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Hold The Line

Client Talking Points

Slicing Through The VIX

The S&P 500 held its line of support for us at 1557 on an immediate-term TRADE basis. Guess what happened to volatility (especially after that fake AP tweet was taken care of)? The VIX fell back below TRADE support of 14.82. We can go much lower and the pain trade right now, as far as the VIX goes, is at 10.97. Remember: Nothing is impossible.

Euro Trip

We covered our short position in the Euro yesterday (via FXE) at the low end of our risk range: 1.29-1.31. There's plenty of long-term TAIL risk for the EU that should have those trading the currency on their toes watching every move the ECB makes. Will they cut rates to zero? Will they bail everyone and their mother's pension out? Wait and see. The next meeting is May 2nd and we'll know a lot more then and knowing is half the battle. 

Asset Allocation

CASH 24% US EQUITIES 24%
INTL EQUITIES 18% COMMODITIES 0%
FIXED INCOME 6% INTL CURRENCIES 28%

Top Long Ideas

Company Ticker Sector Duration
IGT

Decent earnings visibility, stabilized market share, and aggressive share repurchases should keep a floor on the stock.  Near-term earnings, potentially big orders from Oregon and South Dakota, and news of proliferating gaming domestically could provide near term catalysts for a stock that trades at only 11x EPS.  We believe that multiple is unsustainably low – and management likely agrees given the buyback – for a company with the balance sheet and strong cash flow as IGT.  Given private equity’s interest in WMS (they lost out to SGMS) – a company similar to IGT that unlike IGT generates little free cash – we wouldn’t rule out a privatizing transaction to realize the inherent value in this company. 

FDX

With FedEx Express margins at a 30+ year low and 4-7 percentage points behind competitors, the opportunity for effective cost reductions appears significant. FedEx Ground is using its structural advantages to take market share from UPS. FDX competes in a highly consolidated industry with rational pricing. Both the Ground and Express divisions could be separately worth more than FDX’s current market value, in our view. 

HOLX

HOLX remains one of our favorite longer-term fundamental growth companies given growing penetration of its 3D Tomo platform and high leverage to the 2014 Insurance Expansion from the Affordable Care Act. 

Three for the Road

TWEET OF THE DAY

"Kingsbridge Armory in The Bronx to be transformed Bronx into the world’s largest ice-skating mecca stks.co/iSgJ AWESOME" -@LDrogen

QUOTE OF THE DAY

"I may not have gone where I intended to go, but I think I have ended up where I needed to be." -Douglas Adams

STAT OF THE DAY

Over $20 billion has been redeemed from exchange-traded products that focus on gold.



Stuff Changes

This note was originally published at 8am on April 10, 2013 for Hedgeye subscribers.

“We are made of the same stuff of which events are made.”

-Ralph Waldo Emerson

 

That’s the opening volley from astrophysicist Eric Chaisson in one of my favorite risk management books, Cosmic Evolution. What’s up with that? What’s up with a chaos theorist prefacing his ideas with the penmanship of a mid-19th century American essayist? It’s all about the storytelling folks. As Taleb recently wrote in Antifragile, “evolution does not depend on narratives, humans do.”

 

While finding the deep simplicity of the Global Macro point that matters can often feel like finding Waldo himself, Chaisson channeling Emerson is consistent with our discipline of Embracing Uncertainty. Emerson was labeled as a “transcendalist” – he preached individualism and self reliance; he did not support dogmatic and/or traditional organizations.

 

We’re human, so we want things about markets to make simple sense within our organizational boxes. But markets change, fast and slow. Sometimes they make sense. Sometimes they don’t.  In the heat of a thermodynamic moment, does every phase change make sense to everyone? Does that change care if you understand it? Of course not. Best we can do is try to keep up.

 

Back to the Global Macro Grind

 

Keeping up with the US stock market hasn’t been easy for the #PTCs (professional top callers). Every time the SP500 sells off to a higher-low (1540 on Friday), they claim victory. Every time we rally off those higher-lows to higher all-time highs, I hear crickets.

 

Crickets? What are crickets? Do you hear them on the floor of the NYSE? Crickets – you can hear the hum when something was supposed to happen, and didn’t. #crickets

 

While I am not entirely sure what kind of a risk management process top-calling is, it fits within the confirmation biases of consensus. My tally is up to 28 high profile PMs, strategists, pundits, etc. who are currently still trying to call the top in US stocks. Maybe this time is different – maybe they’ll all nail it, at the same time. Maybe not.

 

Quantifying sentiment in markets is probably the hardest thing to do – I’ve tested and trialed almost every voodoo signal I have been issued on this front, and I am left with very few that I’d actually act on. Let’s consider those few:

 

1.   Sentiment Spread – the II Bullish/Bearish survey data doesn’t tell me much on most metrics other than its historical spread (ie Bulls minus Bears). This morning, that spread is +2990 basis points wide. Over a decade of my tabulating/monitoring this spread, a relatively safe sell zone is +3500-3700 basis points wide. A relatively safe buy zone is 900-1500 basis points wide.

 

2.   Exhaustion (VIX vs SPX) – while plenty will quibble with this for theoretical reasons (“front month doesn’t reflect sentiment” … “term structure matters more”, etc. etc.), for me it’s just a signal that I’ve built for myself that works most of the time. The problem with it is that it’s not signaling all of the time. So I have to wait on it.

 

If you’ve studied thermodynamics, you’ll agree that waiting for a certain amount of entropy matters before you register a certain amount of consequential change (energy). That’s one way to conceptualize my VIX/SPX signal. What I am waiting on is:

 

A)     SPX immediate-term TRADE oversold

B)      VIX immediate-term TRADE overbought

 

Sounds simple, because it is – after you’ve incorporated multiple-factors across multiple-durations in order to contextualize that immediate-term moment. In other words, it’s a lot easier to roll with the conclusion after the process signals it.

 

I’m not submitting that I haven’t been run over by my signals once in a while. Nor am I suggesting that either the Sentiment Spread or the VIX/SPX signal are stand alone silver bullet signals. They are just two of the many tells I use instead of gnomes.

 

Just to roll through putting the aforementioned into action:

  1. On Friday morning, the SP500 was immediate-term TRADE oversold at 1540
  2. On Friday morning, the VIX was immediate-term TRADE overbought at 15.23

So, our #RealTimeAlerts (immediate-term signaling product) acted, aggressively on that, covering shorts and buying stocks (including the SPY itself). This is not about taking victory laps – this is about being accountable to what I do and why. I feel like putting my process out there like this makes it better. Sharp clients question it; so do my analysts internally. In the end, for me at least, that’s a win.

 

The other side of the buy/cover signal is to have the discipline to sell/short on the bounce. We’ve seen that for a few days since the Friday lows, and now, as the SP500 makes another all-time high, we’ll get another SPX overbought/VIX oversold signal too.

 

Will that happen at VIX 12.21 and SPX 1576? I don’t know. And that’s the point. Embracing Uncertainty in a non-linear and dynamic ecosystem like this is what I do. Stuff Changes. So I need to change alongside it.

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1544-1585, $103.86-107.78, $3.29-3.47, $82.23-83.34, 96.12-100.05, 1.71-1.82%, 12.21-14.51, and 1561-1576, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Stuff Changes - Chart of the Day

 

Stuff Changes - Virtual Portfolio


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Arrow Points Up

“Entropy is time’s arrow.”

-Arthur Eddington

 

That’s not a new reality. But it’s always an important one to remember. Arthur Eddington was the British astrophysicist who first called entropy “time’s arrow” in his 1927 book, The Nature of the Physical World.

 

You don’t have to be a physics guru to understand the concept of entropy. The 2nd law of thermodynamics calls entropy the price paid by an ecosystem when energy changes. I love applying that thought to markets – particularly when they are undergoing phase transitions.

 

“The rates of change of entropy differs for each specific event. All the while the rate of change of time itself is taken to be uniform, ceaseless, and non-negotiable.” (Chaisson, Cosmic Evolution, pg 31)

 

Back to the Global Macro Grind

 

Moving fast, and slow. That’s what markets do. If you could have a signal to probability weight that the market’s entropy is about to change fast, you’d take it. Or at least I would. Some signals really matter.

 

One of the most basic relationships in a market is expected price versus volatility. The key word is expected. The two factors (price and volatility) have to be contextualized across multiple durations.

 

With those thoughts in mind, let’s look at the price of the SP500 vs front-month US Equity Volatility (VIX):

  1. SP500 is in a Bullish Formation (bullish TRADE, TREND, and TAIL)
  2. VIX is in a Bearish Formation (bearish TRADE, TREND, and TAIL)

Three days ago, points 1 and 2 were not true:

  1. SP500 was bearish TRADE (below 1557)
  2. VIX was bullish TRADE (above 14.82)

In between now and then, you were allowed to make a risk managed move (buy and/or cover) on the explicit signal (SPX breaking out, back above 1557, and VIX breaking down through 14.82). You were also allowed to ignore my signal. It’s a free world, sort of.

 

I rarely ignore my signal.

 

Obviously I am simplifying this basic relationship between expected price/volatility. I can front-run the gotcha guys who will say that using front-month VIX instead of the implied term-structure of volatility’s curve is a mistake. But why is it if the signal works?

 

Mixing theory with practice is a dangerous game. You don’t have to take my word for it on that – try it with your own money at home. Some have mathematical theories. Some have qualitative theories. There’s a lot of baggage in theories that don’t embrace change.

 

My sense is that consensus still isn’t bullish enough on the SP500. My sense is that consensus isn’t bearish enough on US Equity Volatility. But, to be clear, my senses aren’t based on how I feel. My sense is my signal.

 

What is the most probable path that consensus considers improbable this morning?

  1. SP500 going to 1603
  2. VIX dropping to 10.97

Do you disagree with that? Why?

 

On Thursday (last week) at 3PM EST here’s where the market was:

  1. SP500 = 1538
  2. VIX = 18.16

This morning:

  1. SP500 = 1578
  2. VIX = 13.48

The context of this 3-day move (across durations) matters. Intermediate-term TREND support for the SP500 (1515) wasn’t violated on the downside inasmuch as intermediate-term TREND resistance for the VIX (18.89) didn’t break-out on the upside.

 

Should there be a difference between how you feel about a market when volatility drops 25% in a straight line? Should you make decisions based on feelings? Or should you re-model what’s becoming more or less probable for different expected price and volatility parameters?

 

I’m asking too many questions this morning. And I apologize for that. Maybe I should have just written a one sentence Early Look that said my model is signaling an up arrow for the SP500, and a down one for VIX to 1603 and 10.97, respectively.

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1, $96.68-104.06, $82.47-83.19, 97.27-101.31, 1.68-1.80%, 10.97-14.82, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Arrow Points Up - Chart of the Day

 

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THE M3: MPEL PHILIPPINES

The Macau Metro Monitor, April 24, 2013

 

 

MELCO CROWN'S PHILIPPINE UNIT SETS SHARE OFFER PRICE Macau Business

Melco Crown (Philippines) Resorts Corp, the Philippine unit of MPEL, set an offer price of Ps14 (MOP2.71) per share for its top-up placement, according to several media outlets.  This means the company will raise more than US$370 million (MOP2.96 billion) from the follow-on share sale.  Melco Crown (Philippines) Resorts is selling a total of 1.10 billion shares, including the overallotment option, said UBS, which is managing the offer with Citigroup.


According to one banker quoted by FinanceAsia.com, the deal attracted strong demand, including from international investors.  The proceeds of the share sale will go towards the cost of furnishing and operating the Belle Grande Manila Bay resort, a US$1-billion gaming complex MPEL is developing in the Philippines in partnership with Philippine-based Belle Corp.  The resort is set to open in mid-2014.

 


 


PNRA SHORT THESIS PLAYING OUT AS EXPECTED

PNRA reported 1Q EPS $1.64 vs. consensus of $1.65 and SSS of 3.3% which missed the 4.3% consensus expectations.  The company pulled the weather card, citing an impact of -1.0% to -1.5% impact from traffic.  The quality of the earning was low in the quarter as EPS benefited $0.05 from resolution of tax matters.  The company left the full year guidance unchanged at +17-19% growth or $6.89-$7.01 (including an extra week).

 

During 1Q13, traffic was -2.4% vs. expectations of -0.9%, which was a sequential decline of -240 basis points from 4Q12.  Even adding back the weather impact of 1.5%, traffic declined 90 basis points sequentially. 

 

The bulls will likely highlight that the March and April comparable sales growth numbers seem back on track, with March running at +4.7% and the first 27 days of April seeing comparable sales growth at +5% at company locations.  Assuming +5.5% in traffic and mix this still suggests negative traffic and we expect traffic to remain pressured for the balance of the year.  Considering the national cable marketing effort that kicked off in February, as part of the higher advertising spending plan for 2013, this is a red flag.

 

Our short thesis remains intact and we expect consensus estimates to be revised down over the coming weeks.  Management maintaining FY13 guidance has heightened the risk that 2H13 earnings miss expectations.

 

The company is hosting its EPS conference call at 8:30am ET.  We’ll post on anything incremental after the call.

 

 

Howard Penney

Managing Director

 

Rory Green

Senior Analyst


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