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MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE

*Interbank risk has been one of the most important gauges YTD for the outperformance in the big cap Financials. We've quantified what the improvement in Euribor/OIS means for each of the Moneycenter banks along with GS and MS. It's worth noting that Euribor/OIS ticked down again last week vs. the week prior, but it's also important to note that the amount of improvement was very small, falling less than one basis point. The TED Spread, however, showed sharp improvement week over week.

 

* Tightening Bank CDS in both American and European financials mirror what we're seeing in the equity market. 

 

* All Downside from Here - In spite of the generally receding risk environment, our firm's Macro quantitative model indicates that in the short term there is 3.5% downside in the XLF vs. 0.0% upside. This is part of the reason we shorted PNC on Friday.   

 

* The MCDX measure of municipal default risk continued to fall sharply week over week.

 

Financial Risk Monitor Summary

 • Short-term(WoW): Positive / 5 of 12 improved / 1 out of 12 worsened / 6 of 12 unchanged

 • Intermediate-term(WoW): Positive / 8 of 12 improved / 2 out of 12 worsened / 2 of 12 unchanged

 • Long-term(WoW): Negative / 1 of 12 improved / 7 out of 12 worsened / 4 of 12 unchanged

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - Summary

 

1. US Financials CDS Monitor – Swaps tightened for 27 of 27 major domestic financial company reference entities last week.

   

Tightened the most WoW: GNW, AIG, XL

Tightened the least WoW: COF, AON, MBI

Tightened the most MoM: AIG, BAC, MS

Widened the most/ tightened the least MoM: MTG, CB, MMC

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - CDS us

 

2. European Financials CDS Monitor – Bank swaps were tighter in Europe last week for 31 of the 40 reference entities. The median tightening was 1.8%.

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - CDS  europe

 

3. European Sovereign CDS – European Sovereign Swaps mostly tightened over last week. Italian sovereign swaps tightened by 17.0% (-73 bps to 354 ) and Spanish sovereign swaps widened by 5.8% (22 bps to 390).

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - Sovereign CDS 1

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - Sovereign CDS 2

 

4. High Yield (YTM) Monitor – High Yield rates fell 49 bps last week, ending the week at 7.45 versus 7.94 the prior week.

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - High Yield

 

5. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 7 points last week, ending at 1633.

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - LLI 2

 

6. TED Spread Monitor – The TED spread fell 4 points last week, ending the week at 45.6 this week versus last week’s print of 50.

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - TED spread

 

7. Journal of Commerce Commodity Price Index – The JOC index fell 3.1 points, ending the week at -12.5 versus -9.4 the prior week.

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - JOC index

 

8. Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by less than 1 bps to 76 bps.

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - Euribor OIS

 

9. ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - ECB liquidity facility

 

10. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 14-V1. Last week spreads tightened, ending the week at 121 bps versus 128 bps the prior week.

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - MCDX

 

11. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production. Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion. Last week the index fell 79 points, ending the week at 647 versus 726 the prior week.

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - Baltic Dry

 

12. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure.  Last week the 2-10 spread widened to 169 bps, 1 bps wider than a week ago.

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - 2 10

 

13. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.0% upside to TRADE resistance and 3.5% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - XLF

 

NYSE Margin Debt - December

We publish NYSE Margin Debt every month when it’s released. NYSE Margin debt hit its post-2007 peak in April of 2011 at $320.7 billion. The chart below shows the S&P 500 overlaid against NYSE margin debt going back to 1997. In this chart both the S&P 500 and margin debt have been inflation adjusted (back to 1990 dollar levels), and we’re showing margin debt levels in standard deviations relative to the mean covering the period 1. While this may sound complicated, the message is really quite simple. First, when margin debt gets to 1.5 standard deviations or greater, as it did last April, that has historically been a signal of extreme risk in the equity market - the last two times it did this the equity market lost half its value in the ensuing period. We flagged this for the first time back in May 2011. The second point is that margin debt trends tend to exhibit high degrees of autocorrelation. In other words, the last few months’ change in margin debt is the best predictor of the change we’ll see in the next few months. This is important because it means that margin debt, which retraced back to +0.53 standard deviations in November, still has a long way to go. We would need to see it approach -0.5 to -1.0 standard deviations before the trend runs its course. There’s plenty of room for short/intermediate term reversals within this broader secular move, as we saw in November and December's print of +0.55 and +0.53 standard deviations.  Overall, however, this setup represents a headwind for the market. One limitation of this series is that it is reported on a lag.  The chart shows data through December.

 

MONDAY MORNING RISK MONITOR: POSITIVE MOMENTUM SLOWS WHILE THE SHORT-TERM SETUP LOOKS NEGATIVE - Margin Debt 

 

Joshua Steiner, CFA

 

Allison Kaptur

 

Robert Belsky

 

Having trouble viewing the charts in this email?  Please click the link below.

 



Giant Defense

“Defense is superior to opulence.”

-Adam Smith

 

If your 2012 defense can shut down both Aaron Rodgers and Tom Brady in back-to-back playoff games, evidently you deserve to win the Super Bowl. Opulent offensive statistics often win awards. Giant Defenses win Championships.

 

Anyone who has followed my hockey or professional career closely knows that I take pride in playing defense. Blocking shots and not losing money on market down days may not get my name in the paper – but that’s ok, I don’t read the Old Wall’s paper.

 

In a consciously conservative move to defend against both US and Global Growth Slowing again sequentially in February, I shorted the US stock market twice last week (at 1327 and 1343 in the SP500). This week, we’ll see if I played defense too early.

 

Back to the Global Macro Grind

 

Being early in this business is also called being wrong. For me, since I’m usually buying on red and selling on green, that happens a lot. After seeing the US stock market fall for 4 consecutive days after Ben Bernanke imposed an Inflation Tax on Consumers and Savers, most of last week’s squeeze came in 4 hours of Friday’s trading.

 

How do you defend against that? It’s not easy. And since there are tens of thousands of fund managers who are in the business of the stock market going up, that doesn’t make explaining why I decide to go on defense any easier.

 

To review my Global Macro Risk Management Process, when I think about countries and probability-weighing the bullish or bearish momentum of their respective economies, I heavily weight the following 3 factors:

  1. Growth (slowing or accelerating?)
  2. Inflation (slowing or accelerating?)
  3. Policy (perpetuating or fighting inflation?)

Most Deflationistas don’t agree with me on this because they are either academics who are not accountable to trading daily, weekly, and monthly P&L risk, and/or they don’t have a Giant Defense that has proactively prepared them to make these calls on the margin.

 

It’s what happens on the margin that matters to Macro Market Expectations most.

 

The reason why I pay such close attention to what Bernanke does is that he drives point #3 – Policy. If you get Fed Policy (hawkish or dovish on the margin) right, you’ll get the US Dollar right. If you get the US Dollar right, you tend to get most other things right.

 

Now plenty of people who are always taking offense to the Strong Dollar = Strong America point probably don’t agree with me on this either. Since we’ve been right on 26 of 27 long/short calls on the US Dollar since founding the firm in 2008, I’m not sure I care.

 

What I care about most is what Policy does to the Dollar - then what the purchasing power of that Dollar does to everything else that’s priced in Dollars. In the last 3 weeks, with the US Dollar down -3.2%, this is what Growth and Inflation Expectations have done:

  1. Inflation Expectations = Gold +7%, Copper +7%, and Oil +4%
  2. Growth Expectations = US Treasury Bonds (10yr) -5%, Yield Spread -6%

Again, a lot of people will take as much issue with me suggesting that falling US Bond Yields and a compressing Yield Curve (Yield Spread = 10-yr yields minus 2-year) represents Growth Slowing Expectations right here and now as they did in July, August, or November of 2011. This is the goal-line of the bull/bear US Equity debate.

 

This morning’s Global Macro Market signals only amplify my Growth Slowing point:

  1. Despite a stiff rally in US Equities on Friday, most other Asian and European equity markets didn’t agree
  2. Chinese stocks (Shanghai Composite) stopped going up at intermediate-term TREND resistance of 2342
  3. France, Spain, and Italy all backed off, hard, at their long-term TAIL lines of resistance (CAC = 3503)
  4. Dr. Copper said no thank you at its long-term TAIL of $3.98/lb resistance (down -1.1%)
  5. EUR/USD failed, again, at its intermediate-term TREND line of $1.34 resistance (down -0.5%)
  6. US Treasury Yield on the 10-year is down to 1.91% this morning and remains in a Bearish Formation

A Bearish Formation in US Growth Expectations (bond yields) is what made me bearish on US Growth in February of 2011 inasmuch as it is right here in February of 2012. Thankfully, unlike in January 2011, I caught most of the January 2012 up move in stocks.

 

Unlike most strategists in this game, I have no problem shifting from offense to defense – I usually slap on the Giant Defense when I see an inflection in the slope of Growth and Inflation Expectations. My process hasn’t changed. The game-time signals have.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, Shanghai Composite, and the SP500 are now $1, $111.36-114.02, $1.29-1.32, 2, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Giant Defense - Chart of the Day

 

Giant Defense - Virtual Portfolio


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

KEITH MCCULLOUGH: THE LARRY KUDLOW SHOW

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CZR: IF AT FIRST YOU DON’T SUCCEED

The good news:  we calculate positive equity value.  The bad news:  just barely and that’s the top end of our valuation range!

 

 

Caesars is once again trying to go public after a failed attempt to sell investors a bag of coal in late 2010.  The story is definitely better but we struggle to get to positive equity value.  Our valuation range per share is -$7 to +$3.  Why the big range?  Why not?  There are so many deltas, discount rates, and projects on the come.  Our point estimate is -$2 so use that if you’re uncomfortable with the big range.  The takeaway is that we can’t get to $8-10 per share.

 

Their pitch this time around is somewhat similar (but a little more developed) than the last go around, with a few exceptions:

  1. They have a public comp in what IGT paid (or massively overpaid) for Double Down and would like investors to give their Playtika business comparable value at $500MM
  2. Online poker in the US is looking like more of a reality with timing and scope still unclear, though.  We think it’s fair to assume IF online poker gets legalized at the federal level, then we could have a $1BN EBITDA pie a few years out where CZR gets 20%.
  3. Their Ohio casino JVs (Horseshoe Cleveland, Horseshoe Cincinnati) are going to open in 2012 and 2013, respectively, and they have an option of getting slots at Thistledown but that’s further away
  4. Vegas is better; regionals are still ‘stable’; Atlantic City is still bad
  5. Maryland has a good chance of happening
  6. Massachusetts could happen but it would just be a management contract so we’re not sure that moves the needle
  7. Pennsylvania is dead and no mention of Texas

What hasn’t changed?

  • Maybe it’s no longer a bag of coal, but it’s not much better than a bag of lemons
  • There is still a lot of deferred maintenance capex
  • Leverage is about 12x 2011 and unlikely to go down by much in the foreseeable future

What’s strange?

  • That CZR is selling you a recovery story in early February with no year-end financial disclosure
  • The small size of the deal

What about the term loan amend and extend?

  • CZR is trying to extend up to $4BN on its B1-B3 Term Loan due in 2015 to 2018
  • In exchange for the extension, CZR will pay an incremental 150bps on the extended piece which would cost $60MM if they get the full $4BN extension
  • For those lenders who opt to extend, 25% of their debt would be paid down with proceeds from a Senior Secured bond offering which would likely price around 8.5% and cost another incremental $30MM of interest if the full $4BN extension happens
  • We don’t think that most lenders will opt to extend since CZR is still burning cash and that would move them to the back of bus behind other lenders

 

Valuation

 

Our point estimate for valuation is -$2 per share.  Yes, that’s negative equity value.  We tried very hard but cannot get above $3 per share at the high end.  Here is the calculation:

 

CZR: IF AT FIRST YOU DON’T SUCCEED - czr3

 



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