Melvin's Market

“What if this is as good as is gets?”

-Melvin Udall


That’s what Jack Nicholson asked a bunch of depressed psychiatric patients in one of the great scenes in American comedy (As Good As It Gets, 1997). Melvin Udall should be re-casted as a modern day money manager.


Obsessive-compulsive about this market, anyone?


Back to the Global Macro Grind


I don’t yet require psychiatric help, but with each passing day I am feeling more and more like a shrink. “Keith, do you really think growth is stabilizing?”… “This market can’t go higher with all this debt, can it?”…


Trust me, it goes on and on and on. I don’t get up at this hour every day to not tell you what I think. The last 2 months have been nothing short of fantastic for stocks – and, this time, the global growth fundamentals actually supported it.


Everything has a time and price. So the question remains, with the SP500 up double digits (+10.2%) now from where you could have bought just about anything lower (November 15th, 2012), is this as good as it gets?


Let’s start with Global Growth… “I’ve got a really great compliment for you, and it’s true.” –Melvin

  1. ASIA – high frequency growth data has been stabilizing for 3 months
  2. EUROPE – high frequency growth data stopped slowing in November
  3. USA – employment growth has been stabilizing for 3 months and Housing is ripping

What about inflation?

  1. ASIA – most CPI and PPI readings were relatively benign in October-December, but should pop up in January
  2. EUROPE  - since they are still dealing with stagflation, it’s all relative, but Brent Oil was cheaper in November
  3. USA – follow the CRB Index - down hard from SEP to NOV, heading higher, faster, now in January = #headwind

So, if policy perpetuated Inflation Slows Growth… and Food/Energy prices continue higher from here until whenever that whenever is, you have yourself the 1st major macro headwind to growth in the last 2-3 months.


If you think you are going to get sustainable (real inflation adjusted) economic growth with $115-130 Brent Oil, you might want to check the tapes on how that consumption growth movie ends.


Isn’t it appropriate and ironic, then, as our bailed-out overlords descend upon Davos this week, that the manic media no longer looks to broken sources for “growth forecasts.” They’ve enlisted JP Morgan’s Jaime Dimon this morning instead. He doesn’t have a macro model but is insinuating that the “foundation is set for 4% growth.”


Right, right…


To be clear, there’s a better chance that hockey is banned in Thunder Bay, Ontario than the USA seeing a sustained 4% GDP growth rate when Oil is above $100/barrel.


To Review: there are 3 stages of growth and inflation in our GIP (Growth/Inflation/Policy) Macro Economic Model:

  1. Slowing
  2. Stabilizing
  3. Accelerating

You don’t have to be a brain surgeon to get Muckernomics – it’s all about time and space. Try it on skates (or with a car) and you’ll get it. Cycles are processes, not points. And there are certain levels of inflation that slow growth inasmuch as there are others that help stabilize it (see our Chart of The Day).


Accepting this as truth would eviscerate the academic credentials of most Keynesians hanging out on your tax-payer dollars in Switzerland this week. Central planners of the Global Currency War still think that if you debauch the Dollar, you’ll see a meteoric rise in export demand (even though exports are only 9% of the US economy, and falling).


Back to Melvin’s Market… higher-highs (and in the case of the Russell2000, all-time highs) are flat out bullish, until they aren’t. If your catalyst shorting this market was Earnings Season, so far that’s what we call being wrong. The Financials led off with borderline excellent results, and now we’re seeing Tech (the market’s worst performer YTD at +2.15%) deliver some early morning bacon.


Since Apple (AAPL) is 17% of Tech (as a % of the Tech ETF, XLK), what it does tomorrow on earnings day really matters; especially after Google (GOOG) and IBM ripped last night in the post. Our quantitative signal on AAPL says to do nothing. It’s still in a Bearish Formation (bearish on all 3 of our risk management durations, TRADE/TREND/TAIL), so waiting and watching for the print is a choice.


In the meantime, the SP500 is immediate-term TRADE overbought at 1496 inasmuch as the VIX is oversold at 12.19. So a big AAPL surprise to the upside might just give you what Melvin called his last word, “freak” – to the upside. And if they miss, people might just freak-out on that too.


If you think this market is crazy, join the club. There hasn’t been anything normal about this for years. Not seeing growth stabilizing when it did might be as crazy as buying is on green is crazy today or tomorrow.


Sell crazy someplace else, we're all stocked up here.” –Melvin Udall.


Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, UST10yr Yield, AAPL, and the SP500 are now $1, $110.93-112.95 (Bullish Breakout for Oil), $79.41-80.14, $1.32-1.34, 87.71-90.61, 1.82-1.91%, $482-528, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Melvin's Market - Chart of the Day


Melvin's Market - Virtual Portfolio

Bull/Bear Class

This note was originally published at 8am on January 09, 2013 for Hedgeye subscribers.

“The first question to be answered is this: What constitutes a class?”

-Karl Marx


Most classically liberal economic historians will recall that Karl Marx and his ideology of #ClassWarfare went out on a low note. The aforementioned quote comes from the final chapter of Marx’s “Capital” in 1894 – not surprisingly, it was called “Classes.”


Capital” was published long after Marx and Engels issued their now infamous “The Communist Manifesto” (1848). It wasn’t unlike some of the fear-mongering pablum you hear from American politicians today – a political strategy born out of crisis.


In Britain, they called this mid-19th century economic crisis The Hungry Forties. Charles Dickens’ “A Christmas Carol” was published in 1843 as a progressive answer to the regressive social-fear being perpetuated by Marx, Carlyle, Malthus, etc. I’m the son of a firefighter and a teacher – I wasn’t raised thinking about Marx’s first question. I don’t think it’s healthy to lead from that perspective either.


Back to the Global Macro Grind


I don’t believe in Class Warfare. It’s a cowardly top-down ordering of humanity by our leaderless #PoliticalClass that attempts to pin us against one another for their political gain. The only class war I see in this country is between them, and the rest of us.


I don’t believe in being part of the Perma-Bull or Bear Class either. That’s so Old Wall. It’s such a marketing thing too. I believe in freedom of choice and bottom-up personal liberties. That includes being able to change my mind.


I guess that means I’d be a bad politician.


To review my decision making process – there are two big parts:


1.       The Fundamental Research Process

2.       The Quantitative Risk Management Process

They are not the same thing. Neither do they always agree. When the research and risk management signals are aligned, I either get loud about my rising conviction or I tone it down and reverse course.


In mid-November, both the research and risk management signals changed to bullish on both Global Growth’s Slope (stabilizing instead of slowing) and equity market direction (the SP500 held its long-term TAIL support line of 1364). So, we changed.


That doesn’t mean this morning’s risks have gone away (I listed my Top 3 Risks in yesterday’s Early Look):

  1. #EarningsSlowing
  2. Rising Oil Prices
  3. Japanese Policy

It simply means I don’t wake up at the top of every risk management morning looking for confirming evidence to my current positioning. To review that position from an asset allocation perspective this morning:

  1. We have our highest Global Equity asset allocation in a year
  2. We have a 0% asset allocation to Fixed Income
  3. We have a 0% asset allocation to Commodities

So, when the research and risk management signals are lined up, I don’t beat around the bull or bear bush – I make the call. No, that doesn’t mean this should be the pension fund asset allocation of the government of Qatar – it simply means that for my hard earned wealth, I like equities, straight up, over bonds.


Our bearish call on Commodities isn’t new. We have been making it since March of 2012. It’s probably a little long in the tooth, so we covered our Gold (GLD) and Gold Mining (GDX) shorts on red this week after getting immediate-term TRADE oversold signals. That doesn’t mean I am bullish on Gold; it just means I can re-short it on the bounce at my immediate-term TRADE overbought signal.


This is a tough game. There are multiple durations and multiple risk factors to consider. But it’s proven to be a lot tougher ever since the SP500 topped in 2007, Oil topped in 2008, and Gold topped in 2011. We try not to buy tops.


Has the SP500 topped for 2013?


I don’t think so. In fact, if the front-end of Earnings Season delivers (the Financials report first with Wells Fargo on Friday and  they will have relatively strong growth due to the strength in both Housing and the Yield Spread), Mr Macro Market may have this right.

  1. The Financials (XLF) are already the best performing S&P Sector at +3.5% YTD
  2. The 2-day correction in the SP500 came on a DOWN volume signal (volume is now accelerating on the UP days)
  3. US Equity Volatility (VIX) risk management signals are telling me the VIX wants to make lower-lows

So, we’ll see if I am right or wrong on this. That’s why we keep score. In the meantime, if you ever see me becoming perma anything, send me a friendly reminder that it’s time to retire to the class of mediocre minds who are inflexible.


Our immediate-term Risk Ranges for Gold, Oil (Brent), Corn, US Dollar, EUR/USD, UST 10yr Yield, VIX, and the SP500 are now $1639-1671, $110.23-112.71, $6.80-6.89, $79.99-80.72, $1.29-1.31, 1.84-1.96%, 13.34-15.11, and 1441-1487, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Bull/Bear Class - Chart of the Day


Bull/Bear Class - Virtual Portfolio


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Brinker’s shares represent the best way to play casual dining on the long side, in our view, particularly if the jobs picture in the United States continues to stabilize.  This morning, Brinker reported 2QFY13 of $0.50, in line with consensus, and sales of $690mm slightly missing $693mm consensus.


In a difficult industry environment, Chili’s produced earnings in line with expectations.  While the top-line was weaker-than-expected, Chili’s still leads the industry.  The headline company same-restaurant sales growth figure was 1% but a holiday shift negatively impacted 2QFY13 comps by 60 bps, implying a 1.6% normalized comp versus 1.7% consensus.  3QFY13 should benefit 3QFY13.


Restaurant-level margin improved by 30 bps versus 2QFY12, to 15.7% of sales, but missed the consensus expectation of 16.1% due to lower-than-expected sales.


While not an impressive quarter, the 2QFY13 result demonstrated that Chili’s has invested in its brand to enable it to continue to take share.  Over the short-term, it’s difficult to discern the impact that Darden’s “price war” will have on Brinker.  Judging by management’s commentary today, the company does not see increased discounting as a threat to its progress toward achieving its guidance. 


Guidance for FY13 was reiterated at $2.30-2.45, or +17-25% growth versus FY12.  Same-restaurant sales growth for the year is still expected to be 2-3%.  Long-term guidance is for margin to be expanded by 400 basis points, driven by unit growth of 1-2% and same-restaurant sales of 2-3%, culminating in 10-13% EPS growth.



Near-Term Points Worth Noting

  • Comparisons are difficult for Chili’s over the next two months
  • The rate of industry hiring is decelerating
  • Food inflation is accelerating and pricing is challenging in the current environment
  • Competitive dynamics point to increased margin pressure, especially given the impact of Darden’s stated plan to sacrifice margin to gain traffic

EAT TRACKING EXPECTATIONS - brinker earnings recap



Howard Penney

Managing Director


Rory Green

Senior Analyst


Takeaway: IGT thesis remains intact: better capital deployment, strong EPS growth, and cheap valuation.

In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance




  • SLIGHTLY BETTER: While the topline was clearly ahead of the Street and our estimate we think that the the core results were weaker than the headline.  Product sales were strong but benefitted from the recognition of deferred units.  Core gaming operations continue to disappoint but gross margins and better cash flow were encouraging.  Overall, the EPS beat vs. our numbers was really a combination of the lower SG&A, R&D, D&A and rentention accruals in the quarter. 


  • SLIGHTLY WORSE:  F1Q 2013 gaming ops revs fell 4% but margins showed improvement. Installed base was up 2%.  IGT is still targeting flat gaming ops yield in 2013 as well as better gross margins
  • PREVIOUSLY:  “In 2013, we expect Gaming Operations revenue and installed base to be about flat with 2012, while gross margin and profit per unit are expected to show modest improvements.”



  • BETTER:  Product sales revenues soared 30% YoY and margins rose 4% YoY, both better than expected. Uptick in margins was due to higher non-box sales and discount sales were down significantly. $5MM in royalty settlement fees also helped.
  • PREVIOUSLY: “On the strength of our VLT business in Canada, Ohio, and Illinois, where we expect to enjoy leading ship shares, we anticipate our product sales revenue and gross profit to deliver double-digit increases, while gross margin may be slightly softer due to mix.”


  • SAME:  IGTi revenues and margins were $1MM and 1% lower YoY, respectively.  Online casino customers, including Italy, rose 20%.
    • “Moving forward, we expect some additional costs and, in the short term, lower revenues and gross margin in our IGTi business as this restructuring plan is executed. On the positive side, these actions are anticipated to reduce annual operating expenses in our IGTi business.”
    • “At our IGTi group, we expect to see continued growth in our mobile real-money wagering business consistent with our past trends.”


  • BETTER:  Adjusted operating expenses were 32% of revenues for the first quarter compared to 34% of revenues in the prior year quarter.  IGT sees more room for improvement.
  • PREVIOUSLY: “For the year, adjusted operating expenses were about flat as a percentage of revenue, and we expect this trend to remain consistent into 2013.”


  • WORSE:  Megajackpots drove gaming ops revenues and average revenue per unit per day lower.  Margins, however, did improve more than 200bps YoY as IGT managed their capital investment.
  • PREVIOUSLY: “We expect to stabilize our MegaJackpot revenues."


  • SAME:  F1Q SG&A grew about $10 million or 12% YoY, with almost the entire increase attributable to investments in Interactive. The YoY increase should moderate in 2H and particularly in 4Q as IGT laps the consolidation of Double Down.
    • “The vast majority of the growth in SG&A this year has been related to our Interactive businesses. That's the IGTi business and then, obviously, the acquisition of Double Down. In fact, the base SG&A has grown less than double-digit dollars. So we would expect to continue to invest in the Interactive business, but at a rate that's less than the revenue growth expectations going forward. And then in the base business, we'd expect again low, low single-digit SG&A growth.”
      • Q: So if I think about that just empirically, maybe $30 million in incremental SG&A?
      • A: I think that's about right on the growth next year, recognizing that we have one more quarter of Double Down next year than we had in the prior first quarter


  • BETTER:  Gaming ops capex was about $30MM in F1Q 2013.  IGT expects total capex to be at or below year-ago levels for FY 2013, however this quarter certainly ran materially below last year.
  • PREVIOUSLY: “I would think about capital in the Gaming Operations business as flat to down slightly.”


  • SLIGHTLY WORSE:  Average revenue per unit per day in the first quarter was $46.80, down 7% over the prior year quarter and down 8% sequentially.
  • PREVIOUSLY: “I would expect that there will be continued pressure on yield, so we're taking active steps in the quarter and have been for the last quarter”


Takeaway: Continue to like prospects over the near and intermediate term due to strong EPS growth, better capital allocation, and cheap valuation




"Our robust first quarter results.... provide a great start toward what we expect will be our fourth consecutive year of double digit growth in adjusted earnings per share from continuing operations"


- Patti Hart, CEO of IGT 



  • Gaming operations:  remains challenged for a variety of reasons.  However, focus on profitability is bearing fruit. 
    • Continue to focus on managing this business for cash flow and profitability
    • That said they are encouraged by the performance of some of their recent releases
    • Developed a new rapid progressive that they will launch next month
    • They are launching more direct marketing programs for MegaJackpots
  • Product sales:  confident that they will continue to gain share
    • Takes the Cake and Dolly Parton very popular
  • Interactive:  impacted by the closure of their international poker network
    • Are now able to launch IGT titles to the online casino in a very efficient fashion. Still expect the DD acquistion to be GAAP accretive by 2014
  • Customer sentiment is improving towards IGT's products


  • What was the CA number shipped in the Q? 1,600 units.  Expectation for CA remain consistent with what they have previously disclosed.
  • Domestic replacement market is continuing to bump along as they expected.  They remain cautiously optimistic on overall replacements and their ability to take more share.
  • High-Five's recent success in the social gaming space?  Not concerned about them in the social gaming space, despite their ability to make good games.
  • Gaming operations yield performance?  Still possible to get to flat YoY yields by YE but are monitoring that.  Their approach to gaming operations is a fulcrum approach: Doing a lot to market direct to consumers on their social gaming platform. They will not chase yield through inefficient capital allocations. Will not use capital to drive yield. 
  • Size of the ASP decline in NA: really primarily VLT driven, but they also had lower MLDs as a % of total shipments in the quarter which were particularly high last year. Expect margins to be comparable to prior year in non-box sales.  Less discounting in the quarter on boxes also helped margins.
  • Game operations margins were improved due to lower jackpot expense and lower D&A
    • There is more room for D&A to continue to go lower and help margins.  However, they are also working hard on licensing fees to contribute to margins.
  • Ship share in December?  Pretty confident that it remained in the high 30's.
  • Success metrics of their game operations: time of games in the field, churn in their install base, yields, measure effectiveness of direct to customer marketing.  MegaJackpots have been traditionally a hit driven business. 
  • Is the $30MM of capex for game operations sustainable? They will put more capital to work if they find appropriate opportunities. They still expect to be at or below last year's capex number.
  • Reason that the acquisition related costs were down was because they re-marked their expenses at year end. They don't do as comprehensive of a review each quarter. Retention and amortization is static throughout the year but retention payment will likely go up throughout the course of the year. 
  • Discounts in NA for game sales were down materially in the quarter. The environment remains very competitive as it has been over the last year.
  • They aren't updating guidance because it's just too early in the year and there is no extraordinary reason to raise or lower guidance right now. There is a lot of timing in play in some of the sizable orders. International markets are still struggling. Also, underlying trends in gross gaming revenues for the market as a whole are also fluctuating.
  • Operating expense increase YoY is almost all attributable to the investments they are making in the Interactive business
  • Outlook for international? Continue to invest in that business. The market is difficult to predict. They are still looking for slight growth in the year. 



  • EPS outlook of $1.20 to $1.30 unchanged
  • Gaming operations: 
    • YoY revenues fell due to lower MegaJackpots and was partially offset by higher lease operations
      • Install base: 56,800 (+2% YoY)
      • Yield: $46.80 (-7% YoY)
    • Gross margins improved 200bps "primarily due to an increase mix of lower-yielding higher-margin lease operations games and lower jackpot expenses"
  • Product Sales:
    • Revenues "increased 30% to $235 million in the first quarter, due to increased North America machine sales related to Canadian and Illinois VLT customers, as well as increased non-machine intellectual property licensing fees"
      • 7,200 units recognized and 6,800 shipped (5,100 replacement) 
    • "North America gross margin increased... largely due to increased non-machine revenues, which included $5 million of royalty settlement fees."
    • The YoY drop in ASPs in NA was "mainly due to an unfavorable pricing mix related to increased VLT sales."
  • Interactive: DoubleDown sales were better than expected while IGTi was weaker
    • DoubleDown: Revenues of $41.3MM and gross margin of 60%
      • DAU: 1,462MM; Booking per DAU: $0.31
    • IGTi: $11.6MM of revenues at a 51% gross margin

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.