“Only practitioners (or people who do things) tend to spontaneously get the point.”
On a flight to Denver last night I had round 2 with Taleb’s new book, Antifragility. It wasn’t painful, but I definitely feel like the guy has something brewing inside of him. Transitioning from a market practitioner to a philosopher can’t be easy.
“I am re-connected to my practical self, my soul of a practitioner, as this is a merger of my entire history as practitioner and volatility specialist combined with my intellectual and philosophical interests in randomness and uncertainty…” (page 13)
People can go a little squirelly when they over-think the complex.
Back to the Global Macro Grind…
Buy or sell? Or, as my 2-year old daughter Callie has figured out (when asking me for something when she senses I am pre-occupied), “yes or no?”. If you are playing this Game of Risk in real-time, you don’t have time to philosophize. Save that for the weekends.
On Monday and Tuesday, we bought the US Equity market open (on red). Yesterday, we sold it (on green). It doesn’t always work out that way - but when it does, at least you know that you did it for a reason.
In yesterday’s rant, I outlined the reasons to make some risk adjusted sales (SP500 and US Treasury 10yr Yields immediate-term TRADE overbought) pre-game. And that’s really why I do what I do. I need a repeatable process so that I can have a plan.
Oh, and the plan is that the plans are always changing …
Some people don’t like that. It doesn’t sound sophisticated, I guess. But on that point, I agree with Taleb: “Simplicity has been difficult to implement in modern life because it is against the spirit of a certain brand of people who seek sophistications…”
“Less is more and usually more effective.” –Nassim Taleb
So, let’s slap on the Practitioner Pants and go down that path this morning (just bullet points from my notebook).
- Russell2000 reversed from its all-time high yesterday, closing down -1.2% at 896
- SP500 was down for the 2nd day in 3, finally making a lower high vs the YTD closing high of 1507
- US Equity Volatility (VIX) continues to signal a Risk Range with lower-highs and lower lows (11.94-14.62)
- US Equity market Volume is finally starting to show some flickers of light (+8% versus the TREND avg)
- All 9 S&P Sectors in our model are bullish on both our TRADE and TREND durations (19 of the last 20 days)
- US Dollar Index signaled immediate-term TRADE oversold at $79.24 yesterday
- US Treasury Yields (10yr) signaled immediate-term TRADE overbought at 2.04%; next support 1.93%
- Apple (AAPL) failed at immediate-term resistance yesterday; Risk Range = $420-461
- Eurostoxx50 and Eurostoxx600 both signaled immediate-term TRADE overbought yesterday
- DAX immediate-term TRADE support line of 7771 needs to hold for price momentum to continue
- Spain’s IBEX is snapping its immediate-term TRADE support of 8494 this morning (-1.6%)
- Italy’s MIB Index is breaking its immediate-term TRADE support of 17189 this morning (-1.1%)
- Greece’s squeezage finally stopped for a day (Athex index -1.5%)
- Euro (vs USD) = immediate-term TRADE overbought at $1.35 (support = $1.33)
- China’s stock market (Shanghai Comp) is signaling immediate-term TRADE overbought at 2384
- Japan’s Nikkei (up +28.6% as the Yen gets Taro Aso’d) has immediate-term TRADE resistance at 11159
- South Korea’s KOSPI remains bearish TRADE (1976 resistance) and bullish TREND (1959 support)
- India’s BSE Sensex is down (net) since being the first major country to cut rates in 2013
- Thailand and Vietnam (momentum markets in Asian Equities) corrected -1.1% and -1.6% overnight
- Brazil’s BOVESPA Index snapped immediate-term TRADE support of 60889, -1.8% yesterday
What’s new? We have 4 major countries (Brazil, South Korea, Spain, and Italy) showing initial chinks in the Global Equity market armor. It’s only an immediate-term TRADE signal (all remain bullish intermediate-term TRENDs), so do with it what you decide to do. I did.
Catalysts? It’s month-end today. Tomorrow you probably get another confirmation on why stocks are crushing US Treasuries and Gold for 2013 YTD (employment #GrowthStabilizing). But, at the same time, Oil prices up here are a new headwind to global consumption.
Buy or sell? Yes or no? These are simple questions requiring simple answers. No one has a Ph.d in playing a game that’s always changing. Stick with the practitioners. We can win this game together.
Our newly minted Senior Sector Head of Consumer Staples, Rob Campagnino, will be hosting an expert call on pyramid schemes ("An Expert's Opinion on Multi-Level Marketing, Pyramid Schemes and Herbalife” featuring multi-level marketing expert Dr. Jon M. Taylor) at 1030AM EST today. Ping if you are interested.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, 10yr UST Yield, and the SP500 are now $1, $113.02-115.22, $79.24-79.81, $1.33-1.35, 89.98-91.68, 1.93-2.04%, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
HLF: Where There is Smoke, There May Not be Fire, but There Will Be Firemen
We expect that someone, somewhere (SEC, FDA, FTC, or IRS) has to take a look at the company. Regardless of the merits of the position or motives of Pershing Square, the fire alarm has been pulled – the firemen will come, shiny red trucks and all.
When and if the negative news flow we anticipate does materialize, look out below.
We think the reaction of HLF’s stock to the news that the Federal Trade Commission was launching an investigation into Fortune Hi-Tech Marketing is a useful road map for what are the likely pitfalls of an investor trying to call an end to the Herbalife saga. On the day the market learned that the FTC took action against another company, HLF’s share price declined more than 8%, actually accelerating to the downside once it was clear that Herbalife was not the FTC’s target, as was originally speculated.
We believe that the opportunity to buy HLF for the long-term comes lower, during and after an agency investigation, recognizing that significant fines or some degradation of the company’s business model is the possible result. Pershing Square’s allegations may represent an inflection point in the company’s business model and momentum in the U.S. That doesn’t mean the U.S. business necessarily goes away, but what we could see is more focus on the sale of its products and away from the recruiting side as a driver of the business model, with a lower growth profile. Admittedly, investors’ focus has been gravitating away from the U.S. for some time, but keep in mind that one of the few things that the U.S. manages to export is regulation.
Not for the faint of heart
Bottom line, volatility and potential government intervention are not the friend of the fundamental investor. Fortunately, we have a model that allows us to trade the noise, and we defer to that model in the short term. We believe that the next data point will be a significant negative catalyst, therefore preferring to wait and observe what may be a lengthy process, with a more constructive view in the longer-term as the process unfolds. As that process unfolds and the company continues to buy back stock, we could be looking at a short squeeze that makes NFLX look like a little hug.
Clash of the Titans
It’s more than a little daunting wading into what has become a Wall Street version of Clash of the Titans – the Herbalife debate. We take heart in a quote from the Old Testament that the religious and non-religious among our readers will almost certainly recognize:
“And David put his hand in his bag, and took there a stone, and slung it, and struck the Philistine in his forehead…”
-1 Samuel 17:49
Thusly emboldened, we set forth with our hand in our bag, expecting what will likely be a target rich environment.
Is Herbalife a pyramid scheme?
Let’s get down to brass tacks -honestly, we don’t know whether it is or isn’t. We think there are some unsavory elements to the business, to be sure, but that leaves us well short of declaring the company a pyramid scheme.
We simply don’t have sufficient data to arrive at an answer. Pershing Square spent 18 months analyzing HLF and developing its short thesis and it still has missing data and holes. Let’s be clear here – we don’t think anyone outside the company currently has sufficient data to make a determination. That includes the funds that have lined up against Pershing Square. Aside from a lack of information, there wasn’t sufficient time for those funds to even begin to conduct the necessary research. Rather, we suspect the strategy was shorter-term in nature – relying on the reputation of the fund managers (much the way Pershing Square did when the short thesis was presented) in order to engineer a short squeeze, hurting an individual that it is abundantly clear they didn’t like on a personal level. Make no mistake; this is personal for some of the people involved. One only has to look online for the video of the personalities involved to see some of the absolute best/worst (depending on your taste for sublime slime) financial TV in recent memory.
We refer investors to comments that appeared on http://brontecapital.blogspot.com/2013/01/notes-on-visiting-herbalife-nutrition.html
“Bill Ackman a Harvard educated (magna cum laude) billionaire New York hedge fund manager bet over a billion dollars on a short position (imperiling his fund and his reputation) without checking the facts. And he did not check the facts because he was so rigid with a misplaced silver spoon that he could not stoop to sit on a subway for thirty minutes and talk with poor people for ninety minutes.”
Ninety minutes of conversation isn’t enough to prove that Herbalife isn’t a pyramid scheme. Ninety hours isn’t enough, nor is ninety days – unless those ninety days are spent with the internal financial statements of the company (a theory we suspect the FTC will test at some point). However, ninety minutes is a sufficient amount of time to get caught up in some common misconceptions as to what isn’t a pyramid scheme. For example:
- A multi-level marketing firm can’t be a pyramid scheme because it sells products and services
- Duration matters – a multi-level marketing firm that has existed for a long time can’t be a pyramid scheme because pyramid schemes collapse under the weight of the illegality, usually sooner rather than later
- A multi-level marketing firm that has a viable and efficacious product is not a pyramid scheme because it doesn’t need to be one.
Please don’t buy Herbalife on the basis of any of the above statements as they are all incorrect.
According to the 2004 FTC Staff Advisory, the "critical question" regarding what constitutes a pyramid scheme centers around "the revenues that primarily support the commissions paid to all participants." Specifically, what is the source of that revenue? If the primary source of the revenue is recruitment and upfront fees paid to join the system, then there is a problem. Again, with respect to HLF, we simply don’t have the information to make that call.
Does the FDA take a look at Herbalife?
Aside from the key investment controversy, we think that there is some risk that Herbalife may run into some issues with respect to making false claims regarding the products. The supplement industry has come under increased scrutiny by both the FDA and the FTC and false claims regarding product efficacy is one area beyond the issue of the primary source of revenue that may trip up the company and investors. More specifically, false claims may be made at the distributor level, with the company having little incentive or ability to reign in its distributors. Eventually (and we have no time frame for this outcome), we believe that the entire supplement industry will meet a stronger and more vigilant FDA and FTC. We do believe that the HLF likely isn’t the worst offender in the industry in this regard and that management does endeavor to make sure that only company literature is offered at nutrition clubs. In comparison, we believe the claims made by NUS distributors are more likely to run afoul of the FDA.
With respect to potential issues at the distributor level (and associated issues between the relative power of certain distributors versus the company) we point investors to a recent article.
“The more the money flowed, the stronger the relationship became between the informants and the traffickers. In one candid conversation, the traffickers boasted about who was able to move the biggest loads of money, the way fishermen brag about their catches. One said he could easily move $4 million to $5 million a month. Then the others spoke about the tricks of the trade, including how they had used various methods, including prepaid debit cards and an Herbalife account, to move the money.”
To be clear, we don’t for a moment believe that Herbalife management had, in any way, shape or form, knowledge of this. But with a large number of distributors with a high level of turnover, management’s ability to scrutinize the behavior of each distributor is more like a mall security guard than the Secret Service.
Does the IRS take a look at Herbalife?
Pershing Square spent a fair bit of time asking why there were so many “distributors” and not so many “customers”. Pershing Square was likely in the right church, but the wrong pew. Our understanding is that sales to distributors are not subject to sales tax, whereas sales to customers obviously are subject to sales tax. If we are correct, a concern for investors is that someone clever at the IRS (if anyone there fits the bill) decides to take a look at Herbalife.
What do we do with stock?
Well, we have the table set, so what’s for dinner? We have some data (other than common sense) to support our view that it is much more likely than not that some government agency takes a look at Herbalife. In our research, one of the experts that we contacted already indicated that that due to a recent conversation with the SEC he is not making any comments to investors or analysts about HLF.
We also think that there is a class warfare component here that the political class can’t ignore. It’s hard to set foot out the door these days without being bombarded by class rhetoric in one way or another. In this case, there is a very real issue with the income levels of the “average” Herbalife distributor and if there is a scheme here, it is very much regressive. We don’t think the SEC (for example) can afford to ignore the fire alarm (keeping with our metaphor) again as it did initially with the Madoff issue. Obviously, the SEC ultimately acted in that case, but we seriously doubt that the political class wants to be in a position to defend the notion of going after the guy that stole a lot of money from a relatively few wealthy people and ignoring the company that (possibly) is stealing a little bit of money from a whole lot of poorer people.
Picture this – Washington DC, 2015 - you are a staff attorney at the FTC, its 4:00 in the afternoon and you have just put in a half hour of overtime courtesy of the U.S. taxpayer. As you are walking out the door, your superior informs you that it has come to light (don’t ask how) that Herbalife was, after all, a pyramid scheme. The question now becomes why no one took a look at it way back at the start of 2013 when someone said, hey, this is a pyramid scheme. That is the textbook definition of a CLM (career limiting move). The go to move for government employees is usually CYA, which means that someone may decide to look into the company.
Therefore, we can’t abide being long the day that investigation (see our comments above regarding the stock reaction when Fortune Hi-Tech Marketing was investigated) is announced and since we consider it a high probability that the day comes, it is very difficult for us to have a bullish bias over the short to intermediate term. We are happy to defer to our models for trading levels on the long side in a name that is very susceptible to a short squeeze as weaker shorts get shaken out on random occasion.
As we are fond of saying at Hedgeye, bottoming is a process, not a point. Well, government investigations are a process as well and both sides will be paid by the hour. Herbalife recently announced that it has retained David Boies (of the law firm Boies, Schiller & Flexner LLP). He’s good, and likely bills out hourly at a rate that would pay the FTC enforcement staff for a day.
There is obviously a potential range of outcomes that it is impossible to handicap – from a clean bill of health to a finding that Herbalife is indeed a pyramid scheme.
What we are going to rely on here is some perspective from history:
- Having expensive lawyers is usually better than having government lawyers
- Government agencies are usually loathe to open up Pandora’s box – the investigation of an entire industry
- The appetite in general for the prosecution of pyramid schemes is not very large
- Herbalife may very well not be a pyramid scheme
- There may very well be issues with certain distributors
Bear in mind that volatility and potential government intervention are not the friend of the fundamental investor, and we believe that the next data point will be a significant negative catalyst. Therefore, we prefer to wait and observe what may be a lengthy process, with a more constructive view in the longer-term as the process unfolds.
Good luck with earnings,
HEDGEYE RISK MANAGEMENT, LLC
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This note was originally published at 8am on January 17, 2013 for Hedgeye subscribers.
“I found the PM not easy to talk to.”
That’s what Eleanor Roosevelt said about her dinner discussions with Winston Churchill in the early 1940s. That’s what I’ve heard plenty of analysts say over the years in this business about their PMs too.
From a leadership perspective, what makes a good PM (Portfolio Manager)? What makes a great one? I’d love to hear your thoughts, because my sense is that there is a best practices answer developing. We are all hostage to the narrow scope of our own personal experiences and confirmation biases.
Of all the hedge fund PMs I’ve had the opportunity to work with, I’d say that Jon Dawson (former Dawson Samberg) was the easiest to talk to. When you are a young analyst, that’s helpful – having a good coach helps you learn. As you mature into a senior analyst, then a junior PM, it’s easy to start talking to yourself.
Back to the Global Macro Grind…
This game isn’t easy. That’s why I like to play it out loud. It’s the ultimate test of the mind. You have to be disciplined but flexible; aggressive, but calm; and patient, but nimble.
Staying in it to win it on the long-side of both US (and Global) Equities for the last 6 weeks hasn’t been easy. The first 17 days of January have left the SP500 stuck right at a 5-year closing high of 1472. I have 6 points of immediate-term upside left.
Contextualizing what that means to me doesn’t start with valuation – it starts with price performance:
- From the recent freak-out Fiscal Cliff low (NOV15) of 1353, the SP500 is up 119 pts (+8.8%)
- From the Bernanke Top (SEP14 intraday top of 1474), the SP500 is down 2 handles
- From the all-time SP500 high (OCT2007), the SP500 is still down -5.9%
Since buying tops isn’t cool (if you bought the SEP14 top, you had to slog for 4 months and be up +8.9% to get back to break-even), you want to be really careful when a market starts signaling that is might be done making higher-highs.
Particularly if you are paid to beat a relative performance bogey, that’s precisely why it’s so hard for PMs to sell-high, and then buy everything back lower. How do you know when a market is going to put in an immediate or intermediate-term top?
Now I am hardly suggesting my PM process is perfect on this front, but it’s better than bad. It’s been built out of making mistakes. And if you ask any absolute return PM in this business with a good to great long-term track record, I guarantee you they tell you this: the key to performing is eliminating big mistakes.
So let’s try to not do that.
If the market takes another run at the bears today, it may very well turn out to be as big a beta mistake being really long US Equities for the next 3 weeks as it was being short them for the last three.
I’m not just randomly choosing this morning to say that – my signals are all about price/volume/volatility:
- Last night was the 1st night in the last 10 trading days that my S&P Sector Model wasn’t what I call “perfectly bullish”
- Yesterday’s close also featured a fresh new negative-divergence with the Russell2000 not making a higher-high
- Since the prior closing high for the Russell (884) was an all-time high, that might matter – all-time is a long time
- Healthcare (XLV) signaled its 1st lower-high in my model of the year (it’s the #2 Sector at +4.5% YTD)
- Financials (XLF) signaled its 2nd consecutive lower-high in my model for the yr (it’s the #1 Sector at +4.6% YTD)
- US Equity Volume registered a bearish signal (SP500 tested making new highs on a down -19% volume signal)
- US Equity Volatility (VIX) signaled immediate-term TRADE oversold at 13.16
- US Equity Market Breadth was negative (44% advancers vs 52% decliners) with the SP500 at the highs
Apple had a 1-day move that explained some of this market skew (Nasdaq up vs Russell down). And that’s where having a quantitative view on a big index name like AAPL helps contextualize the rest of what I am being told to look at.
Since the core principle of how I think about risk management is to Embrace Uncertainty, I don’t know (and don’t really care to attempt to predict), what my signals are going to tell me. I have learned to shut-up, and just listen to them.
It’s not easy to listen. But, as my man Hemingway said, “I like to listen. I have learned a great deal from listening carefully. Most people never listen.”
Our immediate-term Risk Ranges for Gold, Oil (Brent), Corn, US Dollar, USD/YEN, UST10yr Yield, and the SP500 are now $1664-1684, $109.08-110.85, $7.12-7.41, $79.33-79.98 (USD is overbought), 88.06-89.85 (we re-shorted Yen via FXY yesterday), 1.81-1.89%, and 1466-1478, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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
- BETTER - Very strong quarter in Asia with hold adjusted EBITDA in excess of consensus. While volumes are usually inflated when hold is low (players play longer when they are winning), they were quite exceptional in Singapore and Macau. We calculate hold adjusted EBITDA do be a little lower than management's calculation, but still strong enough to beat our hold adjusted estimate for Q1.
- SAME: Sheraton is doing very well. They are fully booked for the upcoming Chinese New Year.
- PREVIOUSLY: “Holiday Inn is running at extremely high rates. The Conrad has more demand than it has supplies and the Sheraton just opened recently last month and we're doing splendidly at the Sheraton."
MACAU MALL VALUE
- SAME: Still believes the retail malls are worth $9-10 billion. They are not in any hurry to sell them.
- PREVIOUSLY: "We've got about $9 billion to $10 billion today. And I'm not going to sell Macao until we finish the bridge which is next month, in December, and we let in the cross traffic....If it does impact it well, I think we could probably reach another billion or maybe more....In terms of monetizing it, we should wait until we get the approval for the Tropical Mall and we put the new retail in Lot 3. So we're still in the midst of that in any event, this is a good turn. There's a good cap rate."
- BETTER: Still sees very significant growth ahead for retail stores in Macau.
- PREVIOUSLY: "We also have 26 more stores opening in the Four Seasons, 43 more stores opening and five in Cotai Central, and the potential of an 800,000 square foot, 300 store mall next to the Sheraton on the Tropical Garden space. So there's a lot more retail to mature for us to essentially maximize that retail facility."
SANDS COTAI CENTRAL
- SAME: SCC EBITDA came in-line with the Street. Margins of 22% were 4% points better sequentially.
- PREVIOUSLY: "Sands Cotai numbers are good, but they can be better. Again, the margins are hurting a bit due to a lack of premium mass."
MARKETING PROGRAMS IN PREMIUM MASS
- SLIGHTLY WORSE: mass drop fell 3.2%. LVS sees growth potential to add more customers in this segment in 2013.
- "We're implementing new marketing programs to both the premium mass market and VIP markets, beefing up our sales force and investing in aircraft. The customers we are targeting with these efforts will come from the areas surrounding Singapore: Indonesia, Malaysia, Thailand, and the wider Southeast Asian region as well as from Hong Kong, Taiwan, China, Japan, and Korea, and Vietnam."
- "We're putting a team on the ground, incentives on the ground to try to drive more of that premium mass customer into Singapore, more tourist-driven and we think it's going to be very successful. We have started that a few months ago. We're looking to put a lot of boots on the ground and our belief is that's the growth in Singapore in the near future."
VIP RC TRENDS
- MUCH BETTER: VIP RC was up 53% to $16.5 billion. They did not see much change in VIP concentration relative to last quarter.
- PREVIOUSLY: "I think it's stayed pretty flat....Singapore looks like a $45 to $50 billion annualized gold market at this time... We don't fear the credit side. We just would like to see more demand in the right kinds of customers. So our bigger challenge, very candidly, is going to be to make sure that premium mass growth returns again. That's the margin 65% plus we'd like to get back to and that's the segment we're really focusing on as far as we think there's short-term appreciation hope."
- MIXED: Slot handle fell 2% YoY, however, LVS sees a recovery in slot volumes going forward. Mall revenues gained 12% YoY. Convention, Retail and Other revenues fell 0.7% YoY.
- PREVIOUSLY: "Slot revenue has decreased by 8% this quarter... because of a decrease in local play. This concerns us and we are putting strategies in place in terms of how we can replace that business with additional business that we're after. The hotel room and MICE businesses have performed exceptionally and are operating at near capacity. There is rarely an empty room in the Marina Bay Sands these days. Retail has also grown meaningfully and we are in the process of developing additional dining and entertainment offerings in our mall."
DEVELOPMENT OUTLOOK & UPDATES
- SAME: LVS is still very interested in this opportunity and are waiting patiently.
- PREVIOUSLY: "In Japan, we are awaiting legislation, which is supposed to be submitted in April to the Diet. After that, there will be an approval process for a year or maybe two as it goes through the Japanese procedures. We're looking at sites in both Osaka and Tokyo and we continue that investigation and have people hired on the ground working on our behalf."
- BETTER: LVS paid a special dividend of $2.75 per share and a recurring dividend of $0.25 in 4Q. Las Vegas Sands has increased the recurring quarterly dividend of the company by 40% to $0.35 per common share, or $1.40 per common share per year, beginning in 1Q 2013
- PREVIOUSLY: "We have every intention of increasing the dividend in the years ahead as our business and cash flows continue to grow."
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