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Not Good: SP500 Levels, Refreshed

POSITION: Short Consumer Staples (XLP)


On every duration that matters in my risk management model, this stock market does not look good: 

  1. TAIL (1266), broken
  2. TREND (1247), broken
  3. TRADE (1181), broken 

And it may be becoming “consensus”…


But consensus can remain right, longer than some can remain solvent.


I do not think this is 2008. I think some refuse to learn the Globally Interconnected lessons of 2008.


This is 2011, and my most immediate-term TRADE line of support is now 1117.



Keith R. McCullough
Chief Executive Officer


Not Good: SP500 Levels, Refreshed - SPX

Shorting Italy (EWI)

Position in Europe: Short Italy (EWI)

Into the close of yesterday’s session Keith shorted Italy via the etf EWI in the Hedgeye Virtual Portfolio.  Italy is a country we’ve come back to numerous times on the short side over the last eighteen months. This time around we got a bounce in the etf to opportunistically trade the security over the immediate term TRADE; however over the intermediate term TREND the country will be hostage to its bond auctions, ECB bond purchasing support, and political instability within the larger context of the country’s and Europe’s sovereign debt and bank contagion crisis.


The country’s outsized debt of 120% of GDP remains a persistent worry, yet pressing is that nearly one-third of its €226 Billion planned bond issuance for 2011 is outstanding. This compares to remaining bond issuance in Germany at 23%, France 17%, Belgium 4%, and Finland 4%, for example, according to Bloomberg.


With the Standard & Poor’s downgrading Italy’s credit rating one notch to A with a negative outlook on 9/19, S&P’s first downgrade of Italy since 2006, demand of  Italian government paper, including the yield it will be priced at, will be increasingly dependent on buying from the ECB under its Securities Market Program [SMP] in the weeks ahead.


We’ve noted in previous work that the 6% yield on 10 year government bonds has been a historically significant level for the PIIGS, meaning that a violation of the line to the upside resulted in an expeditious upward run (see chart below).  Italy, like Spain, has maintained a level below 6% since the ECB restarted the SMP on August 8th, and currently trades at 5.55%.  Last week the SMP bought a total of €3.95 Billion of secondary bonds across the Eurozone (without stating which countries specifically), the smallest amount since the program’s restart that saw €22 Billion in purchases in the first week.


Shorting Italy (EWI) - 1. yie


Investment and political risk remain hot topics in Italy. Investors are still questioning the extent to which Italy’s €54.5 Billion austerity package, which was heavily watered down when it was finally approved last month, will cut enough fat to move the dial on its debt and deficit figures. Much of this indecision is enhanced by the lack of credibility in leadership at the top. And if Berlusconi’s previous scandals weren’t enough to tarnish his reputation, allegedly he has a personal feud with his Economy Minister Guilio Tremonti, perhaps the one man that the market is turning to for a credible answer to the country’s fiscal state.


With the help of our financials team we’ve been able to quantify the exposures of European banks to the PIIGS. As the chart below demonstrates, 4 of the 5 listed Italian banks have over 300% of their Core Tier 1 Capital in PIIGS sovereign debt or commercial loans, with the remaining bank at 287%! While this data is stale, as of the 2010 Stress Test results, it nevertheless paints an ugly picture.


Shorting Italy (EWI) - 1. stein


Italy extended its short-selling ban on Wednesday until November 11th.  The Italian etf EWI is composed of 28.4% Financials, followed by 28.0% Energy, and 21.0% Utilities.


Italy FTSE MIB is down -27% quarter-to-date and over the same period 5YR Italian CDS has risen 300bps to 477bps. As the chart below shows, we don’t see downside support until 12,800, or roughly -13.5% from here.


Shorting Italy (EWI) - 1. ftse mib


Matthew Hedrick

Senior Analyst




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




U.S. Consumer spending rose 0.2% in August while incomes declined 0.1%.  The personal savings rate declined to 4.5%, the lowest level since 2009.




The downward trajectory of corn prices is leading the food processor stocks higher.






YUM’s stock is getting a shellacking on growth concerns in China.  Some of the entry points on the long side of YUM have come at similar times in the past. 


The coffee category is getting crushed, declining 8 of the last 10 days.  At the time of writing the DNKN Black Book, we believed that the coffee stocks were in a bubble and we still believe most stocks within that universe are overvalued – particularly DNKN.


DNKN was initiated “New Hold” at Argus Research.


PZZA saw a big franchisee go bankrupt this week.  Essential Pizza, which operates 72 Papa John's in Minnesota and Colorado, went bankrupt this week after its secured creditor, GE Capital, appointed a receiver who quickly froze the company's funds.  The franchisee has laid the blame at the franchisor’s door, claiming that the company sold defective dough to the Essential Pizza.


PNRA’s third “pay-what-you-wish” café in Portland, Oregon has not gone as well as the two prior social experiment/PR projects in St. Louis and Detroit.  The west-coast iteration, not surprisingly, has attracted homeless and impoverished customers that have taken advantage of the company’s generosity and hospitality.


SBUX CEO "No summer slowdown"




DRI, BJRI, and KONA all declined sharply on strong volume studies.


RT was the standout on the upside yesterday for casual dining.





Howard Penney

Managing Director



Rory Green


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The Macau Metro Monitor, September 30, 2011




Grand Korea Leisure (GKL), a junket operator based in Seoul and runs Seven Luck casino, has stopped extending credit to mainland Chinese high rollers.  GKL, which has a small Macao operation, said the move was temporary and a repeat of a “credit clearing” exercise that saw it halting VIP credit for two months last year.  It did not give a specific reason for the latest move.


A junket operator in Macao said he was not aware of rivals experiencing a credit crunch. However, he had heard of mainland Chinese investors pulling capital from their investments because of monetary tightening at home.  “There are many wealthy factory owners from the east coast of China who have been making good returns from Macao simply by lending money to junket operators in return for 1-1.5 per cent in monthly interest. They have seen Macao as a profitable sideshow to their real business, which is experiencing a slowdown. However, some of them are in need of cash at home and have trouble borrowing from banks. So they are cashing out from Macao,” he said. So far, this only had a limited impact on the junket operators, he added, as they were still seeing strong growth in business.

Get Ready

“The readiness is all.”

-William Shakespeare


You have to give it to William Shakespeare, he had a way with words.  Just as Canadian hockey players have a way with understatement.   When it comes to the daily global macro market grind, Shakespeare’s quote above about says it all.  You are either ready; or you are not ready.  It is really that simple.


I’ve recently been reading, “How Markets Fail”, by John Cassidy.  I wouldn’t say I agree with all of Cassidy’s observations in the book, but he does offer some interesting anecdotes regarding markets and prevailing wisdom.  Near the end of the book, Cassidy takes a break from analyzing markets and describes the origin and construction of the Millennium Bridge in London.


As background, in 1996, the London Borough of Soutwark, the Royal Institute of British Architects, and the Financial Times newspaper held a competition to build a new footbridge from the Tate Modern Art Gallery to St. Paul’s Cathedral, which, of course, would cross the Thames.  The winning bid ultimately came from sculptor Sir Anthony Caro, architect Sir Norman Foster, and the engineering firm of Ove Arup. 


The winning entry was a spectacular design “with steel balustrades projecting out at obtuse angles from a narrow aluminum roadway.”  The designers insisted that the unique looking bridge could support at least five thousand pedestrians.  So, on June 10, 2000, just in time for the Millennial, the bridge was opened up by Queen Elizabeth II with much fanfare and thousands of pedestrians started to walk across the bridge.


The bridge began to immediately sway causing pedestrians to cling to the sides of the bridge and created what has been described as a sea sick feeling amongst those who traversed it.  Two days later, London authorities quickly shut the bridge down for an indefinite period, concerned about the stability of the bridge and safety of pedestrians utilizing it.


After studying the issue, the engineers at Ove Arup concluded that the issue was with the pedestrians and not due to the actual design of the bridge.  In part, the engineers were correct.  The bridge had been designed to gently swing to and fro, but what the designers didn’t account for was that pedestrians would exaggerate these movements in unison as they walked across the bridge.  Arguably, the engineers’ design was not ready.


The natural movement of walking produces a slight sideways force.  Thus as hundreds, even thousands of pedestrians walked across the bridge, they unwittingly created a unified sideways force that amplified the movement of the bridge.  In effect, the natural wobble of the bridge became self-reinforcing and fed on itself.  The savvy engineers at Ove Arup even came up for a name for this action, called “synchronous lateral excitation”. 


In preparing you for the market action in the coming quarter, one of our Q4 themes will be related to this idea of “synchronous lateral excitation”.  In global markets, currently, this concept is increasingly related to heightening correlations across asset classes.  In some instances, this heightened correlation applies to even seemingly unrelated asset classes.  Simply put, investors are increasingly acting in unison, which is amplifying price movements across markets and amplifying future risk. We’ve termed this, the “Correlation Risk” in previous notes.


Interestingly, though, even as cross-asset correlations are heightening globally, there are seemingly outlier markets that remain less correlated.  According to recent report from Bloomberg:


“The 30-day correlation coefficient between the S&P 500 Financials Index and the banking group in the Stoxx Europe 600 Index has averaged 0.65 in 2011, according to data compiled by Bloomberg. The figure for European banks and Japan's Topix Banks Index is 0.25.”


Yes, you read that correctly.  Japanese banks are becoming a global safe haven.  Were you ready for that? 


My colleague, and Hedgeye Asian analyst, Darius Dale recently updated his thoughts on Japan in a presentation.  A key takeaway is that in the last three years U.S. policy makers have been much more Japanese than the Japanese in terms of monetary policy.  In fact, not only did Chairman Bernanke and his associates cut rates more aggressively from the outset of the financial crisis, they have also leaned more heavily on the balance sheet of the central bank than their Japanese counterparts.


Interestingly, and related to the topic of global banking risk, this morning credit default swaps on Morgan Stanley reached a new cycle high of 455 basis points from 275 basis points at the end of August.  In effect, Morgan Stanley is now seen to be as risky a credit as the Italian banks.  Are you ready for that?


Part of increasing correlation between global markets is and has been the advent of increasing economic globalization and integration.  In 2011, it is truly a global economy.  This morning, the Chinese HSBC manufacturing PMI came in at 49.9, which is sub 50 for the third straight month.  The immediate reaction to this tepid manufacturing number from China can be seen in European equities off 1.5 – 3.0% across the board.  The German Dax is leading the way to the downside as a German lawmaker spoke out against an expanded EFSF.


The Hedgeye team has certainly tried to do our best to alert our subscribers as to the dismal outlook for equities this year and this quarter.  To that point, with the last trading day for Q3 2011 today, the SP500 is down -12.1% quarter-to-date. Based on the performance of the SP500 and some broad hedge fund return numbers we have seen, there is another risk to be ready for: fund redemptions.  Redemptions are never fun to talk about, but they are an unfortunate reality in this business that can impact asset prices.


Hopefully this note isn’t too somber heading into the weekend, but as Shakespeare also said:


“Better three hours too soon than a minute too late.”


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Get Ready - Chart of the Day


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