“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter.  But now I would like to come back as the bond market.  You can intimidate everybody”.

-James Carville


Markets are intimidating and they don’t wait for anyone. Nor do they owe anyone a return, as Keith likes to say.   


When James Carville made the above quote, he was referencing the melt up in 10-year yields in the early stages of Bill Clinton’s first term as president.  Bond investors, at the time, were concerned about federal spending.  Subsequent efforts by the Clinton administration to control the deficit, which helped to strengthen the dollar, led to the bond investors’ fears being assuaged: yields trended lower and stocks surged, for the most part, during the remainder of Clinton’s stint as Commander in Chief. 


Markets are at least as intimidating today as they were in the early 1990’s, when real-time prices forced the government to sober up.  In the age of social media, where information is more accessible than ever, anyone can be a part of the debate.  In general, I would argue, this is good for the country as it allows a broader range of views to be heard by a broader range of people.  Popular consensus, in a way, is changing on a tick like real-time market prices, thanks to the democratization of information.  For the political players in Washington, this is intimidating.


Although real-time communication is becoming the norm, certain members of the financial community will likely resist that move and, like others before them across industries that have resisted positive change, they will be left behind.  The Federal Reserve’s inability to prop up equity prices in perpetuity has set alarm bells ringing in Washington this year as Hedgeye’s call for Jobless Stagflation, induced by ineffective Keynesian policies, has manifested itself.  For now, it appears that policy-makers are sticking to their guns, but to the extent that real-time prices and economic data continue to weigh on sentiment, the time for the incumbent players to act could be limited.


Despite Charles Evans’ best attempts, yesterday on CNBC he ignored the fact that markets discount future events (like the cessation of QE), and equity markets have declined globally on expectations that the global economy is slowing.  In the U.S., the primary source of pessimism (and ultimately the primary potential for renewed growth) is the consumer.  Despite trillions of dollars of government spending, consumer’s expectations for an improved economy have not changed significantly over the past three years.   


Yesterday’s bomb of a consumer confidence number from the Conference Board came as no surprise to anyone.  In an effort to look for a positive in what was a decidedly negative report, the stat that stood out the most to me was that more than half of consumers expect the stock market to be lower in a year, the first time that has been true since March 2009.  However, this is not March 2009, this is 2011.


In my view, there are four primary ailments that need to be addressed for a consumer recovery to take place.


(1)    The political machine in Washington, D.C. is broken.


This one is obvious.  The debt and deficit debate put the spot light on everything that is wrong with Washington politics.  Dylan Ratigan recently expressed the frustration many Americans are feeling during his rant on MSNBC during which he accused legislators of being “bought”.  Howard Schultz, the CEO of Starbucks, seemingly agrees as he is encouraging business leaders to just say no and stop funding the madness via political donations.  Ratigan, for his part, has shown no mercy for either side of the aisle.  During his now famous rant, Ratigan accused Democrats of “kicking the can down the road until 2017” and “screwing” future generations by not offering long-term solutions for extractions from the economy.  Turning to Republicans, he stated that they simply want to “burn the place down” and pursue a negative agenda.


(2)    Perpetually low rates is killing confidence


Easy money creates bubbles which have a severe impact on consumer confidence given that consumers are usually the last to the party.


(3)    The Keynesian policies of the FED is slowing GDP growth


Quantitative Easing is inflationary!  While Mr. Evans was on CNBC, refusing to admit that QE2 was inflationary, it was obvious that he was ignoring inconvenient facts while admitting only those that suited his stance.  Markets are discounting mechanisms and hinge on expectations; the longer-term view of QE2 is highly conclusive; the result was a weakened dollar and a 29% surge in the CRB index over the past twelve months.  Stagflation is back and it is scaring the public.


(4)    The Government inflates the data to build up expectations only to be shot down with constant downward revisions


The most glaring example of this is seen in the BEA's use of "deflators." The BEA is telling us that they believe that inflation over the prior two quarters has been running at annualized rates of 2.5% and 2.7% respectively and the annualized inflation rate for the prior four quarters was just barely over 2%.  You tell me!!  Is it really plausible that over the last 12 months we saw net inflation of barely over 2%? 


On Monday, the government reported that personal spending increased 0.8% in July.  This was a 100 basis point improvement from the month prior.  Consumption is accelerating despite numerous headwinds.  I have become very cynical about government data and it does require a leap of faith to assume that the government has accurately captured what is happening in the real economy.


Despite a significant downturn in equity prices during August, the S&P 500 is now 10% “off the lows” into month-end.  The market faces a difficult macro calendar in September including another attempt from the Obama administration to jump-start the economy.  One thing Obama knows is that markets are ready-and-able to tell him if he is not doing the right thing.  Coming up to the election, the incumbent president needs a win, but solutions to the problem of Jobless Stagflation and ideological dogma in Washington, D.C. are what the market of popular consensus is demanding. 


Function in disaster; finish in style,

Howard Penney





The Club

This note was originally published at 8am on August 26, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Stop fighting us and play ball.”

-The Club (1998)


I am writing this morning’s Early Look from my favorite place on earth – from my office on Lake Superior.


There are no central planners here. There are no Keynesians. There is no one who can even attempt to give me a wink and a nod as to what today’s speech from the Almighty Federal Reserve Chairman may bring…


And I like that. I don’t ever aspire to ever be in the area code of The Washington/Wall Street Club.


Any pro who has played this game for real knows what The Club is all about. It can make you laugh. It can make you cry. It’s where a good ole boy by the name of Warren Buffett gets his wheels greased. It’s where former Fed Heads whisper sweet nothings into privileged ears. It’s where the heart of most of America’s leadership and credibility problems in global financial markets resides.


The aforementioned quote comes from a Complexity Theorist by the name of Martin A. Armstrong. Like me, he has his own models that include fractal math. Like me, his macro forecasts are better than the government’s. Unlike me, he went to jail.


Whether or not he was innocent of alleged Japanese bond fraud isn’t the point of this morning’s note. The point is about The Club. If you’ve studied economic history as closely as I have, you’ll at a bare minimum respect not only the generational contributions Armstrong has made to the risk management field, but also his tabulation of the history of The Club’s market manipulations.


“On February 4th, 1998, Warren E. Buffett was forced to come out and state that he purchased in London $910 million worth of silver. Buffett added: “Berkshire has no knowledge of the actions or positions of any other market participant…” (Martin A. Armstrong)


Right Mr. Buffett. You and Mr. Sokol never know anything about nothing. Right.


According to Armstrong, after the Buffett disclosure, the then journalistically relevant WSJ called demanding an answer: “How did you know”? (as in how did you know the large premium price paid for Silver in London instead of buying it cheaper in New York during the silver panic was Buffett’s order before it was news?). Armstrong replied, “It was my job to know!”


Indeed, Mr. Armstrong. Indeed. It is our job to know that someone always knows something.


Who knew Warren Buffett was going to get another sweetheart deal on Bank of America before it was announced yesterday morning? Was the stock up +11% the day prior on huge volume by happenstance? Or did someone in The Club know?


If you didn’t know this is how Old Wall Street operates, now you know…


Back to the Global Macro Grind


Despite Buffett making an investment that puts him in a preferred position ahead of every single common stock holder in BAC, the US Financials ETF (XLF) closed down on the day yesterday. For 2011 YTD, the Financials are now down -20.63%. Since their YTD hopeful highs established in February 2011, the Financials have once again crashed (down -26.1% since FEB 17).


If you were carrying some orange jump suit risk into the day (long the Financials on the pending “news” at the open), you couldn’t have been happy with the day’s ultimate outcome. I guess The Club’s perpetually preferred returns aren’t what they used to be.


Ahead of The Club’s next move in Jackson Hole today, here are some other globally interconnected realities associated with a global market place that doesn’t trade on what Joe Kennedy’s friends know anymore:

  1. US stocks (SP500) = down -15.0% since Bernanke’s 1stever Global Press Conference on Money Printing (April 2011)
  2. German stocks (DAX) = down hard this morning (-1.8%) and continue to crash (down -27% since late April)
  3. Greek stocks (Athex Index) = gone – down another -1.2% this morning and down -48% from their 2011 high
  4. UK Stagflation = reported this morning with Q211 GDP growth only 0.7% y/y and headline inflation running at +4.4% y/y
  5. US Stagflation = to be reported at 830AM EST (ie GDP somewhere around 1%, but subject to 81% downside revisions)
  6. Gold = rallies, big time, off of the Hedgeye TRADE line of support that we gave you yesterday ($1705/oz)

To a large extent, Gold’s 2011 performance reflects a repudiation of Keynesian Economics. The Club’s heavy hand of Big Government Intervention in financial markets is running out of bullets.


The People of the United States of America don’t like ZERO percent interest rates of return on their hard earning savings accounts inasmuch as they don’t like being gamed by an old man giving Bank of America a buzz from his bathtub.


Americans want Transparency, Accountability, and Trust.


Armstrong’s open attacks on The Club probably have something to do with him being put in the slammer. So I better end my morning missive here today or plan on being in Thunder Bay, Ontario for an extended stay.


Armstrong’s view is that “the Crash of 2007 has been an accumulation of this trend that finds coordinated trading to seek that guaranteed perfect riskless trade with political backing…”


Before we get all warmed up by Buffett’s storytelling that Bank of America has a “great management team” and whatever else he had to say yesterday to get printed on his preferreds – just remember Buffett’s #1 reason for buying the same preferred stock position in Goldman Sachs in 2008. He said it was because he knew his old boys in Washington would bail them out.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1705-1811, $81.21-85.20, and 1107-1182, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The Club - Chart of the Day


The Club - Virtual Portfolio




TODAY’S S&P 500 SET-UP - August 31, 2011


Despite a significant downturn in equity prices during August, the S&P 500 is now 10% “off the lows” into month-end.  The market faces a difficult macro calendar in September including another attempt from the Obama administration to jump-start the economy.  As we look at today’s set up for the S&P 500, the range is 62 points or -3.95% downside to 1165 and 1.16% upside to 1227.











  • ADVANCE/DECLINE LINE: +762 (-1722)  
  • VOLUME: NYSE 1017.24 (+11.51%)
  • VIX:  32.89 +1.89% YTD PERFORMANCE: +85.30%
  • SPX PUT/CALL RATIO: 1.84 from 2.26 -18.61%


  • TED SPREAD: 32.05
  • 3-MONTH T-BILL YIELD: 0.01% -0.01%
  • 10-Year: 2.19 from 2.28    
  • YIELD CURVE: 1.99 from 2.08

MACRO DATA POINTS (Bloomberg Estimates):

  • 7 a.m.: MBA Mortgage Applications, prior (-2.4%)
  • 7:30 a.m.: Challenger Job Cuts, prior 59.4%
  • 8:15 a.m.: ADP Employment, est. 100k, prior 114k
  • 9:45 a.m.: Chicago Purchasing, est. 53.3, prior 58.8
  • 10 a.m.: Factory orders, est. 2%, prior (-0.8%)
  • 10 a.m.: NAPM Milwaukee, est. 52.7, prior 57.6
  • 10:30 a.m.: DoE inventories
  • 12:30 p.m.: Fed’s Lockhart speaks on economy in Lafayette, La.



  • Tropical Storm Katia may become hurricane later today, National Hurricane Center says; path uncertain
  • Lions Gate (LGF): Carl Icahn agreed to sell his Lions Gate shares for $7 each to end battle for control over the studio. Parties agreed to end all litigation






  • Containers Slump to 50-Year Low as Sales Slow: Freight Markets
  • Mongolia Said to Plan Three-City IPO for Tolgoi Next Year
  • Oil Heads for Monthly Decline as Slower Growth Curbs Demand
  • Coal Discount Shrinking in Asia on Japan Rebound: Energy Markets
  • Copper Set for First Monthly Drop in Three on Growth Concern
  •  Colombia Raises Gold Reserves by 2.3 Tons in July, IMF Data Show
  •  Oil at 4-Week High as Stimulus Speculation Counters Supply Gain
  •  Chan Exits Sino-Forest 22 Years After Tiananmen ‘Nightmare’
  •  Oil Rises to Highest Level in Almost Four Weeks as Fuels Climb
  •  Vietnam Coffee Said to Be Trading at Discount on Record Harvest
  •  U.S. Natural Gas Output Rises to Highest Since January 2005
  •  Gold Rises in New York on Expectations Fed Will Continue to Ease
  •  Sugar to Drop as Europe, India Boost Supplies, Kingsman Says
  •  Commodity Shipping Costs Fall as China Ore Stockpiles at Record
  •  Coffee Rallies as World Supply May Tighten; Cocoa, Sugar Decline
  •  Rubber Drops From Three-Week High on Concern Economy to Slow
  •  Wheat Drops on Speculation Demand for U.S. Exports May Shrink
  •  Copper Rises to Three-Week High on U.S. Economic-Growth Outlook.






  • Germany Jul retail sales (1.6%) y/y vs consensus (1.9%), prior revised (2.1%) from (1.0%)
  • Germany Aug unemployment change (8K) vs consensus (10K), unemployment rate +7.0% vs consensus +7.0%
  • Greece is burning down 4%





  • Most Asian markets traded higher this morning despite weak US consumer confidence; China’s performance  was uninspiring +0.03%







Howard Penney

Managing Director

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.


Galaxy delivers another record quarter and exceeds expectations.




  • Group Adjusted EBITDA of HK$1.1BN in 2Q11, up 93% YoY
  • Starworld Adjusted EBITDA of HK$685MM in 2Q11
    • VIP RC HK$158BN
    • LTM ROI: 74%
    • Occupancy 98% in 2Q
    • 24% US GAAP EBITDA Margins
  • Galaxy Macau Adjusted EBITDA of HK$376MM and revenues of HK$2.4BN for the first 47 days of operation
    • Property is continuing to ramp with the opening of new product openings
    • Occupancy of 88% and finished the month of June with 92% occupancy
    • US GAAP EBITDA margins of 22%
    • VIP RC: HK$50BN, Net win HK$1.78BN, win % of 3.5%
    • Mass drop: HK$2.4BN, Net win: HK$410MM, hold %: 17.5%
    • Slot Handle: HK$1.8BN, Net win: HK$114MM, hokd %: 6.3%
  • Construction materials Adjusted EBITDA of HK$178MM for H11
  • Cash: HK$6.7BN (including HK$1.6BN of restricted cash)



  •  Demand for construction materials increased due to the increase of infrastructure projects in the China
  • Galaxy Macau is exceeding the targeted daily visitation of 30,000
    • Opened 3 additional VIP in 3Q11 for a total of 10 rooms
  • Starworld continues to focus on cost control and improvement of operating efficiencies
  • City Clubs: $49MM of EBITDA in 2Q


  • Mass business at GM is ramping up. They are tweaking the offering at the property.  Have 72 shuttle programs. Have an aggressive database sign up program. See growth in their Mass revenue each and every week and are confident that they will get their fair share.
  • Slowdown of VIP in Macau? Not seeing any - July was off to a great start and August is going to be just as strong and are confident that market growth will exceed 30% for the 2011
  • Non-gaming revenue mix at GM is similar to other properties in the market
  • Galaxy Macau premium direct is a growing segment for them but they are much more weighted towards junkets
  • Mass hold should increase at GM as volumes ramp and dealers become more efficient
  • Timing of the additional 800 rooms at GM - right now they are just under 2,000 rooms in operation and hope to have all the rooms open by Golden Week in Oct / no later than 4Q
  • Pre-opening expenses were all GM related
  • Capacity for 600 tables at GM - opened with about 450 and that's where they are now - they will try to optimize the mix. 1/3 VIP  and 2/3 Mass mix.
  • City Clubs and Construction Materials are core holdings for them
  • Thoughts on their market share once Sands Cotai opens?
    • They are more focused on ROI than market share - return expectations are mid teens to low 20's
  • Hold Adjusted EBITDA - benefited EBITDA by HK70-80MM at GM.  Even though their hold at Starworld was good the mix was poor so they didn't benefit from decent hold at all.
  • Phase 2-4 of Galaxy Macau
    • PH2: Master planning for the project as a whole is ongoing and will move forward with PH2 when they think that the market is ready for new supply
  • They are well ahead of the curve in terms of margins are concerned at GM compared to other openings
  • Profit sharing vs. Revenue sharing is in the same direction as Starworld. Will not compete on commissions.
  • Capex - $12.8BN was spent through June 30th and leaves about HK$3.7BN. New Capex is HK$16.5BN for GM
  • Pre-opening should be less than HK$100MM in 2H 2011.  They believe that they have accrued for all of their opening expenses. Anything else will not be material.
  • Pursing a very aggressive expansion strategy with their construction business, have no intent to dispose of it.  At some point in time, they will dispose of the business but not at this point. 
  • Starworld is about 50/50 Mass/ VIP table mix
  • They are now 100% top line driven at the City Clubs - they had some hold challenges this quarter.  The change in the deal structure impacted results.  Thinks that they can do HK$50-60MM/ Q in EBITDA.
  • They are significantly north of 30,000 visitors per day at GM
  • Actually direct VIP is about 6% of the market in this past quarter. Wynn is only at 8% last quarter, not in the mid teens. 
  • They will dip their toes into the direct VIP business at GM
  • Any slowing in Visa approval?
    • In August, they had the first visit official visit from the central government- they are confident that they will have government support for Macau growth.
  • ADR for GM is in the HK$1,500 range. 

Noda Wins!: Bullish on Japan?

Conclusion: Yoshihiko Noda’s ascent to prime minister of Japan may be just what Japan needs to reverse the deterioration of its sovereign balance sheet. Though purely speculation at this point, it does create a major TAIL risk that needs to be managed by the long-term Japan bear community – us included.



Position: Bullish on JGBs (TREND); Bullish on the Japanese yen (TREND).


First thing’s first: The Japanese economy remains a slow-motion train wreck. As we have thoroughly outlined in our Japan’s Jugular slide deck, Japan’s fiscal laxity, ageing population and Indefinitely Dovish monetary policy are all preventing the country from experiencing sustained healthy levels of economic growth. In fact, without deflation providing an illusory boost to real GDP growth, the Japanese economy has literally gone nowhere over the last 20 years, with the most recent nominal GDP report (2Q) back at 1991 levels of ~460 trillion yen.


Noda Wins!: Bullish on Japan? - 1


Along with a couple of notable names in the hedge fund community, we remain long-term bears on Japan’s economy. What separates our process from theirs, however, is a distinct emphasis on timing. And from a timing perspective, we see catalysts lining up for being long of long-maturity JGBs and the Japanese yen, as well as removing Japanese equities from our list of top short ideas. No we are not getting outright bullish on Japanese equities, but we are affirmatively signaling that the conditions for shorting them are eroding on the margin.


Noda Wins!: Bullish on Japan? - 2


This marginal shift in our intermediate-term outlook for Japanese asset classes comes amid a noteworthy shift in Japan’s political situation. Yesterday, it was confirmed that Finance Minister Yoshihiko Noda will succeed the now-departed Naoto Kan as Japan’s next prime minister – the country’s sixth in five years and the third since the ruling DPJ party took control of the lower house in 2009.


Noda, who is among Japan’s most fiscally conservative officials, has upheld rhetoric suggesting that he won’t back away from Kan’s desire to rein in Japan’s fiscal deficit (currently at 8.1% of GDP) and produce a balanced budget in ten years. In fact, he flat out said that the DPJ had let the country down in this regard and called for raising the 5% consumption tax by “the middle of the decade” in order to secure funding for accelerating social security expenditures and a third reconstruction stimulus package totaling around ¥10 trillion.


It remains to be seen whether or not he can galvanize the fractured Japanese leadership and rally the Keynesian bureaucracy around the idea of deficit cutting any better than his predecessor. If history has taught us anything, it pays to take a wait-and-see approach with regards to Japanese policy, given the astonishing turnover in leadership we’ve seen in recent years. That said, however, Noda appears to have enough internal support to at least begin to have a healthy debate about balancing Japan’s budget without letting politics get in the way of progress.


In this light of this development, we maintain our favorable view of the Japanese yen and are now outright bullish on long-term JGBs as Noda’s agenda proves bond market friendly: higher taxes should beget slower growth and more cash flow for the sovereign to begin paying down its massive debt burden (~220% of GDP). Regarding the yen specifically, Noda appears to be backing off his interventionist tilt (three record interventions in the last year alone) with the latest $100 billion FX reserve scheme; additionally, Japan’s Cabinet Office is currently embarking on a campaign to educate the public on the “merits of a strong yen” – suggesting policymakers are perhaps coming to grips with the futility of their interventionist efforts.


Time will ultimately tell whether or not these TREND-duration ideas become TAIL-duration turnaround stories. That conversation is much better served for a later time and date, however. For now, we remain long-term bears of the Japanese economy and we need to see a great deal more fiscal and monetary policy adjustment before changing our view here. On the margin, however, Noda’s victory should ultimately prove positive for Japan’s balance sheet and we’d be remiss to present it as otherwise.


Darius Dale



Noda Wins!: Bullish on Japan? - 3


The policy of inflation, and the stagflation that results, is weighing on confidence in the United States. 


As the August 12th edition of the Early Look stated, “If the similarities between 2011 and 2008 are bad, the differences are almost worse.”  The University of Michigan Confidence number for August was the worst reading for that metric since 1980.   Today’s Conference Board number is the lowest level for more than two years and its seventh lowest level on record.


Today’s Conference Board Consumer Sentiment Index print confirmed what we already knew: inflation as a policy, and the stagflation that has resulted, is weighing on confidence.  Confidence in August came in at 44.5 versus expectations of 52.  The sequential drop from the revised July figure of 59.2 was the largest point drop since October 2008.  On August 12th, following the release of the University of Michigan Consumer Confidence number for August also missed expectations by a wide margin.   For an economy that relies on consumption for roughly 70% of its GDP, this is a worrying trend.  As the chart immediately below illustrates, the confidence print has missed expectations on three-of-the-last-four Conference Board releases.





The improvement in consumer sentiment over the past couple of years has been almost entirely driven by the expectation that future conditions were to improve while consumer perceptions of the present situation have been flat (at a historically low level) with some marginal uptick.  We have dubbed this growing spread “The Optimism Spread”.  As the chart below illustrates, this spread has collapsed in recent months as Washington’s incompetence has been under the spotlight as outlook for employment soured and volatility in financial markets increased greatly. 





All in all, despite gasoline prices coming down from their May peak, and declining during the month of August, confidence has cratered in the United States.  Jobless Stagflation is not something the Hedgeye Macro team has been highlighting for some time and we believe the impact of a broken monetary policy is being underscored by these ugly economic data points.









Howard Penney

Managing Director


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