• run with the bulls

    get your first month

    of hedgeye free



We have recently fielded several questions about ETF structures with enhanced leverage features.

The matter of ultrashort ETFs pricing has been a hot topic of conversation for the past two or three months as investors who purchased and held them realized returns that diverged significantly from the results they had anticipated. The common issue that many investors encountered was a misunderstanding of the actual mechanics of the products.

Ultrashort ETFs, such as TBT -the ProShares Long-Term Lehman Bond Index product that is used for the charts below, replicate a short position that is recalibrated daily rather than a static leveraged position in the underlying (which would not be possible to duplicate in this type of structure mathematically). As such, investors that have purchased the shares and held them have often been very disappointed as illustrated by the first chart below which illustrates the divergence in returns realized by a long term holder of the ETF vs. a static short in the underlying index. The increasing number of shareholders holding the ETF over multiple trading sessions has increased with volume since inception (see "OVERHANG" in the second chart on the first illustration panel).

The confusion over these structures has been compounded by the existence of active options for many, which has led some retail investors that regularly engage in buy-write strategies to buy ultrashort ETFs and sell call options against the position without fully understanding what they were buying and selling.

For intraday traders who are utilizing the ETF as it was intended, the returns have come in with a very close correlation to a leveraged short intra-day position in the underlying, as illustrated in the second illustration panel below. Since the trading-leverage drought started last year the ultrashort class of ETF has become a magnet for hedge funds employing short term strategies who have found leverage to be difficult to extract from their prime brokers.

Ultimately, it seems unlikely that an ETF will be introduced that can truly approximate the economic exposure of a static 2-to-1 leveraged short position given the inherent credit exposure assumed by the issuer of any such product in the event that the underlying investment declined by an amount greater than the value of the actual ETF. As such I would expect that sophisticated speculators looking for multi session exposures will probably prefer futures and options markets whenever available.

Andrew Barber


IFO Sentiment data for Januray released today registered better than anticipated with the Business Climate sentiment index at 83, up from a revised 82.7 in December. Current Assessment was down 2 to 86.8 (still significantly higher than anticipated) and Expectations were at 79.4, up from a revised 76.9 reading for December and much better than economists had forecasted.

The slight uptick in sentiment indicates a less-than-toxic outlook for Germany. Chancellor Angela Merkel agreed this month to spend €80 Billion ($105 Billion) over two years to overturn the country’s worst recession since WWII.

We are currently neutral on Germany’s Equity market.

Andrew Barber

Matthew Hedrick

The Liquidator

The Liquidator - asset allocation012809

“What is a committee? A group of the unwilling, picked from the unfit, to do the unnecessary.”
-Richard Harkness
I haven’t had to ‘You Tube’ CNBC for a while now, but I guess all it takes is the first 3-day rally in the US stock market since November to remind us all how reckless some of these entertainers on our nation’s manic financial media network can be.  After all, most of the “traders” on Dillon Radigan’s “Fast Money” have never seen a bullish tape that they didn’t chase.
Unfortunately, this tape isn’t bullish, yet. Clearly, Dillon Radigan doesn’t proactively manage the process by which his “committee” of Fast Money group thinkers gets excited at immediate term tops and freak-out at immediate term lows, well… because… the man doesn’t have an investment process.
A wise man who taught me a great deal in this business once told me that it is better to be an idiot in this profession and remain silent, than to open your mouth in a meeting and remove all doubt. Last night, Fast Money’s Joe Terranova – the man they call “The Liquidator” – reminded me of as much. After (not before) this 3-day rally, this momentum trader of everything that goes up was firing his mouth off on being bullish on everything from Brystol Myers (thanks, we just sold into that), to energy stocks. Then he proclaimed his mystery of faith by asserting himself as a resident expert on what this “Bad Bank” proposal means – it was truly a professional embarrassment.
When someone who has no idea what they are talking about looks into one of these cameras and gives you that ridiculously serious stare that the producers of Fast Money order their performers to deliver, please watch your step. The only thing worse than an idiot giving you financial advice is an idiot who always has conviction.
The real “Liquidator” that you should be focused on this morning is the US Government. In a perverse way, the anteing up of larger and larger socialist stimulus plans and government bailout expeditions is going to be good for the stock market, at a price, in the very short term. Why is that? Well, quite simply because this has disastrous implications for both America’s balance sheet and her long standing leadership in having the world’s currency reserve standard. The more we show the world that we are willing to capitalize individual gains on Wall Street, and socialize the losses, the less the US Dollar will be worth.
There is a penalty for malfeasance, and yes the US Dollar can go down, a lot, as a result. In the immediate term, if the US Dollar breaks down and closes below the levels that I issued in yesterday’s missive, the stock market should continue to work higher. No, I am not saying this is good – and neither is General Electric’s AAA rating when you consider that they support the class action law suits waiting to happen with their said professional “traders”… it all ends very badly. But again, everything has a time and a price.
For generations, mismanaged countries have had to de-value their currency in order to dissuade their citizens to save. This, of course, encourages people to take on additional risk in order to find a relative return. Is it bad? You bet your Madoff it is… but try ramping the US Dollar up another +3-6% from here, and let me know how that feels in your stock portfolios.
The fact of the matter is that the US stock market’s only up month (December) since the Crisis of Credibility went into full swing, came in a month where the US Dollar broke down. If you’re more into the Fast Money thing, the first 3-day consecutive rally in US stocks came on the heels of a US Dollar decline as well. For the week to date, the SP500 is +1.6% and the US Dollar is down -1.7%. That’s as tight an inverse correlation as you are going to find. That’s just the math.
The worst part about this reactive government intervention is that it is being run by committee. Then we have the manic media interpret the reactive decision making with some of the most reckless advice I have ever heard. This is bad.
I ‘You Tubed’ the output of that new Obama committee via Larry Summers Meet the Press interview in a note to our macro clients earlier this week. The bottom line is that the stimulus package is going to be much larger than that $825B number, and Summers knows it. Page One of the WSJ this morning finally addresses my point, so Joey T will get that memo for his slapstick punditry on tonight’s show. He’ll only be 3 days late.
Joe, sorry to steal your high conviction thunder, but your stage name, “The Liquidator” is owned by one Resolution and Trust Corporation. This “Bad Bank” idea is somewhat similar in scope to what the US government implemented during the Savings & Loan Crisis. Don’t forget that between 1, this US government owned asset management company, closed/dissolved 747 thrifts (banks) with assets of almost $400B – yes that’s beelions – and no, it didn’t end well for shareholders of last resort. That’s a “Liquidator”!
The politicized US Federal Reserve will be front center later today with an FOMC decision that has been compromised. When you cut rates to zero, the only thing left to do is implement emergency bailout plans, and get Fast Money traders in heat trading the futures. With the US futures spiking higher last night, and CNBC promoting it with a live chart, I sat there in wonderment trying to think of how many times the American public has to see this hope-fest of entertainment better suited for the E! channel before she finally understands that this network has virtually been wrong in leading you to buy into these bailout plans at every turn…
GE’s stock goes down for a lot of reasons, but why is the obvious fact of liability in their media portfolio so deceptive? Don’t ask Radigan’s “committee” – this is a group “picked from the unfit, to do the unnecessary.”
In the immediate term, the SP500 range of 861 to 873 will be very much overbought. Unless the US Dollar breaks down, you are best served liquidating longs today into strength, rather than listening to the man formerly known as “The Liquidator.”
Best of luck out there today.

The Liquidator - etfs012809

Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.


Over the last 7 quarters, Starwood has benefited from a weakening dollar. If current FX rates hold, this tailwind will turn into a nasty 2009 headwind. The first set of charts was pulled from Starwood’s presentation touting the benefit of international diversification. Roughly 45% of Starwood’s owned EBITDA and 55% of its fee income is derived outside the United States. We estimate that over 50% of HOT’s International Owned RevPAR is exposed to Euro currency countries, followed by exposure to the Australian dollar, British pound, and Argentinean peso and Brazilian Real.

And that’s not all. Starwood’s reported North American RevPAR includes results from its Mexican and Canadian hotels, which account for 16% of total owned EBITDA, or 23% of NA EBITDA. For the last 6 quarters, HOT’s reported NA RevPAR has benefited from the appreciation in the Canadian dollar. In the 4Q08, the average CAD FX rate was .83 vs. 1.02 in 4Q07, representing 19% y-o-y depreciation. At current rates, of .79 this would equate to a 16% drag on RevPAR when translated into USD in 2009. The Mexican Peso isn’t doing much better, down 16% y-o-y in the 4Q08, and at current rates tracking down 21% for 2009.

The second chart highlights the recent FX boost and the FX pain we estimate HOT will face as a result of its international exposure. Unfortunately, the domestic business won’t be picking up the slack any time soon. Smith Travel is reporting that year to date upper upscale hotel chains are trending down 23% nationwide, and down 25% in the cities where HOT has the most exposure.

A 50% EPS cut may indeed be in the offing.

Anna Massion

International diversification won't be beneficial in 2009
International RevPAR could fall 20-25% in 2009 due in part to Fx


My exclusive consultant on the ground in Macau sent me a very thoughtful write up on how Beijing may be viewing Macau. If true, Macau may not be the investment oasis we all thought. Here are his thoughts verbatim:

“在中国新年,当它是传统的为了中国人民能递幸运的金钱对他们的家庭和朋友时,我们有这个问题为您: 如果您在MOP40Bn在税收入采取,因为政府在北京允许它的公民到您的赌博娱乐场自由地移动,并且您然后送MOP5.5Bn回到祖国,那是否不会被认为税? 我认为我们可以全部同意澳门的天作为自由市场经济是。 北京编写足够的数据在前6个月签证制约期间确切地知道什么“每6星期”签证政策的作用一次有在澳门经济对 “一次每10星期”选择。 允许词条通过香港或没有现在于另一根杠杆安排北京的。 如果澳门为政治局的口味快速地成长为(或太减慢),北京可能在将来做必要的调整。 为在计划经济被修造的国家,这是一个重要工具。 它意味着天30%, 40%甚至50%成长在澳门是。 在那上下文, MOP5.5Bn的最近付款由澳门政府对四川省的人民必须严密被审查。 只被授予了, 2008年,澳门政府能花费什么的~MOP20Bn,粗砺一半这花费了in。 并且那MOP20Bn非常明智地未可争论花费。 无论如何,为送MOP5.5Bn的城市状态~500,000为地震重建到它的君主乞求问题: 在澳门被积累仅存钱罐为“特别项目”的财富,当他们在北京也许升起? 在可怕四川地震以后,有大量压力在澳门“做更多”,并且许多甚而相信澳门的“缺乏贡献”对基础设施的早重建在四川直接地导致了放在适当的位置的签证制约。 但它采取的澳门将做什么与所有金钱? 当它在大厦公共基础建设时,来到零用钱Edmund的政府反复证明是不适当的: 轮渡终端和光路轨是只最可看见的这些失败。 那么可能这为北京是最佳到罪状澳门入遣返回国这些资金。 一种税为是祖国的一部分。 一种税为容忍所有恶习澳门促进”。

And in English:

“On Chinese New Year, when it is traditional for Chinese people to hand Lucky Money to their family and friends, we have this question for you:

If you take in MOP40Bn in tax revenues because the government in Beijing allows its citizens to travel freely to your casinos and you then send MOP5.5Bn back to the motherland, would that not be considered a tax?

I think we can all agree that the days of Macao as a free market economy are over. Beijing has compiled enough data over the last 6 months of visa restrictions to know exactly what the effect of a “Once every 6 week” visa policy has on the Macau economy vs. the “Once every 10 week” option. Allowing entry via Hong Kong or not is another lever at Beijing’s disposal now. If Macao grows to fast (or too slow) for the taste of the Politburo, Beijing can make the necessary adjustments in the future. For a country that is built on a planned economy, this is an important tool. It means that the days of 30%, 40% or even 50% growth in Macao are over.

In that context, the recent payment of MOP5.5Bn by the Macao government to the people of Sichuan Province has to be examined more closely. Granted, in 2008, the Macao government was only able to spend ~MOP20Bn, roughly half of what it took in. And arguably that MOP20Bn was not spent very wisely. None the less, for a city state of ~500,000 to send MOP5.5Bn for earthquake reconstruction to its sovereign begs the questions: Is the wealth that is being accumulated in Macao only a piggy bank for “special projects” as they may arise in Beijing?

After the horrific Sichuan earthquake, there was plenty of pressure on Macao “to do more” and many even believe that Macao’s “lack of contribution” to the early reconstruction of infrastructure in Sichuan directly led to the visa restrictions being put in place. But what will Macao do with all the money it is taking in? The government of Edmund has proven time-and-again to be inept when it comes to spending money on building public infrastructure: the Ferry Terminal and Light Rail are only the most visible of these failures. So maybe it is best for Beijing to guilt Macao into repatriating these funds.

A tax for being part of the motherland. A tax for tolerating all the vices Macao promotes.”


Since October 23, when HOT gave its outlook for 4th Quarter and preliminary 2009 guidance, RevPAR has continued to plummet from negative mid to high single digits to a run-rate of -20% during the first 17 days of January, with Upper Upscale tracking down almost 23%. The rest of the world isn’t doing that much better with worldwide RevPAR tracking at negative double digits in most regions across Europe and Asia Pacific.

Bottom line is that the street is still way too high and HOT management way too optimistic in its guidance. The only bright spot may be for credit investors as cash flow should remain positive in 2009.

The Street is currently projecting $905 million and $1.26 in mean EBITDA and EPS for 2009. Before we cheer the Street for being conservative vis-à-vis management guidance of $1 billion and $1.55, respectively, consider this. The Street is probably too high on EBITDA by about 15% and EPS probably needs to fall by 50%.

Below are some of our key assumptions:

Owned Business:

- US Owned RevPAR (ex Canada & Mexico) of -12.5%, NA RevPAR of -16% in 4Q08 with no great improvement in 2009. Canada & Mexico represent about 22.5% of HOT’s North American owned EBITDA and on a blended basis those currencies have depreciated 17.5% y-o-y in the 4Q08 and would have about an 18% drag on 2009 comparisons if FX rates stay at current levels
- Local currency international RevPAR of -12% in 4Q08 and -10% in 2009. However on a constant dollar basis the dollar appreciation vs HOT’s currency exposure should produce an incremental drag of ~10% in 4Q08 and 2009 (at current FX rates). So we’re talking about RevPAR down about 20% in each of the next four quarters.
- Taking into account recent cost cutting measures, decreases CPI and global commodity deflation we believe that EBITDA margins will be down 550 bps and 410 bps for HOT’s owned portfolio for 4Q08 and 2009, respectively (not same store).

Management & Franchise Business:

- Managed and franchised net room growth of 4.7% for 4Q08 and 5.5% in 2009. However, we wonder whether attrition rates will accelerate amongst franchisees as they attempt to cut back on capital expenditures in the face of deteriorating income, and are unable to maintain brand standards.
- Despite the room growth, we believe that fee income will be down about 10% in 4Q08 and almost 15% in 2009. Incentive fees are sure to take a hit.

From a valuation standpoint, almost 9.5x 2009 a reasonable EV/EBITDA and 24x earnings is nothing to get excited about. Starwood does look “ok” on a FCF yield basis, trading at an almost 8% yield, and probably isn’t the best short for credit investors. However, it will be interesting to see how the stock trades when estimates get cut in half.

get free cartoon of the day!

Start receiving Hedgeye's Cartoon of the Day, an exclusive and humourous take on the market and the economy, delivered every morning to your inbox

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.