White Coats

"If you're not confused, you're not paying attention."
~ Tom Peters
Yesterday, the SP500 locked in its 3rd consecutive down day, taking its correction to -3.8% from the year-to-date high (946) established last Friday. With the SP500 having broken my immediate term TRADE line (917), but holding comfortably above the intermediate term TREND line (845), now we have ourselves a good ole fashioned game of bulls and bears trading a proactively predictable range.
The REFLATION bulls have been in it to win it since the US Dollar started collapsing in March. The easy money here has been made. Being long everything that's denominated in Dollars was a winner, and everyone finally has to agree with that revisionist math. Alongside that crescendo of consensus comes compression in returns. As the head trader at a hedge fund I used to work for would say - "that's it - the guys in the white coats have figured this out."
He's a funny guy - he calls the "quants" the guys in the "white coats". You know, the nerdy guys who do math before they do "fundamentals". But isn't math fundamental? The pretension of this business is funny - if you're at a fund that combs through 10K's and engages in the almighty "one on one", you honestly think of yourself as being the fundamental guy, dismissing the scientists and mathematicians process as "quant." I wonder what Darwin would think about this industry...
Darwin taught us that if you are confused and/or losing, that you better evolve. That's what makes a great global market operator - she keeps moving. High R-Squares and inverse correlations are not perpetual. People in this business chase trends and eventually crowd out returns. That's not new. Yes, the tickers might change, but the behavioral side of this business never does.
Out of the 9 sectors in the SP500, the worst 4 performers yesterday were XLF, XLE, XLB, and XLI (in that order of worst (Financials), to 2nd worst (Energy), to Basic Materials and Industrials). With the US Dollar down, this was downright confusing. When the Dollar is down, the REFLATION trade is supposed to work!
Since I am long Energy (XLE), that was annoying. Why is the market all of a sudden starting to annoy us? I'll give you three of my latest thoughts:
1.       After both a crash and a squeeze of generational proportions, range bound markets can be annoying
2.       REFLATION traversing the last part of its easy money move and morphing into INFLATION will be annoying
3.       RE-REGULATION of the US Financial Market is annoying
On the first point, I think I have riffed enough - calling for crashes and bubbles AFTER they occur doesn't work. Managing toward tail risk is a proactive exercise, not a reactive one.
On the second point, my investment team is doing a great deal of work as of late. Yesterday's CPI report in the US not only flashed DEFLATION, but the lowest CPI reading since 1950! I don't see reported inflation coming onto the field as THE political football until Q4. Three of my leading indicators on that front are 10-year US Treasury yields, Dr. Copper, and the prices of West Texas Crude oil.
Here are my current levels where I think REFLATION becomes INFLATION come Q4:
1.       10-year yield > 3.29%
2.       WTIC Oil > $71.31/barrel
3.       Copper > $2.24/lb
On the third point, this is where confusion reigns. Primarily because his "economic" team is dominated by lawyers, college professors, and politicians, President Obama doesn't get this yet, because no one on his team does. For those of us real-time practitioners of the trade - stock market operators if you will - confusion in market's breed contempt. Contempt erodes confidence. Without confidence, markets lose multiples.
On the topic of RE-REGULATION, I will point to three of the best written points I have read as of late.
1.       In his June "Investment Outlook", Bill Gross wrote: "Of one thing you can be sure however: over the next several decades, the ability to make a fortune by using other people's money will be a lot harder. Deleveraging, reregulation, increased taxation, and compensation limits will allow only the most skillful - or the shadiest - into the Balzac or Forbes 400."
2.       In his "Weekly Screed", our Chief of Compliance (ex-Carlyle hedgie with me), Moshe Silver wrote: "Bair is, as far as we know, the only regulator in charge of a federal agency who actually gets her hands dirty when things get ugly. Her agency confronts massive financial failures - failures that wreck communities, shutter industries, and ruin people's lives - and Bair has waded in to join the battle on more than once occasion. Bair's public image is that of a person more concerned with doing her job than with keeping her job."
3.       In his comments overnight, Bank of England Chief, Mervin King said: "some of these banks may be too big."
Confusion is what it is. Like this rain we are getting on the East coast, it's annoying. But no matter where you go this morning, there it is... and we have to deal with it... so get up from your desk and go buy yourself a white coat would ya!
My immediate term downside support level for the SP500 remains 904, and upside resistance 933.
To Laura's grandmother, Mimi, we will miss you dearly. Thanking you for making us all smile,


EWZ - iShares Brazil-President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt -leading to an investment grade credit rating. Brazil has managed its interest rate to promote stimulus. Brazil is a major producer of commodities. We believe the country's profile matches up well with our re-flation theme.

SPY - SPDR S&P 500 -The S&P 500 is positive from a TREND duration and negative from a TRADE duration. Yesterday was not a bad recovery from the 904 line, but not convincingly bullish either.  

QQQQ - PowerShares NASDAQ 100 - We bought Qs on 6/10 to be long the US market. The index includes companies with better balance sheets that don't need as much financial leverage.

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 think Energy works higher if the Buck breaks down.  Bearish TRADE and bullish TREND.

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.  



XLP - SPDR Consumer Staples - We shorted XLP on the bounce on 6/17. The immediate term TRADE line here is breaking down and so is consumer confidence. TRADE is negative, TREND is positive.

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.



PNK is known for its development.  Not that the company is a bad operator.  It's just that they've developed some of the nicest regional properties including Lumiere Place, L'Auberge Du Lac, and Belterra.  Of course, you cannot build without financing and Dan Lee and company have been very adept at raising debt and equity over the years to fund these projects.  They will have to do it again, this time with a new bank facility and a sub or senior bond deal.  Although with these guys, you can never rule out an equity deal (highly unlikely at this stock price).

PNK's current bank facility matures in December 2010 and the leverage covenant will likely bust in Q1 2010.  A new facility, amendment, or extension is a certainty.  The company also has about $400 million worth of senior subordinated bonds maturing in 2012 and 2013.  We believe the most likely course of action involves a new credit facility finalized over the next month or two, followed by a large bond deal.  Some observations:

  • PNK probably cannot start Sugarcane Bay without having the money to finish it and cover the overhang of the 2012 notes maturing - that would just be very risky in this market
  • They have to get rid of the 2013s because the indentures really strap the company's ability to use the credit facility. A covenant in the 2013s prevents PNK from drawing more than $350 million on the credit facility unless the Consolidated Coverage Ratio rises above 2.0x on a pro forma basis.
  • If the company is going to refinance the 2013s they may as well get rid of the 2012s. If they don't, they still have the issue of using the R/C to pay off the maturity and doing yet another deal in 2011
  • In the current environment, we come up with a rate of 10.5% on the new $600MM of notes as the current ones are trading at a yield of 10.6%. Even though they are called Subordinated, they are effectively Seniors given the restrictions on additional leverage - so when those go away new debt should price higher, or as high, even if it's called "senior"
  • The bank market is the most constrained so if they downsize the credit facility from $650 million to $450 million, they can probably get all in pricing around 6%
  • The only reason not to get rid of the notes is if they think they can get above 2.0x Consolidated Coverage Ratio. PNK might move above 2.0x over the next few quarters, but could also miss their opportunity to tap the current opening of the high yield markets. Also, proceeding with Sugarcane may preclude them from doing that in any event.

With those thoughts in mind, we've come up with the following assumptions:

  • 1) PNK closes on a new $450MM credit facility early in Q3 2009. We are assuming a rate @ L +4%, with a 2% floor. Currently PNK is borrowing at LIBOR +2%, or around 3.5% currently. With the floor in place, PNK's effective rate rises 2.5% under our assumption.
  • 2) After the new credit facility is arranged, PNK retires the 2012 (8.25%) & 2013 (8.75%) senior subordinated bonds with a new $600MM deal @10.5%.


The following chart shows where we shake out relative to the Street.  Our revenue and EBITDA estimates are pretty much in-line, but EPS is below.  Clearly, the Street hasn't made the appropriate cost of capital adjustments.




Six Hong Kong residents, three Thais, two mainlanders and one Macau resident have been charged with organized crime, brutal murder and dismembering in relation to the death of Lai King-man, 60, nicknamed "Police Man", Macau's Public Prosecutions Office said yesterday.

The crime is believed to be gang-related. Lai and one of the gang members, last name Ma, had a dispute over money.  On the night of September 6, Lai was dragged from the Venetian Macao casino and held in a VIP room in a restaurant.  He was then stabbed to death and dismembered in what one of the prosecutors described as an "atrocious crime".

Lai reportedly had debts of 2 million yuan (HK$2.27 million) - two decades after he lost the money in an underground casino in Shenzhen.

It is unclear why his creditor, who ran the casino, began to chase the 20-year-old debt last year.

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Sports Apparel: Strike 2

Last week was the worst year over year change in sports apparel since July 2008. Everything was down at an alarming rate. Sporting goods retailers fell down by 15%, discount/mass channel declined by 40%, and the recently strong family retailer channel decreased by 10%. I call it like it is, and will VERY rarely pull the weather card. But last week's impact was unmistakable. The average temperature was 6-15 degrees cooler than average across virtually the entire US - with warmer temperatures only in Virginia, Georgia and parts of Texas. I won't even begin to call out the rain, because it rained pretty much everywhere. See weather charts below.


So what does this all mean? While I can explain the week away, it doesn't mean we can ignore the facts - especially given that sales have been weakening since early May, and need to pick up in mid June when seasonal demand should increase. The bottom line is that the June better darn well finish on a great note with some nice pent-up demand, otherwise we're all going to see some GREAT deals on athletic apparel in July. Good for consumers, but bad for the retailers and certain brands.


Sports Apparel: Strike 2 - chart

Sports Apparel: Strike 2 - Daily Weather Records image 1

Sports Apparel: Strike 2 - Departure of Average Temperature from Normal PNG

Sports Apparel: Strike 2 - Table

German Snapshot


Polls suggest the center-right is gaining momentum and confidence is rising

Fresh off a victory in European Parliament elections, German Chancellor Angela Merkel and her Christian Democratic Union (CDU) party increased her spread over its main challenger, the Social Democratic Party (SPD), based on a weekly Forsa/Stern poll ended June 12th.

While the CDU lost a point to 35% on the prior week, the SPD dropped three points to 21%, and Merkel's most likely coalition partner, the pro-business FDP, gained one point to 15%. The decline of the SPD, led by Foreign Minister Frank-Walter Steinmeier, may reflect the party's inability to win state aid for retail-giant Arcandor, which filed for insolvency last week. 

ZEW published its economic sentiment indices yesterday. The survey said that investor and analysts expectations for economic developments six months ahead increased to 44.8 from 31.1 in May, while current economic conditions improved to -89.7 from -92.8 in May. 

We continue to have a bullish bias on Germany, due in part to the fiscally conservative leadership of Merkel. The latest German CPI number in May mirrored that of the Eurozone at 0.0% on an annual basis. The disinflationary trend on prices (driven by the decline of fuel costs) will help encourage consumers to spend and if the Euro can back down off of $1.40 it will benefit the export-heavy economy. We still expect to see mild growth starting in early '10 as the country works through ~6% GDP contraction this year. Despite a contraction in the unemployment rate in May of 10bps to 8.2%, we believe the number will rise sequentially and provide a headwind for sentiment. Expect employment to remain a focal point coming into elections in late September.

Matthew Hedrick


German Snapshot - eurocpi

The Demographic TAIL


I'm in the midst of writing a post on oil elasticity and as such have been reviewing some interesting research on OPEC's website and happened upon the table below, which outlines projected population growth rates.   Over the course of the next few weeks, we will be officially introducing our third duration, which we will call TAIL.  This duration denotes investment themes of 3 years or more, and, as always, these themes will have a price attached to them.  In the OPEC 2008 World Oil Outlook, which as an aside is an incredibly detailed publication, I found the attached table which outlines population levels and growth for the major regions around the world.  Demographics are clearly in the TAIL, but will be moving into TREND and TRADE in the coming years.  The table is outlined below:

 The Demographic TAIL - dj1

There are a few key takeaways:

  • There are two groups of regions: those taking share in the world population race and those losing share. The regions taking share include: Middle East and Africa, South Asia, OPEC, and South East Asia. The regions losing share include: North America, Western Europe, OECD Pacific, China, Other Europe, and the former Soviet Union.


  • China is the nation losing the most share as it is projected to go from 20.2% of the world's population in 2006 to 17.7% of the world's population in 2030.


  • OECD Pacific, FSU (the former Soviet Union), and Other Europe are the three regions that projected to decline in population from 2006 to 2030; and


  • The three regions with the largest projected growth, Middle East and Africa, South Asia, and South East Asia, are currently 44% of the world's population and over the next ~20 years will contribute 73% of the world's population growth, or 1.2BN people.

Over the course of the coming year, we will be write more TAIL notes, and many of these will have a demographic underpinning.  The global population share shift has implications for consumer spending, energy use, geo-political risks, and product development, to name a few areas.  Both investors and management teams that do not have their focus on the TAIL as it relates to demographic trends are ignoring important fundamental shifts that will drive markets for decades to come.

Daryl G. Jones
Managing Director


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