Bernanke's Mess

“It took a lot of hard work to get us into this mess.”

-Neil Barofsky’s Dad


The more I learn, the scarier Washington, D.C. gets. The aforementioned quote didn’t come from a politician. It came from Barofsky’s freshly printed tell-all book about crony socialism, Bailout (page 32). That time it was about TARP. This time it’s about Qe. Unless you want to wander on into the next politically perpetuated crisis willfully blind, I highly recommend you read it.


I wasn’t born in this country, but I do love it – and I will fight for its liberties. Hell would freeze over before the Founding Fathers of the Unites States of America signed off on a centrally planned market event like the one an un-elected academic will host today.


Whether he wants to accept responsibility or not, Ben Bernanke has signed off on the #1 thing that has been driving stock and commodity markets for the last 2 months – expectations. Up or down, whatever happens today will be Bernanke’s Mess.


Back to the Global Macro Grind


A)     Market up = mess for the economy: that’s right, if the man pushes 0% money out to 2015, 2016, then infinity and beyond, that’s a mess for a lot of people in this country. Just ask a retiree living on a fixed income, or a small business owner. When your cost of living is rising faster than your income, that’s called a tax hike.


B)      Market down = mess for the market: yep, since corporate revenue growth is slowing at its fastest rate since 2008, where do you think corporate margins go from their all-time peak? What do you think a collapse in the Fed’s final bubble (1st it was internet stocks, 2nd housing; now it’s commodities) is going to do to companies like Caterpillar (CAT) who aren’t prepared for that?


But, like it was in October 2007 (up double digits YTD), the “market is up” and we don’t hold the Fed accountable to its mandate? As a reminder, that mandate is:

  1. Price Stability
  2. Full Employment

Meanwhile, this is what we have:

  1. Price Volatility like markets have never ever seen (ever is a long time)
  2. Unemployment that’s higher than where it was on January 20, 2009 (7.8%)

So we better empower this guy to do more of whatever has not worked. And I mean really beg for it. If this insanity can only end in a blow up, I say get on with it so that I can start hiring again and get on with my day.


Since I have nothing else to write about this morning, let’s just review where we stand pre-game (1230PM Bernanke release):

  1. Financials (XLF) are up +3.83% in less than 2 weeks, front-running the Fed
  2. Energy stocks (XLE) are up +3.96% in less than 2 weeks, front-running the Fed
  3. Basic Materials (XLB) are up +3.76% in less than 2 weeks, front-running the Fed

Front-running? Bad word, for people who actually take on the Orange Jump Suit risk to be in the know pre-game. But that’s the game of expectations Ben Bernanke and his group-thinkers have perpetuated; that’s where the money’s at. Follow the money.


If 2 weeks of causality (Fed policy expectations) is too short-term for you, let’s look at the last month instead. Here are the inverse correlations between the US Dollar (down) and everything big that people are being forced to chase (30 day correlations):

  1. Gold -0.96
  2. Silver -0.95
  3. CRB Commodities Index -0.94
  4. Eurostoxx600 -0.86
  5. SP500 -0.74

In other words, get the US Dollar right, and you get everything but the US Economy right. Gold, last I checked, is not a “Full US Employment” trade. It wasn’t in the 1970s either.


Back to the two risk management words never uttered by our Central Planner in Chief (Correlation Risk), if I shorten that back up to 2 week correlations front-running Bernanke, the SP500’s inverse correlation to the US Dollar goes higher to -0.86. That’s because it’s closer to the main event. And that’s being driven by the aforementioned moves in the Financials and Commodities.


As Neil Barofsky says at the end of Chapter 2, “I might be completely on my own” (page 38) in calling Bernanke out on this mess of expectations at this point. But I doubt it.


When I started this firm in early 2008, I vowed to fight Old Washington and Wall Street for the truth. “What is the truth?” If that ruffles the odd feather, I’m doing my job. That’s what Canadian-American Patriots fighting for the purchasing power of their dollars do.


My immediate-term support and resistance risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, Russell2000, and the SP500 are now $1, $114-116.22, $79.45-80.94, $1.26-1.29, $1.69-1.77%, 830-846, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Bernanke's Mess - Chart of the Day


Bernanke's Mess - Virtual Portfolio

Expert Call Summary

Takeaway: $NAV- Other manufacturers have yet to decide on further legal action on the EPA's NCP regime at Navistar. Decision due in about 50 days.

Emissions Call Summary

Below, we highlight some of the key topics covered on our emissions expert call with Dick Penna today.  Dick currently represents Paccar and previously represented Volvo on truck emissions issues related to the non-conformance penalties applied to Navistar’s engine.  The call was excellent and contained a number of valuable details, which can be heard by listening to a replay of the call at



       Legal Options

  • Volvo, Daimler and Paccar, among others, are meeting tomorrow to discuss litigation strategies regarding the EPA’s non-conformance penalties with respect to Navistar.
  • Further litigation could shatter the “clarity” that Navistar has said the “Final” rule provides.
  • If competing manufacturers decides they want to challenge the EPA ruling (which they must do no more than 60 days after appearance in the Federal Register, which was September 5th, 2012) they will have a good shot, but it is still very difficult to predict court cases in the DC Circuit.
  • There is a citizen suit provision in the Clean Air Act where if somebody believes the EPA is not enforcing the law, they can give the EPA 60 days notice to do so.   If the EPA does not change what it is doing, then they can be taken to court.  The odds of that happening are pretty slim, but that is another possible legal path.  The most likely groups to attempt this would be the environmental and other public interest groups.

The Landscape Created by the EPA

  • The EPA will create deterrents for companies who do not comply with their regulations, but they will also stand on their head to not put anyone out of business.
  • As for the competitors who were complying with EPA standards, you can quarrel whether or not the $3,700 fine was enough to act as a deterrent.
  • Navistar may purchase emissions credits from Cummins to gain compliance.

2014-2018 Regulations

  • To comply with the 2014-2018 emissions standards, companies will be using different tires and aerodynamics which will likely introduce additional costs.  There is not much concern here about a pre-buy mainly because despite the additional costs these new EPA regulations will align fuel efficiency incentives for both truck manufacturers and operators.
  • The manufacturers all signed on to meet the 2014-2018 regulations, so they probably think they can meet the standards at a reasonable cost.

Looking Ahead

  • The EPA has just completed the 2017-2025 emissions rules for light-duty trucks, and we can expect to start hearing about future heavy duty regulations in the next few months.
  • These post 2018 regulations will likely depend on the outcome of the presidential election.
    • If Romney is elected he will most likely not make future regulations more stringent than the 2014-2018 regulations.
    • If Obama wins the election, regulations are likely to become even more rigorous after 2018.
    • We would probably need to switch to lower sulfur fuels for further tailpipe emissions gains.  That has ripple effects because there are costs that the refiners must now pay to reduce the level of sulfur in their diesel.

Light Vehicles

  • New emissions standards for light vehicles are rigorous. The changes coming over the next 7 to 10 years are likely to be rather aggressive.
  • In the future we are also going to see a lot more “light weighting”, as manufacturers turn to lighter metals or carbon fibers. 
  • We will also see multispeed transmissions and continuously variable transmissions as well as direct injection gasoline.

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Takeaway: LV Strip slot business unattractive over the near and long-term

  • Slot volumes have not grown across a 10 year span and these numbers are not even inflation adjusted
  • Weakening demographics - older and fewer slot players - play a big role in the stagnant growth.  Despite all the efforts to cultivate a younger customer base, the post baby boom generations are not playing the slots.
  • YTD, slot volumes have declined 2%, not exactly representative of a recovery



Macau: Enter The Supertables

Takeaway: Macau's table cap is approaching its limit. Casinos are moving to "Supertables" as a way to bypass the cap and cater to customers.

While Macau is dominating the gaming space compared to Las Vegas, there is a slight issue at hand involving table game limits. Currently, Macau casinos have a table cap of 5500, which is in effect until the end of March 2013. The cap isn’t a law but rather a government stipulation that can be changed at any time. So how does a savvy business overcome the cap? Easy: you build a Supertable!



Macau: Enter The Supertables  - supertablescc



These new “Supertables” seat 12 players and have two dealers as opposed to a traditional 6-8 player, single dealer setup. Las Vegas Sands (LVS) is leading the charge with 32 Supertables in place compared with the Venetian’s 20 and Starworld’s 5. Galaxy Macau has a single Supertable in place.


At the end of Q2 2012, the Macau government reported 5498 tables in operation. As LVS gets ready to open the second phase of its Sands Cotai Central (SCC) casino on September 20, investors are worried about the cap affecting the amount of table games in place since the SCC won’t get new table allocations until December of January. Sands China is making room for the additional 200 tables expected at SCC in late 2012/early 2013.


Until the table cap rises, we could see this Supertable trend quickly catching on with casinos. 

GPS: A Cautionary Tale

Takeaway: The Gap is up against stiff competition and needs to work on improving margins - stat.

Michael Francis has joined The Gap (GPS) as their head of marketing. This is the guy who thought it’d be a good idea to give out free haircuts at JCPenney (JCP). If that doesn’t make you nervous, a few other problems with GPS will.


Three years ago, GPS was sitting on a net cash position of $2.3 billion. Now it is down to $400mm and shrinking. The company’s been engaged in share buybacks over the past few years and while that’s fine and dandy, it has hurt their cash position. 



GPS: A Cautionary Tale - gapchart1



The Gap also needs to work on improving its margins and retaining market share. There are plenty of competitors going head-to-head with The Gap out there: Macy’s, TJ Maxx, Ross Stores and even JCPenney. Just because the company has hit on the colored jeans trend doesn’t mean it can sustain driving existing and new trends.


Retail Sector Head Brian McGough makes an excellent point in a note on GPS we’ve outlined below:


“The consensus has GPS earning $2.40 next year. Then $2.72 the year after. We’re about 10% below next year, and 20% below the year after. We’d argue that barring a disproportionately large capital investment (which would drive returns lower) GPS will never see $2.50 again – ever. And as we say at Hedgeye, ‘ever’ is a long time.


That did not matter with the stock trading at $15 a year ago. But it certainly matters today at $35.  Let’s say we’re dead wrong, and the Street is spot-on. Then you’re paying 12.9x earnings for a number that GPS will earn in FY 2014. That’s right up there with AAPL, NKE and RL. Which would you rather own?