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Chart Of The Week: Where Is The Depression's Vol?

You’d think, that with the coming of the alleged Apocalypse, that Volatility would be shooting to new highs. See the chart below – not so much…

In the final week of February, with the SP500 getting rocked (down -11% for the month!), the Volatility Index (VIX) was actually down -6% on the week. This past week, while the SP500 tanked another -7%, the VIX was up a modest +6%, finishing the week with a down day, closing -1.7% at 49.33. On a 2 week basis, in the thralls of raging rhetoric that the Great Depression cometh, what gives here?

Of course this isn’t the Great Depression – anyone who studies economic history gets that – but it is what we have now coined as The Great Recession… and with all recessions, not matter how Great, there are such things as early cycle leading indicators. Provided that Volatility continues to make lower highs on rallies, the VIX may very well turn out to be one of the more classic ones.

From an immediate term Trade perspective (3 weeks or less), the VIX is obviously in a bearish position for stocks. Interestingly however, from an intermediate Trend perspective (3 months or more), its breaking down. Dampening volatility in the face of decelerating volume on market down days is, on the margin, a bullish leading indicator for stocks – for an immediate term Trade, at least.

I have intermediate Trend line resistance for the VIX at 51.04. If we breakout above that line, it will undoubtedly be bearish for stocks – but for now, you can tell me what this chart will be signaling to you, particularly if the VIX breaks to lower intermediate term lows.

The immediate term bottoming process in the US stock market will be a process, not a point.

Keith R. McCullough
CEO & Chief Investment Officer

The Great Recession

"Depression is rage spread thin."
-George Santayana

Now that CNBC is running segments titled "Recession or Depression", and Bloomberg's #1 "Exclusive" story this morning is titled "Depression Dynamic Takes Hold...", what more evidence do we need? Aren't these two sources of reactive and revisionist editorials the great soothsayers of market prediction?
Of course not, that's silly ... more appropriately summarized, as Jon Stewart pointed out recently - if he only listened to CNBC in proactively preparing him for this downturn ahead of time, he would have a million dollars (provided that he started with $100 million)...
As the US stock market was hitting new cycle lows intraday on Friday, I started buying US equities more aggressively. I took our Asset Allocation Model Portfolio to 24% in the USA, and took down my cash position from 70% to 58%. As I was doing so, my inbox was brimming with about as many notes as I received in December of 2007 when I was shorting everything from Goldman to Bill Ackman's genius levered long position in "Tar-geh"...  some people didn't want to sell anything then, and those same people aren't allowed to buy anything now...
I am buying US Equities now, primarily because the early cycle economic indicators (China, oil, yield curve, etc...) are telling me that it is as safe now as it has been to do so since 2002... No, I don't call the daisy train at one of the aforementioned networks to get the ok on my view. The second reason to be buying here is actually turning into a very simple one - because I don't have a boss telling me I can't...
To be clear, I am buying American here for a Trade. While I appreciate that some investors don't trade, that won't stop me from doing what it is that I do. Investing for the "long run" or with the illiquidity factor associated with the super smart "Ackmanists" of the world may indeed sound legitimate, but at -24.3% for 2009 to-date may also leave a mark...
Unless you are 96% in cash (like I used to be), you probably should care about the immediate term "Trade" - in raging bear markets, these 1-3 day moves are much more powerful to the upside than in down ones. Maybe that's why for the YTD my Asset Allocation Model is only down -1.74% (no, being down is not good); we have stepped up and bought the market when no one is allowed to, then sold into the fire engine community who HAS to chase ...
Last week, the Asset Allocation Portfolio (no stocks, just ETFs) was -0.12% - the SP500 was down -7.0%. Under no circumstances was I proud to be down last week. My number one objective when I was running other people's money was always not to lose it. That remains the modus operandi with my family's capital, as it should.
Where all of these investment "styles" went wrong is fairly easy now to deduce, and I won't belabor those reasons or blame Obama for the capital destruction that has occurred. That would be both lame and depressing. The New Reality is that all of that is either behind us, or a waste time of time to rehash. Been there, done that...
What is most interesting to me now is to own the debate against the Depressionistas who are out there getting air time from the manic media. Like undisciplined children, it's time to give some of these people a "time out." The adults in the room can now take away the children's crackberries and handout some history books. Hate to break it to you little ones, we are now going to coin this The Great Recession...
Are recessions bad? You bet your Madoff they are... How about The Great One? Well, you can flip the channel onto the Money Honey and she'll definitely remind you that those ones are worse! But don't mistake this for a depression, and start sending out the "scary" chart of the day like penny stock Citigroup or whatever of the bucket shops out there who have a charting tool are doing - these are called marked to market price declines, not a Main Street American Depression...
Hopefully someone in the media gets why I am now understanding that what we have here is The Great Recession. While some people on Wall Street are rightly expressing their personal depression, they are wrongly straight-lining that statistically insignificant personal position across a globally interconnected economy. Fortunately, as the US Treasury Yield Curve, Dr. Copper, Wal-Mart, and China reminded me last week, Wall Street is no longer going to own the debate as to where this economy is headed next - the clients will. Some of them have blue collars... some of them are Chinese... I know, I know - very weird stuff I am talking about here...
Why I'm Not Depressed: It's all about the delta. The revisionists are straight-lining the record setting acceleration in unemployment into becoming a repeatable rate of growth - mathematically speaking at least, that's silly. Whether you want to look at this relative to the mid 1970's when year-over-year trough to peak unemployment last ramped this quickly (up 300-400 basis points year over year), or in terms of percentage accelerations across different durations, my conclusions are the same - the rate of growth in the US unemployment rate is setting up to SLOW... right as the manic media worries people about it most.
Is there downside left in the US stock market? Of course there is, but a lot less downside than what I was worried about in 2007 - -56% less actually...
My Partner Howard Penney gave me the day off writing Friday's note... but taking a step back to my Thursday Early Look note, I had downside support for the SP500 at 683 - that's where we closed the week... I know - man is that McCullough guy full of himself and lucky sometimes...
Well, I can tell you this... it's better being lucky than being Depressed.
Best of luck out there this week.



  • 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.

  • USO - Oil Fund- We bought oil on Friday (3/6) with the US dollar breaking down and the S&P500 rallying to the upside. With declining contango in the futures curve and evidence that OPEC cuts are beginning to work, we believe the oil trade may have fundamental legs from this level.

  • QQQQ - PowerShares NASDAQ 100 - We bought QQQQ on a down day on 3/2 and again on Friday of last week.

  • 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 three standard deviations oversold.

  • CAF - Morgan Stanley China fund - The Shanghai Stock Exchange is up +20.4% 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 on a down day. 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.

  • LQD -iShares Corporate Bonds- Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back. Moody's estimates US corporate bond default rates to climb to 15.1% in 2009, up from a previous 2009 estimate of 10.4%

  • SHY -iShares 1-3 Year Treasury Bonds- On 2/26 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 down versus the USD at $1.2619. The USD is up versus the Yen at 98.7420 and up versus the Pound at $1.3963 as of 6am today.


Total Macau Baccarat revenues fell 17% in February, driven primarily by a 20% decline in Rolling Chip (RC) turnover. The 17% drop actually improved sequentially from January’s 19% decline. I actually thought the volume decline would be worse considering the comparison. In the first half of last year, the junkets flooded the market with credit driving 30-60% monthly increases in Rolling Chip volume. Mass market revenue declined 6% in February.

In terms of total market share, LVS was the biggest winner, gaining over 300 bps of share sequentially, although still 400 bps below its December 2008 peak of 28.6%. Galaxy and SJM both gained over 100 bps of share. Galaxy has been on a little bit of a roll with its 2nd straight sequential gain and its 14.2% February market share was the highest since November 2007. The February losers were MGM (low hold % on the RC business) and Crown. Wynn Macau held fairly steady at around 16.2%.

On the super profitable Mass Market business, market shares were fairly consistent with prior months. The only real trends that appear to be emerging are the opposite paths of MGM and LVS. LVS lost a little bit of Mass Market share for the 3rd straight month while MGM gained share over the same time period.

Trends appear to be emerging in the RC segment. MGM and SJM are on the upswing, due in part to higher commissions paid to the junkets. MGM generated 250 bps of market share gains over the last two months. Revenue share would’ve also grown sequentially if not for an abnormally low hold %. LVS and Crown each lost share for the second straight month in RC.

All things considered, Macau seems to be doing fine despite the crazy RC comparisons and the stringent visa restrictions. We’ve been concerned with the RC comparisons, as we pointed out in our 01/08/09 note “MACAU: CREDIT A BIGGER NEAR TERM ISSUE”, but investors have finally discounted that and we can see the light at the end of the tunnel. Macau will lap the credit flood in September where last year’s comparisons actually turn negative. There is also a reasonable probability that the visa restrictions will be eased by then as Beijing may provide a tail wind for the new Macau Chief Executive. Macau remains the only worldwide gaming market with excess demand and we are sensing a turn to the optimistic side of the pendulum.

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So Bank of America/Merrill Lynch/US Government raises their 2009 EBITDA estimate by 14% or $24 million and jacks up 2010 by 12%. The 2009 EBITDA hike translates into $0.40 in incremental EPS for a company that is projected to generate no EPS in 2009, yet somehow that is “tweaking”, as the analyst described it.

This is disingenuous. Not only is the analysis disingenuous but it is faulty. Rather than raise his price target by the $3 required by the higher estimate, the analyst lowered his target multiple by a full turn or a $4 reduction. The net result? A target price reduction of $1 and presto: a negative spin on an outstanding quarter. I find it hard to process a lower target multiple when regional market trends are stabilizing in general, and actually improving for PNK.

Of course, this is probably not the sole cause of the strange reaction in PNK’s stock to numbers that surely bested even the whisper numbers. Ahead of the quarter, we were leaning towards sell before the news but the operating performance exceeded our most bullish projections. So why was the stock down? Here are some educated guesses.

• Fear of Texas – A bill was introduced in February to legalize slots in Texas. Most of PNK’s markets service the Texas population. However, there were absolutely no developments late last week. More importantly, we don’t think Texas will legalize slots any time soon.
• The large seller argument – This common explanation for unexplained down moves in stocks actually has some merit in this situation, so we hear.
• Increased Sugarcane Bay budget – PNK increased the scope and cost of its Lake Charles project by $50 million. Nobody likes to see more capex but this project has not even begun. I’m not particularly worried about this.
• Covenants - I actually feel a lot better about the covenant situation. After the strong Q4 results, a 2009 covenant breach is highly unlikely. The 2010 story is hardly dire and while a breach could occur, time is on PNK’s side and so will be the banks. I’m not worried.
• PNK is a gaming stock – What can I say about this? Despite stabilizing trends in the regional markets in general and strong trends for PNK, nobody wants to own gaming, until they do.
• Faulty analysis – See the discussion above.

US Market Performance: Week Ended 3/6/09...

Index Performance:

Week Ended 3/6/09:
DJ (6.2%), SP500 (7.0%), Nasdaq (6.1%), Russell2000 (9.8%)

2009 Year To-Date:
DJ (24.5%), SP500 (24.3%), Nasdaq (18.0%), Russell2000 (29.7%)

Keith R. McCullough
CEO & Chief Investment Officer


On the surface, RCL is a short seller’s dream: 1) lousy fundamentals,2) high leverage, and 3) liquidity/covenant issues comprise the bulk of the negative thesis. With 31% of the share sold short and a forward p/e ratio of 5.5x, shorting RCL is indeed the consensus call.

We have no response to the high leverage argument. We calculate leverage at 8x in 2010, although it will decline materially once the new ships come on line. Our only counter to the fundamental argument is that near term bookings appear better than investors may be expecting and Europe has been resilient. Where we may differ with consensus is on point number 3.

RCL really doesn’t have any covenant issues:

• Fixed Charge coverage test is actually negative (cash flow from operations/ (sum of dividends + scheduled principal payments – new financings)
• Net Debt to Capitalization Ratio was below 50% at 12/31/2008, and we project it peaking at 57% at the end of 2010, still below the 62.5% max
• Minimum Shareholder’s Equity was $4.7BN vs an actual of $6.6BN at 12/31/2008.

RCL may have some liquidity issues, but not until 2010. We are well below 2009 consensus earnings and cash flow estimates yet RCL maintains more than enough liquidity to fund its significant capex. See the chart below. 2010 will be awfully tight, however. Here are our assumptions:

• They will get the financing for Oasis and Allure in 2009
• By the end of 2009 all ship commitments should be fully financed removing that overhang
• $600MM funding need from: cash flow from operations of $800MM – capex of $2.2BN + new ship financings of $1.7BN – maturities on 2008 debt of $800MM – maturities on 2009 debt of $100MM
• Sources at 12/31/2009 of $650MM: R/C capacity of $400MM + cash on hand of $250MM

A 2010 funding shortfall is a real possibility, a 50% probability in our estimation. However, even in this scenario, RCL would likely procure an extension on one its 2010 maturities, albeit at a higher interest cost:

• Alternative would trigger a cross default and most of the lenders have exposure on multiple pieces of debt
• Last thing unsecured lenders want is for RCL to have to raise secured debt under its carve out
• RCL could always monetize it’s in the money hedges

The good news is that 2010 is truly a bridge year. Capex steps down materially in 2011 and presumably RCL will be in the clear in terms of liquidity. Now if only RCL can sustain the recent “less bad” operating momentum there could be a nice near term story here.

Plenty of 2009 liquidity but 2010 is tight

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