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Last of the Mohicans?

Takeaway: What an epic 48 hours it has been. Just. Total. Chaos. The reality? Everything is playing out precisely how it should have played out.

Last of the Mohicans? - mohicans

 

What an epic 48 hours it has been.  Just. Total. Chaos.

 

We are officially going over the “Waterfall” now. Boats are in midair. People are hanging on trees. Everybody is scrambling, trying to explain what they missed. Trying to make sense out of it all. Hat tip to Bernanke-sponsored bedlam with a big assist from our Central-Planning Fed Overlords.

 

The reality? Everything is playing out precisely how it should have played out.

 

If you’re data-dependent, if you have a rigorous quantitative process backing the research (God forbid), this was a fairly straightforward call to make. US growth has been accelerating as we have been saying all along (well ahead of consensus).

 

Here are the facts: US economic data stabilized from December 2012 through March 2013. From April to June, growth accelerated. On June 18th the Russell 2000 hit an all-time high. Yesterday, on June 19th, the Fed basically repeated all of this and outlined their view on tapering. Cue market mayhem.

 

All of these market dislocations (Treasuries, commodities, etc) were percolating underneath the surface of consensus well before yesterday and today’s frenzy.

 

The reality is that gold is crashing. Treasuries are crashing. Oil is crashing. As far as gold is concerned, the number one thing that has it down on its knees is rising bond yields. If you’re selling gold today, I don’t know what to tell you. Sorry? Gold could eventually go down to $800 for all I know.

 

This huge selloff we’re witnessing in gold, Treasuries and emerging markets – we are in the early innings of what could be a long-term macro trend.

 

Last of the Mohicans? - mohicans2

 

Turning our attention to the rest of the world: What a disaster. Asia is a bloody mess. Go back to the tapes, we’ve been sounding the alarm here for a while now. Asian markets overnight were a debacle with the Weimar Nikkei “outperforming” its peers by only declining 1.7% (no, we still don’t like Japan).

 

As for China—just nasty. I don’t know what else you would call it. Meanwhile, the Hang Seng is down 14.4% since the end of January. Now it’s not as nasty as Brazil, or Russia, but it’s pretty darn nasty. India down 2.9%; Indonesia down 3.7%. Even though we like the Philippines, (it’s an interesting micro story within the broader disaster which is Emerging Markets) we sold that as well. We realized the research there was going to be trumped by the risk management signal.

 

You can’t be dogmatic in your stance. When the macro flows take over, get out of the way.

 

Europe? It doesn’t look good, either. That’s not new. Now if the DAX trend line at 8013 breaks, that would definitely be news. That is a critical line. Most trend lines in Europe are broken. The FTSE just broke its trend. So if the DAX breaks, there will not be one—not one—out of the 86 countries whose equity markets we follow that will have held its trend line, other than the US stock market.

 

Investors are running out of places to put their money. So in a sense, the S&P 500 is the last of the Mohicans. Keep a close eye on the 1583 level on the S&P 500.

 

Now the question is at what point do growth expectations in equities get prices in? I don’t know the answer to that. That’s what we’ve been trying to convey recently. What we have been saying is number one: Don’t buy fixed income and don’t buy commodities or anything that we haven’t liked for six months. Number 2: Take down your equity exposure. That’s the risk management order of the day.

 

Ranting and raving about what has transpired these last six months is no longer my task. It’s history. Right now you take a deep breath. You wait and you watch.

 

One of the first things we’ll be buying is Financials (XLF). We like the Financials. Particularly with the yield spread at 211 basis points wide and climbing. That’s a very bullish indicator for the group. Your buy list should have a lot of financial names on it. After that, we’ll go to the old bailiwick which is consumption-oriented names in healthcare and consumer itself.

 

Keep an eye on that 1583 level on the S&P 500. It’s key. If that breaks, it’s bye-bye to the Mohicans.

 

(Editor's Note: This commentary comes from from Hedgeye CEO Keith McCullough's morning conference call. If you would like to learn more, please click here.)


INITIAL CLAIMS: THE LADY OR THE TIGER

Takeaway: Don't be fooled. The labor market is steamrolling ahead even though people think it's starting to weaken

Below is the breakdown of this morning's claims data from the Hedgeye Financials team.  If you would like to setup a call with Josh or Jonathan or trial their research, please contact .

 

Fool Me Thrice

We've always been fond of our friend Peter Atwater's use of "The Lady or the Tiger" metaphor to contextualize different market dynamics, and the current setup in the labor market seems to us sufficiently apropos. In this case, the market thinks it's getting the Tiger, but in reality it's getting the Lady. In short, the labor market is now a total mirage.

 

The non-seasonally adjusted data is improving at the fastest rate we've seen year-to-date. NSA 4-wk rolling initial jobless claims are today 9.2% lower than at the same point last year. To reiterate, that's the fastest rate of improvement we've seen this year. We show this in the second chart below.

 

Meanwhile, the SA (seasonally-adjusted) data is showing total stagnation. The slope of the curve (the trend line) for SA claims since the start of March is now flat, as the first chart below shows. The interesting dynamic is that the labor market appears to be stagnating at the same time that the Fed is ratcheting up expectations for withdrawing support. This is almost identical to the setup we've seen in the prior three years. #PatternRecognition. 

 

The takeaway is that over the short to intermediate term we would expect weakness in the sector to continue. As a reminder, our simple model for thinking about the [Financials] sector revolves around three core tenets: labor, housing and the Fed. All three fronts are now under seige. 1. Tapering expectations are shifting rapidly. 2. The SA labor market data (the headfake) is stagnating. 3. Housing data remains very strong, but the swift backup in rates is raising fear about the sustainability of the recovery. At a minimum, it's pointing to a deceleration in the rate of recovery.

 

Taking a longer-term view, we see the setup as very favorable. The labor market is indeed improving rapidly. The Fed will likely be sucked back into the market by a) the rise in rates, and b) the perceived deceleration in the labor market, and c) (most importantly) by the selloff in equities. Housing remains a Giffen, so rising prices will continue to self-reinforce. 

 

We published a note in mid-April entitled "Beware the Ides of April", which was a sector-based risk management snapshot of how every name in the sector responded to the last go-around of perceived Fed exit/labor market deterioration. We'll be publishing a redux of that note this morning. 

 

The Data

Prior to revision, initial jobless claims rose 20k to 354k from 334k WoW, as the prior week's number was revised up by 6k to 340k.

 

The headline (unrevised) number shows claims were higher by 14k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims rose 2.5k WoW to 349.25k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -9.2% lower YoY.

 

INITIAL CLAIMS: THE LADY OR THE TIGER - JS 1

 

INITIAL CLAIMS: THE LADY OR THE TIGER - JS 2

 

INITIAL CLAIMS: THE LADY OR THE TIGER - JS 3

 

INITIAL CLAIMS: THE LADY OR THE TIGER - JS 4

 

INITIAL CLAIMS: THE LADY OR THE TIGER - JS 5

 

INITIAL CLAIMS: THE LADY OR THE TIGER - JS 6

 

INITIAL CLAIMS: THE LADY OR THE TIGER - JS 7

 

INITIAL CLAIMS: THE LADY OR THE TIGER - JS 8

 

INITIAL CLAIMS: THE LADY OR THE TIGER - JS 9

 

INITIAL CLAIMS: THE LADY OR THE TIGER - JS 10

 

INITIAL CLAIMS: THE LADY OR THE TIGER - JS 11

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


Dicey: SP500 Levels, Refreshed

Takeaway: If 1605 snaps, there’s no TREND support to 1583. As a result, the plan from here is to wait and watch.

POSITION: 6 LONGS, 4 SHORTS @Hedgeye

 

Dicey is as dicey does. US economic data is surprising on the upside (Existing Home Sales, Philly Fed) as Asian and Emerging Market data is surprising on the downside. Markets aren’t economies – anything can happen.

 

Our decision to sell stocks for the last few weeks was based on the signal. Our signal almost always trumps the research view. And in this case it’s the US economic data being too good that ultimately became the problem for Gold and Bonds. Who would have thunk.

 

Across our core risk management durations, here are the lines that matter to me most:

 

  1. Immediate-term TRADE resistance = 1631
  2. Immediate-term TRADE support = 1605
  3. Intermediate-term TREND support = 1583

 

In other words, if 1605 snaps, there’s no TREND support to 1583. As a result, the plan from here is to wait and watch. I like to be in no hurry when consensus is clamoring to move.

 

Sometimes doing nothing is the best move you can make,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Dicey: SP500 Levels, Refreshed - SPX


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INITIAL CLAIMS: THE LADY OR THE TIGER

Takeaway: Don't be fooled. The labor market is steamrolling ahead even though people think it's starting to weaken. Meanwhile, the 2-10 hits 205 bps.

Fool Me Thrice

We've always been fond of our friend Peter Atwater's use of "The Lady or the Tiger" metaphor to contextualize different market dynamics, and the current setup in the labor market seems to us sufficiently apropos. In this case, the market thinks it's getting the Tiger, but in reality it's getting the Lady. In short, the labor market is now a total mirage. The non-seasonally adjusted data is improving at the fastest rate we've seen year-to-date. NSA 4-wk rolling initial jobless claims are today 9.2% lower than at the same point last year. To reiterate, that's the fastest rate of improvement we've seen this year. We show this in the second chart below.

 

Meanwhile, the SA (seasonally-adjusted) data is showing total stagnation. The slope of the curve (the trend line) for SA claims since the start of March is now flat, as the first chart below shows. The interesting dynamic is that the labor market appears to be stagnating at the same time that the Fed is ratcheting up expectations for withdrawing support. This is almost identical to the setup we've seen in the prior three years. #PatternRecognition. 

 

The takeaway is that over the short to intermediate term we would expect weakness in the sector to continue. As a reminder, our simple model for thinking about the sector revolves around three core tenets: labor, housing and the Fed. All three fronts are now under seige. 1. Tapering expectations are shifting rapidly. 2. The SA labor market data (the headfake) is stagnating. 3. Housing data remains very strong, but the swift backup in rates is raising fear about the sustainability of the recovery. At a minimum, it's pointing to a deceleration in the rate of recovery.

 

Taking a longer-term view, we see the setup as very favorable. The labor market is indeed improving rapidly. The Fed will likely be sucked back into the market by a) the rise in rates, and b) the perceived deceleration in the labor market, and c) (most importantly) by the selloff in equities. Housing remains a Giffen, so rising prices will continue to self-reinforce. 

 

We published a note in mid-April entitled "Beware the Ides of April", which was a sector-based risk management snapshot of how every name in the sector responded to the last go-around of perceived Fed exit/labor market deterioration. We'll be publishing a redux of that note this morning. 

 

The Data

Prior to revision, initial jobless claims rose 20k to 354k from 334k WoW, as the prior week's number was revised up by 6k to 340k.

 

The headline (unrevised) number shows claims were higher by 14k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims rose 2.5k WoW to 349.25k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -9.2% lower YoY, which is a sequential deterioration versus the previous week's YoY change of -9.2%

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 1

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 2

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 3

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 4

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 5

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 6

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 7

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 8

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 9

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 10

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 11

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 12

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 13

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 14

 

<chart14>

 

Yield Spreads

The 2-10 spread rose 14.2 basis points WoW to 205 bps. 2Q13TD, the 2-10 spread is averaging 165 bps, which is lower by -2 bps relative to 1Q13.

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 15

 

INITIAL CLAIMS: THE LADY OR THE TIGER - 16

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


Morning Reads on Our Radar Screen

Takeaway: A quick look at some stories on our radar screen.

Howard Penney – Restaurants

McDonald’s Premium Burgers an Abenomics Indicator? (via WSJ)

The 9 Highest Calorie Drinks You Can Get At Starbucks (via Business Insider)

 

Morning Reads on Our Radar Screen - reading

 

Keith McCullough – CEO

Gold Tumbles to 2 1/2 Year-Low After Fed (via Bloomberg)

Government U-turn fails to quell Brazil protests (via BBC)

The starting point in the immigration debate (via Adam Smith Institute)

 

Josh Steiner – Financials

Bernanke’s Forward Guidance Is Transparent as Mud (via Bloomberg)

U.S. banks failed to follow mortgage standards: monitor (via Reuters)

 

Kevin Kaiser – Energy

SandRidge ousts CEO Ward, Bennett takes the helm (via Reuters)

 

Matt Hedrick – Macro

Italy's Five Stars lose their twinkle as ejection of MP sparks ugly row (via The Guardian)

 

Daryl Jones – Macro

Blackhawks defeat Bruins in OT to even Final (via NHL.com)


SWISS CHEESING THE PNK BULL CASE

$5 in free cash flow – ‘nuff said.  Umm, not so fast.  There’s a lot more to say.



That is the bull case in a nutshell - $5 in free cash flow per share post deal.  I’ve heard it/read it from the buy side and sell side alike.  In fact, I’d go so far as to say it is consensus.  PNK is a consensus long.  There, I said it.  And why wouldn’t it be?  With the acquisition of Ameristar (ASCA), $5 in free cash flow per share is coming in 2015 for a yield of 25%.

 

But wait, wasn’t that $5 calculated pre-divestitures?  And if you like PNK with 25% yield, then you must love Boyd Gaming (BYD) at over 25% with less leverage.  Come to think of it, there are a lot of holes in the long PNK thesis.

  • $5 is not sustainable.  PNK maintains $271 million in federal NOLs – which have value but should be valued separately (NPV of over $1 per share) – so the $5 should be tax effected to calculate recurring FCF.  This adjustment results in FCF per share of $4.05 to $4.25.  But…
  • The $5 was calculated before the FTC forced PNK to divest ASCA Lake Charles and Lumiere Place.  Assuming these assets can be sold for 7.0-7.5x EBITDA, the $5 becomes $4.30-4.50.  Tax effected, FCF per share drops to $3.25-$3.45.
  • So $3.35 is not a bad number right?  Well, let’s not forget about leverage and its impact of FCF yield.  More than 6.5x post deal leverage is not sustainable.  Free cash flow will not accrue to equity holders until PNK reduces its leverage to under 4x or 2018 at the earliest.
  • All this FCF accretion and calculations are predicated on the sustainability of this ridiculously low interest rate environment.
  • As a reality check, let’s evaluate the old gaming valuation standby metric of EV/EBITDA.  I calculate a multiple of over 8.0x 2014 EV/EBITDA and 7.5x 2015.  Remember that regional gaming companies have traded within a range of 5.0-8.0x forward 12 months EBITDA.
  • But valuations have been re-rated higher as gamers are viewed through the real estate prism.  PENN’s announced REIT conversion certainly had this impact.  However, we don’t think PNK will reach low enough leverage to pursue a REIT conversion until 2019.
  • The real estate angle notwithstanding, do we really want to put historically high multiples on a business with declining ROICs and falling ROIs on new builds?  The US is already saturated with slots and there is no end in sight in terms of potential for new states legalizing casinos. 
  • At the same time that supply is increasing, demand is waning – and it’s not the economy, stupid!  Domestic casinos face a declining slot customer base.  The data suggests that Baby Boomers are the last of the generational slot players.  I’m Generation X – the Atari generation – and I’m not going to start playing slots when I turn 60.  

SWISS CHEESING THE PNK BULL CASE - FCF


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