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Missing The Cut

"I just made mistakes... And obviously you can't make mistakes and expect to not only make the cut but also try and win a championship."
-Tiger Woods

After shooting a second 2nd 74 and Tiger missing the cut at this weekend's British Open, one of the more prescient thinkers in our subscriber base pointed out that quote to me. His point was that this is how the leaders of the US Financial system should behave. Holding themselves accountable. Looking in the mirror, calling it like it is.

Instead, what you're going to see this morning is more of the same. Woods will be back at the practice range, and Wall Street's finest group-thinkers will be out in full force talking about the economic "recovery" that they completely missed. Sadly, unlike Tiger - they'll behave as if they missed nothing at all.

Who missed this REFLATION trade? YouTube them and you tell me. Rewind the tape to 5 months ago and show me which one of these economic savants weren't scaring the hell out of the American public ranting about Great Depressions. AFTER seeing the SP500 rip higher for another +7% weekly move, are they bullish? You bet your Madoff they are - AFTER the fact. Washington and Wall Street job security depends on revisionist history.

Asia continues to teach America a lesson in high octane, unlevered, growth. Last night, Japan was closed but the rest of Asia roared higher for another big up day. The world's new economic leader, China, closed up yet another +2.4%, taking her 2009 score to +79.5% - that's another new YTD high. On the heels of Chinese strength, stocks on the Hang Seng tacked on another +3.7% move. Hong Kong equities are up +12.5% in the last 5 trading days and have now piled on a +35.6% YTD gain!

The New Reality remains: China's 21st century domestic consumption growth is reminiscent of that little train that could in the early part of the 20th century, the United States of America. China is now The Client. It's time for America's institutional investors to be "long of" what China needs versus what the US government wants them to need. Copper and oil prices were up +10% and 8%, respectively, last week - outperforming US Bonds, big time.

China doesn't need any more US Treasuries. Get your 200-day Moving Monkey to pull up a chart of the yield on 10-year US Treasury yields. Yes, at 3.7% this morning it is breaking out across all 3 of my durations (TAIL, TREND, and TRADE). Yes, Ben Bernanke is going to be chasing the long end of the marked-to-market curve. Yes, that change in US Federal Reserve policy rhetoric is as imminent as a monkey making money on the long side of the REFLATION trade right now.
Imminent returns? Oh yes, fellow commoners - if we Burn our Buck like this, everything priced in those bucks will continue to REFLATE. Never mind these silly details like Bankers, Debtors, and Politicians getting paid. You American commoners didn't make the Wall Street Club's cut! After missing the cut, the US government will be issuing you a zero rate of return on your savings account, and some Q4 inflation just in time for Christmas.

This morning the Buck is Burning, again, trading down another -0.56% at $78.87 on the US Dollar Index. After last week's -1.1% dollar decline, the negative price momentum associated with a completely politicized monetary policy in America continues. Going back to when Nixon abandoned the gold standard (1971), the US Dollar has only sustainably violated the $80 level twice. No, don't remind those Washington professors of economics when the last time was - that too, would be professionally embarrassing.

There is no embarrassment in admitting when you are wrong. Every mistake I make is up with a real-time quote on the Research Edge portal. Not learning from your mistakes is what is embarrassing - and unfortunately, Greenspan's ghost still remains in this country's leadership closet.

Tomorrow, Ben Bernanke will have one more opportunity to establish some credibility in America's currency. I am fairly certain however that his Humphrey Hawkins testimony will not be focused on how alarmist the US government's rhetoric had to be in order to get interest rates to an "emergency level" of ZERO.

The global macro market of countries, currencies, and commodities are currently betting that Bernanke maintains that the US outlook didn't miss the cut. Marked-to-market odds currently have the politicization of the short end of the US yield curve remaining intact. That's why the US yield curve is very close to being as steep as it has EVER been.

My intermediate term TREND support for the SP500 remains 871. My long term TAIL of resistance remains 954. The best thing I can tell you right here and now is stay with our proactive plan in managing risk around that range.

What you are hearing from Wall Street's consensus forecasters will continue to be completely backward looking. After a +40% move in the SP500, the House of almighty Goldman is raising their SP500 target this morning. Thanks for the Early Look guys - what would this country do without your stewardship.

Best of luck out there this week,


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.

CYB - WisdomTree Dreyfus Chinese Yuan - The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

COW - iPath Livestock - This ETN tracks an index comprised of two thirds Live Cattle futures, one third Lean Hogs futures. We initially began looking at these commodities because of recession inspired capacity reductions combined with seasonal inflections. A series of macro factors including the swine flu scare, a major dairy cattle cull in response to collapsing milk prices and the collapse of the Argentine agricultural complex due to misguided policy provided us with additional supporting fundamental data points for the quantitative set up in price action.  

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.

GLD - SPDR Gold - 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.

XLI - SPDR Industrials - We don't want to be long financial leverage, which is baked into Industrials.

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.

DIA  - Diamonds Trust- We shorted the financial geared Dow on 7/10, which is breaking down across durations.

EWJ - iShares Japan -We're short the Japanese equity market via EWJ on 5/20. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

XLY - SPDR Consumer Discretionary
- We shorted XLY on 7/9 on a rip as our team has turned negative on consumer.  

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


The economic environment is destroying real value in MAR’s timeshare business that is not being captured in adjusted earnings

Before 2008, there was no need for MAR to over-collateralize their timeshare note sales.  MAR was forced to over-collateralize its last two deals (one in 2008 and in March of this year) by 18% and 28%, respectively.  So what exactly did they write off this quarter since they retained no interests in the older deal?

When MAR books a gain on a note sale, the gain is equal to the NPV of the interest the company collects (~13%) and the interest on the notes (~7.5%).  If there is a “trigger event” caused by elevated defaults, MAR doesn’t get that “excess” cash flow and has to write down the value of the residual on their balance sheet as a result of having to use a higher discount rate.  Once a trigger event occurs, this accelerates payment to the senior pieces of the debt structure and MAR no longer gets paid any interest on its “residual”.

In Q1 the company didn’t actually hit the triggers, but were very close so they increased the discount rate used in the NPV to value the excess stream up to 25%.  In Q2 they hit the triggers, wrote down the residual and took the cash flow hit.  Once the hit was taken, MAR was able to decrease the discount rate to 18% because the risk was already reflected across the portfolio. MAR also made the assumption that the triggers cure in 6 months, since the few months during which they experienced heighted delinquencies will roll out (test is on a 3 month rolling basis) if delinquencies stay at currently observed rates of around 10%.

Of course, now that MAR retains the actual over-collateralized pieces, they just take a direct hit when defaults occur, but also reap the benefit of defaults that are lower than projected.  Risk levels are enhanced.  Year to date, MAR has taken $25 million in residual write-offs and $43 million in charges related to loan loss reserves.  This is real value being lost here that cannot simply be discarded as irrelevant, one-time charges. 



Citing, “a person with knowledge in the matter”, Bloomberg.com released a story stating that LVS plans to file an IPO of shares in its Macau casinos with Hong Kong regulators early next month to raise up to $4BN.  The gaming company is also seeking amendments to its Macau bank loan, including covenant relief (as the maximum permitted leverage steps down in 3Q09) and permission to issue as much as $US1.5 billion in new debt according to an unidentified source.

LVS is seeking to raise capital to restart work on its US$12 billion projects on the Cotai strip.  LVS hired Goldman Sachs to help it buy back as much as US$800 million of bank loans via modified Dutch auctions as permitted by its last credit amendment which could allow LVS to get its total leverage beneath the covenant step down in 3Q09.  LVS President Michael Leven said on July 8th that the company could raise at least US$2 billion selling a minority stake in its Macau business in Hong Kong.


MACAO’S TOURIST PRICE INDEX (TPI) ROSE BY 1.77% IN Q2 macaudailyblog.com

Macau’s Tourist Price Index for the second quarter of 2009 rose by 1.77% year-over-year, according to the city’s Statistics and Census Service.

The indices of Restaurants service and food, Alcoholic drinks and tobacco increased notably by 6.29% and 6.1% respectively.  Accommodation saw a 4.75% decrease year-over-year.  On a trailing four quarters basis, the TPI for the period ending 2Q09 increased by 5.33%, with significant increases of the indices of Clothing and footwear (11.28%), Restaurant service (10.24%) and Food, alcoholic drinks and tobacco (9.45%).

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 “Never allow a crisis to go to waste” – Rahm Emanuel

An ever expanding list of states look to expand gaming. In the unlikely event of a v-shaped economic recovery, a state(s) of fiscal desperation will still prevail. We’re entering an extended bull market for slots.

Hopefully, the slot companies are heeding Mr. Emanuel’s advice and pushing their lobbying efforts at maximum effort.  There are plenty of dominoes yet to fall while many are already tilting.  Prospects for expanded gaming in Ohio, Iowa, Illinois, and Pennsylvania look decent.  With the pressing need for cash, states may step on the accelerator.  Long timelines experienced in Pennsylvania and Maryland are unlikely in these desperate times.

Here’s the state by state summary:

  • Ohio - Governor Strickland signed a directive instructing the director of the Ohio Lottery to immediately begin the process of implementing VLT’s at racetracks.  More details will become available today as the budget is released.  The approved legislation permits a maximum of 2,500 video lottery terminals at each of Ohio’s seven racetracks.  Requirements for each of the racetracks include a $100,000 application fee, a $65 million licensing fee, 50% of all net revenue being retained by the state, and capex requirements of at least $80 million in the first five years of operation with at least $20 million of that in the first year.  The proposal to open the door to four new casinos in downtown Cincinnati, Columbus, Cleveland, and Toledo could be back on the table. The Ohio Jobs and Growth Plan (OJGP) petition to have casinos voted on again in November collected more than twice the necessary amount of signatures required by the state government (400,000).  The Secretary of State is expected to give a final ruling on whether there is a sufficient number of valid signatures on the petition.  Despite the racetracks directive from Gov. Strickland, the OJGP plans to continue its campaign for four new casinos in Ohio.


  • Illinois - The Video Gaming Act was signed into law as part of House Bill 255.  The Act creates a new video poker market under the control of the Illinois Lottery Commission.  The Illinois Coin Machine Operators Association believes the number will end up being around 45,000 to 50,000 units.  The machines will be placed in licensed establishments (bars, taverns), licensed truck-stops, licensed fraternal establishments, and licensed veteran establishments.  The Illinois Gaming Board anticipates that it will be at least a year before gamblers in the Prairie State can legally play video poker.


  • Iowa - In light of Illinois approving video poker, Iowa is trying to decide how best to maintain its gaming market. The Iowa Gaming Commission held a public meeting on Thursday and, after some public comment, unanimously agreed to consider licensing new casinos.  Commissioners’ comments seem to indicate that they will be protective of casinos that are already open and that this process for granting new licenses will be more complicated than it was in the past.   The deadline for applications for licenses is October 1st and the commission is expecting five applications.  Press reports indicate that it could take up to a year for the commission to make any final decision.  Lyon County, in northwestern Iowa, could have a strong chance; the market is underserved and so cannibalization of other casinos’ revenue would not be an issue.  It would also draw from the Sioux Falls, South Dakota, market.  It seems likely that at least two new casino licenses will be granted with 2,000-3,000 slots.


  • Pennsylvania - A Pennsylvania state House panel has approved, on the second attempt, a bill that would legalize and tax video gambling machines in bars.  The proposal is designed to generate grants for tuition costs at one of the fourteen state-owned universities or the fourteen community colleges in Pennsylvania.  Some of the votes for the bill were more tepid than others.  Rep. Curtis Thomas voted yes but still wants to make major changes to the bill when it comes up for action on the House floor.  Even if the House passes the bill before the summer break, Senate action is unlikely before the fall. 


IGT is the obvious play on new gaming jurisdictions since it is the largest slot provider in the world and tends to garner a larger market share in new casinos and expansions (60% vs 40% in replacements).  IGT generates about $0.015 in EPS per 1,000 slots sold.  Indeed, the stock has performed well recently due in part to the potential for new markets.  The long term takeaway is that there will be expanded gaming, the fiscal crisis will dictate that.  The only question is which states and when?  The right trading strategy might be to fade optimism of new legislation and buy into pessimism.  Either way, slots could be at the cusp of a huge bull market as replacement demand is troughing and state fiscal desperation opens new markets across the country.

Casual Dining - June Knapp Track

Malcolm Knapp reported that June same-store sales declined 7.7% with traffic down 7.2%.  For the second consecutive month, comparable guest count results were better than sales, which points to the significant discounting in the industry.  Even with companies trying to drive traffic at the expense of average check and margins, traffic trends decelerated sequentially from May on a 1-year, 2-year and 3-year basis. 

These June numbers do not reflect the same level of decline that we witnessed back in December, but the Q2 numbers overall are worse than Q1.  Same-store sales declined 6.6% on average in Q2 versus -4.2% in Q1.  We will learn more about company-specific Q2 results over the next couple of weeks and the winners will be those companies that have been able to offset these soft sales results with continued cost cutting.


McDonald’s plans to release its June same-store sales figures as part of the second-quarter earnings release, which is scheduled to be published before the market open on Thursday, July 23.

The latest proprietary McDonald’s Franchisee Survey asked respondents about their June same-store sales results. For the 35 domestic franchisees -- representing roughly 227 restaurants -- who responded, the aggregate June same-store sales figure is 2.7%.

This survey marks the 39th time that a McDonald’s Franchisee Survey has been published. In the prior 38 times, the actual U.S. same-store sales number reported by McDonald’s has been within 100 basis points of the survey results on 26 occasions, and within 200 basis points of the survey results on 33 occasions. 

The average magnitude of the difference between the survey and the actual result reported by McDonald’s is about one percentage point.

Assuming about 4% pricing, MCD continues to experience negative traffic trends.  Given the extreme discounting we are seeing from MCD, margin pressure can only follow at some point.

These numbers support out favorable position on SBUX and cautious stance on MCD.


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