“Call it what you will, incentives are what get people to work harder.”
Nikita Sergeyevich Khruschchev served as Premier of the Communist Party of Russia from 1958 to 1964. In Russian Communist Party terms, Khrushchev was considered a liberal reformer, especially vis-à-vis his predecessor Stalin. Although to be fair, a comparison to Stalin is a relatively easy comp in that regard.
The irony of using a quote on incentives from a prominent Communist leader is not lost on me. Obviously, most attempts at Communism, with China currently being a slight exception, have failed to actually provide the incentives to create economies that are sustainable, flexible, and adaptive. The root of this is that the actual individuals who underscore any economy do not have the correct incentives in a communist society.
Just imagine, if you will, an economic system in which the harder you work and the more you make, the more the government takes from you. Sounds crazy, no? Or perhaps it just sounds a little like the escalated taxation system that we have also developed in the West in which the more you make the more the government takes and then the more they spend. And then when they can’t take anymore from you without the risk of popular unrest, they just borrow. Then the governments default and feel shame.
But I digress.
Contemplating incentives are critical when considering the investment landscape. As it relates to Europe, one of the more interesting charts I’ve seen recently is that of real euro exchange rates. The chart was produced by the Peterson Institute for International Economics. The chart, which is highlighted in the Chart of the Day, indexes real effective exchange rates based on relative labor costs.
This chart shows Germany versus the so called PIIGS – Portugal, Ireland, Italy, Greece, and Spain. The analysis is staggering in that it emphasizes the massive advantage that Germany gets from having a fixed currency, the euro, across the Euro-zone. Instead of the currency market acting rational and increasing the value of the German currency, the Germans are given a long term relative advantage by being part of the Euro-zone.
So, on one hand, despite domestic political pressure, Germany is clearly at least somewhat incentivized to protect and sustain the euro. That said, while the euro does provide Germany with a long term and sustainable economic advantage, the Germans are not incentivized to protect the euro at all costs. Germany will exist just fine if the euro failed, while for many nations – Italy, Spain, Portugal, Greece, and so on, it will be an unmitigated disaster. Those nations would effectively be shut out of the international debt markets and would likely experience massive inflation.
Arguable Ray Dalio said this best, when he wrote in a recent note:
“For this reason, we think the popular assumption that the Germans and the ECB (which requires agreement of the key factions within it) will come through with the money to make all these debts good should not be taken for granted. Said differently, we think there are good reasons to doubt that European bank and sovereign deleveragings will be prevented from progressing to the next stage in a disorderly way, without a Plan B in place. This "fat tail" event must be considered a significant possibility.”
As I interpret it, his point is primarily that incentives are not fully in place for Germany and the ECB to provide a carte blanche bailout of Europe. Therefore, the more likely scenario is that sovereign debt debacle continues in Europe.
And if you don’t want to believe me or Ray Dalio, then take Angela Merkel at her words. According to reports from last night:
“The chancellor told lawmakers a quick move to eurobonds or other forms of joint liability would be constitutionally impossible in Germany and insisted that "supervision and liability must go hand in hand." She said they could only be considered if and when "sufficient supervision is ensured."
Changing topics slightly, this morning we will be launching coverage of the Industrials Sector with Jay Van Sciver. Hopefully, you won’t hold the fact that he has a Yale degree against him (we certainly don’t). In addition, he also has over a decade of experience covering Industrials from the buy-side. Like many of our Sector Heads, he will cover a broad universe and go to where the action is in terms of investable ideas. In the call today, he is going to discuss some of his investment ideas as well a deep dive on airlines. Email if you are institutional investor and would like to participate.
Not to totally steal Jay’s thunder, but his initial view of the airlines is not overly positive. In fact, some airline “stalwarts” such as Delta and United have more than 85% buy ratings from the sell side. Delta, in particular, is at almost a 52-week high and only 1.2% of its shares are short. This isn’t totally surprising since Delta is “cheap” on conventional metrics.
Now if this time is totally different for the airlines, Jay may be wrong on his thesis. That said, it is a little hard to believe that much has changed in this highly competitive industry. Just like every other period in modern airline industry, management teams are incentivized to shift planes to competitive routes to suck the profits out of those routes and eventually out of the system.
A key catalyst from Jay’s research is the American bankruptcy, which may actually kick start a new bankruptcy cycle. By the end of Q3, AMR should have lower costs than both Delta and United and these costs will be rapidly passed on to customers. Since Delta and United cannot rapidly cut costs to compete since many costs involve long tail labor expenses, their profitability will come under increasing pressure in Q3 and beyond.
I should probably stop there at risk I give away too much and you aren’t incentivized to sign up for Jay’s call at 11am eastern today. But I will leave you with one quote on airlines from Sir Richard Branson:
“I’ve always said the quickest way to become a millionaire is to start as a billionaire and get into the airline business.”
Of course, Branson has his incentives as well, which are to keep competitors out of the airline business!
Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1, $88.02-93.62, $81.99-82.63, $1.24-1.26, and 1, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
The Macau Metro Monitor, June 27, 2012
MELCO CROWN SET TO PARTNER IN MANILA CASINO WSJ
Belle Vice Chairman Willie Ocier said the company is in talks to have MPEL to operate the casino portion of its $1 billion resort project but declined to provide further specifics. Although nothing is finalized, a decision could come as early as today.
Though Belle, a property developer, owns the casino license, it lacks gambling experience, so it signed an agreement to outsource the casino management to Philippine bingo operator, Leisure & Resorts World. The two companies were to evenly split the resort's EBITDA, said a source. The new deal may see MPEL take over Leisure & Resorts' 50% share of the resort's revenue, the source said. Leisure & Resorts will still likely remain involved in the project in some capacity, however.
Belle has one of four licenses to build casinos in the Manila Bay area. It is controlled by the country's richest man, Henry Sy. The other licensees are Bloomberry Resorts Corp, who is set to open a $1.2 billion casino-resort in early 2013, Resorts World Manila, and Universal Entertainment Corp, a pachinko company run by Kazuo Okada.
EMPLOYMENT SURVEY FOR MARCH-MAY 2012 DSEC
Macau unemployment rate remained unchanged at 2.0%. Total labour force decreased slightly by 1,000 from the previous period to 344,000; the labour force participation rate stood at 71.9%, down by 0.5% points.
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“The real test is how you behave when the crowd is roaring the other way.”
Question: from an expectations perspective, have markets really changed since George Goodman penned The Money Game in 1968? As the weak whisper and the manic chase, that question has been on my mind for the last few weeks. Just a question.
While I’m at it, here’s another question: are you #Fedup yet? This morning’s Most Read (Bloomberg) headline = “US Stocks Gain Amid Speculation of More Fed Stimulus.” That’s awesome, right?
Right, right. And so is eating yellow snow.
Back to the Global Macro Grind…
Maybe Bernanke should read something from the late 1960’s and early 1970’s. Actually, wait a minute, Fred Kelly wrote in 1930 that “the crowd always loses”, so maybe Bernanke did read that. The man knows the 1930’s!
The Real Test in this game is not whether you are a student of one window of history. It’s whether or not you can beat the crowd. If Bernanke thinks he can thread the needle here into and out of next week’s FOMC meeting (June 20th), I say godspeed to him on that. He’s got the crowd right addicted to the drugs at this point, so how this all ends is anyone’s guess.
That said, I bought Gold and took my US Equity exposure up from 0% to 6% on red yesterday morning. Heck, why not roll the bones with The Bernank? This guy is a genius. Or at least that’s what the Washington crowd says.
Obviously I don’t play this game like roulette. That’s what some other people do (with other people’s money). The moves I make on red and green are based solely on my process. That investment process has 2 big parts:
A) The Research View
B) The Risk Management View
To be crystal clear, research and risk management are two very different things.
Quite often, as is the case with evaluating Fed Policy, what our research says Bernanke should do (nothing) and what he might do (something) are opposing thoughts.
When that happens, The Real Test is to remain sane and press the right buttons at the right time.
Timing? Yep, it matters.
In a market that’s being driven by a Correlation Risk that’s going to 1, timing matters, big time. Get the daily direction of the US Dollar right, and you’ll get a lot of other things right. With the USD down -0.35% yesterday, the best performing sector in the SP500 was the commodity heavy Basic Materials sector (XLB) at +1.9%.
Here’s an update on that (correlation risk between the US Dollar Index and everything else on a 2-month duration):
- SP500 = -0.92
- Euro Stoxx600 = -0.94
- CRB Commodities Index = -0.93
- WTI Crude Oil = -0.95
- Gold = -0.78
- Rubber = -0.93
I really hope you haven’t been long Rubber for the last 2 months.
Hope, of course, is not a risk management process. Neither is whining about “valuation” while ignoring the Correlation Risk. When it matters, it matters – and your Real Test as a real-time Risk Manager is to solve for that.
This is why I have been so hard on Bernanke and Geithner. If we get their dogmas and policies out of the way, we’re making the 1stcritical (causal) step in getting expectations for more USD driven correlation risk out of the way.
I know, it makes simple sense. What is not simple is that short-term political career risk (admitting they’ve had this all wrong since going to Qe2) gets in the way of the truth.
The truth is that Big Government Intervention policy expectations drive market expectations. That’s not free-market capitalism. That’s just really screwed up.
Maybe I’ll be long Gold for an hour. Maybe I’ll be long it for a week. Maybe I’ll be long it to $2,000 an ounce. I have no idea. And I shouldn’t, because I have no idea what this un-elected central market planner is going to do next.
What I do know is that if Obama gives Bernanke the political weaponry to debauch the Dollar one more time before the election, Gold and Oil are going to rip, and #GrowthSlowing is going to become the Research View of 2012.
My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1604-1648, $96.27-99.42, $81.98-82.56, $1.24-1.26, and 1304-1340, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Media reports of MPEL involvement in Philippines deal are probably accurate.
We think MPEL may have reached a deal to invest US$200-300 million in an integrated casino resort project already under construction. The project is a joint venture between local property developer Belle Corp and Leisure & Resorts World, a Philippine bingo operator. Total project cost may be as high as $1 billion.
MPEL would manage the casino and together with its investment, could have rights to over 50% of the cash flow. This looks like an incredibly high ROI opportunity for MPEL. We believe that Resorts World Manila, the only integrated casino resort in the Philippines, is generating $250-300 million in EBITDA on its current $650 million investment. Even if one assumes only $200 million in EBITDA for the Belle Casino, that would generate an ROI of at least 50% to MPEL.
Obviously, there are regulatory issues in closing this transaction; not so much with MPEL, however. The Australian authorities may have issues with James Packer and Crown doing business in the Philippines. Some foreign regulators have voiced concerns about PAGCOR serving as both an operator and regulator of casinos. Of course, the Philippines also maintains some notoriety with regards to corruption.
TODAY’S S&P 500 SET-UP – June 27, 2012
As we look at today’s set up for the S&P 500, the range is 30 points or -1.06% downside to 1306 and 1.21% upside to 1336.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: on 6/26 NYSE 833
- Up from the prior day’s trading of -1657
- VOLUME: on 6/26 NYSE 712.29
- Decrease versus prior day’s trading of -5.50%
- VIX: as of 6/26 was at 19.72
- Decrease versus most recent day’s trading of -3.24%
- Year-to-date decrease of -15.73%
- SPX PUT/CALL RATIO: as of 6/26 closed at 1.55
- Down from the day prior at 1.86
CREDIT/ECONOMIC MARKET LOOK:
CLIFF – as in the USA fiscal kind, draws closer as the denominator (GDP) goes lower. Keith wrote in the Early Look note yesterday about the UST 2yr being one of my proxies for sov debt risk. It’s certainly not the only indicator, but how it moves (on the margin) matters. Long-term TAIL support for the 2yr has been 0.28%; well above that at 0.31% this morning – that compresses the Yield Spread too.
- TED SPREAD: as of this morning 37
- 3-MONTH T-BILL YIELD: as of this morning 0.09%
- 10-Year: as of this morning 1.63
- Unchanged from prior day’s trading
- YIELD CURVE: as of this morning 1.33
- Up from prior day’s trading at 1.32
MACRO DATA POINTS (Bloomberg Estimates):
- 7am: MBA Mortgage Applications, June 22 (prior -0.8%)
- 8:30am: Durable Goods Orders, May, est. 0.4% (prior 0.0%)
- 8:30am: Cap Goods Orders Nondef Ex Air, May, est. 1.7% (prior -1.9%)
- 8:30am: Cap Goods Ship Nondef Ex Air, May (prior -1.4%)
- 10am: Pending Home Sales M/m, May, est. 1.5% (prior -5.5%)
- 11am: Fed to buy $1.5-2.2b notes in 2/15/2036-5/15/2042 range
- 1pm: U.S. to sell $35b 5-yr notes
- House, Senate in session
- Lawmakers in House, Senate will try to clear transportation funding bill and measure on student loans; may tie them together to win passage
- House Transportation Committee panel hearing on Jones Act waivers issued last year after strategic oil reserve was tapped in response to supply disruptions caused by the conflict in Libya; DOT Deputy Secretary John Porcar is to testify, 10am
- House Natural Resources Cmte hearing on hydropower, 10am
- House Financial Services Committee meets to consider its third semiannual report on the panel’s activities and to mark up a bill that would amend the Electronic Fund Transfer Act to limit fee disclosure requirements
- House Judiciary holds hearing on international intellectual property rule enforcement, 10am
- House Subcommittee on Communications and Technology will examine how viewing has changed as broadcasting, cable, satellite, Internet and other platforms have evolved, 10am
- President Obama meets with Abu Dhabi Crown Prince Mohammed Bin Zayed
- Obama hosts picnic for members of Congress at White House
- EIA Administrator Adam Sieminski speaks at energy outlook conference held by Bipartisan Policy Center, 9am
- U.S. Energy Information Administration to discuss agency’s 2012 energy outlook, 1pm
- Food and Drug Administration will convene advisers for two days to weigh the safety of metal-on-metal hip implants
WHAT TO WATCH:
- Microsoft lost an EU challenge to a EU899m ($1.2b) antitrust fine, was cut to EU860m, court said “essentially” upheld penalty
- Facebook initiated at neutral at Citigroup, buy at Goldman
- SEC said to authorize lawsuit against Harbinger’s Falcone
- Best Buy founder Richard Schulze said to consider taking co. private
- Apple wins preliminary injunction against Samsung Galaxy Tab
- Stockton, California to file for bankruptcy after talks with bondholders, labor unions failed, biggest U.S. city to seek court protection
- May durable goods orders forecast +0.5%, probably failed to make up for worst 4 mos. since recession
- Spanish Prime Minister Mariano Rajoy said he will urge other EU leaders at a summit this wk to take measures to “stabilize markets using the available instruments”
- Italy sells 185-day bills at 2.957% vs 2.104% on May 29
- Glencore GBP16.9b ($26.4b) offer for the rest of Xstrata is in doubt after No. 2 shareholder Qatar Holding demanded the bid be increased by 16%
- Announcement on News Corp. breakup may come by tomorrow
- Philip Falcone said to face lawsuit from regulators over personal loan
- SEC money-fund rule said to include capital or floating shrs
- Monte Paschi to seek EU3.4b in govt. aid
- Morgan Stanley faces test on ServiceNow IPO after Facebook flop
- Netflix asked U.S. lawmakers to prevent cable providers from squelching its growth by imposing online-data consumption limits for customers
- Google said to unveil $199 tablet at I/O conference starting today
- Lockheed joins EADS lobbying Panetta to help stop budget cuts
- Lennar (LEN) 6am, $0.16; Preview
- McCormick (MKC) 7am, $0.61
- Commercial Metals (CMC) 7am, $0.37
- General Mills (GIS) 7am, $0.59; Preview
- Monsanto (MON) 8am, $1.58; Preview
- UniFirst (UNF) 8am, $0.99
- AGF Management (AGF/B CN) 8am, $0.27
- Paychex (PAYX) 4:01pm, $0.34
- Progress Software (PRGS) 4:30pm, $0.22
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
GOLD – get the Dollar right, and you’re still getting Gold right. Gold looking more like the Euro day to day; don’t underestimate how long Paulson is of the ETF (17% of it); liquidity matters and so does the downward pressure on price when an asset is in a Bearish Formation like Gold is. Next support = 1549, but that’s loose. This remains a Bernanke Bubble.
- Heat Wave Wilts Corn as Supply Drops Most Since ’96: Commodities
- Corn Reaches Nine-Month High as U.S. Crop Damage May Worsen
- Oil Falls as Rising U.S. Stockpiles Outweigh Supply Disruptions
- Glencore Xstrata Deal Threatened as Qatar Seeks Higher Price
- Copper Drops as Expanding Stockpiles May Signal Weaker Demand
- Cocoa Extends Gains on Manufacturing Buying as Sugar Declines
- Gold Set to Decline on Concern Europe’s Crisis Will Boost Dollar
- Rosneft Said to Offer 200,000 Tons ESPO Crude for August Loading
- Billionaire Deripaska Targets China to Expand Russian Food Sales
- Gold’s $1,520 Support ‘Key’ to Stopping Drop: Technical Analysis
- South Korea Power Shortages Costing $10 Billion a Year: Energy
- Iron-Ore Price Forecast Lowered by Australia as China Cools
- Corn Futures Jump as U.S. Harvest Faces Damage: Chart of the Day
- Heat Wave Wilts Corn as Supplies Diminish
- Sinopec to Process 1.6% Less Oil in Third Quarter, Oilchem Says
- JPMorgan Reduces Second-Half 2012 Oil Outlook on Slowing Economy
- Iraqi Crude Exports Via Turkey Halted for About 10 Hours
GERMANY – both German stocks and German Bunds have broken their immediate-term TRADE lines of support (for the DAX, that’s 6249, putting it back into a Bearish Formation – bearish on all 3 of our risk mgt durations). As Growth Slows, GDP falls and risk ratios rise. Germany and Italy actually look like better shorts than Spain now. That’s new.
The Hedgeye Macro Team
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