"Success depends upon previous preparation, and without such preparation there is sure to be failure."
Regardless of whether we're bullish or bearish, a proactively prepared investment process allows us to manage the risk implied in deflating or reflating asset prices.
Many a wanna be short seller of everything "Depression" has just been reminded that there is massive risk implied on the upside in a Bear market. Risk in markets is omnipresent. The most relevant risks are always embedded in expectations - this, of course, includes the probability for a raging short squeeze.
After one of the most expedited 2-week bear market rallies in the last 113 years, a lot of the early cycle global macro signals that we've been writing about will now become crystal clear. The entire Street is now getting bullish on the call our head of Tech, Rebecca Runkle, had in semiconductors 6 weeks ago; and all of a sudden some of the most fantastic shark biting of the shorts that I have ever seen in my career is happening in the American casual dining names that our head of Restaurants, Howard Penney, has been bullish on since December. Yes, both main Street Americans, and their pet sharks can still strap on the ole feed bag.
Volatility, as measured by the VIX, has been cut by almost 50% in the last 5 months, and assets from West Texas Crude Oil to Russian Equities have re-flated by over +41% in a straight line over the course of the last 5 weeks. Copper and China are racing one another for the lead in 2009 YTD gold medal race - as of this morning, copper is +25% YTD and the Shanghai Stock Exchange Index closed up for the 7th day in a row, taking YTD gains for the Chinese to +28.5%.
The CRB Commodities Index closed at 229 last night - now it's FLAT for the YTD. The Nasdaq, which doesn't have GE or any of the Financials, closed at 1577 yesterday, and is now only down -1.4% for 2009. Market prices are leading indicators - do all of these aforementioned prices give any objective mind reason to believe that we are on the precipice of entering the Great Depression Part Deux? Of course not - that's what the bears of 2008 are still rushing to their publishers to write books about. It's yesterday's news.
We get paid to have our feet on the floor early every morning in order to help you proactively prepare for today and tomorrow. Understanding history, or yesterday, is a critical component of this process. Some people don't like it when I take victory laps - but that's ok, ask my good friend Benoit Morin how passive I was about celebrating Yale Hockey goals in them ole school Yale/Princeton tilts we used to have up here in New Haven - not very!
We approach this game like professional athletes. There is a discipline, passion, and pace at which you need to play the game. Striking the balance between emotion and control is always the greatest challenge. I call it playing on the Research Edge. But in no sport, that I know of at least, does the replay not matter. In what was the horse and buggy whip Wall Street of yesteryear, I guess portfolio managers could get away without issuing the transparency associated with mirrors - but guess what, You Tube is here - those days are over.
Today is a new day, and I'm only as good as my last game - so what's my "call"? Well, like any proactively prepared risk manager, I make most of my moves into the close on the day prior. I've had my head handed to me enough times in this business to finally understand that there is never a mistake in booking large percentage gains. Do I think that everything we are long should continue to re-flate? I sure hope so... why else would I be long something? Does that mean that things can't get overbought? Of course not...
For accountability/transparency purposes, I issued an intraday note to our Macro clients into the close yesterday titled "Shark Bite, Part Deux: SP500 Levels, Refreshed" outlining the following levels of resistance: SP500 TRADE resistance at 817; TREND resistance at 829.
The SP500 closed 60 basis points above that immediate term TRADE 817 line, but 84 basis points below the intermediate term TREND line. More importantly, my support level for the SP500 was all the way down at 770, which is -6.3% lower. Anytime the risk outruns the potential reward like this, I sell.
I raised the Cash position in my Asset Allocation Model from 59% back up to 71% yesterday. I sold my long positions in Russia and Brazil for +15% and +10% gains, respectively, taking my Allocation to International Equities down from 19% to 10%; and I sold down my Allocation to US Equities from 13% back down to 10%.
Call me conservative, or call me names - this is what I do. I manage risk by managing my exposures around price levels using a scenario analysis that is much closer to a market operator's "stress test" than what the US Government is currently trying to sell you on.
The US Government did the proactively predictable yesterday and traded what economist Paul Krugman accurately labeled "Cash for Trash". No, I'm not a Krugman lover, but you know I love a good one liner that's paired up with an objective conclusion - especially when it stirs a bee in the bonnet of the Goldman brain-trust that continues to dominate the West Wing. Larry Summers was really agitated by Krugman's refusal to STAND DOWN - he doesn't like to hear opinions that differ from his own.
Short term "trading" is what it is. I call it risk management. The US Government is as reactive a short term trader of political capital that you'll find in this global marketplace right now - as long as you understand that, and can remove all emotion while managing around your cash position, you can proactively pick off the market's behavioral patterns associated with the new reactive American crackberry culture.
Be careful out there today. After a 21.6% 2-week re-flation, the real-time risk managers understand that this Bear is far from dead.
EWC - iShares Canada-We bought Canada on Friday 3/20 into the selloff. We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's socialist past, and believe next year's Olympics in gold-rich Vancouver should provide a positive catalyst for investors to get long the country.
DJP - iPath Dow Jones-AIG Commodity -With the USD breaking down we want to be long commodity re-flation. DJP broadens our asset class allocation beyond oil and gold.
XLK - SPDR Technology-Technology looks positive on a TRADE and TREND basis. Fundamentally, the sector has shown signs of stabilization over the last several weeks. Semiconductor stocks, which are early cycle, have provided numerous positive data points on the back of destocking in the channel and overall end demand appears to be stabilizing. Software earnings from ADBE and ORCL were less than toxic this week and point to a "less bad" environment. As the world stabilizes, M&A should pick up given cash rich balance sheets in this sector and an IBM/JAVA transaction may well prove the catalyst to get things going.
EWA - iShares Australia-EWA has a nice dividend yield of 7.54% on the trailing 12-months. With interest rates at 3.25% (further room to stimulate) and a $26.5BN stimulus package in place, plus a commodity based economy with proximity to China's H1 reacceleration, there are a lot of ways to win being long Australia.
CAF - Morgan Stanley China fund - The Shanghai Stock Exchange is up +28.4% for 2009 to-date. We're long China as a growth story, especially relative to other large economies. We believe the country's domestic appetite for raw materials will continue throughout 2009 as the country re-flates. From the initial stimulus package to cutting taxes, the Chinese have shown leadership and a proactive response to the credit crisis.
GLD - SPDR Gold- We bought gold on a down day. We believe gold will re-find its bullish TREND.
DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.
LQD - iShares Corporate Bonds- Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back. Moody's estimates US corporate bond default rates to climb to 15.1% in 2009, up from a previous 2009 estimate of 10.4%.
EWJ - iShares Japan - Into the strength associated with the recent market squeeze, we re-shorted the Japanese equity market rally via EWJ. This is a tactical short; we expect the market there to pull back when reality sinks in over the coming weeks. Japan has experienced major GDP contraction-it dropped 3.2% in Q4 '08 on a quarterly basis, and we see no catalyst for growth to return this year. We believe the BOJ's recent program to provide $10 Billion in loans to repair banks' capital ratios and a plan to combat rising yields by buying treasuries are at best a "band aid".
EWU - iShares UK -The UK economy is in its deepest recession since WWII. We're bearish on the country because of a number of macro factors. From a monetary standpoint we believe the Central Bank has done "too little too late" to manage the interest rate and now it is running out of room to cut. The benchmark currently stands at 0.50% after a 50bps reduction on 3/5. While the Central Bank is printing money and buying government Treasuries to help capitalize its increasingly nationalized banks, the country has a considerable ways to go in the face of severe deflation. Unemployment is on the rise, housing prices continue to fall, and the trade deficit continues to steepen month-over-month, which will hurt the export-dependent economy.
DIA -Diamonds Trust-We re-shorted the DJIA on Friday (3/13) on an up move as we believe on a TRADE basis, the risk / reward for the market favors the downside.
EWW - iShares Mexico- We're short Mexico due in part to the country's dependence on export revenues from one monopolistic oil company, PEMEX. Mexican oil exports contribute significantly to the country's total export revenue and PEMEX pays a sizable percentage of taxes and royalties to the federal government's budget. This relationship is unstable due to the volatility of oil prices, the inability of PEMEX to pay down its debt, and the fact that PEMEX's crude oil production has been in decline since 2004 and is down 10% YTD. Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.
IFN -The India Fund- We have had a consistently negative bias on Indian equities since we launched the firm early last year. We believe the growth story of "Chindia" is dead. We contest that the Indian population, grappling with rampant poverty, a class divide, and poor health and education services, will not be able to sustain internal consumption levels sufficient to meet targeted growth level. Other negative trends we've followed include: the reversal of foreign investment, the decrease in equity issuance, and a massive national deficit. Trade data for February paints a grim picture with exports declining by 15.87% Y/Y and imports sliding by 18.22%.
XLP - SPDR Consumer Staples-Consumer Staples was the third worst sector yesterday. XLP has a positive TRADE and negative TREND duration.
SHY - iShares 1-3 Year Treasury Bonds- On 2/26 we witnessed 2-Year Treasuries climb 10 bps to 1.09%. Anywhere north of +0.97% moves the bonds that trade on those yields into a negative intermediate "Trend." If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yield is inversely correlated to bond price, so the rising yield is bearish for Treasuries.
"Success depends upon previous preparation, and without such preparation there is sure to be failure."
On the other hand, ASCA’s amendment was particularly attractive for the company. This is probably the best comp when considering PNK in its eventual negotiations for a higher leverage ratio in its covenant. While PNK doesn’t appear to have an issue currently, the company may brush up against its maximum ratio in 2010.
Summary of recent gaming credit facility amendments:
- MGM MIRAGE, Amendment 1
• On September 30, 2008, MGM entered into an amendment to its Credit Agreement.
• Amendment increased the maximum total leverage ratio to 7.5x beginning in 4Q08 which will remain in effect through 4Q09, with step-downs thereafter.
• The amendment also revised limitations on secured indebtedness
• Drawn pricing on leverage above 5.0x was increased moderately
- MGM MIRAGE, Amendment 2
• On March 16, 2009, MGM entered into a second amendment to its Credit Agreement.
• Amendment provided a waiver of non-compliance with the total leverage ratio covenant or interest charge coverage ratio covenant for quarter ended March 31, 2009 quarter waived through May 15, 2009.
• 300MM repayment of R/C funded balance, which may not be re-drawn
• 100 bps increase in drawn pricing and establishes a base rate floor of 4.0% and a LIBOR floor of 2.0%
• Additionally the Amendment restricts MGM and its subsidiaries from:
- Paying dividends or distributions on, or repurchase equity,
- prepay outstanding indebtedness
- make certain investments, including investments in CityCenter above the stated thresholds or if Infinity World Development Corp. fails to make its corresponding investments, or if any obligations under CityCenter’s senior credit facility have been accelerated
- incur additional debt,
- incur liens on assets,
- merge or consolidate with another company, dissolve or liquidate
- dispose of material assets,
- create unrestricted subsidiaries and
- prepay trade payables.
- WYNN RESORTS
• On November 13, 2008, Wynn Resorts entered into an amendment to its Credit Agreement.
• Amendment allows Wynn to make a debt buyback of up to $650 million of loans outstanding.
• Amendment contained the following relevant provisions:
– Loans acquired under debt buyback are cancelled and retired immediately upon closing;
– Loans cancelled and retired are no longer deemed outstanding under Credit Agreement;
– Wynn has the option to conduct Dutch Auction for loans outstanding.
• Wynn successfully purchased $625 million of loans at a discounted price of 93.375%, resulting in retirement of $625 million of principal for payment of $596 million on November 26, 2008.
- AMERISTAR CASINOS
• On March 13, 2009, Ameristar entered into a third amendment to its Credit Agreement.
• Amendment increased the maximum permitted leverage ratio and senior leverage ratio beginning the quarter ended September 30, 2008 by 25 to 50bps through maturity
• Increased the applicable margin by 1.25%
• Added a new covenant where TTM EBITDA needed to exceed $275MM
• Existing $500MM subordinated debt limitation was eliminated
• Amount of Cumulative Capital Expenditures permitted increased to $1.1BN from $1.0BN
• Permitted Annual Dividends payments decreased from $40MM to $30MM
• Cumulative amount of stock repurchases permitted decreased from $125MM to $50MM (plus any amount available under the dividend basket)
• Reclassified the maturing R/C due Nov 2010 as non-extending loan commitments and permitted to request in the future to convert their Non-Extending Revolving loan Commitment to a new Tranche of Extending Revolving Loan Commitments that mature on August 10, 2012 (subject to quarterly $12MM of principal amortization commencing on Dec 2010)
– pricing would be negotiated at the time of the extension request, but amount is non-negotiable
• The existing Incremental Commitment Facility was expanded to permit ASCA in the future to obtain Incremental Term Loans that mature on or after 11/10/2012 in order to reduce the Non-Extending Revolving Loan Commitments (Terming out debt permission)
• $9MM on-time fee paid to lenders
Presuming Big 5 and TSA have the liquidity to pursue these locations, this could offer up an opportunity to fill out their respective stores bases west of the Mississippi.
If these players bow out, don’t completely count out Dick’s. For those who might have missed Dick’s remarks on the Q4 earnings call, they specifically identified G.I. Joe’s filing as a potential opportunity to move into that area and hinted at another in distress (i.e. Sportsman’s). With several states “up for grabs” in terms of a market share leader, we could see a return of the Wild West as Big 5, TSA and Dick’s grab for share.
As a sidenote, among the list of unsecured creditors is Columbia at #22 with $628k at risk, or just over $0.01 per share. We note that the company also has roughly $0.02 at risk related to the G.I. Joe’s filing in a quarter where it guided to $0.06. We have earnings closer to $0.20.
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Quadrant 1: This is where sales are growing faster than inventory, and margins are positive. The percent of companies falling into this basket went from 23% to 6%. Counter to what might initially seem to be the case, this is quite bullish. Statistically, the best shorts are sourced in this quadrant. ROST is the one that stands out to me here as being the most vulnerable.
Quadrant 3: This quadrant is the inverse of Q1. Inventory is building AND margins are off. Some of the worst companies can spend years in this quadrant. But it is also the source of some of the best longs, as the next move (within 2 quarters) is historically a move into Q4 (margins off, but the balance sheet gets clean). Names that stand out to me include Bed, Bath and Beyond, Hibbett, J Crew, Under Armour, Ralph Lauren and Liz Claiborne. This quarter, we saw 63% reside here vs. 46% last quarter.
• Financial situation began to deteriorate in 2007 with new competition, collapse of the housing bubble, smoking ban passage, and weakening economic environment
• Requested a waiver of financial covenants under its Senior Revolving Credit Facility in July 2007
– By 3Q07 route gaming EBITDA was down 46% and casino EBITDA was down 22% (y-o-y), and down 37% and 17% YTD, respectively.
– Amendment completed on 12/14/2007
• In February 2008, Herbst hires Goldman to evaluate strategic alternatives (recapitalization, refinancing, restructuring, reorganization)
• On March 11, 2009 Herbst reached an agreement with the majority of its lenders to accept its proposed pre-packaged Chapter 11 plan
– Casino and slot business split into two separate holding companies
– Herbst family will receive 90% of new plan equity in the slot route company in exchange for contribution of the new gaming device license agreement
– Conversion of the Senior Credit Facility into debt and equity of the reorganized companies, with bank lenders getting 100% of the equity in the new casino company and 10% of the new equity in the slot company
– Termination of the company's 8.125% Senior Subordinated Notes and 7% Senior Subordinated Notes and cancellation of all existing equity in the company.
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