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Shifting Expectations

Client Talking Points

Shifting Expectations

By now it’s pretty obvious that one of our big Q4 Macro themes, #EarningsSlowing, has taken effect and is widespread throughout the market. What’s interesting is that while we’ve been shouting about this since late February, the Old Wall is finally changing their stance on earnings. Consensus numbers and price targets are shifting at the banks and brokers; only took them nearly a year to get it right.

The Bernanke Top

Some people will tell you that stocks are “cheap” here. We say “they can get cheaper” because they can. Take technology for instance. Since the Bernanke Top (September 2012), the XLK ETF is down -10%, AAPL is down -14% and AMZN is down -15%. And on top of it, they’re missing on earnings. So while you might want to rush in and be a buyer, we warn that technology can get a lot cheaper. 

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Remains our top long in casual dining as new sales layers (pizza) and strong-performing remodels (~5% comps) should maintain sales momentum. The company is continuing to enhance returns for shareholders through share buybacks . The stock trades at a discount to DIN (7.7x vs 9.3x EV/EBITDA) and in line with the group at 7.3x.


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.


While political and reimbursement risk will remain near-term concerns, on the fundamental side we continue to expect accelerating outpatient growth alongside further strength in pricing as acuity improves thru 1Q13. Flu trends may provide an incremental benefit on the quarter and our expectation for a birth recovery should support patient surgery growth over the intermediate term. Supply costs should remain a source of topline & earnings upside going forward.

Three for the Road


“The problem with political jokes is they get elected.” -@Giggles270346


“History is the version of past events that people have decided to agree upon.” -Napoleon Bonaparte


Apple profit rises 24% on iPhone sales. 


Takeaway: BYI delivers a beat in the face of high expectations and a challenging competitive and macro environment.



Bally’s performance this quarter earned some stripes in justifying its premium group multiple.  Despite the higher bar set for the Company and challenging macro and competitive environment, they still managed to beat expectations.  Gross margins for all segments in of their business were better than we projected, and we were a cent ahead of the Street in terms of EPS.  Also encouraging was the continued buyback activity in the quarter and the re-upping of the buyback authorization.  Raising guidance was the clincher.


The biggest upside surprise in the quarter for us came from gaming operations.  We expected good growth in the Q due to strong WAP placements but actual results beat our number by 3%.  Margins were a little weaker than expected, but that did not impact EPS, as BYI benefited from the WAP link in NJ.  The results were particularly impressive given the reclassification of some low yielding centrally determined games into systems.  Assuming that Michael Jackson and Grease continue to perform well, gaming operations is poised to easily exceed $400MM in FY13.


Gaming equipment sales also beat our estimate by 5%, but the beat was due to earlier than expected shipments of VLTs to the Atlantic Lottery Corporate and the sale of 175 VGTs into IL which we didn’t expect to hit until next quarter.  We estimate that the VLT and VGT units boosted revenues by $11MM and EPS by $0.07-$0.08 this quarter.  However, SG&A was also likely boosted due to the sales commission component of that number.  Therefore the net affect was likely a lot lower. The one glaring negative in the quarter were international sales which are likely to continue to disappoint in the near future.


Systems revenue, while in-line with our estimate, generated better than expected margins.  Given the pending pickup in new system installs, which carry lower margins, we’re not going to get too excited about the high margin in the quarter.  However, as iVIEW DM continues to make traction and as more applications like NASCAR progress, margins should lift over time.  Top-line would have actually missed our number if not for the reclassification of certain centrally determined games.  To be honest, we’ve been asking BYI’s for years why those units weren’t in systems to begin with since that’s there they belong.


Given the results posted this quarter, the continued momentum of BYI’s WAP games, anticipation of NASCAR, continued improvement in replacement cycle, and the final opening of the VGT market in IL, coupled with visibility on their systems business, we believe that the stock can continue to work in the near-term. 


This note was originally published at 8am on October 12, 2012 for Hedgeye subscribers.

“Against the assault of laughter, nothing can stand.”

-Mark Twain


If there was one key takeaway from the Vice Presidential debate last night it was simply this: Biden laughed.  I took an unscientific poll on Twitter and people seem to be split on the actual winner.  Republicans lean towards Ryan and Democrats lean towards Biden.  I think my colleague Keith McCullough probably summed it up best this morning when he wrote to me:


“USA lost credibility as Ryan didn’t deliver in taking Biden’s old politics to task.  Ryan looked like a rookie and Biden looked like a snake.”


But you know Keith, he’s not really known to have an opinion on things …


From a quantitative perspective, the Intrade Presidential contract is basically trading at the same level as it was going into the debate.  According to Intrade, Obama has a 63% chance of retaining the Presidency and Romney is at 37%.  So there you have it, despite Biden’s best attempt at a Mark Twain laughter assault, the Px90 juiced whippersnapper Ryan held his own.


The next two debates will be held between Romney and Obama.  The first one is a town hall format and will be on Tuesday, October 16th and the final debate will be held on October 22nd, with a focus on foreign policy.  Given Obama’s weak performance in the first debate, these will be more closely watched than historical debates. The likelihood is that Obama will perform much better and they too will become non-events.


Even if the debate fireworks are behind us, the election itself is only heating up.  According to the national polls, this race is basically tied.  Based on the average of the last four key national polls, Romney is ahead on average by +0.7 points.  Interestingly, Rasmussen, who has been the most accurate pollster in the last two election cycles, actually now has Obama back ahead.  Undoubtedly the tightness of this race is no laughing matter for those with a party affiliation.


We will be joined with Neil Barofsky on November 7th, the morning after the election, to discuss the potential policy impact.  Neil was the former Special United States Treasury Department Inspector General that was appointed to oversee the Troubled Asset Relief Program, or TARP.  From an investment perspective, the election is critical because it lays the foundation for future fiscal and monetary policy.  In this respect, we think Neil will be the ideal person to discuss post election policy as he knows many of the key players.  If you are not currently an institutional subscriber and would like to become one to get access to the call, email sales@hegdgeye.com.


In the chart of the day, we’ve highlighted U.S. Federal government spending as a percentage of GDP going back to 1947.  The takeaway, which many of you know, is that federal spending has been going up and to the right for almost seven decades.  As we’ve been told by some key Republican insiders, this will be Romney’s primary focus if he is elected. That is, he will look to dramatically shrink the size of the government.


From an economic and investment perspective this could, perversely, be a real negative for economic growth in the short run.  Ultimately though, putting capital back in the hands of capitalists and getting the U.S. fiscal house in order should be positive for the U.S. dollar and economic growth in the long run.  Canada in the mid-90s is a prime example of a modern economy that took its pain, but then rebounded in a meaningful way.


Another positive related to the election is that when it is over, at least it will relieve the uncertainty among decision makers.  This uncertainty is manifested in many ways with a key way being an unwillingness of executives to invest in their businesses. 


My colleague Hesham Shaaban forwarded me an article this morning that encapsulated this point well.  According to this article from Bloomberg, the number of companies saying “profits will trail estimates compares to those who are saying they will exceed them climbed to 4.3:1”.  In a nutshell, when 4 out of every 5 companies in America think the future will be worse than the past, you can not expect hiring to accelerate.


#Earningsslowing is one of our three themes this quarter and clearly is already starting to play out.  At a point, of course, this all gets priced in, but we would just recommend treading carefully in that regard until the end of earnings season as there is stock specific risk associated with the fact that earnings in corporate America are peak-ish.


Speaking of stock specific risk, our retail team will be hosting a conference call on Carter’s, Inc (CRI) this coming Monday.  This won’t be your typical old Wall Street initiation call.  In fact, this is going to be one of those new Wall Street 2.0 calls where we are actually going to tell you that Carter’s is a stock that you should short, or at the very least lighten up on.  Imagine that, a Wall Street research firm making a short call.  I mean, who does that?


Speaking of short ideas, a key one is the little retailer called J.C. Penney (JCP).  Needless to say, even though JCP seem to be getting back into the coupon business by sending $10 coupons to customers as gifts, we still think this is a name to avoid.  On the contrary, our financials team indicated yesterday they thought J.P. Morgan (JPM) would beat numbers this morning and, lo and behold, JPM beat by $0.18.  It seems the fat cat bankers on Wall Street are laughing, as well!


Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1761-1792, $112.66-115.71, $79.26-80.07, $1.28-1.30, 1.64-1.71%, and 1426-1446, respectively.


Enjoy your weekend.


Keep your head up and stick on the ice,


Daryl G. Jones


Laughter - Chart of the Day


Laughter - Virtual Portfolio


The Macau Metro Monitor, October 26, 2012




Starting sometime next year, operating hours at the border checkpoint between Cotai’s Lotus Bridge and Hengqin Island will be extended for both passenger and goods vehicles.  Passenger vehicles can currently cross at the Hengqin checkpoint between 9am and 8pm.  Cargo trucks have access from 8am to 8pm.  Simplified customs procedures are also being planned.



Macau's unemployment rate remained stable at 2%, compared with the June-August period.  Total labour force increased by 5,500 QoQ to 351,000, with an increase of 5,700 in total employment and a decrease of 200 in the unemployed.  Analysed by industry, 26.4% of the employed were working in Recreational, Cultural, Gaming & Other Services, and 15.8% in Hotels, Restaurants & Similar Activities.


Major Changes

“An economic model conditioned on the notion that nothing major will change is a useless one.”

-Nate Silver


I’ll reiterate Hedgeye Risk Management’s top Global Macro Theme for Q4 of 2012 this morning: #EarningsSlowing. We are finally seeing Major Changes to buy-side expectations for revenue and earnings. The sell-side’s estimates remain in lah-lah land.


As Nate Silver writes on page 193 of The Signal And The Noise, “anticipating these turning points is not easy.” But I fundamentally believe that if you study history, do math, and believe in the probability of mean reversion occurring, it’s certainly less hard.


“So we should have some sympathy for economic forecasters. It’s hard enough to know where the economy is going. But it’s much, much harder if you don’t know where it is to begin with.” (Silver, page 194). Since March, Global #GrowthSlowing has caught most consensus economists off-sides in 2012. Now #EarningsSlowing (which happens on a lag versus revenues) has analysts off-sides too.


Back to the Global Macro Grind


Flying back from California yesterday, I was watching Amazon (AMZN) and Apple (AAPL) earnings roll across my tweet-tape, and I couldn’t help but think, ‘gee, wouldn’t it have been nice if all the bulls warned us that both companies would miss and guide down?’


The risk that needed to be managed in AMZN and AAPL isn’t what you’ll see when the stocks open today - we’re already 5 weeks into what’s turning into a very serious draw-down in Tech (XLK) overall.


From the Bernanke Top (September 2012):

  1. Technology (XLK) = down -10%
  2. Apple (AAPL) = down -14%
  3. Amazon (AMZN) = down -15%

Remember, AAPL represents 20.6% of the Tech Sector (XLK) ETF. So Tech is outperforming AAPL at this point (and the SP500 is outperforming Tech). That means that anyone who was outperforming being long AAPL until September is probably now underperforming. Typically when this kind of rotation starts to happen in your portfolio, beta starts to eat your alpha.


Overall, beta (the SP500) is outperforming both Tech, AMZN, and AAPL. Since the Bernanke Top, the SP500 is in what we call a correction (down -4.2%). A draw-down is different than a correction. When you have double digit losses in a position, the next question isn’t “what is the stock down on the open?; it’s will this position start to crash?”


We define “crash” as a peak-to-trough price decline of 20% or more. Russia is teetering on moving back into crash mode this morning (RTSI down -1.8% on the session; down -18.3% from the March global #GrowthSlowing top). We’ll give the ole Bernank some credit for that one too – Russian stocks have everything to do with Petro-Dollars – and now we have Strong Dollar, Down Oil.


Away from the market’s leaders missing, that’s the other Big Beta thing going on out there this morning – remember, get the Dollar right, and you get a lot of other things right. Looking at Global Equity risk, the current 60-day Correlation Risk between the USD Index and the broad indices are as follows:

  1. SP500 = -0.87
  2. EuroStoxx600 = -0.95
  3. MSCI World Index = -0.91

So, you can look at risk from a bottom’s up stock perspective and/or from a top down (SECTOR, COUNTRY, or ASSET CLASS) beta risk factoring perspective, and you’ll learn a lot more about what’s really going on out there.


Keynesian economists have been saying that the Fed’s Policy To Inflate has not been causal to Correlation Risk. I say that’s a crock. If Romney wins the election (on that risk factor, probabilities in your conditional Bayesian model should be rising, not falling), there is a very good chance that the most asymmetric risk in all of Global Macro (Strong Dollar) busts a big move to the upside.


If that happens, the aforementioned correlations are probably going to keep moving towards 1.0, and we’ll probably be really right, in the immediate-term on Hedgeye’s 2nd Global Macro Theme for Q4 of 2012: Bubble#3 (Commodities).


I re-shorted the Gold Miners ETF (GDX) with that causal relationship in mind yesterday. I also re-shorted the Industrials Sector ETF (XLI) on green yesterday too.


Jay Van Sciver’s bearish thesis was very cogent in yesterday’s Early Look. If you believe there’s a bubble in Mining Capex, you’re probably in agreement with us that the revenue and #EarningsSlowing risk to pro-cyclical Industrials like Caterpillar (CAT) and Komatsu (KMTUY) remains to the downside as well.


Major Changes aren’t always underway in markets, but when you can get in front of the big ones you can save yourself, family, and clients from losing a lot of money.


Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, AMZN, AAPL, XLK, and the SP500 are now $1, $105.98-110.66, $79.64-80.25, $1.28-1.30, $217-228, $591-613, $28.44-29.14, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


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