"I'm trained in weapons, demolition, and unarmed combat. I'm a sniper, and I'm the platoon medic. But most of all, I'm an American."
-Marcus Lutrell, US Navy SEAL
For Memorial Day weekend, I re-read "Lone Survivor." If you're looking for a reminder as to what it takes to face real adversity for your country, that would be the required reading.
What we've had to deal with on a day-to-day basis in financial markets is not even in the same solar system as what Marcus Lutrell overcame in Afghanistan. To the lost heroes of SEAL Team 10, and all those who watch over this country while our families sleep - we can never Thank You enough. We get to wake-up and play this game every day because of you.
This game of REFLATION that I have been riding in the US stock market for the better part of 2009 became a materially riskier one to be invested in last week. I think the BIG move in the REFLATION trade is behind us, so I'm starting to get out.
What was the inflection point? That's simple - going from a proactively predictable exercise of Breaking The Buck, to crashing it. As the US Dollar broke what I consider emergency support (at the $81.48 line on the US Dollar Index), I opted to cut my Asset Allocation to US Equities and Commodities to 27% and 12% of my max exposures, respectively. Additionally, I made 20 consecutive sales in our virtual stock portfolio. I now have 18 long positions and 12 short positions.
What Tim Geithner and his boss have labeled a "Stress Test" pales in comparison to what lies in front of them if this US currency crisis starts to trend sustainably in its current direction. Amplifying this international economic problem is The New Reality that America's enemies (North Korea, Iran, the Taliban, etc...) are more than willing to use the weaponry of market-timing to their advantage.
Market timing? Who does that? I do - and apparently "they" do too. Does anyone in Washington think for one second that the timing of missile testing and insurgencies doesn't incorporate some level of marked-to-market sophistication?
C'mon guys, let's seriously wake-up and smell the Robusta beans this morning. Our enemies are more than happy to inaugurate President Obama into the real global macro stress testing that was always pending. Markets are where people in this world get paid. Geopolitical risk is a monetize-able weapon of considerable destruction.
These aren't my politics. This is my investment process. I'm trained in real-time market prices. But most of all, I am a Risk Manager. If you want to try and tell the guy sitting next to you that there is no basis for these concerns, ask him to pull up a live quote. Market's don't lie folks; people do.
Oil prices shot up +9% last week to $62/barrel. Gold prices were up another +3%, taking its 3-week cumulative run to +8%. Yields on 10-year US Treasuries busted out to new YTD highs at 3.45%. Treasury Bonds on the long end of the curve got smoked alongside the US Dollar. Yes, the aforementioned commodities are priced in Dollars. Yes, both of these commodities always reflect a level of implied geopolitical risk.
All the while last week, some of my favorite contrarian indicators (sell side strategists and economists) are explaining that this is the beginning of a bullish move, and that "reflation isn't inflation" - thanks for the revisionist memos from the national history society guys.
I have been talking about credit markets improving, on the margin, for almost 6 months. This morning, I am going to start talking about them looking too good. The slope of the US Treasury yield curve hasn't looked better. At almost 260 basis points, the spread between 10 and 2 year US Treasury yields is exceptionally wide. And the TED Spread (3month Treasuries, minus 3month LIBOR) is as narrow as it has been in a long time.
So what do we do? Do we parrot consensus and jump into the US Equity REFLATION trade with both feet? C'mon. Let's get as serious as this currency situation has become. It's time to get very serious about the risks that have mounted over the course of the last week. The US stock market, while up last week, is down for 4 consecutive days for plenty of reasons - and I think I have called out some big ones here this morning. A market that rallies to lower-highs is as bearish as a market making higher-lows is bullish.
Where do we go from here? With the VIX (Volatility Index) down -60% from its October/November highs, and the TED Spread collapsing 400 basis points from that same time of real-world economic stress, my answer is not to higher-highs anymore. It's time to manage risk through the new game of Survivor that's developing, real-time.
In "Lone Survivor", Marcus Lutrell reflects on a veteran of six SEAL combat platoons, Eric Hall's, code of American conduct (Hall was one of Lutrell's instructors and stated to his prospective SEALs), "We don't put up with people who feel sorry for themselves... anyone lies, cheats, or steals, you're done, because that's not tolerated here. Just so we're clear gentlemen."
Just so we're clear, President Obama - it's time to step up and show the world what "I am an American" really means. Your country's currency is begging for leadership.
Best of luck out there this week,
XLE - SPDR Energy- We bought Energy on 5/13 with the dollar up. We think it works higher if the Buck breaks down. Bullish TRADE and TREND remain.
CAF - Morgan Stanley China Fund- A close end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the wave of returning confidence among domestic Chinese investors fed by the stimulus package. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth.
EWD - iShares Sweden-We bought Sweden on 5/11 with the etf down on the day and as a hedge against our Swiss short position. From a fundamental setup, we're bullish on Sweden. The country issued a large stimulus package to combat its economic downturn and the central bank has effectively used interest rate cuts to manage its economy. Sweden's sovereign debt holds a strong AAA rating despite Swedish banks being primary lenders to the Baltic states. We expect Sweden to benefit from export demand as global economies heat up.
XLV - SPDR Healthcare-Healthcare looks positive from a TRADE and TREND duration. We've been on the sidelines for the last few months, but bought XLV on a down day on 5/11 to get long the safety trade.
TIP- iShares TIPS - The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%. We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.
GLD - SPDR GOLD -We bought more gold on 5/5. The inflation protection is what we're long here looking ahead 6-9 months. In the intermediate term, we like the safety trade too.
XLU - SPDR Utilities - We shorted Utilities on 5/22 as it is trading below the TREND line. As long term bond yields breakout to the upside, Utility investments are the relative yield loser.
EWJ - iShares Japan -We re-shorted the Japanese equity market via EWJ on 5/20. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.
EWW - iShares Mexico- We're short Mexico due in part to the repercussions of the media's manic Swine flu fear. The country's dependence on export revenues is decidedly bearish due to volatility of crude prices and when considering that the country's main oil producer, PEMEX, has substantial debt to pay down and its production capacity has declined since 2004. Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.
IFN -The India Fund-We have had a consistently negative bias on Indian equities since we launched the firm early last year. Despite recent election results likely proving to be a positive catalyst, long-term we believe the growth story of "Chindia" is dead. We contest that the Indian population, grappling with rampant poverty, a class divide, and poor health and education services, will not be able to sustain internal consumption levels sufficient to meet targeted growth level. Other negative trends we've followed include: the reversal of foreign investment, the decrease in equity issuance, and a massive national deficit.
LQD - iShares Corporate Bonds- Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back. Moody's estimates US corporate bond default rates to climb to 15.1% in 2009, up from a previous 2009 estimate of 10.4%.
EWL - iShares Switzerland - We believe the country offers a good opportunity to get in on the short side of Western Europe, and in particular European financials. Switzerland has nearly run out of room to cut its interest rate and due to the country's reliance on the financial sector is in a favorable trading range. Increasingly Swiss banks are being forced by governments to reveal their customers, thereby reducing the incentive of Switzerland as a tax-free haven.
"I'm trained in weapons, demolition, and unarmed combat. I'm a sniper, and I'm the platoon medic. But most of all, I'm an American."
I think our delta charts tell a story. Regional gaming began turning "less bad" in January/February and the stocks squeezed higher beginning in mid-March. While not necessarily deteriorating, trends have leveled out and are at a critical juncture. With the exception of Missouri (loss limit removal) and Illinois (lapping the smoking ban impact), the six month moving averages have flattened or even turned negative.
The macro environment suggests a potential turn for the worse. Gas prices are rising, the initial government stimulus has flooded the economy, and people for the most part have received their tax refunds, which were larger than normal. The key question in my mind is what happens to the savings rate. Yes, the rate already spiked to 4%, higher than it's been through most of the housing boom. However, 4% is still well below the pre-housing boom average of 8-10%. The wealth effect suggests that with housing prices down 25% nationally, savings rate may revert to more normalized levels, much to the detriment of consumer spending.
Regional gaming should be less susceptible to another consumer downturn than other consumer discretionary sectors (certainly more protected than Las Vegas), but will not emerge unscathed. Could we already be in the midst of a leg down? Tough to say, but current valuations are not exactly implying another downturn. As can be seen in the following chart TEV/LTM EBITDA multiples are in the middle of the historical range, although at levels higher than when we last saw gaming bond yields in double digit (1) territory.
While trailing multiple is not our favorite metric, the data is instructive on relative historical basis, if not on an absolute basis. Forward EV/EBITDA multiples are in the 6.5x-7.0x range which, as we highlighted in our 4/20/09 note, "GAMING REGIONALS: THE FALLACY OF EV/EBITDA", is probably the right range given the higher cost of capital. Regional free cash flow yields remain in double digit territory, but low double digit, which is probably where they should be. BYD remains the standout with a FCF yield at 25% and the only "back up the truck" valuation.
Crown's City of Dreams (COD) will open on June 1st. Unlike its sister property Altira, formerly Crown Casino, COD will focus on the Mass Market (MM) segment. Over 90% of COD's table games will be dedicated to MM.
So who are the other big MM players? Here's the breakdown of the Macau operators and their exposure to MM:
On the surface, SJM and LVS are most at risk of losing share from the opening of COD given their MM exposure. However, COD is situated on the Cotai Strip, across from The Venetian and Four Seasons. Cotai traffic will increase dramatically and cross visitation to the LVS properties should offset some of the capacity increase. I'm less enthused about the peninsula properties of SJM, MGM, and Wynn. The higher end Mass customer at Wynn Macau in particular seems to be a target of COD.
Over the intermediate term, however, the outlook is more positive. Macau remains possibly the only market with excess demand. Despite the visa restrictions, MM has been holding its own on a YoY basis. We adhere to the school of thought that Beijing will loosen the restrictions later this year to provide a tailwind to the new Macau Chief Executive.
The COD ramp will be interesting to watch. I expect COD to do quite well in the Mass Market business from the start. However, analysts consistently overestimate start up margins. Moreover, COD's strategy to market directly to VIP's, circumventing the high cost junket structure, is logical but also obvious. If it was so easy to do why hasn't anyone else (Wynn?) mastered the strategy. If they can figure it out God bless them. The property would be a home run.
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The Las Vegas Sun reported that some CityCenter condo buyers are trying to renegotiate their purchase contracts to better reflect market conditions. Market conditions could suggest prices almost 50% below what the buyers had already agreed to. We know of some in the gaming investment community (buyside and sellside) that are probably in this camp.
A little macro analysis might have persuaded the buyers to wait and not buy at the peak. A little more macro analysis back in the spring of 2008 would've persuaded gaming analysts to downgrade gaming as housing prices had already been falling.
We've been critical of investors and especially sell side analysts that "don't do macro". It has shown in their work over the last year and it looks like it may be adversely affecting their personal investments as well.
"...We feel with a lot of small landlords, and we and they are experiencing a lot of uncertainty. Many new store deals are falling out because of lack of money on the landlord side and small landlords are having a great difficulty getting bank financing.
When the retail environment improves we will grow our store base at a faster rate. "
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