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Sands China has approached banks to arrange a US$1.5-billion, (MOP12 billion) six-year, revolving credit facility.  The casino operator has approached its current lenders and targets to invite more than 10 banks to become senior lenders, Bloomberg reports.  The news agency says the pricing is thought to be at an all-in rate of slightly under 200 basis points over Libor.



According to PBoC, China's new yuan-denominated lending in October amounted to 506.1 billion yuan (82.44 billion U.S. dollars), an increase of 700 million yuan YoY.  This was below Dow Jones estimate of 600 billion yuan.



Louis XIII Holdings raised HK$1.03 billion (US$133.5 million) for a planned casino resort in Cotai.  The proceeds from the combined sale of equity and zero-coupon convertible bonds will fund construction of its US$1-billion casino resort.


The financing deal included a share placement of HK$735 million, and HK$300 million of convertible bonds taken up by the Ontario Teachers’ Pension Plan.


TODAY’S S&P 500 SET-UP – November 11, 2013

As we look at today's setup for the S&P 500, the range is 30 points or 1.28% downside to 1748 and 0.42% upside to 1778.                                       










THE HEDGEYE DAILY OUTLOOK - 10                                                                                                                                                                  



  • YIELD CURVE: 2.44 from 2.32
  • VIX closed at 12.9 1 day percent change of -7.26%

MACRO DATA POINTS (Bloomberg Estimates):

  • 6:15am: Bundesbank’s Lautenschlaeger speaks in London
  • 12pm: Bundesbank’s Weidmann speaks in Basel
  • U.S. Rates Weekly Agenda
  • FX Weekly Agenda


    • Iran faces United Nations nuclear-monitoring test
    • Veteran’s Day, most federal govt. offices closed
    • EU, U.S. begin 2nd round of negotiations on Transatlantic Trade and Investment Partnership at wk-long talks in Brussels


  • Shire buying ViroPharma for $4.2b will gain blood-disease drug
  • Transocean reaches $1.1b div. accord with Icahn
  • Apple said developing curved iPhone screens, new sensors
  • Amazon introduces Sun. deliveries with U.S. Postal Service
  • China economic rebound gives boost to Xi amid reform summit
  • Cooper not yet entitled to $35/shr from Apollo, judge says
  • CPPIB/Dexus A$2.8b Commonwealth fund bid is accepted
  • “Thor” tops N.A. box office, at low end of ests. w/ $86.1m
  • Typhoon Haiyan hits Vietnam; up to 10k Philippines deaths


    • Silver Wheaton (SLW CN) 6:30am, $0.23
    • Gogo (GOGO) 7:30am, $(0.31)
    • CCL Industries (CCL/B CN) 8:15am, $0.45
    • Assured Guaranty (AGO) 4pm, $0.61
    • Sotheby’s (BID) 4pm, $(0.47)
    • Rackspace Hosting (RAX) 4pm, $0.16
    • Hologic (HOLX) 4:01pm, $0.37
    • Strategic Hotels & Resorts (BEE) 4:01pm, $0.13
    • SemGroup (SEMG) 4:05pm, $0.36
    • Sunstone Hotel Investors (SHO) 4:15pm, $0.29
    • Northern Tier Energy (NTI) 4:45pm, $0.40
    • Legacy Oil + Gas (LEG CN) 8:30pm, $0.08
    • Premier (PINC) Aft-mkt, $0.29
    • News Corp (NWSA) Aft-mkt, $0.02
    • Athlon Energy Inc (ATHL) Aft-mkt, $0.16


  • Gold Vault Opens in China as Bullion Goes From West to East
  • Hedge Funds Cut Bullish Gold Wagers on Fed Outlook: Commodities
  • Copper Rises for Third Day After China’s Industrial Production
  • Brent Rises Second Day After Iran Talks Fall Short of Agreement
  • Gold Drops to Three-Week Low as Jobs Data Spur Tapering Bets
  • Corn Extends Rebound From Three-Year Low on U.S. Harvest Outlook
  • Cocoa Falls After Bullish Bets Climb to Record; Coffee Rallies
  • Oil Bets Drop to Four-Month Low as Glut Expands: Energy Markets
  • Money Managers Cut Cocoa Net Long to 64,649 Contracts by Nov. 5
  • Gold-Mining Puts at Four-Year Low Signal Worst Is Over: Options
  • Rice to Sugar Crops Damaged in Philippines by Super Typhoon
  • Russia May Become Major LNG Supplier After Novatek’s China Deal
  • Commodities Seen by Hackett May Be Near Low of 3-Yr Bear Market
  • Palm Oil Output in Malaysia Advances to Highest in 13 Months


























The Hedgeye Macro Team














Fed Powers

This note was originally published at 8am on October 28, 2013 for Hedgeye subscribers.

“The powers delegated by the proposed Constitution to the federal government are few and defined.”

-James Madison


In other news, one of Bloomberg’s leading headlines this morning takes the other side of Madison’s Federalist Papers: “Yellen Poised to Rival Obama with Financial Power.” Isn’t that just terrific!


Have no #EOW (end of world) fear, yet. There are plenty of voices in America (and abroad) who still believe that an un-elected, un-checked, and un-accountable Federal Reserve is about to meet its maker – The People.


“Unlike the modern Statist, who defies, ignores, or rewrites the Constitution for the purpose of evasion, I propose that we, the people, take a closer look at the Constitution for our preservation.” –Mark R. Levin, The Liberty Amendments (pg 12)


Back to the Global Macro Grind


I’m not a Tea Party person, but I often wonder why more dogmatic Democrats don’t show “folks” like Mark Levin some love. Some of these Constitutionalists hate the Republican party more than Dems do!

Irrespective of your politics or Sox/Cards affiliation, every morning in America is a great one where we can “take a closer look at the Constitution” and the un-precedented power both Bush and Obama have put in the hands of Bernanke and Yellen.


I read Levin’s new book in 8 hours. At a bare minimum, it was worth my time to re-realize what I didn’t remember about the US Constitution. At a maximum, it made me think. Unless Americans want their currency to burn, Venezuelan style, they better start thinking about this, and fast, too.


Last week’s US #GrowthSlowing signals in equities we’re definitely considering what Down Dollar, Down Rates means:

  1. Slow-Growth Indices led last week’s US stock market strength: Utilities (XLU) +2.0%, REITS +1.8%, MLPs +1.7%
  2. Pro-Growth Indices flashed their 1st major negative divergence of 2013: Russell2000 +0.3%, Financials (XLF) -0.2%

If you broaden your vantage point to currencies and commodities, you can see the causal Fed factor at work here:

  1. US DOLLAR: down another -0.6% last wk and down -3.4% in the last 3 months to now NEGATIVE -0.7% YTD
  2. GOLD: up another +2.7% last wk and up +1.7% over the same 3 month period as Mr. Market front-runs the Fed

All the while, what the Fed is really sponsoring here (volatility instead of price stability) flashed its 1st major divergence versus the “US stock market at all-time highs” thingy in 2013. Stocks up = VIX up.


Not to be confused with every other US equity market rally of 2013 that we were long of (we’re short this one):

  1. US Equity Volatility (VIX) is making a series of higher-lows (instead of lower-lows) now
  2. The 11-handles that the VIX saw in both March and August of 2013 were aligned with US #GrowthAccelerating

No, this has nothing to do with being a Republican or Democrat. It has nothing to do with social issues either. It has everything to do with Mr. Market’s expectations of what causal impact the Fed’s “no-tapering” decision could have on the slope of US economic growth.


To review US economic growth’s slope in 2013:

  1. #GrowthAccelerating: Q4 2012 GDP of 0.14% accelerated to +2.48% by Q2 of 2013
  2. ISM and PMI “New Orders” pinned 60-handles in Q3 of 2013
  3. The first batch of OCT 2013 weekly and monthly US economic data has slowed, sequentially

“Sequentially” is an important word. How many of your favorite political market/econ pundits could even tell you what it means? *Hint: slope of the line.


And away from this week’s FOMC decision to pander to the Bond Bull Lobby, you’ll be getting more of what you saw in the US Consumer Confidence (U of Michigan survey) last week (73.2 OCT vs 77.5 SEP, #GrowthSlowing). Here’s the Macro calendar:

  1. Thursday: Chicago PMI for October should slow sequentially from September’s 55.7
  2. Fiday: ISM for October should slow sequentially from September’s 56.2

I know. Who cares? It’s all about the Fed right? Yeah, right.


More like it’s all about your investing Style Factors. To get those right, you need to get the slope of these growth lines right.


And if, god forbid, we take a few hours to consider the Constitutional conflict of interest in the Fed trying to “smooth” things embedded in the line (like gravity and/or growth), we might actually drive ourselves right nuts.


I can get nuts. I felt nuts selling at the all-time highs of October 2007 too.


Our immediate-term Risk Ranges are now as follows:


UST 10yr Yield 2.44%-2.60%

SPX 1739-1775

DAX 8891-9012

VIX 11.59-14.96

USD 78.72-79.71

Gold 1322-1369


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


Fed Powers - Chart of the Day


Fed Powers - Virtual Portfolio

Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.


The Economic Data calendar for the week of the 11th of November through the 15th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


THE WEEK AHEAD - weekahead


Takeaway: Here are Hedgeye CEO Keith McCullough's refreshed levels for our high-conviction stock ideas.



Takeaway: Current Investing Ideas: BNNY, BYD, FDX, FXB, HCA, HOLX, MD, NKE, RH, SBUX, TROW and WWW

Below are the latest comments from our Sector Heads on their high-conviction stock ideas. Please note that we added the British Pound (FXB) to Investing Ideas on Friday. Here is a link to our report.


BNNY – Thursday night after the close, Annie's reported its fiscal Q2 2014 results: the top and bottom lines saw strong sequential and year-over-year growth while gross margin was pressured and frozen pizza results were weaker. 


Despite slightly uneven quarterly results we remain bullish on the company as its 2H outlook stands to benefit from product roll-out, and COGS and SG&A efficiencies, including from its acquisition of Safeway’s manufacturing plant (announced 3 days ago) in Joplin, Missouri, where the company has been producing over 50% of its snacks business since inception in 2002.  The purchase price is $6M, plus the cost of inventory and supplies at the close – it is expected to be an all cash transaction.


We remain buyers of the stock on weakness, however today wasn’t that day with the stock up intraday over +5%!


BYD – Hedgeye Gaming, Lodging and Leisure Sector Head Todd Jordan has no update this week on Boyd Gaming. 


FDX – Shares of FedEx, a top performing transport year to date, eased this week amid higher oil price and a weaker equity market.  Industrials sector head Jay Van Sciver says that, should economic growth slow, FDX’s share price could be negatively impacted in what we would characterize as a short- to intermediate-term negative.  Long-term, Van Sciver sees the Express business offering meaningful upside profit potential as the company restructures the division.


HCA – Health Care sector head Tom Tobin has reviewed his model for 2014 and 2015 both for underlying trends and after adding on the impact of the ACA.  The selloff in recent days, despite a solid quarter, with a big acceleration in surgeries, looks related more to the poor showing from Tenet Health Care (THC) in Q3 and weak Q4 guidance, as well as the rollout problems of healthcare.gov. 


On the rollout, Tobin saw a great survey from the Commonwealth Fund showing 25% of the visitors to the site had a Health Status of Fair or Poor.  This is over 2X the percentage in the population of the uninsured at large.  Tobin sees this as a positive, because it shows that those in need, and likely to end of needing hospital services, are looking to buy an insurance policy on the Exchange, rather than relying solely on public health facilities.


HOLX – Health Care sector head Tom Tobin has updated two key data sources for his Hologic long thesis this week.  The first is a blunt force data collection process he employs to figure out how many facilities have purchased a 3D Tomosynthesis system.  October was one of the best months HOLX has had since they launched the system, adding 28 facilities and climbing to 426 overall.  Penetration rates remain low at 5%, so Tobin expects a long runway ahead.  And he points out that the growth has occurred even without a billing code. 


The other update was his OB/GYN survey which continues to show a consistent trend of positive patient volume with continued pressure for Pap testing.  Tobin thinks he has isolated a key part of the market’s bear thesis on HOLX, namely the decline in testing from increasing testing intervals from every year to every three years.  Tobin expects that share gains and patient volume should offset the increase in testing interval.  Lastly, while the rollout of the ACA’s website healthcare.gov continues to limp along, there are some signs of progress.  The website ranking for helthcare.gov has begun to fall, presumably as the backlog of interest gets worked down.  Says Tobin, “We’ll see if that plays out in the news flow the next few weeks.”


MD – Despite the volume headwinds, Mednax beat expectations in Q313. Near term maternity trends remain flat, which is better than a decline, but Tobin would like to see the uptick he has been expecting for some time now.  Tobin’s OBGYN survey and macro indicators haven’t yet turned positive, and he continues to monitor them carefully.  In the meantime, Tobin says there are plenty of other tailwinds to continue to support the long thesis.


NKE – Retail sector head Brian McGough notes that Adidas negatively preannounced earnings back in September, and this week it subsequently showed sales erosion in every region of the planet except Western Europe. This week, says McGough, Puma came out and did the same – it noted that earnings will be positive, but will be significantly below last year.  What most Americans don’t know is that Adidas and Puma are fierce rivals.


The simple story is that Adidas was started by Adi Dassler and was joined by his brother Rudolph. (For language sticklers, McGough points out that the correct pronunciation is Ah-di-das, not Uh-dee-das). Unfortunately, the brothers had a pretty big rift, and Rudolph left to start his own shoe company, which ultimately became Puma. Needless to say, the town of Herzogenaurach (have fun pronouncing that one), Germany remains decidedly split between those with allegiance to Adidas vs. those that embrace Puma.  While these two brands were busy missing numbers, says McGough, their fiercest competitor sat halfway across the world smoking them (both its numbers and its competitors). The competitive gap between Nike and its peers is growing.

RH – Retail sector head Brian McGough says Restoration Hardware opens its new 28,000 square foot art gallery in the Chelsea district of New York City this week. Along with the art gallery, the company will publish its first iteration of the RH Contemporary Art Journal and roll out an art-centric website. A second gallery is expected to open in LA in 2014.  This is RH’s newest product offering, but McGough doesn’t see it driving substantial revenue growth in the future.


The real opportunity, he says, is in areas like RH Kitchen, where former William’s Sonoma Brand President, Richard Harvey, was hired to lead the roll out.  But even if it doesn’t represent major profit potential, McGough sees RH Art as a brand builder.  Unlike music – where the company has also established a presence – artworks are right in the company’s wheelhouse and can only help RH build its brand and gain exposure as it rolls out its new Design Galleries.


SBUX – Hedgeye Retail Sector Head Howard Penney recently conducted a proprietary Retail Coffee Consumer Survey and the results were not surprising.  60% of consumers surveyed like the taste of Starbucks coffee very much, higher than any of their peers.  Considering 90.7% of Starbucks customers value the quality and overall taste of coffee/drinks more than anything else, it is clear that the company has a loyal group of core customers. Penney believes the national rollout of La Boulange will drive incremental food and coffee sales.  SBUX remains the best long-term company in the restaurant space and the long-term TAIL continues to seem unlimited.  


TROW – Financials sector senior analyst Jonathan Casteleyn says mutual fund flow during the week continued to be positively skewed to equities, with another strong inflow into stock funds and continued redemptions within bond funds.  “There is a confluence of short term market moving inputs to consider that will determine forward asset allocation,” says Casteleyn.  But he says the intermediate term trend continues to point to continued increasing demand for stock funds, supporting the bullish environment for T. Rowe Price Group


Casteleyn points out that domestic equity mutual fund products have not had inflows since 2006.  The year 2013 is working solidly on the first net inflow in 7 years, which has retail investors slowly tip-toeing back into mutual funds. Casteleyn’s research shows that fund flow gravitates to mutual funds with industry-leading performance – in short: folks like to go with a proven winner – which means TROW, with the best performing fund family in the asset management industry, should benefit the most from re-emerging mutual fund interest.


WWW – Retail sector head Brian McGough says two of Wolverine World Wide’s little talked-about brands, Sebago and Stride Rite, made significant changes to their management structure over the past week. Sebago announced that Frank Annunziata will be the new VP & GM, while Stride Rite named Ira Hernowitz President of the Stride Rite Children’s Group. Both of the new executives are outside hires, Annunziata from Clarks and Hernowitz Toys R Us.  These brands are not in themselves significant to McGough’s WWW thesis, but he says the hiring trend is noteworthy. Along with the hiring of Gene McCarthy to lead the Merrell Brand in August, the company has now gone outside the company three times to hire executives to lead their brands. While the talent pool is certainly greater outside of WWW’s walls, McGough suspects this may be sending a sour message to the company’s broader employee base about where it is looking to source its talent.


Macro Theme of the Week – Currencies: What If They Had A War And Everybody Came?

Just when we thought it was safe to go back into the Euro…


Hedgeye’s Q4 Macro theme #EuroBulls laid out the case for investing in Eurozone markets.  The Eurozone was flashing positive signals as the slope of various indicators had turned decidedly positive.  This included such key metrics as consumer confidence, PMI numbers, auto sales – and of course, the strength of the Euro itself.  Our Strong Euro call was the flip side of the clipped coin that is the weakened dollar, as we watched our central bank continue its policy of the “Three D’s”: D-value, D-grade and D-bauch the Dollar. 


Currency traders may tell you otherwise, but the markets know the Dollar is still Top Dog among global currencies.  And so far, the tail is not yet strong enough to wag the dog.  So as the value of the dollar falls, the value of stuff priced in dollars goes up.  In the world of currency trading, this means just about every other currency in the world has been rising in value.  This was a big piece of our transition from being bullish on the Eurozone, to being outright bullish on the Euro itself, and incidentally on just about any currency that’s not the Dollar, as we wrote glowingly last week about everything from the Swiss Franc to the Pound.


That was all well and good until European central banker Mario Draghi unleashed this week’s “November Surprise.”  If America’s currency relies on divine assistance (“In God We Trust”) the European Central Bank (ECB) is the greenback’s Deus ex machina.


E-roding The Euro


Hedgeye’s guru on all thing European, Matt Hedrick, put out a sterling piece last week (pun intended) titled “Buy The Euro: #EuroBulls.”  This was on the heels of an ECB whisper campaign that dropped the currency for an abrupt 2% correction.  Hedrick’s analysis was sharp and penetrating.  Unfortunately, the call was wrong, for all its being well reasoned.


Hedrick observed that European central banker Mario Draghi had finally gotten the knack of central bank meddling: Draghi’s market interventions have tended to be far milder and far fewer than Mr. Bernanke’s.  Draghi had acknowledged in recent public statements that the data show signs of a recovery across the Eurozone – an analysis that Hedgeye agrees with, hence our #EuroBulls call.  Hedrick wrote last week that Draghi’s outlook “suggests to us that neither liquidity measures nor a rate cut (why waste the powder now?) would be warranted over the near term.”  As long as Draghi holds the line on Keynesian excess, wrote Hedrick, and holds off printing a few extra trillion Euros, the Eurozone economy should continue on its strengthening trend – and so should the currency.


We find Draghi’s rate cut all the more perplexing in the face of positive trends across the Eurozone.


Eurozone PMI readings have held in positive territory, indicating an expansionary trend; economic, consumer and business confidence readings are all showing solid upward trends across Europe; retail sales are trending higher, even at the “periphery,” as Spanish, Italian and Greek figures push higher; and new automobile registrations are up solidly year over year – we see the 6.1% year-over-year increase in big-ticket discretionary items as a significant indicator of confidence; it means consumers are prepared to pay a large percentage of their income, and to carry financing into the future.


So why did Draghi drop the ECB’s key rate this week?  Says Hedrick, “we saw no need to use monetary ‘powder’ this month given improving economic data across the region supporting our call for #GrowthAccelerating.”  Hedrick notes that Draghi’s rate cut was not a reaction to a sudden surge or a surprise in economic readings.  Draghi foresees a “prolonged period of low inflation,” but Hedrick notes Draghi’s “subdued inflation outlook (below the 2% target) had been well communicated over the last two meetings, including forecasts for low levels of inflation to extend late into 2014.”  From a global tactical perspective, Draghi said explicitly that EUR/USD levels are not a policy consideration.  This parrots the read we are getting from Fed watchers, who insist that Bernanke’s decisions are made solely on the Fed’s read of the domestic outlook.  (“Data dependent,” they call this – which means, “What the data will be depends  on what I want to do with the Dollar.”)


In his prepared remarks, Draghi said “output is expected to continue to recover at a slow pace, in particular owing to a gradual improvement in domestic demand supported by the accommodative monetary policy stance. Euro area economic activity should, in addition, benefit from a gradual strengthening of demand for exports.”  Translation: if we weaken our currency, European consumers will spend more money, and the rest of the world will buy more of our exports.


So a global currency war is breaking out – but with everyone firing their heavy artillery off in different directions, all insisting they have no desire to engage with each other.  Every economy claims to be operating independently, oblivious of what is going on outside their borders.  The Fed claims to be looking at the domestic interest rate and employment picture; what happens in the European economy has no impact on US policy.  Europe is looking at its own deflationary trajectory; policy is not impacted by the weakened Dollar and the attendant rise in the value of the Euro.


In For A Pound

None of this makes any sense to us.  The world is interconnected like never before, and becoming more so.  Central bankers are pretending otherwise, with the effect that everyone’s neighbor is getting beggared, but no one is willing to admit that’s what’s on offer. 


The one bullish takeaway that remains – indeed, that is strengthened by events – is our call on the Pound.  We are bullish on the regime change at the Bank Of England.  We believe new BOE head Mark Carney has fresh ideas and a focus to use forward guidance to direct the economy to stable growth.  On the fiscal side, there are signs that the country’s early austerity decision during the global recession as paying off as growth outstrips its European neighbors.  With the UK deficit continuing to improve, the Carney central bank looks less likely to cut rates or push additional QE over the medium term.  Indeed, in last month’s policy meeting the BOE voted 9-0 to keep rates on hold and the asset purchase program unchanged.


We are firm believers that the health of an economy is reflected in its currency – and that a policy that deliberately weakens the currency necessarily weakens the economy.  UK data suggests continued improvement which should continue to bolster the GBP versus major currencies – alas, with a particularly favorable comparison versus the Dollar as the Fed continues to burn the Greenback by refusing to taper.


Where will this lead?  There’s no shortage of pundits out there ready to tell you what to do in reaction to the latest policy moves from Europe – and policy non-moves from the Fed.  From where we sit, there are times when the only sensible reaction is no reaction at all.  Right now we don’t believe the central bankers (who have to keep their grip on power); we don’t believe elected leaders and policy makers (who have to keep We The People buying their story); we don’t believe the media (who have to sell newspapers) and we don’t believe the financial firms who have to sell stocks, bonds and ETFs. 


What we believe – we believe the market.  We’re watching the market and we’re waiting.  Sooner or later, the signals will emerge.  Market data may not always be easy to read, but at least it doesn’t lie.


Sector Spotlight – Financials: Mergers and Acquisitions  


Financials sector analyst Jonathan Casteleyn adds investment bank Greenhill & Company (GHL) to the Investing Ideas list this week, seeing it as a key beneficiary of the uptick in M&A activity as US companies look to re-engage in strategic activity and to grow through acquisitions particularly if, despite currency manipulation, European markets stage a recovery.


In his latest institutional “Black Book” presentation, Casteleyn laid out a case for an increase in M&A activity into 2014 after flat trends for the past several years.  Cash on corporate balance sheets is at record highs, which is assisted by borrowing costs at near all-time lows.  With stock prices also at all-time highs, CEOs have another weapon to use for deal making (buying other companies with stock), and Casteleyn says the eventual rise in interest rates will lead companies to turn their focus from stock buybacks and dividends, to increased M&A activity.


Amongst a mid-tier group of M&A firms – GHL is Casteleyn’s top pick, but other recognizable names include Lazard and Evercore, which will also reap outsized profits from a ramp-up in M&A activity.  Globally, M&A is a $15 billion annual business but the global M&A market currently remains cyclically depressed – 2013 deals in the US will run at half the level they did in 2006, before the financial crisis.  In Europe, it looks to be about one-third.  This decline in activity has created the equivalent of an “excess inventory” of attractive deal candidates.  Casteleyn says the time is coming when these deals will start to flow and the current corporate depression mentality will start to change.


Corporations in the US have an average of 4.3% of total assets in cash.  This is nearly 20% above the historical average of 3.6%.  At nearly $1.5 trillion, there’s a lot of corporate cash sloshing around with corporate controllers having a hard time allocating this cash, because no one – but no one – is paying them interest on it.  The flip side, of course, is that it costs less to borrow money today than at any time in nearly the past sixty years.


CEO confidence has rebounded sharply off its 2008 lows, and advances in the CEO confidence index have historically preceded periods of increase M&A activity; similarly, equity valuations have risen to levels that have historically driven higher levels of transactions.  Add to this dynamic that private equity firms are currently sitting on about $389 billion dollars that needs to be invested.  The structure of private equity funds is that certain percentages of cash generally need to be invested on schedule; this means that every year there is another chunk of cash that must be invested. So this large amount of un-invested cash will have to make its way into the industry which will increase M&A activity.


Those are among the major drivers of US domestic M&A activity.  Looking back to Hedgeye’s #EuroBulls Macro theme, Europe’s economy is strengthening, business and economic sentiment indicators are improving, setting the stage for a possible M&A run on the continent.  And remember that the UK’s new central banker has publicly announced it’s “Game On” in the City of London, essentially urging the banks to get out there and Get Busy.


All these factors lead Casteleyn to forecast double-digit growth in M&A activity through 2014-2015.  The smaller boutique firms have gained market share versus the bulge-bracket behemoths and are up to over 17% of M&A transactions – and remember that they have much higher overall profitability on these deals, because their M&A activity is not diluted by other operations.  This makes these investments somewhat one-sided, but Casteleyn believes now is the time to take this side.


If all these factors come together, Casteleyn projects the run rate on M&A activity could spike by 27%.  Even if they don’t all click, a simple cyclical recovery could see M&A activity rebound by double digits.  Finally, the smaller firms aren’t caught up in the regulatory troubles that plague their giant competition.  An optimist will say they are running a low-exposure business.  A cynic will say: by the time the M&A scandals hit, we’ll be out of the stocks.  A realist will point out that, with over a trillion dollars available for corporate transactions, there will be a long lead time before problems are likely to surface, leaving a reasonable time frame to invest in the group.


Investing Term – Financials: Remember the Fifth of November?

If “the business of America is business,” the business of money has long been the business that drives America’s business.  The Financial sector is comprised of companies that provide a broad variety of services.  Sub-groups within the sector include insurance, commercial and retail banking, institutional and retail brokerage and investment services, but also companies providing a variety of services including mortgages, equipment leasing, all the way down the food chain to such operations as pawnshops and payday lenders.


Through the equities bull market that started in the early 1980s, and especially after the repeal of Glass Steagall and the Gramm-Leach-Bliely Financial Services Modernization Act of 1998, banks and investment firms saw their share of total corporate profits nearly double – from around 8%-12% of S&P earnings in the decades following WWII through the 1970s, to over 20% by the time the housing bubble peaked in 2006-2007. 


Post the financial crisis, major banks – which now house far more complex operations, and much more money than their predecessor firms ever did – are facing an existential crisis.  Their share of corporate profits has now dropped back to post-WWII type levels, their PE ratios have returned to much more modest multiples, and they are no longer feeling the love from the marketplace. 


In the Too Big To Fail era pre the financial crisis, banks found new ways of leveraging their assets to create greater profits.  Among the most famous were credit default swaps (CDS), a banking innovation widely credited to JPMorgan which used CDS in the 1990s to free up capital from its reserves, thus making more cash available for profit-making activities, while effectively leveraging their regulatory capital.  (The history of Morgan’s use of CDS and the regulatory process around it are well described by Financial Times columnist Gillian Tett in her book Fool’s Gold, a worthwhile read for anyone who remembers the financial crisis – or who wants to be reminded…)  Other less straightforward measures employed by the major banks – because the law permitted it, and because regulators were largely catatonic – included relying on customer deposits and their government guarantees to finance risky lending and proprietary trading practices.  The biggest firms combined these practices together with leverage far in excess of historical norms, first to drive their earnings to unprecedented levels, and second… well, you know what happened.


Today the Financials sector is in a very different place.  Once-mighty firms are writing huge checks to the government as financial penance, often for ill-defined acts that may not have been criminal.  A clear example is the JPMorgan “London Whale” episode, which certainly represents a failure of risk management.  However, with the exception of the bank’s federal oversight authority, the Controller of the Currency, which clearly failed to perform proper audits of the institution, it is not clear that anyone committed an act deserving of punishment.  Yet JPM is writing checks for over $13 billion, in large part to put this episode and other alleged transgressions behind them.


The earlier increase in price range in bank and financial stocks – “multiple expansion” in Wall Street analyst-speak – was an enthusiastic embrace of banks doing many more things than they used to, and using far more leverage in the process.  In the aftermath of the financial crisis – and in the wake of massive trading losses, fraud charges, and multi billion-dollar regulatory fines – investors have shrunk their expectations.  Not only are major bank PE ratios back down from their lofty heights, the very raison d’etre of the segment is in question. 


Financials sector head Josh Steiner says the big banks now face an uphill struggle against market forces – forces which, as Casteleyn points out above, favor leaner and smaller operators – against public opinion, and against Washington that has clearly flipped from being the lapdog of the banks, to being something of a terrier.  The major banks have a choice: either hunker down and continue to pay themselves for as long as they can, all the while writing checks to various federal agencies to pay for their sins, real or imputed; or they can divest large chunks of their aggregated operations, undoing the link between the taxpayer and the banks’ own risk operations, for example, and setting the retail depositor free.


The last word on Too Big To Fail clearly belongs to the man who spoke the first word on the topic: Sanford Weill, who in 1998 created Citigroup and with it, the very concept of Too Big To Fail.  In July of last year, Weill generated howls of outrage and disbelief with a comment in a CNBC interview.  Asked for his view on the state of the industry he himself created, Weill said “What we should probably do is go and split up investment banking from banking, have banks do something that's not going to risk the taxpayer dollars, that's not too big to fail.”


Commentators were aghast.  They saw Weill expressing remorse, admitting that creating Citigroup was a bad idea.  Clearly, Weill’s statement expressed no such thing.  Ever the tough financial genius with a broad view of the marketplace, Weill knew the big banks had run their course, and that the future belonged to smaller institutions that could maneuver deftly.  Once mighty giants, the big banks had become lumbering oafs, and no one was better positioned to see this than Weill.


Time to break up the banks?  More than a political notion, it may be the best thing for profitability and market multiples in the sector.  Forget Ben Bernanke – where’s Sandy Weill when we need him?


Happy Guy Fawkes Day.



- By Moshe Silver

Moshe is a Hedgeye Managing Director and author of the Hedgeye e-book Fixing A Broken Wall Street


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