The Fed Remains in the Box

Conclusion: As we anticipated, Chairman Bernanke did not provide an indication that incremental easing is coming in the short term today in his speech in Jackson Hole. Our view is that if it comes, it is likely a 2012 event.


The most focused-on stock market event of the week in Jackson Hole, Wyoming has turned out to be largely a non-event. The text of Chairman Bernanke’s speech was circulated prior to him giving the speech at 10am eastern this morning. We spent time parsing through his comments and there was really no change from his prior public comments. Specifically, Bernanke stated the following this morning about policy duration:


“In particular, in the statement following our meeting earlier this month, we indicated that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. That is, in what the Committee judges to be the most likely scenarios for resource utilization and inflation in the medium term, the target for the federal funds rate would be held at its current low levels for at least two more years.”


Chairman Bernanke went on to say that while the Federal Reserve is willing to “employ its tools as appropriate to promote a stronger economic recovery in a context of price stability”, he stopped short of indicating what form incremental stimulus would take and on what time frame. Thus, the great QE3 waiting game continues.


Our view of incremental easing remains that the Federal Reserve will be in a proverbial box in terms of incremental easing until at least the end of 2011, if not well into 2012. The primary reason for this is simply that the data will not support further easing.


In the chart below, we graph all-items CPI going back three years and highlight when QE1 was announced and then implemented and also highlight when QE2 was hinted and then implemented. The key takeaway is that inflation was running at much lower levels, largely below 1%, when the first two rounds of quantitative easing were implemented. Currently, this measure of inflation is north of 3% and set to remain at that level through the next couple of quarters based our models.


The Fed Remains in the Box - 1


Just as pertinent to Fed decision making is employment data. As the chart below outlines, in the prior two periods of quantitative easing, monthly non-farm payrolls witnessed a substantial and sustained decline of at least three months. As of now, monthly non-farm payrolls are still positive, albeit marginally and the last three months, ending in July, have averaged additions of only 72K. This is a substantial decline from the prior three months, which averaged 215K additions. Nonetheless, history suggests that we would need to see negative payrolls for a sustained period prior to incremental easing being implemented.


The Fed Remains in the Box - 2


Stepping back, the majority of Bernanke’s speech today related to the theme of the actual conference, which is the outlook for the longer term prospects for the U.S. economy. Bernanke spent a good portion of the speech addressing his perspective on both the positives and negatives relating to long term economic growth of the United States. The one area which he flagged as an impediment to the economic prospects was fiscal policy. To quote the Chairman:


“. . . the country would be well served by a better process for making fiscal decisions. The negotiations that took place over the summer disrupted financial markets and probably the economy as well, and similar events in the future could, over time, seriously jeopardize the willingness of investors around the world to hold U.S. financial assets or to make direct investments in job-creating U.S. businesses.”


In part, the negotiations around the debt ceiling have been an issue, but, if anything, they characterize a short term impediment. Longer term is the actual issue of structural deficits and debt. While we aren’t necessarily surprised, it would have been valuable to have Bernanke address these issues head on for what they are: long term impediments to U.S. growth. We have oft quoted Reinhart and Rogoff’s data from, “This Time is Different”, which clearly shows that as nation’s debt-to-GDP accelerates beyond 90%, its future growth slows. In the last chart below, we show this graphically for the Japanese economy.


The Fed Remains in the Box - 3


My colleague Darius Dale wrote a note earlier today discussing monetary policy of Australia. In the note, he quoted Bank of Australia Governor Glenn Stevens who recently noted:


“In terms of macroeconomic ammunition, there would be not that many countries who could say they had more than us in the event of a really big episode.”


We are obviously not big fans of government intervention, but one key risk to consider in a more dire economic scenario, is that the Federal Reserve, unlike Australian counterpart, is largely out of ammo.


Daryl G. Jones

Director of Research

Uncertainty: SP500 Levels, Refreshed

POSITION: Short Financials (XLF)


I accept Uncertainty in my risk management process. Period.


The only thing that I am certain about is where my risk management lines are and that they will change as price, volume, and volatility data does.


I’ve been saying there was a heightening probability of a market drawdown on Fed “expectations” day. That’s all risk management is – understanding which way the uncertainty is tilting and considering heightened or lowered probabilities.


While it looked like the SP500 had an immediate-term shot at making a lower low of 1108 today (when it was down 2% in a straight line post Bernanke not doing QE3), it obviously looks less likely now. That could change in 3 hours. So I’ll just wait and watch.


The long-term TAIL of resistance remains at 1256. Immediate-term TRADE resistance is now 1183. And immediate-term TRADE support moves up 2 points to 1110.


In the Hedgeye Portfolio, I covered our Italy short (EWI) this morning as Europe rallied “off the lows” into the close. That makes the LONG/SHORT positioning pretty much neutral with 10 LONGS and 10 SHORTS, for now…



Keith R. McCullough
Chief Executive Officer


Uncertainty: SP500 Levels, Refreshed - SPX

JCP: Shorting Again


Keith just re-shorted JCP in the Hedgeye virtual portfolio - again here on an up day managing near-term risk around a very high conviction TREND and TAIL short idea with Trade Support at $23.03. There is no change to our thesis on the name, only price.


Please contact  if you would like see our fundamental view on why there is a meaningful duration mismatch between the storytelling on the Street vs. economic reality.


JCP: Shorting Again - JCP Trade Trend 8 26 11



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Two Schools of Thought

Conclusion: Call us dogmatic, but we continue to stand by our belief that currency debasement in the form of deficit spending, debt buildup, and Indefinitely Dovish monetary policy is not supportive of the long-term prosperity of America.


Ahead of the “free” world awaiting word of more Fed “stimulus” out of Jackson Hole, we thought we’d take the time to give you a brief glimpse at what sober and proactive monetary policy looks like.


During three hours of questioning today, Reserve Bank of Australia governor Glenn Stevens had the following to say regarding the RBA’s current monetary policy stance: 

  • “In terms of macroeconomic ammunition, there would be not that many countries who could say they had more than us in the event of a really big episode.”
  •  “If we did see a very dramatic change for the worse in the global economy, certainly we have plenty of interest rates to play with if need be.”
  •  “Our banks are strong, our currency is sound and our sovereign credit position is in the international top tier.”
  • “If we are entering another period of weaker international conditions, this is a pretty good starting point from which to do so.”
  •  “Consumer ‘caution’, while making life hard for the retail sector, is also building resilience in household balance sheets.” 

Australia, which has the developed world’s highest benchmark interest rates at 4.75% (nominal) and 1.15% (real) and is on track to deliver a fiscal surplus in the upcoming fiscal year, has a lot of ammunition left indeed should it need to react to a potential European banking crisis or a prolonged period of slow global growth. Contrast that with the U.S., where both the Fed and Congress are running out of bullets and the last shot fired (QE2) largely resulted in Sticky Stagflation as a result of higher commodity prices.


Two Schools of Thought - 1


Another thought: rather than do all that he can to entice overleveraged Australian consumers (155% of disposable income vs. 133% for U.S. households prior to the financial crisis) to re-lever, Stevens is welcoming and respecting the move up in Australia’s household savings rate, which accelerated to 11.5% in 1Q. This is in stark contrast to the Fed’s official policy stance, which, for the last 3-plus years has been trying aggressively to suspend the gravity that accompanies both the economic cycle and structural changes in the economy.


It’s no secret that we’re fundamentally opposed to Keynesian monetary and fiscal policy. And as the global economy continues to slow, we think the number of people willing to evaluate U.S. monetary and fiscal policy for what it truly is will grow. Whether Republican presidential candidate Rick Perry teams up with Dallas Fed President Richard Fisher and gives the U.S. a Ronald Reagan/Paul Volcker-like shock in 2013 is something we don’t have any edge on at the current moment. It is, however, the biggest risk to anyone buying “cheap” U.S. equities for the “long term” because Heli-Ben told them too.


Darius Dale



ASP’s have been stable despite historically weak demand.



Over the last 5 years, average selling prices (ASP’s) for slots have increased at a healthy clip.  Since 2007, ASP’s for the 4 public suppliers increased 22%. Over the last year though, we’ve seen ASP growth decelerate to about 3%. 


SLOT ASP’S STILL STRONG - slot supplier


The industry also experienced some dramatic shifts in wallet share since 2007 among the ‘Public 4’.   WMS’s wallet share jumped 15% from 19% in 2007 to 34% in 2010 at the expense of BYI, IGT and to a smaller extent, ALL.  During the first half of 2011 we saw some reversal of this trend as WMS was the biggest wallet share donor – losing 3% YoY mostly to BYI and IGT, who each garnered 2% more of operator wallet share.


Despite the big moves down in their stocks following calendar Q2 earnings releases, both WMS and BYI increased their wallet shares this past quarter.  Consistent with our replacement demand analysis, the pricing picture does not seem as dire as the recent stock price performance suggests.




The slot picture is not as ugly as many believe.



Replacement demand is growing nicely.  The problem is that the industry is in a bad stretch for new casinos and expansions.  Next year, the two start to grow at the same time.  Is this the beginning of the long awaited growth phase for slot suppliers?


Now that the numbers for Aristocrat are out, we know how many units and dollars the “big five” manufacturers reaped from this ‘challenged’ market in the first half of 2011.  We estimate these suppliers represent about 95% of total North American slot sales.


Approximately 34k new slots were sold in 1H11, a 3% increase from 1H10.  The vast majority of new slot sales came in the form of replacements – which we estimate accounted for 84% or 28.6k of total slot sales compared to 77% of total slot sales in 1H10.  Replacements increased 13% YoY while sales of new and expansion slots declined 31% YoY.  Based on our research, replacement shipments bottomed out in 2008 at 38k units and have been increasing ever since.  Unfortunately, any growth in replacements has been offset by the absence of new market growth and lack of expansions.  That should change in 2012. 





In the first half of 2011, Konami and IGT gained market share YoY.  BYI’s share market share remained flat YoY, while WMS lost 4 percentage points of share YoY and ALL’s share fell 1% YoY. For 2Q11, BYI, IGT and Konami gained share YoY while ALL and WMS lost share YoY.

  • IGT:  2Q ship share of 28% and 29% in 1H11, compared to 28% and 27% for the same periods in 2010 and better than full year 2010 share of 27%
  • WMS:  2Q ship share of 25% and 23% in 1H11, down from 28% and 26% for the same periods in 2010 and full year 2010 share of 25%.  We believe WMS overshot for a couple of quarters but share around 25% is probably reasonable going forward
  • BYI:  2Q ship share of 18% up from to 17% in 2Q10. 1H11 ship share increased 1% to 15%. 2010 ship share was 15%.  With its new platform, BYI should stabilize in the high teens
  • Konami:  2Q ship share of 9% and 15% in 1H11, up from to 8% and 12% figures for the same periods in 2010. Konami’s 2010 ship share was 13%.
  • ALL:  1H11 market share declined 1% YoY to 11% 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%