For the first time during this credit crisis, the gaming operators can see a silver lining in their cloudy financial positions. The three month LIBOR has plunged to 1.09%. All of these companies maintain significant borrowings off of their credit facilities where the interest rate is determined by a (tiny) spread over LIBOR. The EPS tailwind for 2009 EPS is huge. We are not big EPS followers at Research Edge, but the low rate environment will have a big positive impact on cash flow.

Rock bottom LIBOR alone doesn’t pull these guys out of the debtor’s prison they put themselves in. Taking on excessive debt levels to invest in low ROI projects was a strategy that was destined to fail. Fail it did; shareholders and bondholders have paid the price. Unfortunately, that is a sunk cost. On the margin, the liquidity picture may be looking a bit brighter.

The following charts examine the 2009 financial impact from LIBOR going from just over 3% in late October to the current rate of 1.09%. We looked at late October as the starting point because the companies last gave guidance during the Q3 earnings season. Moreover, that may be the last time many analysts updated their models.

ASCA, BYD, LVS and MGM are the biggest beneficiaries in terms of EPS and cash flow. These companies all maintain very attractive credit facilities and significant borrowings off of those facilities. BYD should receive the largest boost with the October to January decline in LIBOR impacting EPS by 46%. ASCA and MGM are on track for over a 30% increase each. In terms of cash flow, LVS, ASCA, and BYD could all see interest cost savings in excess of 10% of their projected 2009 EBITDA.

Combined with deleveraging bond buybacks, the low rate environment should help MGM and BYD get through 2009 without busting covenants. This will put BYD in the clear for 2010 and beyond but MGM still needs new financing to avoid covenant breaches in 2009. The problem for LVS is the leverage covenant in its Macau bank facility which will likely be breached even with the lower rates. Similarly, ASCA faces a potential Q2 senior leverage covenant breach.

Of course, this analysis assumes a) rates will persist here for all of 2009 and b) analysts have not updated their interest rate assumptions since late October. The actual impact is likely to be less, due to a) and b) above, and worse operating trends. However, while investors have certainly focused on the operating fundamentals, we don’t believe the LIBOR tailwind is appropriately reflected in some of the stocks.

Hope and Hypocrisy

Hope and Hypocrisy - asset allocation012009

“Lead, follow or get out of the way!”
George S. Patton

Basically, that’s what I hope Obama gets up and says to the run-of-the-mill market pundit who works for a firm that has no credibility, yet hypocritically questions Obama’s leadership credentials. “Hi, I don’t like Democrats, they aren’t capitalists… but my firm contributes massively to the Democratic party, and my boss asks for bailout money every other day.” Unfortunately, depending on who you are, neither hope nor hypocrisy are investment processes.

Today, of course, is the long awaited Inauguration Day of America’s 44th President. Was the day trader’s Obama rally into the close on Friday? Was it the +5% move in the 5 hours of trading from last Thursday at noon until Friday’s opening SP500 prints at 857? Was it the 6 week +25% rally in the SP500 that ran out of gas on January the 5th? Or is it the +13% cumulative gain we have already baked into the SP500 cake at last week’s 850 close?

Was it none of the above? Do we wait on specific calendar dates that the entire world is staring at on the day of? Or do we have a process that bobs and weaves using prices versus expectations? I don’t know what other people do, but you know where I stand on this. Every day, the math changes alongside both the facts and fictions that the global marketplace offers us. This morning is the first time in a very long time that my math says there is an equally weighted risk/reward setup for the SP500’s price, in the immediate term. I see downside risk to 818, and upside reward to 885. Trade that range.

While the intermediate “Trend” of volatility breaking down as the US market continues to make higher lows remains, that certainly doesn’t mean that the bulls can’t spend a day, week, or month getting water-boarded in a dunk tank. As sure as the sun will rise in the East this morning, you know the bulls who turned bearish in November are still being force fed the apocalypse cometh narrative from the likes of Nouriel Roubini and Jimmy “The Bowtie Cat” Rodgers – this is what these guys do – they are alarmists. They scare people who don’t have a macro process.

Can the perpetual bulls be more bearish than the long standing bears? I really have no idea. While Roubini’s process is an impressively academic one, supported with plenty of history and math, some of these talking heads on the entertainment networks clearly operate using a one factor model – emotion. If they tape goes up, they press play on the bullish narrative fallacy. If the tape goes down, they say “I’m not an economist”, blame the market, and rarely feel shame.

Overseas, the Russians and all those levered to the almighty “petro-dollars” are feeling a whole lot more than shame – they are feeling the pain! Russia’s stock market, which was flashing negative divergences in our model for all of last week, finally crashed again, breaking its October 24th low of 549. The Russian Trading system Index is currently lagging all of European trading, dropping another -3% to 515, taking it -6% below its prior low, and putting its cumulative crash since Christmas at -24%. Yes, the word to describe this is crash.

Crashes happen when what people hope doesn’t happen, happens. It was only 9-12 months ago that I would write about the geopolitical risks associated with “Putin Power” – now those days of his political hubris are gone, but that doesn’t mean that he won’t behave like a man in desperation can behave. As we have seen in Gaza, there are unintended consequences to the realities associated with a crashing oil price. Crash? Yes, at $33/barrel this morning, oil has crashed, losing -78% of its value in 6 months!

Middle Eastern stock markets in Saudi Arabia and Qatar are getting smoked this morning, trading down -4.2% and -6.1%, respectively. Yes this is bad, for some. It will be interesting to see if Maria Bartiromo gets another one of those “exclusive” interviews today with Saudi Prince of Citigroup, and best buds of the Pandit Bandit himself, Prince Alalweed. Remember his interview with CNBC a few months back when he had the campfire and camels in the background? That was embarrassing.

So was my call to short the US Dollar two weeks ago “with impunity.” The US Dollar reminded us all last week that when there is a Crisis of Credibility spreading across the globe, that cash can indeed remain king. The US$ Index and the VIX (volatility) Index outperformed nearly everything other than China last week, closing up +2% and +8%, respectively. In the face of the US government trying their darndest to de-value the US Dollar, it seems that the Japanese, Russians, Canadians, and Asians from India to South Korea are one upping them!

The South Korean Won is down almost -9% already for 2009 to date, and the year is only 2 weeks old! Last year the Won got hammered, losing -26% of its value as their new US trained head of state tried the Greenspan thing, and got clobbered by the oncoming train called macro-economic cycles. The Maestro you see, didn’t do Macro – he did the Politico! We need to re-train these politicized financial neophytes.

With the exception of China, I am effectively net short Asia right now, and this hedged position is paying off nicely so far in 2009. Overnight, South Korea and India closed down another -2.4% and -2.5% respectively underperforming the other Asian country I am short (Japan) by the hair of their chinny chin chin (we are short EWY, IFN, and EWJ – see our virtual portfolio at <> ). These countries are not China, and now they are decoupling versus China. The next person who has it in them to remind us of their “Chindia” thesis of yesteryear gets a Research Edge fleece.

Despite reporting their first drop in their employment rate since 2003, the Chinese stock market reminded us all last night that they are moving forward with their own organic growth plans. Stocks trade on the future, not the past. Despite broad based weakness in Asian stock and currency markets overnight, the Shanghai Stock Exchange close up another +0.37%, taking its cumulative gain since the new year to +9%. Make no mistake, from a quantitative perspective, any close above the 1951 line on the Shanghai Index is a bullish breakout.

Amidst the hope of many Americans today, there will be plenty of hypocrites dancing on hot coals. Once the drama of Obama passes this afternoon, we’ll all be facing the realities associated with The New Reality. While the apex of the liquidity crisis has passed, a very relevant credibility crisis remains – and there will be no quick fix. The only solution will be to “lead, follow… or get out of the way.”

Best of luck out there this week,

Hope and Hypocrisy - etfs012009


What’s In A Name?

That which we call a rose, by any other name would smell as sweet.
- Shakespeare, “Romeo and Juliet”

An on-line dating service guarantees to find you a compatible match, using a sophisticated scientific screening method. If your subscription to the service runs out and you still have not found your soul mate, they will give you an additional six months for free. To anyone who has ever participated in the Singles Scene, this sounds like the old joke: First prize is one week in Philadelphia. Second prize is two weeks in Philadelphia… (Sorry, Philly – Go Eagles!, next year)

GoldenTree Asset Management, a credit hedge fund, has been hit with a wave of redemption requests, after posting losses in its portfolio. Management has invoked a clause in its offering documents that permits it to pay investor redemptions not in cash, but “in kind” – meaning that, if you are upset about how badly your portfolio has been trashed and want out, they will give you more of it, thereby tying you up in the same garbage for a longer time. When is a dollar not a dollar? When it’s a Pay-In-Kind. In the brokerage business this is called “averaging down”, and is a great way to generate commissions, if not customer profits.

Word to the wise hedge fund compliance officer: managing OPM is not dating. In Shakespeare, thwarted lovers kill themselves. In real life, angry investors will bury you. Oh yes they will – them, and their hungry, hungry lawyers.

Hedge funds might take this opportunity to do a thorough review of valuation models. In the last year-plus environment, shame on you if you are not already running a regular end-to-end look at valuations of anything you own that you cannot mark to market daily.

The Financial Times article about GoldenTree (January 14, page 13, “Fund To Pay Investors ‘In Kind’”) quotes a “person with direct knowledge of this” as saying that historically, “GoldenTree tried to keep 80 per cent of its investments in easily tradable securities and 20 per cent in less liquid investments. But recently, as the markets melted down, that ratio flipped.”

“Flipped”? Here’s how we read between those lines: we had no idea that markets could do this, we couldn’t figure out how to hedge properly, we totally blew our investment process and violated every parameter and representation in our offering documents. Wanna sue us? No prob. We’ll be glad to make a big settlement payment.
In kind…

Green Eggs And Ham
Your customers are your bread and butter. Churn them, but never burn them.
- from The Big Man’s Ten Commandments

See if you can spot the magic word in this quote from The Wall Street Journal (January 13, page C1, “Help Wanted: Wall Street Stockbrokers, No Joking”). “Brokers are particularly valuable because so many other businesses that churned out huge trading and investing profits remain staggered by the credit crisis and recession.”

That’s right, folks. Wall Street is going back to churning the good old fashioned way.

Stu Travis, “the Big Man”, can lay credible claim to having invented the cold calling stockbroker. As a young rep at Lehman Brothers in the early 1970’s, Travis went head to head with the other rising star rookie, Marty Shafiroff. Shafiroff, ultimately the greatest stockbroker on Wall Street, is the author of Successful Telephone Selling in the ‘80s and (predictably) Successful Telephone Selling in the ‘90s –books that have been avidly consumed by generations of stockbrokers.

Stu Travis, in a legendary scene from those halcyon times, marched down the hall one day and slapped a note on the door of Shafiroff’s office that read: “Stu Travis – first broker to ever do one million dollars in a single month.”

That million was “gross” – commissions – and it’s a big number for a whole year, even today.

Stu called himself the Big Man, and he was big. As all who knew him can attest, the expression “larger than life” was coined with Stu Travis in mind.

Well over six feet tall, by the time we came to know Stu he had lost the rail-hard body of the former US Marine and had become big in every sense of the word. In the days before smoking bans, Stu could be seen at his desk before six AM, his tie hanging loose down the front of his silk shirt, a giant Cuban cigar between his teeth, exhorting his minions to the battle of the day ahead. We learned great wisdom at his knee. Of all the rascals to come out of the world of retail brokerage, Stu was undeniably the most colorful, the most entertaining and, for all his faults, the most loveable. After Stu, rascalsim went into a decline. After Stu came the Bad Guys, then the Scumbags, followed by the Bridge and Tunnel Crowd, the Uptown Crowd, and the Wise Guys. Stu’s early passing in 1996 left a generation saddened and bereft of a beloved character who was both mentor and mascot. The generations of bad guys who came along in Stu’s wake gave Rascals a bad name.

In the early 1970’s Stu circulated a memo to the managers at Lehman Brothers which spelled out what was to become the famous Lehman System, the toolkit that brought average Americans into the fold of stock market investing and made stockbrokers and their employers wealthy in the process.

The first call is the Cold Call, and it is what gives the brokerage business its name.

“Hello, Mr. Jones! My name is Joe Broker, from the firm of Banker, Broker and Dealer. How are you today? Mr. Jones, have you ever heard of my firm? We are a well established investment bank here on Wall Street serving the investment needs of major corporations, governments, and a select group of private investors. We have selected you, based on your business profile, as someone who might possibly wish to benefit from our investment expertise. On a limited basis, perhaps four times a year, when the partners of the firm are taking a position for their own accounts, we would like to contact you and show you the investment position we are considering. On that basis – and with no obligation – would you be interested in hearing from us?”

Armed with the Lehman System, a growing army of stockbrokers took the world by storm, and the growth in the number of US households owning equities to a current level of better than 50% was largely fueled by their enthusiasm. People who had brokers could talk at cocktail parties. People who did not have a broker boiled in silent rage that somewhere, somehow, somebody else was making absolute gobs of money in the stock market. Men felt inadequate.

Greed is much in the news, but it takes more than greed to bring low mighty nations. Commentators neglect the narcissistic wound inflicted by the thought that someone else is making more money than we are. In the bull market of the 1980’s and 1990’s people panicked to buy stocks, not merely to make a profit, but to beat others to the opportunity. People were obsessed by the conviction that money was there to be made, and those who did not make it were truly Losers. Picking up on this trend – and whipping it along – stockbrokers manned the telephones like gunners in a dogfight. Brokers cold called America with story after story, and America responded by sending large amounts of money to total strangers on the basis of a phone call. If Charles Revson became rich by selling hope in a bottle, Wall Street did one better. We dispensed with the bottle and just sold the hope.

Investment bankers and traders looked down on stockbrokers, but the cold-calling stockbroker made Wall Street run. The Lehmans, the Bear Stearns, the Merrill Lynches generated billions in revenues, making millionaires out of people not even qualified to perform manual labor and creating a vast market for the ineffable crap put out by growing armies of bankers, many of whom were no more suited to structuring viable companies than they were to performing neurosurgery. We had arrived.

Selling was the thing. There was one famous brokerage firm whose training program consisted of drilling the sales force using Dr. Seuss’ Green Eggs and Ham. The objective of selling was to wear the prospect down until he gives in.

Is it refreshing that Wall Street is now getting back to basics? Is this what will make America great once again? Bank of America bought Merrill Lynch, in what will surely go down in history as one of the greatest bait-and-switch sales in the history of the brokerage industry. It is clear that this is a sale for which the customer was not suitable, that the buyer did not have the requisite sophistication, or financial wherewithal, to make this purchase. Where were the Risk Managers? Where the Compliance Officers?

Now Citi is foisting the rubble of Barney – Smith, that is – upon Morgan Stanley. Morgan, with its history as an investment bank, knows a thing or two about selling. But Morgan Stanley is now a bank. By which we mean, a “bank” bank. What is a bank doing hiring 20,000 stockbrokers?

The Financial Times (January 14, page 21, “Analysts Pick Gloomy Time to Sound Optimistic”) looks at the building tsunami of bullishness on Wall Street, focusing on “the upbeat assessment of prospects – including a double-digit recovery in S&P 500 company earnings by the end of the year.” This article is required reading for anyone within sniffing distance of a brokerage account, and spells out the combination of constraint and groupthink that drive investor dollars down drains that “nobody could have predicted.”

Call us nobody – and forgive the self-serving plug – but this is why a thinking person with a dollar wants a Research Edge investment process, and not a Wall Street process. The standard Wall Street research model referred to in the Financial Times article is designed not to bring investors money making investments, but to generate revenues for brokerage firms, in the form of commissions. “Gross”.

Morgan Stanley is offering its newly-acquired sales force one billion dollars in aggregate bonuses to ensure they remain with the firm and generate gross for their new employer. Bank of America, meanwhile, has just been given $15 billion to make up for its atrocious lack of judgment in buying Merrill. The Wall Street Journal (January 16, page C1, “BofA’s Latest Hit”) reports that this is to cover “previously undisclosed losses from its Merrill Lynch & Co. acquisition”, adding that Treasury “will also backstop as much as $120 billion of assets at the bank”.

In brokerage compliance parlance, we call this $15 billion an unauthorized trade, but every time we try to get the compliance department on the line, Washington keeps hanging up on us.

What has not been mentioned in any of the reporting on this disaster is the other side of broker compensation, which is Payout. We would guess the Barney Rubble brokers who are being paid a billion to stay at Morgan Staley are also on accelerated payouts, which will have a further effect on your portfolio – and not a good one.

Top producing brokers who move to a new firm are generally given a bigger percentage of gross commissions generated, to incentivize them to stay. Whereas a typical large firm broker may be getting thirty-five cents of every dollar of gross, we have seen firms giving payouts as high as 90% for the first year. In our scenario, a Smith Barney producer generating $3-$4 million a year might get a deal for 75% in year one.

This incentivizes the broker to stay with the firm. It also incentivizes him to churn your account. After all, a 75% payout will not be around forever. And the employing firm needs the gross to step up, because taking only 25% of the broker’s commissions, the firm is taking a loss.

Now for the sixty-four trillion dollar question: FINRA reports a total of 665,000 registered representatives in the US. Of these, 16,000 are now Merrill Lynch brokers, 20,000 Smith Barney brokers. All of them live by generating gross. What are they all going to sell?

Analyst research.

Are you worried about the recession? Are you hoping the markets will recover so that your 401(K) will give you a year or two of sipping gin and tonics in your rocker before you shuffle off this mortal coil?

Forget it.

Here’s the calculation: A bank buys a brokerage firm. Banks don’t know anything about the brokerage business, which is a coincidence because brokers don’t know anything about investing. Oh, and by the way, what’s up with all the media commentators talking about the “advisers” and the “advisory business model”? The media have unquestioningly bought Wall Street’s cynical line. These are not “advisory personnel,” they are stockbrokers. They don’t do investment expertise. They do Gross.

So the Fed gives away a trillion or so – this is money you had withheld from your paycheck. This goes to prop up firms who were so incompetent at running their businesses that they caused the global financial markets to collapse, endangering your paycheck, your savings, your retirement, and the American way of life. One firm takes a billion or so of your money and pays it to 20,000 stockbrokers in “stay bonuses”. These brokers will have to generate plenty Gross to justify their bonuses, an average of $50,000 each. And if they are on an accelerated payout, the firm will get even less revenue out of those gross commissions. What will they do? Why, they will immediately call you and pressure you until you invest your after-tax dollars in their firms’ investment research (see above).

But don’t worry, because the after-tax losses you suffer when you lose this money in the stock market can be applied to offset your earnings – assuming you have any. You can do your own break-even calculation: at your expected level of compensation (assuming the market meltdown does not affect the “real economy” – another policy triple-speak canard), how much money should you invest with a stockbroker – assuming I will lose 80% of your investment within one year – to maximize the after-tax return of matching your loss carry-forward against my earned income? That number, on a pre-tax basis, should be an indicator of how much the Government can safely pay to the banking firm where your stockbroker is now employed, and still enable you to break even on a net basis.

Look for a huge upsurge in enthusiasm and optimism from Wall Street, as research departments churn out rosy forecasts about the glorious upturn that’s right around the corner. Look for calls from armies of brokers, all saying things like “don’t give up on America”, and “don’t sell America short”, and “America will always bounce back”, as they churn your portfolio all the way to the end of the rainbow, by which time they, at any rate, will have a pot full of gold. Your gold.

Our advice? Urge your college-graduating sons and daughters to become stockbrokers. That way, as the money hemorrhages away, at least you will know where yours is going. Blood is thicker than water. But money is thickest of all.

America, you cannot say we did not have this coming. Merrill Lynch “downsized” by laying off risk managers and compliance officers, all with nary a grumble from the regulators. What should we expect?

Our regulators operate at the behest of Congress. Congress serves at the pleasure of the People and passes the laws we demand of them. The People – we have met the People, and it is us. Looks like the buck stops at our own front door. We should not count on too much protection from the regulators, now that the Government has become the Stockbroker of Last Resort.

That’s what we call Gross.
In memoriam
Stu Travis, “The Big Man” – 1

Moshe Silver
Director of Compliance
Research Edge LLC

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.

Chart Of The Week: VIX vs. SPX

Enough of this holiday weekend stuff – it’s time to get back in sync with managing risk in the US stock market. China led Asia higher today, but European stock markets continued to wallow.

Last week, our old friends from October (Volatility and Cash) outperformed pretty much everything on our macro screens (see chart). On a week over week basis, the US Dollar was +2% and the VIX was +8%. This combo crushed the potential for either commodities or stocks to get a bid – they closed down -3% and -4.5% on the week, respectively. The only way to get the SP500 and CRB Commodities Index to “re-flate” is to bury both the US currency, and the consensus fears expressed via volatility.

The overlay of the chart below is an important one to keep front and center on your screens. The VIX’s intermediate “Trend” will remain a bullish factor for the US stock market, provided that it doesn’t close above the 55.02 line. Can the SP500 test my support line of 818? You bet your Madoff it can – but if the VIX doesn’t confirm, don’t hang out down there without covering any shorts for too long, or you’ll be faced with the same snap rally you saw from the lows last week, as the VIX backed off my line.

Keith R. McCullough
CEO / Chief Investment Officer


Gottschalks’ Ch 11 filing is theoretically a short-term negative and LT positive – that is, if capacity actually goes away (doubtful). ROST is the big loser, with JCP, M and TGT next in line.

Another retailer down. Gottschalks filed for bankruptcy last week after running out of gas on its $125mm debtor-in-possession financing from a group of lenders including GE Capital. The company says it will conduct business “as usual” during the process while it attempts to find a buyer. Good luck finding vendors that will ship ‘as usual.’

The common view is that when a retailer shuts its doors, there is a near-term margin hit for competitors due to irrational pricing, but that gives way to a cleaner and more sane market. My problem with this is that it simply does not usually work out that way. The stores usually end up simply switching hands or lingering in a state of mediocrity. This time around, I’d argue that creditors don’t want to own these stores, and those who are liquid long cash in retail are probably not looking and aged legacy department store assets. Let’s not forget that GOTT has meaningful overlap with Mervyn’s, which account for a combined $2.7bn in apparel/home furnishings sales.

Who are the losers? ROST takes first with roughly 3.5% of its stores overlapping a Gottschalks or Mervyn’s in a 5 mile radius. JC Penny and Macy’s have the next best exposure to the bankrupt stores.

US Market Performance: Week Ended 1/16/09...

Index Performance:

Week Ended 1/16/09:
DJ (3.7%), SP500 (4.5%), Nasdaq (-2.7%), Russell2000 (3.1%)

2009 Year To Date:
DJ (5.6%), SP500 (5.9%), Nasdaq (3.0%), Russell2000 (6.6%)

Keith R. McCullough
CEO / Chief Investment Officer

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 80.46%
  • SHORT SIGNALS 78.35%