Chinese Chicken

This note was originally published at 8am on April 04, 2013 for Hedgeye subscribers.

“Chickity China the Chinese Chicken. You have a drumstick and your brain stops tickin’.”

-Barenaked Ladies (1998)


Thank goodness the A-Shares are closed today.


Ok, perhaps that is quite a bit dramatic, but we’re certainly not thrilled by the fact that the Shanghai Composite Index is down -3.8% since our Macro Team pitched Chinese equities on the long side in our 2/27 Best Ideas Presentation (underperforming the regional median equity market gain of +1.3% by 507bps).


The lesser analyst in me would’ve begun the note pointing to the SHCOMP’s +6.8% delta since 12/10 (when we originally introduced the idea), calling for the index to continue making higher-highs and higher-lows over the intermediate term.


While that remains our base case scenario – for now at least – we would be remiss to ignore what we have learned from Dr. Daniel Kahneman’s work in the then-groundbreaking field of prospect theory – specifically in that economic agents A) assign an asymmetrically greater absolute value of utility to losses then they do to gains and B) multiple gains and/or losses are accumulated to create an overall feeling about a series of transactions that extends from the most recent, not original, reference point.


Applying prospect theory to our bullish bias on China, the absolute value of the negative utility associated with the -3.8% delta since 2/27 is likely in excess of the positive utility associated with the +11% delta from 12/10 to 2/27. Loosely applying the above quote from our Canadian friends up north (which itself hardly makes sense even in the context of the song it is sourced from), it would be fair to say that the Chinese stock market has indeed indulged in a rather infamous “drumstick”.


Cutting to the chase, it was our view that Chinese authorities would delay any tightening of monetary policy and/or macroprudential regulation until well after the country’s economic recovery had been firmly entrenched – creating cover for at least 3-6 additional months of potential upside for a traditionally high-beta market. With the introduction of the early-MAR propriety curbs, the late-MAR clamp-down on wealth management products (WMPs) and the dramatic acceleration in official recognition of systemic risks in the financial sector, however, it has become quite clear to us that the aforementioned view was dead wrong.


No doubt these measures will have some negative impact on Chinese economic activity, which we still see as accelerating over the intermediate term. But as prospect theory would have, the negative delta from our original, fairly-subdued expectations for a Chinese economic rebound to our updated view of an even more muted acceleration likely registers the entire sequence as a negative utility event.


In broader terms, it’s bad when your bull case gets less bullish, at the margin. Moreover, to the extent that the bull case was consensus across the investment community, the initial delta from “positive” to “less-positive” in any fundamental thesis is often the first cue for experienced short-sellers to enter a particular market.


Is China a short?


While we don’t believe it is (at least not yet; as evidenced by Keith’s buy signal on the CAF yesterday afternoon), we would be downright slipshod to not thoroughly debate the merits of the bear case, which we did in our 3/28 note titled “IS CHINA CAREENING TOWARDS FINANCIAL CRISIS?”. To recap a few highlights:

  • Last week China Daily reported that the China's banking regulator has urged banks to pay close attention to the credit risks in key industries affected by the economic downturn and hit by overcapacity woes. Zhang Ping, Chairman of the National Development and Reform Commission recently said that the industrial sectors suffering most from overcapacity include steel, cement, electrolytic aluminum, plate glass and coal coke sectors, each of which is operating at 70-75% of total capacity. Analysts estimate the outstanding loan portfolio of those industries may amount to around 30T-40T yuan ($4.83T-$6.44T or 22.6-30.2% of total banking system assets at the end of JAN). Per the PBOC, outstanding loans to the property sector were 12.1T yuan at EOY ’12.
  • In addition to these on-balance sheet risks, China has roughly 15T yuan of off-balance sheet credit (28.8% of GDP) in the form of commercial bills, trust financing, entrusted loans, etc. that has increasingly been allocated to riskier borrowers in recent years (per various agencies, including the IMF) – many of whom which have outsized exposure to property prices, such as property developers and local gov’t financing vehicles (LGFVs). The latter entity has 636.8B yuan in bonds outstanding as of EOY ’12 (+148% YoY) and 9.3T yuan of loans outstanding (17.9% of GDP) – 20% of which are “funding projects which are largely not profitable and thus are vulnerable to [repayment] risk,” per PBOC Governor Zhou Xiaochuan.
  • The next round of interest rate liberalization should promote better real returns and improved access to credit for Chinese households and SMEs, respectively, and that may perpetuate an unwind of off-balance sheet lending activities, which, according to most sources, have been largely capitalized with the surplus savings of China’s private sector that are seeking higher real yields via Trust Products and WMPs, where average annualized yields are 37% higher than the PBOC’s benchmark 1Y household deposit rate of 3%. To the extent there are any weak hands in the WMP or trust financing sectors, a lack of new inflows, at the margins, would expose the “ponzi-scheme” nature of some products (per the words of the Xiao Gang, Chairman of the Bank of China) – specifically those that rely on short-term funds in order to invest in illiquid fixed assets and fund distributions largely with new net inflows.
  • Ultimately, the most recent WMP regulations should translate into slower (and potentially even negative) growth in the supply of credit within the shadow banking channel and to the extent any existing liabilities facing repayment risk aren’t able to be rolled over, we will start to see default rates accelerate across China’s shadow banking sector. Any spillover effects across key industries – particularly in the oversupplied construction and construction materials sectors – could adversely impact Chinese bank NPL ratios (currently at 0.95%) on a lag.

In spite of all this, we continue to hold a reasonably high degree of conviction in our bull case on China, as a core driver of the thesis (i.e. Strong Dollar) is, in fact, the same bull case for US equities we have held since late 2012 that consensus has largely ignored and/or fought all year. To sum it up in a few bullets:

  • As expected, early MAR growth data is supportive of the Chinese economy resuming its trend of broad economic acceleration (the official Manufacturing PMI accelerated to 50.9 from 50.1 and the official Non-Manufacturing PMI accelerated to 55.6 from 54.5).
  • A sequential slowing in China’s MAR CPI and PPI figures (due out 4/8) is highly probable from the Lunar New Year jump in FEB. Moreover, continued gains in the CNY (at a ~19yr high) should weigh on inflation expectations over the intermediate-to-long term as China reorients its economy, though rebalancing certainly won’t happen overnight. Amid rebalancing, the country’s import model should change (less commodities; more consumer goods), ultimately increasing the impact of currency fluctuations upon consumer prices.
  • Lastly, continued USD strength should continue weighing on the prices of internationally-traded commodities, which should ultimately allow the pace of economic activity to creep higher in China on a lag. China’s heavy industry benefits from energy and raw material deflation via margin expansion and potentially increased production, at the margins, in a backdrop of subdued credit expansion. Additionally, Chinese consumers benefit from food and energy deflation by freeing up share of wallet for more discretionary goods and services.

All told, being long of China is certainly a non-consensus position at the current juncture. In spite of fairly recent gains, the fundamental backdrop for the Chinese stock market is as convoluted as it has been in quite some time. As such, we are sticking to our process and deferring to the quant on this one.


Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/JPY, UST 10yr Yield, VIX and the SP500 are now 1542-1594, 106.26-109.11, 82.55-83.46, 93.07-96.11, 1.81-1.93%, 12.31-14.54 and 1546-1576, respectively.


Keep your head on a swivel,


Darius Dale

Senior Analyst


Chinese Chicken - Chart of the Day


Chinese Chicken - Virtual Portfolio

Equilibrium's Test

“Only in equilibrium can we not distinguish past from future.”

-Eric Chaisson


If it appears that I have been back and forth on the US stock market all week, that’s because I have been. The nature of any non-linear ecosystem of colliding factors is often just that – uncertain.


Remember, I think of markets in terms of chaos theory and thermodynamics. Markets have blasts of entropy (the price paid when the complexion of the overall market’s energy changes), but they also oscillate back and forth from equilibrium.


What does that mean? Markets are built to confuse. That’s why they impose a lot of pain on a lot of people at the same time. “If not periodically checked, entropy will tend toward a maximum in any system” (Cosmic Evolution, pg 25). Think about that in terms of Gold.


Back to the Global Macro Grind


When my Research and Risk Signals are aligned across durations, it’s easy to make buy/sell decisions. When my front-runner (my immediate-term TRADE duration) whips back and forth between bullish and bearish, making decisions gets a lot tougher.


That’s where the SP500 and VIX are today – and they are hyper correlated:

  1. SP500 = bearish TRADE (1557 resistance); bullish TREND (1515) support
  2. VIX = bullish TRADE (14.27 support); bearish TREND (18.89 resistance)

We also call this Duration Mismatch (i.e. when one duration’s signal has a different conclusion than the other). I get less concerned about our fundamental research view when the TRADE is bearish than when the TREND is – when both are bearish, I short the market.


That’s why bearish TRADE/TREND setups are our Best Short Ideas:

  1. COMMODITIES (CRB Index) = bearish TRADE (289 resistance); bearish TREND (298 resistance)
  2. GOLD = bearish TRADE (1496 resistance); bearish TREND (1641 resistance)
  3. FCX (Freeport McMoran) = bearish TRADE ($31.92 resistance); bearish TREND ($34.18 resistance)
  4. YEN (vs USD) = bearish TRADE (95.87 resistance); bearish TREND (91.17 resistance)
  5. ITALY (MIB Index) = bearish TRADE (15,991 resistance); bearish TREND (16,313 resistance)

It’s a lot more profitable to get bearish about these things when they initially confirm TRADE/TREND breakdowns than it is shorting them after big drops. Obviously the big stuff (Commodities, Gold, Yen) has been breaking down for almost 6 months now, so you want to be proactive in managing the mean reversion risk associated with the immediate-term Risk Range. Bearish TRENDs bounce.


What is the immediate-term Risk Range?


That’s what I consider the most probable range of price within an immediate-term (3 weeks or less) time frame. Since time and space changes, so does my model.


It’s dynamic – meaning I tweak it throughout every day for my volatility and volume assumptions. If you think of it like an engine, I need to monitor accelerations and decelerations and be both proactive and reactive (i.e. I need to manually change the gears).


To use the SP500 as an example:

  1. My immediate-term Risk Range = 1
  2. My immediate-term TRADE line = 1557
  3. So, I could buy it A) at the low-end of my range (1539) or B) buy it on a breakout > 1557

Since every move I make is #timestamped in real-time, you can see that over the years I’ve evolved. I am more and more indifferent than I have ever been on buying oversold signals versus buying breakout signals.


Theoretically, you’d always like to buy something lower and sell it higher. Sometimes that’s dead wrong (lower can go lower and lower). If the front-runner (TRADE line breakdown of 1557) continues to confirm and attacks the TREND line (1515), and you’re buying it all the way down, you A) better have deep pockets and/or B) a longer-term investment time horizon.


One of my favorite lines on that score is Jeff Gundlach’s coarse description of an “investor” – a trader who is underwater. And when I really think that through in terms of how I risk manage my research team’s best ideas – that’s dead on. If I buy something, I want it to be the right spot. Being too early is also called being wrong.


Astrophysicist, Eric Chaisson, says “the greater the randomness or disorder, the greater the entropy” (pg 24). Agreed. But, in my process at least, it’s a lot easier to make decisions when entropy is obvious than it is when equilibrium is testing my patience.


Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, EUR/USD, UST10yr Yield, VIX, Russell2000, and the SP500 are now $1, $97.58-102.91, $82.26-83.12, 95.87-101.91, $1.29-1.31, 1.68-1.76%, 14.27-17.46, 899-929, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Equilibrium's Test - Chart of the Day


Equilibrium's Test - Virtual Portfolio

investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.


Yes, that is likely a positive signal.  Looking through the hold-adjusted lens, MGM Macau had a bang up quarter.



Q1 earnings two weeks from today should be a positive catalyst for MGM. We’re in-line with the Street for Vegas but higher for Macau on a hold-adjusted basis.  MGM Macau held low in Q1 at the VIP tables but volumes were terrific  - its best quarter ever.  CEO Jim Murren appearing on CNBC ahead of earnings today at 10:15am today is probably a signal of a good upcoming quarterly announcement.


We remain concerned with the longer-term outlook for domestic gaming as we’ve discussed ad nauseam (sorry to be repetitive but we think it’s some damn good analysis).  However, it does appear that there is some near-term stability in Las Vegas as management will no doubt discuss on their earnings call.  But Macau was the real story in Q1.  Quarterly hold-adjusted EBITDA could exceed $200 million for the first time.


We estimate that MGM will report $2.3BN of net revenue and $516MM of consolidated property level EBITDA.  We also look at wholly-owned EBITDA plus MGM’s pro-rata share of MGM China and City Center, less corporate and stock compensation expense which produces EBITDA of $466MM.





We project MGM’s Las Vegas Strip properties to produce net revenue of $1,184MM and EBITDA of $273MM.  We believe RevPAR is up 1.5% YoY, flatish YoY casino and other growth and low single digit (1-2%) operating expense declines.

  • Bellagio:  $282MM of net revenue and $72MM of EBITDA
    • 2% RevPAR increase
    • -2% growth in casino & other
      • 1Q12 had low hold according to MGM but casino & other revenues increased 16% YoY
    • 2% expense decline
  • MGM Grand:  $241MM of net revenue and $50MM of EBITDA
    • 2% increase in RevPAR
    • 2% increase in casino & other
    • 2% decline in YoY expense growth
  • Mandalay Bay:  $183MM of net revenue and $45MM of EBITDA
    • Flat YoY RevPAR
    • 3% increase in casino & other
    • 2% decrease YoY expenses
  • Mirage:  $155MM of net revenue and $33MM of EBITDA
    • 2.5% RevPAR increase
    • 5% increase in casino & other
    • 1% increase in expenses
  • Other US
    • MGM Grand Detriot net revenue of $138MM and EBITDA of $40MM
    • Mississippi net revenue of $121MM and EBITDA of $23MM

MGM Macau is projected to report $737MM of net revenue and $180MM of EBITDA

  • If MGM Macau held at its historical average of 2.95%, we estimate that the property would have reported EBITDA of a whopping $205MM.
    • We think Rolling Chip volume set a quarterly record for MGM Macau including an incredible month of March.  RC climbed 16% and 38% in Q1 and March, respectively.
    • Volumes tend to rise when hold is low and that was certainly the case here
    • We estimate Mass revenues climbed 28%

Our assumptions in HK$MM’s are as follows:

  • Net casino revenue of $5.6BN and total revenue of $5.7BN
    • Net VIP win of $3.4BN
      • VIP Turnover: 205,900 assuming 9% direct play
      • Hold of 2.70%
      • Rebate rate of 38.5% or 1.04%
    • Mass table win of $1.6BN
    • Slot win of $573MM
  • Variable expenses of $3,581MM
    • $3,064MM of taxes and gaming premiums
    • $495MM of commissions to junkets
  • Fixed expenses of $700MM

We estimate that City Center will report $66MM of EBITDA on $277MM of net revenues

  • Aria:  $222MM of net revenue and $53MM of EBITDA
  • Mandarin Oriental:  $13MM of revenue and $1MM of EBITDA
  • Crystals:  $14MM of revenue and $9MM of EBITDA
  • Vdara:  $23MM  of revenue and $6MM of EBITDA
  • $6MM of development and administrative expenses

Other stuff:

  • D&A:  $226MM (vs. guidance of $227MM)
  • Corporate & other:  $41MM (guidance of $40-45MM)
  • Stock Comp:  $9MM (guidance of $9MM
  • Net interest expense:  $234MM
  • Income from unconsolidated affiliates & non-operating items from unconsolidated affiliates of ($24MM)
  • $6MM of tax expense
  • Minority interest of $59MM


TODAY’S S&P 500 SET-UP – April 18, 2013

As we look at today's setup for the S&P 500, the range is 31 points or 0.84% downside to 1539 and 1.16% upside to 1570.            










  • YIELD CURVE: 1.48 from 1.47
  • VIX closed at 16.51 1 day percent change of 18.27%

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Init Jobless Claims, April 13, est. 350k (est. 346k)
  • 8:30am: Cont Claims, April 6, est. 3.075m (prior 3.079m)
  • 9am: Fed’s Kocherlakota speaks in New York
  • 9:30am: Fed’s Lacker speaks on credit in Charlotte, N.C.
  • 9:45am: Bloomberg Economic Expectations, April (prior -4)
  • 9:45am: Bloomberg Consumer Comfort, April 14 (prior -34)
  • 10am: Philadelphia Fed, April, est. 3.0 (prior 2.0)
  • 10am: Leading Indicators, March, est. 0.1% (prior 0.5%)
  • 10am: Freddie Mac mortgage rates
  • 10:30am: EIA natural-gas storage change
  • 11am: Fed to purchase $2.75b-$3.5b in 2020-2023 sector
  • 11am: Bank of Canada’s Carney speaks in Washington
  • 12pm: Fed’s Raskin speaks in New York
  • 1pm: U.S. to sell $18b 5Y TIPS
  • 4:15pm: Asmussen, Rehn, Dijsselbloem speak in Washington


    • 10am: Senate Armed Svcs Cmte hears from Dir. of Natl Intelligence James Clapper, Defense Intelligence Agency Dir. Michael Flynn on threats
    • 10am: Senate Health and Labor Cmte hears from Labor Sec. nominee Thomas Perez at confirmation hearing
    • 11am: President Obama speaks at interfaith service in Boston
    • 11:30am: House Speaker John Boehner, R-Ohio, holds briefing
    • 1pm: State Dept hears public’s final comments on Keystone, which would carry tar sands from Canada to U.S. Gulf Coast
    • House to vote on H.R. 624, Cyber Intelligence Sharing and Protection Act, which White House threatened to veto


  • G-20 draft affirms pledge to avoid competitive devaluations
  • Herbalife unlikely to hire new auditor before investor meeting
  • PBOC’s Yi says yuan trading band to widen in near future
  • Japan March exports exceed analyst ests. after yen slide
  • Wells Fargo urges judge to dismiss U.S. mortgage loan fraud suit
  • SEC to move past financial crisis cases under new chairman
  • American Express profit beats est. as card spending climbs
  • SEC sues Schottenfeld trader Mancuso over Goffer insider tips
  • Biggest cinemas delay ‘Iron Man’ ticket sales in Disney dispute
  • Explosion hits Texas fertilizer facility, unknown number dead


  • BB&T (BBT) 5:45am, $0.68
  • WESCO International (WCC) 6:15am, $1.14
  • KeyCorp (KEY) 6:17am, $0.19
  • Fifth Third Bancorp (FITB) 6:30am, $0.39
  • AutoNation (AN) 6:45am, $0.64
  • Hubbell (HUB/B) 6:58am, $1.09
  • Danaher (DHR) 6am, $0.76
  • UnitedHealth (UNH) 6am, $1.14 - Preview
  • Morgan Stanley (MS) 7:15am, $0.56 - Preview
  • Sonoco Products (SON) 7:30am, $0.53
  • Verizon Communications (VZ) 7:30am, $0.66 - Preview
  • Fairchild Semiconductor (FCS) 7:30am, $0.05
  • PrivateBancorp (PVTB) 7:30am, $0.29
  • Watsco (WSO) 7:30am, $0.33
  • Baxter International (BAX) 7am, $1.05
  • Omnicom (OMC) 7am, $0.75
  • People’s United Financial (PBCT) 7am, $0.18
  • Penn National Gaming (PENN) 7am, $0.65
  • PepsiCo (PEP) 7am, $0.71 - Preview
  • Philip Morris International (PM) 7am, $1.34 - Preview
  • TransForce (TFI CN) 7am, C$0.26
  • Alliance Data Systems (ADS) 7am, $2.52
  • Pool (POOL) 7am, $0.05
  • Snap-on (SNA) 7am, $1.34
  • PPG Industries (PPG) 8:11am, $1.54
  • Syntel (SYNT) 8:30am, $1.03
  • Amphenol (APH) 8am, $0.86
  • Freeport-McMoRan (FCX) 8am, $0.71 - Preview
  • Peabody Energy (BTU) 8am, $(0.14) - Preview
  • Blackstone Group (BX) 8am, $0.53
  • Sherwin-Williams (SHW) 8am, $1.09
  • Union Pacific (UNP) 8am, $1.96 - Preview
  • Cypress Semiconductor (CY) 8am, $0.01
  • Nucor (NUE) 9:01am, $0.24 - Preview
  • Home BancShares (HOMB) 9:15am, $0.61
  • Ultratech (UTEK) 9am, $0.49
  • Acacia Research (ACTG) 4pm, $0.50
  • Align Technology (ALGN) 4pm, $0.23
  • Cubist Pharmaceuticals (CBST) 4pm, $0.32
  • Chemed (CHE) 4pm, no est.
  • Chipotle Mexican Grill (CMG) 4pm, $2.13 - Preview
  • Hub Group (HUBG) 4pm, $0.42
  • Associated Banc-Corp (ASBC) 4:01pm, $0.25
  • B&G Foods (BGS) 4:01pm, $0.37
  • Google (GOOG) 4:01pm, $10.67 - Preview
  • Microsoft (MSFT) 4:02pm, $0.68 - Preview
  • Capital One Financial (COF) 4:05pm, $1.62
  • E*TRADE Financial (ETFC) 4:05pm, $0.12
  • International Business Machines (IBM) 4:05pm, $3.05
  • Cepheid (CPHD) 4:05pm, $(0.02)
  • Forward Air (FWRD) 4:05pm, $0.39
  • Intuitive Surgical (ISRG) 4:05pm, $3.97 - Preview
  • Electronics for Imaging (EFII) 4:05pm, $0.32
  • EastGroup Properties (EGP) 4:05pm, $0.77
  • Restoration Hardware Holdings (RH) 4:06pm, $0.61
  • Advanced Micro Devices (AMD) 4:15pm, $(0.17)
  • City National (CYN) 4:15pm, $0.92
  • Celanese (CE) 4:30pm, $0.78
  • Glacier Bancorp (GBCI) 4:30pm, $0.28
  • Valmont Industries (VMI) 5:30pm, $2.52
  • Western Alliance Bancorp (WAL) Aft-mkt, $0.21
  • Cytec Industries (CYT) Aft-mkt, $0.87 


  • Copper Poised to Enter Bear Market as Industrial Metals Slide
  • Nickel Rout Seen Easing With Output Costs Breached: Commodities
  • Gold Gains as Price Drop Lures Buyers, Economic Data Falls Short
  • Goldman’s Contrarian Currie Foresaw Gold Collapse Paulson Missed
  • Brent Rises From Nine-Month Low; No Emergency OPEC Talks Seen
  • Copper Set to Enter Bear Market on Demand Concern: LME Preview
  • Gold Tumble Stokes Demand From Indian Bazaars to Chinese Malls
  • Gold’s Worst Plunge Since 1983 Ends 12-Year Bull Run: Timeline
  • Palm Oil Advances as Decline to Lowest This Year Seen Excessive
  • Gold’s Deviation to Stocks Tips Equities Rally: Chart of the Day
  • Oil Firms Break Promise on Biofuels as Chevron Defies California
  • BHP Billiton Cuts CEO Pay as Mining Industry Profits Decline
  • China’s Poultry Feed Demand to Slump 20% on Bird-Flu Outbreak
  • Copper’s Drop ‘Not Sustainable’ Near Term, NAB’s Knight Says























The Hedgeye Macro Team












Today we shorted Dollar General (DG) at $51.68 a share at 3:49PM EDT in our Real-Time Alerts. Dollar General is immediate-term TRADE overbought and McGough doesn't like the top-line compares pending.



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