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,



Keith R. McCullough
Chief Executive Officer


Giant Defense - Chart of the Day


Giant Defense - Virtual Portfolio


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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




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:




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 80.52%
  • SHORT SIGNALS 78.68%


The Economic Data calendar for the week of the 6th of February through the 10th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.





Weekly Asia Risk Monitor: All Good For Now?

Conclusion: The potential for another implementation of The Bernank Tax upon Asian economies clouds the region’s fundamental outlook while market prices continue to price in a consensus disregarding of this risk.


Virtual Portfolio Positions in Asia: Long Chinese equities (CAF); Short Japanese equities (EWJ); Short Indian equities (INP).



All % moves week-over-week unless otherwise specified.

    • Median: +1.2%
    • High: Taiwan +6.1%
    • Low: Australia -0.7%
    • Callout: Asian equity markets are up +8% YTD on a median basis
  • FX (vs. USD):
    • Median: +0.6%
    • High: New Zealand dollar +1.4%
    • Low: Hong Kong dollar flat
    • Callout: India’s rupee is up +8.9% YTD vs. a regional median increase of +2.7%
    • High: Hong Kong +3bps
    • Low: Indonesia -16bps
    • Callout: Philippines is the only Asian country to see 2yr sovereign yields rise YTD (+43bps)
    • High: Vietnam +29bps
    • Low: Indonesia -22bps
    • Callout: Indonesia -75bps YTD
    • High: Vietnam +31bps
    • Low: India -19bps
    • Callout: Philippines -63bps YTD
  • 5YR CDS:
    • Median: -1%
    • High: China, Korea, Thailand all flat wk/wk
    • Low: Indonesia -6.9%
    • Callout: Japan +9.8% over the past three months vs. a regional median tightening of -13.6%
    • Median: -0.1%
    • High: Vietnam +25bps/+2%
    • Low: Indonesia -45bps/-8.2%
    • Callout: China +19bps/+6.6% YTD vs. a regional median widening of +2.4%
    • Median: flat wk/wk
    • High: Vietnam +53bps/+4.4%
    • Low: India -75bps/-7.9%
    • Callout: China -48bps/-14.2% YTD vs. a regional median decline of -0.9%
  • CORRELATION RISK: Both Asian equities and Asian currencies are developing very high positive correlations to the CRB Foodstuffs Index on a 3wk basis: MSCI AC Asia Pacific Index = 98% correlated; the JPM Asia Dollar Index = 97% correlated. At a point, however, rising food prices will start to impact Asian inflation readings and slow inflows as monetary easing is taken off of the table.

Full price and performance tables can be found at the conclusion of this note.



The  JAN PMI data out of Asia was rock solid, as indicated by the chart below:


Weekly Asia Risk Monitor: All Good For Now? - 1


Looking to FEB and beyond, the fundamental outlook for Asian growth data is less clear than some of the YTD moves across Asian equities/FX would have you believe. Particularly, the quantitative setup for the U.S. Dollar Index is as uncertain as the outlook for future U.S. monetary and fiscal policy. Obama or Romney/Gingrich? Heli-Ben or Bernanke-in-a-box?


Regardless of outcome(s), the market price of the U.S. Dollar remains the #1 leading indicator for Asian growth, inflation, and policy on both an absolute and expectations basis. Given, we think the current setup warrants appropriate hedging across Asian asset classes.


Weekly Asia Risk Monitor: All Good For Now? - 2


Get the U.S. Dollar right, and you’ll tend to get a lot of other things right – like global energy prices and Asia’s growth/inflation/policy dynamics:


Weekly Asia Risk Monitor: All Good For Now? - 3



Growth – Generally speaking, JAN was a solid month for Asian economic growth data:

  • China: The official Federation of Logistics and Purchasing Manufacturing PMI ticked up in JAN to 50.5 vs. 50.3 prior. The unofficial HSBC reading ticked up to 48.8 vs. 48.7 prior.
  • China: The official Federation of Logistics and Purchasing Services PMI ticked down in JAN to 52.9 vs. 56 prior. The unofficial HSBC reading held flat at 52.5.
  • China: The peak rate of deterioration in Chinese economic growth appears to be in the rear-view mirror for the intermediate term, supporting China’s USD-denominated corporate bond market, which posted the best gain throughout Asia in JAN (+5.1%), per JPMorgan credit indexes. Spreads have narrowed as well, with AAA/sovereign spreads compressing -10bps this week.
  • Hong Kong: Real GDP growth slowed in 4Q11 to +3% YoY vs. 4.3% prior. Retail Sales came in flat in DEC at +23.4% YoY.
  • Japan: Manufacturing PMI ticked up in JAN to 50.7 vs. 50.2 prior. DEC Industrial Production growth essentially flat on a YoY basis (-4.1% vs. -4.2%) and accelerated on a MOM basis (+4% vs. -2.7%). Overall Household Spending growth accelerated to +0.5% YoY vs. -3.2% prior. Small Business Confidence nudged up slightly to 45.7 vs. 45.6 prior.
  • Japan: Japanese employment continues to go in the wrong direction, though a declining working population limits upside on the headline unemployment rate, which backed up +10bps to 4.6% in DEC. From a micro perspective, Japanese manufacturers are hurting with persistent yen strength, as the USD/JPY at current levels dramatically impairs profitability. NEC Corp., Nippon Sheet Glass, Sumco are all planning layoffs in the order of 1,000-10,000 jobs in 2012; Sony, Sharp, Hitachi, and Panasonic are likely planning cuts in multiples of those numbers after each recently revised down their annual loss forecasts for FY12.
  • India: Both Manufacturing and Services PMI readings saw forceful upticks in JAN; the former to 57.5 from 54.2 prior and the latter to 58 from 54.2 prior. Further, Indian Export growth accelerated in DEC to +6.7% YoY vs. +3.9% prior. A sign that the Indian economy is growing perhaps too quickly relative to the central bank’s intermediate-term outlook for inflation, Indian banks borrowed 1.3T rupees on average per day from the RBI in JAN, up from 1.16T in DEC. This systematic overextension of liquidity may resurface in the form of hotter inflation data in the coming months.
  • S. Korea: Real GDP growth slowed in 4Q11 to +3.4% YoY vs. +3.5% prior; on a QoQ basis, growth also slowed: +0.4% vs. +0.8% prior. DEC Industrial Production growth slowed to +2.8% YoY vs. +5.8% prior and DEC Service Industry Output growth slowed as well: +1.6% YoY vs. +2.7% prior. Looking to the JAN data, Export growth slowed to -6.6% YoY vs. +10.8% prior and Manufacturing PMI ticked up to 49.2 vs. 46.4.
  • Singapore: Manufacturing PMI ticked down in JAN to 48.7 vs. 49.5 prior – a stealth leading indicator that FEB’s Asian growth data is unlikely to be as rosy as JAN’s.
  • Indonesia: Export growth slowed in DEC to +2.2% YoY vs. +10.2% prior, while Consumer Confidence ticked down slightly in JAN to 91 vs. 91.6 prior.
  • Thailand: Export growth accelerated in DEC to -2.1% YoY vs. -13.1% prior, while Thailand’s Business Sentiment Index ticked up in DEC to 48.5 vs. 39 as the country continues recovering from dramatic flooding in 2H11.
  • Australia: JAN’s NAB Business Sentiment Survey came in slightly better on the margin, with “Confidence” ticking up to 3 from 2 and “Conditions” holding flat at 1. Private Sector Credit growth slowed in DEC to +3.5% YoY vs. +3.6% prior, with growth in Mortgages (an indicator of housing demand) slowing to another all-time low growth rate of +5.4% YoY from +5.6% prior. Australia’s Manufacturing and Services PMI readings both ticked up in JAN: the former to 51.6 vs. 50.2 prior; the latter to 51.9 vs. 49 prior.
  • Australia: Aussie DEC/4Q11 housing market data came in fairly putrid: Home Price growth slowed in 4Q to -4.8% YoY vs. -3.4% prior – completing the largest calendar year drop since 2002; New Home Sales growth slowed in DEC to -4.9% MoM vs. +4.4% prior; Building Approvals slowed in DEC to -24.5 YoY vs. -17.5% prior. Australia’s weak housing market and bleak L/T outlook for demand remains a TAIL-duration headwind for the Australian dollar from an interest rate perspective. Cash rate futures are pricing in a 62% change Stevens lowers the country’s benchmark interest rate by -25bps on FEB 7 to 4%.
  • Australia: Australia’s Trade Surplus rose to record A$19.3B in 2011 aided by coal and iron ore shipments and Asian demand (accounting for over 2/3rdsof Aussie exports).
  • Taiwan: Real GDP growth slowed in 4Q11 to +1.9% YoY vs. +3.4% prior, which is the slowest rate of growth since 3Q09. On the bright side, the country’s Manufacturing PMI reading ticked up in JAN to 48.9 vs. 47.1.
  • Philippines: Real GDP growth came in slightly faster in 4Q11: +3.7% YoY vs. +3.6% prior.

Inflation – Headline inflation generally continued on its trend down across the region, giving Asian policymakers additional scope to reduce interest rates. Uncertainty surrounding the magnitude of The Bernank Tax will likely keep them in the box for now:

  • India: India’s power generation industry has delayed $36B worth of investments in capacity in the YTD, raising the risk of continued energy shortages, which ultimately translate into higher costs of production that eventually trickle into consumer prices.
  • S. Korea: CPI slowed in JAN to +3.4% YoY vs. +4.2% prior and Core CPI slowed to +3.2% YoY vs. +3.6% prior. Both readings give the central bank scope to consider easing monetary policy.
  • Indonesia: CPI slowed in JAN to +3.7% YoY vs. +3.8% prior and Core CPI came in flat at +4.3% YoY.
  • Thailand: CPI slowed in JAN to +3.4% YoY vs. +3.5% prior and Core CPI accelerated to +2.8% YoY vs. +2.7% prior.

Policy – China continues to make headlines on this front: 

  • China: The China Business News reported that the China Securities Regulator may “substantially” increase quotas for the Qualified Foreign Institutional Investors program – potentially more than doubling the current QFII quota of $30B. If true, this is yet another step Chinese regulators have taken in recent weeks to steward capital into its equity markets.
  • China: Premier Jiabao reiterated what he’d been saying for months – his gov’t will maintain curbs on its property market with the intent of bringing prices down to a reasonable level and that economic policy will be “fine-tuned” to support growth. This is consistent with our recent attempts to temper expectations surrounding China easing monetary policy to a meaningful degree – particularly in the face of a Bernank Tax hike!
  • China: The State Council will establish a CNY15 billion ($2.4B) fund to support small companies. In addition, preferential tax treatments for small companies will be extended through 2015 alongside Chinese banks being forced to increase their risk tolerance of bad loans to such businesses. While small in aggregate dollars, this latest batch of “fine tuning” is supportive of Chinese employment and economic growth at the margin and shows Chinese policymakers are will do their best to continue supporting the real economy while taking some of the air out of the property market.
  • China: The PBOC hasn’t sold three-month bills in five weeks – doing all that it can to support liquidity and credit expansion without materially easing.
  • Hong Kong: Financial Secretary John Tsang, equipped with a budget surplus equivalent to 5% of GDP, is using his bloated coffers to help stimulate growth by increasing tax exemption wage levels by +11.1% to HK$120k. Tsang, who is forecasting growth of +1-3% in 2012 (down from +5% in 2011), also stated that he’s prepared to boost the government’s capital expenditures again, after a record HK$58B allocation in 2011.
  • Hong Kong: Speaking in Davos, the aforementioned Tsang said that he’s “never been more scared about the global economic outlook”. When it comes to leading global growth, no countries do it more consistently than Singapore and Hong Kong. As such, we think it’s wise to allocate a fair degree of merit to his forecasts relative to those of other global policymakers.
  • Japan: Finance Minister Jan Azumi told reporters this week that his department “stands ready to act decisively against excessive and speculative currency moves if needed”, suggesting to us that the BoJ is preparing to intervene in the FX market after ¥14.3T in yen sales last year – the third-highest total on record after attempted debasements in 2003 and 2004. The BoJ’s balance sheet is expanding as well, with growth accelerating to +15% YoY in JAN vs. +13.5% prior. We continue to expect the BoJ’s balance sheet to expand to unprecedented levels in 2012 amid heightened sovereign debt issuance.
  • India: Despite elevated rates of Inflation and fairly decent economic growth, the Indian gov’t continues to make headlines with its inability to tighten fiscal policy. The budget deficit has already eclipsed 92.3% of the full-year target only three-quarters into FY12 – more than double the 44.9% rate through the third quarter of FY11. On the revenue front, India has collected only 63.1% of the full-year target through the third quarter of FY12 – well down from 85.6% through the corresponding period in FY11. Per the JAN 24 minutes, “credible fiscal consolidation”, or the lack thereof, remains one of the key roadblocks keeping the RBI from materially easing monetary policy, alongside sustainable declines in inflation.
  • India: Speculation around monetary easing was supportive of a net +$3B in international equity inflows and another +$3.2B in international inflows into India’s debt markets, the both of which helped propel the rupee to a +7.2% gain in JAN – the largest monthly gain on record.
  • S. Korea: After planned CNY-denominated debt purchases in 1H12, the Bank of Korea is considering the purchase of “several hundred million” dollars worth of Chinese equities in 2H12, as part of their systematic diversification of $306B in FX reserves.
  • Taiwan: Recently reelected president Ma Ying-jeou named Sean Chen as his premier, an indirect signal that buoying Taiwanese economic growth is atop his policy initiatives during his next four-year term given Chen’s former role as head of the nation’s securities regulator.


Key economic data releases and policy announcements:

    • Indonesia: 4Q Real GDP; JAN Consumer Confidence
    • Australia: TD Securities Unofficial CPI; Retail Sales
  • MON:
    • Australia: JAN Construction PMI
    • New Zealand: 4Q Wages
    • Taiwan: JAN CPI; JAN WPI
    • Philippines: JAN CPI
  • TUES:
    • Japan: DEC Current Account Balance
    • Taiwan: JAN Trade Data
  • WED:
    • China: JAN CPI; JAN PPI
    • Japan: JAN Economy Watchers Survey; DEC Machine Orders
    • S. Korea: Monetary Policy Decision
    • New Zealand: 4Q Employment Data
    • Malaysia: DEC Trade Data; DEC Industrial Production
  • THURS:
    • Japan: JAN Consumer Confidence; JAN PPI
    • Indonesia: Monetary Policy Decision
    • Philippines: DEC Trade Data
  • FRI:
    • China: JAN Trade Data
    • India: DEC Industrial Production

Darius Dale

Senior Analyst


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