“The tiger will see you a hundred times before you see him once.”
I’ve never been hunted down by a Siberian Tiger, but I’ll take John Vaillant’s word for it on how that might feel. On page 51 of The Tiger, he partly explains how I felt in very short order yesterday. Risk happens fast. Feelings aren’t what you want to be managing in your portfolio.
How could you not feel this? At 10AM EST yesterday, the SP500 was at 1524, and the Volatility Index (VIX) was at 13.63. I thought we were going to test the YTD high (1530 SPX) and volatility would continue to collapse. I thought wrong.
Actually, if you told me the reason why we were going to have a violent reversal (as in a +39% six-hour energy move in the VIX and the worst US stock market down day since November 7th) was the Italian election, I wouldn’t have changed my position either. I should have.
Back to the Global Macro Grind …
Should have, could have, would have – they are all loser excuses people make, so don’t expect me to make them this morning.
We made some good moves yesterday (covered our Yen short at the YTD low, shorted Utilities at the YTD high), but my overall net long position in US Equities was dead wrong. There is no excuse making in my books. The score doesn’t lie; people do.
Whether I think Italy should matter doesn’t matter. It’s what the market says matters that matters. So let’s get on with our day and focus on not making more mistakes.
As I wrote yesterday, I don’t start with the Research View (it actually improved again yesterday with Strong Dollar taking Oil prices down to a 7wk low), I start with the Risk Management Signals – here they are in the USA, across durations (TRADE, TREND, and TAIL):
- SP500 broke immediate-term TRADE support of 1502; remains bullish TREND and TAIL with 1463 TREND support
- Russell2000 broke immediate-term TRADE support of 901; remains bullish TREND and TAIL with 869 TREND support
- VIX ripped through all lines of resistance and moves to bullish TREND provided that 17.18 holds (watch this closely)
- US Dollar Index remains in a Bullish Formation (bullish TRADE, TREND, and TAIL)
- CRB Commodities Index remains in a Bearish Formation (bearish TRADE, TREND, and TAIL)
- US Treasury 10yr Yield broke immediate-term TRADE support of 1.96%; remains bullish TREND and TAIL with 1.84% TAIL support
Then, if I dig inside that 1st factor (SP500) and break it into Sector Style Exposures (dividing the pie into 9 S&P Sectors):
- 5 of 9 Sectors are still in Bullish Formations: Healthcare, Financials, Industrials, Utilities, and Consume Staples
- 2 of 9 are bearish on both TRADE and TREND durations: Basic Materials and Tech (AAPL = 14.9% of the Tech ETF)
- We bought Financials (XLF) into the close yesterday and shorted Utilities (XLU) on the open – both on signals
So, net net net – not a lot has changed here from a Research View perspective. The only S&P Sector that is down YTD is the one we’d expect to be down (Basic Materials), as we expect to see a Strong Dollar perpetuate A) commodity deflation and B) consumption #GrowthStabilizing.
However, that doesn’t mean the Risk Management Signals are going to let us out of The Tiger’s grasp right here and now. Immediate-term TRADE breakdowns force people to make decisions on intermediate-term TREND positioning. And that’s what we need to do next.
Looking at Global Macro risk more broadly, across Global Equity markets:
- Japan was down -2.26% last night (after being up +2.4% the day prior) and remains in a Bullish Formation (no TRADE breakdown)
- China’s Shanghai Composite was down -1.4% (broke TRADE support of 2321, but held TREND support of 2209)
- South Korea’s KOSPI was only down -0.47% overnight and is holding last week’s bullish TRADE/TREND breakout
- Brazil’s Bovespa remains bearish TRADE and TREND (that’s not new, and largely because of the Commodity exposure)
- Germany’s DAX broke TRADE support of 7670 again this morning; remains bullish TREND and TAIL with TREND support of 7528
- Italy’s MIB Index is a bloody mess, down -4.5% this morning and back into a Bearish Formation
So, do we give up on the Research View? Or do we acknowledge that short-term (TRADE) durations breakdown, breakout, and whip around - always stressing our ability to navigate the markets intermediate-term TRENDs?
Italy and France are dysfunctional economies being managed by a socialist #PoliticalClass (not new news – this is the 62nd Italian government since WWII). Brazil is going down for the reasons we think are bullish for the #1 research factor in our model (commodity deflation is a global tax cut for consumers).
Risk Sees my position. It sees yours too. It’s never “off.” It’s always on, and whether it was a SP500 price of 1524 (10AM EST) or 1487 (4PM EST), evidently it goes both ways, fast. I’ll be doing a lot of waiting and watching for the next few days, to make sure yesterday’s 6hr move wasn’t an emotional head-fake.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST10yr Yield, and the SP500 are now $1, $112.61-116.38, $80.72-81.98, 91.65-94.41, 1.84-1.96%, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on February 12, 2013 for Hedgeye subscribers.
“Every gun that is made, every warship launched, every rocket fired, signifies in the final sense a theft from those who hunger and are not fed, those who are cold are not clothed.”
-Dwight D. Eisenhower
As I was preparing for my week long sojourn over to the United Kingdom, I actually had to think seriously about what type of currency I wanted to bring. After all, in this day and age of the modern currency war, the movement of currencies can be dramatic and shocking. If you don’t believe me, just ask those good folks that were long of Venezuela’s Bolivar going into Friday. In a split second, the government unilaterally devalued the Bolivar by 32% and likely put a few currency traders out of business.
In terms of global economies, according to the CIA Fact Book Venezuela is just the 34th largest economy in the world at just $400BN in annual economic output. Despite this, there were a number of multinational companies that were impacted by the devaluation. Specifically, Colgate-Palmolive and Smurfit Stone have taken charges, with comparable companies like Avon, Proctor and Gamble and Kimberly-Clark certainly at risk of a short term hit to both earnings and assets.
Obviously the popular pushback when we stress currency wars with U.S. focused equity managers is that they are a 3rd world type risk and not a concern or issue that will become broadly prevalent. In fact, this consensus view was verified to me as I opened the Irish Times this morning to an article titled, “Fears of an Imminent Currency War Are Wide Of the Mark.” Of course, many of these money managers have only been managing money for the last 10 – 15 years, so they may have missed this little critter called the Plaza Accord.
Now admittedly, the Plaza Accord was not a unilateral devaluation or war, but rather an agreement by Germany, Japan, France, the United States, and the United Kingdom. The agreement by these five nations was to intervene in global currency markets with an objective of devaluing the U.S. dollar in relation to the Japanese Yen and German Deutsche Mark.
Not surprisingly when the world’s largest central banks gang up to achieve a goal, they succeed, and the U.S. dollar depreciated dramatically over the next two years. In fact, the dollar depreciated versus the yen by almost 50% from 1985 to 1987. By some economists, this devaluation was heralded as a glorious success as the devaluation was controlled and did not lead to a financial panic.
While the last point is true, the strengthening of the Japanese yen was likely a key catalyst for one of the most significant bubbles of the last three decades, if not hundred years – the Japanese real estate bubble. Naturally, given that the U.S. dollar was set to decline, the Japanese that had their assets abroad repatriated and began purchasing Japanese real estate, and purchased more, and purchased more. In fact, at one point choice properties in Tokyo’s Ginza district were trading hands at $20,000 per square foot.
For Japan, the acquiescence to the United States to devalue the U.S. dollar led to an asset bubble of incomparable proportions and then an effective lost decade(s) of economic activity (and then some) as the Japanese economic system de-levered. My point in highlighting this is simply that devaluations, like much of government intervention in the markets, has unintended consequences. In hindsight, the Japanese likely never would have signed up for the Plaza Accord had they understood the unintended consequences. In part, this experience is likely shaping their new policy of going at their currency strategy alone, rather than suffering the beggar thy neighbor option of a Plaza Accord type agreement.
There is obviously a worst case scenario as it relates to currency wars, that scenario in which all nations devalue at once. Not unlike during the Cold War, when both the Soviets and Americans were armed to the hilt with nuclear weapons, this global devaluation is also likely a race to MAD (Mutually Assured Destruction). For lack of a better term, we’ll call it Currency Armageddon.
The broad implications of a massive global currency war actually relate back to the quote from Dwight Eisenhower at the start of this note. In a normal war, goods are taken from the people to create weaponry. As a result, the average person is worse off during a war. On some level, a currency war is no different.
As currencies are devalued, the purchasing power of the average citizen is degraded and as a result so is their ability to purchase basic goods. If you don’t believe me, ask the average citizen of Venezuela whose purchasing power was decimated by this move on Friday. This quote from a recent Bloomberg article about a rush to buy airline tickets was particularly apropos:
“I came because I heard American Airlines is going to raise fares by 100 percent, that’s to say, above the devaluation.”
Interestingly, there is an alternative to Currency Armageddon and its unintended consequences. This is the exchange rate system implemented post World War II called the Bretton Woods system. In this period of semi-fixed exchange rates, competitive devaluation was not an option. Not surprisingly, under Bretton Woods global economic activity thrived and was stable.
This is not to say that Bretton Woods was an ideal system, but what seems less than ideal is the ability of major governments to unilaterally devalue on a whim, which is the nature of the monetary system today. The most recent example of this is of course Japan and the rampant devaluation of the yen. This will last until the average retiree in Japan starts to feel the fiat currency squeeze like the Venezuelans have. Interestingly, Japan is almost half way there with a Yen that is down over -15% in only three months.
Now, on one hand, shorting the yen was an existing idea we re-presented on our Best Ideas call on November 15th and that trade is up ~14% since then, so we are happy about that. But as we contemplate risk managing future economic shocks, the idea of Currency Armageddon is a risk that every day seems less and less like a tail risk and more like a 2013 type event, despite what we might be reading in the Irish newspapers.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, and the SP500 are now $1641-1669, $116.52-118.72, $79.82-80.54, 92.78-94.66, 1.93-2.01%, and 1507-1523, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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Darden surprised some people today by guiding to -3%-to-+3% EPS growth in FY14 versus consensus of +11%. We are awaiting further insight from the second day of the Analyst Meeting tomorrow but, needless to say, the Analyst Meeting, thus far, is confirming our bearish stance on Darden.
Email us for a copy of our original SHORT thesis black book, published in July 2012.
Below are some general thoughts, with charts, on the guidance offered by management after day one. We will have more detailed comments on individual brands and the minutiae of management’s strategy, following the second day’s presentation tomorrow.
Expectations Taking a Beating
Darden’s share price gained on Friday as investors covered on the news that EPS guidance for FY13 was being revised to $3.06-3.22. Consensus is now seeking $3.24 in EPS this year. We are at the low end of the guided range.
During the first day of the Analyst Meeting, management gave consensus expectations another thrashing, guiding to -3% to +3% EPS growth in FY14, versus consensus of +11%.
Could Go Lower – Traffic Assumptions Likely Aggressive
It seems to us that Darden’s management team may be overly optimistic in its underlying assumptions behind the FY14 earnings growth.
Over the near-term, which we took to mean the next 2-3 years, the company is guiding to same-restaurant sales growth of 1-2%, comprised of 1% check growth, 0-1% traffic growth. The company’s unit growth of 4% is expected to drive sales to roughly 6% per year, with the exception of FY14 when the Yardhouse acquisition should boost that number by 1%.
We believe that the traffic assumptions are likely aggressive. The past seven years have seen negative comparable traffic growth for the industry. Looking at the trend of Darden’s largest two brands’ traffic performance versus industry peers, it could be a stretch to get to positive traffic growth (on a sustained basis) any time soon.
Today’s results (which are still being tabulated) suggest a hung parliament in Italy, with Berlusconi taking the upper house and Bersani winning the lower house. Given that both houses have equal powers, the stalemate suggests that today’s results will force Italy’s President to call for an interim government and another round of voting.
The results show that Italians voted against the fiscal reforms under Monti. The Italian 10YR yield increased 12bps versus to 4.49% and the spread versus German bunds increased 14bps as the EUR/USD fell -0.89% to $1.3076 on the day.
Broadly, today’s results show that economic uncertainty breeds political uncertainty, a case we seen time and time again across the Eurozone. We think this power vacuum should put upward pressure on Italian sovereign and bank spreads, a drag on the country's already weak economic fundamentals.
While final votes are still being tabulated, the key take-aways of today’s results are:
- Strong support for Peppe Grillo and his anti-austerity party (The Five Star Movement, M5S) and increased support for Silvio Berlusconi’s center-right People of Liberty Party (particularly in the upper house) took needed support from Pier Lugi Bersani and his center-left Democratic Party alliance to led to a mixed upper and lower house result.
- Since Grillo’s party is not looking to form a coalition with anyone, his support is simply creating a wedge in coalition building
In the Lower House (630 seats) -
- Bersani took majority control, gaining some 340 seats, on 29.2% of the vote, according to projections
- Berlusconi got 28.7% and 121 seats
- Grillo received around 111 seats on 26.1%
- Monti took a mere 8.4%
In the Upper House (315 seats) -
- Berlusconi may have "won" the Senate race with 113 seats, according to RAI forecasts by gaining the key swing regions of Sicily, Campania and Lombardy
- Bersani – 105 seats
- Grillo – 63 seats
- Monti – 20 seats
IL approvals chugging along, albeit at a slowing pace
Today, the Illinois Gaming Board (“IGB”) released a list of all licensees, which included 1279 licensed establishments, implying the approval of 136 incremental establishments, a deceleration from January and December. The February approvals compare to 188 in January and 350 grants in December. To date, there have been no establishment licenses revoked and 91 establishments have been denied licensure. There has been one terminal operator who had its license revoked along with 22 terminal operators and 1 manufacturer that have been denied licensure. Currently, there are 2,596 establishments pending approval, a 4% increase from January.
Each location can have a maximum of 5 machines so 1,279 approved locations imply a current maximum market size of 6,395. There were 3,394 machines online in January, up from 2,290 in December. VGT revenue in January rose to $9.78 million from $7 million in December. It looks like average win per day in January was around $115/day.
We stand by our prior estimate of a 10,000 unit market by the end of 2013. We expect that most of the VLT sales (upwards of 75%) will come with some sort of financing, but the vast majority will be accounted for as for-sale machines.
Our understanding is that ASPs should be around $12k range. We believe that distributors receive a 10-15% cut of the purchase price as their commission, with the big suppliers paying on the low end of that range and some of the smaller guys paying at the higher end of that range. Typically, distributors take the machines on a consignment basis, meaning that suppliers cannot recognize revenues until the machines are placed in the establishments.
DETAILS ON PENDING APPLICATIONS:
Manufacturer: 3 (including Speilo and Konami)
Terminal handlers: 143
Terminal operators: 11
Establishments: 2,596 pending
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