Year's End

“Year’s end is neither an end or a beginning, but a going on, with all the wisdom experience can instill in us.”

-Hal Borland


No matter where we go this morning, here we are – at the end of a what’s been a very long year.


While the Institutionalization of US Equities can play short-term games with our hearts and minds into month, quarter, and year-end markups, the #1 game in town from a Global Macro Theme perspective in 2011 was Growth Slowing.


For Global Macro Risk Managers, what did that mean? 

  1. Major Asian, European, and US Financials Equities crashed from year-ago levels
  2. Commodities crashed from their 2011 YTD peaks
  3. US Treasury Bonds remained in a raging bull market 

Since, magically, the SP500 has rallied once again (on no volume) to yet another lower long-term and YTD high (-19.3% and -7.3% from OCT 2007 and APR 2011 highs, respectively), I am certain that the marketing departments of Buy-And-Hold Inc will quibble with my globally interconnected interpretation of it all…


Quibble away.


Here are some of the early Major League Macro year-end final scores: 

  1. India (BSE Sensex) = -24.8% YTD
  2. China (Shanghai Composite) = -21.6% YTD
  3. Japan (Nikkei) = -17.3% YTD 

Now an Institutionalized chap running other people’s money in “Asian Equities” might try to argue that being long Japan instead of India equated to him “beating” an Asia-Pacific Index. But “cheap” stocks look a heck of a lot cheaper in Japan -17.3% lower – and his investors may quibble with the representation of his “outperformance.”


How about other countries and commodities? 

  1. Hang Seng Index (Hong Kong) = -19.97% YTD
  2. CRB Commodities Index = -8.4% for 2011 YTD
  3. Copper = -23.4% YTD 

So, I guess, another Institutionalized manager could say being long Hong Kong outperformed long China and being long Gold outperformed being long Copper…  




But these guys better not be on the record at the beginning of 2011 telling you that they nailed those relative outperformers because they thought Global Growth was going to be just fine. That’s like me telling you my Power-Ball ticket was closer to the winning number than yours. There’s only so many times you can change the thesis on why you were long!


Understanding that Piling-Debt-Upon-Debt Structurally Impairs Growth was critical to getting out of the way of most of these nasty 2011 draw-downs. That’s why the ladies and gentlemen who preferred to buy US Treasury Bonds on January 1st and hold them through today are smiling right now.


Check this out: 

  1. 10-year US Treasury Yield started 2011 at 3.29%
  2. 30-year US Treasury Yield started 2011 at 4.33%
  3. Today, 10 and 30 year Yields are trading at 1.89% and 2.89%, respectively! 

The math on that generates -43% and -33% drops in 10 and 30 year UST Bond Yields for 2011 YTD. The inverse picture of that math is best shown in the powerful 2011 chart of the TLT (which uses 20-year yields, splitting the difference between my two bellwethers).


Growth Slowing?


Yep. That was the #1 macro call of 2011. And you could have expressed that in many different ways (long FLAT, which we bought in FEB of 2011 is up +28.01% since).


As I flip the switches on my risk management machines to 2012, I’m getting peer pressure to make another outside of consensus call. Sorry, I can’t do that, yet. Timing matters. Rarely do we get a signal on December 31st.


I’m not going to broker you a gratuitous “2012 Outlook” or sell you some ad space either. In the New Year, I’m going to do exactly what I did this morning – and the morning before that… 

  1. I’m going to stick with my process
  2. I’m going to buy on red
  3. I’m going to sell on green 

And I’ll try my best to not be overly bullish or bearish on anything that worked and/or didn’t work for us in 2011, because “all the wisdom experience can instill in us” reminds me that past performance is no predictor of future results.


My immediate-term support and resistance levels for Gold (covered our short yesterday), Oil (we’re short Brent Oil), China (we bought the CAF yesterday), Consumer Discretionary (we’re long XLY), Long-term Treasuries (TLT), and the SP500 are now $1, $106.89-109.11, 2154-2226 (Shanghai Comp), $38.24-39.98 (XLY), $119.16-123.87 (TLT), and 1, respectively.


It’s been a pleasure and a privilege to both play on this team and earn your business in 2011. On behalf of all of us at Hedgeye at Year’s End, we’d like to wish you the very best of health and capital preservation in 2012.




Keith R. McCullough
Chief Executive Officer


Year's End - Chart of the Day


Year's End - Virtual Portfolio


What does the Department of Justice’s new position that the Wire Act 1961 only applies to sports betting mean for online (and offline) gaming in the US? 



Responding to Senators Reid and Kyl's letter seeking clarification on the interpretation of the Wire Act, the Department of Justice (DoJ) recently published an opinion that essentially amounts to a reversal of previous Justice stances.  We believe that this change in opinion can be the spark for some long awaited Federal online poker legislation which would have widespread implications for our sector.  However, it may take 18-24 months even in the best case scenario before we see anything really happen so the buzz and in some cases, euphoria this announcement caused may be premature.


While the new opinion states that only online sports betting is a violation of the Wire Act in instances of intra-state offerings, this doesn’t mean that other forms of intra-state gambling are legal.  Online gambling is illegal in almost every state (aside from Nevada).  State-based lottery and land-based casino wagering are specifically allowed where any form of gambling is legal.  In order for online gambling to happen without Federal regulation, each state would need to pass legislation – and in many cases change its constitution. 


There are a myriad of scenarios that can occur between now and when/if something passes outside of Nevada.  Some states will follow on Nevada’s heels and try to pass some sort of online gaming legislation – which can take the form of just lottery offerings online or actual online poker.  Given the recent Wire Act opinion, states that have legal online gambling laws will then be able to pool liquidity.  However, any state legalization of online poker (excluding Nevada) would likely take at least 2 years to materialize.  Online lottery offerings can happen sooner.  At the same time, Senators Kyl and Reid will likely make a push to get something passed on the Federal level.


Keep in mind that a Justice Department decision, particularly one that is controversial, can be reversed by the Courts or future Departments of Justice.  The only way to ensure the legalization of online gaming is to codify it into law.  


Federal route and potential outcomes

Our legislative sources do not believe that an internet gaming bill will pass on its own.  Senators Kyl and Reid will likely try to tack on i-gaming regulatory language to the new payroll tax bill which is scheduled to be voted on in February/March 2012.  The current Reid/Kyl language proposes that if operators are licensed through a proficient regulatory body (e.g. Nevada or NJ), then the operator will be allowed to offer online poker to other states where online gaming is legal, rather than having a national regulatory body that licenses operators.  The current language proposes that States can opt-out of on-line gaming and doesn’t allow lotteries to offer online poker.  Apparently, Republican Minority Leader McConnell supports the Kyl/Reid initiative so it is likely that the tack on language will pass muster in the Senate.  However, the House is a whole different animal.  It doesn’t help that Sheldon Adelson, who has been a major supporter of House Republicans, has been opposed to online gambling. 


The currently proposed language is being vehemently opposed by state lotteries which are against Federal gambling regulation and by tribal gaming which prefer to be regulated by the NIGC.  As a reminder, gambling has historically been a state regulated issue so any federal legislation is highly controversial to constituents which support state rights.  Should the legislation pass in 1Q12 then there still needs to be technology approval and rules vetting which we believe would take 18-24 months before everything is said and done.  There will also likely to be a flurry of States opting out – like Utah, for example.  

If the currently language doesn’t pass but still has momentum, then there is likely to be a heated debate over changing the opt-out provision to an opt-in provision.  Lotteries will want the same rights as other licensed operators, even though initially they are likely to just provide the sale of traditional products online.


State Route

Nevada is the first state to pass a regulatory framework to license and legally allow online poker.  Under the most aggressive scenario, licensed operators will be allowed to offer I-poker to players in Nevada within a year, although we believe that 18-24 months is more likely.  Even with the onset of online poker offerings in a year, we believe that the market size and opportunity will be fairly small and immaterial given that Nevada lacks liquidity on its own.  Technically, licensed operators like CZR, MGM, and BYD will boost liquidity by combining online play with land-based play.  However, until a large state like California or New York pass something, it’s unlikely that I-poker will be meaningful. 

Without Federal legislation, there could be a patchwork of state initiatives that are not compatible.  It also raises the question whether states where lotteries are the body through which gaming is regulated (e.g. New York, Maryland, Rhode Island, etc) would want to combine with Nevada to increase liquidity.  We believe that California and Iowa will want to pursue state legalization of I-poker regardless of what happens at the Federal level unless something passes in 1Q12.  However, even through a state-only route, it will likely that up and running online gaming operations will take a long time to materialize since licensed US operators will proceed cautiously without additional federal clarity on the topic.




Who wants what?

Supporters of online poker legalization generally want legislation passed at the federal level since this is the best way to ensure a liquid market with a uniform regulatory structure.  Federal legislation is also by far the fastest path to building a US market of any material size.  While not all of the casino operators want internet gaming to be legalized, most will agree that to the extent it is legal, they would prefer federal regulation.  LVS is the only operator that we are aware of that is vocally opposed to internet gambling at this point.  


The slot guys support online gaming legislation at the federal level but will likely not really benefit much from just I-poker legalization.  The hope for the manufacturers is that the legalization of I-poker becomes the stepping stone for legal online casino gambling.  International gaming operators, especially online operators, all support Federal level legislation for obvious reasons.  Tribes are split on the issue of online gaming, but most would prefer to be regulated by the NIGC if something is approved.  Lotteries oppose federal legislation and prefer state legislation.  However, if something is passed at the federal level, lotteries want states to be able to opt-in vs. opt-out of the legislation and they want to have the same rights to introduce online games as other licensing bodies (Nevada/NJ).



Trade Update: Covering GLD


Keith covered our short position in the gold etf GLD this morning at $149.02 for 4.9% gain.  


He remarked on the trade, "Booking another gain in gold.  Across 26 long/short positions taken since 2008, we have been right 89% of the time in GLD."


GLD is immediate-term TRADE OVERSOLD with support at $148.98; TRADE-range resistance is up at $154.92 (4.2% upside from the current price).  Given, risk heavily outweighs reward in being short GLD at the current price on the immediate-term TRADE duration.


On our intermediate-term (3 months or more) TREND duration, GLD is bearish with resistance at $165.91.  We will continue to trade gold with a bearish bias as long as it remains broken on our risk management durations, and the current inverse correlations with the USD persist.  Gold currently has a -0.91 correlation to the US Dollar Index - the highest that correlation has been among all durations up to three years.


Trade Update: Covering GLD - gold km


Kevin Kaiser



Initial Claims Rise ... Expect More of the Same

The headline initial claims number rose 17k WoW to 381k (up 15k after a 2k upward revision to last week’s data).  Rolling claims fell 5.75k to 375k. On a non-seasonally-adjusted basis, reported claims rose 69k WoW to 490k.  


We've pointed out for the last several weeks that in the last two years claims have shown a tailwind from week 36 through year-end, and then tend to reverse that trend in the opening 1-2 months of the new year. This morning's print is consistent with that trend. That said, the larger, secular trend in place at the moment is ongoing improvement in claims. This is obviously a tailwind for lenders from a delinquency standpoint. That said, it will be dwarfed by the elimination of reserve release that will rear its head in 4Q earnings when companies start reporting in two weeks. We often look at Discover as a leading indicator on this front as they're an off-cycle reporter (November fiscal year-end). Discover's quarter told the tale quite clearly. Although they beat estimates and generally reported solid metrics, the optical sequential slowdown driven by the absence of reserve release led the stock to get sold. Don't be surprised when the impact is far greater at the big banks. 












2-10 Spread

The 2-10 spread tightened 2 bps versus last week to 165 bps as of yesterday.  The ten-year bond yield fell less than 1 bp to 192 bps.






Financial Subsector Performance

The table below shows the stock performance of each Financial subsector over four durations. 




Joshua Steiner, CFA


Allison Kaptur


Robert Belsky


Having trouble viewing the charts in this email?  Please click the link at the bottom of the note to view in your browser.   


Simple Explanations

If you can’t explain it simply, you don’t understand it well enough”

– Albert Einstein


For some reason, finance and science maintain a rather unique fascination with generating overly complicated and confounding verbiage to describe fairly straightforward and pedestrian concepts.  In my 30 years, I have had the lamentable pleasure of being a professional in both vocations. 


Before joining HEDGEYE, I was a molecular biophysicist.  I’m still not sure I can tell you exactly what that is, but it sure sounds impressive.  I’ve also been a dishwasher, business owner, carpenter, physiologist, bartender, Ph.D researcher, industrial sheet metalist, and successful self-taught trader.  Wandering philanderer? I like to think of it as Generation Y’s version of a renaissance man. 


Across disciplines, many times a process that, superficially, appears complex is really only the summation of a series of simple questions asked and answered.  The trick, of course, is in asking the right questions and then having the ability to successfully source the correct data as inputs for the model.


In finance and science, it just so happens that the canonical blueprint for increasing scarcity values calls for the addition of unnecessary technical jargon and intentional obfuscation of the details around the process in a way that makes the output appear overtly complex and thus, through the trappings of behavioral psychology, more desirable.


So, as the edifice of Wall street 1.0 has continued to implode under the weight of institutionalized, levered conventions of its own creation, on the healthcare research side, we’ve been working to develop an investment research process that successfully functions outside of the legacy construct of management one-on-one’s, recycled expert opinion, and valuation-in-isolation and intuition driven decision making. 


At the heart of the HEALTHCARE MACRO modeling effort has been the analysis and integration of government data sets which have proven effective in helping us create a quantitative, independent, and thus far, successful process for tracking real-time consumption across the health economy broadly and major sub-industries specifically.  Longer-term, healthcare consumption growth continues to be defined by domestic demographic trends. 


From a macro level, understanding how this approach functions from a practical investment research perspective can be explained fairly simply.  Broadly speaking, the consumption curve for healthcare services across the age continuum is fairly static with elastic demand occurring largely at the margin.  Given fixed census trends, if one is able to determine per capita consumption by age for a particular procedure or service type, a reasonable estimate for the underlying growth trend can be derived.


Having a quantifiably justified estimate for underlying organic growth, finding higher frequency data sets that accurately reflect real-time demand and solving for the shorter-term impacts of larger, more acute factors such as employment/insurance status makes it possible to both identify and forecast cyclical growth inflections as well.  Conviction is found where the demographic, per capita consumption by age, and the higher frequency macro data function to drive company model inputs that back test with strong correlations across durations. 


Taking a TAIL perspective on the healthcare sector, as an example, let’s take a short walk down demography lane and examine the consequences of the existent, secular domestic demographic shift and some of the resulting longer-term investing implications. 


Given that the consumption curve for healthcare services across age buckets remains relatively fixed, the glacial movement of U.S. demographic trends holds specific consequences both for healthcare and the larger economy broadly.  Therefore, it is important to understand that the period of greatest acceleration in per capita healthcare consumption comes as people age into their 50’s. Equally important is the fact that this 50-64 year old subset is covered, in large part, by high margin, commercial insurance.


The largest acceleration in medical consumption in combination with high margin insurance, places the 50-64 year old demographic as the heart, and profit center, of the health economy. This demographic is now in a secular decline (although the continued acceleration in employment for this age bucket remains a near-term positive for healthcare consumption). In fact, extending current census trends and per capita healthcare consumption by age out over the coming decades reveals a secular bear market for healthcare that won’t see its trough until 2024! 


This trend has definite and specific consequences for the hospital industry as well.  With roughly 30 cents of every healthcare dollar flowing through the hospitals, the industry sits at the heart of the healthcare economy and is inextricably beholden to meaningful shifts in utilization and service consumption growth.


At present, the current demographic setup is one which will see the 45-64 year old age group graduate into Medicare at a faster rate than those underneath can fill the void.  In other words, the spread between those aged 45-65 and those aged 65-85 will reach its narrowest point in 2011 before embarking on a protracted expansion where hospital margins will face a secular decline as negative margin Medicare volumes grow faster than commercial admissions.


In this scenario, we continue to believe high-tech, med-tech remains the relative loser as hospitals focus cost initiatives across controllable supply expenses.    ZMH remains our favorite long-term short in the space.


The outlook isn’t completely dismal, however.   The 30-40 year old demographic will continue to accelerate for the better part of the next decade.   Here, women’s health and companies levered to birth volumes remain favorably positioned to benefit from this secular trend.  Moreover, women’s health, along with dental and domestic U.S. physician office exposure, continues to sit positively across a number of our strategic TRADE & TREND themes as well.


(Please email  for more on our ZMH specific fundamental and demographic work, additional detail on where we’re targeting long exposure, or further detail on how we marry the HEALTHCARE MACRO process with our fundamental, company research.)


As the transparency curtain gets pulled further back on the collective global balance sheet, staring into the mirror of a leveraged overconsumption past will continue to reveal some painful realities.  Growth will remain impaired as developed economies deal with structural debt/deficit issues.  Beta will continue to auger to the latest centrally planned headline, and government intervention will continue to sponsor market volatility.


And while Euro & Bureau – Crats continue to hold summits and engineer soundbytes in a flagging attempt to placate markets looking for tactical solutions to structural problems, we’ll continue to evolve our own process. 


It’s not perfect, but it has worked a lot more than it hasn’t – and it’s repeatable. 


Buy Low. Sell High. Repeat.  Pretty Simple. 


Our immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, Italy’s MIB Index, and the SP500 are now $1, $106.01-107.93, $1.28-1.30, 14,466-15,094, and 1, respectively.


Christian B. Drake


Hedgeye Healthcare


Simple Explanations - Demographic Trends 122911


Simple Explanations - hvp

Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.