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Beautiful Rage

This note was originally published at 8am on March 12, 2013 for Hedgeye subscribers.

“How with this rage shall beauty hold a plea?”



As our Director of Research, Daryl Jones, said on CNBC last week, “this is the most hated rally we’ve ever seen.” Hating the truth isn’t cool. But, as the late Andre Gide noted, “it’s better to be hated for who you are, than to be loved for someone you are not.”


Reality is that if you hate this market, you are raging against one of the more impressive 4-month changes in Asian and US growth prospects that we have seen in a decade. Cheering for the end of the world isn’t cool either.


A strong US currency, at the big turns (for both Reagan in the early 1980s and Clinton in the early 1990s), can be a Beautiful Rage. If sustained, it’s a pro-growth signal. So, from here, to have or not to have a #StrongDollar, remains the question.


Back to the Global Macro Grind


One of the most obvious places we’ve been monitoring Bear-Rage is in the term-structure of US Equity Volatility (VIX). At every lower-high (and lower-low) we’ve seen in the front-month VIX, many have still held onto their future fear expectations. That’s not working.


Looking at the Front-end of Fear (where front-month VIX is trading):

  1. VIX was down another -8.2% yesterday to close at a fresh 5yr low of 11.56
  2. VIX just crashed (and quickly), down -40% from its FEB25, 2013 “Italian Election” day lower-high
  3. VIX has been crashing, down -49%, from its DEC28, 2012 Congress New Year’s Eve lower-high

When I say lower-highs, I mean long-term lower-highs. And this has really been our point throughout the last 2-3 months. What was long-term support for the Front-end of Fear (14-15 VIX), is now solidifying itself as intermediate-term TREND resistance.


Just to put some risk management levels around that – across our core risk management durations:

  1. VIX immediate-term TRADE resistance = 13.98
  2. VIX intermediate-term TREND resistance = 16.21
  3. VIX long-term TAIL resistance = 17.18

So, the Front-end of Fear is being pulverized into what we call a Bearish Formation (bearish across all 3 of our core risk management durations – TRADE, TREND, and TAIL).


And, all the while, all you’ll hear from the hedge fund community is how the “term structure” of VIX doesn’t agree. In other words, consensus doesn’t agree with higher-highs in US stocks (perpetuated by lower-lows in volatility). That’s why it keeps working.


Bridgewater’s Ray Dalio outlines what an oversupply in consensus hedge funds has meant for returns. The correlation of hedge fund returns to US stock market beta = +0.9. If you want to be freaking out about something, freak-out about that.


Why is the asset management business changing? Well that’s pretty simple. It’s called evolution. Plenty of our pension fund, mutual fund, and RIA clients are changing what it is that they do as this globally interconnected game of global macro risk changes.


That has big implications. Don’t forget that the RIA (Registered Investment Advisor) community is as large (in terms of assets under management) as the hedge fund community.


Country, Currency, Commodity, etc. ETFs and the like are allowing lower-fee structures and strategies to compete, head-to-head, with Global Macro Hedge funds. Don’t fear that – competition is a beautiful thing too.


Some other tactical points to consider (in the immediate-term) as the VIX is crashing:

  1. Things that are crashing tend to bounce, fast – so watch what US stocks do once VIX tests our 11.21 oversold level
  2. SP500’s immediate-term Risk Range of 1534-1565 is finally signaling more downside than upside in US stocks
  3. Immediate-term Risk Ranges change as fast as price, volume, and volatility factors do – so keep moving

We’re not suggesting that we are smarter than anyone else. We have a broad spectrum of clients we are collaborating with. We are using quantitative signals and research to highlight what we think are becoming more probable non-consensus market moves.


In order to convince you that our risk management process is both flexible and dynamic, we have to Embrace Uncertainty. Selling certainty is like selling fear; over long periods of time, you’ll get run over by being anchored to either one or the other.


Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, Russell2000, and the SP500 are now $1556-1593, $109.51-110.98, $82.21-82.93, 93.56-96.81, 1.95-2.09%, 11.21-13.98, 928-951, and 1534-1565, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Beautiful Rage - Chart of the Day


Beautiful Rage - Virtual Portfolio


IL approvals ring in their second best month



The Illinois Gaming Board (“IGB”) released a list of all licensees, which included 1,554 licensed establishments, implying the approval of 275 incremental establishments, marking the 2nd biggest month of approvals behind December.  


To date, there have been no establishment licenses revoked and 100 establishments have been denied licensure. There has been one terminal operator who had its license revoked along and 24 terminal operators and 2 manufacturer that have been denied licensure.  Currently, there are 2,420 establishments pending approval, a 7% decrease from February.


Each location can have a maximum of 5 machines so 1,554 approved locations imply a current maximum market size of 7,770.  There were 4,353 machines online in February, up from 3,394 in January.   VGT revenue in January rose to $13.6 million February from $9.78 in January.   It looks like average win per day in February was around $111/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 units.


Our understanding is that ASPs should be around the $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.



Distributor:  2

Manufacturer:  2 (Speilo and Konami)

Supplier:  2

Technicians:  21

Terminal handlers:  133

Terminal operators:  10

Establishments:  2,420 pending


The Macau Metro Monitor, March 26, 2013




Real-time information on border traffic at the Border Gate, Outer Ferry Terminal in NAPE and the Cotai borders can now be accessed online.  The websites are www.fsm.gov.mo/m and www.fsm.gov.mo/psp/.  The information platform will also describe the traffic status in four categories according to the required time for transit: “fast”, which takes about 15 minutes, “busy”, “crowded” and “traffic to be diverted”.


FEBRUARY PASSENGER MOVEMENT Changi Airport Group, Channel News Asia

Changi Airport handled 4.12 million passenger movements in February 2013, an increase of 9.2% YoY.  Changi Airport Group (CAG) said travel demand was boosted by the Lunar New Year holidays which this year fell in February compared to January last year.




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TODAY’S S&P 500 SET-UP – March 26, 2013

As we look at today's setup for the S&P 500, the range is 22 points or 0.56% downside to 1543 and 0.86% upside to 1565.          










  • YIELD CURVE: 1.69 from 1.68
  • VIX  closed at 13.74 1 day percent change of 1.25%

MACRO DATA POINTS (Bloomberg Estimates):

  • 7:45am: ICSC weekly sales
  • 8:30am: Durable Goods Orders, Feb., est. 3.9%
  • 8:30am: Durables Ex Transportation, Feb., est. 0.5%
  • 8:30am: Cap Goods Orders Nondef Ex Air, Feb., est. -1.0%
  • 8:55am: Johnson/Redbook weekly sales
  • 9am: S&P/CS 20 City M/m SA, Jan., est. 0.75% (prior 0.88%)
  • 9am: S&P/CaseShiller Home Price Index, Jan., est. 146.17
  • 10am: Richmond Fed Manufacturing, March, est. 6 (prior 6)
  • 10am: Consumer Confidence, March, est. 67.2 (prior 69.6)
  • 10am: New Home Sales, Feb., est. 420k (prior 437K)
  • 10am: New Home Sales M/m, Feb., est. -3.9% (prior 15.6%)
  • 11am: Fed to purchase $2.75b-$3.5b notes in 2020-2023 sector
  • 11:30am: U.S. to sell 4W bills
  • 1pm: U.S. to sell $35b 2Y notes
  • 4:30pm: API Energy Inventories


    • House, Senate not in session
    • Supreme Court hears arguments on whether 2008 Proposition 8 Calif. voter initiative that halted same-sex marriage in state violated rights of gays, 10am
    • Portuguese Finance Minister Vitor Gaspar speaks at Brookings Inst on “Portugal and the Euro Area,” 10am
    • Apple, Samsung will ask appeals court to overturn ruling that they reveal fin. information they want kept secret, 10am
    • Fish, wildlife, plants climate change adaptation strategy released on conf call by Dep Interior Sec David Hayes, U.S. Fish and Wildlife Srvc Dir Dan Ashe, NOAA’s Eric Schwaab, 1pm
    • Washington Day Ahead


  • Hulu board gauging interest in video site from potential buyers
  • Feb. U.S. durable goods orders probably rose most in 5 mos.
  • Intel said to make progress in talks w/networks for TV rights
  • Ford CEO Mulally says he’s concerned about Japanese yen
  • Bristow gets GBP1.6b contract for U.K. Search & Rescue Fleet
  • Dallas Fed President Fisher sees U.S. economic growth at 3%
  • T-Mobile said to discuss iPhone at event tmw: CNET
  • FHFA to ban fees, commissions on “forced” home insurance: WSJ
  • Mongolia, Turquoise, Rio aim to resolve issues near-term
  • Kuroda wants to achieve BOJ’s 2% price target in 2 yrs
  • S. Korea GDP expands at slowest pace since global recession
  • Wal-Mart sues union in Florida over store demonstrations
  • Hess Corp.’s Russian subsidiary gets ~30 bidders: Vedomosti
  • Sarris sees no loosening of Cyprus capital controls for weeks


    • Children’s Place Retail (PLCE) 6am, $1.04
    • Argonaut Gold (AR CN) 7am, $0.13
    • Neogen (NEOG) 8:45am, $0.27
    • Mattress Firm Holding (MFRM) 4:01pm, $0.32
    • SAIC (SAI) 4:02pm, $0.51


  • Mongolia Increases Gold Reserves to Highest Since August 2008
  • Brazil Soy Boom Bottlenecked as China Left Waiting: Commodities
  • Gold Drops a Third Day as Cyprus Bailout Curbs Investor Demand
  • WTI Oil Trades Near Five-Week High; U.S. Stockpiles Seen Rising
  • Copper Advances in London as U.S. Manufacturing May Boost Demand
  • Oil Supplies Jump to Nine-Month High in Survey: Energy Markets
  • Corn Declines as CME Increases Margins, Reducing Grain’s Appeal
  • Coffee Futures Fall in London on Ample Supply; Cocoa Advances
  • Rebar Falls in Shanghai as Chinese Banks Begin Property Curbs
  • Rice Exports From India Seen at Record as Harvest Set to Rebound
  • Fredriksen Bets $2.6 Billion New Ships Will Beat Glut: Freight
  • Two Miles of Sea Covers Big Oil’s Next-Generation Field: Energy
  • Record-Free Gold Run Longest Since 28-Year Gap: Chart of the Day
  • Rubber Declines as Yen’s Rebound Cuts Appeal Amid Cyprus Concern






















The Hedgeye Macro Team









DKS: Is DKS Done De-Risking Lease Portfolio?

Takeaway: The rate at which DKS has been de-risking its real estate portfolio has halted in its tracks. DKS remains a value trap. Avoid it.

Conclusion: We think the biggest take-away from the DKS 10K is the one that no-one will talk about.  Specifically, the rate at which the company has been de-risking its real estate portfolio has halted in its tracks. We recently turned negative on DKS -- and that was before having this datapoint. A negative change on the margin in its lease portfolio on top of weak comps, peak margins, and a dramatic increase in capital intensity is a great formula for returns to go negative. DKS remains a value trap. Avoid it.


Here’s Our Logic

One things we focus a lot on is a given company’s ‘Lease Flexibility Ratio’, which is a term we use to measure the weighted average duration of a company’s operating lease portfolio. We calculate this by dividing the total lease obligations by the payments obligated in year one. Simply put, in almost all cases, the shorter the Lease Flexibility Ratio, the more flexible and healthier it is for the company in question.  This does not mean that the asset is not secured for a longer time period, but simply that the minimum financial obligation associated with the asset is low.


Why would a company have a high ratio (ie very inflexible)? One of two reasons. 1) Either it has extremely long-dated leases. Target and Whole Foods are both at 20x, while Kohl’s is 26x (JCP is only 11x -- bad for KSS). 2) The other reason would simply be that a given retailer wants to secure real estate that it can’t afford. If such is the case, then one of three things happens.


a)      The retailer signs up for a significantly escalating minimum payment each year, or

b)      It signs up for a location before competitors, and accepts the obligation well before it sees associated sales, or

c)      It removes kick-out clauses or other safety features that would otherwise reduce certain obligations in the out-years of a lease agreement.  


We think DKS is a combo of a) and b).


DKS: Is DKS Done De-Risking Lease Portfolio? - dks lease


We look at these ratios to compare two things; 1) a given retailer’s lease structure versus competitors, and 2) how a company’s lease portfolio changes on an annual basis versus itself. That’s where Dick’s is interesting.


Historically, DKS has had a Flexibility Ratio that we’d call egregious.  5-years ago, for example, DKS’ average portfolio duration was over 12-years. That’s nearly as high as Costco – which sits at 14x. Costco is a destination if there ever was one in retail. Dick’s may be a nice store, but it’s no Costco.


The good news is that over the past 4-years, DKS’ weighted average duration has come from 12.2 years down to 8.0 years. That’s been very bullish for DKS’ ability to leverage occupancy with a lower comp than the 4-5% it needed back in 2007. We’ve seen that hurdle rate come down closer to 3% over the past few years. Again, good news.


The bad news is that in 2012 it ticked back up again.  It only went up by 0.2x, which is hardly enough for us to cry wolf. But make no mistake, the reduction in its lease minimums is one of the factors why we’re been positively predisposed to owning DKS at certain times throughout the past few years.


But today, margins are at peak, comps are trending only in the +1-3% range, and management admitted that it needs catch-up investment to acquire the appropriate omni-channel strategy. As such we’re seeing capex trend up this year by almost a third to $300mm, without an obvious near-term payoff.  Maybe we’d be patient for a retailer with above-average defendability in its business model, but unfortunately, we think that over a third of DKS’ business is at very significant risk from web-based competition (not to mention brands’ own direct brands – mind you, Nike is 17% of sales).


Our research call here is clearly negative.

Matter of When not If with Herbalife?

Takeaway: One expert weighs in with what he says might happen next with Herbalife.

This note was originally published March 25, 2013 at 16:12 in Consumer Staples

Today we had a call with Professor William Keep, an expert on Multi-Level Marketing and Pyramid Schemes, to further the discussion on Herbal (HLF). 


Professor Keep gave a very balanced presentation on the industry and outlined some important agency and company-level considerations, including that he believes Pershing Square’s “subtlety” has likely forced the hand of a government agency to look at the company.   That is completely consistent with our thinking.


He thinks that regulatory bodies were not prepared for Herbalife, and are now left holding a bag full of something that may get on them if there is another Madoff moment (failure to act). He notes that any potential agency will not be quick to act, there’s not a lot of capacity at the state level to prosecute these cases, and that Peter Vander Nat (head of the FTC tasked with MLMs) has prosecuted 15 cases and won them all.


Professor Keep suggested that the size of the industry and likely scope of any potential case against HLF won’t keep Pandora’s Box closed given the brightness of the spotlight shining on the situation.


He says that if there’s any investigation, it will take years. He cites Burn Lounge, a case that took 5 years and a significant expenditure of limited regulatory resources to prosecute, as an example. Further, companies like HLF will put up plenty of money to defend themselves as Amway did, spending $30MM + to defend itself across multiple states back in 1979.   


On company-level reforms and transparency Keep believes that MLMs could do a better job tracking retail sales inside and outside of the network. He believes this is currently possible and the only explanation for the lack of it is due either to laziness or for perceived gains through obfuscation.  Also, he sees that the need of regulators to better address incentive structures based on recruitment. Finally, he believes the industry shrouds reporting the numbers of active vs inactive distributors, and the distinction between the two, as areas for all companies to comply with to limit obfuscation.


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.


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