The 14 gaming venues that failed a second round of air quality tests earlier this year have submitted plans to reduce the size of their smoking zones.  Secretary for Social Affairs and Culture Cheong U said the government would review the plans by the end of January.  There were six venues operating under the licence held by SJM that had not submitted revised plans by the December 10 deadline.



Macau CEO Chui wants Beijing to open the border crossings for more hours each day.  Government spokesman Alexis Tam Chong Weng said Chui would discuss this and immigration and customs arrangements on Hengqin Island during a three-day visit to Beijing, which starts today.  Tam said the mainland’s staffing requirements were the main obstacle to having the border crossings open longer by the Lunar New Year holidays.

What Do You Care?

This note was originally published at 8am on December 02, 2013 for Hedgeye subscribers.

“If a science has an adjective, it probably isn’t a science.”

-Richard Feynman


As far as American physics goes, California’s Richard Feynman was as cool as cool gets. Above and beyond his brilliant contributions to the field, Feynman was a great communicator. His ability to teach reminded us how well he understood the subject matter.


Just before he passed away in 1988, Feynman left us with some behavioral thoughts and life lessons. One of the two books he published during the year of his death was titled What Do You Care What Other People Think?


“The book’s title is taken from a question his first wife, Arline, often put to him when he seemed preoccupied with his colleague’s opinions about his work.” (Wikipedia) Is there a better question for how your portfolio is positioned, every day?


Back to the Global Macro Grind


I certainly hope you don’t care what most “economists”  think about your portfolio. But I highly suggest you respect what Mr. Macro Market thinks. He can save you from missing the big obvious stuff.


One of the glaringly obvious things you should have cared about in 2013 was Mr. Macro Market’s phase transition to bucking up for GROWTH as an investment Style Factor. With the SP500 closing up another +2.8% in November, here are the YTD growth scores:

  1. LOW YIELD (Higher Growth) Stocks +41.3% YTD (vs High Yield, Slower Growth, Stocks +15.8%)
  2. TOP 25% EPS GROWTH Stocks (by SP500 quartile) +39.2% YTD
  3. HIGH BETA Stocks +37.9% YTD (vs Low Beta +23.3%)
  4. NASDAQ and Russell2000 +34.5% and +34.6%, respectively, YTD
  5. GOLD -25.9% YTD

In other words, being long the Gold Bond thing didn’t work like it did during the pervasively SLOW GROWTH 2010-2012 period of A) Interest Rate Repression B) Dollar Debauchery and C) Bernanke’s Policy To Inflate.


All it took to get growth expectations up (i.e. priced by Mr. Macro Market) were: 

  1. US Dollar that didn’t go down (US Dollar Index peaked at +6% YTD in July)
  2. Tapering Expectations = #RatesRising
  3. US GDP #GrowthAccelerating 

Oh, and you needed all 3 of those things to happen, all at the same time. In the absence of central planners trying to get in gravity’s way, even Keynesian “economists” call these pro-growth cycle moves “coincident” indicators.


No matter what the #EOW (end of the world) consensus view on US growth was 1 year ago today (when consensus “economists” expected +1.6% US GDP Growth and SP500 of 1528 for 2013), here we are – tracking closer to +3% US GDP growth and SP500 = 1800.


What did you care if #OldWall was off on GDP by almost 50% and the SP500 by 272 points? And what do you care about where consensus is today? Do you all of a sudden “buy growth”? Or is now precisely the time you should start to get out?


Using the same Hedgeye playbook (our GIP Model: Growth, Inflation, Policy):

  1. US GROWTH: odds that the slope of US Growth’s acceleration peaking in Q313 are rising
  2. US DOLLAR: whatever was left of USD strength continues to erode (down for 3 consecutive weeks)
  3. US RATES: 10yr Yield is signaling a lower-high vs the YTD high in US growth expectations (SEP 10yr of 2.97%)

All the while, from a purely quantitative modeling perspective, the SP500:

  1. PRICE is making higher-highs now on decelerating VOLUME (not good)
  2. VOLUME is trending down -9-14% versus our TREND based average into the “all-time highs” (not good)
  3. VOLATILITY (VIX) front month VIX continues to make a series of higher-lows (not good)

Up PRICE on down VOLUME and rising implied VOLATILITY as lagging GDP and employment data jams people into chasing the highs? Isn’t that just peachy.


But what do the central planners perpetuating Down Dollar and Rate Repression from here care? What do you care? Sadly, US currency and rate markets were only allowed to trade “freely” until the said “scientists” at the Fed said no-taper (SEP 18th), after all.


Our immediate-term Risk Ranges are now:


UST 10yr Yield 2.70-2.81%

SPX 1797-1815

VIX 13.01-14.19

USD 80.46-80.91

Pound 1.62-1.64

Gold 1223-1276


Best of luck out there today,



What Do You Care? - Chart of the Day


What Do You Care? - Virtual Portfolio

Book Review: Knowledge and Power

Takeaway: Buy it. Read it.

Hedgeye Risk Management CEO Keith McCullough shares some of his thoughts on Knowledge and Power: The Information Theory of Capitalism and How it is Revolutionizing Our World, by George Gilder (2013). 


"This is a thought leader’s book," according to McCullough. "With so many people whining about not having a 'solution' to Washington’s economic policies, ask yourself if we’re asking the right leaders for new ideas."


Bottom line according to Keith?


"This book is the Antichrist of broken Western-academic-economic-policy groupthink."


Book Review: Knowledge and Power - gild2


Summary Thoughts

  1. One of the few books that attempts to link non-linearity and information/chaos theory to today’s markets/economies
  2. Using economic history and market practitioners, Gilder effectively crushes the perceived wisdoms of broken sources
  3. Juxtaposed vs government intervention, a refreshing reminder of the role of the capitalistic entrepreneur in America

Content Highlights

  1. “Most human beings understand that their life is full of surprises.” (pg 1) #intro chapter – The Need for a New Economics
  2. “We are almost entirely incapable of predicting the future. Yet economics purports to be strangely exempt from this fact” (pg 1)
  3. “It is an economics of surprise that distributes power as it extends knowledge” (pg 5) #truth about innovation and evolution
  4. “All information is surprise; only surprise qualifies as information. This is the fundamental axiom of information theory” (pg 15)
  5. “From Adam Smith’s days to ours, economics has focused on the nature of economic order” (pg 16) promising #certainty?
  6. “Interest rates are critical for information-theory economic analysis because they are an index of real economic conditions” (pg 24)
  7. “Profits differentiate between the normally predictable yield of commodities and the unexpected returns of creativity” (pg 25)
  8. #EntropyEconomics (Chapter 4) = one of the best named chapters of the last 3 yrs #study
  9. “economists everywhere have counseled governments… to attend everything except what matters most: innovation” (pg 27)
  10. “The most important feature of an information economy… is the overthrow, not the attainment, of equilibrium” (pg 30) #nonlinear
  11. “Entropy is a measure of surprise, disorder, randomness… its opposites are predictability, order, tyranny…” (pg 34)
  12. “Republicans… both Bushes through McCain… all cherish the illusion that leading economists possess vital wisdom” (pg 38) #joke
  13. “Believing that a weaker Dollar is just the thing to spur a sluggish economy… they miss the devaluation of all the assets” (pg 38)
  14. “George Romney capitulated to these forces” (pg 38) and being advised by Glenn Hubbard, ultimately Mitt did too #BigMiss
  15. “Wealth actually springs from the expansion of information and learning” (pg 46) #capitalism #freedom #liberty
  16. “Smith’s vision of the entrepreneur as a tool of the market… rather than its creator constitutes the original sin” (pg 47) #AdamSmith
  17. The Light Dawns (chapter 7 concludes that Smith, Keynes, Hayek, and Samuelson have all been proven wrong) (pg 63) #true
  18. “Looking for disequilibria to reconcile into equilibrium, economists suppress multifarious complexities” (pg 71) #yep
  19. “Savings reflect the profitability – the upside entropy – in an economy” (pg 72) excess cash flows born out of positive info surprise
  20. “The entrepreneur is the savior of the system because he capitalizes himself” (pg 77) #evolution
  21. Fallacies of Entropy and Order (chapter 9) (pg 79)
  22. “Most of the history of economics revolves around the issues of how order and equilibrium can be maintained” (pg 85) #Krugman
  23. “None of these economists of equilibrium was comfortable with a dynamic economics” (pg 85) #Growth #Change #Surprise
  24. “Order is not spontaneous, but it is a necessary condition for all the surprises of freedom and opportunity” (pg 87)
  25. “Everyone thinks he knows what information is… information is change in what we know” (pg 101) great quote
  26. “They had no heads. The frenzy was all they had… the urge was all they felt” –Tom Wolfe (pg 104) #behavioral econ
  27. On Austin Goolsbee: “chairman of the President’s council of economic advisors exhibited as little understanding…” (pg 114)
  28. “… much of the profession is empirically bankrupt because it is no longer taught economic history” –Charles Kindleberger (pg 115)
  29. “The successful executive pursues not efficiency but effectiveness” –Peter Drucker (pg 126)
  30. “The goal of financial reform should be to end this divorce between knowledge and power” (pg 132) secular #theme of book
  31. “Unlike an inexorable, Newtonian “great machine”, the economy is not a closed system” (pg 133) don’t tell #Keynesians that
  32. “High entropy regulation destroys the environment that it seeks to enhance” (pg 150) #BigGovernmentIntervention #Fed
  33. “If a science has an adjective, it probably isn’t a science” –Richard Feynman (pg 159), Ivy League “economics” is no science
  34. “Pursue opportunities is the counsel of the capitalist” (pg 161) #bingo
  35. “It has become a virtual casino” –Bob Wilmers (CEO of M&T Bank) (pg 168)
  36. “Paulson/Bernanke in constant conversation with unhealthy institutions; wouldn’t talk to leaders of healthy banks” –Allison (pg 170)
  37. “In my career, the Fed has a 100% error rate in predicting and reacting to important economic turns” –John Allison (pg 175)
  38. “wealth is only valuable if combined with information” (pg 178) #perspective
  39. “America’s leading entrepreneurs, with some exception, display discipline and self control, hard work and austerity” (pg 183)
  40. “Greed is an appetite for unneeded and unearned wealth and power” (pg 184) beauty quote about #politicians
  41. “All progress comes from the creative minority” (pg 192) otherwise why would society glorify their stories?
  42. “Taleb, in all likelihood, deems you a turkey” (pg 197) in Chapter 18, The Black Swans of Investment, criticizing Taleb
  43. “I believe, however, that the fool of randomness is Taleb” (pg 200) #aggressive!
  44. “21st century intellectuals have looked to information theory for a solution” (pg 201) maybe, sort of, but hardly consensus
  45. “Great books, great ideas, and great thinkers” (pg 207) on Mark Skousen’s Freedom Fest annual conference
  46. “No one in your company knows less about your business than your see eff oh” –Peter Drucker (pg 218) CEOs need vision
  47. “Stockman ended up capitulating to his critics” (pg 219) appropriately critical of David Stockman’s “CFO” myopia
  48. “0% interest rate policy of the Federal Reserve diverts the wealth of savers to governments, crony capitalists, etc” (pg 224)
  49. “History tells us that the threat to prosperity is not debt but socialism” (pg 225) great focus pt quote
  50. “Just as the post war recovery of the 1950s confounded Paul Samuelson’s gloomy predictions” (pg 234) #Keynesian failures
  51. “fragmented, the academic sciences are turning to politics, panics, and cartels to preserve their old privileges” (pg 270)
  52. “Most of the courses they took were either self-evident or wrong, ideological, or tautological, twisted, or trivial” (pg 270)
  53. “Now an abstruse and occasionally revealing discipline has emerged called quantum information theory” (pg 271)
  54. “Governed by entropy (measuring freedom of choice), it is a science of human liberty” (pg 271)
  55. “Just as the bureaucrat needs arbitrary power, the capitalist needs capital” (pg 275) #excellent conclusion



Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.


Takeaway: Current Investing Ideas: CCL, FDX, FXB, GHL, HCA, MD, NKE, RH, SBUX, TROW and WWW

Please see below the latest comments from Hedgeye Risk Management analysts on their high-conviction stock ideas as well as "Trend Levels" for each respective stock. "Trend" is a duration of 3 months or more.


In addition, below the stock updates, we have selected two institutional research pieces we believe are worth highlighting as well as the "Macro Theme of the Week."


Editor's note: There was a typo in the original version that has since been corrected. In the "Macro Theme of the Week," the sentence that read, "The obverse of that coin is declining prices, declining volume, and increasing volatility, signaling that investors are agitated, nervous, and possibly on the verge of panic" should read, "The obverse of that coin is declining prices, increasing volume, and increasing volatility, signaling that investors are agitated, nervous, and possibly on the verge of panic."




CCL – Hedgeye Gaming, Lodging & Leisure Sector Head Todd Jordan has no update for Carnival this week. 

FXB – The British Pound remains the Hedgeye Q4 Macro Theme (#EuroBull) champ. Macro analyst Matt Hedrick remains bullish on the GBP and EUR versus the USD.  Here’s the setup:


Central Bank Intervention: Hedrick expects Janet "Mother of All Doves" Yellen to remain the uber dove on policy and push out any QE taper expectations to at least late in Q1 2014. This should burn the Greenback lower. 

BOE “Hawks”: Mark Carney and the BOE will likely remain on hold with interest rates and the asset purchase target, built on improving UK fundamentals, which should encourage the British Pound higher.

Island Insulation: Says Hedrick, “The UK was the first country to issue austerity in Europe. We are seeing the through-put of that decision with fundamentals improving ahead of its European peers. We maintain a bullish bias on UK equities (etf EWU).”

Bullish Data: From Services and Manufacturing PMIs to Industrial Production, the data remains supportive of the UK’s underlying health and continued improvement, factors that should drive the currency higher.  

FDX – FedEx reports its FY2Q 2014 this week, with many pluses and minuses potentially creating volatility in the headline results.  Fuel prices, which were a meaningful headwind last quarter, should be less this quarter.  This is because of a lag between fuel costs incurred and the fuel surcharges passed on to customers. 


On balance, we continue to see the opportunity of FedEx Express to improve margins though its multi-year restructuring, driving potential upside for patient – independent of a single quarter’s results.



GHL – While industry merger and acquisition (M&A) volumes continue in fits and starts, the U.S. private equity (P/E) community has definitely increased activity intraquarter in 4Q with significant activity from private equity funds this week alone. The harvesting of $8 billion from the IPO of Hilton Hotels by Blackstone Group is generally a good sign for future M&A activity.


The correlation between private equity harvesting activity (IPO exits or M&A exits) and private equity investing (new P/E money being put to work) has been very high historically at a 0.92 R-squared. Thus the second largest absolute private equity gain in history via this week's Hilton IPO is generally a good sign for sponsor activity into 2014 and beyond. This week's private equity activity also included a forming $3.3 billion bid for Lightsquared, a bankrupt wireless network provider, by private equity firms Centerbridge Partners and Fortress Investment Group. While most of the time private equity firms act as their sole M&A advisor, renewed activity from P/E does create advisory mandates from the company's or assets targeted by P/E firms. Greenhill remains our favorite idea for incremental improvement within M&A activity into 2014.


HCA – We held our Healthcaster Barmometer call this week.  It was great.  We continue to see trends in surgical volumes, (particularly in Orthopedics and Cardio) as likely to continue accelerating from here. On maternity, 25% of all inpatient admissions, our survey is pointing to continued softness in Q413, but we are looking forward to easy year over year compares come 1H14. 


The deferred pool of first time mothers continues to increase and now stands at 10% to 20% of the annual maternity run rate in the US. In our survey, patient traffic continues to run positive and we expect those visits to lead to better trends in surgical volume going forward.   


MD – Our maternity survey presented earlier this week continues to show weak year-over-year volume for maternity trends in Q413.  However, even if births remain at 0% for 2014, we can still drive respectable upside in earnings for 2014.  Moreover, if we see even a small percentage of potential first time mothers return who have deferred starting a family in 2014, we think we'll see maternity trends return to 1-2% growth. that would represent a meaningful and highly accretive change for MD.  Numbers can move much higher, so we'll be monitoring our survey closely, as well as several macro economic data series, in the next few months as comparisons ease into 1H14. 


NKE – Nike is set to print its 2Q14 earnings on Thursday the 19th, after the close. We’re expecting a solid print for Nike, unlike its German counterparts (Adidas and Puma) who missed earnings to an embarrassing degree over the past quarter.


We’re looking for for Nike’s top line to grow in excess of 10%, which is pretty darn impressive for a company with $27 billion of revenue. The company guided to a 50 basis point improvement in gross margins for the quarter. We think they’re sandbagging, and that we should see total Gross Margin improvement in the +100 basis point range (put another way, a full point ahead of last year).


NKE also guided to mid-teens growth in SG&A for the quarter – but yet again, we think we should see something closer to 12%.  When all is said and done, we think that adds up to EPS of about $0.65 per share, which is well above the Street at $0.58.  We have lingering concerns about Nike longer-term due to its management reorg, but this quarter won’t do a thing to support any of that concern. It should be a bullish event.



RH – Let's start off by addressing the elephant in the room... the headline news departure of Restoration Hardware Co-CEO Carlos Alberini. This arrangement had a shelf life. Co-CEOs don’t last. Never have.  And make no mistake -- title or no title -- this is Gary Friedman's company.


In fact, if it were Gary who was stepping down right now, we'd consider it an absolute thesis-changer.  He's the brains behind the plan to get to $10 in earnings. Carlos was good, but he is replaceable.  In fact, we'd argue that Karen Boone (CFO) is less replaceable than Carlos.  The guy is good. Really good. But what they essentially had was a CEO, COO, CFO -- and though they'll probably get someone to replace Carlos (it's a pretty appealing job -- many will want it) they can certainly continue to execute without him. We don’t want to minimize Carlos' expertise. Where we really viewed Carlos as being critical is when the company starts opening a significant numbers of 40k-50k square foot stores. That's where we think Gary's expertise starts to run its course, and RH needs a proven retail store growth expert.  Gary is not replaceable. But finding someone to execute on store openings -- while a very hard job -- is something that has a pool of many hundreds of people that could do the job.


Now let's hit on the good news…and that's pretty much everything else.


The quarter was phenomenal. The company beat on the top line, gross margin, SG&A, and, of course, EPS. The big stat was the RH Direct was up 47%. The key, of course, is all the noise being made over the past two weeks about being weak because of the elimination of the Fall Sourcebook -- and weak ComScore data pointed to a precipitous drop-off in the numbers. That simply was not the case, not even close. If we wanted to criticize one number it would be comp, at 29% it was a little lighter than we expected. That however, doesn’t trouble us in the slightest. As we’ve discussed ad nauseum, RH currently only sells 20% of its SKU’s in its Legacy Store format and ships 90% of its product from distribution centers. Whether sales come from stores (93% of which are Legacy Stores) or .com doesn’t matter when the top line grows at +39%. 


SBUX – Remember the $450 metallic Starbucks holiday gift card we spoke about last week?  Well, those 1,000 cards sold out in seconds.  The SBUX brand remains as relevant and resonant as ever before, but the stock’s recent performance has been disappointing of late.


Despite being up 43.4% over the past year, the stock is down -6.4% over the last month as consensus earnings estimates have been revised down by -0.8% over this time.  The stock is currently trading at a P/E of 18.8x and 15x EV/EBITDA on a NTM basis.  Though expensive, Managing Director Howard Penney continues to think SBUX is one of the best run companies in the restaurant space and the long-term TAIL for the stock seems unlimited.


TROW – Some analysts as well as media outlets are still in denial about the start of a rotation from U.S. fixed income into U.S. stocks, however the debate in our minds is a short one. With only a few weeks left in 2013, we have compiled the year-to-date flow totals from the Investment Company Institute for mutual funds and from Bloomberg for exchange traded funds. The trends from our perspective are quite clear.


Within mutual funds, the $1 trillion that has come into bond funds since 2008 (or the start of the Fed's quantitative easing program) has started to unwind with the first outflow in fixed income funds within the ICI data since 2007. Conversely, the nascent production in stock funds (while consistently dismissed) has been historically quite impressive being double that of the $74 billion that came into equity mutual funds in 2007. While the $159 billion running inflow into stock funds thus far in 2013 has had an international fund bend ($131 billion has gone into international stock funds versus just $28 billion into domestic equity funds), there is still ample reason to think that U.S. stocks can continue to generate new inflows (still record amount of cash on U.S. corporate balance sheets, generally low yields can allow stocks higher multiples, and the unwinding of the commodity super cycle and U.S. bond fund outflows needing to be invested somewhere).


We don't estimate that a substantial change from these current trends will occur until mid 2014 (these current themes are intact with forthcoming Fed tapering to continue to hurt the demand for fixed income and that U.S. stocks can at least have a positive start to 2014). Thus our favorite long idea remains T Rowe Price (TROW), a manager with industry leading equity performance to hoover up new industry equity flows and also a strong balance sheet to seed new products and also continue its streak of 26 consecutive years of dividend increases.


WWW – Two quick news items on Wolverine World Wide – 1) the company declared a $0.06 quarterly dividend this week payable to shareholders of record on 12/30/13 and 2) Gina Boswell was appointed to the Company’s Board of Directors. We have to admit we don’t know anything about Gina other then the fact she’s an EVP at Unilever and is a former Yalie.


The other thing that caught our attention this week was the company’s announcement that they would be laying off 90 workers from WWW’s headquarters in Rockford, MI in order to consolidate customer service and consumer relations operations across their brands. In this circumstance downsizing is a positive. This is a good reminder that WWW is still in the process of integrating the PLG brands (Sperry, Saucony, Stride Rite, and Keds) it acquired last October. The company has done a good job of curbing the streets expectations for PLG, but we’re not buying it. The simple fact is that the company’s accretion guidance doesn’t match the math, and PLG brand operations have been integrated into WWW’s portfolio ahead of schedule.


But, there is still work to be done as demonstrated by the company’s recent announcement. We see tremendous growth potential for the company to leverage their existing global supply network for the less globally penetrated PLG brands. Currently the wholesale distribution is fully implemented on SAP. The retail channel SAP implementation is still a work in progress. These are critical first steps in the move to international growth. If the company continues on its current trajectory we believe that International will start to boost the top line much faster than the rest of the street is expecting. In this case – actions and math speak louder than words.


*  *  *  *  *  *  *

Click on the titles below to unlock each research piece.


We are getting increasingly negative on the slope of domestic economic growth. On Wednesday, Hedgeye's Keith McCullough and Darius Dale did a full slate of meetings with funds in NYC; without violating any confidentiality by getting bogged down in the details, here are the key takeaways we were effectively pounding the table on.


McDonald's (MCD): Rebuilding, Not Strengthening

In October, McDonald’s spoke of strengthening its underlying business momentum in 2014.  In November, however, the talk has shifted to rebuilding its underlying business momentum in 2014.  As we have been calling out for the greater part of 2013, MCD has issues in its underlying core business that management must address. 



Macro Theme of the Week – Don’t Let The Bear Get You!

You can’t expect the Fed to spell out what it’s going to do. Why? Because it doesn’t know. - Stanley Fischer


It’s been a busy week.  Which do you want first, the Good News, or the Bad News? 


The US stock market made an all-time high, then backed off hard.  New York’s own Joe Torre was named to the Baseball Hall of Fame.  In Washington, five warring regulatory agencies reconciled for an hour to sign off on the Volcker Rule.  In Butner, North Carolina, Bernie Madoff observed the fifth anniversary of the day he turned himself in to the feds, while in Ottawa, Canada’s national postal service announced the end of home mail delivery because of budgetary constraints.  From Jerusalem came word that former Israeli central banker Stanley Fischer is the likely candidate to be Fed vice-chairman under Janet Yellen, and from Vatican City comes the announcement that Pope Francis has been named Time Magazine’s Person of the Year, narrowly beating Edward Snowden and Miley Cyrus.  No puff of white smoke was released.


Stanley Fischer’s resume includes years as chief economist at the World Bank, and his time as a professor at MIT where he mentored European central banker Mario Draghi, as well as our very own Ben Bernanke.  Lest you think this makes him unsuited to oversee US monetary policy, we offer a few items from his years as Israel’s central banker. 


At the Bank of Israel, Fischer created a policy committee whose purpose was to act as a brake on the power of the chairman.  Fischer, who was born in Zambia, won praise from his colleagues by taking the trouble to learn Hebrew, despite the fact that all his colleagues at the bank were comfortable in English – and despite the fact that he was the boss.  His stewardship of the Israeli economy included policies requiring Israeli home buyers to make 25%-30% down payments in cash.  No exceptions.  Fischer may not exactly duplicate these successes here – his English is probably good enough to get by in Washington, but we suspect he will have a tough time going head to head with Mel Watt on the subject of mandatory down payments for homebuyers.


Thanks to the new radioactive Congress, Mel Watt has been put in charge of the Federal Housing Finance Agency, the body that oversees Fannie Mae and Freddie Mac.  Watt replaces acting director Edward DeMarco who doggedly refused to implement reductions in mortgage principal for borrowers who are underwater on their mortgages.  Observers expect Watt to move forward with a program of underwater principal reduction for GSE borrowers (loans held at Fannie and Freddie).  Current stepped-up restrictions on loan servicing have already made it difficult to foreclose on delinquent borrowers.  New rules coming into effect in January will add to these restrictions, raising the question: Is there still such a thing as a Secured Loan? 


Aside from its impact on real estate market pricing, there’s a risk that mortgage principal reduction could become a Last Straw, convincing investors that it’s dangerous to do business with the federal government.  Yellen and Fischer could be boxed into a corner and be forced to actually increase the Fed’s buying in order to absorb panic selling of mortgage-backed securities that are suddenly seen as riskier than the mortgage-backed issues the Fed is currently buying.  In short, turbulence in the housing market could return to center stage as a major factor in the markets next year.  Shades of 2007?   


As far as the Volcker Rule is concerned, there will be legal challenges.  But the immediate challenge is that the regulatory agencies charged with implementing it are barely equipped to keep their bathrooms stocked with toilet paper, much less to launch a major industry surveillance initiative.


The SEC and CFTC are cash starved, and Congress does not appear disposed to help (Financial Times, 11 December, “Cash-Strapped Regulators Face Heavy Volcker Workload”).  The CFTC is in such dire straits they may have to furlough employees for two weeks in 2014.  They have already said they may have to outsource, or completely forego certain key inspections.  The SEC is better off financially, but only just.  It remains to be seen how much clout Chairman White will wield with Congress.


The one agency that appears to be sufficiently funded to take on the additional burden of Volcker Rule inspections is the Office of the Controller of the Currency.  You will recall that the OCC was the agency that performed multiple routine audits of HSBC’s Mexican accounts but failed to detect the bank laundering nearly a billion dollars of Mexican drug cartel money.  And as overseer of America’s banking industry, the OCC didn’t bother to dig down and figure out what JPMorgan’s “London Whale” was really doing.  No wonder they have so much money; they never do anything.


And speaking of regulators doing nothing, the fifth anniversary of the Bernie Madoff story is a reminder that America’s regulators – with the apparent exception of Ms. White at the SEC – continue to be incapable of sustaining the integrity of our markets.  The collective regulatory failure to catch Madoff in the act – SEC, FINRA, the various exchanges, brokers and fund managers where Madoff executed transactions (or didn’t) and managed assets (or didn’t) – is the financial regulatory equivalent of the intelligence failure in the run-up to 9/11.  From where we sit, it doesn’t look any better today.  Oh well… at least we got Congress to pass another 1000 pages of legislation…


Pope Francis incurred the wrath of the Right – Rush Limbaugh called him a “communist” – with his apostolic exhortation Evangelii Gaudium, the “Joy of the Gospels,” a document that opens with the words “The great danger in today’s world, pervaded as it is by consumerism, is the desolation and anguish born of a complacent yet covetous heart, the feverish pursuit of frivolous pleasures, and a blunted conscience.”  Admonishing the faithful to turn their attention to the poor, Pope Francis blasts today’s “idolatry of money and the dictatorship of an impersonal economy” as a reincarnation of the Golden Calf.  “One cause of this situation is found in our relationship with money,” he writes, “since we calmly accept its dominion over ourselves and our societies. The current financial crisis can make us overlook the fact that it originated in a profound human crisis: the denial of the primacy of the human person!”


Who does this guy think he is, Jesus Christ’s personal representative?


Meanwhile, the stock market has turned very suddenly and very decidedly bearish.  You might have missed it if you are following market technicians looking at 200 day moving averages, but Hedgeye’s macro work uses its own unique toolkit.  This week Hedgeye CEO Keith McCullough appears on Hedgeye TV explaining his warning to “Beware This Big New Market Risk Signal.”


The mechanics of the stock market tell a story – one that you can read, once you figure out the grammar.  In this case, says McCullough, they’re practically screaming.  Keith developed his market models over nearly a decade as a hedge fund portfolio manager.  He uses a simple three-component snapshot to derive a near-term market signal.  The model looks at Price, Volume, and Volatility.  When Price and Volume are rising, and Volatility falling, that’s an ideal near-term bullish set-up.  It means more participants are entering the market, and are confidently adding money, happily paying higher and higher prices.  It signals building confidence in the immediate term which, simply put, means you will be able to find someone else to sell your stock to when it goes up.


The obverse of that coin is declining prices, increasing volume, and increasing volatility, signaling that investors are agitated, nervous, and possibly on the verge of panic.  Says McCullough, this is precisely the signal the markets are flashing now, and it’s a new one.  If you have followed our Macro work you know that we have been in favor of buying this bubble.  Now, says McCullough, it is signaling that it may be ready to pop.


Prices are declining, meaning more selling coming into the market.  Volume is declining, signaling a mismatch between the need to sell and the appetite to buy.  And volatility is rising, indicting uncertainty.  Sellers want to wait until they get their price. Rising volatility gets people upset, and people who are upset make less rational decisions.  You don’t want to be the last person trying to sell your stock when volatility hits a critical point. 


This negative near-term signal flashed on our screens this week, the first meaningful bearish signal we’ve had in a long time.  Investors sitting on profits should consider taking them, while traders looking to ride the momentum of this bubble shouldn’t be surprised if trades go against them in a big way.  In a market atmosphere characterized by gloom and uncertainty, a spike in volatility could trigger a rush for the exits.   Imagine a crowded dance club.  Imagine four hundred people in a space designed to hold no more than 250.  Imagine a single exit door just wide enough for two people to pass through.  Imagine a fire.  Imagine you’re at the back of the room.   


Happy Friday the Thirteenth.


- By Moshe Silver

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


The Week Ahead


The Economic Data calendar for the week of the 16th of December through the 20th 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 - week

[VIDEO] #TweetKeith: You Ask, Keith Answers

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