The Edge

This note was originally published at 8am on September 06, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Where is the edge? And how do I stay the right distance from the edge?”

-Ray Dalio


That was Ray Dalio’s answer on the key to risk management success (“Mastering The Machine”, by John Cassidy, New Yorker, July 25th 2011). Like he did in 2008, Dalio is beating most of his hedge fund competition in 2011. Hedgeye calls that a repeatable process.


Where was The Edge in 2011? Global Growth Slowing. Period.


While there will be plenty of storytelling and finger pointing about how it was a pig in Europe or a politician in America, that’s pretty much it. If you got Growth Slowing right, you got a lot of other things right.


Growth won’t slow forever. But it didn’t stop slowing in the US on Friday and it doesn’t appear to be slowing in Europe this week either. When growth stops slowing, that will be a critical signal to start thinking about going the other way.


The cover of Barron’s this weekend asked “Where Do We Go From Here?” Good question. But for the answers, Barrons (like many other legacy financials media outlets) continues to use the wrong sources. Why many of these journalists are using the same sources that missed Growth Slowing in 2008 is not clear. Why they don’t use Hedgeye is simple: we are their new competition.


In my Early Look note from August 11thtitled Forecasting Dark (“Weather forecast for tonight: dark.”-George Carlin) I highlighted what Washington/Wall Street continue to use as their source for “blue chip” strategy. At the beginning of 2011 here were some of the higher profile estimates:


Forecasts for 2011 US GDP Growth:

  1. Bank of America = 3.2%
  2. Barclays = 3.1%
  3. Citigroup = 3.1%

Forecasts for 2011 SP500 Returns:

  1. Bank of America (David Bianco) = 1400 (up +11.4%)
  2. Barclays (Barry Knapp) = 1420 (up +13.0%)
  3. Citigroup (Tobias Levkovich) = 1400 (up +11.4%)

As of last week’s train wreck US unemployment report and another -31% estimate cut from the US Government on Q2 2011 GDP, here’s fact versus prior fictions:

  1. Q1 2011 US GDP Growth = 0.36%
  2. Q2 2011 US GDP Growth = 0.98%
  3. SP500 YTD Return = -6.7%

Now, to be fair, there are still some very contrarian views out there. Consider ISI Group’s latest sell-side hire, Bijal Shah, who proclaimed in Barron’s on August 22, 2011, “higher unemployment isn’t necessarily terrible news for equity markets.”


It just was last week.


So (drumroll), after seeing the data, here are your real-time Wall Street revisions from Barron’s this weekend:

  1. Deutsche Bank (Binky Chada) drops their January 2011 year-end SP500 target from 1550 to 1425
  2. Goldman Sachs (David Kostin) drops their January 2011 year-end SP500 target from 1450 to 1400
  3. Credit Suisse (Doug Cliggott) drops their January 2011 year-end SP500 target from 1250 to 1100

Whoa, hold your horses! Is that one major sell-side firm with a price target below the market’s last price? Indeed. This isn’t Doug Cliggott’s first rodeo getting a bearish move right.


So what do we do with all of this incompetence in forecasting?

  1. Realize that the sell-side hasn’t capitulated yet and cut their estimates to the right level (they will at the bottom)
  2. Accept that both the US Government and their economic advisors (the sell-side) continues to use the wrong models
  3. Keep doing what it is that we’ve done to call both the 2008 and 2011 Growth Slowdowns

Not that I’m still keeping track, but on February 3rd, 2011, JP Morgan’s Thomas Lee put out a note titled “Circle of Life”, raising his 2011 EPS  target in the SP500 to $97.50 from $94 saying that it “smells like a secular bull market…”


While I’m not certain how to use the scratch-and-sniff model, what we can be certain of is that most of these sell-side strategists quickly revert to calling markets “cheap” when both their earnings and price targets are wrong.


Of course, anything can be deemed “cheap” if you use the wrong growth and earnings estimates…


Who has the right earnings estimates? You can drive a truck through Deutsche Bank and Credit Suisse views on the “E” in PE for 2012:

  1. Binky Chada says $106
  2. Doug Cliggott says $81

So, Chada will call the SP500 “cheap” because he is using 11x earnings (1173/$106) and Cliggott will call it more expensive at 14x (1173/$81). Who is right? What’s the right multiple? Who has The Edge?


Don’t worry, those are not the risk management question you need to answer this morning. The answer that you have to perpetually impute is “how do you stay the right distance from the edge.”


To do that, you’ll need a repeatable risk management process as well.


My immediate-term support and resistance levels for Gold, Oil, and the SP500 are now $1818-1903 (bullish but overbought), $83.87-97.34 (bearish), and 1145-1193, respectively. Europe capitulated yesterday. There’s a good chance another immediate-term low in US stocks comes at a higher-low than the prior closing low (1119) and US Treasuries are putting in immediate-term highs.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The Edge - Chart of the Day


The Edge - Virtual Portfolio


Notable macro data points, news items, and price action pertaining to the restaurant space.






Rising food prices that defy easing global inflation may challenge policy makers in countries including China to control costs without hurting economic growth, according to Bloomberg.


According to, cattle feeding margins and beef packing margins both declined substantially last week as boxed beef cutout prices dropped.





The Beverage space outperformed its food, beverage, and restaurant peers yesterday as SODA led the group higher.   SODA has declined almost 50% since its early August peak but was upgraded yesterday and traded up 5.2% yesterday.


THE HBM: MCD, PFCB - subsectors fbr




  • MCD Japan’s August same-store sales declined 8.2%.
  • MCD global same-store sales results for August are being released this morning.  The Street is looking for 5.0%, 4.5%, 6.0%, and 3.7% for the Global, U.S., Europe, and APMEA, respectively.
  • MCD is facing a PR challenge after one person was left dead and nine sickened after breathing toxic fumes in the restroom of a McDonald’s restaurant in South Georgia.  The current theory is that the fumes were caused by cleaning chemicals but an investigation is underway.



  • PFCB presented at the William Blair & Company Emerging Growth Stock Conference yesterday.  The company has enlisted a call center for to-go orders and also said that mobile and online orders have higher check average.

THE HBM: MCD, PFCB - stocks 99


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Despite easy comps, August is coming in pretty weak.  At the very least, Q3 won’t be a repeat of Q2.  



As we mentioned in our note, “REGIONALS: SHOW ME THE GROWTH, MO" (9/6/11), preliminary revenue data from Missouri may indicate a soft August for the riverboat markets.  So far this year, we have three states that have reported August revenues:

  • Illinois same-store gaming revenues down 11% against an August 2010 comp of –6%
  • Iowa same-store gaming revenues down 1% versus –3% last year
  • Indiana revenues down 5% versus –1% last year
  • Even Pennsylvania – which we wouldn’t have characterized as mature yet – fell 6% this August in same-store gaming revenues

One fewer Sunday can’t explain the August weakness.  Nor can a difficult comp, since regional gaming revenues (riverboat) fell 2% in August of 2010.  So what’s going on?  We think it is mostly macro.  Gaming proved to be one of the most, if not the most cyclical consumer sector in the last downturn.  Statistically, housing prices and unemployment have been the most significant drivers of gaming revenues.  Unfortunately, housing prices are still declining and unemployment remains above 9%.  Looking through this lens, we shouldn’t be surprised.


For the first time in many quarters, we don’t see widespread earnings upside for domestic gaming operators.  In fact, some are at risk of missing including ASCA, PENN, and BYD.  We still think PNK has enough secular margin improvement and Louisiana exposure to put up another beat but the size of that beat may not be what investors are used to.  Sentiment is likely to turn, in our opinion. 


PENN looks particularly vulnerable since it has widespread exposure (more negative data points) and more downside to its trough valuation.  Estimates for PENN’s PA casino are also looking high given the surprising and severe slowdown there.  Finally, being a Wall Street darling now could be a liability on the way down.


The following charts analyze regional gaming revenues on a sequential basis.  From this view, the regional performance looks even worse.  Depending on the state, sequential performance began to deteriorate in May, June, or July and all three states depicted underperformed again in August.







ECB Notes: Message is economic uncertainty at the global level

Below we highlight some of the major call-outs from ECB President Jean-Claude Trichet’s press conference following the Bank’s unanimous decision to leave the ECB’s Main refinancing rate UNCH at 1.50%. In short, he warned of the uncertain global outlook on the horizon, with risks weighing to the downside, including revisions to GDP. In typical Trichet form, he was tight-lipped about future interest rate moves, yet should the global conditions he presented materialize, logic would follow that a cut may be warranted. And we’re calling for global growth slowing!


GDP: according to ECB staff projections, which the Governing Council reviews in making its monetary policy decisions, annual  Eurozone GDP for 2011 was downwardly revised to 1.4% - 1.8% vs. the previous forecast band of 1.5% - 2.3%.  2012 annual GDP was also revised down to 0.4% - 2%.


Inflation: as measured by CPI, inflation is expected at 2.5% - 2.7% (Y/Y) for 2011 and 1.2% - 2.2% in 2012, based on ECB staff projections.  [or UNCH vs previous estimate for 2011 and narrower for 2012 projection].  With the mandate of 2% CPI as the target rate, Trichet remained confident that this level will be achieved in 2012, while CPI should remain elevated in 2011. 


M3: Trends in money growth have stabilized over the last months, with expansion at a modest pace.


Economic Analysis and Risks: Trichet cites the Japanese earthquake; dampening factors of slowing global growth; elevated energy prices; deteriorating global equity markets and business confidence; and remaining tensions due to Europe’s sovereign debt contagion as key factors weigh on the Council’s monetary policy decision.


QA: As is typical, the questions posed at Trichet in the press conference were far more interesting than his prepared remarks for they cut to the heart of many issues plaguing the region, yet little response was given.

On fiscal policy: as usual, Trichet had no comment on fiscal policy, returning to the Bank’s sole mandate of price stability. He mentioned the need of countries issuing fiscal consolidation packages to front-load them. He had no specific comments on the size and scope of Italy’s austerity package, which passed a confidence vote in the Senate yesterday and must clear the lower house of Parliament in the coming days.


On Liquidity Measures: Trichet stressed the fixed rate non-standard measures of the ECB with full allotment on the 1w, 1m, and 3m will be extended into the end of Q4. Here he defiantly states that there are no liquidity issues for Euro area banks on the whole. Among further comments in which he insistence on the health of Euroarea banks, Trichet is in opposition  to IMF head Christine Lagarde who recently said that Euro area banks are undercapitalized and a statement from Deutsche Bank’s Josef Ackermann that the current climate “reminds one of the autumn of 2008”.


On SMP facility: Trichet did not comment on the future size and scope of the Bank’s bond purchasing program, which resumed in early August. He reiterated that the Bank will provide weekly totals of its secondary buying, which has included:  €22B for the week ended Aug. 12; €14.3 for 8/19; €5.3B for 8/26; and €13.3B for 9/2.


In his closing remarks Trichet noted his respect for the founding principles of the Stability and Growth Pact. In short, it’s clear how politically motivated Trichet is to keep the Eurozone intact, including support of the common currency. Our call remains that should Germany not give the necessary backing to the EFSF, or should a unanimous vote to pass the facility not be met (the timing of which should be late September and early October), the ECB, against its mandate, will likely have to step in to directly and play a larger role to support the sovereign and banking issues across the region. Should this be the case, we could see massive inflation risks in the common currency.


For now, we are not invested in Europe, having covered our short position in the UK (EWU) on 9/6. We continue to see slowing fundamentals not only in the periphery but in the core as well. Additionally, France’s AAA credit rating hangs in the balance. The EUR-USD fell sub $1.39 during Trichet’s remarks and is settling just north of $1.40 intraday. Our immediate term trade levels on the cross are $1.39-1.43, with a broken intermediate term TREND level of $1.43.


In other news, the BOE left its main interest rate unchanged at 0.50% and kept its asset purchasing program unchanged at 200B GBP. We continue to highlight the nation’s sticky stagflation, which should dampen its economic outlook over the coming quarters.  While the BOE too could cut rates, the ECB has more room to play with on the downside given its interest rate differential, which is positive on the margin.


Matthew Hedrick

Senior Analyst


ECB Notes: Message is economic uncertainty at the global level - B. ECB


Today, Keith bought MPEL in the Hedgeye Virtual Portfolio.  The Street is still too low on 3Q and the stock is as cheap as it was at $4.



Keith bought MPEL in the Virtual Portfolio at $12.70.  According to his model, MPEL has rock solid support at $12.49 (TRADE) and $11.90 (TREND).  Fundamentally, MPEL continues to be a favorite name of ours heading into 3Q earnings for several reasons: 1) Street is ~20-25% too low on 3Q EBITDA; 2) among the Macau names, it is the cheapest (under 8x - same forward multiple as when it was a $4 stock) and has the least downside to trough March 2009 levels; 3) Besides Galaxy, which is feeding off of the opening of Galaxy Macau, it is the only operator to have gained revenue market share since Q2 end; 4) It has 100% exposure to Macau, which is experiencing significant growth.  



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