Mr. Hypothetical

“No one can possibly achieve any real and lasting success, or get rich in business, by being a conformist.”
-J. Paul Getty
On the margin, I thought the unemployment report for May was bearish and the one just reported for June bullish. Bearish and bullish for the US Dollar that is...
Fully accepting that the aforementioned statement is a long way from consensus, I am cool with that – it was when I called the May report US Dollar bearish. I have a quote taped on the inside of my notebook from the Science and Technology section of The Economist dated February 7th, 2009 that says “what seems to be going on is that everyone instinctively feels compelled to copy the others, rather than making an independent assessment of the situation.” The article was about evolution.
Are we, as an investment community here in the United States of America, taking this Crisis in US Financial Credibility as an opportunity to evolve? Or are we doubling down on the groupthink that got us in this mess?
Consider the following Bloomberg headline this morning (#2 in terms of stories read as of 530AM EST) “Stocks, Oil, Metals Drop on Economy Concern; Yen, Dollar Gain.” Does that even make any sense? If you believe that global currency markets are lagging indicators, maybe… but the entire notion that long term interest rates (10y year US Treasury yields) and the US Dollar strengthening off its lows in the last 3-days is a lagging indicator doesn’t make any sense to me. Currency markets are leading indicators.
With the SP500 having corrected -5.3% from her YTD high of 946, if you are still in the Depressionista camp and you are following the perpetually negative stance of Alan Abelson, you might even believe that unemployment is NOT a lagging indicator. While I still can’t believe he wrote that, he probably can’t believe that Chinese stocks hit another YTD high last night either! 
Perpetually polarized in your political or investment view is not an evolutionary process. Objective minds get that. When Abelson called the “second derivative” thesis “hypothetical, but bullish” this weekend, what he was implying, I guess, is that calculus is some form of alchemy.
The New Reality is this: the US investment community’s consensus drum beaters need to evolve or the USA is going to continue to get run-over by the Chinese at +71.6% YTD. The ways of investing along the lines of the perceived wisdom of Wall Street’s crowd have rendered a YTD return for the Dow Jones Industrial Index of -5.7%.
Yes, the Dow is an old school index that the math guys rarely use anymore (30 components are less statistically relevant than 500 – fascinating conclusion), but next to London’s FTSE index, which has lost -5.6% YTD (as of this morning’s down -1.2% open), that’s about as bad as major country indices get.
Now back to last Thursday’s unemployment report. In terms of our intermediate term TREND cycle work, our investment process cares about one line item in that report – the unemployment rate.
At 9.5% year-over-year unemployment, the month of June was only a +10 basis point rise versus that of May (9.4%). This stands in stark contrast to the +50 basis point rip we say in May versus April (8.9%) and this, Mr. Hypothetical, is what we call a sequential deceleration in the rate of growth.
So what did I do with this? After the May report (first week of June), I started selling down gross long exposure to US Equities  and shorting US Consumer stocks. I currently hold a 9% position in the Asset Allocation Model to US Equities, and I’m short both Consumer Discretionary (XLY) and Consumer Staples (XLP).
Now what do I do? With the topping process of a lagging economic indicator in the rear-view, I will be covering my shorts in US Consumer stocks, and taking up my gross long exposure to US Equities. Being short anything on a perpetual basis is no risk management process of mine.
I know, I know… this probably doesn’t rhyme with what you’re seeing on CNBC this morning. It definitely doesn’t jive with a front cover article on Barron’s called “Short These Stocks.” But you know what? I really couldn’t care less. If all I did was follow these thundering herds, I might be agreeing with Merrill (or is it Banker of America?) this morning and getting bullish on my Chinese growth estimates AFTER the Shanghai Composite Index has move +80% to the upside!
Let’s not get our shorts in a knot this morning. The New Reality is that the crash and bubble watchers are consensus, and we men and women of the risk management gridiron see a fairly straightforward immediate term trading setup that’s both proactively predictable and manageable.
Looking back at another peak in sequential US unemployment gains (May) provides the US Dollar an immediate term bid. Dollar up = everything else down. That’s what I saw on Friday. What I see now, at a price, is an opportunity to start getting invested again. Buy low, sell high.
I have intermediate term TREND line support for the SP500 down at 871 and long term TAIL resistance for the US Dollar Index up at $82.32. Understanding that US stocks have an inverse correlation to US currency has been the 2009 strategy, and until that math breaks down there’s no reason to dance to the consensus beat of Mr. Hypothetical’s alchemy.
Best of luck out there this week,


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.

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 resource rich 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.  Energy flashed a major negative divergence last week.  TRADE and TREND are positive.

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.

XLV– SPDR Healthcare — We re-initiated our long position in healthcare on 6/29. Our healthcare sector head, Tom Tobin, wants to fade the public plan, and he’s been right on this one all year.

- Buying back the GLD that we sold higher earlier in June on 6/30. In an equity market that is losing its bullish momentum, we expect the masses to rotate back to Gold.  We also think the glittery metal will benefit in the intermediate term as inflation concerns accelerate into Q4.


EWI – iShares Italy – Italian Prime Minister Silvio Berlusconi has made headlines for his private escapades, and not for his leadership in turning around the struggling economy. Like its European peers, Italian unemployment is on the rise and despite improved confidence indices, industrial production is depressed and there are faint signs at best that the consumer is spending. From a quantitative set-up, the Italian ETF holds a substantial amount of Financials (43.10%), leverage we don’t want to be long of.

XLY – SPDR Consumer Discretionary – We shorted XLY on 6/19 as our team has turned negative on consumer in the last week. 

XLP – SPDR Consumer Staples – We shorted XLP on the bounce on 6/17.   Added to the position on 7/1, as our stance on the consumer is no longer bullish like it was in Q2, when gas prices and mortgage rates were dramatically lower.

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.



Galaxy Entertainment is weathering the current financial storm by adopting a more prudent growth strategy to suit demand.  One example of this is the slowing of the construction of its HK$10 billion Cotai mega-resort.  Executive Francis Lui Yiu-tung told the SCMP that Galaxy would be patient and wait for "more solid trends developing in the market before we pull the trigger".  

For now, the company is focused on the bottom line; 2,400 gaming staff recently received an effective 13.3% pay cut.  Galaxy has also bought back US$200 million in its own bonds at a 50% discount.  Mr. Lui calls for infrastructure improvements to drive visitors to the Cotai resorts.  Many are viewing the performance of City of Dreams as a leading indicator of the future development of Cotai.



Although revenue-share numbers leaked by the DCIJ show that the Macau market was down 17% in June compared to last year, compounding worries about swine flu, cancellation of "zero-cost" tours, and the economic crisis, there is reason to be optimistic.  Despite gaming revenues for the first half of 2009 being down 12%, the half-yearly trends from 1H07 through 1H09 have followed a positive trajectory.  The first half of 2008 was an anomaly, so 1H09 saw negative growth year-over-year, but the positive long-term trend remains intact. 

Destination Macau cites commentary from "casino bosses around town" stating that the 400,000 less visitors in May 2009 didn't hurt business too much.  It is likely that this was low-end traffic made up for by VIP volumes.



Two new imported cases of the A-H1N1 flu were detected yesterday, bringing the total number of cases to fifty-six.  Nine people have been released from quarantine, having recovered from the flu.  Presently, there are one hundred-and-twenty-four people receiving domestic medical observation. 

The pandemic alert in Macau is at level 6, while the World Health Organization's pandemic alert remains at phase 6, with a moderate severity. 


It's difficult to predict the future but the Macau market participants cannot even predict the present. What's going on with the visa restrictions? Ask ten different people, get ten different answers.  Our best guess is that Beijing is constantly tinkering with the goal of restricting market growth to the mid-to-high single digits, in-line with China's GDP growth.

We think, by now, Beijing has a pretty good feel for how much to turn the spigot to drive the desired growth in Macau. The days of 15% growth are over but controlled mid-to-high single digit is likely. Given the excess demand that Beijing must restrict to maintain moderate growth, Macau EBITDA likely warrants a higher multiple.  However, over the next 18 months, Mass table supply growth will be significant (see chart below) and we doubt Beijing is targeting same store growth.  Thus, same store growth in the Mass segment will be decidedly negative.

BEIJING WON’T OFFSET MASS TABLE SUPPLY INCREASE - macau mass market table growth 

The market share wars are likely to escalate.  As we found out during our trip to Macau in late June, some properties are beginning to offer rebates to players of between 0.3% and 1.0%, depending on whether there is a buy-in amount.  Q2 margins should look worse on a sequential and YoY basis for Q2 2009.  As can be seen in the following EBITDA chart, margins are already in decline.  The promotional environment will only worsen, putting even more pressure on margins through mid 2010. 


The Mass properties are particularly at risk:  LVS's Venetian and Sands, Wynn Macau, and MGM to a lesser extent.  The Sands must also contend with SJM's Oceanus opening up in late 2009 which will be as direct of a competitor as there can be.  We wrote about this in our 6/28/09 note "OCEANUS TO SINK SANDS".  On the other hand, City of Dreams hasn't stolen many customers from Venetian which is good for Cotai but a negative for the Peninsula including Wynn Macau. 

Those clinging to the great Beijing savior might be disappointed.  Yes a new Chief Executive is taking over late this year.  While there may be some incentive for Beijing to provide a bit of a tailwind, a 25% increase in visitation is highly unlikely.  Same store revenues are going lower.

The only potential winner here is the guys adding new supply, particularly MPEL with City of Dreams and SJM with Oceanus. 

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Market Commentary

With City of Dreams opening on June 1st, June should've been a better month in the aggregate.  It wasn't a total disaster though as Mass revenue increased and Rolling Chip (RC) volume declined only modestly.  Low RC hold % made the market performance look much worse.

LVS was the only winner this month, due to "lucky" hold at both properties.  WYNN had a bad June, partly attributed to worse hold than May, although still in the "normal" range.  Galaxy & SJM are holding their own.  We all know about the abysmal hold at Crown so no point in belabouring that issue.  Here are the aggregate numbers.

Total table revenues down 17% to $978MM

  • Mass revenue up 3% y-o-y
  • RC revenue down 24%
  • RC volume down only 4%
  • Slot revenue flat


Y-o-Y property observations

LVS's table revenue down 6%

  • Sands table revenue down 27%, with RC down 34% and Mass down 14%
  • Venetian table revenue up 7%

WYNN table revenue down 36%

  • Mass down 16%
  • RC down 41%

SJM table revenue up 3%

Galaxy table revenue down 17%

  • However, Starworld's table revenue was actually up 1%

MGM table revenue down 19%

  • Entire decline coming from VIP as Mass was flat y-o-y

Altira (Crown) table revenue down 57%


Market Shares

LVS market share 25% up from 20% in May

  • Sands market share at 8.5% vs 7.1% in May, mostly due to better hold (65 bps better in June than May)
  • Venetian up to 17% from 13% in May, mostly due to better hold (May was a weak month at 2.4% but June was high at 3.6%)

Wynn down to 13.7% from 17.25% in May

  • Partly due to worse hold at 2.75% vs 3.3% last month
  • Cotai gaining share at the Peninsula's expense?

MPEL share down to 9.1% from 10.4% in May

  • Everyone knows hold was bad, 1.6% blended vs 2.92% in May

SJM share down 1% to 30.75%

Galaxy share flat sequentially at 12.8%

  • Starworld share up to 9% from 7% in May

MGM share up to 8.3% from 7.4% in May

Keith McCullough Sees 'Reflation' in Fourth Quarter

SP500 Levels, Refreshed...

Be patient here, the immediate term TRADE line for the SPX is broken. I have immediate term TRADE support at 885. -KM

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