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Faustian Investing

“In the end, you are exactly—what you are. Put on wig with a million curls,

Out the highest heeled boots on your feet, Yet in the end you remain just what you are.”

-Mephistopheles

 

Today is August 23rd.  To many of you stock market operators, it is just another day of finding compelling investments and tweaking those market exposures.  But for those of you who didn’t know, it is also National Compliance Officer Day.  So take a few minutes and go see that guy or gal who runs your compliance department, who you typically like to avoid, and give them a big thank you.

 

One of the first hires at Hedgeye was our compliance officer, Rabbi Moshe Silver.  Not only would I put his knowledge of the compliance up against anyone’s, but he is also kind of funny.  By kind of I mean he tells jokes, even if they aren’t all funny.  In all seriousness, Moshe, on behalf of all of us, thank you for your fine work as our compliance officer and teammate.

 

Now that I officially have my compliance officer off my back for a few months, let’s get back to the global macro grind.  A topic I want to start with today is China.  Maybe you’ve heard of it? It’s the country that has taken a massive amount of economic market share over the last two decades.  I just wanted to flag a few interesting nuggets from China over the last couple of days.  They are as follows:

  • Chinese iron ore prices are at their lowest levels since 2009 and mills are beginning to default on supply contracts;
  • Zhang Honxia, chairman of China’s largest cotton-textile maker, said: “The Chinese economy is only at the beginning of a harsh winter.  We are in worse shape now then compared with 2008-2009.”;
  • Iron ore output in China is down 8.1% in July;
  • The Shanghai Composite hit a three-year low yesterday;
  • Japanese exports to China in July were -11% year-over-year; and
  • The IMF has estimated that China’s capacity utilization has fallen to just 60% versus 80% in the pre-crisis era.

To be clear, I didn’t hand pick those data points to paint some bearish mosaic.  They are actually just what I wrote down in my notebook and, candidly, they are a little depressing as it relates to Chinese growth.

 

Last night’s PMI readings were of similar nature, if not worse, for China.  In aggregate, the PMI for August fell to 43.0 from 45.1 in July.  The specifics were even more dreary, new orders fell to 46.6 from 48.7, new export orders slumped to 44.7 (the lowest reading since the financial crisis), and inventories rose to 53.6.  Inventory up and orders down are a toxic mix for any company, let alone the world’s second largest economy.

 

Despite this plethora of negative data points, the equity markets keeps grinding higher.  Perversely, bad news is good news because bad news means more central bank easing.  The only term I can really think of for this type of investing (and no offense to those of you that are profiting from it) is Faustian Investing.

 

As many of you know, Faust is a protagonist in a classic German legend.  He is a very successful scholar, but like many successful people, he wants more.  As a result, Faust makes a deal with the devil and exchanges his soul for unlimited knowledge and worldly pleasures.  To me, buying equities at a VIX of 15.1 on hopes of further easing from central bankers feels like a deal with the devil.  Incidentally, there is a gentleman named Jon W. Faust who is a special advisor to the FOMC Board of Governors.  And I couldn’t make that up even if I wanted to …

 

Speaking of easing, many have asked our view of whether some incremental news on the monetary policy front could come out of Jackson Hole next week.  I will touch on that in a second, but let me just start with this, it is likely priced in.  The SP500 is up 11% in almost a straight line from the lows of the summer into Jackson Hole.  And from interacting with our many subscribers and even more followers on social media, this is the “catalyst” people are talking about.

 

Now, as to whether the Fed will actually do anything next week is a different question.  The key economic takeaway yesterday from the release of the FOMC’s minutes was that, “economic activity increased at a slower pace in the second quarter than earlier in the year and that labor market conditions had improved little in recent months.”  So as a result:

 

“Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.” 

 

There you have it: the Fed is poised to ease!  I’m just not sure it will be at Jackson Hole next week.  The last time Bernanke announced action at Jackson Hole was QE2 in 2010.  At that point, equity markets had undergone a serious two month sell off, the government had just lowered its reading Q2 2010 GDP growth to 1.6%, and broad economic indicators were more anemic than they are now (we will have a detailed post on this later today). 

 

So in summary, we think any potential action at Jackson Hole is both unlikely and also priced into equities.  To express this from a non-Faustian investing perspective, yesterday in the virtual portfolio we bought the U.S. dollar and shorted gold.

 

The greater question, though, is whether incremental easing will have any impact on economic activity. In the Chart of the Day below, we show both major recent Fed policy announcements in Q3 2007 and Q3 2010 and subsequent global economic activity.  In both instances, growth slowed and inflation accelerated.  Be careful what you wish for from those devilish central bankers.

 

Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500 are 1, 113.71-116.12, 81.41-82.11, 1.23-1.25 (TREND resistance = 1.26), 1.66-1.75% and 1, respectively.

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Faustian Investing - Chart of the Day

 

Faustian Investing - Virtual Portfolio


Grass Money

This note was originally published at 8am on August 09, 2012 for Hedgeye subscribers.

“But you go through and scare the game and your cattle eat the grass so the buffalo leaves and the Indian starves.”

-Quanah Parker

 

That’s one of the most important quotes from one of the most important leaders of 19th century Western American history. I’d bet that a large percentage of Americans don’t know who the Principle Chief of the Comanches was (or why what he did for the US cattle business between 1870-1884 was so critical).

 

That’s why I read so much history. It helps me contextualize longer-term investing themes within the boundaries of how humans are forced to make short-term decisions. Ultimately, the Comanches traded their long-term liberties for short-term “Grass Money.” If you know anyone begging for bailouts, for the love of the country, please ask them to think about that.

 

As S.C. Gwynne reminds us at the end of Empire of The Summer Moon, the same kind of question should be on your mind this morning about devaluing your hard earned currency for the sake of short-term asset price inflations - “whether or not the Indians should do what everyone else in America did: lease.” (page 297)

 

Back to the Global Macro grind…

 

If Grass Money killed the buffalo, Fiat Fool Money is going to kill whatever is left of your “free” markets. On the heels of China and India reporting another round of #GrowthSlowing data overnight, “futures rally on hopes for Chinese stimulus.”

 

Alrighty then. I guess we’ll suspend economic gravity for another day.

 

Here’s the China data, in context:

  1. Industrial Production growth = +9.2% y/y vs +9.5% in June of last year
  2. Retail Sales growth = +13.1% y/y vs +13.7% in June of last year
  3. Fixed Asset Investment growth = flat y/y at 20.4%

So,

 

A)     On the margin (where risk managing macro matters most) growth continues to slow

B)      These are hardly the “freak-out” recession or stagflation type levels of growth requiring a Geithner-like bailout

C)      Chinese stocks were up a whopping +0.6% on the “news” (still down -12% from where they were in May)

 

In May, not only Chinese growth, but global growth really started to accelerate on the downside. That’s why almost every major stock market in the world stopped going up in March-April. Markets discount future events.

 

But what are they discounting now?

 

A)     The long-term (TAIL) of lower-highs on lower volume (bearish)

B)      The immediate-term (TRADE) short squeeze (bullish)

C)      The ongoing hope that bailouts will earn everyone a year-end bonus sticker

 

Hope, of course, is not a risk management process. Timing matters. If you bought beta (the Russell2000) in March-April, you’ve lost money. If you bought the wrong stocks (MCD, PCLN, CAT, etc.) in March-April, you’ve lost a lot of money.

 

This morning you either buy or sell. And I think that if you buy beta today (SPY or IWM – pick your major US index), come September-October, you’ll lose a lot more money too.

 

Rule #1, don’t lose money.

 

Rule #2, don’t forget Rule #1.

 

Rule #3, don’t smoke Grass Money when central planners are trying to have you forget Rules #1 and #2.

 

My immediate-term support and resistance risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Russell2000, and the SP500 are now $1603-1624, $108.03-113.18, $81.72-82.64, $1.22-1.24, 788-803, and 1386-1408, respectively.

 

Bes of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Grass Money - Chart of the Day

 

Grass Money - Virtual Portfolio


THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – August 23, 2012


As we look at today’s set up for the S&P 500, the range is 9 points or -0.25% downside to 1410 and 0.39% upside to 1419. 

                                            

SECTOR AND GLOBAL PERFORMANCE


THE HEDGEYE DAILY OUTLOOK - 1

 

THE HEDGEYE DAILY OUTLOOK - 2

 

THE HEDGEYE DAILY OUTLOOK - 3

 

 

EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: on 08/22 NYSE -648
    • Decrease versus the prior day’s trading of -344
  • VOLUME: on 08/22 NYSE 600.77
    • Decrease versus prior day’s trading of -6.27%%
  • VIX:  as of 08/22 was at 15.11
    • Increase versus most recent day’s trading of 0.60%
    • Year-to-date decrease of -35.43%
  • SPX PUT/CALL RATIO: as of 08/22 closed at 2.41
    • Up from the day prior at 1.10

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD: as of this morning 33
  • 3-MONTH T-BILL YIELD: as of this morning 0.10%
  • 10-Year: as of this morning 1.68%
    • Decrease from prior day’s trading of 1.69%
  • YIELD CURVE: as of this morning 1.43
    • Unchanged from prior day’s trading

MACRO DATA POINTS (Bloomberg Estimates)

  • 8:30am: Initial Jobless Claims, Aug. 18 wk., est. 365k (prior 366k)
  • 9am: Markit US PMI Preliminary, Aug., est. 51.5 (prior 51.8)
  • 9:45am: Bloomberg Consumer Comfort, Aug. 19 (prior -44.4)
  • 10am: New Home Sales, July, est. 365k (prior 350k)
  • 10am: New Home Sales, M/m, July, est. 4.3% (prior -8.4%)
  • 10am: Freddie Mac mortgage rates
  • 10:30am: EIA natural-gas change
  • 11am: Fed to purchase $1.5b-2b notes 11/15/2022-2/15/2031
  • 1pm: U.S. Treasury to sell $14b 5-yr TIPS (reopening)

GOVERNMENT:

    • House, Senate not in session
    • Quinnipiac U,, CBS News, NY Times discuss swing-state poll on Obama/Romney matchup conducted in Fla, Ohio, Wisc., 10am
    • Federal Election Commission holds audit hearing on McCain- Palin 2008, McCain-Palin Compliance Fund, 10am
    • FERC meets on natural gas, electricity market coordination in U.S. Southeast, 9am
    • Oxfam America holds a conference call briefing on final rules for oil, mining transparency provision of Dodd-Frank Act Consumer Protection Act after SEC vote, 10am
    • SEC holds closed meeting on enforcement matters, 2pm

WHAT TO WATCH:

  • Best Buy said to resume talks with founder Richard Schulze about agreement to allow him to conduct due diligence
  • Sales of new homes in U.S. probably climbed 4.3% in July
  • Euro-area services, manufacturing contract for seventh mo.
  • Pfizer lawyers to ask federal judge today to throw out claims the fen-phen diet pills caused fatal disease
  • Hertz said to start soliciting Dollar Thrifty shareholders to gauge their selling price
  • EU regulators resumed review of UPS’s bid for TNT Express; set new deadline of Dec. 20 to rule on deal
  • David’s Bridal agreed to be acquired by Clayton, Dubilier for $900m: N.Y. Post
  • U.S. to expand missile defense system in Asia: WSJ
  • Chesapeake Energy accused of letting CEO McClendon profit from Texas oil, gas wells while denying same chance to leaseholders on properties
  • Qantas cancels order for 35 Dreamliners after annual loss
  • Pilots at American Airlines, US Airways said to be considering terms of transitional labor pact if carriers merge
  • Sirius holders lost bid to stop Liberty Media from seeking to acquire controlling stake
  • SEC Chairman Mary Schapiro canceled vote on proposal to tighten money-market fund rules amid opposition
  • Ancestry said to seek higher buyout bids from Permira, TPG
  • Facebook won FTC approval for acquisition of Instagram
  • Citigroup urges SEC to block Nasdaq’s Facebook plan to pay $62m in compensation
  • China manufacturing may contract at faster pace in August
  • First Solar plans to develop solar farms in India
  • Broadview Networks filed for bankruptcy protection yesterday
  • Lawyers for Kazuo Okada return to Nevada court today to argue for access to Wynn Resorts’s book\ Brazil may need to import U.S. ethanol if fuel mix raised this year, CEO for Bunge in Brazil told Bloomberg News

EARNINGS:

    • Big Lots (BIG) 6am, $0.41
    • Hormel Foods (HRL) 6:30am, $0.41
    • Patterson (PDCO) 7am, $0.49
    • Lancaster Colony (LANC) 7:16am, $0.79
    • Signet Jewelers Ltd (SIG) 7:30am, $0.83
    • Toro (TTC) 8:30am, $0.63
    • Micros Systems (MCRS) 4:02pm, $0.60
    • Autodesk (ADSK) 4:02pm, $0.49
    • Aruba Networks (ARUN) 4:03pm, $0.17
    • Salesforce.com (CRM) 4:05pm, $0.39
    • Solera Holdings (SLH) 4:05pm, $0.62
    • Mentor Graphics (MENT) 4:15pm, $0.17

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

 

THE HEDGEYE DAILY OUTLOOK - 4

 

 

CURRENCIES

 

THE HEDGEYE DAILY OUTLOOK - 5

 

 

EUROPEAN MARKET

 

THE HEDGEYE DAILY OUTLOOK - 6

 

 

ASIAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 7

 

 

MIDDLE EAST


THE HEDGEYE DAILY OUTLOOK - 8

 

 

 

The Hedgeye Macro Team

 

 


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THE M3: VISAS; MGM LOAN; S'PORE INFLATION

The Macau Metro Monitor, August 23, 2012

 

 

MAINLAND VISAS TO MACAU MADE EASIER Macau Business

The Ministry of Public Security has announced an easing on restrictions on travel to Macau by people living in six big mainland cities--Beijing, Chongqing, Guangzhou, Shanghai, Shenzhen or Tianjin.  Those permanent residents of those cities will be able to get visas for travel to Macau, Hong Kong or foreign countries.  The president of the Macau Travel Industry Council, Andy Wu Keng Kuong said the easier visas could mean more visitors to Macau.

 

MGM LOAN ATTRACTS 12 BANK COMMITMENTS Macau Business

The US$1.5 billion (MOP12 billion) loan currently in syndication for MGM China Holdings Ltd has attracted commitments from 12 banks.  The commitments reach just over US$1.4 billion, said the source.  MGM China is eyeing to close syndication of the facility by month-end  The proceeds will be used by MGM China to repay debt.  The company is offering to pay a margin of 250 basis points over Libor on a leverage ratio of four times or more.

 

SINGAPORE INFLATION SLOWS AS SCOPE FOR MONETARY EASING RISES Bloomberg

S'pore CPI rose 4% YoY.  The median estimate of 18 economists in a Bloomberg News survey was for a 4.5% increase, after a +5.3% pace reported earlier for June.  The July core inflation rate was 2.4%.  Singapore trimmed its prediction for 2012 expansion this month and said the island’s growth outlook “remains cautious,” increasing pressure on the Monetary Authority of Singapore to join central banks from China to the Philippines in adding stimulus. 


CHART DU JOUR: GAS PRICES

Takeaway: So now the regionals have to worry about gas prices too?

  • We’ve shown that historically, high gas prices are a statistically significant hurdle for regional gaming revenues
  • Despite common thought, YoY change has a bigger impact than sequential changes in gas prices – at least, statistically speaking
  • Gas prices are now higher than last year for the first time since March, but not significantly so.  The trend is still a little disconcerting, though.

 

CHART DU JOUR: GAS PRICES - gas2


DNKN: Not A Slam Dunk(in)

Takeaway: $DNKN will have a difficult time growing SSS with a lack of new products in the pipeline. It's also expensive compared with other QSRs.

Dunkin’ Brands (DNKN) is expected to miss expectations for the second successive quarter as it struggles to grow in the coming quarters. Dunkin’ IPO’d a year ago in the midst of a coffee bubble and is running out of growth drivers to save itself as it trades at an extremely high EV/EBITDA multiple of 13.5x. Chipotle (CMG) is the only other company that trades at a higher valuation in the same QSR space.

 

One big problem for Dunkin’ outlined by Restaurant Sector Head Howard Penney in a note from today was that Dunkin’s same store sales accelerated from 2% to 7% due to new products and the introduction of Dunkin-brand K-CUPS for Green Mountain’s (GMCR) Keurig machines. Since these events will not reoccur in the next year, it will be hard to compare and keep SSS growth at a similar level.

 

Penney’s bearish case on DNKN is outlined below:

 

If we were conspiracy theorists, which we are not, we would likely frame the Dunkin’ Brands story something like this:

 

1.      The insiders could not get out fast enough, with their “swan song” leveraging up the company to buy the remaining stake this month

2.        Of the 14 members of the DNKN board, 5 are representatives of the selling stockholders 

3.        The selling to investors of the “white space” growth opportunity was made possible by the new franchise distribution agreement.  In theory, this should help accelerate franchise unit opening.  Franchise units opening have been slowing for two quarters (U.S.  Gross openings were flat year-over-year in 2Q12, while net openings of U.S. Dunkin’ Donuts units came to 19 versus 54 expected by the Street)

4.        In trying to put their best foot forward to generate investment banking fees, sell-side expectations for what DNKN can do operationally are stretched.  For example, for nearly every company we track, consensus expectations have 1 and 2 year SSS trends slowing over the next two quarters except DNKN and DNKN is lapping its most difficult SSS compares in over 5 years

5.        As you can see from the chart below, consensus expectations are for the company to reaccelerate unit opening after missing for the past two quarters

 

 

DNKN: Not A Slam Dunk(in) - DNKNchart


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