 1991), there is nothing to respect about the accuracy of either the US government’s economic forecasts in 2011 or what US Growth Slowing implies for any rating agency that has to impute a massive top line slowdown into its rating. AFTER the top line (revenues) slows, both the sell-side and ratings agencies downgrade – not before. They are THE lagging indicators.


Bloomberg Consensus (78 buy-side and sell-side institutions) forecasts for US GDP Growth in Q3 and Q4 of 2011 are still at +3.2% respectively. Our models continue to point to rates of U.S. economic growth that are HALF, or less, of those consensus estimates.


There is nothing questionable about this math: the US stock market has lost -12% of its value since the end of April for a lot of reasons – but one of the most obvious has been Growth Slowing.


Back to the Global Macro Grind


Why are US Treasuries bid to new all-time highs (all-time is a long time) on the “news” of a rating agency downgrade this morning? That’s simple. This is old news to the analysts who provide Wall Street with leading indicators.


To review the time stamps:

  1. March 5, 2010: Jim Grant issued an effective downgrade of USA’s long-term bonds
  2. May 14, 2010: Hedgeye cites Grant’s work and reiterates the conclusion using Reinhart & Rogoff data to compliment our own
  3. August 3, 2010: Hedgeye holds a conference call titled “Should US Debt Be Rated Junk?”

As recently as July 7th, 2011 in his quarterly client letter, Greenlight Capital’s David Einhorn wrote (on page 3): “Earth to S&P, if you can foresee a near-term default scenario that is plausible enough for you to warn about it, AAA cannot be the correct current rating.”


Einhorn, like Jim Grant, is one of the world’s most competent financial analysts. He has been profiting from the incompetence of ratings agencies and the governments who pay them for years. Einhorn and his clients won’t be freaking out this morning or looking for Bill Miller and Timmy Geithner to throw them some completely conflicted and compromised view of S&P’s work. They’ll be profiting from it.


Tomorrow starts today – so what’s next? Well, let’s start with what AAA not being AAA means for everyone else’s ratings.

  1. It’s now politically palatable to downgrade other AAA rated Sovereigns (France)
  2. Big Bank Ratings that rode USA’s AAA Rating Uplift need to be downgraded

After we moved to ZERO percent US Equity exposure in the Hedgeye Asset Allocation Model last Monday, our Financials guru, Josh Steiner, wrote an important note titled “New Risks For Financials” where he dug into this obvious problem of Big Bank Rating Uplifts:


“There are 8 banks that benefit directly from the United States AAA credit rating through ratings uplifts. They include: BK, STT, BAC, C, WFC, JPM, GS and MS. If the US isn’t AAA, then the implicitly backed Too Big To Fail banks can’t rely on the US’s ratings to get AAA debt themselves.”


Now Steiner has been The Bear on the moneycenter banks and US Housing since this time last year (sorry Meredith Whitney). Hedgeye has shorted Banker of America (BAC) 10x since 2010 in the face of “smart” money buying it on “valuation.”


Well, sorry “smart” money, valuation is not a catalyst.


Neither is a pending downgrade of a bank’s credit rating. Citigroup (our top short idea above and beyond BAC right now, which is saying something!) could see a 2-notch downgrade with the end of these “ratings uplifts”. This will add notably to already existing NIM pressure on Citi’s earnings (NIM = Net Interest Margin).


And when S&P or Moody’s “downgrades” Citigroup, we’ll cover the short position on that “news” too. Timing matters.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1, $84.02-92.03, and 1165-1219, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Questionable Mathematics - Chart of the Day


Questionable Mathematics - Virtual Portfolio


TODAY’S S&P 500 SET-UP - August 8, 2011


Today’s market moves are not about USA’s credit default risk (US Treasuries are pushing toward all-time highs this morn). It’s all about analytical incompetence on Growth Slowing and where “risk” is priced. 


There is no market in the world that is bullish on either the Hedgeye TRADE or TREND duration other than Venezuela; Europig bond buying only creates short-term short covering in Italy/Spain; the intermediate to long-term result of Big Government Intervention looks more like Greece (down 40% now since February!).


As we look at today’s set up for the S&P 500, the range is 54 points or -2.87% downside to 1165 and 1.64% upside to 1219.






THE HEDGEYE DAILY OUTLOOK - daily sector view


THE HEDGEYE DAILY OUTLOOK - global performance




  • ADVANCE/DECLINE LINE: -1503 (+1315)  
  • VOLUME: NYSE 2254.25 (+23.77%)
  • VIX:  32.00 +1.07% YTD PERFORMANCE: +80.28%
  • SPX PUT/CALL RATIO: 2.59 from 2.24 (+15.74%)



TREASURIES – 2s and 10s getting bid up to new highs as yields capitulate to 0.25% and 2.49%, respectively. If you had the USA sovereign “credit risk” trade on, you have to cover your shorts; PIMCO needs to be buying back those Treasuries too.


  • TED SPREAD: 26.65
  • 3-MONTH T-BILL YIELD: 0.01% -0.01%
  • 10-Year: 2.58 from 2.47    
  • YIELD CURVE: 2.30 from 2.20


  • 11 a.m.: Export inspections, corn, soybeans, wheat
  • 11:30 a.m.: U.S. to sell $29b 3-mo., $27b 6-mo. bills
  • 4 p.m.: Crop conditions


  • G-7 finance ministers and central bank governors to “take all necessary measures to support financial stability and growth,’’ they pledge in a statement today
  • S&P’s downgrade of U.S. credit rating leaves France as the AAA country most likely to lose its top grade, some investors and economists say
  • S&P holds 8:45 a.m. conference call to discuss U.S. downgrade
  • Best Buy (BBY) may slide if management can’t figure ways to retake market share from online competitors, Barron’s said



COMMODITIES – nothing new here; we signaled this last week, but it’s critical to remind ourselves that both TREND and TAIL lines for oil and copper have snapped. We call this Deflating The Inflation – in the end, good for global consumers.


THE HEDGEYE DAILY OUTLOOK - daily commodity view




  • Commodity Currencies a Refuge as Intervention Upends Havens
  • Central Bankers Confront Decision on Which Risk Scares Them Most
  • Investors Cut Bullish Commodity Bets in ‘Panic’ on Economy
  • Tokyo Rice Halted After First Futures Trading Since 1939
  • Oil Falls to Trade Near Eight-Month Low as S&P Cuts U.S. Rating
  • Gold Tops $1,700 for First Time as U.S. Rating Cut Spurs Demand
  • Rio, Mitsubishi Bid A$1.49 Billion for Rest of Coal & Allied
  • Gold Futures Surge to Record $1,697.70 on Haven Demand
  • Goldman Raises Gold Forecasts, Keeps Long Recommendation
  • Copper, Zinc Fall as S&P Cuts U.S. Credit Rating; Aluminum Gains
  • Commodities Drop as U.S. Credit-Rating Cut May Worsen Slowdown
  • China Aluminum Prices May Gain on Power Cuts, Chinalco Says
  • Gold May Extend Advance to Record $1,750: Technical Analysis
  • Wheat Falls for Fourth Day as U.S. Rating Cut ‘Spooks’ Markets
  • Commodity-Tied Government Bond Yields Surging: Argentina Credit
  • Copper in London Gains 0.4%, Reversing Decline to Six-Week Low
  • Rio Says Higher Labor Costs, Aussie Dollar Curb Expansion Plans
  • Palm Oil Drops as Commodities Decline on U.S. Rating Downgrade



THE HEDGEYE DAILY OUTLOOK - daily currency view




  • EUROPE: Greece is gone, fyi (market down another 2.6% today; down -40% since FEB); that’s how the storytelling of central planners ends
  • Bank of France Jul business sentiment indicator, industry 98 vs prio 99, services 98 vs prior 99
  • Bank of France estimates Q3 GDP to grow +0.2% (first estimate)
  • Eurozone Aug Sentix (13.5) vs consensus +1.9, prior +5.3

THE HEDGEYE DAILY OUTLOOK - euro performance




  • ASIA: could have been much worse; down 1-4% across board with markets like India rallying intraday, Koreans panicked at the bottom, so down most
  • Japan June current account surplus ¥526.9B vs cons ¥678.3B. June trade balance +¥131.5B, (82.7%) y/y.


 THE HEDGEYE DAILY OUTLOOK - asia performance









Howard Penney

Managing Director

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Employment data that came out on Friday was mixed for the restaurant industry.


The level of employment among 20-24 year olds grew in July, which is a positive data point for the QSR industry, but the level of growth slowed on the margin to 1.4% from 1.5% the month prior.


Much of the positive sentiment from management teams during 2010 and the early part of 2011 was based upon improving job prospects for Americans.  While payrolls did beat expectations on Friday, expectations are not high and the initial jobless claims trend suggests that the unemployment rate is going to remain elevated for the foreseeable future.





As the chart below shows, employment growth in the food service industry continues to be strong.  The data lags the employment by age data by one month.  Given the heightening concerns that have depressed business and consumer confidence (particularly expectations) of late, it will be interesting to see if the hiring data for July shows a slowing in hiring trends in the restaurant industry.





Howard Penney

Managing Director


Rory Green



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



Post Earnings Commentary

July 22: Amendment to Borgata Settlement Agreement

  • “The amendment provides that the mandated sale of the trust property be increased by 18 months to 48 months.  During the first 36 months (or until March 24, 2013), MGM Resorts has the right to direct the trustee to sell the trust property.  If a sale is not concluded by that time, the trustee will be responsible for selling MGM's interest in the Borgata during the following 12-month period.”

June 17: Closing of $300MM in Senior Convertible Notes

  • “Closed the previously announced private offering to Emerging Corporate Limited (an entity owned indirectly by Ms. Pansy Ho) of $300 million in aggregate principal amount of its 4.25% convertible senior notes due 2015.  The Company received approximately $311 million in net proceeds from the offering.  The net proceeds will be used to repay a portion of the Company's outstanding revolving indebtedness under its senior credit facility.” 

June 3: Completion of MGM China IPO

  • “Pansy Ho and MGM China Holdings Limited (SEHK: 2282) today announced the successful completion of the previously announced initial public offering of 760 million shares, representing 20% of the post issuance base capital stock of MGM China, at an offer price of HK$15.34 per share reflecting the top of its previously announced range.”


Youtube from Q1 Conference Call

  • “Convention room nights represented 20% of our room mix in the first quarter. That’s an increase of 5 percentage points year-over-year and the best Convention mix quarter we have had since the first quarter of 2007… For the remainder of this year, we’re pacing ahead of last year in every month in terms of convention bookings.”
  • “Consumer spending is strengthening, and we will take advantage of this through a very strong event calendar that we have throughout the summer and into the second half. We see evidence that consumer spend is in fact strengthening. One metric for example which has been slow to recover has been the revenue-per-occupied room excluding Hotel and Casino, in other words, the Retail, Entertainment and Other type of revenue.”
  • Over the next four months we’re consistently outpacing last year’s rooms on the books. April occupancy end rate, for example, up nicely, driven by strength in those Retail segments. Our event calendar is also improved and it’s up significantly year over year. I think it’s up over double digits in terms of events booked at both the Mandalay Event Center and the MGM Grand Garden.”
  • “Since we launched this program, we have enrolled over one million new customers into our loyalty program… Our regional properties have seen an increase in the number of active players and in terms of trips in the first quarter, led by Beau Rivage, where trips were up approximately 10%. Our gold and platinum levels, our higher level customers, have seen trips up in the double digits indicating people are migrating up the benefit scale and the benefits are compelling.”
  • “On an actual basis, our net revenue was up 3% and our adjusted property EBITDA attributable to our wholly-owned operations was up 12%. Both of these would have been higher, up 6% and 25% respectively, had we held at the midpoint of our normal range. And to remind folks that range is 19% to 23% on our table game hold side. That negatively impacted our wholly-owned EBITDA, adjusted property EBITDA, by approximately $34 million of which over half of that $34 million was attributable to Bellagio alone.”
  • “Excluding resort fees, RevPAR was up 11% in the quarter year-over-year.”
  • “We also received approximately $31 million in distributions from MGM Macau during the first quarter. And just last week, we received a tax refund of $175 million, thereby taking our pro forma liquidity of excess cash and amounts available under our revolver to over $1.1 billion currently.”
  • 2Q11 Guidance:
    • Corporate expense:  $30MM - $35MM
    • Stock compensation expense: $9MM - $10MM
    • Depreciation expense: $150MM - $155MM
    • Gross interest expense:  $265MM - $275MM with no capitalized interest
    • RevPAR: “up in the mid single-digits in the second quarter, and we’re on pace from that standpoint, actually did a little bit better than that in April already”
    • FY2011 Capex of $275MM
    • City Center commentary:
      • “Aria experienced a higher than normal hold percentage for the first quarter, which contributed to EBITDA and had an impact of approximately $13 million”
      • “ We continue to be more efficient with the operations of Aria, which has allowed us to further reduce expenses and improve margins while overall traffic and volumes have sequentially increased each quarter. Additionally, Aria benefited from a favorable property tax adjustment in the first quarter of about $6 million… On an annualized basis, the benefit going forward is going to be about a $17 million benefit annually.”
      • “First quarter Convention business at Aria was extremely strong with over 72,000 room nights. Future bookings continue to be strong. 2011 convention room nights on the books have already surpassed forecasted totals for the year. Convention business for the 2012 year and beyond looks extremely positive as lead volumes and bookings continue to outpace last year and our forecast “
      • As of March 31st, 82% of Crystals’ leasable area was occupied by tenants open for business following the opening of Tag Heuer. Jimmy Choo is scheduled to open this August, and we are in final negotiations with Dolce Gabbana for a men’s and a separate women’s store with an estimated January 2012 opening.”
      • “Cash at CityCenter is approximately $100 million of which $20 million is cage-cash.”


It’s hard to even get excited about the long term with this kind of uncertainty.



WMS’s F4Q left little reason for investors to stay optimistic.  Considering the company’s track record, investors could have looked past one quarter of poor performance and given management the benefit of the doubt.  However, two quarters in a row of pitiful results and lots of excuses extinguish confidence in even the most bullish of analysts.  As we sat and listened to the call last night, we couldn’t help but shake our heads and ask - why is Gamache trying to sell us junk in a box?


There were so many things wrong with the quarter, that we don’t know quite where to begin.  One thing that became clear though is that WMS is now a ‘turnaround’ company and will remain in the penalty box for many a quarter to come.  While the March quarter was filled with operational issues, management’s forward outlook took a major step down.  Management claims that more uncertainty in the economy vs 3 months ago is driving the outlook and we at Hedgeye do not disagree with their macro assessment.  However, WMS probably had a “come to Jesus” moment that they have little to no visibility in their business – due to the economy, heightened competition and worse ship share - but also maybe to a disconnect to what their customers wanted.  Was WMS was pushing junk in the box to their customers as well?  


We’re going to be revising our estimates for the FY12, but below are some thoughts following a conversation with management.

  • Color on the write downs and impairments in the Q and to come:
    • Product sales:
      • Orion was the unit that produced the Helios platform – which wasn’t selling. Customers prefer the higher priced xD machines than the cheaper Helios platform.
      • The original plan was to wind-down the BB1 cabinet over a few years but now they have decided to accelerate that wind-down
      • Impairments represent the layoff in work force of these two product lines and remaining inventory
    • R&D:
      • Postponed many projects which led to a write down
    • Gaming operations:
      • The write down was on licenses which largely had to do with postponed R&D and delays in release.
  • Lease business:
    • Units are basically being leased based on the present value of selling price plus some nice financing rate.
    • They will look to do more of these deals if they can expand floor share vs. doing a straight sale and if the ‘economics’ make sense… yes, they are essentially just doing more financing for customers and deferring revenues.
    • Italy:
      • Italy has been a big disappointment.  Novamatica is the competitor that they referred to as ‘mucking’ things up for everyone else.  Regulators aren’t happy with the integrity of the games and therefore, they are continuously tied up in the retesting phases which is holding up the approval of their games and likely those of BYI’s games.
    • Used game sales and lower margins?
      • All of the used games are basically received as trade-ins which count as a reduction towards new purchases for customers.  A year ago, they were making 20-25% margins; now only 10-15% on trade-in re-sales.
      • WMS claims that they aren’t giving more discounts to their customers but rather that the resale value for used machines has declined since the market is ‘flooded’ with them.  Regardless of the excuse, WMS is eating the lower margin – so this is just another form of discounting… hence, their ability to keep high ASPs.
    • They will likely sell less international units next year. 
    • Their view of the NA market is clearly more bearish than ours.  We feel that some of that may be conservatism, but a lot of it is share losses and more deals that will come in the form of leases rather than sales
    • Other game operations should be flat sequentially and then begin to grow. The growth will come from :
      • Annual royalty payments that just come in at year end
      • Online Casino
      • Network gaming – portal applications
      • Operating leases – Seminole was place at the end of the quarter but was a very small contributor given the timing of installation
    • Reasons for delays in the gaming operations titles:
      • They put too much network functionality into too much of their product line and as a result, have had too many reworks and approval delays.  Expect 2 more quarters of declines in their install base.
    • We estimate that flooding caused almost a $1/day decline in average daily yields this quarter

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