“Success is to be measured not so much by the position that one has reached in life as by the obstacles which he has overcome.”
-Booker T. Washington
This weekend one of my colleagues circulated an article written by Malcolm Gladwell in The New Yorker titled, “How David Beats Goliath”. The gist of the article is that there are actually advantages to being the “David”, or the underdog, in an industry, game, or confrontation. On a basic level, this often occurs because the underdog does not subscribe to the same norms as his or her opponent. In fact, to succeed “David” has to be quicker, more tireless, and, most importantly, more innovative.
In the article, Gladwell uses basketball as a case study to highlight his point. He cites example after example of basketball teams that have beaten more talented teams by aggressively utilizing the full court press. In effect, instead of letting more talented opponents bring the ball down the court and set up their plays, the teams Gladwell highlights aggressively went after their opponents in their own end.
In top level basketball such as the NCAA or NBA, the full-court press is rarely used despite the evidence that it enables those teams with lower talent levels to be much more competitive. One of the more successful basketball coaches to use the full court press is Rick Pitino. Despite struggling as a coach in the NBA, Pitino has had a steller NCAA record of 616 wins and 227 losses, in part due to his use of the full-court press.
So, why don’t more coaches adopt Pitino’s strategy? Well, many actually do reach out to Pitino to come watch his practices and learn from him, but as Gladwell writes:
“The coaches who came to Louisville sat in the stands and watched that ceaseless activity and despaired. The prospect of playing by David’s rules was too daunting. They would rather lose.”
Being an underdog is not easy work.
On Friday the SP500 closed down -1.7% and no doubt many stock market operators felt like underdogs. The last time we had a sell-off in that area code was June 25th when the SP500 was down -1.6%. At a VIX of 15-ish, which is where Friday started, no one was expecting an almost two percent declining in equities, especially when the market is so “cheap”.
One of the key negative catalysts on Friday was #EarningsSlowing – one of our key Q4 investment themes. As is usual when complacency sets in, negative events occur when they are least expected to happen. On Thursday this occurred with Google’s (GOOG) earnings being released earlier than expected and being worse than expected. Although, to be fair, revenue was still up 45% year-over-year, but in the investment business expectations, as always, are the root of all heartache.
Earnings from Google on Thursday were then compounded on Friday with news from Asia that some of Apple’s (AAPL) supply chain was looking to take some margin back from the Cupertino giant. As reported in the Korea Times this morning, Samsung Display has now said that they will terminate its contract with Apple as Samsung is unable to supply its flat-screens at “high discounts”.
On the earnings front this morning one of our Industrials team’s favorite short ideas, Caterpillar (CAT), has come out with disappointing numbers and guidance. According to CAT:
“Cat dealers have lowered order rates to well below end-user demand … Production across much of the company has been lowered, resulting in temporary shutdowns and layoffs.”
The simple thesis for CAT is that next year’s earnings will be lower than this year’s earnings. While many companies may continue to grow earnings in 2013, even if CAT isn’t one of them, a bigger issue goes back to the point of expectations. In the Chart of the Day we highlight the view of margin expansion that is baked into consensus expectations headed into 2013. Needless to say, we do not see an acceleration in margin expansion in an environment where revenue is barely growing at 2% year-over-year in aggregate for the SP500.
Interestingly, CAT also plays into our second key quarterly theme, which we have called Bubble #3. A key tenet of this thesis is that the decade long boom we have seen in commodities driven by loose monetary policy is getting close to the last inning. This is most directly supported by slowing economic growth in China, which just printed one of its worse GDP numbers since the Great Recession.
Coincident with this commodity boom has been mining companies investing well beyond depreciation and amortization for more than a decade. This, too, will mean revert as we are seeing with CAT’s guidance this morning. We are expecting to see more follow through on this theme as more of the mining complex reports in the coming weeks.
Stepping away from earnings, the most significant global macro catalyst in the short term is clearly the November 6th election in the United States. Currently, the race has no underdog. The two candidates are virtually tied in national polls, they are virtually tied in the elector college, and in terms of favorability ratings they are, as well, virtually tied. Intrade still has Obama with a slight edge, but that too may well be fleeting.
In terms of insight into the election outcome, we will be joined this Wednesday at 1pm for a call with Professor Ken Bickers from the University of Colorado. He has crafted an interesting analysis based on state-by-state election economic situations that, according to his analysis, suggest that Romney may win in a run-away. Clearly, this is a non-consensus view. We hope you can join us for the call and will circulate the dial-in to institutional subscribers later this week.
Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $108.67-112.61, $79.15-80.24, $1.29-1.30, 1.73-1.82%, and 1, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
Takeaway: Bank swaps and sovereign swaps moved in tandem, tightening considerably last week while Chinese steel continues to show signs of weakness.
* American bank default swaps have tightened significantly. The improvement seems to be the result of ongoing improvement in housing as well as reasonably strong earnings.
* European bank CDS also tightened across the board last week with only 1 out of the 37 reference entities we track widening. This is a bit surprising considering that the EU Summit failed to produce any tangible solutions once again.
* Sovereign swaps around the globe moved sharply lower, mirroring the move in bank swaps.
* Steel prices in China have generally been trending lower since August of last year. Prices have fallen 13% over the last six months but are up 1.3% MoM.
* The MCDX, our preferred measure of municipal default risk, tightened WoW
* Our Macro team’s quantitative setup in the XLF shows 1.6% upside to TRADE resistance and 1.5% downside to TRADE support.
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 5 of 12 improved / 1 out of 12 worsened / 7 of 12 unchanged
• Intermediate-term(WoW): Positive / 7 of 12 improved / 1 out of 12 worsened / 5 of 12 unchanged
• Long-term(WoW): Positive / 7 of 12 improved / 2 out of 12 worsened / 4 of 12 unchanged
1. American Financial CDS – A clean sweep. Swaps tightened for all the American financial reference entities we track. Considering the mixed reaction to earnings in the space, it's a notable divergence.
Tightened the most WoW: AXP, MS, BAC
Tightened the least WoW: WFC, COF, GS
Tightened the most MoM: RDN, HIG, MS
Widened the most MoM: MBI, WFC, LNC
2. European Financial CDS – Europe was not as good, only 36 of 37 reference entities improved. Spanish banks showed some of the sharpest improvement.
3. Asian Financial CDS – Asia took its cues from the U.S. and EU. Bank swaps in China and India were tighter WoW. Japanese banks were also generally tighter.
4. Sovereign CDS – Sovereign default swaps around the world moved sharply lower, with an average decline of 22.8%. Notable call outs include German sovereign swaps, which tightened by 30.4% (-15 bps to 34 bps) and Spanish sovereign swaps, which tightened by 81 bps to 273 bps.
5. High Yield (YTM) Monitor – High Yield rates fell 13.7 bps last week, ending the week at 6.52% versus 6.66% the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 0.7 points last week, ending at 1735.53.
7. TED Spread Monitor – The TED spread fell 1.2 bps last week, ending the week at 22.3 bps this week versus last week’s print of 23.5 bps.
8. Journal of Commerce Commodity Price Index – The JOC index fell -1.0 points, ending the week at -0.65 versus +0.4 the prior week.
9. Euribor-OIS spread – The Euribor-OIS spread tightened by 1 bp to 11 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk.
10. ECB Liquidity Recourse to the Deposit Facility – The amounts drawn under this facility have been steadily declining since July 2012. The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB. Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system. An increase in this metric shows that banks are borrowing from the ECB. In other words, the deposit facility measures one element of the ECB response to the crisis.
11. Markit MCDX Index Monitor – Spreads tightened 6 bps, ending the week at 132 bps versus 138 bps in the prior week. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 16-V1.
12. Chinese Steel – Steel prices in China fell 1.6% last week, or 61 yuan/ton, to 3745 yuan/ton. Over the last six months, Chinese construction steel prices have fallen ~13%.This index is reflecting significant weakness in China's construction market.Chinese steel rebar prices have been generally moving lower since August of last year. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.
13. 2-10 Spread – Last week the 2-10 spread widened to 147 bps, 7 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.6% upside to TRADE resistance and 1.5% downside to TRADE support. At the moment, the XLF is both positive TRADE and TREND.
Margin Debt - August: +0.73 standard deviations
NYSE Margin debt rose to $287 billion in August from $278 billion in July. It's interesting to note that this most recent print brings the two series back into convergence. We like to to look at margin debt levels as a broad contrarian sentiment indicator. For reference, our approach is to look at margin debt levels in standard deviation terms over the period 1. Our analysis finds that when margin debt gets to +1.5 standard deviations or greater, as it did in April of 2011, it has historically been a signal of significant risk in the equity market. The preceding two instances were followed by the equity market losing roughly half its value over the following 24-36 months. Overall this setup represents a long-term headwind for the market. One limitation of this series is that it is reported on a lag. The chart shows data through August.
Joshua Steiner, CFA
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This note was originally published at 8am on October 08, 2012 for Hedgeye subscribers.
“America feels broken.”
That about sums it up. That’s the opening line to what I’ve found to be a surprisingly thought provoking book just published by MSNBC’s Chris Hayes, Twilight of The Elites. Hayes is not Chris Matthews. He’s half his age, and he has much better hair.
Hays also has a much more balanced approached in attempting to explain the sometimes un-explainable - the zeitgeist of the US Political Economy: “Over the course of the last decade, a nation accustomed to greatness and progress has had to reconcile itself to an economy that seems to be lurching backwards.” (page 1)
That’s why people got so fired up about the Jack Welch suggestion about the US jobs report on Friday. Conspiracy theories are no longer conspiracy theories when they are proven to be true. The truth is that we have both a failed Keynesian spending jobless recovery and money printing induced inflation. Any government “report” suggesting otherwise only perpetuates The People’s distrust.
The other thing I like about Hayes is that he actually thinks about what I attempt to explain every morning from a completely different perspective. He grew up in the Bronx and was a Philosophy major at Brown. In Chapter 1 of his book he introduces the framework of “Insurrectionists and Institutionalists.” I am one of the former, and appreciate his making up a word for those I criticize as the latter.
“Whatever my own insurrectionist sympathies – and they are considerable – I am also stalked by the fear that the status quo, in which discredited elites and institutions retain their power, can just as easily produce destructive and antisocial impulses as it can spur transformation and reform… when people come to view all formal authority as fraudulent, good governance becomes impossible.”
Again, that’s why what Welch said is still driving the “institutionalist” media batty again this morning – but they are missing the point. Hayes nails it, calling this a “Crisis of Authority”… and the longer it “persists, the more it runs the risk of metastasizing into something that could threaten what we cherish most about American life: our ability to self-correct.” (page 29)
Back to the Global Macro Grind…
It’s not my job to be a Bull, Bear, Republican or a Democrat. My job is to empathize with both sides of the debate, and attempt to probability-weight which way the crowd will lean in and around those polarized perspectives. If you listen to both sides closely enough, you can actually hear that both make some great points.
Last week, the US Dollar was down for the 1st week in 3, so stocks and commodities were up. That’s not a political point. That’s just what’s happening today in markets. They are completely correlated to currency moves. Hugo Chavez has nailed this inasmuch as both Bush and Obama did – he devalued his currency, stocks ripped another +31% higher last week to +245% YTD, and boom – re-election!
Even if you don’t have an education, you probably get the math – if I devalue what’s in your pocket, you can buy less of what you need with what’s left in your pocket. From 1920’s Germany to Charles de Gaulle in France, Policies to Inflate have been around for a lot longer than polarized journalists attempting to spin easy money any other way.
But what do we do when all that asset price inflation deflates?
- We get Bernanke to call it what 21% of people in France suffer from (depression)
- We beg and plea for more bailout policies to re-flate
- We say “it’s different this time”, just so we can feel better about it
All the while, economic gravity has proven to bite both Democrat and Republican politicians in the behind. Politicians have never been able to “smooth” either the Global Growth or US #EarningsSlowing cycles – and this morning, we have to once again deal with both.
At 130PM EST, Daryl Jones and I will host our Q4 2012 Global Macro Themes Conference Call (email Sales@Hedgeye.com for access) where we’ll take a closer look at the following intermediate-term TREND to longer-term TAIL risks:
- Earnings Slowing – what does it mean when corporate margins are coming off all-time peaks?
- Bubble #3 – what do Bernanke Bubbles (Commodities) do now that he’s out of communication bullets?
- Keynesian Cliff – what happens if the USA bonks the Debt Ceiling before The Cliff?
Sadly, some of these themes are political. That’s a direct function of our governing elite fundamentally believing that they are the solution (rather than the cause) to our economic problems.
Both Neil Barofsky (Democrat author of Bailout) and Sheila Bair (Republican ex-Chairperson of the FDIC) have recently called the likes of Timmy Geithner out in their tell-all books about the reality of our situation. The problem with government is government itself.
America isn’t broken; your trust in your government is.
My immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500 are now $1755-1776, $108.44-112.45, $79.24-80.25, $1.29-1.31, 1.59-1.74%, and 1447-1464, respectively.
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
The Macau Metro Monitor, October 22, 2012
MGM COTAI RESORT'S GAMING TABLES PUT INTO QUESTION Macau Daily Times
Francis Tam, the Secretary for Economy and Finance, stressed that the government has yet decided on the allocation of gaming tables for new casinos, which will largely depend on the non-gaming business these gaming operators have. Tam clarified that the number of gaming tables is just a target put forward to the authority by MGM for its Cotai project, but currently the government has yet to make a decision on the allocation of new gaming tables. The Secretary also stressed that no new gaming tables will be allocated to casinos this year.
CONSUMER PRICE INDEX FOR SEPTEMBER 2012 DSEC
Macau CPI for September increased by 5.69% YoY and 0.01% MoM.
INTRODUCTION TO THE LAW ON CASINO ENTRY AGE Macau Daily News
The Legislative Assembly passed the bill rising the entry age to casinos to 21 with effect from November 1, and the new law will apply to both gaming employees and casino visitors.
Takeaway: With a reacceleration in Oct-to-date sales and significantly stronger results in September, we are taking up our numbers for $FL & $FINL.
Concerns over slowing growth in the athletic specialty channel as reflected by weekly footwear figures has been overstated in recent weeks. The latest read on monthly sales by channel confirm that the Athletic Specialty channel significantly outperformed our expectations. Coupled with a reacceleration in October-to-date sales, we’re taking up our numbers for FL and FINL.
It’s important to keep these weekly figures in perspective because they represent sales in aggregate across ALL channels representing Athletic Specialty/Sporting Goods (~60% of sample), Shoe Chains (~20% of sample), and Dept/National Chain Stores (~20% of sample). As seen in the chart below, the continued underperformance in the other channels cause weekly sales to significantly understate performance in the Athletic Specialty channel. Such was the case in September, but to an even greater magnitude than usual due to considerable weakness in the Dept/National Chain Store channel.
- Following a strong August (+9.2%), we were modeling September sales up +2% given weekly sales came in up +0.3% and reflecting the typical adjustment for athletic specialty channel outperformance.
- September actually came in up +7.6% significantly better than we had estimated
- Oct-to-date weekly sales are tracking +3.3% sequentially stronger than Sept by 3pts.
- Based on the reacceleration in October sales reflecting several new basketball launches, we are modeling October sales in the athletic specialty channel to be running up +9%.
- In addition, we’ve seen a modest reacceleration in apparel sales month-to-date as well.
- In looking at FL’s 3Q, it’s important to note sales contribution by month which are front-end loaded to August (~42%) compared to September (~35%) and October (~23%).
- As such, we have good visibility on how domestic sales are shaping up easing concerns of incremental weakness in what has been one of the strongest multi-year trends in retail.
All in, we’re taking our FL comp for quarter up to +9.5% from +7.5% and EPS to $0.59 vs. $0.54E and remain 3% and 7% above consensus estimates for this year and next at $2.52 and $2.90. We are modeling a +8% comp for FINL and EPS of $0.12 vs. $0.11E (we have SG&A a bit higher) and are +6% and +8% Street estimates with EPS of $1.78 and $2.05 in (Feb) FY13 and FY14 respectively.
We remain positive on both stocks. Given relative underperformance of FINL due to investor concern over the potential of incremental costs related to Macy’s (we see as a shift in timing, but not dollars), we favor FINL over FL at these prices. We are also incrementally more positive on NKE, which is one of our top ideas.
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