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Mercy Calling

“Nothing emboldens sin so much as mercy.”

-Shakespeare

 

US stock market bears and Gold bulls alike are begging for mercy this morning, and we will give it to them. I am getting my first coordinated overbought (SP500) and oversold (Gold) signal of 2013. Both signals are explicitly linked to an overbought one in the US Dollar Index. #StrongDollar, on behalf of the 99% of us, we salute you.

 

The aforementioned quote is one of my favorites in Shakespeare’s Timon of Athens. When I read it in college, I glazed right over it. When I re-read it in William Silber’s Volcker – The Triumph of Persistence, I smiled. I have had 2 feet on the floor, every day, for 5 years competing with sell-side research that doesn’t have the downside I do if I start to get things really wrong. I don’t want mercy.

 

Volcker believed in mercy – but he also believed free market actors needed to understand and feel pain. After the Policies to Inflate of the 1970s , Volcker reminded Dan Cordtz on ABC in 1980 that “people need to change their expectations and their behavior, and that is always an uncomfortable process.” (Volcker, pg 198). So was being long “inflation” and/or commodities for the next 7-8 years.

 

Back to the Global Macro Grind

 

Bernanke, of course, doesn’t have the spine to say anything remotely close to what Volcker did throughout the early 1980s. And the sad reality of our centrally planned market lives (after Bernanke) is that someone like Janet Yellen or Turbo Tax Timmy won’t either.

 

But, as my man Einstein, would say – everything is relative. And the probabilities continue to mount that both the Japanese and Europeans will be more dovish than anyone at the Fed is allowed to be; particularly when we see a 6% handle on US unemployment.

 

American confidence in government was so beaten down by Nixon, Carter, and Arthur Burns (the 1970s version of Bernanke), that by the time 1982 rolled around consensus couldn’t believe that #CommodityDeflation served as a tax cut. Growth stabilized and:

  1. Gold kept getting hammered as #GrowthAccelerating became clearer in 1
  2. Oil prices went straight down – the average price per barrel under Reagan = $16.53!
  3. US Dollars ripped the #EOW America camp a new one (average USD Index = $115.25 under Reagan)

No this isn’t an I love Reagan thing. Have mercy on me, please. US politics makes me sick, blah! If the US Dollar Index were to scream +37% to the upside (from today’s price), and Oil were to crash (like down more than 80% from here), would you be happy?

 

That’s what I am talking about when I say #StrongDollar, Strong America. Russian oligarchs, Middle Eastern Kings, and American Oil/Mining execs might disagree with me on that. Just a bit.

 

What’s in your wallet? How much Gold are you going to bring to buy beers at tonight’s Bruins game? The shiny metal expectations of a Ben Bernanke to Infinity and Beyond world are fading folks. Gold is crashing (-25% since that epic policy day for Bernanke in September of 2012, when Cramer proclaimed “I love Gold here!”); smoked again this morning, -1.5% to $1372/oz.

 

Here are my big mercy signals (immediate-term TRADE overbought and oversold) born out of this USD/Gold capitulation:

  1. US Dollar Index = immediate-term TRADE overbought at $84.21 (remains in a Bullish Formation)
  2. Gold = immediate-term TRADE oversold at $1370 (remains in a Bearish Formation)
  3. SP500 = immediate-term TRADE overbought at 1660 (remains in a Bullish Formation)

Overbought and oversold is as prices do. So I could be wrong on this (i.e. early) by 1-2 days or I could be really right. The entire point about my risk management process is making mercy decisions when the pain points to the highest probabilities I can model.

 

The hardest thing to do in this game is wait on your pitch. I still swing at outside pitches way too often. Whenever I do, it’s either my emotions or our research views that get the best of me. For those mistakes, I have no one to blame but myself.

 

The easiest thing to do in Global Macro is ride trends. The big moves (particularly at bifurcation points in policy) tend to be more glacial than you see in single stocks. Gold went up for 12 straight years don’t forget. Unwinding #EOW (end of the world trade) will take time.

 

Process Review - our risk management model is Duration Agnostic. That means we contextualize the short term within the long-term:

  1. TRADE = 3 weeks or less (our immediate-term risk ranges live in this time frame)
  2. TREND = 3 months or more (our best backtests live here – i.e. the calls we tend to get the most right)
  3. TAIL = 3 years or less (usually our best rate of change signal, only when the TREND agrees with it)

So, Bullish Formations are securities that are bullish on all 3 of our core durations (TRADE, TREND, and TAIL) and Bearish Formations are just the mirror opposite of that.

 

Gold is the mirror opposite of the US Dollar and the SP500 right now. That’s why we are very loud and consistent about our views on all 3 of these big macro moves. Get the US Dollar right, and you tend to get a lot of other big things right.

 

Getting the mercy pain points right is a very immediate-term risk management exercise. I do all of that timing/probability work underneath the hood myself. I used to tar basement walls for my Dad too. I like getting my hands dirty (if someone pays me to). Mercy Calling is a dirty job, but someone has to do it.

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, UST 10yr Yield, VIX, Russell2000, and the SP500 are now $1, $100.18-103.98, $82.93-84.21, $1.28-1.30, 100.21-103.39, 1.86-1.99%, 12.23-13.87, 971-993, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Mercy Calling - Chart of the Day

 

Mercy Calling - Virtual Portfolio


THE M3: SJM EXECS SELL SHARES; BOWIE COMMENTS; VENETIAN SUBCONCESSION

The Macau Metro Monitor, May 16, 2013

 

 

2 SJM EXECUTIVES SELLING UP TO $56.7 MLN OF COMPANY'S SHARES WSJ

CEO Ambrose So and COO Louis Ng are selling a total of 20 million shares in a price range of HK$21.50 to HK$22.00 each (representing up to $56.7MM).  The price range represents a discount of 4.4% to 2.2% to Wednesday's closing price of HK$22.50, it says. Deutsche Bank is handling the deal.

 

MGM CHINA SEES MACAU'S VIP GAMING BUSINESS CONTINUING TO PICK UP Bloomberg

Double-digit growth from VIP customers is “sustainable” for the industry and the casino operator’s business from high-stake gamblers is “solid,” said MGM China CEO Grant Bowie.  “Everyone was speculating some negative impact, but the leadership change wasn’t an impact,” Bowie said, referring to the government transition in mainland China. “There’s also a level of resilience in terms of how China market is performing relative to the global market.”

 

MACAU GOVT REASSURED LAS VEGAS SANDS' BANKERS Macau Business

Secretary Tam sent a letter to one of LVS’ bankers to assure that the company could operate in Macau autonomously from its Chinese partner, Galaxy, even in the event of termination and extinction of Galaxy Casino’s concession contract.  Venetian Macau is technically a sub-concessionaire of Galaxy Casino S.A. since 2002.  A copy of the letter was sent to Bank of Nova Scotia – at the time a lead arranger of project debt for LVS – in 2006 and signed by Mr Tam.

 

According to Business Daily, that assurance was important, because some of the gaming operator’s banking partners – many of them Western companies – fretted that the company’s Macau rights, technically and officially a sub-concession, could be at risk if the supposedly senior partner Galaxy Casino S.A., a local unit of Galaxy Entertainment Group, lost its primary licence.  The letter states that “Venetian Macau S.A. shall be able to exploit games of chance and other games in casino [sic] in Macau autonomously from Galaxy Casino S.A., even in the event of termination and extinction of Galaxy Casino S.A.’s concession contract…”


 

 

 

 


Trade of the Day: YUM

Takeaway: Keith booked a nice gain selling shares of YUM this morning.

Keith booked a gain today in YUM, selling the stock at 10:15am at $70.45 a share.

 

Keith writes of his trade, “Backcheck. Forecheck. Paycheck. (We’re) booking our third consecutive gain for Sir Howard Penney (Hedgeye’s Restaurants sector head) in YUM since April. He (Penney) remains bullish on this very tradeable stock.”

 

Trade of the Day: YUM - YUM


Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

IS JAPAN SIGNALING AN END TO THE “END OF THE WORLD” TRADE?

Takeaway: If the crashing yen and tumbling JGB market are signaling anything to us, it’s that the end-of-the-world trade appears to be ending.

SUMMARY BULLETS:

 

  • JGBs are fast falling in price on a combination of improved domestic and global growth expectations and a parabolic increase in domestic inflation expectations. Credit risk is not a meaningful factor in the recent backup in JGB rates.
  • If the crashing yen and tumbling JGB market are signaling anything to us beyond Japan, it’s that the end-of-the-world trade appears to be ending. To varying degrees, these signals are being confirmed across the US Treasury bond market and in the price of gold, which are also breaking down/broken down quantitatively.
  • Could we see a 1994-style or 2003-style backup in super-sovereign interest rates over the next 12-18 months? Absolutely – especially if you believe in the reflexive @HedgeyeMacro bull thesis for the US economy: #StrongDollar = #ConsumptionTaxCut; #HouseholdFormationAcceleration; #BabyMakingBacklog; #ParabolicHousingMarket; and #LaborMarketImprovement.
  • The key question investors should be asking as it pertains to their US equity exposure is whether today’s setup is more akin to 1994 (SPX down -1.5%) or 2003 (SPX up +26.4%). The Weimar Nikkei 225 doesn’t really care all that much, as it appreciated +13.2% in 1994 and +24.5% in 2003 in spite of the commensurate backups in JGB rates.

 

It would be an understatement to say that JGB yields are backing up across the curve. From their respective YTD lows (2/12 for 2Y; 4/4 for 10Y and 4/5 for 30Y), nominal JGB yields have backed up +11bps, +41bps and +79bps on the 2Y, 10Y and 30Y tenors, respectively. Looking to the 2Y and 10Y tenors, specifically, the JGB market’s pricing in of the regime change at the BOJ (unprecedented monetary base expansion; longer maturity purchases) has now been completely unwound.

 

IS JAPAN SIGNALING AN END TO THE “END OF THE WORLD” TRADE? - 1

 

Looking to the 10Y JGB tenor specifically, the recent selloff has some investors believing that the time is now as it relates to a JGB market swoon. Irrespective of the fact that a lot of those same investors have been inappropriately making that call for years, we are finally inclined to side with them at the current juncture as yields have finally broken out above our long-term TAIL line of resistance (now support).

 

IS JAPAN SIGNALING AN END TO THE “END OF THE WORLD” TRADE? - 2

 

From our macro team’s perspective, there are three primary reasons why a super-sovereign debt security like a JGB, UST or Bund would fall in price:

 

  1. Expectations of #GrowthAccelerating
  2. Expectations of #InflationAccelerating
  3. Credit risk rising

 

Below, we explore all three from Japan’s perspective and offer up our thoughts on what may be the beginning of the end for the #EOW (end-of-world) trade (i.e. long USTs, JGBs, JPY and Gold).

 

#GrowthAccelerating?

As we mentioned in a recent research note, the trend in Japanese economic data is finally starting to improve – which is to be expected given that the country is attempting to confirm an escape from its third recession in the past five years. From an international perspective, we continue to sing the praises of our non-consensus bullish thesis on US economic growth. #StrongDollar commodity deflation has proven to be a marvelous offset to analytically-loose fiscal policy fears (sequestration and tax-hikes) in the YTD.

 

IS JAPAN SIGNALING AN END TO THE “END OF THE WORLD” TRADE? - UNITED STATES

 

Jumping back to Japan specifically, BOJ Governor Haruhiko Kuroda today rejected an opposition-party member's argument that the recent surge in the Japanese equity market is out of line with Japan's real economy, stating: "At this moment I do not think they are in a bubble."

 

As previously mentioned, JGB yields are starting to back up in aggressive fashion – much like they did back in 1994 and 2003, alongside a commensurate backup in yields across the US Treasury curve. Both were positive signals for Japanese equities then and the current signal is likely indicative of the asset allocation shift we have been calling for in recent months.

 

IS JAPAN SIGNALING AN END TO THE “END OF THE WORLD” TRADE? - 4

 

IS JAPAN SIGNALING AN END TO THE “END OF THE WORLD” TRADE? - 5

 

To that tune, only 6.8% of Japanese household financial assets are held in equities vs. 14.4% for the Eurozone and 32.8% for the US. Clearly there’s lots of hay to bale for “Mrs. Watanabe” and her 55.2% allocation to currency and deposits – which then are funneled back into JGBs via bank intermediation.

 

This circuitous  method of sovereign financing has saddled roughly one-fourth of Japanese banks balance sheets with low-yielding JGBs – exposing them to a meaningful degree of interest rate risk. Per a 2H12 report out of the BOJ:

 

  • Japanese banks would face a total of 6.7 trillion yen ($84 billion) in losses if rates rise by +100bps;
  • Losses at major banks would total 3.7 trillion yen, while those at regional banks would amount to 3 trillion yen; and
  • The average maturity of Japanese debt held by large lenders is about 2.5 years and about 4 years for regional banks.  

 

Of course, Japanese banks would love for yields to back up in a controlled manner (i.e. at a rate where credit expansion can occur to help offset marked-to-market losses on existing holdings). The average interest rate on new loans across the Japanese banking system has consistently tracked the 10Y JGB yield to new all-time lows over the past 20 years, compressing banks’ NIMs and eroding banks’ earnings power in the process.

 

IS JAPAN SIGNALING AN END TO THE “END OF THE WORLD” TRADE? - 6

 

#InflationAccelerating?

You know where we stand on Policies To Inflate and the likely unintended consequences of Japan burning its currency at the stake, so there’s no sense in wasting anyone’s time rehashing that here. What is worth pointing out, however, is the fact that Japanese breakevens have gone absolutely parabolic, closing at 1.84% on the 5Y tenor. The JGB market is taking Abenomics quite seriously.

 

IS JAPAN SIGNALING AN END TO THE “END OF THE WORLD” TRADE? - 7

 

IS JAPAN SIGNALING AN END TO THE “END OF THE WORLD” TRADE? - 8

 

On the recently released APR Consumer Confidence report (which ticked down -0.3ppts MoM to 44.5), the percentage of Japanese households that expected consumer prices to rise increased +370bps MoM to 82.8% – good for a ~4.5yr high.

 

#CreditRiskAccelerating?

This is probably the least likely cause of the recent plunge in JGB prices. At this point, reminding investors of Japan’s bleak sovereign fiscal situation is not worth the time it would take to type it. That being said, however, the Japanese sovereign itself is not immune to interest rate risk – particularly if the aforementioned backup in rates is being driven by inflation, rather than economic growth.

 

It’s worth noting that debt service already consumes 47.2% of tax and fee revenue in Japan, which also equates to about 4.6% of nominal GDP. The sovereign interest expense alone accounts for 44.5% of debt service and 1.8% of nominal GDP – and that’s on a weighted average cost of capital of 1.2%.

 

IS JAPAN SIGNALING AN END TO THE “END OF THE WORLD” TRADE? - 9

 

IS JAPAN SIGNALING AN END TO THE “END OF THE WORLD” TRADE? - 10

 

IS JAPAN SIGNALING AN END TO THE “END OF THE WORLD” TRADE? - 11

 

From a credit market perspective, buyers and sellers of CDS contracts on the Japanese sovereign continue to see waning risk of a sovereign default. That’s bad news for crisis sellers across the investment landscape. Again, you won’t ever see us #timestamp a call on sovereign credit risk without some confirming evidence from the credit market itself – of which there is none in Japan at the current juncture.

 

IS JAPAN SIGNALING AN END TO THE “END OF THE WORLD” TRADE? - 12

 

All told, we see limited signs that the recent backup in JGB yields is being driven by credit risk. The only new news on the Japanese fiscal policy front worth mentioning is the Ministry of Finance’s decision to punt the announcement of its medium-term fiscal reconstruction plan to the SEP G-20 Summit in Russia, originally scheduled for next month’s G-8 meeting in the UK.

 

That’s an extremely loose catalyst for the credit risk camp to hang their hats on here. In fact, the only bearish credit risk scenario we can piece together from that is the fact that it will come after the Upper House elections in late-JUL. By then the LDP will have a likely majority there as well, giving it full reign to enact whatever fiscal policies it pleases – including kicking the can down the road on the first VAT hike, which is scheduled to occur early next year. Recall that former DPJ Prime Minster Yoshihiko Noda staked his political career on getting that piece of legislation ratified.

 

#EOW Ending?

If the crashing yen and tumbling JGB market are signaling anything to us, it’s that the end-of-the-world trade appears to be ending. To varying degrees, these signals are being confirmed across the US Treasury bond market and in the price of gold, which are also breaking down/broken down quantitatively.

 

IS JAPAN SIGNALING AN END TO THE “END OF THE WORLD” TRADE? - 13

 

IS JAPAN SIGNALING AN END TO THE “END OF THE WORLD” TRADE? - 14

 

Could we see a 1994-style or 2003-style backup in super-sovereign interest rates over the next 12-18 months? Absolutely – especially if you believe in the reflexive @HedgeyeMacro bull thesis for the US economy: #StrongDollar = #ConsumptionTaxCut; #HouseholdFormationAcceleration; #BabyMakingBacklog; #ParabolicHousingMarket; and #LaborMarketImprovement.

 

The key question investors should be asking as it pertains to their US equity exposure is whether today’s setup is more akin to 1994 (SPX down -1.5%) or 2003 (SPX up +26.4%). The Weimar Nikkei 225 doesn’t really care all that much, as it appreciated +13.2% in 1994 and +24.5% in 2003 in spite of the commensurate backups in JGB rates.

 

Darius Dale

Senior Analyst


CHART DU JOUR: MASSIVE INCREASE

MPEL’s Mass push has been an overwhelming success

 

  • Mass revenue per table still climbing at a fast rate for all operators with the exception of capacity constrained SJM
  • MPEL’s Mass business has come a long way in 2 years and the operator is firmly entrenched as the market leader in terms of productivity and growth (along with Galaxy on the growth front)
  • Remind us again why MPEL deserves such a valuation discount?  It can’t be due to operational prowess.  EBITDA is not shown here but MPEL is also the market leader in same-store EBITDA growth over the same period.

 CHART DU JOUR: MASSIVE INCREASE - mass1


PF - No New Holes to Poke in a Solid Quarter

The issues with PF are well known – crappy categories and sluggish top line sitting atop a highly-levered balance sheet.   As we mentioned previously, the company does have some margin levers to pull in ’13, which may be helped over time by lower commodity costs.  All of these factors came together in what was a pretty solid first quarter out of the IPO gate.



What we liked:

  • EPS of $0.34, ahead of somewhat unreliable consensus estimate
  • A substantial improvement in gross margins (+290 bps) against an easy comparison – this is where we see the most opportunity for progress for the company in 2013, as per our prior piece on the name
  • Excellent FCF quarter ($49.5 million or $0.42 per share versus $20.3 million in the year ago)
  • Next quarter’s comparisons remain unchallenging, so we could likely see a repeat of the margin performance posted in Q1
  • New dividend (as of last night) - $0.72 annually

What we didn’t like:

  • Lackluster sales growth in Birds Eye Frozen (+0.7%) and Duncan Hines (2.3%) even with volumes flattered by the timing of Easter
  • Inventories increased 2.6%, outpacing sales growth

Bottom line, with the newly instituted dividend, downside in the name is probably limited to $22/$23 per share (where the yield with the annual $0.72 dividend creeps above 3%).  Further, with another quarter of easy margins comparisons, there is likely some further upside in the shares despite what we see as full valuation.

 

Call with questions,

 

Rob

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

E:

P:

 

Matt Hedrick

Senior Analyst



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This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.

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