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DFS: The Time To Short

Takeaway: With DFS set to report on Thursday, we think the company has a negative EPS growth story on its hands that makes for a good short.

In the past, we’ve been too bearish on Discover Financial Services (DFS). The stock has had a fantastic run and we simply timed the cycle prematurely, thinking that delinquency rates were stacked against the long side. Cycles come and go and when you look at the loss of value for some companies in the past, it’s easy to be bearish. In the last cycle Discover lost 83% of its value, Capital One lost 90% and American Express lost 84%.

 

 

DFS: The Time To Short  - DFS 2

 

 

With DFS reporting on Thursday, we’ve shorted DFS in our Real Time Positions as the numbers finally add up on a quantitative basis. We expect a year-over-year negative trend in EPS and think the company is running on fumes at this point.

 

DFS: The Time To Short  - DFS 1                                                                                                                                     


We Are American

WE ARE AMERICAN

 

 

CLIENT TALKING POINTS

 

WE ARE AMERICAN

Americans catch a bad rep sometimes. For whatever reasons, financial professionals and policy makers think they can outsmart the public time and time again. And you know what? That’s simply not the case. Be it the gentleman in Arkansas who pulls money from a mutual fund or the misguided youth protesting with the Occupy Movement in New York, people are catching on and smarting up. They are tired of central planning policy that has killed their ability to generate yield and has created no economic boost that’s tangible. Devaluing the dollar has run its course, and soon the planners and policymakers will have to move on to something that doesn’t involve the word “easing.”

 

 

THUS THE EARNINGS SLOW

Our focus on the slowing of growth is still alive and beating in our hearts as we shake our head at Bernanke’s failed policies. But in the immediate-term, we have turned our attention to corporate earnings. Make no mistake about it: earnings are slowing. Companies like FedEx (FDX), Intel (INTL), Norfolk Southern (NSC) and Oracle (ORCL) all paint a picture of lower guidance and falling revenues. It’s interesting because this is one thing Bernanke can’t step in and fix with the wave of a magic pen. As we continue farther into the Q312 reporting game, things will likely become worse.

 

 

_______________________________________________________

 

ASSET ALLOCATION

 

Cash:                  Flat

 

U.S. Equities:   Flat

 

Int'l Equities:   Flat   

 

Commodities: Flat

 

Fixed Income:  Flat

 

Int'l Currencies: Flat  

 

 

_______________________________________________________

 

TOP LONG IDEAS

 

WENDY’S COMPANY (WEN)

Our conversations with Wendy’s franchisees indicate that sales have been trending sequentially higher in 3Q versus 2Q. We believe the company is about to announce the end of the company’s Sisyphean breakfast initiative after a prolonged “testing” phase. Given the capital demands on the company over the next few years as it invests to upgrade its asset base, shifting capital from the distraction that has been breakfast is a positive. The tail is less certain as it will take years for the system to rejuvenate the asset base and push out the older franchisees that don’t want to make the necessary investments to bring the asset base in line with contemporary industry standards..

  • TRADE:  LONG
  • TREND:  NEUTRAL
  • TAIL:      NEUTRAL            

 

PACCAR (PCAR)

Emissions regulations in the US focusing on greenhouse gases should end the disruptive pre-buy cycle and allow PCAR to improve margins. Improved capacity utilization, truck fleet aging, and less volatile used truck prices all should support higher long-run profitability. In the near-term, Paccar may benefit from engine certification issues at Navistar, allowing it to gain market share. Longer-term, Paccar enjos a strong position in a structurally advantaged industry and an attractive valuation.

  • TRADE:  LONG
  • TREND:  LONG
  • TAIL:      LONG

 

LAS VEGAS SANDS (LVS)

LVS finally reached and has maintained its 20% Macau gaming share, thanks to Sands Cotai Central (SCC). With SCC continuing to ramp up, we expect that level to hold and maybe, even improve. Macau sentiment has reached a yearly low but we see improvement ahead.

  • TRADE:  LONG
  • TREND:  NEUTRAL
  • TAIL:      NEUTRAL

  

_______________________________________________________

 

THREE FOR THE ROAD

 

TWEET OF THE DAY

“’Futures flat as Fed hopes offset Caterpillar’, LOL” -@KeithMcCullough

 

 

QUOTE OF THE DAY

“The middle of the road is where the white line is-and that's the worst place to drive.” –Robert Frost

                       

 

STAT OF THE DAY

5 million. The amount of Apple iPhone 5s sold in just three days.

 

 

 

 

 


Thinking That Way

This note was originally published at 8am on September 11, 2012 for Hedgeye subscribers.

“I wouldn’t be doing my job if I started thinking that way.”

-Neil Barofsky

 

In one of the more riveting introductions to a book I have read in some time (Bailout – “An Inside Account of how Washington Abandoned Main Street While Rescuing Wall Street”), that’s what former Special Inspector General for TARP, Neil Barofsky, told former Assistant Secretary of the Treasury for Financial Stability, Herb Allison.

 

Herb was one of Hank Paulson and Timmy Geithner’s guys. He was also the former CEO of Fannie Mae and President of Merrill Lynch. While objectively analyzing the biggest taxpayer bailout in US history, Allison told Barofsky “you’re really hurting yourself” and asked him “have you thought at all about what you’ll be doing next?”

 

Evidently Barofsky had thought about it. He decided to tell the truth. Meanwhile, as we test 4.5 year highs, memories are short and storytelling is back. I, for one, haven’t forgotten the lessons of 2007-2008. The truth is, neither should you.

 

Back to the Global Macro Grind

 

After 3 weeks down, US stocks had 2 up days, then a down day. After 4 months down, Chinese stocks had 3 up days, then a down day. What is the truth? With the price of Oil up +31% since late June, is economic growth going to magically appear?

 

To Review:

  1. Dollar Down inflates asset prices (stocks and commodities) in the short-term
  2. Rising Inflation Expectations slow real (inflation adjusted) economic growth in the long-term
  3. As Growth Slows, begging for bailouts (and more Dollar Debauchery) is what Old Wall Street does

This is not new. In fact, what’s quite sad about it at this stage of the game is that everyone knows precisely how it works. How else would you explain the following?

  1. CFTC bullish futures and options contracts testing all-time highs (1.33 million contracts) as demand slows
  2. Gold speculative contracts up +35% and +10% wk-over-wk in the last 2 weeks, respectively (pre Fed meeting)
  3. Again, Oil prices up +31% in a straight line (bull contracts pushing 200,000) since mid-June as global growth has slowed

And, again… these are just questions. I wouldn’t be doing my job if I didn’t ask them that way.

 

Another risk management question about the current #BailoutBull rally in stocks and commodities is how does this all end? One of the easiest ways to answer that question is reversing what’s driven asset prices higher (Dollar Down). What happens when the Fed runs out of communication ammo and the largest Ball Under Water trade (Dollar Up) in US history rips to the upside again?

 

Sadly, at this point, Obama, Geithner, and Bernanke know the answer to that question just as well as Vladimir Putin does. President Bush understood it too. We call it the Correlation Risk. Central planners don’t call it anything because that would be an admission of the most obvious risk in the world right now. It would also make them accountable for it.

 

Here’s the update on that (Correlation Risk between the US Dollar and everything else on our immediate-term TRADE duration):

  1. Gold -0.92
  2. Silver -0.88
  3. Copper -0.89
  4. CRB Index -0.89
  5. SP500 -0.73
  6. Eurostoxx600 -0.77

In other words, with the US Dollar on 3-month lows, mostly everything Big Macro that moves on no-volume these days has gone straight back up to lower long-term highs. All the while, the US Dollar continues to make higher long-term lows (see chart).

 

As a result, the next calamity in stocks and commodities will be no different than the one we just saw from the March highs to the June lows. Every one of these centrally planned debaucheries of the currency ignites shorter-term rallies and steeper corrections.

 

It also perpetuates structural long-term growth slowing, globally. And why the Fed can’t figure out the why on that is very simple – they haven’t run real-time businesses that have to meet payrolls. Therefore, they don’t get expectations.

 

Thinking That Way, for anyone who hasn’t spent their entire life getting paid by the largesse of the US Government’s broken policy promises, isn’t tyrannical. It’s just common sense.

 

My immediate-term support and resistance risk range for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr US Treasury Yield, Russell2000, and the SP500 are now $1694-1745, $113.47-115.48, $80.11-81.21, $1.24-1.28, 1.56-1.67%, 823-846, and 1419-1441, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Thinking That Way - Chart of the Day

 

Thinking That Way - Virtual Portfolio


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Holding Our Position

“We are holding our position.”

-General George S. Patton

 

That’s what one of America’s greatest said on the eve of July 31, 1944 when Patton “outlined the basic procedure for his men until war’s end.” In specifically addressing his intentions toward the enemy, he also added that “we’re going to go through him like crap through a goose.” (The Soul of Battle, page 289)

 

In terms of how I think about our proverbial enemy in Global Economics (The Keynesian Army of Academia), that sounds about right. As I watched a good man win $30,000 after hitting a Hole-In-One yesterday at the Homes For The Brave fundraiser in CT, I said to myself ‘divine intervention!’ Somewhere, something out there is telling me Americans are smarter than our failed policy makers.

 

After their 2-day Viagra rally, Bernanke’s Bailout Beggars are back on their heels. Our Q2 2012 Global Macro Theme of “The Last War: Fed Fighting” isn’t easy. But it ain’t over till it’s over either. We’re Holding Our Position that Policies To Inflate (Qe3) will only perpetuate the global growth slowdown. We believe that Strong Dollar is the only way to long-term American prosperity.

 

Back to the Global Macro Grind

 

Don’t look now, but US stocks are down for 5 of the last 6 days and have done nothing but go down versus the YTD highs established on the day after Bernanke became completely politicized (September 13th, 2012).

 

From that goose poop intraday high on September 14th of 1474 in the SP500:

  1. US stocks are down -1.2% and -1.9% respectively (SP500 and Russell 2000)
  2. CRB Commodities Index is down hard, from 320 to 305 (-4.8%)
  3. US Treasury Bond Yields are down even harder, from 1.89% to 1.69% (-11%)

Ok, maybe calling it goose poop is a bit much. But if you bought stocks/commodities up there and shorted bonds, and put your nose real close to your P&L since, it’s closer to the truth than a rumor.

 

On a more serious note, this is getting serious. The Chairman of the Federal Reserve continues to make promises to markets that he cannot keep. Reality here is sad and simple, at the same time:

  1. Money Managers are forced to front-run Bernanke, chasing asset prices higher into central planning events
  2. Then they all need to sell, at the same time, before economic gravity takes hold, and prices correct

This is the anti-thesis of part I of Bernanke’s Congressional mandate (“price stability”). It’s also the #1 reason why A) people won’t hire and B) people won’t invest in this market at a 4.5 year top. Real people with real money don’t trust this market as far as they can throw an NFL replacement ref.

 

Now, to be fair, the equity bulls who got smoked from March-June have absolutely “nailed it” from July-September – maybe for all of the wrong reasons (#GrowthSlowing) – but nailing it is nailing it when it comes to the score.

 

But where do they go from here? In March perma-bulls said “3-4% growth is back, earnings are great, and stocks are cheap.” Today, we have both Growth and Earnings Slowing, but something like 216,000 global “easings” which are, allegedly, going to trump earnings season.

 

In addition to what Fedex (FDX), Intel (INTC), Staples (SPLS), Norfolk Southern (NSC), Bed Bath & Beyond (BBBY), and Oracle (ORCL) have previewed in the last 2 weeks, here’s the Growth and #EarningsSlowing Update from Caterpillar (CAT) last night:

  1. CAT cut 2012 and 2015 guidance without a lot of specifics
  2. Management hinted that 2012 Revenues would “come off” by about $2 Billion Dollars
  3. Management insisted cutting 2015 guidance from $15-20 in EPS to $12-18 in EPS was “not a guidance cut”

So, in our Research Meeting today I’ll ask our new long-cycle master Industrials Managing Director, Jay Van Sciver, if it’s “not a guidance cut”, what specifically does that goosy stuff smell like to you?

 

To review: when people say “stocks are cheap”, this CAT puke example really speaks to the heart of what that might mean. Cheap is cheap if the company can actually deliver on revenue and earnings expectations. “Cheap” gets cheaper when companies guide down:

  1. If you bought CAT in February 2012 at $116, assuming $20 in 2015 EPS, you paid what you thought was 6x EPS on 2015
  2. If you shorted CAT in February at $116, assuming $12 in 2015 EPS, you shorted it at 10x hopeful 2015 EPS

Ok, so 6-10x is cheap, I guess, if you use 2015! I’d need at least 6 Bud Lights and a 50% chance at Powerball to put my name on a 2015 forecast right now, by the way.

 

In the meantime, what about 2013? What if the company can’t drive earnings above $9 for the next 3yrs? What does Chinese “construction off 40%” (per CAT management) mean to Q3 and Q4 of 2012 revenues and earnings assumptions?

 

If you are long CAT, we’re guessing you don’t know the answer to those questions this morning. That’s ok, neither does CAT’s management. Therefore, goose or no goose, we are Holding Our Position: Short CAT as growth and earnings slow.

 

My immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $106.73-111.44, $1, $78.85-80.63, $1.28-1.30, 1.63-1.79%, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Holding Our Position - Chart of the Day

 

Holding Our Position - Virtual Portfolio


THE M3: SJM COTAI; IMPORTED WORKERS

The Macau Metro Monitor, September 25, 2012

 

 

BEING FIRST IN COTAI NOT THAT IMPORTANT: SJM BOSS Macau Business

SJM CEO Ambrose So said regarding his Cotai project, “These are not projects you can do in two days. They take around three years to complete. So it’s not a matter of life and death who gets over the line first in terms of [government] permission."  So reiterated his hopes of getting 600 to 700 live gaming tables for its Cotai project. He also admitted that the recent shareholder battle over the control of Greek Mythology Casino, one of SJM Holdings’ satellite casinos, had hurt the gaming operator’s gross gaming revenue market share.  “We will try our best and hope we can achieve our target of about 30% [market share].”

NEW RECORD FOR IMPORTED WORKERS (AGAIN) Macau Business

The number of imported workers in Macau reached a new all-time high in August.  According to official data from the police released today, Macau had a total of 107,400 imported workers by the end of August, 61% of whom came from the mainland.  This was the second month in a row in which a new all-time high for imported workers was set.


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