The Wall

This note was originally published at 8am on June 15, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Would it be excessive of me to ask you to save my life twice in a week?”

-Tyrion, Game of Thrones


I was speaking at a Canadian Economic Development dinner last night. At the end of my presentation I opened it up for the customary Q&A. Most of the questions were concerned with where Oil and Metal prices could go when Bernanke and Geithner run out of US Dollar Debauchery bullets.


Whenever talking about mean reversion and/or tail risks, the most obvious two-word risk factor that I explain (that neither Berrnanke or Geithner ever mention) is CORRELATION RISK. After I walked through that, a nice Scottish-Canadian man stood up and said, “this is more of a statement than a question – you are scaring the hell out of us.”


I politely replied (he was Canadian remember), “after what happened again out there into the US market close today, you should be scared.”


Back to the Global Macro Grind


Yesterday’s stock and commodity markets were trading off into the close, and then completely reversed course to the upside after our overlords floated a headline to the market that central planners were “prepared to take coordinated action.”


Whew, thank God for that!


Fear is what central planners are feeding you. Without fear-mongering the citizenry, they can’t print, bail, and print. Without fear of being held accountable for their own policy moves (Growth Slowing, equity market outflows, crashing market prices, and no political re-election) they wouldn’t be making these ridiculous short-term decisions.


At this point, it’s clear that they have gone over The Wall. They cannot go back. And no, that doesn’t mean that it ends well when they realize what’s on the other side either.


In HBO’s latest mini-series hit, Game of Thrones, The Wall separates the known (centrally planned kingdom societies) from the unknown. It’s the perfect metaphor for how conflicted and compromised Keynesian politicians must feel right here and now in 2012. They fear what they cannot see. They fear letting free market prices clear.


We let losers win until The Wall no longer holds. In the meantime, Mr Market is already in motion in taking down the Old Wall.


If you are afraid of a small part of The Wall coming down this weekend, you should be – because now these market morons have ramped expectations (market prices) right back up to the walls of Hedgeye’s immediate-term TRADE lines of resistance.


What does that mean?


That means that if market prices fail, again, at this interconnected wall of resistance, there is very little left in terms of Big Government Intervention catalysts and/or downside market price supports.


Across countries, commodities, and currencies, here are your immediate-term TRADE walls of resistance:

  1. SP500 = 1344
  2. Russell2000 = 775
  3. Euro Stoxx50 = 2179
  4. CRB Commodities Index = 280
  5. Japan’s Nikkei225 = 8731
  6. Shanghai Composite = 2348
  7. South Korea’s KOSPI = 1897
  8. Germany’s DAX = 6281
  9. Spain’s IBEX = 6797
  10. Greece’s ATG Index = 664
  11. Oil (Brent) = $104.87
  12. Gold = $1645
  13. Copper = $3.44
  14. 10yr UST Yield = 1.73%
  15. EUR/USD = $1.27

If, by chance, The Wall of resistance to do more of what has not worked is overcome, beyond that is another wall – The Wall of intermediate-term TREND resistance. Economic gravity is thick.


It remains unclear if these people making these short-term political decisions to manipulate market expectations have any idea about what I am talking about. It remains unknown if they ever had a proactive process of preparation to meet the challenges that remain outside The Wall of their leadership’s groupthink. It is a problem – it is them.


Fortuitously, in anticipation of some version of this political gong show, I got longer earlier this week. Don’t expect me to keep a 67% Cash position into this weekend though. I only have 4 SHORT positions left in the Hedgeye Portfolio. Expect that number to go up, maybe a lot, too.


My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1586-1634, $95.90-98.71, $81.73-82.36, $1.24-1.27, and 1310-1344, respectively.


Happy Father’s Day Dad – best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The Wall - Chart of the Day


The Wall - Virtual Portfolio


The Macau Metro Monitor, June 29, 2012




Steve Jacobs alleges in court documents that Sheldon Adelson personally approved of prostitution and knew of other improper activity at his company's properties in the Chinese enclave.  Brad Brian, an attorney representing LVS, called the allegations false and scurrilous.  Jacobs alleges other documents that haven't been turned over include records of misuse of "blue card' work permits and the hiring of illegal workers in Macau; emails and records of Adelson controlling a "Chairman's Club" allowing favored members, including known or suspected organized crime figures, exclusive access to Sands China's most luxurious accommodations; and email requests from Adelson to a Macau lawmaker who Jacobs said was hired as outside counsel after Jacobs was fired.


The judge scheduled a July 13 hearing on possible sanctions against the company and its lawyers for failure to disclose to the other side and to hear that some documents sought by Jacobs' legal team had been brought from Macau to the U.S. more than a year ago.



Clark County District Judge Elizabeth Gonzalez delayed Kazuo Okada’s request for Wynn Resorts Ltd’s books.  A decision will only be made after the casino operator’s lawyers have a chance to question Mr Okada about his request, Clark County District Judge Elizabeth Gonzalez ruled.  She agreed with Wynn Resorts’ attorneys that the deposition was needed to determine if Mr Okada had a “proper purpose” for requesting Wynn records and books from as far back as 10 years ago.

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Part of The Game

“… part of the Game is the anticipation of how the other players will behave.”

-George Goodman, The Money Game


It’s both fascinating and frightening that central planners will be emboldened by the market’s reaction to their latest plan. Europe is fixed again, and everything is back to being fine until people report their month and quarter end. The duration on that trade = 3 days.


Price Stability Update: At 230PM EST yesterday, the SP500 was tanking, down -1.3% on the day to 1314. An hour and a half later, it was +1.1% higher at 1329. This morning it’s trading up another 16 handles higher than that. This is really starting to rhyme with 2008.


This is one of the many reasons why I am in 94% Cash this morning (up from 91% yesterday and down from 100% last week). Part of The Game is understanding that there are times when the game becomes so volatile and arbitrary that it’s best to get out of the way.


Back to the Global Macro Grind


If I haven’t been crystal clear on this since March, let me write it one more time – I am bearish on growth. Doing more of what has not worked is only going to slow economic growth further. Central planners do not get that; markets do.


Yesterday’s rip into the close and this morning’s melt-up in the US equity futures only amplifies my greatest fear about markets that are trading purely on the anticipation of the next Big Government Intervention catalysts – government itself.


If you disagree with me, that’s fine. If you think governments do a good job creating jobs, innovation, and confidence, you’re probably thinking they are going to do a great job running our stock markets too.


That’s the long-term TAIL risk. All long-term investors need to acknowledge this and raise Cash on all rallies to lower-no-volume-highs. Since the March top, you’ve had (and, evidently, will continue to have) plenty of opportunities to get out.


Enough about the long-term implications of this market gong show. Since not many people are allowed to invest or manage risk on that long-term duration anymore, here’s how the immediate-term TRADE setup looks for US Equities:

  1. SP500 closing > 1320 keeps it bullish TRADE (1320 support); bearish TREND (1365 resistance)
  2. Russell2000 closing > 764 keeps it bullish TRADE (764 support); bearish TREND (795 resistance)
  3. US Equity VIX closing < 21.15 keeps it bearish TRADE (21.15 resistance); bullish TREND (18.22 support)

In other words, I’ll cover/buy at 1320 and short/sell at 1365, and let these government people deal with themselves everywhere in between. If 1320 snaps like it did intraday yesterday again, I’ll be recommending prayer.


In Europe, all 3 of our risk management durations (TRADE, TREND, and TAIL) were signaling bearish up until the minute of this morning’s European market open. Now, all immediate-term TRADE lines that were resistance become support:

  1. EuroStoxx50 > 2169 makes it bullish TRADE (2169 support); bearish TREND (2316 resistance)
  2. Germany’s DAX > 6251 makes it bullish TRADE (6251 support); bearish TREND (6669 resistance)
  3. Spain’s IBEX > 6698 makes it bullish TRADE (6698 support); bearish TREND (7289 resistance)

All the while, the Euro (versus the USD) is having one of its biggest short squeeze days of what was an awful Q2. Trading +1.1% this morning to $1.25, it would have to close > $1.26 to recapture its immediate-term TRADE line of support. So watch that closely.


Again, get the EUR/USD right, and you get a lot of other things right. US Dollar down hard this morning is also why everything from the price of Copper (+2.2%) to almost anything that ticks in US Equities is up. Enjoy your 4th of July tax hike at the pump.


Just don’t confuse government sponsored immediate-term TRADEs with long-term economic prosperity. It’s perverse, but what these people are doing is managing their short-term political career risk for the sake of short-term market pops, to lower highs.


Each lower-high in stock and commodity markets is met with lower and lower market volume. That’s Part of The Game. When The People no longer trust it, they just get out of the way too.


My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Germany’s DAX, Spain’s IBEX, and the SP500 are now $1, $88.36-96.89, $82.19-83.08, $1.24-1.26, 6, 6, and 1, respectively.


Best of luck out there today and enjoy your weekend,



Keith R. McCullough
Chief Executive Officer


Part of The Game - Chart of the Day


Part of The Game - Virtual Portfolio

NKE: No More Hall Pass

Big questions go far beyond a lousy print. Though we call financial controls into question, we think the global growth story here is very much intact. Nike just put up an uncharacteristically weak, unusual and inconsistent year.  The Board knows this. It won’t happen again.



These results deviated from our expectations more than any other Nike quarter in over a decade. The print was simply bad... No ifs, ands or buts about it. Yes, there were one-off factors that contributed to about 75% of the $0.20 miss from the consensus, but there are much bigger questions to be asked and answered.


Here’s what bugs us…

  1. This is the third quarter in a row where Gross Margins came in off of management’s’ guidance. After adjusting for a shift in R&D and a negative customs ruling for 4-years of imports, NKE came in right in line with (Nike’s loosely defined) guidance. But two quarters in a row of missed expectations on GM was suspect for this company to start with. Now they miss it again on a reported basis. The market will no longer extend a free pass on this one.
  2. Gross Margins are sitting at the lowest point since 2004, and that’s the case while inventory growth is improving on the margin, and Nike is sitting on a very healthy order book in aggregate. We should absolutely, positively be seeing margins go the other way.
  3. Is it me, or was the company’s tone on that conference call way too laid back? This was a gnarly, hairy quarter, and the after-hours reaction was the most negative Nike has seen in over a decade.  Hubris has not been Nike’s friend in the past 20-years, as it’s one of the only things that has routinely gotten Nike in trouble. Fortunately, it’s our sense that many of the factors that have caused this have been systematically weeded (or breeded) out in recent years. In addition, we’d note that when the company sticks to its plan and ignores the near-term whim of the Street, it has almost always proves to be a value-creating strategy. But all-in we’d rather have seen less of a gap between current operational activity and Nike’s portrayal of that that picture.
  4. Futures growth in China of 2% on a constant $ basis (5% R$). This is so bad. We all knew that there was trouble brewing in China. We saw it in Nike’s inventories last quarter and then with competitors like Li Ning which blew up 2 weeks ago due to inventory issues. But 2% order growth is far too Japan-esque. In fact even Japan grew at a greater rate. On the plus side, revenue and EBIT were both up 21% in China, and inventories did not get worse on the margin. But we’d rather have seen an inventory cleansing process lead to a pick-up in orders. Remember that this is a 38% margin business. We could care less if they give up a few margin points to keep the growth growing. That didn’t happen. Does this mean that China won’t be a $4bn business in 3 years? Not at all. But it cannot continue to push product into the market without negative implications. What it goes to show is that Nike China is human. Macro matters.
  5. One thing we never thought we’d ever ask ourselves with Nike is the efficacy of its financial controls. No one who understands the innards of this company would argue with the statement that it is arguably in the top 1% of public companies as it relates to financial integrity. But facts are facts, and missing Gross Margins three times in a row in a business model that Nike built around being able to control such a big part of this (futures allow the company to lock in costs, reverse engineer product inputs, and manage FX) simply smells uncharacteristically ‘un-Nike’. One needs to wonder if the financial controls are lacking. We think that nothing has deteriorated from a control perspective. But perhaps with the business being more global, more consumer direct (i.e. with Nike having to eat higher costs as opposed to passing to retailers), and being broken out in so many dimensions – region, product, consumer – that the business is outgrowing systems that are in place for managing a traditional wholesale model with a high degree of forecast accuracy. This thought process is over-simplified, of course. But it would be intellectually dishonest to not ask it.


Now…the good news.

  • We’re likely coming in ahead of consensus at $5.75, $6.75, and $8.00 for May13, 14 and 15, respectively. That’s 20% CAGR, and more than 2x implied guidance for the upcoming year. Call us a glutton for punishment after everything noted above, but consider the following…
  • We think that the company’s revenue and SG&A guidance is light for the upcoming year. Consider that Nike is just coming off a very big investment cycle. Capex is leveling off, and the SG&A spent over the past two years on R&D for products such as FlyKnit, Fuel+ and NFL are FY2013 revenue events – not 2012. So those that are concerned about the product cycle rolling over will be sorely mistaken. We think that NFL alone will grow into a $500mm business in 2-years, and Fly/Fuel will accelerate throughout FY13 with minimal cannibalization.
  • Add a sale of Cole Haan and Umbro (for which Nike gave excellent disclosure) and we’re likely looking at around another $800mm-$1bn by year end in cash to play with. The point here is that Nike is entering into a cash flow harvesting cycle.
  • Mid-high single digit top line growth (guidance) would suggest 2H that would need to come in low-single digit (1Q is tracking to come in North of 10%, we think). That’s simply too hard to model.   
  • In addition, what FX impact is bad for Sales/Gross Margin is good for SG&A.  We think that the company downplayed this.
  • Nike is making a call now that gross margins will be ‘up slightly’ for the year. The only way management would make this statement is if plan is much higher. Our rather strong sense is that Nike knows that its credibility is on the line, and cannot handle another disappointment. This would capsize much of the goodwill Nike has fought so hard (and subsequently won) from the investment community over the past decade. We’re not banking on anything above guidance, bc the reality is that we revoked Nike’s hall pass as being one of the very few that we’ll give the benefit of the doubt for GM expansion. But in adding back ‘1-offs’, the hit to raw materials, and giving Nike better pricing, we think it nets out to GM improvement better than 50bps.


There will, no doubt, be a host of analysts dueling Friday morning with downgrades vs. falling on swords defending the name. We definitely were looking for a better number in the quarter – there’s no masking that. But our rather strong sense is that the global growth story here is very much intact. Nike just put up an uncharacteristically weak, unusual and inconsistent year.  The Board knows this. It won’t happen again.


For those of you who have had this name in a pile on your desk, do yourself a favor over the holiday week and move this file to the top of the heap. Tomorrow might not be the time to buy it – or next week or next month. But we don’t think that the time to step in will be as far out as next quarter. 


Please contact us for our updated models.


-          LUV fleet has aged, but less quickly than the fleets of legacy carriers.  The gap has widened.

-          Airlines are aging their operating assets unsustainably, so current free cash flow is not sustainable.

-          This should eventually be good news for aircraft OEMs with respect to US demand.





Expert Call/Sector Event:  We are hosting an expert call on Industrial sector antitrust policy, with a focus Airline industry consolidation.  We will focus specifically on US Airways bid for AMR, as well as changes in antitrust policy with respect to the Industrials sector.  Our expert will be Lisa Harig, a Partner at McBreen & Kopko and head of the firm’s Washington D.C. office.  She is a former in-house counsel for Trans World Airlines, Inc. and BearingPoint, Inc.  Ms. Harig represents domestic and international clients, including airlines, manufacturers and individual aircraft owners.  Her practice focuses on a wide range of corporate, transactional, compliance and regulatory matters, including representation before the U.S. Department of Transportation and Federal Aviation Administration.  Please contact us or your Hedgeye Sales representative to participate.  The call is scheduled for July 10th at 11AM. 


Sector Comment:  Chinese heavy equipment sales continue to deteriorate – falling 20% to 30% year over year across the board.  This is not a vote of confidence for future construction activity.  This might impact commodity prices, but it also is a negative for competitors like CAT and Komatsu with exposure to the market.  Weak demand at home may eventually force SANY and Zoomlion further into developed markets.  Our macro team has done excellent work on growth in China.





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