The Hangover

“Would you please put some pants on? I feel weird having to ask you twice.”
-Phil Wenneck, The Hangover
This morning’s most important quote is the same one that’s been the most critical to global macro on every morning of 2009 - the US Dollar. The #1 headline on the Bloomberg box today is “Stocks, Commodities Retreat; Dollar, Treasuries Rise.” This correlation isn’t new. This is the inverse relationship between REFLATION and the once almighty Buck.
The #2 story on Bloomberg is about the same thing, Alexei Kudrin’s commentary that the US Dollar is in “good shape.” Getting less attention is the second part of what the Russian Finance Minister had to say overnight, which is that “it’s too early for an alternative” to the world’s reserve currency.
“Too early” simply implies the simple matter of time. The New Reality in the global financial system is that heads of state and finance have finally shifted away from the “if” to the “when”. This is what’s new. The Piggy Bankers have been paid, but America is going to pay for this by losing her status as the world’s financial fiduciary.
Kudrin is making comments ahead of the BRIC Summit (Brazil, Russia, China, India) that is being held in Russia tomorrow. Like Geithner, Kudrin doesn’t really do macro, so he’s probably having a little sit down with Putin and Medvedev right about now, given that his comments have crushed the Russian stock market for its biggest one-day drop in 2-weeks (down -4.1%). If you sponsor strong Dollar rhetoric, you are sponsoring The Hangover associated with the unwind of the REFLATION trade.
China doesn’t seem to mind the US Dollar moving higher for once. Why is that? Well, because they are one of the biggest losers of the great American REFLATION trade. As American policy makers are Burning The Buck, the US Dollar denominated Debtors get paid, not the Creditors. The Chinese, like American Consumers, could do without spiking costs in terms of what they actually need – crude and capital.
Maybe this is why the Chinese stock market flashed such an eye opening positive divergence overnight versus the rest of Asia’s stock markets. With stocks in Japan and Hong Kong giving back 1-2% of their respective recent rallies, the Shanghai Stock Exchange powered forward for another +1.7% daily gain.
US Dollar up was what we saw the US stock market digest on Friday. The immediate rotation that US risk managers moved toward was impressive. The entire complex of the REFLATION trade had The Hangover, while the recipients of lower energy/commodity prices (US Consumer and Healthcare stocks) outperformed. In the face of a rational rotation, the SP500 registered a new YTD high at 946. Again, albeit on low volume, that was impressive.
After a +40% trough-to-peak move that a lot of people missed, can the US stock market continue to work higher without REFLATION? That’s a good question. Is the REFLATION trade over? That’s obviously another one that one should be considering this morning.
Until I see a breakout and close above the $81.86 line in the US Dollar Index, my answer will be that the REFLATION trade will continue to dominate. This morning, the Dollar is trading +0.85% at $80.81, and you’re seeing the US Equity Futures trade down alongside REFLATION markets like the aforementioned one in Moscow. You’re also seeing the price of Dr. Copper trade -4.5% below its YTD high that was established last week. Burning The Buck has dominating impact across currency, commodity, and country level ETFs.
After Alexei Kudrin has his slap on the wrist talk with the boys who run the joint, I expect Russian rhetoric to lock arms with the same that has dominated world markets for the last 3-weeks. In the long run, the world’s reserve currency is going to be a basket, not a Buck. This will take time. Understanding the difference in duration between The Hangover and The US Currency Credibility Crisis will be all that remains in between. Trade the range.
My immediate term upside target for the SP500 is now 949 and downside is 932.
Best of luck out there this week,


QQQQ – PowerShares NASDAQ 100 — We bought Qs on 6/10 as a better way to be long the US market than the SP500. The index includes companies with better balance sheets that don’t need as much financial leverage.

FXA -CurrencyShares Australian Dollar Trust—Thanks to recovering Chinese demand for commodities, the sure handed management of RBA Governor Glenn Stevens and comparatively modest consumer debt levels –Australia’s GDP continued to expand in Q1 while other industrialized economies saw double digit declines.  As with Canada, we like the Australian economy as an offset to the toxic US balance sheet. 

XLV – SPDR Healthcare —Healthcare looks positive from a TRADE and TREND duration. We bought XLV on 6/08 to get long the safety trade.

EWC – iShares Canada — We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We’re net positive Harper’s leadership, which diverges from Canada’s large government recent history, and believe next year’s Olympics in resource rich British Columbia should provide a positive catalyst for investors to get long the country.  

XLE – SPDR Energy — We bought Energy on 6/05. We think it works higher if the Buck breaks down.  Bullish TRADE and TREND remain.

CAF – Morgan Stanley China Fund — A closed-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.

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.


SHY – iShares 1-3 Year Treasury Bonds – If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.

UUP - U.S. Dollar Index – We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. Longer term, the burgeoning U.S. government debt balance will be negative for the greenback.

XLU – SPDR Utilities – As long term bond yields breakout to the upside, Utility investments are the relative yield loser. So far this thesis has gone against us.

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


Given that Trian controls the company, I initially came to the conclusion that the use of proceeds from the bond offering will be used to pay a special dividend. Why? It's a classic move by a private equity firm that wants to get paid. While a dividend is still possible, it's less likely. If they do end up paying a dividend, it would be a long-term negative and would limit the operational flexibility of the company.

Without fully understanding the use of proceeds, the offering is likely dilutive annually by $0.04-$0.05; the announced $550 million of unsecured debt will likely carry a coupon of approximately 9%. To answer the question as to why do an offering now, Andrew Barber's June 12 post titled "RATES, VOLATILITY AND LINES IN THE SAND" provides an interesting perspective. It's probably because they can - the credit markets are open and it might not last. As Andrew pointed out, "In today's environment, the reality for mid and lower grade issuers is simple: they are simply taking liquidity whenever and wherever they can find it after a long drought, and are likely more focused on their cash needs in 2 months than prevailing rates in 2 years."

Given this thought and the background of the principles at Trian, speculation is rampant that WEN is going to make an acquisition. I guess it could, but an acquisition would be viewed as bad for the stock; this partially explains why the company traded massive amounts of volume last week. Right now WEN is a turnaround story; the company needs to fix what it has before it takes on another concept.

I view an acquisition as unlikely and of course, the company line is that there is "nothing imminent." The biggest opportunity for WEN is to fix the margins on its current assets. Layering in a dual brand at Wendy's to help breakfast and or dinner sales are a very complicated process and are a very high risk proposition.

Importantly, it could take years to have an impact on profitability. Every dollar of capital the company has needs to be reinvested into fixing the existing asset base. This management team needs to prove to the street that it can execute its current business plan before the street will accept additional risk.

In the minds of senior management it's not a question of whether margins can be restored, but instead, management is confident they will be fixed by 2011. With margins being fixed in two years time, management needs to be thinking now about restarting the organic growth engine by that time. Organic growth for WEN is going to come from domestic and international unit growth, dual branding of the Wendy's and Arby's brands and growing the breakfast day part. None of this will come easy and there will be skeptics about the company's ability to grow internationally, but the planning process needs to start now if it going to be in the 2011 business plan.

I am very skeptical about WEN's international opportunities, given that I have witnessed the company fail multiple times. The excuse provided for the company's failure to execute internationally in the past was not bad management, but failure of the brand to perform at the same level as it does in the United States. That being the case, there is no need right now for massive amounts of capital to fund the international growth initiatives. Aspects of these growth initiatives are in contrast to the company's cost cutting story as they require "infrastructure investment" to lay the ground work for growth.

Absent of buying a "breakfast" concept, there is no need for capital beyond the company's current capabilities to grow the breakfast day part. In the short run, WEN will be replacing the horrid Folgers brand they are currently selling by testing new products that hopefully will resonate with consumers. While there are huge opportunities for breakfast within the Wendy's system, the concept's real estate strategy never contemplated selling breakfast, leaving some units incapable of executing the daypart properly due to poor locations.

WEN needs to upgrade its asset base, particularly Arby's, but this needs to be done systematically. Remodels are not easy to execute and need to be done in a thoughtful way that enhances returns. Not all remodel programs are created equal and WEN does not need a war chest of cash to do this.

Lastly, we can't rule out buying back stock. Adding leverage to WEN's balance sheet just to give the money back to shareholders is a big mistake. Leveraging up the balance sheet WILL NOT create shareholder value and limits the company flexibility to navigate a difficult environment. The money WEN is borrowing is not cheap and needs to be reinvested in a way that will generate incremental returns to shareholders. Right now, it is difficult to see where the ROI is going to come from.

The uncertainty of the debt offering throws into question the direction of the company. WEN's business plan had relied on a cost cutting strategy to fix margins by 2011, but the company's decision to raise capital to fund future growth initiatives goes against that very strategy. Same-store sales trends ate stagnant, and there is limited visibility to what is going to put Wendy's products and marketing initiatives on the map. Arby's is also suffering from a consumer identity crisis.

Despite the fact that senior management feels comfortable working with Peltz and team, the recent services agreements reek of corporate excess in a challenged economic environment. This relationship only adds to the discounted valuation the company is currently getting.

Trading at 6.4x NTM EV/EBITDA, WEN is undervalued relative to its global restaurant peer group trading at 9.0x NTM EV/EBITDA but is trading in line with its small-cap domestic peers. Roland Smith and team now have a bigger hurdle to leap to gain confidence that they can execute on a business plan that creates value for shareholders.





Fernando Chui Sai On is set to be the only candidate in the upcoming election for CE.  Ho Chiu Meng had been his main rival, but he announced to the Macau Daily News that he would not stand in next month's CE election. In order to run for the position, Ho Chiu Meng was required to resign from his current position as chief prosecutor and he has not done so.

It is said that Chui Sai was not Beijing's preferred candidate for the position. However, it seems unlikely that the changing of the guard in Macau will alter current laws regarding visas and the curbing of junk visitation in the near-term.



City of Dreams has had a less impactful first week than had been anticipated.  While it was known that VIP and premium mass market play would take some time to get up to speed, there has been some surprise at unofficial marketshare numbers suggesting no meaningful sequential gain on the part of Melco-Crown. 



Two major takeaways from the May gaming revenue numbers:

  • 1) SJM and WYNN gained considerably in terms of volume, as the number of rolling chips purchased overall was the highest since last August.
  • 2) The gap between SJM and LVS (31% to 21%) has widened as a result of higher volumes for SJM and lower win-hold rate for LVS.



The Macanese government has pledged to spend MOP100m on at least two flu shots for each resident. This comes as Hong Kong's chief has closed schools and nurseries to prevent the spread of the flu.  This has caused some concern among casino operators, fearful that their business will be impacted by flu fears.




The Macau Daily Blog posted an article outlining four "big phenomenons" [sic] hurting Macau.

  • 1) Dropping EBITDA margins.
  • 2) Mass Market has been squeezed
  • 3) The product mix being put out is the same across the board. No "wow" factor
  • 4) Junk tourism. Low value, low yield, for operators.



Macau is enjoying a taste of Bollywood magic with a galaxy of Indian stars arriving in the city for one of Asia's most-watched film awards. Oscar winning composer A.R. Rahman, who wrote the score for Slumdog Millionaire, superstar Amitabh Bachchan and Bollywood's leading couple Aishwarya and Abhishek Bachchan, are among those visiting the Las Vegas of the east for the 10th International Indian Film Academy (IIFA) awards.



MGM Mirage, the casino company controlled by Kirk Kerkorian, and Malaysia's Genting Bhd. are considering a possible partnership, spokesmen from both companies said.



High rollers in Macau are increasingly playing the slots.  Slot machines remain a minor segment of the market, at 6% of total revenue. However, in Q109 slots accounted for some $743m in revenue vs $81.5m of revenue in Q104.

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City of Dreams has only been opened for two weeks but we thought we'd give you some initial impressions from our guys on the ground.  Warning:  these insights are early and anecdotal in nature.  We are actively attempting to corroborate all of the following.

  • Weak Rolling Chip (RC) turnover at City of Dreams - MPEL acknowledges it will take a while to ramp up the RC segment. We are hearing CoD only did HK$4BN in Rolling Chip turnover over first 10 days, or HK$400MM per day. By contrast, Venetian and Wynn Macau average approximately HK$700MM and HK$900MM per day, respectively, during the summer months. All three properties maintain approximately 140 RC tables.
  • Traffic strong at CoD- indicative of the mass market focus. Uncertain of the turnover per customer but hearing it is somewhat low.
  • CoD may be experiencing low hold
  • Venetian Rolling Chip business holding up - the junkets are reporting that RC turnover at Venetian hasn't been impacted much.
  • Venetian traffic down - see chart below
  • Wynn losing MM and RC customers to MGM? - Something is going on here. We've heard it from multiple industry sources.

We'll have more to report this week and next.  I will be in Macau on 6/22-26 visiting the operators, suppliers, junkets, developers, etc.  Stay tuned.




Consumer sentiment continued to improve in the month of June, although the University of Michigan index rose by less than expected, it was certainly not a bad number.   The index rose to 69 in mid-June from 68.7 in May, up sharply from the 28-year low of 55.3 in November, but still below the 88.2 ten year average.


As I said in the Early look, it appears the numbers ARE peaking. The market forecasts were for a higher number, in the area code of 69.5.

It not clear to me that it's prudent to plan for a strong summer season for the consumer.  From where I sit a cautious consumer still prevails and most remain resolute about becoming more practical when making purchasing decisions.

As we head into the key summer driving season the price of gas at the pump is surging.  While the relative "affordability" compared to last year's $4+/gal price tag has most consumer feeling less of a pinch, the 63% increase year-to-date will put the brakes on incremental spending.  Especially with the sequential increase that is outlined in the chart below.

Howard Penney

Managing Director




Research Edge Position: Short XLU

We are short XLU currently; this is a trade that has set up nicely from a technical standpoint and ties in with our reflation theme.  With rising fuel costs and increased rate regulation the utility sector is looking at a potential squeeze on margins on the horizen, not to mention the anticipation that emission costs will increase as control measures (or caps) come into play.

Our model portfolio does not allow for options, and we are outright short.  For those of you that trade options and are looking to capture premium, the near month calls might be attractive.

Currently the implied volatility levels for XLU have remained high compared to the broad market on a historical basis; with at-the-money July calls showing levels in the 24 to 25 range, vs. a 30 day realized volatility of 24.5 and a VIX at 28. This volatility could in part reflect some of the bond market action we commented on this morning due to the sectors rate sensitivity.

For those brave souls who are looking to harvest premium here a short call look position looks relatively attractive as the macro and technical factors intersect with decent premiums  -particularly as broad market volatility  levels continue to trend down. Note also that this ETF goes ex-dividend in the coming week, another positive for the play.

Andrew Barber


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