Bonds: The Proverbial Falling Knife?

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Bonds: The Proverbial Falling Knife? - bo9



The US bond market is at an all-time high, with $38 trillion of US bonds outstanding.  Nearly a quarter of that – $11 trillion – is US Treasury debt, and another $8 trillion is mortgage related.  And note that the latest abdication of duty by the nation’s bank regulators – described in the previous section – will add significantly to the mortgage-related number.  The relaxing of lending standards is allegedly aimed at stimulating housing.   But Hedegeye’s work has shown that the housing sector hasn’t needed government stimulus for almost a year.  In fact, if the government were to butt out, the housing sector would recover on its own timetable, in concert with other improving demographic measures such as new family formation, rising birth trends, and improving employment.  Here you see a perfect example of how government meddling is guaranteed to create a bubble in an already over-inflated bond market. 


Adding fuel to this particular conflagration, the major brokerage firms have trimmed their fixed-income books, trying to get out of the way of the proverbial falling knife.  This means there is shrinking liquidity in a market that has gotten way too big already.  This will increase volatility, and will force bond prices still lower.  Oh, and it’s decidedly bad news for those investors (presumably mostly foreign pension managers and insurance companies) who will buy the soon-to-be-issued new mortgage paper that will be generated now that the banks don’t have to have skin in the game.


Casteleyn says the bond market represents 2/3 of the securities market, meaning there are two dollars in bonds for every dollar of stock – even after the equities market has risen 100% in the last 4 years!  This skewed relationship is unwinding, triggered by the Fed initiating its Quantitative Easing program in 2008.  The start of QE caused a number of market dislocations.  By taking a large portion of the apparent risk out of the fixed income market, it drove down the premium that corporate bond yields had traditionally offered over Treasuries, and even resulted in yields on junk bonds coming down heavily to what were historically considered low-investment-grade levels. 


Most obviously, QE forced investors to seek out riskier assets in their desperate quest for return, with the result that the stock market roared back from its post-Crisis lows.  This appears to have been Bernanke’s straightforward objective, and he has certainly achieved it.  Casteleyn’s analysis makes it clear that the “Bernanke glow” is just the beginning of a bull market in equities that could be every bit as massive as the 30-year bull market in bonds that has now ended.


Casteleyn says money is flowing out of the fixed income market, and into equities, at rates not seen since before the financial crisis.  Last week alone investors withdrew $11.1 billion from fixed income mutual funds.  Equity funds continue seeing their first positive year since 2007, with inflows at $1.3 billion for the week, resulting in the first annual inflow into stocks in over 5 years.


For those who are afraid they “missed the move,” there remains more than $2.6 trillion of investible capital in money market funds, although with the expectation that money funds are never drawn down to zero, investors will have to make allocation decisions between stocks and bonds.  Casteleyn says pensions have historically low allocations to stocks and record high exposure to fixed income – which means that as the bond market continues to kick off losses, fixed income will continued to be sold to reallocate into equities. 


Casteleyn points out that the current setup of this rotation from bonds into equities is following its historical cycle. This means that the bulk of the rotation is winding up in money market funds before the eventual re-planting into the new asset class. Thus the carnage in fixed income currently is largely landing in money funds before the eventual reallocation to equities.  Still, even while waiting for investors to take the plunge, we have seen the initial signs of inflows into stock funds this year for the first time in 5 years.  Inflows into equity funds are averaging $2.7 billion a week this year, a reversal from the $3 billion weekly outflowsin 2012.


Of all the not-so-unintended consequences of the Fed’s program to promote risk-seeking behavior, one actually not intended consequence could be overstuffing money market funds to a point where the funds buy increasing quantities of risky paper.  This has happened before – writing in February of 2012 in the Wall Street Journal, Sallie Krawcheck, former president of the Global Wealth & Investment Management division of Banc of America warned about the lack of transparency of the funds, as well as the decidedly dicey composition of their portfolios.  You may be aware that the SEC has introduced a rule requiring certain classes of institutional money market funds to post an actual net asset value, and not an artificial $1 price.  What you may not know is that for many years, as more and more money flowed into money market funds, managers went further afield in their hunt for yield – including buying bonds in such places as France, Italy and Spain – and Greece – in the midst of the Financial Crisis.


Heard enough?  The good news is: you haven’t missed the next big up-move in equities.  The scary good news is, this bull market in equities may run much farther, and last much longer than many people anticipate.  Keep your eye on Hedgeye – we’re keeping our eye out for you.

Morning Reads on Our Radar Screen

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

Keith McCullough – CEO

Germans Hide Cash in Diapers as Swiss Secrecy Crumbles (via Bloomberg)

Dollar index steadies near six-week high (via Reuters)

Power cut leaves most of Venezuela without electricity (via BBC)


Morning Reads on Our Radar Screen - ber4


Daryl Jones – Macro

Barack Obama’s Staggering Incompetence (via Commentary)


Kevin Kaiser – Energy

How Not To Be a Turkey (via Mercenary Trader)


Jonathan Casteleyn – Financials

Wall Street still influences its own rules with over 2,000 meetings with the CFTC to help shape ongoing regulation (via Bloomberg)


Matt Hedrick – Macro

Berlusconi Impeachment Push Helps to Drive Italian Stocks Lower (via Bloomberg)


Howard Penney – McDonald’s

McDonald’s Vegetarian Friendly Move (via Technomic)


Today at 11:30am EDT, please join the Hedgeye Macro Team for a ~15min conference call titled “Paddling Upstream?: Navigating #EmergingOutflows”. On the call, Senior Analyst Darius Dale will host a live Q&A session regarding recent developments in EM financial markets and our outlook for those asset classes and the economies that underpin them.


CLICK HERE to download the accompanying 80-slide presentation; we look forward to fielding any follow-up questions you might have on today’s call. Please see below for the dial-in details.




  • We think a protracted tightening of global credit conditions driven by sustained USD appreciation and a back-up in US interest rates will weigh on growth in EM fixed investment via an inflection(s) in portfolio and FDI flows. That same tightening will also weigh on growth in EM consumption via an inflection in purchasing power as overvalued EM currencies continue to mean revert lower.
  • Moreover, we think global asset allocators in developed markets are simply running out of places to direct marginal investment flows and growth assets priced in a strengthening USD are one of the few places that remain attractive on a go-forward basis. The resurgence of European capital markets and a resumption of JPY-induced Japanese equity reflation also supports a continuation of the DM vs. EM bifurcation that we have seen accelerate in 2013. Thus, our #EmergingOutflows thesis should continue to play out in spades.
  • Lastly, we think the impact on China’s secular economic slowdown will weigh heavily upon EM economic growth, as China’s credit-fueled fixed assets investment bubble has been a primary driver of marginal demand for many/most of the larger emerging market economies’ exports. In particular, the policy-induced unwind of said bubble should sustainably slow export and FDI growth across key commodity-producing countries.




  • CONFERENCE CALL & PRESENTATION: Q2 2013 MACRO THEMES (4/16): #EmergingOutflows: Consistent with our call for continued U.S. dollar strength and commodity deflation, we think the very early innings of the next round of emerging market crises is upon us. Sustained USD appreciation exposes EMEs to a variety of economic risks that asset allocators have not had to appropriately discount for over a decade.
  • CONFERENCE CALL & PRESENTATION: EMERGING MARKET CRISES: INDENTIFYING, CONTEXTUALIZING AND NAVIGATING KEY RISKS IN THE NEXT CYCLE (4/23): We currently see a pervasive level of risk across the emerging market space at the country level and have quantified which countries are most vulnerable. As such, we find it prudent for investors to reduce their allocations to emerging market equity and currency risk in favor of US equity and US dollar exposure. #StrongDollar and commodity price deflation have been and should continue to be key catalysts for EM underperformance.
  • EXPERT CONFERENCE CALL & PRESENTATION: WILL CHINA BREAK? (4/29): We co-hosted a conference call with our Industrials Team, led by Managing Director Jay Van Sciver, featuring Carl Walter, co-author of Red Capitalism: The Fragile Financial Foundations of China's Extraordinary Rise (2012). The Party’s use of state owned banks to drive economic growth through fixed asset investment has left the financial system loaded with bad assets. The bad assets mirror bad investments in the real economy. They also can limit the ability of Chinese banks to make new loans.
  • CONFERENCE CALL & PRESENTATION: ARE YOU SHORT CHINA [AND OTHER EMERGING MARKETS] YET? (6/12): We think the outlook for Chinese credit growth is structurally impaired. Moreover, we anticipate that growth in non-performing loans will accelerate sustainably over the long term. Lastly, we believe that net interest margins across the Chinese banking industry face immense regulatory headwinds that may ultimately have dire consequences for China’s fixed assets investment bubble.
  • CONFERENCE CALL & PRESENTATION: Q3 2013 MACRO THEMES (7/15): #AsianContagion: China sneezes and the rest of Asia catches the flu. #RisingRates and #StrongDollar continue to perpetuate #EmergingOutflows across the developing Asia region while a likely resurgence of positive sentiment surrounding the Abenomics agenda and continued yen weakness should help Japanese equities continue to outperform the region.




  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 125514#
  • Materials: CLICK HERE



For questions regarding this call or to schedule a 1x1 discussion with Darius directly, please email


Best regards,


The Hedgeye Macro Team

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Regional markets still struggling



"Our operating results continue to be impacted by the soft regional gaming trends and several of our properties were impacted by flooding and spring storms that occurred in the Midwest during May and June...Partially offsetting the softness were Pompano, Black Hawk, and Lake Charles which all experienced year over year increases in net revenue and combined adjusted EBITDA flow through of 60%. In Cape Girardeau we continue to refine our business model in order to ramp up the property....The increased adjusted EBITDA is a reflection of improved operating efficiencies and improved promotional spending.

"While customer feedback regarding the property (Nemacolin) has been extremely positive, initial results have not met our expectations.  Many local customers have told us they are having difficulty accepting the mandatory purchase requirement, which they view as an admission charge, that doesn't exist at other casinos in the region. We are exploring alternatives to make access to the casino more appealing and least disruptive to customers as possible. In addition we are making operating changes to match the level of customer demand."


-Virginia McDowell, President and Chief Executive Officer



  • Continue to reduce operating expenses at corporate office
  • Excluding one-time items FY2014, there would have been a penny of income
  • Because of valuation allowance, going forward in FY2014, tax provision will be $1.4MM/Quarter regardless of P&L
  • FQ1:  $169MM debt on revolver; $1.050 BN notes; $3MM - other debt
  • Leverage: 6.6x; borrowing capacity is $95MM

Q & A

  • Consumer trends:  similar to competitors' comments, they see a decline in trips but spend per visit was higher by $4.  Retail revenue and lower-end customers have been weak as well. Consistent trends across different markets. Revenues have been consistent.
  • Cape:  slower ramp due to pressure from lower end and retail (most profitable customers). Thus, they need to build on rated databases. Would need a couple of years to fully ramp on the property.
  • Philly license:  $25MM LoC mgmt fee - if project is elected, the fee may be returned or put into capital structure. Timing - fall 2013 or later
  • Vicksburg/Jackson road construction will be completed by the end of September
  • Focus on deleveraging the company
  • Lake Charles market impact from Fertitta purchase:  nothing will change 
  • Rhythm City casino sale:  moving forward on schedule; need to finalize with non-profit partner
  • Interest coverage: 2.2x
  • Good correlation between customer habits and stock market
  • Competitive environment:  a couple of markets (mainly new markets) have seen heightened promotions
  • $2MM annual cost savings:  3/4 of the savings have been in place (not fully recognized in Q1)
  • Pompano:  targeted marketing strategies benefited the property more than the removal of slots at internet cafes
  • FL legislature:  Disney actively involved
  • Additional Cedar Rapids license?  No demand for that market, says ISLE.  Waterloo will not be significantly impacted.
  • Lumiere:  ISLE did take a look at it
  • Maintenance capital on slot equipment:  pretty constant
  • NJ i-gaming:  federal solution would be best; NV and NJ pairing up. ISLE cannot pursue i-gaming license in NV

Short Bearish Consensus

Client Talking Points


The #StrongDollar is loving the continued strength in US economic data. Witness the August ISM beating big with an impressive New Orders print of 62.3. Boom. That looks very 2003 breakout-ish. It's something to noodle over as bearish consensus loathes the idea. It's the 4th up week in a row for US Dollar. The Yen is down in the face of that. Cue a +3.5% two-day move for the Nikkei to start September. Nikkei is now up +36.5% year-to-date. Correlation matters.


The 10-year Treasury punched the 2.90% line again yesterday. Economic surprises continue to fight the Fed’s dogma. It's at 2.87% this morning as we continue to see a healthy back-and-fill to another higher-low. We remain short the long-bond (TLT) and Junk (JNK) on our Top Q313 Global Macro Themes of #RatesRising and #DebtDeflation. Rinse and repeat.


The Doctor definitely does not like this whole commodity bubble revival hope dance. It's fading fast (again) after yesterday’s bounce. Our Hedgeye TREND resistance of $3.39/lb remains firmly intact. Incidentally, our trend resistance for Gold is $1483. FYI, we’ve been just day trading the emotional side of that commodity.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.


Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016.


Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward.  Near-term market mayhem should not hamper this  trend, even if it means slightly higher borrowing costs for hospitals down the road.

Three for the Road


Its time for @BarackObama to use weapons of mass currency appreciation against Putin's Oil @KeithMcCullough


"America will never be destroyed from the outside. If we falter and lose our freedoms, it will be because we destroyed ourselves." -Abraham Lincoln


The six heirs of Wal-Mart founder Sam Walton have as much wealth as the bottom one-third of all Americans combined.

New Best Idea: Short Kinder Morgan

After extensive research and analysis, we have come to the conclusion that the nation’s largest combined energy infrastructure company and oil producer  – Kinder Morgan – is a house of cards, completely misunderstood and mispriced.


We will release a full report with our thesis and supporting evidence on Tuesday morning, 9/10/2013, to all Hedgeye Energy clients.  At 11am EST that morning, we will host a brief call for clients to hit on the highlights of the report, and take Q&A.


Key topics that we will hit on:

  •  “Like a toll road” – except for that E&P segment that generates +20% of KMP’s segment DCF.
  • Cut “Sustaining CapEx” to the bone…  How does Kinder Morgan do it?
  • How “Certain” are KMP’s “Certain Items”?
  • KMP’s investor presentation “returns” vs. actual returns to the KMP unitholder.
  • Dissecting the complex corporate structure: KMI, KMP, KMR, and EPB.
  • The absurdity of the Incentive Distribution Right (IDR) and the incentives it really creates.
  • $78 BILLION of combined market cap sitting on top of $1.6 BILLION of tangible equity?  A complete valuation analysis.

We are convinced that the Kinder Morgan complex will eventually collapse.  In our view, it is not a matter of if, it is a matter of when.   We look forward to presenting our work, and the debate that is sure to follow.


Kevin Kaiser

Senior Analyst


***All Hedgeye Energy clients will receive the report and conference call dial-in information early Tuesday morning.  If you are not already a client and are interested in our work, please email .***


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