Whatever: SP500 Levels, Refreshed

POSITIONS: Short Industrials (XLI)


We too will do whatever it takes to manage the risk of what’s becoming a proactively predictable range. As long as these central planners continue to encourage reckless bailout expectations like they did in 2008, the probability of a big move lower rises.


Our fundamental research view of #GrowthSlowing reminds us why Industrials (GROWTH) continue to underperform Energy (INFLATION) here in Q3. Short term commodity price inflations are not growth. They slow growth even further. It’s not only a shame that Bernanke has not yet acknowledged that; it’s going to be his legacy (and our economic risk) if he continues to perpetuate it.


Across our risk management durations, here are the lines that matter to me most:

  1. Intermediate-term TREND resistance = 1376
  2. Immediate-term TRADE support = 1359

If 1359 snaps, this market will look as bad as it did pre the whatever thing from Draghi. If it doesn’t, we’ll just keep managing the risk of this 1 range. I’d like to see another no-volume intraday screamer > 1376 to short SPY itself.


Enjoy your weekend,



Keith R. McCullough
Chief Executive Officer



Whatever: SP500 Levels, Refreshed - SPX

SBUX: Wake Up And Smell The Coffee

Starbucks (SBUX) put up a disappointing quarter for Q3FY12 yesterday, sending the stock down double digits as of this morning on the open. Simply put, the company is feeling the effects of soft economic trends, increased expenses, and the pressure of trying to run five different concepts at once: Starbucks, Seattle’s Best, Tazo Tea, La Boulange, and Evolution Fresh.


We have been long Starbucks in the Hedgeye Virtual Portfolio since April 2009, when we bought it at $11.52 a share (timestamped for the record, of course). We will continue to hold it because we did two things right: we got SBUX at the right time and at the right price. Even with this pullback, this is not the right entry point for getting long Starbucks. Our Managing Director of Restaurants, Howard Penney, is sticking to his guns and advising to stay on the sidelines for now.


The macro environment isn’t helping anyone in the restaurant business at the moment. Company-specific problems aside, inflation has driven food and fuel prices up to high levels thanks to the Federal Reserve’s policy of quantitative easing.


SBUX: Wake Up And Smell The Coffee - SBUX liesahead


As we stated back in June, the $100 million acquisition of La Boulange will take time to integrate into the business. It will also dilute Starbucks’ EPS a few cents a share for the next few quarters. We believe management needs to lower expectations for the back half of 2012. Margins will improve as commodity costs come down over time.


Internationally, Europe is a mess for Starbucks and is largely out of the company’s hands. We’ve all read the headlines about the situation in the Eurozone. It’s understandable that Spaniards aren’t running out to buy Venti frappuccinos with 25% unemployment plaguing the country. Over time, a European turnaround is quite possible as long as management continues to operate competitively and efficiently.


SBUX: Wake Up And Smell The Coffee - SBUX AmericaSSS


In China, the goal is to have 1500 stores opened by 2015. Despite the macroeconomic picture being painted in China (growth slowing), there’s a lot of excitement around the push the company is making there. Starbucks has challenges it must face over the next year. If it can overcome them, there’s plenty of room to grow.


Our hold calculation has historically differed meaningfully from management’s.  Here is why.



Let’s face it, gambling is a volatile business.  While the odds normalize over the long-term, even a big casino company can be significantly impacted by luck over a quarter.  Gaming management teams have done a terrific job focusing on the hold impact on quarterly conference calls when hold is low but less so when hold is high.  Go figure.  And statistically speaking, as LVS and WYNN grow, hold volatility will be less important.  Not in terms of absolute dollars as an analyst on the call seemed to believe, but in terms of percent impact.


So we certainly appreciate the company’s additional disclosure.  The issue we have is not with the transparency, although management failed to comment on the positive EBITDA impact in the Q1 earnings release/conference call.  Rather, it’s the methodology.  As can be seen from the following chart, we calculate significantly smaller quarterly impacts from low hold than the company, especially in the most recent quarter.




Issues with LVS’s methodology:

  • The company only calculates the hold impact on VIP business when the hold percentage at a property is outside the range of 2.70-3.00% and then calculates the differential to the midpoint (2.85%).  So EBITDA from a property holding at 2.99% will not be adjusted at all but one that holds at 2.69% will be.  A swing from 2.70% to 3.00% is material.  For instance, that represents about $25-35 million in EBITDA for MBS alone.  Our calculation just adjusts each property to its historical average.
  • LVS does not adjust for abnormal Mass hold; but we do, using the 6 quarter trailing average.
  • Since it’s impossible to calculate, neither LVS nor Hedgeye factors in that patrons play more when they win and less when they lose.  Thus, volumes are not static across different hold percentages.  This has the impact of dulling volatility so generally both methodologies will overstate the impact of hold variations.
  • LVS doesn’t use the “range” methodology for LV operations like it does for Macau/Singapore.  This doesn’t seem consistent.
  • Mass hold in Macau/Singapore and table hold in Las Vegas is measured by the amount of chips bought.  Thus, if the velocity of play changes, so will hold percentage, theoretically.  For example, in down economic times, players may exchange dollars for the same amount of chips they always do but they may not gamble as much.  The denominator (volumes) will be the same but the numerator (gaming win for the casino) will likely be less, resulting in a lower hold percentage than normal.

Q2 was certainly impacted by low hold percentage and that needs to be discussed.  However, we calculate the impact was roughly half of what LVS estimated and almost all of the impact was concentrated at MBS as can be seen below.



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We've Got A Situation







By now it should be obvious that the Eurozone is a amalgamation of bailouts. Greece will soon need another and week-by-week it has become clear that Spain is in need of more money Spain just reported a record unemployment rate of 24.6%. That’s one-in-four people out of work. More QE leads to rising food and gas prices, which does not bode well for the 24.6%.


Please keep in mind that growth IS slowing and will continue to slow as we head into August. At this stage in the game, we can only wait and see what happens to Italy down the road. Spanish stocks lead the losers this morning, down -1.7% (down -30% since March) and we remain bearish on all 3 of our risk management durations: TRADE, TREND and TAIL.


As recording artist Notorious B.I.G. once quipped: “Mo’ Money, Mo’ Problems.”



Starbucks (SBUX) missed their Q3FY12 earnings yesterday after the close. The company is enjoy the effects of higher costs courtesy of the Bernanke QE and trying to run five different concepts at once (La Boulange, Evolution Fresh, etc.). We still advise remaining on the sidelines for SBUX, however, as we’re not bearish enough on the brand to make a call yet. We’ve been long Starbucks in the Hedgeye Virtual Portfolio since 2009. We timed it right and got it at the right price. This simply isn’t a good entry point for Starbucks and we’ll continue to hold it in our Virtual Portfolio as Schultz & Co. try to work things out over time.



Coined by Keith, this term summarizes yesterday’s rally in US equities quite well. We rip 20 handles in the S&P 500 to the upside and next thing you know, we’re in a bull market. Never mind that growth continues to slow on a global level. All it takes is a wave of the wand from a central planner to make people believe that there is hope in this market. And as we always say: hope is not a risk management process. A day of dollar down and US equities + gold up means everything is back to normal, right? We’ll see how long this farce keeps up for.


Really, we must wait patiently and see what Ben Bernanke does/says next week. We don’t think that QE3 is a reality and that includes some nonsense where the Fed goes buying mortgage-backed securities. Should our prediction prove correct, we’ll go looking to short the S&P 500 or Russell 2000 at the right time and price.




Cash:  Down                   U.S. Equities: Flat


Int'l Equities: Flat            Commodities: Flat


Fixed Income: Up            Int'l Currencies: Flat





This company is transitioning from cash burn to $75mm annual free cash flow generation thanks to completion of a reimaging program and refranchising of JIB units. Qdoba is the leverage; a maturing and growing store base will bring higher margins. We see 8.5% upside over the next 6-9 months.




TAIL: LONG            



SS volume accelerated in 1Q12 and employment remains a tailwind to both admissions & mix. We expect acuity to stabilize and births and outpatient utilization to accelerate out of 1Q12, while supply cost management continues as a margin driver and acquisition opportunities remain a source for upside.







We continue to expect outpatient utilization to pick up in 2H12 alongside stabilization in acuity with ortho and cardiac/ICD volumes supporting both pricing and inpatient admissions growth. Births should serve as a tailwind into year-end, recent and prospective acquisitions offer some upside to 2012/13 numbers and the in place repo offers some earnings flexibility. With European and Asian growth slowing, we like targeted domestic revenue exposure as well.

                                                                                                                                                                        TRADE: NEUTRAL






Tweet of the Day: “I'm not sure what a SIPC-like insurance fund capped at $500K would do for the futures industry. I'm not sure what [it] does for securities.” -@johnpneedham


Quote of the Day: “Democracy is a process by which the people are free to choose the man who will get the blame.” – Laurence J. Peter


Stat of the Day: Facebook posted first quarter 2012 revenues of $1.058 billion, up 45 percent year over year from $731 million. The company reported $1.18 billion in revenue. Earnings per share also came in right at 12 cents per share. 955 million active monthly readers.

Crumble Cake Europe

This note was originally published at 8am on July 13, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“I get no respect. The way my luck is running, if I was a politician I would be honest.”

-Rodney Dangerfield


I’ve been handed the Early Look pen this morning and thought starting with Dangerfield’s humor was in order.  After all, I cover Europe for the macro team and there’s nothing funny about what’s going on in the region.  Frankly stated, we don’t see a “bazooka” in Europe over the intermediate term as Eurocrats remain politically divided and in a slow and reactive mode to address sovereign and banking imbalances, slapping band-aids on peripheral woes at every corner, but failing to craft a real “path” forward.


Unfortunately, now the stakes are much higher as Italy is Too Big to Bail.  For reference, Italy’s total sovereign debt alone is €1.9 Trillion with €372 Billion in debt coming due in the next 12 months versus the combined EFSF and ESM bailout facilities worth around €700-800 Billion. To boot, markets continued to shake this week on statements from Italian PM and technocrat-in-Chief Mario Monti that Italy may want to tap the Eurozone bailout mechanism to help lower its borrowing costs (the 10YR is currently at 5.99%); that he has no plans to seek another term when elections are called next spring; and on Moody’s downgrade of the Italian sovereign yesterday to Baa2 from A3.  And if the political state wasn’t fractured enough, rumors also flew of a Berlusconi comeback. Can you say Bunga Bunga increased risk premium Party!


Interestingly enough, much hangs on the Eurozone’s ability to craft a fiscal union (compact) alongside its monetary union. It is firmer ground on this step that we think is critical before real action can be delivered on such proposed plans as:  a banking authority; pan-European deposit insurance; European Redemption Fund; European Financial Transaction Tax; and Eurobonds.


That said, we see the passage of a fiscal compact many months to years out, if ever, as countries will be slow to give up their sovereignty to Brussels/Frankfurt. Further, we’d expect the aforementioned facilities to receive approval after much foot-dragging and politicking as the ECB is likely to be wary of extending its balance sheet as a backstop for the programs while strong fiscal nations like Germany will likely balk at signing off on lower creditworthiness in exchange for the region’s risk (Eurobonds).


However, as these programs stew, the most pressing issue right now is that the European Stability Mechanism (ESM), originally targeted to be operational by July 1 with firepower of €600 Billion, is in limbo given that Germany’s Constitutional Court passed on making a decision on it this week; already German Finance Minister Wolfgang Schaeuble warned that a ruling (in conjunction with the fiscal compact) could be pushed to this Fall!


We mention this indecision on the ESM and fiscal compact from the Germans for a number of reasons:

  1. A lack of decision on Germany’s commitment will broadly breed further indecision across capital markets until the court makes a decision.
  2. Spain’s €100 Billion bailout is dependent on the loans from the EFSF and ESM, and further clarity on the firepower of both facilities is essential because A.) they were not originally crafted with a specific mandate for bank bailouts; and B.) lending first through the sovereign (at least as they were originally intended), before sovereigns can then loan to banks, will simply pile on more sovereign debt and perpetuate the cycle of more sovereign and banking imbalances across the weaker states.
  3. We believe Germany is still carrying the biggest policy stick in Europe (despite a stronger “socialist” French-Italian handshake developing) and how Merkel and her courts rule will have great impact on how Germany may or may not choose to underpin a future fiscal union.


In the Balance


If the political landscape and potential direction of the Eurozone sounds convoluted, it is! We return to our fundamental  view that neither bailouts nor encouraging more borrowing through cheaper money is the solution to Europe's problem of over-indebtedness. That said, we fully realize that when assessing Europe one must recognize that what Eurocrats “should” do (from an economic policy perspective) may be very different from what they “will” do.   


Given the runway on a ruling from the German Court and the fact that there are no planned Summits (i.e. catalysts) around which markets could rally over the intermediate term, we expect Crumble Cake Europe to continue to trade on headline risk, and the EUR/USD cross to remain a relative loser until more decisive action is taken from Eurocrats. As we show in the chart below, the cross broke our intermediate term TREND Line of $1.22 this week and is nearing 2010 lows, back when Greece received its first bailout in May. 


Should Europe play out as we expect – continued slower growth beyond consensus and Eurocrats socializing weaker members and changing the goalposts along the way– we fear that the next two years across the Eurozone could look a lot like the last two years – short of a default from Italy or more expedient action on such measures as Eurobonds.


I suppose I misspoke at the beginning of this missive when I said there was nothing humorous in Europe. Yesterday, Italy's national statistics office threatened to stop issuing data on the economy, saying that it has been crippled by government spending cuts aimed at reducing national debt.


Whether or not Italy has an agency to report its economic data reminds me of the old philosophical question: “If a tree falls in a forest and no one is around to hear it, does it make a sound?”  Unfortunately for the Eurozone, the whole is only as strong as its weakest parts and everyone is forced to listen!


Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1559-1589, $96.76-103.01, $82.81-84.06, $1.20-1.23, and 1329-1354, respectively.


Have a great weekend!


Matthew Hedrick

Senior Analyst


Crumble Cake Europe - el   EUR


Crumble Cake Europe - vp 7 13

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