prev

The Only Wall Street Strategy Note Without the Name Of A 1960s Dance In It This Morning

“We can never be gods, after all--but we can become something less than human with frightening ease.” 

-N.K. Jemisin, “The Hundred Thousand Kingdoms”

  

I think we can all be thankful for one thing this morning: we no longer have to talk or joke about “The Twist”.  The current Federal Reserve Board once again proved their incompetence as it relates to managing the monetary affairs of the nation.  Not only did the stock market not twist, or torque (as Morgan Stanley so calls it), it tanked. 

 

Yesterday actually harkens back to the heady days of 2008 when former Secretary of the Treasury, Hank “The Market Tank” Paulson, would get on T.V. to ostensibly calm the markets and inadvertently talk the Dow down a few hundred handles. 

 

We’ve said it once, and we’ll say it again, the best action that the Federal Reserve can take is to stop what they are doing.  QE 1 was ineffective, QE 2 was ineffective, and QE 2.5 Twistaroo will not work either. 

 

As The Economist wrote back in March 2011:

 

“Operation Twist has long been considered a failure. Early studies found little impact on yields, vindicating those who argued that the price of a security depends only on expectations—of inflation, for example, or monetary policy—not its relative supply.”

 

Not only did QE1 and QE2 not work, but The Twist itself was tried before in 1961 and deemed a failure.

 

In case you missed the Fed’s announcement yesterday, or have just decided to tune the Fed out, I’ll explain their intention.  The plan is for the Federal Reserve to buy $400 billion of bonds with maturities of six to 30 years, while at the same time selling an equal amount of debt maturing in three years or less.  These actions will occur between now and next June.

 

Ostensibly, the intention of such an action would be to narrow the yield curve and bring down long term interest rates.  Undoubtedly the Fed Heads are hoping this will lead to a rash of mortgage refinancing, which will free up cash for consumers to spend.  This idea is cool in the theories of macroeconomic textbooks. . . unfortunately real life is not theoretical.  This action actually has very negative implications for an already tenuous global banking sector.

 

Simply, a narrowing of the yield curve hurts financial stocks.  The cash flow of financial companies is driven by a funny little critter called net interest margin, or NIM.  Banks borrow short and lend long, and thus collect a spread on the transaction.   As the yield curve naturally narrows, or forcefully narrows by Keynesian intervention, the margins for banks compress. 

 

Our Financials Team, led by Josh Steiner, actually discussed this very topic a few weeks via a 65+ page in-depth study on the topic (ping if you’d like to trial our Financials vertical and receive access to the deck and Steiner’s team for dialogue).  In the Chart(s) of the Day today, we borrowed two charts from Steiner’s presentation.  The first chart shows that asset yields for the major banks, Bank of America, JP Morgan, Citigroup, and Wells Fargo specifically, track the 10-year yield with a very high correlation.  So, as 10-year yields decline, so too do asset yields for major banks.  In the second chart we show the potential impact on margins.  In short, as we think 2012 earnings estimates for the major banks could get cut in half.

 

The credit default swap markets for the major banks reacted as we expected yesterday and widened dramatically.  Specifically:

  • Bank of America 5-year CDS widened 11.7% to 372 basis points;
  • Wells Fargo 5-year CDS widened by 12.6% to 142 basis points;
  • Citigroup 5-year CDS widened by 12.5% to 260 basis points;
  • Morgan Stanley 5-year CDS widened by 12.0% to 355 basis points;
  • JP Morgan 5-year CDS widened by 10.6% to 146 basis points.

It’s worth mentioning that Moody’s came out and downgraded the long-term credit ratings of Bank of America and Wells Fargo, citing, “an increased likelihood that the federal government allows a large U.S. bank to collapse.” We’re not so sure how much, if at all, impact this had on the credit markets, given that: a) ratings agencies are lagging indicators and b) the results of allowing a “large U.S. bank to collapse” didn’t go so well the last time (Lehman Bros.).

 

As indicated by the moves in the CDS markets, the irony is that the Fed’s actions yesterday negatively impacted the creditworthiness of major banks and, no doubt, their willingness to more aggressively extend loans and credit. 

 

For those of you that aren’t applying for Canadian passports after the Fed’s actions yesterday, we are hosting call at 11am eastern today titled, “What’s Next for the Eurozone?”  Akin to the idea of being the tallest dwarf, the intermediate term future looks increasingly negative for Europe, which on a relative basis actually makes the U.S, in particular the U.S. dollar, look good.

 

On the call today we are going to spend time going through the history of the European Monetary Union, discuss the lead up to the beginning of the sovereign debt crises, as well as potential outcomes.  A key focus on the call will be on the exposures of the European banking sector to PIIGish sovereign debt.  In some instances, these exposures make subprime look like a speed bump.

 

We will be sending the presentation and dial in materials for the call to our clients later this morning, but if you are not a client and would like to trial our institutional service then please email our head of sales, Jen Kane, at .  Jen recently returned from maternity leave and would love to chat with you.

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

The Only Wall Street Strategy Note Without the Name Of A 1960s Dance In It This Morning - 1

 

The Only Wall Street Strategy Note Without the Name Of A 1960s Dance In It This Morning - 2

 

The Only Wall Street Strategy Note Without the Name Of A 1960s Dance In It This Morning - Virtual Portfolio


Unconscious Anchoring

This note was originally published at 8am on September 19, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The anchoring-and-adjustment heuristic, as it is called, is unconscious.”

-Dan Gardner

 

I sold into the end of Friday’s 3-day rally, taking the Hedgeye Portfolio to 11 LONGS and 8 SHORTS. Last Tuesday, I held my longest net long (longs minus shorts) position of Q3 2011. Short Covering Opportunities are fun when you get them right.

 

Do not confuse a Short Covering Opportunity with a change in the intermediate-to-long-term fundamental reality that Global Growth Slowing is here to stay as long as the market keeps begging for Keynesian policy to bail us out. Remember, Big Government Intervention does two things to your markets and your lives: 1. Shortens Economic Cycles and 2. Amplifies Market Volatility.

 

Put another way (in Hedgeye speak), do not confuse a TRADE (immediate-term) with a TREND (intermediate-term) or TAIL (long-term). Since there is neither responsibility in Old Wall Street recommendations or an ability to be what we call Duration Agnostic when considering risk, you need to capitalize on the Sell-Side’s propensity to anchor on intermediate-term TRENDs, after they have occurred.

 

In “Future BabbleWhy Expert Predictions Fail and Why We Believe Them Anyway” (2010), Dan Gardner does a nice job simplifying this behavioral economics  concept of “anchoring” by citing The Wheel of Fortune Experiment by Daniel Kahneman and the late Amos Tversky. 

 

“Kahneman and Tversky showed that when people try to come up with a number, they simply do not look at the facts available and rationally calculate the number. Instead, they grab onto the nearest available number – dubbed “the anchor” – and they adjust in whichever direction seems reasonable. Thus, a high anchor skews the final estimate high; a low anchor skews it low.” (Future Babble, pg 100)

 

That’s Old Wall Street.

 

Using the #1 risk factor that we’ve been hammering on for all of 2011 (Growth Slowing), here’s how this looks from a Wall Street/Washington Strategist or “Economist” perspective: 

  1. Nearest Available Numbers: Q1 2010 US GDP = 3.94% and Q2 2010 US GDP = 3.79%
  2. Old Wall Street’s Adjusted 2011 US GDP Estimates (in Q1 of 2011) = up +3-4% GDP Growth for 2011-2012
  3. Actual Q1 and Q2 2011 US GDP numbers (subject to 30-81% downside revisions) = 0.36% and 0.98%, respectively 

And, kaboom.

 

But, but, but… this year’s -18% peak-to-trough drawdown in US Equities from the April 2011 peak was all about a tsunami in Japan and Europigs not getting their fiscal houses in order, right?

 

Right. Right.

 

So now Old Wall Street is cutting both their Global and US GDP Growth forecasts to the NEAREST AVAILABLE NUMBERS and we’re, as our friends in the media like to say, “off the lows”, with a nice +5.4% Short Covering Opportunity in the SP500 last week.

 

Nice. Really nice.

 

What else happened week-over-week that caught my craws attention: 

  1. US Dollar TRADE and TREND breakout holds support (this is new)
  2. CRB Commodity Inflation continues to break down (at the beginning of Q2 we called this Deflating The Inflation)
  3. As US Treasury Yields finally make higher-lows, Gold continues to make lower-highs (they are inversely correlated) 

So what did I do with that? 

  1. I made the US Dollar Index a 6% position in the Hedgeye Asset Allocation Model (UUP)
  2. I sold my long Silver position and remain very cautious on all commodity long positions other than Corn (CORN)
  3. I traded a proactively predictable range in the SP500 as its bullish on one duration (TRADE) and bearish on the other (TREND) 

If I have said this 10x in the last week in meetings and on the phones with clients, I have said it a 1000x in the last 3 years. The best path forward for American prosperity is via a strong US Dollar.

 

Strong Dollar Deflates The Inflation. Period. That’s why the US Consumer stocks act a lot better than the Financials and Industrial stocks. Some stocks might, but this country is not going to recover on “cheap exports.” The 71% of the economy that matters = US Consumption. Strengthen the US Dollar and rates of “risk-free” returns on savings accounts and we solidify American income and consumption.

 

If you’re holed up in some Old Wall Street Sell-Side office on Park Avenue and don’t get that trade, take a walk outside and ask an American retiree how he or she feels about The Mucker Plan – a strong US Dollar in the hand is better than a snaky Geithner and a Keynesian Europig in the bush. Anchor on that.

 

My immediate-term support and resistance ranges for Gold, Oil, Germany’s DAX, and the SP500 are now $$1781-1819, $86.26-90.11, 4891-5652, and 1183-1224, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Unconscious Anchoring - Chart of the Day

 

Unconscious Anchoring - Virtual Portfolio



real-time alerts

real edge in real-time

This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.


ARCO - GAME ON

Having visited Asia and Latin America over the past two weeks, I have been spending more time on the emerging markets stories associates with some of the bigger restaurant names.  In particular, YUM, MCD, ARCO, SBUX and DPZ are all benefiting from the current growth trends.  For the time being, it’s an insignificant part of the DNKN story.

 

The above-trend growth in emerging markets is driven by strong fundamentals including favorable demographics, including a growing middle class, and well-positioned western brands are poised to reap benefits.  In many markets (particularly Brazil and China) the improvement in transactions being seen in the restaurant industry is driven by accelerating wage rates and a burgeoning middle-class.

 

McDonald’s recently indicated that in China the government wants to double wages by 2015 to help sustain the growth of the middle class.  In Brazil, based on an oft-used formula (GDP from 2 years ago + last year’s inflation), Brazil wage rate inflation should rise about 7% in 2011 and about 14% in 2012.

 

One of the best ways to play the emerging markets story is by being long ARCO.   ARCO has the exclusive right to own, operate and franchise McDonald's stores in 19 Latin American & Caribbean countries.

 

The long-term story is supported by management’s extensive operational experience in the region coupled with a strong – perhaps the strongest – brand.  The company also enjoys the benefit of operating within a vast geographic area.  ARCO operates in 19 countries/territories representing a market of approximately 575 million people: bigger than the US, UK, France Germany & Italy combined.  In addition, favorable demographics in the regions will allow for significant unit and same-store sales growth.

 

Over the next five years, the business model for ARCO looks like 9-10% same-store sales growth, 6-7% unit growth and continued margin expansion.  This should lead to 18-20% sales growth and 25-30% EPS growth.  Importantly, all of this can be accomplished from internally generated cash flow. 

 

There are some concerns that offset my bullish stance on the stock.  Brazil represents about two-thirds of ARCO’s EBITDA and the four next largest markets (top five comprise 90% of EBITDA) are Argentina, Mexico, Venezuela and Puerto Rico.  Inflation in both food and labor are a concern, but for the time being, increased transactions, pricing and internal efficiencies are some mitigating factors. 

 

From a MACRO standpoint, ARCO also represents a commodity play insofar as the company’s core markets are sensitive to economic swings, up or down, caused by commodity price moves.  The recent commodity boom has brought significant wealth to Latin American commodity-rich countries.  Our MACRO team is somewhat cautious on Brazil as inflation should trend down and growth should continue to slow through 4Q11 and into 1Q12.  The quantitative set up for the Bovespa is mixed with bullish TRADE; bearish TREND. 

 

Lastly, while the 180 day lockup period ends on October 12th, there definitely is some potential for selling by the sponsors of the IPO. .

 

At 10.7x NTM EV/EBITDA, ARCO is priced for growth but sells at a discount to some of the more US-centric restaurant companies which trade between 15-22x NTM EV/EBITDA.  While the company has the ability to double the unit count it’s is still “a franchisee” which historically have traded a significant discounts to the “franchisor.”  ARCO is trading a slight premium to MCD at 10.2 EV/EBITDA.

 

My take away from meeting management is Buenos Aires was very favorable and I continue to believe that business trends remain robust in all the key markets, while Mexico is still a problem child.  I also believe that a big upside surprise could be the potential geographic expansion outside the core nineteen markets the company currently operates in. 

 

If you need any specific details please feel free to contact me.

 

Howard Penney

Managing Director

 

 

 

 

 

 


LVS INVESTOR DAY: PART 6

US comments

 

 

LAS VEGAS (JOHN CAPARELLA)

  • Market is recovering; FIT is stronger; group is stronger; ADR should be up in 2012 and they are reinvesting in their property to make sure things stay fresh
  • Expect some increase in visitation in 2012 and there will be some increase in airlift into the market
  • 7 months of positive occupancy trend data
  • Since 2007, there were 14,000 new high-end room openings; good news is that there are no new room developments for about 4 years
  • Focused on driving rate
  • This summer's ADR and occupancy trends are very encouraging
  • Group room nights are projected to be 800k compared to 700k in 2008.
  • In 2009, they had 31% comp rooms; 27% comped rooms in 2010 and 7% YTD through July.  Will increase to 9% in 2012 which should help slot play.
  • A $10 increase in ADR will increase hotel revenue by $23MM and EBITDA by $19MM
  • Venetian:  Remodeling sports book by Nov 11, Premuim Suites by 1Q12, clock tower entrance and retail space by 2Q12, casino renovation by 3Q12, and sands expo renovation by end of 2013

 

SANDS BETHLEHEM (BOB DESALVIO)

  • Opened 302 room hotel in May 2011
  • Only 80 miles from Midtown Manhattan
  • Future expansions include: 150k SF retail outlet mall and 50k SF event center
  • Opening 8 stores in Nov 11 and additional 16 stores at Feb 12 Grand Opening; next competing outlet center is 1 hour away
  • Event center opening in May 12 - Livenation will be promoting their facility
  • Leveraging their database to be selectively promotional with their new hotel capacity
  • Baccarat represents 45% of total drop in August
  • They were up 21% YoY in August Table win

 

Q&A

  • They are neutral on online gaming. They believe that i-gaming will negatively impact land based casinos and that it will encourage underage gambling.

Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.

next