-Morgan Freeman, Shawshank Redemption
Earlier this week, I raced a 95 year old lady down the Merritt Parkway on my way home from work.
To review: while driving north from our new HQ in Stamford, I watched in my rearview mirror as a navy blue Mustang darted back & forth between lanes before pulling up beside me, then speeding ahead.
After racing to catch-up for a confirmatory, second look…90 is, apparently, the new 25.
The age was undeniable, but there were no coke bottle glasses, no cautious, granny-fied 3 o’clock- 9 o’clock hand positioning, no squinty eyed lean forward, no Buick or Oldsmobile.
Just a sharp gaze and tangible life energy.
The experience was a pleasant surprise and a welcomed contrast to the latest, consuming iteration of beltway brinksmanship – which, unsurprisingly, lacked both pleasantness and originality.
Back to the Global Macro Grind…..
I don’t know granny’s life recipe for sustained physiological alacrity – but the ‘pleasant surprise’ of her apparent vitality dovetails nicely with one of our top 3 Macro Investment themes for 4Q: #GetActive
Without giving away the full, institutional macro alpha thunder, our call for an increase in active investment management is predicated on a few key points:
1. Big Government Intervention: Our fiscal policy creation process remains a circus and the new golden boy in the monetary policy arsenal – the “communication tool” – remains in beta testing and breeding decidedly more market uncertainty than price stability at present. Collectively, we expect policy intervention to continue to perpetuate Market/Currency/Economic Volatility. Volatility breeds both opportunity and a heightened probability for an expedited drawdown in equities and …
2. Active Management outperforms in down markets: Historically, on average, the HFRX Equity Hedge index outperforms the SPX in down markets and that outperformance increases as the magnitude of negative monthly S&P500 performance increases. At extremes of negative market performance, the HRFX has outperformed by ~800bps on a monthly basis. Hedge funds apparently hedge after all.
3. Sector Picking will Matter: As the Chart of the Day below illustrates, the variance in sector performance this year is near a historic low Put differently, it hasn’t really mattered what sector you bought – beta has been the new alpha and simply buying the market was the best allocation decision. Over the intermediate term, a mean reverting breakout in the variance of sector returns is almost a guarantee. Consider the performance delta between Financials and Utilities in the quasi-analogous post-1994 period, after Greenspan began his rate raising campaign. Financials returned 50%, 32%, and 45% in 1995, 1996, and 1997 respectively. Utilities returned 25%, 0%, and 18% over that same period. A 3Y CAGR of 42% for Financials vs 14% for Utes.
In truth, #GettingActive is really just an investment euphemism for Trading.
Trading generally gets a bad rap because it doesn’t fit the canonical ‘stocks for the long-term’ dictum, it doesn’t market well and, well, it’s hard – the recent multi-year trend in collective hedge fund benchmark underperformance hasn’t been a siren song for incremental actively managed AUM either.
Keith has actively managed market risk in the Hedgeye portfolio for 5+ years, actively manages the Hedgeye HFT (High Frequency Tweet) machine and is probably more” active” than constrained in opining on markets, policy and policy makers.
To the latter point, sometimes I think the punditry of the Early Look prose occasionally belies the reality of our risk managed positioning.
For instance, while we were highlighting an increased likelihood for a policy induced deceleration in domestic growth back on Oct 9th/10th, at the same time, we were taking up both our gross and net long positioning into the back end of the 4% market correction.
From a process perspective, our conviction level rises and we typically get louder about an idea when both the research (fundamental) view and the quantitative risk management signal are both in agreement.
But what if there is no fundamental data?
The gov’t shutdown the last two weeks has served as an illustrative example of how our risk management process works in practice – primarily because there was no incremental fundamental data to inform our marginal macro view, leaving the risk management signal as our principal signaling mechanism for driving portfolio decisions.
Contrasting yesterday’s price signals and subsequent allocation decisions with those made a week ago exemplifies the process.
What were the market and price signal dynamics back on Oct 10th and why did we buy the dip:
- $USD – V-bottomed off its long-term tail line of support at 79.21
- VIX – was breaching its TREND support level of 18.98 on the downside
- SPX – recaptured TREND support at 1663
- 10Y Treasury – Held TREND support of 2.58%
- U.S. Stocks moving towards immediate term oversold, down for 11 of the prior 15 days
With all the price signals in agreement, the highest probability swing was to get longer and play for the 24 handles of immediate term upside.
Yesterday’s price signals were very similar:
- 10Y Treasury – 10Y was back to flirting with a TREND breakdown through 2.58%
- $USD – The dollar was moving back towards testing TAIL support at 79.21.
Down Rates + Down Dollar + Rising Policy Uncertainty is not a factor setup we want to be long of over the intermediate term, but we kept the portfolio unchanged at 6 Longs, 3 short into the close. Why?
- SPX – higher highs are bullish and equities were not signaling immediate term overbought
- VIX – Debt Default fear remained for sale with the VIX continuing in free fall
- Squeezage – with hedge fund short positions as YTD highs there’s room to let the squeeze rally breath a bit.
- Hilsenrath’s mid-afternoon proclamation that Oct-Taper is officially a no-go & Bernanke/Yellen risk remains acute juices the immediate term downside risk for both the dollar and interest rates.
So, we didn’t buy the rip or tighten up net exposure.
What will we do today? I don’t know – and that’s largely the point. As always, we’ll let the market signal tell us which way to lean.
Does timing matter? Implicit in allocations to active strategies is a belief that it does.
As Keith queried on twitter yesterday afternoon:
“If timing didn't matter, why are you watching Twitter right now?”
Similarly, are markets efficient or irrational and reflexive?
Fama won the Nobel prize for “proving” the former. At the same time, Shiller won for proving the latter. Seems about right.
Activity/Variety is both the spice of life and nature’s most potent cerebral exfoliant.
Take a different route to work in the morning, eat dinner with your left hand, simplify a few radical expressions, invest some incremental capital in the growth inflection happening across the pond, turn down CNBC and turn on #tweetshow today at 3pm.
Switch it up, Get Busy.
Our immediate-term Risk Ranges are now:
UST 10yr Yield 2.55-2.67%
Enjoy the Weekend.
Christian B. Drake
TODAY’S S&P 500 SET-UP – October 18, 2013
As we look at today's setup for the S&P 500, the range is 50 points or 2.20% downside to 1695 and 0.68% upside to 1745.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.25 from 2.28
- VIX closed at 13.48 1 day percent change of -8.36%
MACRO DATA POINTS (Bloomberg Estimates):
- 8am: Fed’s Lacker speaks on orderly resolution in Washington
- 11am: Fed to purchase $1.25b-$1.75b notes in 2036-2043 sector
- 1pm: Baker Hughes rig count
- 1pm: Fed’s Tarullo speaks on orderly resolution in Washington
- 2pm: Fed’s Evans speaks on economy in Chicago
- 3:40pm: Fed’s Dudley speaks
- 4:30pm: Fed’s Stein speaks in Boston
- 8am: Fed conf. on “Planning for Orderly Resolution of a Global Systemically Important Bank”
- 8:30am: CMS Deputy Administrator speaks at America’s Health Insurance Plans State Issues conf.
WHAT TO WATCH:
- Barclays, Citigroup FX traders’ msgs said to be scrutinized
- LG Display leads Apple supplier gains on Morgan Stanley report
- Morgan Stanley must face group lawsuit by Singapore investors
- KKR sues Halliburton to enforce $256m arbitration award
- Royal Brunei in talks with Airbus, Boeing to buy planes
- China GDP growth rebounds after Li stimulus to meet target
- Hedge funds seek to trade in comfort as bankruptcy insiders
- JPMorgan sells Chase Manhattan Plaza in NYC to China’s Fosun
- U.S. video-game sales jump in Sept. on ‘Grand Theft Auto’
- U.S. Government, IPads, Ford, U.K. GDP: Wk Ahead Oct. 19-26
- Baker Hughes (BHI) 6am, $0.78 - Preview
- Celanese (CE) 5pm, $1.15
- First Horizon National (FHN) 7am, $0.19
- First Niagara Financial (FNFG) 7:15am, $0.19
- General Electric (GE) 6:30am, $0.35 - Preview
- Genuine Parts (GPC) 8:49am, $1.20
- Honeywell Intl (HON) 6:30am, $1.24 - Preview
- Ingersoll-Rand (IR) 7am, $1.10
- Interpublic Group (IPG) 7am, $0.18
- Kansas City Southern (KSU) 8am, $1.11 - Preview
- Laboratory Corp of America (LH) 6:45am, $1.80 - Preview
- Morgan Stanley (MS) 7:15am, $0.40 - Preview
- Parker Hannifin (PH) 7:30am, $1.47
- Schlumberger (SLB) 6:30am, $1.24 - Preview
- SunTrust Banks (STI) 6am, $0.68
- Textron (TXT) 6:30am, $0.47
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Asian Gold Demand Seen Surging by HSBC on Elevated Inflation
- Wheat Bears Prevail as Demand Slows for Record Crop: Commodities
- Copper Heads for Biggest Weekly Gain in Four on Chinese Growth
- Iron Ore Futures Debut in Dalian as China Seeks Pricing Power
- Wheat Climbs as Demand for U.S. and EU Supplies Seen Sustained
- WTI Crude Set for Second Weekly Decline, Nearing $100 a Barrel
- Palm Oil Advances a Second Week as Exports From Malaysia Climb
- Natural Gas Futures Set for Weekly Loss on Ample U.S. Stockpiles
- Gold Swings as It Heads for Best Week Since August on Stimulus
- Chinese Steel Products Output Up 16.3% Yoy on Stimulus: BI Chart
- Stevens Silent as Commodities Spur Aussie Rise: Chart of the Day
- WTI Crude May Fall After U.S. Inventories Climb, Survey Shows
- Railroads Shipping Oil Face New Rules After Quebec Fire: Energy
- Goldman Sachs Cuts Arabica Coffee Forecasts by 7.7% on Weather
The Hedgeye Macro Team
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In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance
- BETTER: LVS reported a solid beat on the back of better margins in Macao driven by stellar growth on yielding up mass win per table. On the capital side, LVS raised their dividend and bought back a lot of stock. What's not to like?
- BETTER: Mass win per table per day increased 117.7% YoY while mass table, slot and ETG win per day climbed to $4.3 million, an increase of 174.3% YoY, significantly beating estimates. In the spring, they will bring 75 more mass games. SCC still has room to grow.
- "SCL mass table games has grown 60% in the last year to $920 million from $577 million a year ago in this segment and the margin is still mid-40s, 45%, 46%, 47%."
- "Upside in this segment comes from the organic growth in the Macau market, specifically in Cotai, our ability to leverage our hotel and retail asset base in Macau and in Cotai, in particular, to drive much higher win per unit, we're just in a unique position to improve dramatically and see SCL's mass table growth grow to $4 billion to $5 billion, $6 billion years ahead."
FOUR SEASONS PREMIUM MASS
- BETTER: Over 60 tables now in the premium mass segment at Four Seasons. Four Seasons mass drop was outstanding, up 146% YoY - blowing away estimates.
- "As we move more into this premium mass business there, I think the numbers will get better and the hold percentage will be what it's going to be. We know with that kind of volume, the hold percentage pretty much stays flattish when it's all said and done."
- BETTER: Recurring annual dividend will be increased to $2.00 per share, or $0.50 per quarter, for FY 2014, an increase of 42.9%. LVS repurchased approximately $299.6 million of common stock (4.6 million shares at a weighted average price of $65.18) during 3Q. In the future, they expect to buy back >$75MM/month until the remaining $1.65BN authorization is used up.
- "We publicized last year that our dividends would increase by a minimum of 10% per year, most of the market expectations are that we'll do actually more than that. But there is a dividend bias in the company to continue to increase the yield on our stock, the stock has gone up, so that means we have to increase our dividends to keep the yield at where it should be. We have announced a $2 billion buyback of stock. We are progressing with that buyback and we'll continue to do that until the $2 billion is taken care of."
- LITTLE BETTER: Based on current schedule, LVS is targeting a late 2015 opening, but may be able to open a few months ahead of schedule. Expect building permit will be given on a timely basis.
- "Based on our current construction schedule, and subject to timely government approvals, we are targeting the opening of the Parisian Macao for late 2015."
SINGAPORE RC VOLUME
- SAME: RC volume rose 17% to $13.8BN.
- PREVIOUSLY: "We've been pretty consistent in the range of $12 billion to $16 million roll per quarter. I think that will remain intact for the foreseeable future."
- SAME: 3Q EBITDA of $87.1MM was in-line with expectations. Table games drop decreased 6.4%
to $544.3 million reflecting lower baccarat drop. Slot handle both grew 2.6% YoY.
- "On the gaming side, we are very dependent on high-end premium Asian players who come here. And although we've participated, we've done very well in that segment, we're happy to be in it, the entire town doesn't share equally in that. Slot and mass tables continue to be mediocre. I wouldn't call it a head fake as much as it's just a challenging market that will slowly get better, but I wouldn't look for rapid improvement in the next few quarters."
- "Win per unit per day on the pure mass in Las Vegas is very challenging. The premium mass, the better customer who comes in for special events, fights, high frequent, out of Southern California, that is getting better."
Investors do not seem very negative on the outlook for CAT’s 3Q earnings for an odd reason. They tend to think that everyone else thinks that CAT will miss, limiting the relevance. Investors are also looking for an announcement on structural cost actions at Resource Industries, which may cloud the 2H outlook. Our view is that CAT has an end-market demand problem, not a cost problem.
CAT is also expected to issue preliminary sales and revenue guidance for 2014. Many expect that it will be the Industrials guide of the quarter. We think not – few analysts take guidance from CAT seriously anymore. Remember “steady as she goes” for the 2013 outlook given in 3Q 2012? Sales and revenues were supposed to be “roughly the same as 2012, in a band of about plus-or-minus 5%.” Recall that 1Q 2013 sales and revenue were actually down 17.3%. Following some short-term reaction, the market is likely to take a 2014 outlook with an excavator full of salt.
We generally do not bet on quarters – it is a tough game. A change in assumptions for warranty or accounts receivable allowances could leave even the best estimate off target. A simultaneously announced buyback or acquisition could render the reported results old news before they are even read. That said, there are a number of reasons why we expect weaker results this quarter.
While we will be ‘surprised’ if results do not disappoint, we are not ‘in’ CAT for this quarter’s results. Rather we are focused on the long-term down-cycle in resources-related capital spending. In the long run, resources-related capital spending requires rising commodity prices to remain far above maintenance-type levels. Currently, resource-related capital spending is well above the levels needed to support long-term demand growth.
CAT Inventories: CAT has guided flat company level inventories for 2H 2013, meaning that inventory levels at year end should be roughly the same as at the end of 2Q 2013, as we understand it. However, in the third quarter “inventory could come down some as we have many of our Northern Hemisphere facilities take vacation shutdowns during the months of July and August.” The company level inventory headwind should have continued into 3Q 2013, but consensus doesn’t seem to reflect it. Dealer inventories are also expected to decline through 2H 2013.
Can CAT Get To $6.50? That inventory outlook intersects poorly with the implied margin in current guidance. Here is what we wrote on 8/9/2013 - our view is unchanged:
To hit guidance, CAT’s margins in 2H would need to improve ~30% vs. 1H with NEGATIVE MIX and NEGATIVE PRICING in Construction Industries and Resource Industries. Sure, that might happen – and 795F Trucks might fly. As we have written repeatedly – CAT is letting us down easy (gradually) and we have a tough time getting to $6.00 in 2013 EPS. This is just a rough sketch of guidance - not what we expect, which we published here.
Current consensus has margins at about 11.5% in the back half of the year, which would also represent a substantial and unlikely improvement in profitability from 1H. Given the expectation of continued inventory reduction in 3Q, we are not sure why consensus expects margins to expand. A guide down seems quite likely.
Not Just Resource Industries: CAT management admonished us not to hyper focus on mining capital spending, shifting investor attention instead to Power Systems. That may not be a great plan. We have long expected the resource-related capital equipment portions of Power Systems to also experience meaningful pressure. The most recent dealer statistics (below) show declining sales in Power Systems. That seems consistent with our broader definition of resource-related capital spending. It is also not a great set-up for 2014 sales and margins.
Construction Industries: In a noticeable omission, CAT does not fully discuss the >500 basis point drop in Construction Industries margin in 2Q 2013 YoY. It apparently relates to dealer inventory reductions, too, but that explanation does not fit the ‘it’s just a mining equipment demand drop’ narrative. CAT’s construction equipment division participates in an intensively competitive business, but we are a bit surprised by the recent weakness. As we understand it, lower capacity utilization in Resource Industries impacts the other divisions as well, given shared platforms, and that is a very hard problem to isolate or correct.
3Q and 4Q Expectations: Forecasting quarterly earnings for CAT is challenging, in no small part because we do not know how much revenue will come out of the backlog. Last quarter, CAT emphasized inventory headwinds, but not the draw on backlog and the likely favorable pricing in it.
- We expect charges in 3Q for the structural capacity reductions at Resource Industries. We also think a goodwill impairment charge is likely in 4Q for BUCY goodwill, as impairment testing should come at year-end.
- Excluding those factors, we would expect a 3Q result in the neighborhood of $1.30-$1.50 vs. consensus of $1.67. We could be wrong for several reasons beyond backlog, including currency and cost controls, but that is what we get. Once a company gets into identifying restructuring charges, as CAT seems likely to do this quarter, lots of interesting items can be called special. That said, we think current guidance is a long-shot and expect CAT to struggle to earn $6.00 this year.
- Instead of a buyback, we expect a miss to be paired off with a cost reduction plan targeted at Resource Industries. Of course, the cost impact of low volume at Resource Industries is not easily isolated, so that is where we will be interested to see some detail. We could obviously be wrong in this expectation.
- We expect comments about 2014 to be positive and focus on the eventual end of dealer inventory draw downs. We note that JOY and Sandvik have seen large mining order and revenue drops without a dealer network.
Other Indicators: While we do not rely on these sort of tea leaves, secondary indicators for CAT are do not suggest an approaching inflection point:
- Insiders Selling: In the last couple of years, insiders have only bought 2,000 shares in the open market while selling hundreds of thousands. Selling may have slowed down in recent months, but we do not see the open market purchases that might accompany an inflection for CAT.
- Sell Side Estimate Revision Trends: Since the first week of October there have been a number of downward revisions to estimates. Quiet period or not, we all should have a sense of how this ‘revision’ process works.
We continue to see CAT as exposed to a significant, multi-year decline resources-related capital spending through both its Resource Industries and Power Systems segments. Investors appear to be hoping for a cost reduction plan capable of resolving a lack of demand/cyclical downturn problem. We continue to expect CAT shares to underperform through the down-cycle.
Solid quarter driven by Macau (esp. Sands Cotai Central and Four Seasons)
CONF CALL NOTES
- Hold normalized EPS grew 47.2%
- Hold adjusted EBITDA of $1.24BN
- Growing faster than the market in both Mass and VIP in Macau
- SCC is on track to produce $1BN of EBITDA per year
- Bridge from HK airport to Macau will be completed by 2016 and should provide a big boost to Macau visitation. The airport provides service to 100 airlines.
- Construction continues at the Parisian Macau. They are targeting a late 2015 opening and potentially a bit earlier.
- Activity in Japan is increasing
- Korea is also showing increased activity
- Madrid: still subject to the government approvals and incentive grants
- $5BN of capital returned to shareholders so far. $1.6BN remaining under the buyback program and in the future expect to buy back at least $75MM of stock per month.
- 25% of their EBITDA in Macau is generated from non-gaming amenities
- Focused on maximizing cash flow
- 3 of the 4 properties in Macau had north of 30% margins. What are they doing to deliver such strong results?
- In the Spring, they will open up 75 more mass games at SCC
- As mass grows at their properties, that helps their margins
- SCC has a lot of room to grow
- FS: Junket performance there is exceptional but are also getting great results out of their premium mass segment. Think that getting the optimal mix at the property is key.
- Operating expenses look higher at MBS?
- They are focused on giving more rooms to their premium mass segment and attracting more overseas visitation. They are up over 46% YoY in that segment (visitation).
- Their goal is to get to more than $5MM/day of premium mass play vs. $4-5MM now
- What was the cash RevPAR/ADR at MBS? Looks like commissions increased?
- Commissions remained the same
- They are comping more rooms to overseas guests (RWS is doing the same thing). This has had some impact on margins.
- Their casino ADRs are higher than cash ADRs
- CFO search has not actually begun. Will not start until end of the year/beginning of 2014
- FCPA investigation update? Nothing new to report.
- Non-Guangdong visitation into Macau is also growing faster than Guangdong visitation
- They will not be opportunistic re: stock buybacks - they have committed to $75MM per month until the $1.65BN is used up.
- There has not been a discussion regarding special dividends. That will be discussed at year end.
- Japan would be north of a $6BN investment
- In Korea they would spend less than what they spent in Singapore
- In Vietnam it would be less than Korea given lower labor costs
- In Taiwan, costs would be similar to Korea
- Next year's capex: $500MM of capex on their existing properties - 50/50 split between maintenance and revenue enhancing projects
- Table cap is good for them because it increases the yield per table and that benefits margins. Given the size of their buildings they can also keep adding ETGs.
- Japan: no news regarding partnerships. Have been all kinds of rumors but there has been no clarification of Japanese ownership. They are talking about finishing the first phase of legislation complete by December/ January. Thinks that both Osaka and Tokyo want LVS.
- Government approvals still needed for the Parisian project
- Building permits
- Table allocations (hearing that some people won't be happy with their allocations). They will just take the lower performing tables from their other properties.
- Reserve levels in Singapore as high as they have ever been? They have always reserved conservatively at 32% now. Collecting money has always been difficult since they are usually from mainland customers
HIGHLIGHTS FROM THE RELEASE
- "The prudent management of our cash flow, including the ability to increase the return of capital to shareholders while maintaining a strong balance sheet and ample liquidity to invest in future growth opportunities, remains a cornerstone of our strategy. I am therefore extremely pleased to announce that our recurring annual dividend will be increased to $2.00 per share, or $0.50 per quarter, for the 2014 calendar year, an increase of 42.9%."
- The company repurchased approximately $299.6 million of common stock (4.6 million shares at a weighted average price of $65.18) during the quarter ended September 30, 2013
- Venetian visitation "continues to grow and exceeded 4.5 million visits in the quarter"
- Unrestricted cash: $3.2BN
- Total debt: $9.8BN
- 3Q Capex: $206MM; "including construction, development and maintenance activities of $152.7 million in Macao, $26.0 million at Marina Bay Sands, $25.3 million in Las Vegas, and $1.5 million at Sands Bethlehem"
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