“The world is not the way they tell you it is.”
That’s easily one of the top opening sentences to any book in my library (The Money Game, by George Goodman). And oh how true does it ring about the game so far in 2013.
You see, so far 2013 is all about you. “You – your identity, anxiety, and money” – that’s what Goodman (under the pseudonym of “Adam Smith”) titled Part I of Chapter 1 in 1968. So what I am about to write this morning is not new. It’s just put another way.
“The successful investors I know do not hold to the way it ought to be, they simply go with what is.” (page 19)
Back to the Global Macro Grind…
Now maybe people write these sorts of things at all-time highs in markets (the Russell2000 made another all-time closing high yesterday at 906 = +6.7% YTD). Maybe they write them at the lows too. I’d just as soon as think about them all of the time.
One way to contextualize behavior is by using math across multiple-factors and durations. Internally (and at hedge funds I have built and traded portfolios for), we call them STYLE FACTORS.
If you punch in style factors on either Amazon or Wikipedia, you’ll get a promo for the “Otterbox Commuter Series Hybrid Case” (iPhone4) or something about the “Seven Factors of Enlightenment” (Buddhism). So, while I think most quantitatively oriented risk management platforms consider these factors standard, they are far from Jeremy Siegel’s view of portfolio theory.
Style Factors are what are moving your portfolio now – here are some big ones that are outperforming YTD:
- High Short Interest = +6.8% (outperforming low-short interest stocks by almost 1%)
- High Beta = +8.1% (outperforming low-beta by over 4%)
- High Debt/EV = +7.0% (outperforming low-debt/EV by 60bps)
I can also slice and dice your portfolio across geographic, sector, and size (market cap) factors. And I do for our clients who ask us for this custom advisory and risk management work, but for your general reading purposes this morning I guess the bottom line is to take my word for it – it works.
Why does it work? Particularly when you overlay it with a multi-duration (TRADE/TREND/TAIL) price/volume/volatility model, it basically tells you what the machines are chasing. If you can front-run the machines, you are one step ahead of your competition. And that may not sound like what we all learned at school, but it’s the way that today’s game is.
If you own something like Netflix (NFLX):
- You are long High Short Interest
- You are long High Beta
- You are smiling
Combined with a little storytelling from the management team and a catalyst on top (the recent quarter and conference call), that makes for a tasty YTD return. It also drives the fundamentalist who thinks the stock is “expensive” right nuts.
“If thinking of this fascinating, complex, n-person process as a Game helps, then perhaps that is the way we should think. It helps rid us of the compulsions of theology.” (George Goodman)
In other words, don’t play the game you want – play the game that’s in front of you. Modern day math, machines, and real-time signals help augment your go-to-moves. They also help you realize when it’s a good time to just get out of the way.
Yesterday was the 1st down day in the SP500 in the last 8 trading days. Within minutes of the market going down, my contra-stream (I built it on Twitter for my own behavioral observation) lit up like we were about to see the apocalypse. *Note: we didn’t.
I’m as leery about buying high as anyone, but through making many mistakes I’ve taught myself to use the risk of the range (within the context of all aforementioned factors) as my guide instead of my gut.
For the SP500 itself, here are some important Risk Ranges to contextualize and consider:
- SP500 = Bullish Formation (bullish TRADE, TREND, TAIL) with immediate-term TRADE support at 1488
- S&P Sector Studies = all 9 are bullish TRADE and TREND for the 17th day out of the last 18!
- US Equity Volatility (VIX) = Bearish Formation with a Risk Range of 12.04-14.36
In other words, go with what is, until it isn’t. The high-probability hand you keep playing is that US stocks make higher-highs as equity volatility makes lower-lows. If and when that changes (it will, and maybe abruptly), Mr. Market will let you know.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr yield, VIX, and the SP500 are now $1, $112.28-114.62, $79.61-80.14, 89.69-91.14, 1.89-2.01%, 12.04-14.36, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on January 15, 2013 for Hedgeye subscribers.
“We are what we repeatedly do. Excellence, then, is not an act, but a habit.”
American, European, and Japanese governments have a habit – it’s called tax-payer funded spending. In order to finance this habit, they A) tax you and B) issue debt. Try part B) at home - levering yourself up to pay your political bills typically doesn’t end well.
I know. I know. ‘This time is different’, ‘print the damn coin’, ‘America voted for this’ – blah, blah, blah. This is what Big Government Interventionists of the 21st century repeatedly do. Obama, sadly, is no different than Bush on this score. They both needed to perpetuate a class struggle in order to sell it to their respective Keynesian economic constituencies.
My quibble isn’t political; politics are now about economics. The French have been arguing about this since at least the early 19th century. As one of the 1st economic historians, Adolphe Blanqui, wrote in 1837: “In all the revolutions, there have been but two parties confronting each other; that of the people who wish to live by their own labor, and that of those who would live by the labor of others.”
Back To The Global Macro Grind…
No matter what your politics, you do have to make real-time decisions out there. What else are you supposed to do when politicians are changing the rules of the game on the fly? For the last decade, one of the main risks to growth has been government.
The outgoing Timmy Geithner says the timing of the #DebtCeiling D-Day is “mid-February.” At the latest, my research team has it in early March (coincidentally, March 1st is also when sequester kicks in). Now that it’s mid-January, that means this game of risk is on.
A game? Sadly, yes - a high-stakes game of political chess (they are playing with your money) that will likely require you to do up your chinstrap. Buying stocks in mid-January is hardly as easy as it was buying them in mid-November. Everything in markets has a time and price.
How is risk priced today versus 2-months ago (November 15th)?
- November 15th, the SP500 closed at 1353 = 8% LOWER
- November 15th, the Russell2000 closed at 769 = 13% LOWER
- November 15th, the US Equity Volatility (VIX) closed at 17.99 = 33% HIGHER
Back then (seems like forever ago you could have been long, no?):
- Global Growth was going from slowing to stabilizing
- Fiscal Cliff Fear was all over consensus media
- The NHL was still on strike
Those were some pretty tough times! And today what?
- Global Growth has stabilized
- Oil is starting to break-out again
- Japan and the US are competing with who can “stimulate” the most with debt
And on and on and on the cycle of Big Government Interventionist policy goes….
But this should surprise no one at this point. This is what Keynesian Policy makers repeatedly do:
A) They Shorten Economic Cycles
B) They Amplify Market Volatility
Can you imagine what The Rest of Us will do if the #PoliticalClass just top ticked another market move at an all-time high in the Russell2000? What will The People do if their money manager jammed them into equities at the top of the “fund flows” news cycle?
On a cheerier note, Global Growth hasn’t slowed (yet) and by the looks of Lennar’s (LEN) backlog numbers this morning, our bullish call on US Housing remains intact. Risk never stops moving – it moves both ways.
We’ll corner all angles of this real-time risk debate on our Q1 2013 Global Macro Themes call today at 1PM (email Sales@Hedgeye.com if you’d like to join). Our Q113 Themes are:
The first two themes won’t sound new to any of you who read what we write every day. Our process is dynamic – as market prices, economic data, and risk management signals change, we try to. It’s never easy – but neither is excellence.
Our immediate-term Risk Ranges for Gold, Oil (Brent), Corn, US Dollar, EUR/USD, USD/YEN, UST 10yr Yield, and the SP500 are now $1644-1689 (covered our GLD short yesterday during the Obama speech), $110.32-112.82 (bullish breakout in Oil), $7.08-7.26 (shorted CORN yesterday), $79.29-79.98, $1.31-1.34, $87.43-89.41 (Yen oversold yesterday), 1.84-1.94%, and 1454-1475, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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Finally a catalyst?
BYI has underperformed IGT lately and really has traded in a fairly tight range for the better part of a year. We’d say this stock is in need of a catalyst and Thursday night’s earnings could be that catalyst. We project BYI to beat F2Q consensus by roughly 5% - revenue of $249MM and Adjusted EPS of $0.79. We expect BYI to exceed consensus in both gaming ops and gaming equipment sales.
We’re projecting $89MM of gaming equipment revenue ($11MM ahead of consensus) at a 47.7% gross margin ($6MM ahead of consensus).
- The Street is projecting a $5MM QoQ decrease, while we are projecting a $6MM QoQ increase. We believe the Street is wrong because:
- In the last 7 years, there has only been 1 year where December revenues have not been materially higher than September’s. Since BYI’s fiscal year end is in June, F1Q tends to be the weakest quarter of the year for them for gaming equipment sales. The average uptick from F1Q to F2Q over the last 7 years has been $11MM.
- Replacements are usually weaker in September than December, since the September quarter is a seasonally strong quarter and casinos typically avoid disrupting their floor during that time.
- 5,050 units recognized in FQ2
- 900 international unit sales
- 4,150 NA unit sales
- A QoQ increase in replacements excluding Canada
- ~600 units shipped to Atlantic lottery corporation
- ASP of $16.5k, down QoQ and YoY, reflecting mix shift towards Canada and IL VLTs
- $5MM of parts and other revenue
We’re projecting $57MM of systems revenue ($2MM below the Street) at a 72.5% margin ($3MM below the Street).
- BYI guided to a QoQ increase due to commencement of installations to Canada and/or South Africa
We expect gaming operations revenue of $103MM ($5MM above the Street) at a 70.7% margin ($2MM above the Street).
- Should see growth in the WAP foot print and benefits of a full quarter of revenues from Michael Jackson and Grease units installed in September
- Gaming operations revenues have increased for the last 7 quarters. While it’s true that September is a seasonally stronger period for gaming operations revenues, we would point out that:
- BYI’s footprint has less seasonality than WMS or IGT since a lower % of its install base is on true revenue share vs a fixed fee
- Since FY2005, the average decline from the September to the December Q has been $1MM - the Street is projecting a $3MM sequential decline
- Growth in BYI’s install base is a large mitigating factor to seasonality. In the September Q, the WAP install base grew 26% QoQ and there was low single digit growth in all other categories outside of centrally determined games. Even if there were no incremental placements in the December quarter, and assuming that all those WAP units weren’t placed in the beginning of July, there should be a nice increase in the number of average installed units in the December Q compared to the September Q, which should lead to QoQ growth.
- The reclassification of the centrally determined units from gaming operations to systems already occurred last quarter had a $1.5MM impact on gaming operations (no impact to total revenues or bottom line)
- SG&A: $68MM
- R&D: $25MM
- D&A: $6MM
- Net interest expense: $4MM
- Tax rate: 38%
Takeaway: Bulls will gloss over the mgmt chg, but Cole was the 2nd highest paid person at M, and was there for 40 years. He matters.
Macy’s announced after the close that Thomas Cole, Chief Administrative Officer, will be leaving the company in May 2013. Our sense is that Mr. Cole is leaving on his own accord and under good terms after 40 years at the company. That said, make no bones about it… Cole is important to the organization. Formerly a Vice Chair, he is responsible for orchestrating everything from internal audit, human resources, external affairs, systems, technology, logistics, credit, non-merchandise purchasing, sustainability, and store planning, design and construction. There’s a couple of other functions as well – all of which have been spread out to three existing and one new individual in the Macy’s organization.
The bulls – if they acknowledge this announcement at all -- will tout that this is a company with a deep bench, and that they are not concerned to see such an important executive leave the company. The reality is that if there is any positive it is that there will be $2-3mm in EBIT freed up with the departure of his compensation (only half a penny per share). Keep in mind that Cole was the second highest paid person in the company – making 20% more than CFO Karen Hoguet, the primary interface of the company to the Street.
Our sense is that whenever we see someone leave who has so many responsibilities and has greater tenure than anyone else on the org chart – it simply cannot be glossed over.
CEO Lundgren said as much in his quote
“Tom’s influence has been particularly profound over the past seven years as we integrated the acquisition of The May Department Stores Company, migrated to the nationwide Macy’s brand, developed new business and organization structures, aggressively pursued our omnichannel vision and improved our customer shopping experience. Tom played a key role in these subjects and many, many more.”
Macy’s remains one of our top short ideas.
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