The Economic Data calendar for the week of the 30th of July through the 3rd of August is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.




CONCLUSION: By authorizing BOJ purchases of foreign currency assets, Japanese policymakers risk materially elevating the risk of sustained yen depreciation and inflation within the JGB market. Though we have yet to receive anything concrete on the policy front, we will be paying close attention to the next two BOJ monetary policy board meetings for signs of official movement in this direction.


As both economic growth and inflation slow from a cyclical perspective in Japan, nominal JGB yields are trading at/near multi-year lows across the curve (8yrs for 2s; 9yrs for 10s; 2yrs for 30s) on heightened expectations for BOJ balance sheet expansion. While we continue to anticipate they’ll be on hold throughout the immediate term (next meeting AUG 8-9), we do think such speculation is warranted and will ultimately prove prescient by the BOJ’s SEP 18-19 meeting. Then, the BOJ will have had the opportunity to mull over a heaping helping of [likely] nasty economic data and incrementally dovish inflation data in making its policy decision. Key catalysts on this front include: 

  • 7/29: JUN Industrial Production;
  • 7/30: JUL Manufacturing PMI; JUN Jobs Report;
  • 8/7: JUL Economy Watchers Survey;
  • 8/8: JUN Machine Orders;
  • 8/9: JUL Consumer Confidence; JUL Machine Tool Orders; JUL Manufacturing PPI;
  • 8/12: 2Q GDP;
  • 8/21: JUL Trade Data;
  • 8/23: JUL Services PPI;
  • 8/29: JUL Retail Sales;
  • 8/30: JUL Jobs Report; JUL CPI; JUL Industrial Production;
  • 8/31: 2Q Corporate CapEx;
  • 9/9: 2Q GDP – 2nd reading;
  • 9/10: AUG Economy Watchers Survey; 3Q Business Sentiment Index; and
  • 9/11: JUL Machine Orders; AUG Manufacturing PPI. 



We reiterate our bearish TRADE and TREND fundamental thesis on Japanese equities; more details can be found in the hyperlinked note above. Turning back to JGBs, we received two very interesting data points in the last 24-36 hours that pose varying degrees of risk to this market. The first risk is an acceleration of sales by Japan’s Government Pension Investment Fund (GPIF). The second, and far more serious risk, is outright BOJ purchases of foreign currency denominated assets, such as Eurozone periphery sovereign debt.


On Thursday, Takahiro Mitani, president of GPIF (the world’s largest public pension fund, overseeing 113.6 trillion yen ($1.44 trillion)), plainly stated: “Payouts are getting bigger than insurance revenue, so we need to sell Japanese government bonds to raise cash.” While this trend (i.e. waning pension and insurance fund demand for JGBs) in and of itself is not new news (they’ve been selling JGBs intermittently since 3Q10), it is a stark reminder that the clock is indeed ticking from a demographics/household assets perspective as it relates to the Japanese economy’s ability to domestically absorb incremental stock of JGBs. Our generous calculations give the Diet ~10yrs before they pass the “point of no return”.




For reference, GPIF has ¥71.9 trillion of its assets in JGBs or 8% of all JGBs outstanding; the other pension funds in Japan own an additional 1.3% of outstanding JGBs and Japanese insurance firms own an additional 22.4%. JGBs remain at risk over the long term to the extent these market participants are incrementally forced to supplement cash balances by chasing yield abroad or by selling what they can (i.e. what’s been working; i.e. JGBs).




Regarding these points, Mitani agrees that liquidity may increasingly become an issue – forcing some combination of the aforementioned strategies: “To boost returns, we may have to consider investing in new assets beyond conventional ones.” We’ve been vocal in our work on the JGB market in lauding the inflation-adjusted, FX-adjusted returns JGBs provide to domestic Japanese investors. With the yen’s secular appreciation story still intact (up +50.8% vs. the USD and +67.3% vs. the EUR over the last 5yrs), it has made little economic sense for Japanese investors to chase returns offshore. As such, it’s no surprise to see that, despite such low nominal yields in the Japanese bond market and poor domestic equity returns, less than one-fifth (19.7%) of the GPIF portfolio is in foreign currency denominated assets.


That could potentially change in a major way over the intermediate-to-long term, leaving both domestic equities and JGBs at risk of increased institutional selling pressure. The key catalyst on this front takes us to the second, more material risk we alluded to above – outright BOJ purchases of foreign currency denominated assets, which former Ministry of Finance official Takatoshi Ito is urging his cronies at the BOJ to consider. His logic is simple: sustained BOJ purchases of foreign currency denominated assets (like Spanish and Italian sovereign debt) should, in theory, sustainably weaken the yen and boost exports, while at the same time coming to aid of the Eurozone – a key source of global economic demand.


Obviously, the key side-effect of pursuing such a policy (and perhaps why the BOJ has yet to openly consider it) is that it would, in fact, weaken the yen – perhaps too much too soon. Secular currency depreciation and inflation are two risks that haven’t been priced into the JGB market for many, many years and we’d be remiss to not flag the downside risk of investors having to account for those factors at current, historically-elevated prices.


For more details specifically on these and other catalysts that pose a material threat to the JGB market, please email us at ; we have a compendium of work that we’d be happy to share. The word “catalysts” is specifically bolded because we continue to see heightened risk in lazily succumbing to the consensus bearish thesis on Japanese sovereign debt (fiscal imbalances, yada, yada, yada…). Rather, we continue to mine for and vet specific catalysts – like the ones documented above – to determine whether or not investors should be adequately hedged for a sharp JGB sell-off. One key long-term risk we see is the APR ’13 term expiration of current BOJ Governor Masaaki Shirakawa. Replacing him with an aggressive dove would, in fact, put the risks of secular currency depreciation and inflation squarely on the table.


Have a great weekend,


Darius Dale

Senior Analyst

Weekly European Monitor: Draghi to the Rescue!??

-- For specific questions on anything Europe, please contact me at to set up a call.


Positions in Europe: Short EUR/USD (FXE); Short Italy (EWI); Buying German Bunds (BUNL)


Asset Class Performance:

  • Equities:  The STOXX Europe 600 closed up +0.6% week-over-week vs +0.7% last week. Top performers: Spain +5.9%; Russia (RTSI) +5.1%; Italy +4.1%; Finland +2.8%; France +2.7%; Sweden +1.7%; Germany +0.9%. Bottom performers: Cyprus -13.6%; Greece -7.1%; Portugal -3.0%; Ireland -1.9%.
  • FX:  The EUR/USD is up +1.04% week-over-week vs -0.74% last week.  W/W Divergences:HUF/EUR +1.95%; CZK/EUR +1.13%; PLN/EUR +1.04%; DKK/EUR +0.01%; CHF/EUR +0.00%; SEK/EUR -0.24%; RUB/EUR -1.18%.
  • Fixed Income:  There were significant moves in sovereign yields this week, all of which may be less clear on a week-over-week basis. Nevertheless, Greece saw the largest move, up a monster +196bps w/w to 27.46%.  Portugal rose +85bps to 11.35%.

On Monday Spain and Italy issued short selling bans on all stocks for a duration of 3 months and one week, respectively. This influenced yields early in the week.  Spanish yields rose to an all-time high of 7.62% on Tuesday but declined following Draghi’s comments on Thursday (more below). The Spanish 10YR actually declined -46bps on the week to finish at 6.81%. Italy declined -15bps on the week, but also moved to 6.46% on Tuesday before closing down today at 5.93%.  Germany saw an inflection to the upside with the yield climbing +17bps on the week to 1.35%.  France followed, gaining +15bps to 2.18%.


Weekly European Monitor: Draghi to the Rescue!?? - bbb. yields


Draghi to the Rescue!??

What a difference a week makes. Check, this isn’t a unique statement – it can be said for almost every week in the last two years of European trading. Up, down, and sometimes sideways. European capital markets for most weeks have been manic alongside investors hanging on to every headline and fumes of hope around Eurocrat actions. This week, Draghi stole the podium, but then again what exactly did he promise?  -- Nothing!  He said at an investment conference in London on Thursday that: “within our mandate, the ECB is ready to do whatever it takes to preserve the euro,” adding , “believe me, it will be enough.” And the market rallied!


This comment followed a Draghi interview on Monday with the French newspaper, Le Monde, in which he said that the euro is not in danger, saying that some analysts “don't recognize the political capital that our leaders have invested in this union and Europeans' support," and added that the euro is "irreversible".


Humm!  We too have not discounted the resolve of Eurocrats to fight the fires and keep the Union intact to maintain job security. The issue here, though, is that Draghi hints at possessing some bazooka that he’s been concealing for all this time.  We frankly don’t think there is one, particularly because we can’t envision what one grand bazooka would look like. Certainly there are a number of programs with loose strings, undefined terms, and a lack of consensus (like the Fiscal Compact; Pan-European Deposit Insurance; Eurobonds/-bills; European Redemption Fund; European Financial Transactions Tax; SMP; and the terms and scope of the ESM), all or part of which, if better defined and agreed upon, could buoy capital markets, yet can do little to turn around Europe’s weak growth fundamentals over the near to intermediate term.  The most immediate question mark is if Draghi will reengage the SMP to buy secondary bonds from Italy and Spain after 19 straight months of the facility being dormant.



Fundamentals Stink

I’d encourage you to check out the section below labeled Data Dump.  While this week’s high frequency data is no exception from recent weeks (in the move lower), it’s worth highlighting a few points. Germany, a country looked to for relative growth this year, had a number of weak figures: preliminary PMI Manufacturing came in at 43.3 for JULY (exp. 45.1) vs 45.0 JUN and Services dropped to 49.7 JUL Prelim (exp. 50.0) vs 49.9 JUN. And whether it was the German IFO or GfK confidence surveys, across most all subcategories, numbers declined month-over-month. In particular, Germany’s IFO Expectations fell to 95.6 in JULY (exp. 96.8) vs 97.2 JUN.


Other highlights include Q2 GDP results that came in lower for Spain and the UK. While this data is “stale” and isn’t a huge surprise, the results confirm our forecast of slower growth across most of Europe. Spain’s Q2 GDP fell -0.4% Q/Q vs -0.3% in Q1 (or -1.0% Y/Y vs -0.4%). UK’s Q2 preliminary GDP fell -0.7% Q/Q vs consensus -0.2% and prior -0.3% (or -0.8% Y/Y vs consensus -0.3% and prior -0.2%).



Europe’s August Away Message and the Looming Dark Catalyst Calendar

It’s worth mentioning that a number of key European heads of state are taking vacation in August, including Germany’s Angela Merkel and her finance minister Wolfgang Schaeuble; France’s Francois Hollande; Italy’s Mario Monti; and Portugal’s Pedro Passos Coelho according to a Bloomberg article.   As Keith would say, if Eurocrats are not going to accomplish anything on their five hour lunches, they’re certainly not going to get anything done sitting at the beach!


From a calendar perspective we continue to express the importance of 12 September when Germany’s Constitutional Court rules on the constitutionality of the ESM and Fiscal Compact. If Germany doesn’t pass the ESM, in particular, the program is back to square one, and leaves the region further in stitch as the EFSF funding ticks down (and is massively undercapitalized to deal with potential sovereign and banking bailout needs/risks on the horizon). Please note that as of now, even if the German Court passes, there is no specific language governing the scope of the ESM, beyond the three vague paragraphs issued at the June 28-29 Summit Meeting.



Some catalysts to keep front and center that may influence capital markets:


20 August - Greece has a payment of a €3.2B bond (held by the ECB) that matures. Payment is still being discussed.


September - Troika officials will return to Greece in September to complete their final assessment of the implementation of the bailout program. Could there be another debt restructuring?


Late September - According to La Tribune, Moody's will evaluate the consequences of the Eurozone crisis on France's AAA rating by the end of Q3. We think a downgrade to AA is a real probability.


Mid- October - There’s a possibility of a German Sovereign credit rating downgrade, especially should France be reduced by a notch beforehand.


Spain - Debt maturity schedule scares as the Treasury is bumping up against sovereign debt maturities of €20.27 of debt maturing on two days, on 29-Oct and 31-Oct.



The Ridiculous Statement of the Week

German Finance Minister Wolfgang Schaeuble and Spanish Economy Minister Luis de Guindos issued a joint statement that said the recent spike in [Spanish] interest rates does not reflect “the fundamentals of the Spanish economy, its growth potential and the sustainability of its public debt”.



Portfolio Moves:


Today Keith made a number of trades in our Hedgeye Virtual Portfolio related to Europe. He shorted the EUR/USD via the etf FXE, shorted Italy via EWI (note there is a selling short ban against stocks trading on the FTSE MIB that ends today), and went long German Bunds (BUNL). 


Keith’s trading calls are tactically taking advantage of price dislocation and not major changes in our broader theses across Europe. Note that Draghi’s comments greatly impacted market prices this week.


Keith’s comments are below:


EWI - I've seen some ridiculous 1-2 day moves in the last 5yrs. This one might take the cake. Italy right back to immediate-term TRADE overbought.


BUNL - German Bunds are immediate-term TRADE oversold within their bullish intermediate-term TREND.


FXE - Whatever it takes right back at you Mr. Draghi. Re-shorting the Euro at the top end of our immediate-term TRADE range (of $1.23).


Weekly European Monitor: Draghi to the Rescue!?? - bbb. eur



Call Outs:


Moody’s - Changes Aaa-Rated Germany, Netherlands, Luxembourg Outlook to Negative, putting them in line with Austria and France which have been on a negative outlook since February 13, 2012. France - President Francois Hollande’s transaction tax is set to take effect Aug. 1, not all investors will be paying it.  To escape the tax, many institutional investors will turn to so-called contracts for difference, or CFDs, offered by prime brokers that let them bet on a stock’s gain or loss without owning the shares.  Traders have used it successfully to skirt the U.K.’s stamp duty.


EFSF - Moody's changes outlook on the provisional AAA long-term rating of the EFSF to negative from stable.


ESM - ECB council member Ewald Nowotny said in an interview that there are arguments in favor of giving the ESM, the Eurozone's permanent bailout mechanism, a banking license. However, he added that he is not aware of any specific discussions on the matter within the ECB at this point.


SMP - The FT said that Spain's insistence that the ECB to reactivate its SMP is unlikely to elicit a near-term policy response from the central bank. The article noted that the bank believes that its balance sheet should be used as a last resort and any bond buying should first be done by the Eurozone's bailout mechanism.


Moody’s - The Agency changed the outlook on 17 German banking groups to negative (reflecting sovereign outlook).


Spain - Der Spiegel noted that Süddeutsche Zeitung reported on Thursday that the EU is considering using the EFSF to buy Spanish bonds from private banks. The paper cited an unnamed EU diplomat who said that "If Madrid submits a request we are prepared to act". It added that sources close to the German government said that Berlin was not opposed to bond purchases in principle.


Spain - Reuters, citing sources, reported that Spain is not considering seeking immediate help from the EU to ease its surging borrowing costs, despite German and Italian newspaper reports on Thursday that said Madrid was ready to ask the EFSF to buy its bonds. However it added that the Eurozone is considering possible action for later this year.


Spain - ECB data noted that Spanish banks trimmed their holdings of government bonds by €1.3M in June, the third consecutive month of decline. The article pointed out that in the four years to March, that figure had increased by €77B.


Greece - Citi raised its probability of Greece leaving the euro in the next 12 to 18 months to ~90% from its earlier estimate of 50-75%. The firm said that an exit would most likely happen in the next two to three quarters.


Eurozone banks - Eurozone debt makes up ~8% of the total holdings of the 10 largest US prime money-market funds, or ~$49B, down from 30%, or $230B in May 2011.


Ireland - Ireland on Thursday returned to the bond market for the first time in nearly two years. Recall that Ireland was forced to secure a bailout in 2010. The National Treasury Management Agency sold €4.19B of a new five-year bond, along with another bond that matures in 2020.



Risk Monitor:

Sovereign CDS were mixed across the peripheral countries this week. On a week-over-week basis Portugal rose the most, up +29bps to 856bps, followed by France +4bps to 172bps. Ireland saw the largest decline (-28bps) to 534bps, followed by Spain (-22bps) to 572bps. 


Weekly European Monitor: Draghi to the Rescue!?? - bbb. cds   a


Weekly European Monitor: Draghi to the Rescue!?? - bbb. cds   b



Data Dump:


Eurozone PMI Composite 46.4 JUL Prelim (inline) vs 46.4 JUN

Eurozone PMI Manufacturing 44.1 JUL Prelim (exp. 45.2) vs 45.1 JUN

Eurozone PMI Services 47.6 JUL Prelim (exp. 47.1) vs 47.1 JUN

Eurozone Consumer Confidence -21.6 JUL Prelim (exp. -20) vs -19.8 JUN

Eurozone M3 3.2% JUN Y/Y (exp. 2.9%) vs 3.1% MAY


Germany PMI Manufacturing 43.3 JUL Prelim (exp. 45.1) vs 45.0 JUN
Germany PMI Services 49.7 JUL Prelim (exp. 50.0) vs 49.9 JUN

Germany IFO Business Climate 103.3 JUL (exp. 104.5) vs 105.2 JUN  (28-month low)

Germany IFO Current Assessment 111.6 JUL (exp. 113.0) vs 113.9 JUN
Germany IFO Expectations 95.6 JUL (exp. 96.8) vs 97.2 JUN

Germany GfK Consumer Confidence 5.9 AUG (exp. 5.8) vs 5.8 JUL

Germany Import Price Index 1.3% JUN Y/Y (exp. 1.9%) vs 2.2% MAY

Germany CPI 2.0% JUL Prelim Y/Y (exp. 1.9%) vs 2.0% JUN   [0.4% JUL Prelim M/M (exp. 0.4%) vs -0.2%]


France Business Survey Overall Demand -24 JUL vs -2 JUN

France Consumer Confidence 87 JUL (exp. 90) vs 89 JUN

France PMI Manufacturing 43.6 JUL Prelim (exp. 45.5) vs 45.2 JUN

France PMI Services 50.2 JUL Prelim (exp. 47.5) vs 47.9 JUN

France Own-Company Production Outlook -8 JUL (exp. -6) vs -5 JUN

France Production Outlook -45 JUL (exp. -35) vs -35 JUN

France Business Confidence 90 JUL (exp. 92) vs 91 JUN


UK Q2 preliminary GDP -0.7% Q/Q vs consensus -0.2% and prior -0.3

UK Q2 preliminary GDP -0.8% Y/Y vs consensus -0.3% and prior -0.2%


Spain Producer Prices 2.5% JUN Y/Y (exp.3.1%) vs 3.2% MAY

Spain Mortgages on Houses -30.5% MAY Y/Y vs -31.3% APR

Spain Mortgages-capital Loaned -32.4 MAY Y/Y vs -26.4% APR

Spain Unemployment Rate 24.63% in Q2 vs 24.44% in Q1


Italy Consumer Confidence 86.5 JUL (exp. 85) vs 85.4 JUN

Italy Business Confidence 87.1 JUL (exp. 88.5) vs 88.7 JUN

Italy Retail Sales -2.0% MAY Y/Y (exp. -4.7%) vs -6.8% APR


Sweden Consumer Confidence 5.6 JUL (exp. 2.5) vs 3.1 JUN

Sweden Manufacturing Confidence -2 JUL (exp. -5) vs -5 JUN

Sweden Economic Tendency 96.1 JUL (exp. 98) vs 98.4 JUN

Sweden Household Lending 4.5% JUN Y/Y vs 4.6% MAY

Sweden PPI 0.4% JUN Y/Y vs 0.3% MAY

Sweden Unemployment Rate 8.8% JUN vs 8.1% MAY

Sweden Retail Sales 0.9% JUN Y/Y (exp. 1.5%) vs 4.6% MAY


Finland Business Confidence -6 JUL vs -6 JUN

Finland Consumer Confidence 0.1 JUL vs 5.8 JUN

Finland PPI 0.5% JUN Y/Y vs 0.9% MAY

Finland Unemployment Rate 7.9% JUN vs 9.5% MAY

Denmark Consumer Confidence 0.1 JUL (exp. -3.0) vs -2.6 JUN         


Ireland Property Prices -14.4% JUN Y/Y vs -15.3% MAY

Ireland Retail Sales (volume) -5.5% JUN Y/Y vs -2.0% MAY


Switzerland KOF Swiss Leading Indicator 1.43 JUL vs 1.15 JUN

Austria Industrial Production 2.6% MAY Y/Y vs 1.5% APR

Netherlands Producer Confidence -5.2 JUL (exp. -4.7) vs -4.8 JUN


Poland Unemployment Rate 12.4% JUN vs 12.6% MAY

Poland Retail Sales 6.4% JUN Y/Y (exp. 9.0%) vs 7.7% MAY

Poland Core Inflation 2.3% JUN Y/Y (exp. 2.4%) vs 2.3% MAY


Hungary Economic Sentiment -23.2 JUL vs -24.5 JUN

Hungary Business Confidence -13.3 JUL vs -14.6 JUN

Hungary Consumer Confidence -51.4 JUL vs -52.6

Hungary Retail Trade -2.5% MAY Y/Y vs -2.8% APR


Czech Republic Business Confidence 2.3 JUL vs 4.6 JUN

Czech Republic Consumer and Business Confidence -3.8 JUL vs -2.2 JUN

Czech Republic Consumer Confidence -28.3 JUL vs -29.3 JUN

Croatia Unemployment Rate 17.3% JUN vs 18.0% MAY


Turkey Foreign Tourist Arrivals 2.7% JUN Y/Y vs -1.5% MAY



Interest Rate Decisions:


(7/24) Hungary Base Rate UNCH at 7.00%



The Week Ahead:


Monday - Jul. Eurozone Consumer Confidence – Final, Business Climate Indicator, Economic Confidence, Industrial Confidence, Services Confidence; Jul. UK CBI Reported Sales, GfK Consumer Confidence Survey; Jun. UK Net Consumer Credit, Net Lending Sec. on Dwellings, Mortgage Approvals, M4 Money Supply; Jul. Spain CPI - Preliminary; May Spain Total Housing Permits; 2Q Spain GDP – Preliminary


Tuesday - Jul. Eurozone CPI Estimate; Jun. Eurozone Unemployment Rate; Jul. Germany Unemployment Data Released by Federal Labor Agency, Unemployment Change and Rate; Jun. Germany Retail Sales; Jul. UK BRC Shop Price Index; Jun. France Producer Prices, Consumer Spending; Jun. Spain Retail Sales, Budget Balance; May Spain Retail Sales; Jul. Italy CPI - Preliminary; Jun. Italy Unemployment – Preliminary, PPI; May Greece Retail Sales


Wednesday - Jul. Eurozone PMI Manufacturing – Final; Jul. Germany PMI Manufacturing – Final; Jul. UK Nationwide House Prices, PMI Manufacturing; Jul. France PMI Manufacturing – Final; Spain Manufacturing PMI; Jul. Italy Manufacturing PMI, New Car Registrations, Budget Balance; Greece Manufacturing PMI


Thursday - ECB Announces Rates; Jun. Eurozone PPI; UK BoE Asset Purchase Target, BoE Announces Rates; Jul. UK PMI Construction; Jul. Spain Unemployment


Friday - Jul. Eurozone PMI Services and Composite - Final; Jun. Eurozone Retail Sales; Jul. Germany PMI Services – Final; Jul. France PMI Services – Final; Jul. UK  PMI Services, Official Reserves; Spain Services PMI; Jul. Italy PMI Services



Extended Calendar Call-Outs:


12 September: Germany’s Constitutional Court rules on the constitutionality of the ESM and Fiscal Compact


Late September: According to La Tribune Moody's will evaluate the consequences of the Eurozone crisis on France's AAA rating by the end of Q3. We think a downgrade to AA is a real probability.


Mid- October: Possibility of German Sovereign credit rating downgrade.


18-19 October: Summit of EU Leaders



Matthew Hedrick

Senior Analyst



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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.



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 80.47%
  • SHORT SIGNALS 78.68%