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Random Illusions

This note was originally published at 8am on August 29, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Make it less random to make it feel more random.”

-Steve Jobs


That’s not a quote to explain why Greek stocks can move up +10.2% this morning (after having crashed -48% since February). That’s what Steve Jobs said about getting the “shuffle” feature right for your iPod.


Dan Gardner (author of “Future Babble – Why Expert Predictions Fail and Why We Believe Them Anyway”) used this Apple analogy to hammer home his point about what psychologists call “the illusion of control.”


“People are particularly disinclined to see randomness as the explanation for an outcome when their own actions are involved. Gamblers rolling dice tend to concentrate and throw harder for higher numbers, softer for lower.” (Future Babble, page 75)


This, of course, is ridiculous. But only the ridiculous can explain much of the “expert” storytelling in our profession.


Last week, I kicked off Monday’s Early Look with a note titled “Uncertainty and Non-Linearity” and I had a tremendous amount of feedback from clients (thank you) on the concept of embracing Uncertainty in both our lives and risk management processes. This morning the process has not changed. My positioning has.


With plenty of asset classes on sale throughout different parts of the week, I was able to put 9% of our 70% Cash position to work by buying Corporate Bonds (LQD), Silver (SLV), and taking up our US Equity exposure from 0% to 3%.


I know, call me a wild and horned up bull.


Here’s how the Hedgeye Asset Allocation Model looks this morning (8 positions):

  1. Cash = 61% (down from 70% last Monday)
  2. Fixed Income = 21% (Corporate Bonds, Long-term Treasuries, and a US Treasury Flattener – LQD, TLT, FLAT)
  3. International Equities = 6% (China and S&P International Dividend ETF – CAF and DWX)
  4. International Currencies = 6% (Canadian Dollar – FXC)
  5. Commodities = 3% (Silver – SLV)
  6. US Equities = 3% (Utilities – XLU)

People always ask me what would get me to change my “market view.” I then have to ask them what market they are asking about. I am a Global Macro man who works with a 40 person team across countries, currencies, commodities, etc, so the answer isn’t as random as where the Dow is going next.


The answer actually gets down to last price. Prices Rule in my multi-factor, multi-duration, Global Macro risk management model. To put that more simply – as prices, volumes, and volatilities change, I do.


A lot of people do not deal with managing risk that way. Some are absolutely certain that God endowed them with a super special ability to think about “valuation” better than you or I can. Some think that markets owe them a “rate of return above the risk free rate.” Some actually don’t put much thought into it at all and just buy all dips.


Across asset classes, here’s what my core 3 factor model (PRICE/VOLUME/VOLATILITY)  said the market was saying week-over-week:

  1. US DOLLAR INDEX = DOWN -0.3% week-over-week and down for the 2nd consecutive week, reminding us that there is no strong US Dollar policy that the Globally Interconnected Marketplace actually believes. If I have written this 100x since 2007, I have written it 1000x - devaluation is not the best path to long-term economic prosperity. It perpetuates short-term inflations.
  2. CANADIAN DOLLAR = UP +2% week-over-week and proving itself where both US Congress and Les Eurocrats can’t (political solidarity). Canada is being led toward a majority that the Globally Interconnected Currency Market can attempt to trust.
  3. EURO = FLAT week-over-week as the Europeans do nothing to change the world’s view that they have no political union that can be believed in. The ever so important vote on the EFSF (European Financial Stability Facility) is up next (late September).
  4. COMMODITIES (CRB Index) = UP another +1.8% week-over-week and holding above both its long-term TAIL and immediate-term TRADE lines of support. This is the Stag in Stagflation that is associated with a debauched US Dollar policy.
  5. OIL = UP +3.8% week-over-week outperforming overall commodity inflation by more than a 2:1 ratio. Getting the stock market up by getting the energy stocks up also gets consumers a nice tax at the pump for Labor Day weekend.
  6. COPPER = UP +2.7% week-over-week to $4.11/lb but not enough to get Dr. Copper back above either its long-term TAIL or immediate-term TRADE lines of resistance (both are converging around $4.17/lb). Copper trading sustainably above $4.21/lb would be one of the key leading indicators that would change my Global Growth Slowing research view.
  7. GOLD = DOWN -3% week-over-week after making all-time weekly closing highs for almost every week of Q3 2011 before that. If you shorted Gold last week, you feel shame this morning. We are long Silver as we think it has less hedge fund risk right here and now than Gold does. Gold and Silver will continue to outperform when real-interest rates are negative.
  8. VOLATILITY (VIX) = DOWN -17% week-over-week and while it’s not conventionally considered an asset class, I don’t see why it shouldn’t be given that the Fed, ECB, and BOJ (Fiat Fools): A) shorten economic cycles and B) amplify market volatility.
  9. US TREASURIES = FLAT on the short end and DOWN on the long end last week as long-term Treasury bonds were immediate-term TRADE overbought in the week prior. Nothing has changed the Treasury Bond Market’s view from an absolute yield pricing perspective. For me to change, I’d need to see greater than 0.28% and 2.49% on 2-year and 10-year yields, respectively.
  10. US TREASURY YIELD SPREAD = UP 13 basis points week-over-week as the long-end of the Treasury curve rallied (10-year went from its YTD low of 2.06% to 2.19% by Friday). We continue to see the intermediate-term TREND of Yield Curve COMPRESSION as one of the most important leading indicators of both US Growth Slowing.

All the while, US stock market bulls had a wonderful week with the SP500 closing up +4.7% (up for its 1stweek in the last 5). But, Prices Rule, and while I moved off of the ZERO bound last week (asset allocation to US Equities = 3%), that certainly doesn’t make me a bull on either an intermediate-term TREND or long-term  TAIL duration. I’d need to see an SP500 close above 1263 for that.


“For humans, inventing stories that make the world sensible and orderly is as natural as breathing. That capacity serves us well, for the most part, but when we are faced with something that isn’t sensible and orderly, it’s a problem” (Future Babble, page 81). That’s why I’ll stick with my own storytelling that both accepts Uncertainty and that the market’s last price makes perfect sense.


My immediate-term TRADE ranges of support and resistance for Gold, Oil, and the SP500 are now $1809-1902, $81.35-88.58, and 1154-1191, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Random Illusions - Chart of the Day


Random Illusions - Virtual Portfolio

CHART OF THE DAY: Nature's Manipulations


CHART OF THE DAY: Nature's Manipulations - Chart of the Day

Nature's Manipulations

“Willful blindness of the non-linear core nature, has led to the attempts to manipulate the markets certainly by government.”

-Martin A. Armstrong


It is the nature of a man who is in the business of being bullish to be bullish. It is in the nature of a woman who is in the business of being bearish to be bearish. Human Nature’s Manipulations of market storytelling is what it is. People push their own book.


Over the last 3 years I have been accused of being both a raging Republican and a Yale campus Democrat. In 2009 I was, allegedly, a “reckless” bull. In 2011, I am, allegedly, a Perma- Bear. All the while, across 1,377 positions that I have taken since founding Hedgeye in 2008, my long versus short positions are close to dead even (660 LONGS, 677 SHORTS). Time stamps matter.


Perma-Process? Perma-Risk Manager? Perma-Mullet? Who knows. What I do know is that if I am not more right than I am wrong on the big stuff, we don’t get paid. Despite Perma-Bulls claiming they nailed it in August, both the US and Global Equity markets got decimated.


Across our Global Macro model’s Global Equity market league tables, here was the score for August 2011:

  1. Greece = down -23.9%
  2. Germany = down -19.2%
  3. Italy = down -15.6%
  4. Russia = down -13.4%
  5. Austria = down -12.7%
  6. South Korea = down -11.9%
  7. France = down -11.3%
  8. Argentina = down -10.7%
  9. Sweden = down -10.6%
  10. Taiwan = down -10.4%

So, I guess, the US stock market bulls who were expecting 3-4% US GDP growth and SP500 returns of 15-20% in 2011 were a little off in August, but they weren’t crashing like everything else (SP500 and Russell 2000 down -6.1% and -8.7% for AUG, respectively).


That must be bullish. And I must have been too bearish.


Heck, just look at how high US stocks bounced “off the lows” in August. That’s just gotta be bullish, no? Without any economic data to back it (US consumer confidence hitting 1970s type lows; housing/mortgage demand at 14 year lows, global stock markets getting smoked, etc), the bears must be too bearish. Right? Ah to be a connoisseur of consensus…


While the answer to who called the August bottom AND actually called the April top remains unclear, what remains crystal clear is that people who are in the business of being bullish bought stocks into August month end.


In the Hedgeye Chart of The Day, Darius Dale, illuminates the simple reality of institutionalized career risk management:


LAST 6 DAYS OF THE MONTH (in the SP500):

  1. APRIL = +2.0%
  2. MAT = +2.1%
  3. JUNE = +2.6%
  4. JULY = -3.8%
  5. AUG = +4.9%


  1. MAY = -1.3%
  2. JUNE = -4.9%
  3. JULY = +1.8%
  4. AUG = -13.4%
  5. SEP = ?

Now, if you want to roll the Bernanke Bones on this, maybe this time will be different. After all, that’s what the Keynesians and Fiat Fools have been telling us all along. But if it’s not, the US stock market could have a big problem in September. That +4.9% month-end markup into August end was the most aggressive yet and, as you can see, the higher they mark’em up, the harder they fall.


Arresting economic gravity is difficult. But Obama is scheduled to release his new bag of goodies next Thursday and, all the while, Charlie Evans can pop in from the Chicago Fed for another US Dollar Debauchery interview (not that his being paid by The Commodity Inflation or sitting on the Chicago Metropolis board with CBOT and UBS execs is a conflict of interest versus the Fed’s “independence” or anything like that).


So sit back and enjoy some price volatility in September as the Fed keeps cranking on full employment and “price stability”! We really need these guys to do a lot more of what didn’t work with QG2. Nature and the non-linear interconnectedness of Global Macro markets be damned.


Today’s risk/reward in the SP500 is dead even. I have 1203 and 1234 as immediate-term TRADE support and resistance. After moving off of my 0% asset allocation to US Equities last Friday (bought Utilities and were up +3.3% on that already) we’re long XLU (Utilities) and short Financials (XLF). Where could I be wrong? All over the place I guess. My every morning starts and ends with Uncertainty.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1, $85.98-89.72, and 1, respectively.


Best of luck out there in September,



Keith R. McCullough
Chief Executive Officer


Nature's Manipulations - Chart of the Day


Nature's Manipulations - Virtual Portfolio



MPEL and LVS going in opposite directions. Is this still the most important Macau metric, Mr. Adelson?



It’s time for an update on Sheldon Adelson’s favorite Macau metric: EBITDA share.  He may not want to put this quarter in the marketing brochure, however.  Sands China lost 4% in EBITDA share QoQ to 26.4% (lowest to date), as opposed to share gains for MPEL and Galaxy.  The opening of Galaxy Macau boosted the parent's share.  MPEL improved its share the most at 4.7% QoQ to 15.8%, partly due to high hold.  Q2 was a record high for MPEL as cost improvements and stellar volume share growth contributed to the strong quarter.



Philippines: One of the Better Stories in Global Macro

Conclusion: The Philippines is shaping up to be one of the better country-level fundamental stories in Global Macro over the intermediate term and our core three-factor quant model is supportive of our bullish thesis.



Position: Long Filipino equities (EPHE).


Today Keith initiated a long position in Filipino equities within our Virtual Portfolio, giving us exposure to one of the few remaining positive fundamental stories out there. Specifically, what we like about the Philippines are accelerating economic growth, slowing inflation, and sound monetary and fiscal policy – the same three factors which cause us to get behind any country on the long side.


On the growth front, our models pin the country’s second quarter real GDP growth rate of +3.4% YoY (reported today) as an intermediate-term bottom. Specifically, we see over 100-200bps of upside over the next two quarters. Even amongst a deteriorating global growth outlook, our view on Filipino economic growth is supported by accelerating domestic demand within the defensive, consumption-led economy (private consumption accounts for just over 73% of GDP).


Philippines: One of the Better Stories in Global Macro - 1


We see demand growth accelerating for two key reasons: 

  1. Inflation is slowing; and
  2. “The Aquino Put” 

To the former point, CPI appears to have peaked in June, with July coming in a +5.1% YoY and our model is pointing to lower-lows from current levels over the intermediate term. This is supported by our Deflating the Inflation thesis and sequentially tougher comparisons across the commodity front in the coming months. 


Interestingly, Fed Head Chuck Evans went on an inflation marketing campaign yesterday on CNBC and attempted to verbally debauch the U.S. dollar to lower all-time lows. Whether the Fed actively pursues such a strategy in the form of incremental policy remains to be seen; we do, however, continue to believe that Bernanke is in a box at least for the next 3-6 months regarding being able to hint at/implement Quantitative Guessing Part III. For now, slowing inflation should provide a much-needed tailwind to Filipino consumption growth.


An incremental tailwind for the Filipino economy at large could come in the form of monetary easing over the next couple of quarters – particularly if we remain correct on the slope of global growth (negative) and global inflation (flat-to-down). Today, Economic Planning Secretary Cayetano Paderanga affirmed our view, saying that the central bank had “more flexibility” regarding the setting of its benchmark overnight borrowing rate, as “inflation is slowing”.


Additionally, Banko Sentral ng Philipinas Deputy Governor said today that “lower economic momentum will be an important consideration” in the next monetary policy meeting (next Thursday). As things continue to unravel in Europe, we expect to see the Banko Sentral ng Philipinas board use popular central banking terms like “uncertainty” when describing the global economic outlook as a reason to hold rates flat (after +50bps of hikes YTD) – joining several other key economies from Asia to Latin America to have done so in recent weeks, most notably Australia and Mexico.


Most importantly, should global growth accelerate to the downside in the coming quarters, Filipino policymakers are well-equipped to weather the storm, with an ability to cut the country’s 4.5% benchmark interest rate, a low and shrinking deficit thanks to President Aquino’s aggressive tactics over the past year (-2.25% of GDP), and a relatively low debt/GDP ratio of 47.3%.


Philippines: One of the Better Stories in Global Macro - 2


Philippines: One of the Better Stories in Global Macro - 3


Philippines: One of the Better Stories in Global Macro - 4


If needed, the Filipino government’s healthy fiscal metrics will allow the country to enact what we have termed “The Aquino Put”. Simplistically, the outspoken president has pledged to increase expenditures on infrastructure in the form of $17 billion worth of investments in the country’s roads, airports, and schools. Specifically, Budget Secretary Butch Abad said today that policymakers may choose to pull forward and implement projects originally scheduled for 2012 “to help the economy recover”.


All told, we are all bulled-up on Filipino equities from a fundamental perspective and our core three-factor quant model is supportive of our bullish thesis. For these reasons, we have chosen to go long of the securities in our Virtual Portfolio.


Darius Dale



Philippines: One of the Better Stories in Global Macro - 5


Overall direct play slowing. So much for eliminating the middle man.



Hidden in the explosive growth in VIP and Mass revenues, direct VIP play growth has been slowing.  Even the direct play king - Sands China - realizes it.  Junkets aren't going away.  In fact, they are growing in power.  Junket VIP remains the fastest growing Macau revenue source.  We've put together the data and here are some of our observations:

  • Direct play growth has slowed down considerably in the 1H of 2011, growing 23% YoY compared to junket RC growing 51% over the same period. 
    • In 1Q11, direct play grew 24% YoY compared to junket RC growth of 55%.  In 2Q11, direct RC grew 22% YoY vs. junket RC growth of 48% over the same period in the prior year
    • LVS direct play volume growth went negative in 2Q11, falling 8% YoY. 1Q 2011 showed 8% growth while 2010 grew 93% YoY.  LVS has made it clear that they will be making a big push with the junkets in 2012 finally putting a nail in the coffin of their strategy to eliminate the junket middle man.
    • MGM also experienced a marked deceleration in direct play growth with 1H11 growing only 4% YoY compared to 32% in 2010 and 114% in 2009.  This is no surprise since Mr. Kwong’s strategy was to grow the junket business which has contributed to the strong growth at the property since he joined last year.
  • As the chart below shows, direct play as a % of VIP RC for the five operators fell to 10% in 1H11 compared to 15% in 2010 and 12.5% in 2009
    • In 2Q11, every operator experienced a decline of direct play as a % of total VIP RC
      • MGM direct play % dropped 10% in 1H10 to just 8.2% from 17.8% in 1H10
      • LVS’s direct play % dropped 6% in 2Q11 to 22% from an all-time high of 27% in 2Q10
      • Wynn’s direct play % dropped 3% in 2Q11 to just 8.4% - an all-time low for the property
      • MPEL’s direct play dropped 1% in 2Q11 to 9% from 10% in 2Q10
      • In 2Q 2011, Galaxy Macau’s direct play as a % of VIP RC was 3.8%.




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