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Theory vs Practice

This note was originally published at 8am on October 04, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“In theory there’s no difference between theory and practice, but in practice there is.”

-Yogi Berra

 

In theory, money printing and piling more debt-upon-debt was going to save the world’s biggest banks. In theory, Old Wall Street had Ben Bernanke’s back on +3-4% US GDP Growth for 2011. In theory, the Yankees should have beaten the Detroit Tigers last night too.

 

Then again, I’m a conflicted, compromised, and constrained Yankee fan – and with that theory, I may as well be a Keynesian this morning. In practice this is called marked-to-market risk management and the question this morning isn’t an ideological one – it’s, what do you do?

 

When I joined the hedge fund elite 12 years ago, I didn’t have to have a Global Macro view. Today, I do. In practice, this game of Globally Interconnected Risk is A) always on and B) always changing. Today, I have to play the game that’s in front of me.

 

Back to the Global Macro Grind

 

Immediate-term TRADE oversold is as oversold does. Today we’ll register the 3rdShort Covering Opportunity we’ll have called for in the last 2 months (the 1st call we made to cover shorts on August the 8th, 2011).

 

Here are the US Equity, Commodity, Currency, and Fixed Income factors that help me decide what we do now: 

  1. The SP500 is immediate-term TRADE oversold in the 1180-1197 range
  2. The Volatility Index (VIX) is immediate-term TRADE overbought at 47.11
  3. This is the first day in the last 6 trading days in US Equities where there’s more immediate-term upside vs downside
  4. The US Dollar Index is immediate-term TRADE overbought at $79.43
  5. The Euro/USD pair is immediate-term TRADE oversold at $1.31
  6. WTIC Oil is immediate-term TRADE oversold at $76.19
  7. Copper is immediate-term TRADE oversold at $2.95/lb
  8. US Treasury Yield Spread is putting in an oversold YTD low of 153 basis points wide
  9. US Treasury 2-year Yields are holding immediate-term TRADE support of 0.21%
  10. Goldman is cutting their Global Economic estimates across the board 

On top of the price/volume/volatility signals that help construct the 10 aforementioned factors in my model, we have a very newsy event on the tape with Deutsche Bank’s CEO (Ackerman) guiding Q3 down, big time.

 

In theory, this is all bad. In practice, a lot of what Goldman and Deutsche Bank are saying isn’t in the area code of what Hedgeye clients would consider new. Our Managing Director of Financials research, Josh Steiner, has been bearish on the banks since February.

 

The US Financials ETF (XLF) is down -29.3% for the YTD. That’s called a crash – and it’s readily apparent in the rear-view mirror. So is the SP500 having collapsed -29.8% and -19.4% from their October 2007 and April 2011 easy-money highs.

 

Today is a day to notice what no one will be focused on. In theory, your Risk Manager should have a process to impute everything that’s happening in the world as of last price. In practice, most money managers will be freaking out this morning making emotional decisions.

 

Capitalize on that.

 

What do I see that’s better than bad that people aren’t talking about this morning? 

  1. South Korean inflation (CPI) dropped sequentially to +4.3% for SEP versus +5.3% in AUG (on the margin that’s not bad)
  2. Chinese non-Manufacturing PMI rose sequentially to 59.3 for SEP versus 57.6 in AUG (China is not collapsing, yet)
  3. USA’s ISM report for SEP rose sequentially (month-over-month) to 51.6 versus 50.3 in AUG (Growth Slowing? not new) 

Again, I’m not calling for a new bull market. Neither am I saying that Growth Slowing has ended. I am simply suggesting that you see this for what it is in most things US Equities (and some things Asian and European Equities) this morning – a Short Covering Opportunity.

 

My immediate-term support and resistance ranges for Gold, Oil, Germany’s DAX, and the SP500 are now $1554-1672 (Gold is now bearish TRADE and TREND), $76.19-81.09 (Oil remains in a Bearish Formation – bearish on all 3 of our risk management durations), 5091-5439 (that TRADE line break in the DAX yesterday mattered), and 1080-1130, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Theory vs Practice - Chart of the Day

 

Theory vs Practice - Virtual Portfolio


THE HEDGEYE DAILY OUTLOOK

THE HEDGEYE DAILY OUTLOOK

 

TODAY’S S&P 500 SET-UP - October 7, 2011

 

Short Covering Opportunities are what they are – we had a big one this week. Now it’s time to manage the downside risk again.  Whispers were bountiful yesterday about a better than “expected” unemployment report. That will surprise me if it comes to fruition. From these levels in macro markets, that’s now a liability for the bulls if it doesn’t.  The Hedgeye S&P model is looking for jobless claims to re-accelerate in the coming weeks to 465,000-475,000 range.

 

As we look at today’s set up for the S&P 500, the range is 27 points or -1.71% downside to 1145 and 0.60% upside to 1172

 

SECTOR AND GLOBAL PERFORMANCE

 

Three days and +5.9% higher than the YTD closing low (1099), once again, the shorts have been squeezed.

 

But will there be follow through?

 

Tomorrow we have a Game Time catalyst with the employment report and there’s a gaping hole down to 1101 support, so stay tuned…

 

Nothing has really changed in the Sector Risk model other than seeing a continued (and healthy) rotation toward sectors that I think would benefit most from a Strong US Dollar (Consumer Discretionary and Technology – both are now bullish on our immediate-term TRADE duration).

 

Deflating The Inflation is good for consumption

 

The only sector that remains bullish from an intermediate-term TREND perspective is Utilities (XLU) and we are long that.

 

THE HEDGEYE DAILY OUTLOOK - levels 107

 

THE HEDGEYE DAILY OUTLOOK - daily sector view

 

THE HEDGEYE DAILY OUTLOOK - global performance

 

 

EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: +2132 (+705) 
  • VOLUME: NYSE 1117.43 (-6.45%)
  • VIX:  36.27 -4.07% YTD PERFORMANCE: +104.34%
  • SPX PUT/CALL RATIO: 1.70 from 1.91 (-11.08%)

 

CREDIT/ECONOMIC MARKET LOOK:

 

  • TED SPREAD: 38.78
  • 3-MONTH T-BILL YIELD: 0.01%
  • 10-Year: 2.01 from 1.92     
  • YIELD CURVE: 1.72 from 1.67

 

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30 a.m.: Non-farm payrolls, est. 55k, prior 0k
  • 9:30 a.m.: Fed’s Fisher speaks on U.S. economy in Dallas
  • 10 a.m.: Wholesale inventories, est. 0.6%, prior 0.8%
  • 10:45 a.m.: Fed’s Lockhart speaks on economy in Atlanta
  • 1 p.m.: Baker Hughes rig count
  • 3 p.m.: Consumer credit, est. $8b, prior $11.965b

 WHAT TO WATCH:

  • Employment in U.S. probably gained 55k last month, economists estimate, not enough to bring down unemployment rate of 9.1%.
  • U.K. bank ratings cut by Moody’s after agency concluded government less likely to provide support.
  • Global investors like Mitt Romney better than any other U.S. presidential candidate, though cool to Republican field in general
  • President Obama hosts Prime Minister of Tunisia Beji Caid Essebsi

 

COMMODITY/GROWTH EXPECTATION                                                                    

 

COPPER – nice rally for the Doctor but, like Asian Equities, it’s simply a short squeeze from immediate-term oversold lows. Most of the manic media was running Copper charts at the bottom last week, but we have been signaling Copper’s having broken its TREND since late-July early-August. That has not changed – TRADE and TREND lines of resistance for Copper now 3.44 and 4.18.

 

THE HEDGEYE DAILY OUTLOOK - daily commodity view

 

 

MOST POPULAR COMMODITY HEADLINES FROM BLOOMBERG:

 

  • China Baby-Formula Maker Buying Arsenic Debt Shows Trust Risks
  • Copper Traders Turn Most Bullish in Six Weeks on China’s Demand
  • Gazprom Extends Drought on Two-Year High Spread: Russia Credit
  • Rio, Ivanhoe Halt Mongolian Bid to Raise Oyu Tolgoi Stake
  • ‘Resilient’ Gold Set for Record Rally, Morgan Stanley Says
  • Oil Set for First Weekly Gain in Three Before U.S. Jobs Report
  • Gasoline Declining to Eight-Month Low on Economy: Energy Markets
  • Gold Heads for First Weekly Increase in Five as Equities Rally
  • Malaysia’s Export Growth Quickens on Higher Sales of Commodities
  • Oil May Fall Next Week on European ‘Downside Risks,’ Survey Says
  • Oil Trims First Weekly Advance in Three Before U.S. Jobs Report
  • Worst Oil Industry Slump Since Lehman May Herald Takeovers
  • Gold May Gain a Third Day on Economy Concern, Physical Purchases
  • Palm Oil Set for Third Weekly Loss on Rising Malaysian Inventory
  • Thai Rice Prices Unlikely to Remain High, Riceland’s Vichai Says

CURRENCIES                                                                             

 

FX: EUR/USD bumping up against a wall of resistance 1.34-1.37

 

EURO – I re-shorted it yesterday into the close at my 1st line of immediate-term TRADE resistance (1.34); there is a wall of resistance overhead with the most impt line being the EUR broken TAIL of 1.39. My highest conviction Global Macro position remains long US Dollar.

 

THE HEDGEYE DAILY OUTLOOK - daily currency view

 

 

EUROPEAN MARKETS

 

EUROPE: wet kleenex day across the board with no tangible bazooka timing - Belgian and Swiss stocks leading Europe lower (banks)

 

THE HEDGEYE DAILY OUTLOOK - euro performance

 

 

ASIAN MARKETS

 

ASIA – tail ends of the squeeze in every market that is still in crash mode (Hong Kong, Korea, Japan, etc) effectively failed at all of my immediate-term TRADE lines of resistance – for HK that’s 18,728; KOSPI 1797; and Nikkei 8777.

 

THE HEDGEYE DAILY OUTLOOK - asia performance

 

 

MIDDLE EAST

 

THE HEDGEYE DAILY OUTLOOK - MIDEAST PERFORMANCE

 

 

 

Howard Penney

Managing Director



Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.65%
  • SHORT SIGNALS 78.63%

Stupid Easy

“It’s not supposed to be easy. Anyone who finds it easy is stupid.”

-Charlie Munger

 

That’s one of the quotes Howard Marks uses to introduce his thought about what he calls “Second-Level Thinking” in his book that I just finished reviewing – “The Most Important Thing.”

 

People on Old Wall Street really don’t like being called stupid. They don’t like being called monkeys either. Both on the ice and in this Globally Interconnected Arena of risk management, I’ve been called plenty of names. It’s what gets me up in the morning.

 

Name calling isn’t nice. Neither is lying to people or blowing up their money. In some conflicted and compromised research report, this game looks gentlemanly. On the front lines though, this game is far from polite. It isn’t easy either.

 

Managing risk isn’t about getting a guy to call you with a whisper about this morning’s unemployment report. Neither is it about assuming we all know what we don’t know. It’s about embracing uncertainty, then considering scenario analyses, probabilities, and ranges. You don’t have to be a contrarian all of the time – but, some of the time, you need to play this game to win.

 

“Of course, it’s not that easy and clear cut … if your behavior is conventional, you are likely to get conventional results… Only if your behavior is unconventional is your performance likely to be unconventional.” (Howard Marks, The Most Important Thing)

 

Back to the Global Macro Grind

 

This morning’s setup across Global Macro is much more concerning to me than the one we were staring down the barrel of on Tuesday morning. Given that most of Asia and Europe was crashing and the S&P futures were trading at 1078 in the pre-market, that probably sounds like an unconventional thing to say.

 

Unconventional is as unconventional does. Covering shorts and buying that opportunity was too.

 

Today, after 3 consecutive days of The Pain Trade (short covering), all of Asia, Europe, and the US have rallied between +5-10% “off the lows.” The S&P futures are +5.9% from the YTD closing low (Monday, October 3rd 2011 = 1099), and if I had a Canadian Loonie for every email and tweet I’ve had that this US unemployment report is going to be “better than expected”, I’d pay myself for once.

 

I know. It’s unconventional for generals in this industry to eat last. It’s unconventional to be yourself instead of who you are supposed to be. It’s also been unconventional to have said Growth Slowing would be the 2011 call that needed to be made. If my behavior has sounded too “confident” or whatever it is that mediocrity calls success in this country these days, so be it.

 

Looking across my Global Macro factors this morning, here’s why I say start selling again today:

  1. Japan’s Nikkei’s 3-day rally failed at TRADE line resistance of 8777 and remains in crash mode
  2. Hong Kong’s rally failed at TRADE line resistance of 18,918 (Hang Sang) and remains in crash mode
  3. South Korea’s squeeze failed at TRADE line resistance of 1797 and remains in crash mode
  4. British banks are breaking down again and the FTSE remains in a Bearish Formation (bearish TRADE, TREND, TAIL)
  5. Belgium and Switzerland have taken over Europe’s negative divergences for this morning (big bank exposures for both)
  6. Russia’s Trading System Index rallied to another lower-high and is down -39% since April when US stocks peaked
  7. Oil prices remain in a Bearish Formation despite another bounce to lower-highs
  8. Copper prices remains in Bearish Formation despite a big short squeeze from a very newsy September oversold low
  9. Gold is now bearish TRADE and TREND for the 1sttime in forever with TREND line resistance up at $1673
  10. SP500’s TRADE, TREND, and TAIL lines of resistance (Bearish Formation) = 1182, 1237, and 1266, respectively

So that’s just the Top 10 unconventional calls you could have been making for the last 3-6 months. If you back this up to when we bought the Growth Slowing Trade (Long the US Treasury Flattener (FLAT) in February) you’ll see a lot of Global Equity prices put in their 2-year cycle peaks in February of 2011, not April.

 

And while its conventional to call out the SP500 as having “staved off a bear market” this week (because it didn’t violate the -20% crash signal; it was down -19.4% on Monday’s close), its unconventional to remind the bulls that Financials (XLF), Industrials (XLI) and Small Caps (Russell2000), have all crashed already in 2011 anyway.

 

Can the market rally on hope? For sure. It just did. But what do you do right now? If this unemployment number is better or worse than expected, my Stupid Easy hockey head answer will remain the unconventional one for 2011 – sell.

 

My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1, $75.92-85.11, and 1101-1172, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Stupid Easy - bearish formation

 

Stupid Easy - virt. port


G2E KEY TAKEAWAYS

BYI was probably the standout – at least relative to expectations.  Not much to cheer about yet but slot sales should pick up next year.

 

 

General Takeaways 

  • The pricing environment was going to be more sensitive this year so even if manufacturers raise prices they are going to give away more discounts/ promotions in the form of aggressive rebates.  We heard that IGT was running a 3 day promotion where if you turned in an old IGT machine, they would give you a $7k credit towards an MLD.  Konami and ALL aren’t raising prices this year.  Konami is running a trade-in promotion where you get $2,500 either by turning in the machine or just removing old machines from the NA market.
  • Everyone has wheels and the participation market is going to remain hyper competitive; this is not good for IGT despite their good content. On the bright side, IGT is becoming much more efficient in repurposing existing participation real estate.
  • Everyone is focused on iGaming down the road and the 500 pound gorilla issue of how to attract a younger player to the slot floor.  Almost everyone had some sort of “skill” based element built into their bonus rounds on the progressive games.
  • Video Poker is gearing up for a replacement cycle and WMS intends to compete.  Either way, a replacement cycle will be good for IGT – over 100k of their Video Poker games are on the 8960 platform which is over 9 years old.
  • 3 Reel Spinners are also coming up for a replacement cycle so there is more attention on the R&D front there from several manufacturers- BYI, IGT and Konami
  • WMS isn’t broken per say but will take a few quarters to get back on the right path
  • Greece will be a good opportunity for the US manufacturers but not in Phase 1 since OPAP is highly likely to pick Novamatica and LTO as their 2 suppliers for the first 16k games
  • A few small guys continue to make traction – ARUZE and AC Coin
  • A pick up in the replacement cycle of any material magnitude remains illusive although that’s offset by the likelihood of good news coming out of new jurisdictions like IL and MA by year end

WMS

 

We walked away from the conference feeling a little better about WMS.  That said, they have a tough 2 quarters ahead of them and may miss expectations.  

 

What went wrong?

  • WMS got carried away with putting 'too many apps' in the box without considering the tough environment.  They looked too far out and not at what clients want now.
  • WMS developed games without consideration for regulatory approval and therefore, shot themselves in the foot since they had already built investor expectations on meeting certain release dates.  By getting stuck in the regulatory cogs, they had no product to refresh aging and waning game ops titles.
  • As they got larger, they experienced growing pains in logistics by taking their eyes off what they do best–game R&D
  • In the meantime, the economy got worse, customers got more price sensitive, competition got more fierce and WMS had no new product.
  • Delays delays delays:  IL VLTs, Italy, Portal Apps, Game Ops approvals

 

However, WMS has simplified their products and is much more focused on delivering gaming ops content over the next twelve months. Also, WMS has a new cabinet in the works that looks like a pinball machine with just a flat screen.

 

IGT

 

Leveraging their platforms with lots of new content has saved them a lot of money on R&D.  The cost to refurbish some of the game ops boxes dropped a few hundred from $4,500.  IGT is basically just sticking with what they do well – developing good product and taking advantage of developing content for an aging install base of 3 Reels spinners and Video Poker.

 

Their message was "expect more" – offering a lot of core for sale product with lots of new titles.  New G23 cabinets with the new MLD that has sharper graphics (photo realistic images) has been out since Feb 2011. They have 55 titles, many of which clone math models which already work well on their top games.  Other ones have new game and play mechanics.  85% of their content is available on MLD formats.

 

IGT has been refocusing on 2 markets that haven't had new content in a while – 3 Reels and Poker. They have an install base of 130,000 video poker games, 100k of which are on the old 8960 platform.  IGT is also introducing a premium for-sale product where they sell the base game and then charge $10/day for each device linked to the bank.  This looks like a response to WMS's portal applications.

 

BYI

 

BYI has been making good use of their iDeck to introduce new skill like components to bonus rounds.  By leveraging their systems with more software products, it looks like they may finally get some traction with iVIEW DM which would be great for growing their recurring revenues.  BYI is also the leader in TableView technology.  They are addressing the issue of investors being concerned that they are too dependent on reels with more video product and the Pro-Curve product.

 

ALL

Aristocrat is focusing on delivering a lot more content to the Verve content on the Game Ops side.  They have a new reel product called Hybrid Steppers, which has transmissive like functionality during bonus rounds.  ALL's pricing on for sale products is likely to be static aside from paying more for some new features like the LED buttons.

 

Konami


Konami is putting more focus on video and not raising prices.  They expect to see an increase in sales YoY again this quarter but sees no general pick up in replacements.



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