Clever Confusion

“A clever person solves a problem. A wise person avoids it.”

-Albert Einstein


Yesterday was not a good day for me. Today will be. This is the game. And I love playing it.


Yesterday, I couldn’t have been more confused between the intraday and end of day signals I was getting in my risk management model. In general, when that happens (and I’ve had to learn this lesson the hard way by getting whipped around), the best decision is to take down exposure and get out of the way.


So this, fortunately, is what I did:

  1. Sold my US Equities in the Hedgeye Asset Allocation Model back down to 0% (from 6% on the open and 12% the week prior)
  2. Sold my LONGS in the Hedgeye Portfolio (different product) down from 9 LONGS on the open to 7 LONGS by the close
  3. Stayed with my best Global Macro long ideas – US Dollar (UUP), Long-term Treasuries (TLT), long UST Flattener (FLAT)

Unfortunately, staying with these long positions (UUP, TLT, and FLAT) made me feel shame yesterday. That’s what you should feel when you lose. Losing means you didn’t have it right. Winners need to lose before they can really learn how to win.


Intermediate-term to long-term investors have not been losing being long these positions for the last 6-9 months as it’s become clear that Global Growth Slowing will dominate Global Macro investing in 2011.


Most of the losers out there who focus on whining and finger pointing will obviously disagree with that statement – blame Europe or blame Canada for US GDP growth being 0.36% in Q1 or China slowing sequentially throughout the year – that’s easier, I guess.


There is nothing that’s been easy about investing in a globally interconnected macro marketplace in 2011. That will not change with French, Italian, and US Equities collapsing early this morning.


Ironically enough, Madame Lagarde seems to be geeking out on Le Chaos Theory this morning, prefacing her great depression fear-mongering speech to the last bastion of money printing – the IMF:


“In our increasingly interconnected world, no country or region can go it alone… there are dark clouds gathering in the global economy.”




On what part? The Lord Voldemort darkness of it all that is required to scare the hell out of people, or the socializing of losses part where only the young can dare “go it alone” in this world and bet on themselves?


If you thought all of this begging, banning, and printing was going to end well, you certainly didn’t get that call from me. In the last 4 years of ranting to you, I have to say that some days it really sucks to have to write about reality.


I’m on the same team as you. I am responsible for both my family and firm’s well being. I am looking to make this world a better place for my kids. But piling-more-policy-upon-policy is not the way out of this confidence spiral. It’s sucking the life out of capitalism.


Let us fail.


That’s the only way anyone on any team I have ever played on was really able to learn. Let me give-away the puck in front of 10,000 crazy fans wearing Badger red in Wisconsin (when my Mom is in the stands wearing blue) and let me hear that building light me up with insults like a Christmas tree in December for giving away a Yale goal.


Mucker, high and off the glass next time, eh?


Avoiding risk is important. It’s a process, not an emotional beta chasing point. Here are some of the most important lines in all of Global Macro to avoid “buying the dip” on:

  1. EUR/USD $1.37 – do not buy Euros on that breakdown if/when it occurs (buy US Dollars)
  2. SP500 – do not buy the SP500 if it cannot sustain itself above 1268 TAIL line resistance
  3. CAC40 (France) – do not buy French stocks if the intermediate-term TREND line of 3403 isn’t recovered

With everyone talking about Italy this morning, focus on France. We’ve been shorting Italy for 2-years and as of this morning it’s still crashing (down -34.5% from its YTD peak). Berlusconi is going away, but European Stagflation isn’t.


Focus on where the puck is going, not where it’s been. If I had to learn that risk management lesson from The Great One, so be it. I’ll take that over losing money today, all day long.

My immediate-term support and resistance ranges for Gold, Oil, German DAX and the SP500 are now $1, $94.01-97.07, 5, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Clever Confusion - 1. EL EUR


Clever Confusion - Virtual Portfolio


The Macau Metro Monitor, November 9, 2011




China’s October housing transactions fell for the first time in three months, declining 25% from September.  The value of homes sold last month dropped to 372.3 BN yuan (US$58.7BN) from 493.9 BN yuan in September, based on data from the statistics bureau.



According to the National Bureau of Statistics (NBS), China CPI rose 5.5% YoY in October, weakening from September's 6.1% rise.  The October CPI growth marked the slowest surge since May this year.  On a monthly basis, the cost of living added 0.1% in October.




TODAY’S S&P 500 SET-UP - November 9, 2011


As bad as Hedgeye was positioned from a Global Macro perspective into yesterday’s close will be as well positioned as I am this morning.  As we look at today’s set up for the S&P 500, the range is 27 points or -1.40% downside to 1258 and 0.71% upside to 1285. 




In the very immediate-term, bullish is as bullish does. If I were to use a 1-factor model (like the 200-day moving average), there would be no mincing of those words as of tonight’s close. Fortunately, I’ve learned not to use 1-factor/1 duration models. 


The bottom line from here is that VOLUME and VOLATILITY signals need to confirm this PRICE move to make it 3 for 3 on the factors that matter to me most (Price/Volume/Volatility). PRICE was a head-fake at the October 31stclosing high of 1285, so stay tuned.


Yesterday’s volume was 25% below the 30-day average. Today’s was down -13%. Tomorrow we need to see the juice. Volatility’s TREND and TAIL lines of support are 26.77 and 22.11, respectively.


All 9 Sectors in this model are bullish immediate-term TRADE (that’s not new) and 7 of 9 are bullish TREND (Financials and Basic Materials are the 2 bears on TREND and TAIL – Small Caps (Russell 2000) are also bearish TAIL w/ resistance up at 778. The SP500’s TAIL line remains 1268.









  • ADVANCE/DECLINE LINE: +1459 (+1153) 
  • VOLUME: NYSE 879.63 (+12.38%)
  • VIX:  27.48 -7.94 YTD PERFORMANCE: +54.82%
  • SPX PUT/CALL RATIO: 1.91 from 2.30 (16.85%)




TREASURIES – long-bond investors in the US have not been suckered into this hope that Global Growth is just fine. 10yr yields already broke the TRADE line of 2.12 supports last week (that’s why we are were long TLT) and are trading 1.98% last as the Yield Spread compression continues.

  • TED SPREAD: 44.42
  • 3-MONTH T-BILL YIELD: 0.01%
  • 10-Year: 2.10 from 2.04    
  • YIELD CURVE: 1.85 from 1.79


MACRO DATA POINTS (Bloomberg Estimates):

  • 7am: MBA Mortgage (prior 0.2%)
  • 9:30am: Bernanke speaks at Fed conference on small business
  • 10am: Wholesale inventories, est. 0.5% (prior 0.4%)
  • 10:30am: DoE inventories
  • 12:15pm: Fed’s Tarullo speaks on regulation in NY
  • 1pm: U.S. to sell $24b in 10yr notes


  • Italian 2-yr note yield rises above 7%, more than 10-yr rate
  • Ohio voters repealed a law limiting collective bargaining for public employee
  • HSBC said outlook for global economy is “challenging”, profit at its investment bank shrank by 53%
  • American Airlines, its pilots union said the two sides may reach a labor agreement within days
  • President Obama to meet with Portuguese President Anibal Cavaco Silva, then speak at National Women’s Law Center
  • SEC’s Robert Khuzami speaks at National Conference on the Foreign Corrupt Practices Act, 8:45am







  • Aluminum Slump Means 25% of Smelters Losing Money: Commodities
  • Noble Said to Plan $700 Million IPO for Agriculture Business
  • ArcelorMittal Outlook Cut to Negative by S&P on Steel Market
  • Oil Increases a Sixth Day as Iran Nuclear Work Poses Supply Risk
  • Sand Like Gold Boosts Greenbrier’s Railcar Production: Freight
  • U.K. Gas Spread to U.S. Rises on Japan Demand: Chart of the Day
  • Nestle Uses Sandbags as Thai Floods Threaten 322 Factories
  • Wilmar’s Profit Misses Estimates on Foreign-Exchange Losses
  • MF Global Settlement Over Losses in Doubt After Bankruptcy
  • Diesel Ending Biggest Gain in Asia Since March: Energy Markets
  • Oil Drops on Concern Italy’s Turmoil May Derail European Economy
  • Copper Advances First Day in Four as China Inflation Cools
  • China Aluminum Output Falls to Eight-Month Low; Copper Drops
  • Freeport Indonesia Workers to Extend Strike for Third Month
  • Corn Futures Advance on Concern USDA May Lower Harvest Estimate
  • Sumitomo Risk Unit Asia Clients Up 67% as Europe, U.S. Slow
  • MF Global Commodity Traders Ask Permission to Access Cash








ITALY – ring the royal Rubicon’s gong – because how people are chasing beta around this Berlusconi event is a certified gong show. They loved chasing yesterday’s US Equity close, now they hate everything Italy. Bond yields have gong parabolic as the MIB Index snaps its only remaining line of support (TRADE line of 15,894). Italy is crashing don’t forget – down -34.5% since its YTD high. Bullish?






CHINA – Growth continues to slow. Period. Not falling off a cliff slow, but slower is what matters in our macro model and we don’t see Chinese GDP growth arresting the slope of its decline until Q1 of 2012. Inflation data came in right on our estimate at 5.5%, but look for that to shoot up again sequentially in November with Oil prices up here.









  • Israel May Lack Capability for Effective Iran Military Strike
  • Iran Continued Nuclear Weapons Work Seeking Warhead Design
  • Oil Increases a Sixth Day as Iran Nuclear Work Poses Supply Risk
  • Syrian Monitoring Project May End as Italy Firm Weighs Options
  • Iran Nuclear Report Prompts U.S., Europe to Move for Sanctions
  • Qatar Dismisses Architect Concern on World Cup Air-Conditioning
  • U.K. Regulator Levies Highest-Ever Fine Against Dubai Investor
  • Dubai Shares Rise as Berlusconi Quit Offer Boosts Europe Outlook
  • Aluminium Bahrain Racketeering Case Against Alcoa Reopened
  • Standard Bank Wins U.K. Case Against Saudi Billionaire Over Loan
  • U.A.E. Stock Markets May Allow Short-Selling in First Half
  • OPEC Boosts 2015 Oil Demand Forecast Following ‘Swift’ Recovery
  • Iran’s Ahmadinejad Says He Won’t Retreat From Nuclear Program
  • Abu Dhabi Islamic Bank to Hold Investor Meetings for Sukuk Sale
  • Gulf General Reports Third-Quarter Loss as Finance Costs Rise
  • Iran 'Will Not Budge' From Nuclear Path, Says Mahmoud Ahmadinejad
  • OPEC to Account for 51 Percent of Oil Supply by 2035, IEA Says
  • Mideast Oil-Tanker Charters May Reach 2011 High, Marex Says


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Solid quarter in both segments and low ball guidance that excludes Ohio and Canada.



"In fiscal year 2011, we grew revenue, leveraged our gaming operations, improved margins, positioned the international business for growth and increased our interactive presence. We delivered strong financial results and held true to the commitments we made to our shareholders by directing our resources towards the highest returning opportunities.  We are focused on improving all aspects of our business, with the expected outcome of improved returns to our shareholders in fiscal year 2012."


- Patti Hart, CEO of IGT



  • At least 50% of their core games are performing at 1.5x house average, up from 1/3 a year ago
  • Interactive business is advancing - added poker, bingo and sports betting with the acquisition of Entraction
  • Estimate that their NA replacement share was 40-45%
  • NA gross margins increase due to higher IP fees, lower production costs, and less promotional activity/discounting
  • Decrease in domestic conversion kits was offset mostly by an increase of domestic IP fees
  • Anticipate further improving their operating margins by growing their gaming operations install base.  Expect their R&D to remain constant in 2012. 
  • Plan to strengthen their interactive division by strengthening their poker liquidity 
  • They are changing their performance metrics to align incentives on delivering machines on customer deadlines
  • G2E: initial orders for G20 machines exceeded 2,000 machines
  • 2012 focus areas:
    • Optimizing operating as a truly global entity trying to leverage their scale
    • Continue to put customers first
    • Entered into a first look agreement with Sony 
  • Guidance assume a 37% tax rate and a share repurchase plan in-line with the last 2 quarters



  • Assumptions behind their low guidance?
    • Management is conservative
    • Low end of the guidance assumes no uptick in replacement, small uptick in game ops and small yield uptick - no IL, OH, Canada
    • High end is a bit more optimistic but no IL, OH, or Canada given the uncertainty in timing
  • Thoughts on market share over the NTM? 
    • Think that they came in mid-40s for replacement share this quarter. Think that they can do mid 30s replacement share and 50% for new openings.
    • It's really about having breadth and depth across every product line for them at G2E
    • Clients appreciated efforts on systems front and investing in steppers
  • Think it's important to give guidance that investors can take to the bank
    • Reason that the guidance is low is that they excluded anything where the timing of openings and new markets was uncertain
    • They do expect margin expansion
  • NA ASPs
    • Saw high ASP's while they picked up a lot of share and in a highly promotional environment is good in IGT's opinion
    • In Q4 they had a slightly lower MLD mix.  Last year they had a big MLD push as well.
  • GM for gaming operations is still lower even adjusting for the charge and mix - WAPs are at a higher % and they have lower margins (but higher margin $)
  • Decline of non-machine sales was due to lower parts and conversion kit sales - reflective of them buying newer boxes instead
  • Entraction contribution - was neutral in the Q - slightly to revenues but nothing to earnings.  Right now it's not material but financially strategically important - same thing for the next few quarters.
  • Will continue to carefully manage their capex on their install base.  Big NY deployment moves things around though
  • Absent a better use of cash (M&A/acquisitions/ partnerships, change out of old platforms in games ops to improve yields) they will continue to pay out a dividend and buyback stock.  They will also accumulate some cash on the balance to address their convert maturity in 2014.
  • SG&A increase sequentially and YoY was due to 
    • Variable comp 
    • Investing in international resources
    • Transaction expenses
  • They are very focused on managing SG&A, so if it's rising, it's because of rising revenues and gross margins
  • They are still in investment mode in Asia - do expect to pick up a bit of share in F12.  Not as much in Europe in 2012
  • Their international ASPs float within $1k of the current range.  Assume that ASPs hold flat YoY.
  • Comment on replacement demand in the quarter - they are focused on the annual number, not so much on the quarterly number.  They are more focused on their 16k number for the FY vs. annualized this last Q.
  • IGT is just modeling what they have solid visibility on and not what they do not. They are comfortable modeling 15k replacement units. Also see a flatish year for new and expansion units if they exclude all the new markets (OH, IL, and Canada)
  • Where they have seen the benefit of their gaming operations capex is in the yield improvements (spent $190MM this year)
  • You should continue to see international drive gaming operations growth.  Goal is to maintain the US install base and grow the international one.
  • Gaming operations D&A looked like it increased? 
    • Picked up in the Q but for the year total D&A is down.  Going forward, capex and D&A should be pretty close to each other ~$200MM.
  • SG&A - bad debt was $1.1MM
  • Aqueduct is a big capex chunk that will come in lumpy.  Shipment was 36-37% in each phase.
  • Aria - recorded most of the systems revenue in the quarter as deferred revenue
  • Mexico?
    • Have 6, recurring revenue base games.  Don't see any exposure from an impairment standpoint right now. 
  • Did ship to both Kansas properties - but one has some deferred revenue since it had a systems piece - ship share was low 40's.  Didn't ship to Miami Jai Lai.


  • "2012 guidance for adjusted earnings from continuing operations in a range of $0.93 to $1.03 per share."
  • Gaming operations:
    • Revenues "increased 8%...  mostly due to improved WAP performance, growth in the International install base and increased interactive revenue with the acquisition of Entraction Holding AB." 
    • "Average revenue per unit per day ...was $58.08, up 9%... on performance improvements in our MegaJackpots brand globally and International lease operations"
    • "gross margin declined to 57%... primarily due to an intellectual property litigation settlement of $5 million.  Additionally, increased jackpot funding costs due to unfavorable interest rate changes reduced gaming operations gross margin by 80 basis points"
    • "IGT's gaming operations installed base totaled 53,900 units, an increase of 1,000 over the prior year and an increase of 600 units from the immediately preceding quarter primarily due to additions in International operations"
  • Product sales:
    • "11,300 units in the quarter, up 38% from last year's fourth quarter, primarily due to an increase in domestic replacement units"
      • NA units shipped: 6.5K units (5.1K replacement & 1.4K new) and ASP of $14.2K
      • International units shipped: 4.6K (2.7K replacement & 1.9K new)  and ASP of $16.9K
    • "Domestic average selling price was flat... International average selling prices increased 4%... due to favorable foreign exchange rates."
    • "Consolidated gross margin on product sales was 54% ... compared to 55% last year primarily due to the higher mix of machine versus non-machine sales in the current year."
  • During 4Q, IGT "repurchased 1.6 million shares of common stock at an average price of $15.30 per share for a total cost of $25 million"

Covering AYT – Trade Update

Conclusion: We are covering our Asian currency basket short in our Virtual Portfolio as Asia is not likely to pick up the pace of rate cuts with oil (inflation) up here in November.


Shortly before this afternoon’s close, Keith covered AYT for a modest appreciation vs. our cost basis within our Virtual Portfolio. We remain bearish on emerging Asian currencies vs. King Dollar over the intermediate-term TREND, but we have chosen to manage the immediate-term risk of crude oil prices breaking out from a quantitative perspective on our proprietary factoring – particularly given the inflationary impact of higher energy and transport costs. Be it what we can model (QE3 speculation) vs. what we can’t (Iran/Israel shouting match), we don’t like what we are seeing in the oil markets because it will bring on more Stagflation. Refer to Keith’s 11/8 Early Look titled “Self Indulgence” for additional analysis on this subject.


Covering AYT – Trade Update - 1


Covering AYT – Trade Update - 2


The quick and dirty as it relates to the knock-on effects of higher energy prices across Asian currency markets is that it could slow the deceleration in headline CPI readings across the region and keep Asian central banks on the sidelines in the short term, which limits, on the margin, any near-term scope for further monetary easing – an outcome that has been largely priced into Asian interest rate swaps markets for the past couple of quarters.


Covering AYT – Trade Update - 3


Of course, a sustained breakout in global energy prices would indeed be a particularly growth-negative event for Asia, as well as the more developed economies such as the U.S. and the E.U. We think the USD is the ultimate winner here as Asian export earnings dwindle and short-term capital flows seek the perceived safety of U.S. instruments. Managing the duration risk will be critical to manage (i.e. don’t short Asian currencies too early in this scenario b/c the beta chase is likely to prevail in the short term). For further analysis behind the extremely damaging side-effects of further U.S. monetary easing from current levels of global growth/inflation, refer to our 10/25 note titled, "Global Growth Update: Incremental Deterioration Forthcoming?".


Darius Dale



Covering AYT – Trade Update - 4