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WHEN LESS IS EVEN LESS

We all know business in the gaming sector is tough, as it is for most consumer discretionary industries. Unlike the regional markets, Las Vegas is getting smacked around on two fronts. Visitation is down huge, but so is gaming revenue per visitor. In fact, the downward trajectory in gaming revenue per visitor is greater. Not to throw salt into the wound but this analysis excludes plummeting room rates, which is a much higher margin revenue source than gaming.

As the following chart shows, the year-over-year changes in win per visitor and total visitation tracked each other pretty closely until to the boom years in the middle of the decade. No doubt fueled by the positive wealth effect of skyrocketing housing prices, customers spent like drunk sailors not only in the casino but on room, food & beverage, retail, and entertainment. The planes and rooms were already full, so casinos jacked up room rates, table betting minimums, ticket prices etc, and they tightened the slot odds. All of this contributed to inflated spend per visitor.

We’ve got a long way to go before this bubble completely deflates. It’s payback time for the consumer.

The spending bubble is deflating

WHEN LESS COULD BE MORE

In every single regional gaming market, revenues are flat to down. The driver in each case is fewer admissions (visitors). The more the merrier of course, but there is a silver lining. Revenue per admission is tracking much better than total admissions and is even up in some markets on a year over year basis.

Higher spend per visit is bullish for two reasons. First, it is the lower end customer that is cutting back on visits. The lower end customer is less profitable so margins could potentially hold up better than the revenue declines would otherwise suggest. Second, the pattern of visitation in 2008 tracked gas prices pretty closely. Intuitively, this makes sense. Gas consumption comprises a greater share of a lower end player’s wallet. High gas prices probably had a big impact on the lower visitation numbers. With prices plummeting, visitation could begin to improve.

The chart below plots the year-over-year average change in regional visitation, revenue per visitor (admission), and gas prices on a trailing twelve month basis. With the exception of the 1999/2000 period, visitation and gas prices consistently move in opposite direction. A significant number of new properties and expansions caused the 1999/2000 distortion.

Win per visitor, on the other hand, seems unaffected by changes in gas prices. Since lower visitation is the sole driver of the regional revenue downturn in conjunction with skyrocketing gas prices, it is intuitive that the recent plummet in gas prices could spark a revenue rebound or at least some stability.

In a sector with rampant investor pessimism (see “A TALE OF TWO YEARS”, 12/26/08), low gas prices could provide a spark of optimism as we head into the New Year.

Gas prices drive visitation but not revenue per visitor

Is Money Supply Inflationary? You Bet Your Madoff!

The Federal Reserve reported their Money Stock Measures yesterday and November showed a y-o-y increase of M2 money supply of 7.6%, which is the highest y-o-y growth rate in the last 12 months and, as seen on the chart below, is on an accelerating trajectory. Undoubtedly, money supply only accelerated in December as the Federal Reserve became even more focused on deflationary pressures and the need to stimulate growth.

We would expect money supply to continue to grow, especially since there no longer exists the “policy lever” option to adjust interest rates now that the current target rate for federal funds stands at 0 - 0.25%, or effectively zero. As Fed Chairman Bernanke outlined in a 2004 speech:

“Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.”

Bernanke’s remarks lead us to believe that the next policy step is to “print” money. More money ultimately results in the declining value of money, which is always inflationary.

We have been a bit of a lone voice beating the “re-flation” drum in the past few weeks, but this report from the Fed seems to suggest, especially if the money supply continues to accelerate, that “reflation” is not a matter of if, but when.

Stock markets are certainly “re-flating” today.

Daryl G. Jones
Managing Director

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The New German Flat Tax on Capital Gains

A new German tax code will be taking effect on January 1, 2009. Until the end of this year the current code for many investments—including stocks or funds—are exempt from tax on profits if one has kept investments for longer than one year. For other forms of profits, such as dividends, the so called “Halbeinkünfte-Verfahren” was applied by taxing only half of the profits with one’s normal income tax rate.

Come January 1, 2009 a new tax code will replace the old code with a flat tax of 25% (plus solidarity money for the former East German states and church tax). This would result in a maximum tax of 28% for future profits from investments. This means, any investments made before the end of the year will be taxed according to the old rules even if it matures or is sold in ten years time.

For many investors the new flat tax will represent a tax increase on investments. Certainly with any tax code there will be exceptions and ways to work around the code, yet the present income tax rules demonstrate that for even the highest income earners (who are taxed at the highest rate at ~45%) the new tax is incrementally higher. Here is an approximate breakdown of current taxable income by income bracket:

Taxable Income (in Euros) for a Single Person Taxable Income (in Euros) for a Married Couple Marginal Tax Rate (2008)
0 - 7,664 0 - 15,329 0%
7,665 - 52,152 15,330 - 104,304 ~15-42%
52,153 - over 104,305 - over ~42-45%

This switch will create organizational stress for investors who will now have to separate “old” investments from future ones in order to avoid problems with tax authorities.

Matthew Hedrick
Analyst


The Bullish Reference Rate

I use 3-month LIBOR is a reference rate, not only for those who need to borrow at LIBOR “plus” but as a measure for global counterparty risk.

Alongside the US Dollar (“re-flation”) and a VIX (volatility) indices breaking down, this crashing of LIBOR is amongst the most bullish macro indicators in my playbook.

Below, we have attached both the “Trade” and “Trend” lines for 3-month LIBOR. Both have been broken. Both are bullish for Equities, Commodities, Bonds, and Real Estate, in the immediate term.
KM

A Macro Mystery

A Macro Mystery - asset allocation123008

“The most beautiful experience we can have is the mysterious. It is the fundamental emotion that stands at the cradle of true art and true science...”
-Albert Einstein

Managing my way around this increasingly interconnected global landscape of macro factors, that’s exactly how I have been feeling over the course of the last few weeks - standing “at the cradle of true art and true science…”

Most will agree that consistently earning an absolute return across global macro investment cycles is far from a science. Some are beginning to agree that math and neuroscience are finding a special place in terms of making accurate market predictions. No one will agree that there is a standard (and legal) investment process that is solely based on “art”. That’s what makes this game great. There is a bid and an ask price for every point of view.

In the US market, here are three critical levels of support that the mathematician in me continues to be beholden to: SP500 864, Nasdaq 1501, and Russell 456. Notwithstanding yesterday’s bone dry volume, the “beauty” of the trading “experience” was that, intraday, all 3 of those levels were broken, tested, and tried. As mysterious as it was, all of those indices rallied into the close …  once again confirming the current bullish “Trade” opinion for which I am currently accountable.

On the global macro front, here are three more critical levels that the “artist” in me finds of mathematical relevance: US Dollar Index $82.80, Gold $804/oz, and LIBOR 2.89%. Provided that both the US Dollar and 3-month LIBOR can hold below those levels, I see a very relevant “Re-Flation” Trade continuing to manifest in both Global Equities and Commodities. Gold, of course, needs to hold $804 to confirm this artistically arithmetic conclusion.

All investors have to have a process. For some, that might be asking their friends what they like – for others it could very well be locking themselves in a room with ear muffs. This is what makes markets – where men and women of conviction take a stand and slap it on the tape. Darwin’s rules will win out in the end – the most repeatable process will self select the largest following. My goal, every day, is to prove that my team’s process is worthy of your respect and consideration.

The Russians have considered many economic processes. Over time, most of them have failed. If a process isn’t repeatable across economic cycles, it will fall by the sword of the global capital flows. Today is the anniversary of the USSR’s formation in 1922. Marxist Socialism was tested and tried back then. For a period of time, it actually worked. In the end, it was not repeatable.

My team was both shocked and dismayed that Stalin was voted to the “Top Three Russians Ever” yesterday. No, this wasn’t a 1930’s poll – this was yesterday! The rise of Putin’s nationalist regime has apparently warmed the hearts and minds of Siberians who now have heat, and we get that… heat is good… but for the entire country to find any level of positivity associated with Stalin is both “mysterious” and shocking altogether.

Why is this relevant this morning? Well… “its global this time”… remember? And while we have to admit that Commodities crashing has made the acronym “BRIC” more of a metaphor for what a wall of them feels like when landing on levered long “prop” desk heads… we cannot forget that Brazil, Russia, India, China, and Khazakstan (BRICK) are no less different than SAID (Saudi Arabia, Iran, Drillers) petrodollar kings of the would be “world is awash with liquidity” narrative fallacy past. All of these countries need “Re-flation” to get paid. They are incentivized to do the unthinkable to ensure that both their stock and commodities markets go higher.

If you want to see where the bodies lie in a war, follow the money. Who gets paid for what and why? Both the Israeli and Saudi stock markets have only moved up into the right of their respective charts since the Gaza bombings began. Today is Day 4 of the incursion, and the Middle Eastern stock markets are cheering it on. This isnt art – these are the facts. Debunking how all of these macro factors are interconnected remains both a “beautiful experience” and a mystery to me all at once. But understanding that the Saudis need a $60-70 strike price in oil is far from trivial.

For now, the technicians, scientists, and BRICK layers alike will have a hard time disagreeing with my aformentioned 6 macro levels. I am far from a poet, but within my macro investment process they certainly do rhyme. “Re-flation” is coming…

My upside target for the SP500 remains 915.

Best of luck out there today,
KM

A Macro Mystery - etfs123008

 


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