SP500 Levels, Refreshed...

An immediate term bottoming process is underway – people are very emotionally geared to the down moves right now, and they should be – we are living through one of American history’s greatest disasters. The behavior of some of our said leaders saddens me to the core.

Make no mistake, the governing intermediate Trend here is one of a raging bear market… and it will continue to be for some time. That’s the price we are going to pay for trading away our financial system’s credibility. My call this morning was, and continues to be, to buy/cover for a Trade. I have refreshed my macro model for prices registered at 11AM EST.

Keith R. McCullough
CEO & Chief Investment Officer

The Good News

"I'll study and get ready, and then the chance will come."
-Abraham Lincoln

After a statistically significant weather aberration here in the North East, it's a little chilly here in the New Haven office this morning. However, in preparation to write this note I am warming up to the idea of getting invested again in America.

No, I'm not interested in investing in them bubbly US Treasuries that everyone from China to Japan is chalk full of (Mr. Buffett, thank you for having our back on that bond bubble call in your annual letter). And no, I'm definitely not getting into them butter fly wing nut derivative things that the sell side taped together and slapped a ticker on either. I'm thinking plain vanilla US stocks, for a "Trade"...

Do not mistake this call as a "Trend" - the intermediate Trend in the US market will likely remain a bearish one for a long time now... but everything in markets has a time and a price. Now is the time to be buying American again, for a Trade.

The US stock market is seeing its lowest prices since 1996 (down -22.5% for 2009 to-date), taking those who "invested for the long run" in October of 2007 down -55% from being walked off the Investment Banking Inc. cliff of the willfully blind. The prices I am seeing are definitely compelling - if you can't at least cover shorts here, I don't know when you'll ever be able to.

Why is it that most institutional investors love to buy everything on sale in this country other than stocks? I'd like to say that I do not know... but anyone who has spent more than a year in this business knows... it's sad and its silly, but its true - the art of managing money is having money to manage - and if you can outperform whatever benchmark your marketing department has established for you, heck... just tone it down and start buying after the brave soul next to you does.

I took our cash position down from 76% to 68% yesterday. I took my Asset Allocation to US Equities back up to 17% (I was at 9% at month end) and, to be clear, I am buying American for a Trade. Trade? Yes, my name is Keith McCullough - I am a risk manager, and I trade.

When you are locked under the dominating intermediate "Trend" (3 months or more) of a bear market, pretty much the only time you can really make money is by buying things when no one else is ALLOWED to. For all of the preaching that I do on proactively managing the risk associated with your factor exposures, the reality is that a lot of people out there still manage money based on the reactive relative performance model of chasing price. Price momentum is a one factor model - and it's not that complicated to predict.

I use a multi-factor risk management model that has 27 macro inputs. The factors run across asset classes and geographies. The factors are dynamic. As prices change, I do. This is not Keynesian. This is simply the only way I can attempt to remove emotion, and remain objective.

Do I make mistakes? Of course I do. I wouldn't be down -1.7% (I was down -0.1% yesterday) in our Asset Allocation Portfolio for 2009 to-date if I didn't. But when it comes to the big macro moves, I rarely get caught with my pants down as those massive tides roll out.

As of yesterday's close, my macro model has immediate term "Trade" downside in the SP500 and Nasdaq of less than 1% versus immediate term upside of +8%. That's the best risk reward scenario I have seen in terms of the US market's prices since November the 20th, 2008. Are things nasty out there? You bet your Madoff they are - this -22.5% down move to start 2009 is only rivaled by the years of 1933 and 1938 in terms of the expediency of the decline.

The savings rate in this country just shot up yesterday to 5%. The US savings rate was almost -800 basis points lower in Q3 of 2005 (at -2.7%, Americans had a NEGATIVE savings rate). On its own, this has been a massively relevant drag on consumer spending in America (close to $900B from the peak of negative US savings to now). Given that consumer spending represents almost 70% of American GDP, the slowdown that has been marked to market in your stock portfolios is very much a fundamental one. The good news here is that this is no longer new news...

There are two things that really matter to an American's economic confidence interval: the value of their homes and price of their portfolios. My Partner, Howard Penney, has done some great work on US housing prices as of late, and without belaboring the analysis that we have written on to support this (see macro portal at, our main conclusion here that matters when it comes to the values of US homes is that they will start to decline at a lesser rate come Q2 of this year. The good news here is that no one agrees with us that this will be new news...

If house prices begin to stabilize, and the US stock market starts to decline at a lesser rate... that will be very good news. In the meantime, study the people around you... "get ready... and then your chance will come." Buy low.

Best of luck out there today.



  • QQQQ - PowerShares NASDAQ 100 - We bought QQQQ on a down day yesterday. The Nasdaq closed down 54.99 points yesterday, or -3.99%, to 1,322.85.

  • EWA - iShares Australia-EWA has a nice dividend yield of 7.54% on the trailing 12-months.  With interest rates at 3.25% (further room to stimulate) and a $26.5BN stimulus package in place, plus a commodity based economy with proximity to China's H1 reacceleration, there are a lot of ways to win being long Australia.

  • SPY - SPDR S&P500- We bought the etf perhaps a smidgen early with the S&P500 at 715, yet will take it at a discount.  The market is also close to 3 standard deviations oversold.

  • CAF - Morgan Stanley China fund - The Shanghai Stock Exchange is up +14.95% for 2009 to-date. We're long China as a growth story, especially relative to other large economies. We believe the country's domestic appetite for raw materials will continue throughout 2009 as the country re-flates. From the initial stimulus package to cutting taxes, the Chinese have shown leadership and a proactive response to the credit crisis.

  • GLD - SPDR Gold- We bought gold last Thursday with the S&P500 in the red and gold down. We believe gold will re-find its bullish trend.

  • TIP - iShares TIPS- The U.S. government will have to continue to sell Treasuries at record levels to fund domestic stimulus programs. The Chinese will continue to be the largest buyer of U.S. Treasuries, albeit at a price.  The implication being that terms will have to be more compelling for foreign funders of U.S. debt, which is why long term rates are trending upwards. This is negative for both Treasuries and corporate bonds.

  • DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.

  • VYM - Vanguard High Dividend Yield -VYM yields a healthy 4.31%, and tracks the FTSE/High Dividend Yield Index which is a benchmark of stocks issued by US companies that pay dividends that are higher than average.
  • SHY -iShares 1-3 Year Treasury Bonds- On Thursday of last week we witnessed 2-Year Treasuries climb 10 bps to 1.09%. Anywhere north of +0.97% moves the bonds that trade on those yields into a negative intermediate "Trend." If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yield is inversely correlated to bond price, so the rising yield is bearish for Treasuries.

  • UUP - U.S. Dollar Index - We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. The Euro is up versus the USD at $1.2632. The USD is up versus the Yen at 97.6740 and down versus the Pound at $1.4055 as of 6am today


We checked in with our Macau sources recently and came away a little more constructive on LVS’ near-term credit situation there. As we wrote about in our 3/1/09 post “MACAU: A SENSE OF OPTIMISM”, we think investors should begin to look past the tough Rolling Chip comparisons of the first 3 quarters of 2009. Relief on the near-term covenant issues would provide the second punch of a solid one-two shot in the arm for LVS.

Our 2/23/09 post, “LVS: RESIDUAL VALUE RESIDING IN MACAU”, outlined possible remedies for the potential leverage covenant breach on the Macau credit facility. Two of these remedies appear more likely since we wrote about them last week. First, it appears LVS is making progress on selling their mall there. A net sales price of $800 million looks reasonable. Second, our sources indicate the Macau government is becoming more agreeable to approving residential sales at the Four Seasons Macau. While previously speculated sales prices at $1,500 per square foot are unlikely, we think investors would still cheer the more likely prices of $800 per square foot, or $600-650 million in proceeds. These transactions would go a long way to curing the 2009 covenant issue.

Other remedies include selling off a portion of the equity in the Macau operations to the public and amending the leverage covenant. We believe both of these options are on the table.

The upshot here is that the market continues to price LVS as an option yet there are a number of equity enhancing levers the company can pull. These levers do not appear to be well understood by investors. Of course, LVS management has a history of disappointing when it comes to asset sales, development projections and timelines, etc. Thus, investors are likely to be skeptical until the company can put something on the tape. If and when they do, look out.

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SP500 Levels Into The Close...

Nasty day out there, and whenever we get oversold like this, this is exactly how it should feel…

Right here and now, my buying the SP500 on the 715 line looks like it was 1% too early, but I am rarely accused of moving “too late” - closing prices are what matters here, and anything south of 708 is a 3 standard deviation move on the immediate term duration model that I am using. Unless something catastrophic happens overnight (oil wouldn’t be trading down like this if there was a terrorist attack in the works), there is a very high probability that we see a meaningful bear market bounce in the coming hours of trading.

Below I have outlined the line that I think we can bounce too first – 757 (dotted red). That would be +7% from the 705 we are currently trading at. That’s plenty enough for me to be buying SPY here.

Let me be clear - oversold immediate term bear market bottoms should be rented, not owned.

Keith R. McCullough
CEO & Chief Investment Officer


The chart below analyzes the Q4 promotional environment as measured by promotional allowances as a percentage of gross revenues. Not surprisingly, each operator spent a higher percent of gross revenues in giveaways. However, with the exception of the Las Vegas operators, the year over year increases were not as great as I would have expected for the rest.

Despite the awful consumer environment, the regional operators managed to keep promotional expenses in check. The promotional percentage increased 1% or less in Q4 2008 in these markets.

One standout of note is Boyd Gaming. BYD’s promotional percentage barely increased despite operating in everyone’s favorite punching bag market: Las Vegas. The Las Vegas locals market is BYD’s largest. Thanks to a severely capital constrained Station Casinos (the largest play in the LV locals market), the promotional environment remained somewhat tame, despite a pretty dreadful top line performance. We are not so negative on the 2010-and-beyond outlook for the Las Vegas market (See “THE LAS VEGAL LOCALS MACRO MODEL”) due in part to Station’s demise. Imagine if BYD could walk away with some of the Station assets?

The situation is much more dire for the other major Las Vegas market, the Strip. As can be seen in the chart, LVS and WYNN saw their promotional percentage increase significantly. MGM hasn’t reported but we expect to see an increase there as well.

EYE ON EASTERN EUROPE: A Facelift of Funds, Hungary Wants More

It’s old news now that the Central and Eastern European patient is sick. We’ve been writing about the estimated $1.25 Trillion exposure of euro-region banks over the last weeks. Austrian banks alone (Raiffeisen and Erste Group banks in particular) have some $280 Billion of exposure to E. European countries, or 64% of the country’s GDP.

On Friday the World Bank, the European Bank for Reconstruction and Development, and the European Investment Bank took action to address the region’s ails, providing a 24.5 Billion Euro relief package to Central and East European banks and businesses. Collectively, the aid will take the form of equity and debt financing, credit lines and political risk insurance.

Bailouts are nothing new in this region. The IMF has already bailed out Latvia, Hungary, Serbia, Ukraine, and Belarus. Yet Europe’s lagging financial crisis (with reference to the US) is finally calling policy makers to action. On Thursday we reported on the UK’s establishment of a Bad bank for toxic assets and the Treasury’s guarantee of some 325 Billion Pounds ($462 Billion) for mortgages and loans to middle to lower income earners.

Friday’s aid to Central and East European countries comes in the face of the horrendous economic numbers we’ve been sorting through over the last weeks. Some of the outliers include: Latvia, a country that saw its GDP contract -10.5% in Q4 ’08 and is forecast to fall to -12% this year and the Ukraine, which saw industrial output plummet -34% in January. Both countries recently had their credit ratings downgraded to BB+ and CCC+ respectively as fear of default on their debt becomes a looming proposition.

In aggregate Central and East European GDPs, currencies, exports, outputs and credit ratings have plummeted while unemployment and bond yields have increased; looking forward the IMF forecast that GDP in Central and Eastern Europe as a whole will shrink 0.4% this year. That’s a very aggressive estimate. Much of the initial boom in the region was funded by “Western” banks like Raiffeisen in Euro and Swiss Franc denominated loans. With the severe devaluation in currencies (see below) like the Polish Zloty at -11.8% versus the Euro, default risk has risen.

Other confirming negative data points include the contraction in capital flow, estimated to fall from $254 Billion in 2008 to $30 Billion in 2009, or -88.2%. We’re also seeing current account deficits (for 2008) rocket upward.

One of the main risk factors that nations have wrestled with —will the European Union be able to afford to help their Eastern neighbors?

Hungarian Prime Minister Ferenc Gyurcsany announced on Friday that he wants the European Union to arrange a package of as much as 180 Billion Euros to help Eastern European economies, banks and companies. He presented the plan formally yesterday at a EU summit in Brussels, and it was outright vetoed. The package was aimed specifically at Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland and Romania (EU members); Croatia and Ukraine (non-EU states); and Slovakia and Slovenia (Euro-region economies).

Gyurcsany’s plan calls into question the willingness of Europe’s stronger nations to bail out the weaker ones. While German Finance Minister Peer Steinbrueck stated on 2/17 that euro-region countries may be forced to bailout other members of the Union that face problems refinancing their debt, it appears unlikely the German opinion would support such a measure when Germany is dealing with its own severe contraction. German unemployment rose to 8.1% in February from 8.0% M/M and recently released data shows that Q4 ’08 GDP fell 2.1% and Exports declined 7.3% on a quarterly basis. And similar stats could be listed for Italy and France. The European Commission predicts that the EU’s $17 Trillion economy will shrink 1.8% this year.

The large nations of Europe may need to decide quickly. Recently, Romanian central bank advisor Eugen Radulescu said Romania needs 10 Billion Euros to cover its current account and budget gaps.

We haven’t been long anything in Europe in 2009, and we remain bearish on Europe as a whole. Sunday’s veto by EU leaders of Hungary’s proposed Eastern European bailout signals that more may not be in store for the region.

Matthew Hedrick

Andrew Barber

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