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IGT CATCHING UP

The stock has been a laggard but better near-term trends, investor friendly cash deployment, and some international visibility may quickly narrow the performance gap.

 

 

IGT’s belief that they can drive their international market share from 15% to 30% over the next several years certainly raises eyebrows.  Considering that the international slot base is 50% larger and growing twice as fast as North America, that would be a very lucrative accomplishment.  We’ll remain a bit skeptical on the 30% but we do think evidence will emerge this year and this quarter to show that IGT is making progress.  Incremental sales will leverage an already beefed up sales and content infrastructure.  In other words, the cost infrastructure needed to drive significant growth in international sales is already hitting the P&L.

 

International growth is not the only catalyst, however.  IGT’s recent large investments in the online gaming space have investors worried about ROIC.  We think management is done making large acquisitions for a while which means their sizable free cash flow needs to be invested elsewhere.  Aggressive and accretive stock buybacks are the most likely vehicle for returning cash to shareholders.  Ultimately, we expect the company to raise its dividend modestly and potentially accretively take out the convertible.  Management appears happy with its current leverage.

 

IGT trades at 13x our fiscal 2013 EPS estimate, yet EPS growth could be 20% for a few years.  The story is coming together and is getting out there.  Management is meeting with investors in Boston and New York this week and a big investor conference is being held in Las Vegas next week.  We think incremental investors may be persuaded by more prudent cash flow deployment going forward (read: buyback) and the progress being made toward the company’s lofty international goals.



Being Wrong

“No amount of experimentation can ever prove me right; a single experiment can prove me wrong.”

-Albert Einstein

 

If your portfolio is 50% long SPY and 50% long AAPL, you are all set – Bonds, Gold, Currencies are all getting crushed. So much for Global Macro diversification.

 

In terms of US Equities, I’m sure most people absolutely nailed it yesterday, but I didn’t. I’d already sold my Long Financials (XLF) position (Sector Rotation into Utilities) and I wasn’t long anything big beta Basic Materials or Energy yesterday.

 

For those keeping score since February, not being long anything Commodities or International Currencies has actually been a very good risk management decision. Not to call out crashing currencies, but the Japanese Yen is down -9.1% since February 1st. Small Caps (Russell 2000) are dead flat from that same date.

 

Back to the Global Macro Grind

 

Since no one who made money in 2011 was long the Financials (XLF) and now, less than 3 months later, everyone I see on TV proclaims to be long them, what are we to do with this Storytelling about a “successful stress test” by the US Federal Reserve?

 

Well, my Being Wrong about the US stock market yesterday is one thing, but being wrong about what this test was all about is not what we do. Check out the parameters of this so called “test”:

  1. US GDP Growth: “stress” was measured using a down -8% GDP scenario
  2. US Unemployment: 13% was the bogey there (after Bernanke is celebrating his contributions to full employment)
  3. US Stock Market (not clear why this is such a critical part of Bernanke’s test) = Dow 5,500

Not a typo. Not Dow 15,000. Dow 5,500. Good thing most of these revolutionary banking outfits passed the test!

 

If I had the insider information that some apparently traded in front of on the pre-release of the “stress test” (someone bought a boat load of Citigroup $38 puts, right before they “failed” the “test”), I wouldn’t have changed my positioning ahead of it anyway. That’s illegal, last I checked.

 

I don’t know what level of experimentation my risk management models could have been stress tested with for me to have not made the risk adjusted decisions I’ve made throughout March either.

 

To put yesterday’s Global Macro move in context, it was a 3.7 standard deviation event across asset classes. Since I have scored/back-tested my model (2007), this has happened less than 1% of the time. Evidently, the 1% in this country still matters.

 

Moreover, what I learned the hard way yesterday was that “a single experiment can prove me wrong.” I cannot understate the 3 dimensional risk associated with US interest rates rising from the ZERO bound. This baby is all on Bernanke’s lap too – don’t forget that he’s the one who has trained us, like Pavlovian dogs, to carry trade 3D Risk:

  1. Daring us to chase yield (got dividends?)
  2. Delaying Balance Sheet restructuring (bad sovereign deficit spending, including the USA)
  3. Disguising Financial Market Risk

Again, if you are long the 50/50 AAPL/SPY portfolio, no worries about this. But, in the rare case that you are long Gold, Bonds, or Currencies, this Disguise of Financial Market Risk doesn’t need to be explained to you. This morning, it’s in your account.

 

For March 2012 to-date:

  1. GOLD = -3.1% (down -7% from its FEB 2012 peak)
  2. TREASURIES = 2 and 10-year UST Bond yields are up +24% and +13%, respectively (bonds smoked)
  3. CURRENCIES = the 2 majors vs the USD (Yen and Euro) are down -3.7% and -1.8%, respectively

So what do I do from here?

 

My risk management process doesn’t chase stock prices on no volume and bombed out volatility signals – so don’t expect me to change my process after Being Wrong on that asset class for a few days. It was only last Tuesday when I was getting long at 1345.

 

Across durations, here’s what my core 3-factor risk management ranges (PRICE, VOLUME, VOLATILITY) are telling me to do:

 

1.   PRICE: immediate-term risk range = 1, so we are immediate-term TRADE overbought or I wouldn’t have shorted SPY yesterday at 3:08PM into the close. Long-term, lower-highs (down -10.9% versus all-time high) are obvious – so is intermediate-term TREND support at 1290.

 

2.   VOLUME: flat out nasty volume signals, across durations, will only be considered irrelevant by people who have blown up in any of the massive Q1 to Q3 US Equity draw-downs of 2008, 2010, and 2011. Long-term volume signals are at generational lows, while yesterday’s immediate-term volume was only the AVERAGE volume of the 30-day composite in my model.

 

3.   VOLATILITY: Yesterday’s Chart of the Day showed you how, like clockwork, this 14-15 Equity Volatility (VIX) zone has been as clear a signal to sell long Equity and Commodity exposure as the sun rising in the East. Snapshot VIX: up +9% in 30mins yesterday to 15.89 before the almighty “stress test” leaked, then straight back down to close at 14.80. Fast.

 

Being Wrong doesn’t make me happy. I have no excuse for it – neither am I searching for one. As Billy Beane said in Moneyball, “I hate losing more than I do winning.” Today, I’ll wait and watch. Being forced to move is no way to win.

 

My immediate-term support and resistance levels for Gold, Oil (WTIC), US Dollar Index, and the SP500 are now $1, $124.21-127.41, $79.59-80.49, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Being Wrong - 1. Bern

 

Being Wrong - 11. VP 3 14


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