Groupthink's Behavior

This note was originally published at 8am on October 11, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Psychologist Irving Janis coined the term groupthink to describe ‘expert’ behavior.”

-Dan Gardner (“Future Babble”, page 109)


When our head of Healthcare Research, Tom Tobin, and I were working at what used to be called Dawson-Samberg (long-time hedge fund that split up) over a decade ago, we were learning what Wall Street “consensus” was by doing. Today, we continue to develop processes to quantify it. This, like any good process, takes flexibility, testing, and time.


Within the context of a long time, “groupthink” is a relatively new phenomena. Irving Janis’ original groupthink research at Yale University didn’t occur until the early 1970s. Since then, it’s been very helpful in analyzing both the military and economic policy mistakes of central planners.


Groupthink can also be applied to analyzing the behavior of short sellers – as in hedge funds – and how and when they make decisions. To be, or not to be hedged – remains the question. With the most obvious of groupthink occurring at the most painful ends of what we call the immediate-term TRADE range.


While it’s hard to believe that Old Wall Street missed making the 2011 Growth Slowing call (after having had the opportunity to review their 2008 forecasting mistakes), it’s even harder to believe that the SP500 can put on a 116 point (+10.7%) move in less than a week and still have so many hedge fund guys trafficking in the same high-short interest hedges.


Believe both.


I remember listening to a friend explain to me that John Paulson was “reducing his exposure to 62% net long” (with leverage) sometime back in early Q3 of 2011 and thinking to myself, that’s not a hedge fund – hedge funds hedge.


But that was just silly young me saying what any prudent Risk Manager should have said about Paulson’s positioning, given my bearish intermediate-term Global Macro view.


After I said it publically on CNBC again in July, I had people do the proactively predictable and tell me I was being whatever they call someone when they are confident in their view. After all, John Paulson is smart. But, then again, so is my team. Market opinions aren’t personal. Neither are the tail risks associated with redemptions and liquidations. It’s all part of the game.


Back to the Global Macro Grind


With the Short Covering Opportunity and the Eurocrat Bazooka Squeezes out of the way, now we can get back to managing risk around newly developed ranges. In the last week, a very important signal has developed on my immediate-term TRADE duration that supports that claim – the SP500 and Volatility have recovered their respective TRADE lines of support and resistance.


What does that mean? First, let’s look at the levels.

  1. SP500 TRADE line support = 1167 and TREND line resistance = 1228
  2. Volatility (VIX) TRADE line resistance = 36.91 and TREND line support = 29.02

Did I just confuse the matter by throwing in another duration (the intermediate-term TREND)? Yes, I did. And that’s the risk management point that we continue to beat the drums on within our process – you have to be able to be Duration Agnostic.


What that means is that bullish is as bullish does for US Equities provided that the TRADE line of 1167 holds. But only to a point (the TREND line of 1228). And with a deep respect for that point, we also have to wake up every morning Embracing Uncertainty – because the minute that 1167 breaks again, we’ll need to be focused on putting our crash helmets back on.


This Globally Interconnected Game of Risk can get even more confusing if you don’t blow out your model to absorbing the uncertainty associated with correlation risks across global markets. Whether they be countries, currencies, or commodities, they’re all there – and they affect Groupthink’s Behavior, big time.


We call that being Multi-Factor in our risk management approach.


So, with a multi-factor (countries, currencies, commodities, etc.), multi-duration (TRADE, TREND, and TAIL) Global Macro model in hand, what do I see going on out there this morning?


Here’s my Top 6:

  1. SP500 bullish TRADE; bearish TREND
  2. VIX bearish TRADE; bullish TREND
  3. Hang Seng in a Bearish Formation (bearish across all 3 durations, TRADE/TREND/TAIL)
  4. Copper and Oil in Bearish Formations
  5. Euro/USD cross in a Bearish Formation with TRADE and TAIL lines of resistance at $1.36 and $1.39, respectively
  6. German DAX bullish TRADE; bearish TREND

I have a lot more than 6 factors in my model – but these are the ones ringing with the most Correlation Risk right here and now. These are my front-runners for managing Global Macro risk.


I have a tremendous amount of confidence in both my risk management model and the 41 people on my team that support its inputs. This confidence is a culture – we are not too proud to change the model’s parameters or throw away the wrong assumptions when they are not working. As prices, volatilities, and volumes change, we do.


Embracing Uncertainty is the furthest thing from what Old Wall Street wants right now. The only certainty I have about that is that Groupthink’s Behavior is going to continue to have performance problems as these markets churn.


My immediate-term support and resistance ranges for Gold, Oil, the German DAX, and the SP500 are now $1640-1679, $80.90-86.41, 5571-5921, and 1167-1198, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Groupthink's Behavior - Chart of the Day


Groupthink's Behavior - Virtual Portfolio

Fragile America

“Mickey Mantle forced us to grow up and see the world as it is, not as we wished it to be.”

-Bob Costas


In one of the more personally introspective books I have read in 2011, that’s how Jane Leavy ends it in “The Last BoyMickey Mantle and the End of America’s Childhood.”


After an 18-year hall of fame career with the New York Yankees (playing in 16 All-Star Games and 12 World Series), Mantle became a missing in action father and husband who effectively drank himself to death by the time he was 64 years old. Everyone in his life could see it coming – no one had the spine to stop him from doing it to himself. The can was kicked.


The aforementioned thought Bob Costas delivered during Mantle’s eulogy was as honest as it was sad. He called Mantle a “fragile hero” (page 382). If that isn’t a metaphor for America’s stock market on this morning in October of 2011, I don’t know what is…


Occupying Old Wall Street


So far, I’ve left Hedgeye’s coverage of this generational protest to my defense partner, Daryl Jones, who is downtown surveying the NYC occupiers this morning. In Mantle’s 1960’s playing days, they called them protesters.


Earlier this week, after strapping on his jeans and mingling with the occupiers in Boston, Hedgeye’s Todd Jordan said the protesters ran the gamut from “end the bailouts” to far left hot points:  environment, war, Che Guevara, etc…


That’s a lot.


I’m not a big fan of judging people and their protests unless I spend enough time to fully understand them. My Dad was a Fire Chief; my Mom a French school principal; and I’m supposed to be whatever people want to call me today. But I’m not an expert on humanity.


I don’t support losers. What I support is progressive change. And no matter how leaderless or hippie these protesters appear on the surface, I think there’s an American Zeitgeist here that’s playing out far away from anything you’ll see today on TV – in silence.


Abraham Lincoln wasn’t a member of PETA, but this is what he said about leadership:


“To sin by silence when they should protest makes cowards of men.”


And, forgetting all of what you think about who is a nut-bar, always remember that someone probably thinks you have a few screws loose too. I think starting my firm is an explicit protest against the opacity and self handed dealings of Old Wall Street. I don’t need to analyze someone who is sleeping on a cardboard box with dreads to tell me what I think about that.


I have no confidence that Occupy Wall Street will find a leader today, but I have even less confidence that Old Wall Street will. That’s pathetic and sad.


At 910AM, our profession will be waiting with baited breath on Timmy Geithner telling us what he’s been groomed to do for 47% of his born life in US Government - bailout banks.


That’s not leadership. The Bailout Bazooka only quenches America’s stock market thirst for another stiff drink. We have a problem – a very big one. And, sadly, it might take another crash to correct it once and for all.


Back to the Global Macro Grind


Yesterday, an up and coming Fed President in Minnesota by the name of Kocherlakota said that “the public will begin to doubt the Fed’s claims about its goals.”


Ya think?


That’s what we should be protesting in this country. The US Federal Reserve and its Keynesian ideologies have failed America on its 2 Congressional mandates – full employment and price stability.


I’ll be going through what I think the solution to this mess is on our Q4 Macro Themes conference call at 11AM EST today (email if you’d like to participate).


Fundamentally, I believe in what both Reagan and Clinton had fits and starts of realizing – a strong US Dollar strengthens American confidence, buying power, and employment.


I don’t believe that because some global warming quack is occupying this morning. I believe that because the data proves that – in the Hedgeye Chart of The Day today a picture tells a thousand words (US Dollar overlay with US Employment back to 1971 when Nixon abandoned the Gold Standard).


Americans aren’t as stupid as our monetary and fiscal policies have been during both Bush and Obama administrations. Like Nixon and Carter, the one thing that Bush Republicans and Obama Democrats have in common is a Keynesian running the US Federal Reserve.


There’s a reason why the name Arthur Burns isn’t remembered by history well. He was the modern day Ben Bernanke throughout the 1970s (minus the Princeton Depression Fear-Mongering thing). Burns and Bernanke are the only Fed heads to A) monetize the US Debt and B) devalue the currency, at the same time.


If Romney or Obama want to win the election, here’s the Hedgeye Political Strategy one-liner – “It’s The Policy, Stupid.”


As the Eurocrats are encouraged by Geithner and his cronies at Investment Banking Inc. to print the biggest bailout in world history this weekend in Paris, it’s no longer time to get hammered on Keynesian Kool-Aid and keep binging on our debt addictions.


It’s time to see the world as it is, not the way the conflicted and compromised are begging for it to be.


My immediate-term support and resistance ranges for Gold, Oil, the German DAX, and the SP500 are now $1, $84.29-89.10, 5, and 1170-1225, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Fragile America - 11


Fragile America - Virtual Portfolio

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 80.47%
  • SHORT SIGNALS 78.68%




TODAY’S S&P 500 SET-UP - October 14, 2011

Provided that the SP500 doesn’t get above 1229 (TREND) on the Google news, we’re crossing the Rubicon of bank earnings Monday (Citi reports today), Tuesday (Goldman and BAC), and Thursday (Morgan Stanley).  JPM’s reaction will leave a psychological mark, as bank earnings and counterparty risk are not going to be resolved for anytime soon.


G20 – the setup here is a little unnerving as Geithner is going to do what he’s been groomed to do for 47% of his born life (bailout banks) appearing again this morning on TV at 910AM (CNBC) as central planning Europeans huddle in Paris.


As we look at today’s set up for the S&P 500, the range is 55 points or -2.80% downside to 1170 and 1.77% upside to 1225











  • ADVANCE/DECLINE LINE: -666 (-2457) 
  • VOLUME: NYSE 898.46 (-15.72%)
  • VIX:  30.70 -1.79% YTD PERFORMANCE: +72.96%
  • SPX PUT/CALL RATIO: 1.40 from 1.70 (-17.69%)


  • TED SPREAD: 38.79
  • 3-MONTH T-BILL YIELD: 0.02%
  • 10-Year: 2.19 from 2.24     
  • YIELD CURVE: 1.90 from 1.95

MACRO DATA POINTS (Bloomberg Estimates):

  • G-20 finance ministers meet in Paris
  • 8:30 a.m.: Import Price Index, est. (-0.4% M/m)
  • 8:30 a.m.: Retail sales, est. 0.7%
  • 9:10 a.m.: Treasury Secretary Tim Geithner speaks on CNBC
  • 9:55 a.m.: UMich Confidence, est. 60.2
  • 10:00 a.m: Business inventories, est. 0.4%
  • 1:00 p.m.: Baker Hughes rig count
  • 2:00 p.m.: Monthly budget: est. (-$64.0b)


  • UBS, Lloyds and RBC had long-term issuer default grades cut by Fitch Ratings, which put more than a dozen other lenders on watch negative as part of a global reviewSlovakia may approve Europe’s enhanced bailout fund today or tomorrow, finishing ratification process
  • Google is seeking agreements with record companies by the end of the month to start a music store that will compete with Apple’s iTunes.
  • Apple is poised to sell as many as 4m units of its new iPhone 4S this weekend
  • Presidents Obama visit a GM plant in Michigan.


COMMODITY/GROWTH EXPECTATION                                                                    





  • Bangkok Will Escape Flooding as Barriers Hold, Yingluck Says
  • Copper Heads for Second Weekly Gain as LME Inventories Decline
  • Oil Heads for Second Weekly Gain on U.S., Europe Demand Outlook
  • Walter Jumps on Report of Takeover by Anglo American, BHP
  • Naphtha’s Top 2011 Premiums Seen on Supply Cuts: Energy Markets
  • Gold Gains in London on European Debt Woes, Physical Purchases
  • Weakest Rupee Sends Refiners to Dollar Borrowings: India Credit
  • Oil Heads for Second Weekly Gain Before U.S. Retail Sales Data
  • Copper Rises, Heads for Second Weekly Gain on Demand Signals
  • Deere Plans to Supply Fewer Combines in U.S., Dealers Say
  • Sugar Futures Rally as Floods Delay Asia Harvests; Cocoa Falls
  • Rubber Drops on Concern Spreading Debt Crisis May Reduce Demand




EURO – the hope trade continues to look more like short covering than anything else as the long-term TAIL of Euro resistance at 1.39 wasn’t even tested this week. As hope turns into a timing problem (no way this bazooka comes anytime soon), there’s a heightening chance of a Euro currency crash down to 1.22 vs USD. Buy the US Dollar (our Macro call today on this at 11AM EST)






Spain has its long-term sovereign credit rating cut to AA- from AA by S&P, which cited likely deterioration of nation’s bank assets and weaker economic growth prospects that will keep unemployment elevated.






ASIA – significant signals continue to remind us that Asia’s Growth Slowdown is accelerating (European demand down hard); both the Shanghai Comp and the Hang Seng failed at TRADE lines of resistance again last night (2489 and 18,842) with HK dropping another -1.4% and Singapore (China’s key regional advisor) cutting GDP growth estimates again to 5%.


India inflation exceeds 9% 10th month amid rate pressure








Howard Penney

Managing Director




In the category of setting expectations too high, DB's US analyst just moved their Q3 EBITDA estimate to $250 million. Good thing the stock is dirt cheap and consensus still too low.



We just can’t get to $250 million.  That doesn’t mean we don’t think MPEL is ridiculously cheap and Q3 consensus is way too low.  The stock should trade up into the quarter but if whisper expectations are for $250 million, the actually print could be a disappointment.  We are at $228 million in Q3 EBITDA which is still almost 20% above the Street.  With some tweaks we can certainly get higher but $250 million looks like a stretch.  The stock does trade at only 7x 2012 EV/EBITDA so really, what's a few million?   


So why is $250 million unlikely?  The only way it happens is if City of Dreams and Altira held abnormally high on the rolling chip junket programs and much lower at the revenue share junkets.  We’re pretty sure overall VIP hold percentage was around 3.08%, which is above normal but already reflected in our model.  However, only a statistical anomaly favoring the rolling chip junkets could help boost EBITDA up to $250 million.  Of course, there are more subtle areas that could contribute: lower promotions (doubtful), better cost controls (possible), but the junket mix would have to be extremely favorable.


We’re not trying to be too cute here.  The fact is the stock looks very cheap and estimates need to go higher.  That’s usually a recipe for share appreciation.  We just want to keep expectations realistic.


Everyone seems to offering the same rhetoric about replacement demand but a closer look reveals some interesting developments 



It’s probably fair to say that the consensus at G2E and the investment community is that replacement demand is likely to stay stagnant - 18 years - for the foreseeable future.  Never mind the math that shows replacements bottomed out in 2008 or that the physical life of a machine is on average no more than 12-13 years.  Interestingly, while suppliers are outwardly espousing the same rhetoric, internally, they are all cognizant of the fact that the 2 major subsectors of the slot market –video poker and 3 reel mechanicals – are older, fully depreciated, on platforms that are no longer supported, and have waning performance.  Dare we say that, despite the conservative rhetoric to investors, a few suppliers are gearing up to replace this aging base of machines?


We touched on this topic in our note, “G2E TAKEAWAY” (10/06/11).  For the first time in a long time, IGT had new video poker products on display at G2E.  IGT has an install base of 130,000 video poker machines – 100,000 of which are on the old 8960 platform – which to our understanding is about 9 years old.  WMS was also making another foray into the video poker market with a product that should be commercial in about 12 months.  Could this be a coincidence?  We think not.  Of course, the high likelihood of IL coming online doesn’t hurt either.


3 Reel spinners are the other oldie but goodie market garnering a lot of attention (not investor attention) these days.  Mechanical spinning represent roughly 30% of the total slot market in the US with 3 reel spinners being the older product.  IGT believes that they have about 130,000 3 Reel Spinners out there today, making up the majority of their total spinner product.  Given the vast install base, we’re not sure how old their install base is but we’re pretty sure that it's over 5 years old.  IGT has a new 3 Reel, one line product out – also targeting the Australian market – 36% of which is comprised of old 3 reel product.   IGT also has some neat features on its MLD platform which it hopes will garner some of the share of 3 reels being taken out.  


BYI’s has confirmed that there are about 35-40,000 legacy S-6000 high denomination, 3 Reel Spinners that are basically approaching obscelence.  BYI is hoping to replace some of those units with its new Pro-Curve cabinet. 


Konami agrees that the 3 Reels out there are old and in need of replacements but hopes that most of the new products gets replaced with video product. After many failed attempts to penetrate the spinner market, Aristocrat is out with a new hybrid stepper that also hopes to grab a share of the maturing market.


We expect to see the incumbents offering deep discounts on very expensive ‘retail’ price tags on new cabinets – mostly in form of trade-ins in order to garner as large of a share of any replacements that occur.  New entrants should also benefit as this will offer operators a chance to diversify their existing floors.  IGT is really the only video poker player to speak of, although the roll off of their Moody patents over the next 2-3 years should spur more competition in the sub-segment of the market.  IGT, followed by BYI, are the manufacturers behind almost all of the legacy spinner product installed on casino floors today.  WMS entered the spinner market with their transmissive reels about 5 years ago and ALL has never been able to get traction in spinner segment from past attempts. 


Bottom line: while the perception is that there is only a small replacement market to speak of, there are some pretty hungry bears out there chomping at the bit.  Of course the easiest solution to aging machines is simply a refurbishment, but we’re pretty sure that if manufacturers have any say in the matter they will use this as an opportunity to force replacements. 

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