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US Housing - A Disconnect?

Finding a bottom always seems easy, in hindsight....

As measures by the NAHB Housing Market Index (HMI) home builders remain cautious and concerned about prospects for the housing market, but that was yesterday;  today's key data point was Commerce Department numbers showing that U.S. builders broke ground on more houses than forecast in May, another sign of a "bottom" that the manic media has leapt on.

Since the end of Q408, our call on housing has been that it would bottom in 2Q and today's news provides further validation for our thesis.  The 17% month-over-month increase in housing starts to an annual rate of 532,000 followed a 454,000 number last month, handily beating both consensus and our expectations.  Last month we described the housing start numbers as an industry "acting rationally". This month's number is not strong enough to indicate that home builders are acting irrationally, but one has to wonder if the demand is really improving. 

The divergence between starts and completions has narrowed by 35% from the high in November of last year -but at 280 thousand units the potential inventory overhang is still both significant and ominous.

While government tax incentives are helping to bring in first time buyers, the bulk of the benefit is in the rear view mirror.  Last week average 30-year fixed mortgages jumped 30 basis points to 5.6% percent, (the highest since November 26, 2008) which suggests that the trends could slow as we head into the summer.  At 5.6%, mortgage rates are 75 basis points higher since April, when the rates were 4.8%. Meanwhile, the Mortgage Bankers Association said total mortgage applications fell 7.2% last week. 

With unemployment at a 25 year high and likely headed higher more consumers are likely to hold off on purchases of big ticket items and the savings rate is on the rise.  The housing market has bottomed for now, that is for sure.  The next move on the margin is less clear, as there is enough cold water to throw on an accelerating rate of improvements.

Howard W. Penney

Managing Director


US Housing - A Disconnect? - cha1

US Housing - A Disconnect? - cha2


As reported by the American Press, CEO Dan Lee intimated that PNK may begin construction of Sugarcane Bay by August.  The Lake Charles sister property to L'Auberge is now expected to cost $407 million, up from $350 million.  The improving credit markets were cited as the catalyst to resume construction.

Now, there is a lot to like about PNK.  Lumiere Place is ramping faster than expected, no doubt aided by the removal of the $500 loss limit in Missouri.  The company maintains significant exposure to Louisiana which has been the strongest performer among the gaming states.  The valuation at about 6.5x EV/EBITDA is reasonable and the FCF yield of almost 15% is attractive.  Last but certainly not least, PNK management has shown uncharacteristic restraint in terms of capital deployment, until recently.

My issue is not that Sugarcane Bay will be a disaster.  It's just that levering up to build at 8x EBITDA (maybe even higher if there is cannibalization of L'Auberge), when the incremental cost of borrowing will fall in the 7-10% range, doesn't seem to make sense.  We calculate only $0.09 in free cash flow accretion per share from Sugarcane Bay.  PNK could generate that level of accretion from the repurchase of only $50 million worth of stock.  PNK's cost of borrowing is going higher anyway - making the 15% FCF unsustainable - but pursuing Sugarcane Bay will expedite and elevate the hike.


Given the higher incremental cost of capital, exercising any development options would seem to detract from the company's value.  A story of harvesting cash flow and open development options seems like the better story for now.

Performance Tension

"Tension is who you think you should be.  Relaxation is who you are." 
~Chinese Proverb
A considerable amount of predictable tension was revealed in yesterday's global market trading. With the US Dollar up +1.5% on the day, the interconnectedness of global asset flows was revealed. Dollar up = lots of stuff that's priced in Dollars down.
After one US market down day from the YTD high, should we all freak out and run for the exits? Some tried. But managing money hysterically on the first day of the week (after global markets hit fresh 2009 highs last week) isn't going to get you paid. Price action was obviously negative across global currency, commodity, and equity markets, but it came on extremely light volume and nothing other than the noises people make when they don't understand macro correlation.
Relaxation is what you can thank your Asset Allocation to cash for. Tension is what you get when you're choking on a "fully invested" mandate AT THE YTD high for the SP500. Did I have a down day in the Asset Allocation Model Portfolio yesterday? Sure. When the market's breadth is 16% advancers to 82% decliners and you don't have shorts, you're not going to have an up day! That's what Asset Allocation is - it's not a hedge fund.
Post registering those YTD highs, hedge funds have been snagging a lot of headlines as of late. People in this business love to talk about performance, especially when it's good - and they should. This is a game where we keep real-time score. But don't forget that in the last 18 months that many a hedge fund manager has proven to be nothing but a glorified levered long investor.
Inclusive of yesterday's "oh my God - the market is going to crash again" calls to arms by the manic media, for the quarter to-date (Q209') the Dow is +13.2%, SP500 +15.8%, Nasdaq +18.8%, and Russell 2000 is +21.1%. Even a clanging monkey like me can make money on the long side in this environment!
So if you're having a great quarter - congratulations. Riding the REFLATION trade has been nothing short of bliss. I get that, and I fully support the message. What I don't get is the perpetual tension associated with anything that goes red. Just relax, and buy them when they are down. The next narrative of a "Great Depression" will be reserved for those who haven't come to grips with The New Reality: Buy red, sell green, and remember that calling for crashes AFTER they occur doesn't work.
Until the crescendo of consensus crushes it's R-Square, the most dominant global macro factor across asset classes will remain the US Dollar Index. Keep it dialed up on your screen - maybe play some classical music as it gyrates. It's one quote. It's easy to see. It's your massage table. Take deep breaths...
The US Dollar Index is trading down -0.79% this morning, and global equity, commodity, and currency markets are stabilizing again as a result. Asia's overnight equity market selloff came before we saw this morning's US Dollar weakness. Europeans woke up to the predictable, which was Russian rhetoric going back to beating the drums with their "colleagues" (the Chinese) and comrades about a new world currency reserve.
Putin Power broker, Dmitry Medvedev, took the conch to kick off the BRIC (Brazil, China, Russia, India) Summit in Russia this morning. What his finance minister (Kudrin) rattled people's cages with yesterday was a one-day, immediate term, TRADE. The Research Edge, intermediate term, TREND is the one that matters. The US Dollar remains broken across durations and it will remain the target of what we have been calling Replacement Rhetoric, for months and quarters to come.
The US Dollar's Credibility Crisis is what we get for paying off American Bankers, Politicians, and Debtors via the REFLATION trade. The world gets it, and with every tick on your screens on Dollar up days, most of the "I don't do macro" guys get it too. Don't stress about it. Just deal with it. "Tension", when it comes to "who you think you should be" isn't productive. Until the US Federal Reserve and Treasury systems lose their political polarization, the US Financial System will be as credible as the bed that said leaders of this system have made it to be.
My immediate term downside support for the SP500 is now 917. If that line were to break alongside a US Dollar Index breaking out to the upside above $81.89, I'll start making some sales. Otherwise, I'm going to stick with what's been working for the last 6 months, and get "longer of" REFLATION  on market weakness as the US Dollar rallies to lower-highs.
Best of luck out there today,


SPY - SPDR S&P 500 - The S&P500 corrected on 6/15 from the YTD high on low volume.  The S&P 500 is positive from both a TREND and TRADE duration. This is a market that has a very predictable range, one we'll trade with a bullish bias.

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 TREND duration and moved to negative territory for a TRADE. 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 resourcerich 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. 
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.

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Mainland police have smashed an online gambling racket in Hubei, China.  Police believe that 50bn yuan was wagered on soccer matches, horse races, and other events nationwide through the operation.  The racket allowed people to gamble without having to travel to the casinos in Macau and elsewhere outside the mainland.  Online gambling is proving to be a difficult problem for the authorities.  Xinhua reported that gambling websites in Taiwan, Macau, Myanmar, the Philippines, Singapore, and Malaysia had all made money from mainland gamblers.



The Zaia show in Macau tonight is part of a global celebration of Cirque du Soleil.  The acrobatic group has been entertaining for 25 years.  The Venetian Macau, where the group performs, will be hoping that the occasion this evening will help to boost visitors.



Talk of Wynn Resorts listing their Macau business on the Hang Seng has resurfaced, almost a year from the initial speculation in July 2008.  Given current market conditions, compared to last year, it would seem more likely to happen at this stage.  While the sustainability of the current upturn in the market is yet to be seen, it is clear that Wynn stands to gain significant funds via share sales.  This is far from a sure bet, but could have serious implications should it go through.

Bush v. Gore . . . Iranian Style

The key geopolitical event over the last few days was, of course, the Iranian "election".  We had a number of astute clients ask for our take on the election late Friday.  Over the weekend we reached out to many of our Middle Eastern contacts, and the answer is nuanced at best.  There are two general interpretations.  The first is that this is a step forward for democracy and pro-Western sentiment in that the anti-establishment voices in Iran have spoken, and even if they have not been heard, the Ahmadinejad administration will have to heed them.  The second interpretation is more dire and suggests that Ahmadinejad has consolidated power and now has the mandate to more aggressively pursue his anti-Western policies, which could include the aggressive pursuit of nuclear weapons.

With 2/3's of the vote counted, the Islamic Republic News Agency reported that current Iranian President, Mahmoud Ahmadinejad, is purported to have earned 66% of the popular vote in the Iranian national election, while the runner up, Mir-Hossein Mousavi, received 33% of the popular vote.  Ahmadinejad represents the conservative movement in Iran, while Mousavi, a former Prime Minister, represents the reform movement.  The reform movement galvanized around Mousavi, particularly the youthful and democratic supporting component, in the days leading to the election.   Mousavi's base is made up of wealthy, urban and more educated Iranians, and he has promoted a free market economic approach with tight fiscal policy and privatization of industry.   Ahmadinejad, on the other hand, has a base that is comprised primarily of the rural poor and government employees (policeman, teachers, etc) with the objective of fighting poverty, a key part of his campaign platform (~25% of Iranian citizens live below the poverty line).

Immediately following the announced results, Mousavi issued a statement implying that the voting was rigged and that he would not, "Surrender to this charade."  We have a limited ability to determine how, or if, the results were fraudulent.  In the United States, and most western democracies, allegations of fraud tend to be localized in nature, such as Florida in 2000 and Ohio in 2004.  National allegations of fraud are typically more difficult to perpetrate because polls leading to the election, in aggregate, are typically a good leading indicator of sentiment and how the election will play out.  In countries such as Iran, polling is more of a political tool, and far from systematic.  In the roughly 15 polls in the two months prior to the election, Ahmadinejad was expected to win anywhere between 24 - 63% of the popular vote (ironically, he "won" more than any poll expected him to win), which is a spread so large that it suggests the polling is largely inaccurate.

Nate Silver, the well known poll analyzer from fivethirtyeight.com, had the following comment about fraud as it relates to the Iranian election:

"Although widespread allegations of fraud, manipulation, intimidation and other all too common elections tactics have been common, statistically detecting fraud or manipulation is a challenge. For example, while mathematicians have been evaluating vote returns for irregularities in normal situational random number distribution, determining what the "correct" results should be is very difficult.

However, given the absolutely bizarre figures that have been given for several provinces, given qualitative knowledge - for example, that Mahdi Karroubi earned almost negligible vote totals in his native Lorestan and neighboring Khuzestan, which he won in 2005 with 55.5% and 36.7% respectively - there is room for a much closer look." 

In effect, proving fraud is virtually impossible without knowing the accuracy of the data.  That said, there are major irregularities versus the 2005 election. The call out above relating to Lorestan would be comparable to George W. Bush getting no votes in Texas in 2004.  Given that Texas is his home state and he carried Texas by a wide margin in 2000, this is  virtually impossible.

Earlier today, Supreme Leader Ayatollah Ali Khamenei announced there would be an investigation into vote rigging claims.  This, of course, followed Sunday's announcement by Khamenei in which he urged the nation to support Ahmadinejad and characterized his election as a "divine assessment."  Ultimately, Khamenei rules Iran legally as dictated in the constitution of Iran.  The Supreme Leader appoints a Guardian Council, which is responsible for approving candidates for any election.  While the Supreme Leader may feign an investigation into vote rigging to appease protesters, the fact remains, he has ultimate spiritual and legal power in Iran and as such will determine who becomes President and what, if any, influence that President may have.  As Genieve Abdo wrote in the Christian Science Monitor this weekend:

"In his victory speech this past weekend, Ahmadinejad said his reelection marked a new future for Iran. But, in fact, by clarifying the supreme leader's power, it signals a future that looks much like Iran's darkest past."

While the popular upheaval in Iran is encouraging, we find it difficult to believe, as Abdo writes above, that much if anything will change in the Islamic Republic of Iran post this election.


Daryl G. Jones
Managing Director



We are being reminded today that home builders remain cautious and concerned about prospects for the housing market.  The NAHB Housing Market Index (HMI) declined one point to 15 in June.  According to Bloomberg the median forecast was a reading of 17.  This is the second time in as many trading days that a reading on consumer behavior was less than expected.  Last Friday, consumer sentiment continued to improve in the month of June, although the University of Michigan index rose by less than expected. 

The NAHB index gauges builder perceptions of current single-family home sales and sales expectations for the next six months as "good," "fair" or "poor." Although the outlook for home sales has improved somewhat in recent months, home builders are facing a few headwinds, including: the expiration of the tax credit at the end of November, an upturn in interest rates, and especially the bottleneck in the loan approval process.

Tomorrow we will get another gauge on housing when the Commerce Department releases housing starts.  The median forecast is for 485,000 versus the prior reading of 458,000.  Given the supply of unsold homes and the number of homes in foreclosure, and now the sequential decline in the HMI, why are housing starts going to improve sequentially?  In fact we could be reading tomorrow that builders broke ground on the fewest homes on record in May!  

Howard W. Penney

Managing Director



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