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Great Misunderstandings

This note was originally published at 8am on September 13, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“To be great is to be misunderstood.”

-Ralph Waldo Emerson

 

Great short sellers in this game have one thing in common – they know when to cover.

 

I was taught how to sell short by doing. That’s not to say I’m the greatest short seller since the Count of Monte Cristo either. That’s simply to say that since 1999 I have had a lot of reps.

 

Like in any other profession, the more you do of something the more you have an opportunity to make mistakes. It’s your mistakes that make you evolve as a Risk Manager – that’s if you choose to let them teach you.

 

There have been plenty of opportunities for people in this game to evolve since 2008. Evidently, some have chosen not to. According to S&P data, only 167 of over 19,000 “recommendations” by Old Wall Street’s analysts this year have been “sell.” Professionally embarrassing.

 

We don’t want to embarrass the competition inasmuch as we want to challenge them. We wake up early every morning with fire in our bellies and a passion to be the change we want to see in this business.

 

Obviously on Washington’s Wall Street there hasn’t been a lot of that going on for the last 9 months – that’s why we do what we do. We want America to start winning again. Every losing streak ends with a win. It’s time to embrace winners.

 

Back to Short Covering

 

I’ve written 2 intraday notes in Q3 of 2011 titled “Short Covering Opportunity” (one on August 8th and one yesterday). Yesterday’s call to cover shorts generated as much questioning and feedback as any time I think I have ever made a call to cover shorts since the thralls of early 2009. This is an important sentiment indicator.

 

Sentiment is one of the hardest things in this game to quantify. I was on multiple client calls yesterday where, ultimately, what very astute investors wanted to know was what I was “hearing” from other clients. My answer to that question is that there is no answer that is of quantifiable relevance. What any of us are “feeling” or “hearing” about markets subjects our performance to Great Misunderstandings.

 

As I wrote in yesterday’s Early Look, stock market fund “outflows” and “sentiment” will be the final stage for the 2011 Equities bears to navigate. What I meant by that is those who have been too bullish in 2011 will have redemptions (outflows) and forced to sell at immediate-term bottoms. All the while, quantifiable sentiment indicators will show signals of immediate-term TRADE capitulation.

 

Here are 3 of those:

  1. II Sentiment Survey Spread (Bulls Minus Bears) = dropped to almost a dead heat in the last week (39% Bulls, 38% Bears) and could easily move to the bearish side (more institutional investors admitting they are bearish at the bottom than bullish – it’s called career risk management into year-end) this week and next.
  2. Volatility (VIX) = immediate-term TRADE overbought yesterday at 43 and is now making a lower-high versus the August 8th Short Covering Opportunity high of VIX 48. Unless you think 2008 starts happening this week (it could!), lower-highs are what they are (bearish on the margin for volatility) and I shorted fear yesterday via a short position in the  VXX.
  3. US Stocks vs US Treasury Bonds = flagged one of their widest performance chasing divergences of the year yesterday (stocks down, bonds up) and, critically, both the UST 10-year yield hit my immediate-term downside target of 1.87% intraday at the same time that the US stock market (SP500) tested lower-lows (then stocks recovered to close at a significantly higher-low).

“Significant” is as significant does. If you are using the wrong models and/or sources to help you navigate this beast of Keynesian Economics gone bad, we’d agree that most bulge bracket sell-side desks aren’t going to be helpful at this stage of the game (unless they are making calls to fade their economist/strategist calls as they “cut estimates” at the bottom).

 

Remember, bottoms are processes, not points. So you need a rigorous and repeatable Global Macro risk management model that has worked in both 2008 and 2011 to know when to cover. Making the turns “off the lows” matters.

 

Lastly, after you take advantage of Short Covering Opportunities, you need to quickly, but patiently, get yourself back into position on defense. There are no rules against re-shorting things that you covered lower. Neither are there any Keynesian laws (yet) that prevent you from thinking quickly as you patiently pick your spots.

 

In Steven Pressfield’s “Gates Of FireAn Epic Novel of The Battle of Thermopylae” (I read it on the beach last week to get me fired up for Q4’s Global Macro battle), Pressfield explains the “role of an officer” in Spartan war as follows:

 

“He was just a man doing his job. A job whose primary attribute was self-restraint and self-composure, not for his own sake, but for those whom he led by his example.” (“Gates Of Fire, page 112)

 

To be great in this globally interconnected game takes passion, patience, and time. The greatest of misunderstandings is how quickly we need to evolve the risk management process before it becomes our Waterloo.

 

My immediate-term support and resistance ranges for Gold, Oil, Germany’s DAX, and the SP500 are now $1801-1849, $86.03-90.51, 4890-5314, and 1141-1174, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Great Misunderstandings - Chart of the Day

 

Great Misunderstandings - Virtual Portfolio



Let It Flow, Bro

“I’m just saying, just let it flow, man.”

-Ray Dalio

 

I think I have milked both the quotes from Ray Dalio’s New Yorker interview and this week’s short squeeze in Global Equities bone dry. While there has been plenty of emotion embedded in this week’s 100 point S&P futures rally, it’s just time to “let it flow”, Bro.

 

“Bro” is a very sophisticated nickname that Wall Street trader types use when addressing each-other. Examples would be: “Bro, that was a monsta print, bro…” or “Bro, the two-hundo is still broken – this rally doesn’t make sense, bro.”

 

Both in the Bro Brotherhood and beyond, this week’s +9% rally in the S&P futures (from Monday’s pre-open low to yesterday’s intraday high) has left a mark. Not surprisingly, you’re seeing the commensurate hedge fund blowups that are associated with price volatility. The Goldman Beta Fund shutdown is a Top 3 story on Bloomberg this morning. Yesterday it was the Euro Bro at UBS.

 

Bull markets generally don’t blow up the Bros. Volatility does. And as a profession we have a lot of work to do in order to evolve the risk management process so that our clients are actually getting the protection we market to them.

 

Bridgewater’s Ray Dalio doesn’t blow up. To the contrary, his $100 Billion Dollar hedge fund capitalizes on other people blowing up. In the same New Yorker interview (“Ray Dalio’s Richest and Strangest Hedge Fund”, by John Cassidy, July 25, 2011) Dalio explains how emotion has no place on his team – or he, at a minimum, needs a way to govern it:

 

“What we’re trying to have is a place where there are no ego barriers, no emotional reactions to mistakes… if we could eliminate all of those reactions, we’d learn so much faster.”

 

Re-think. Re-work. Re-learn.

 

That’s what getting good at this Globally Interconnected Game of Risk is all about - not pointing fingers, fighting change, and/or Mr. Macro Market’s leading indicators.

 

Back to the Global Macro Grind

 

Not surprisingly, after prices have moved higher across the Global Equities universe, my price, volume, and volatility factors look a heck of a lot better than they did last Friday.

 

Let’s look at those core 3 factors in the SP500 for example:

  1. PRICE – what was immediate-term TRADE resistance at 1178 is now support
  2. VOLATILITY (VIX) – what was immediate-term TRADE support at 35.47 is now resistance
  3. VOLUME – remains less than dead in the water on the up moves with Wednesday’s volume signal being +9% above average

Now to be crystal clear on reading these factors, they are on 1 duration (the immediate-term TRADE), not all 3 (TRADE, TREND, and TAIL). From a long-term TAIL perspective, resistance for the SP500 remains up at 1265. In other words, all of the “long-term” investors out there should still be concerned about the long-term.

 

The hallmark of my risk management process is to be:

 

A)     Multi-Factor

B)      Multi-Duration

 

What that means (and I think Dalio would agree with this) is that you can heighten the probability of 1. not missing something big or 2. being overly exposed to one big thing, if you are analyzing multiple-factors (Countries, Currencies, Commodities, etc.) across multiple-durations.

 

So, if we broaden the immediate-term TRADE signals to Europe this morning, here’s what I see (and it’s not good):

  1. Germany’s DAX failing to overcome immediate-term TRADE resistance of 5631
  2. Italy’s MIB Index failing to overcome immediate-term TRADE resistance of 15,014
  3. Spain’s IBEX failing to overcome immediate-term TRADE resistance of 8437

Bear markets get immediate-term TRADE oversold. Then they bounce. We get that. That’s why we’ve made 2 calls in Q3 of 2011 (August 8thand Monday, September 12th) titled “Short Covering Opportunity.” And yes, these “calls” have time stamps.

 

Old Wall Street’s Sell-Side or the pop-media that provides it a marketing platform doesn’t really do the time stamp thing. We don’t champion time stamps to rub it in their face. We are explicitly challenging them to be transparent so that we can figure out if they can be additive to the collective risk management process that this industry needs.

 

Letting $2 Billion Dollar losses in the UBS bonus pool “flow” or blowing clients out of “risk managed” hedge fund products at every capitulation bottom we’ve had in the 2008-2011 period isn’t cool anymore, Bro.

 

My immediate-term support and resistance ranges for Gold (which just broke its immediate-term TRADE line of $1817 and has no TREND support to $1630), Oil, and the SP500 are now $1, $86.54-90.26, and 1178-1212, respectively.

 

Best of luck out there today and enjoy your weekend with your families,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Let It Flow, Bro - Chart of the Day

 

Let It Flow, Bro - Virtual Portfolio


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THE M3: MGM COTAI

The Macau Metro Monitor, September 16, 2011

 

 

MGM CHINA BELIEVES LAND GRAND IN 2011 IS POSSIBLE Macau Business

MGM China chairwoman Pansy Ho said she firmly believes it is possible for MGM China to receive land approval on Cotai in 2011.  Regarding Wynn Cotai's recent approval, Ho said, "There is no point competing even in terms of who gets the land first and who is going to ultimately build it out first.  For us, as long as we are given the fair opportunity, meaning there is no deliberate delay in any sense, then we are very satisfied.”

 

 


FOOD STAMPS TAILWIND FOR YUM?

The restaurant industry has been lobbying for a loosening of restrictions on food stamp recipients’ food purchasing options.  YUM is regularly called out in media reports on the issue so we decided to call the company to get a better understanding of the issues.

 

BACKGROUND

 

We recently reached out to senior vice president and chief public affairs officer at Yum! Brands, Jonathan Blum, to discuss the topic of food stamps.  He provided us with some insight on the company’s efforts to help bring about a modification to the Farm Bill that would allow a portion of food stamp recipients to use their Electronic Benefit Transfer (EBT) cards at restaurants. 

 

Contrary to the overly-simplified headlines of late, the action YUM and others are pushing for would not result in restaurants accepting food stamps across the board.   Rather, under the modification to the Farm Bill that the restaurant coalition is promoting, only participants classified as homeless, elderly, or disabled (HED) would be allowed to use food stamps to buy “hot, prepared food”.  The origins of what is officially named the Supplemental Nutrition Assistance Program prohibited, among other things, the purchase of hot, prepared meals.  Federal regulatory changes in 1978 provided states with the option to allow elderly and disabled food stamp households to use food stamps at restaurants.  In 1996, the program was expanded to include homeless food stamp households. 

 

Thus far only Michigan, Arizona, and California (in certain urban centers only) have opted to allow HED program participants to purchase food at approved restaurants (restaurants in these states still have to apply to the state for authorization).  The coalition within the restaurant industry that is agitating for change, including YUM, is arguing that the rule disallowing the purchase of hot, prepared foods is antiquated given that restaurants are now visited far more frequently by the general public than in the mid 20th century when the program was kicked off.  Furthermore, for elderly and disabled participants in particular, allowing access to prepared, affordable, possibly delivered food makes sense, according to YUM (and we would agree).

 

HURDLES

 

Mr. Blum’s hope is that a modification to the Farm Bill can be brought about in the next thirty days.  It seemed to us from his tone and general commentary that achieving that goal may be difficult for several reasons. 

 

Firstly, mobilizing the federal government to focus on an issue so small relative to other concerns is a challenge.  Secondly, the modification’s effect of moving the power of authorization from states to the Federal government (restaurants would apply to the Federal government, not the states) could be adding a political component to the debate.  It certainly makes sense that it would, given the heightening skepticism of centralized power in this country. 

 

The alternative, if left with the status quo, is for restaurant companies to appeal to individual states to take advantage of the exemption for HED participants, as Michigan, California, and Arizona have done.  Mr. Blum told us that that was likely not worth the effort, despite the 45.2 million people currently registered as participants in the program and the $74 billion of expenditure, annually, that that represents.  To be clear, a modification of the current law would not represent $74 billion of revenue for the restaurant industry but would likely distribute that money differently than it is currently being spent.  In certain, mainly urban, areas of the three states currently allowing HED SNAP participants to spend their allowance at restaurants, YUM is seeing sales improve in the MSD range.  While Florida and Rhode Island are running pilots, there is no sign of any other states following suit, according to Mr. Blum. 

 

CONCLUSION

 

While not privy to any significant insights into the legislative process surrounding this particular issue, we believe that the coalition lobbying for this modification to the Farm Bill are up against difficult headwinds.  The first, as we wrote above, being that the Federal government is proving difficult to mobilize for the lobbyists.  Secondly, given that the modification would involve a ceding of control by states to the federal government of which restaurants would be allowed to accept EBT cards as payment for food, we believe that the current political mood in Washington – one of smaller government and less federal power – may impede the coalition's progress. 

 

We will continue to monitor this issue closely given that it would represent a possible sales boost for YUM’s ailing U.S. business if things were to change.  As the chart below shows, the number of people depending on this program has been growing steadily for some time, despite the slowdown in June from May (the first month-over-month decline since 2008).  There may come a point where states begin to expand options for the growing ranks of participants in the program, even if the federal government does not move to modify the Farm Bill, as YUM hopes.

 

FOOD STAMPS TAILWIND FOR YUM? - foodstamps

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst



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