“Beware of false knowledge; it is more dangerous than ignorance.”
-George Bernard Shaw
Every effective stock market operator knows that investment analysis is at best an imperfect science. The mosaic theory is an apt description because with the absence of a silver bullet (knowing the results of a drug test before everyone else as an example), an investment analyst’s best tool is his or her ability to collect more data than his or her peers and to then use that data to reach a more informed conclusion.
Even then, in the absence of perfect information, many outcomes are flawed. In fact, many analysts are guilty of making what is called a Type 1 error, or a false positive. False positives lead analysts to conclude that a relationship exists when in fact it does not. In medicine, this might occur when a test shows a patient has a disease, when they don’t.
As Europe contemplates another round of extreme monetary policy to offset perceived deflationary pressures, it does beg the question of whether there is a relationship between a monetary policy and a tightening economy. Certainly, many supporters of former Fed Chairman Bernanke point to the fact that the economy recovered under him as evidence that his implementation of the most extreme monetary policy in the history of central banking was the reason for this recovery.
Conversely, though, the question remains whether the economy has recovered at all because of QE or even commensurately with the QE that has been implemented. As former Dallas Fed President Bob McTeer recently wrote in Forbes:
“The hoarding of excess reserves limited the money creation or “printing” that took place despite the Fed’s massive purchases of securities and expansion of its balance sheet. That’s why the dire consequences predicted never came to pass. However, it is also the reason that the Fed’s purchases never stimulated the economy as much as hoped.”
In reality if you print dollars and don’t allow them to be spent, then you are really only debauching the currency by increasing the denominator. Certainly this a policy that is good for the inflation trade, especially relating to those commodities priced in U.S. dollars
Back to the Global Macro Grind...
As Portugal’s bonds fall below the 4% yield for the first time in almost ever, one has to wonder if there isn’t a bit of a false positive emerging in the European peripheral sovereign debt markers. Currently the 10-year yields of Portugal, Italy and Spain stand at 3.99%, 3.27%, and 3.20%, respectively. Certainly these yields are still wide versus German bunds, but are these yields, on absolute basis, truly reflective of the underlying creditworthiness of those economies?
Take Spain as an example. This morning the Spanish central bank is projecting the Spanish economy will grow by 1.2%. Given that this is below par economic growth, it is likely that Spanish unemployment stays above 25%. This morning consumer prices were also reported to have fallen at an annual rate of -0.2%, which is the first decline in consumer prices in four years in Spain and indicative that consumers in Spain aren’t really spending (recent retail sales data show the same).
Clearly, on the margin, the economies in the periphery in Europe have improved, but if you are a buyer of Italian or Spanish 10-year bonds at 3.2%-ish, you need to put on the big boy analytical pants and decide if for that yield, the risk is commensurate. At a 10% dividend yield, Linn Energy ($LINE) might be a good relative bet . . . actually I take that back, we’d continue to stay the heck away from LINE and much of the MLP complex !!!
My colleague Christian Drake, our U.S. focused economic analyst, wrote a note yesterday that he titled, “INFLECTIONS OR FALSE POSITIVES? CLAIMS, CONSUMPTION & CAPEX” where he addressed some of the myriad of U.S. economic data out recently:
- #ItsNot2013: Growth estimates globally continue to get marked down. Slowing topline (GDP) and compressing margins (rising inflation) is not the stuff of market multiple expansion or macro P&L dynamics to remain lazy long of.
- RISING INEQUALITY: Corporate Profits - measured as the % of National Income or GDP - made another new high in 4Q13. The other side of that, of course, is a lower low in labor’s share of income. Latent risks can remain latent, however.
- CAPEX RESURGENCE? General acknowledgement that assets are aging and businesses have under-invested isn’t a catalyst.
- PAY-ME-NOW: Productively continues to grow at a positive spread to unit costs and investors continue to reward the ‘pay-me-now’ corporate capital strategy.
- DURABLE DISAPPOINTMENT: New Orders for Capital Goods non-Defense Ex-Air have been negative on a month-over-month basis for four of the last six months.
- INITIAL JOBLESS CLAIMS: A positive week of data…finally. The next few weeks of data should be important
His conclusion, which is highlighted in the Chart of the Day below, is that although the U.S. economic data is part positive and part negative, GDP estimates continue to fall. Ultimately the direction of GDP change is what matters.
But that all said, as you head into the weekend I would leave you with words of Mark Twain:
“All generalizations are false, including this one.”
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.64-2.75%
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
TICKERS: CZR, PNK, WYNN
EVENTS TO WATCH: UPCOMING EARNINGS/CONFERENCES/RELEASES
Friday, March 28
- Nevada gaming revenues release for February
- Wynn Macau board meeting
Tuesday-Thursday, April 8-10
- Mid-America Gaming Congress (Columbus, OH)
Wednesday, April 9
- SHO Investor Day
Thursday, April 10
- HST Investor Day
CZR – announced an offering of 7 million shares of its common stock. Caesars expects to grant the underwriter of the offering an option to purchase up to 1.05 million additional shares of its common stock.
TAKEAWAY: The equity offering seems unusual given the recently announced transaction where Caesars will sell assets to Caesars Growth Partners for cash and assumption of debt.
PNK – the Missouri Gaming Commission approved the sale of Lumiere Place to Tropicana Entertainment. Pinnacle and Tropicana plan to complete the $260 million, all-cash transaction by the end of 1Q14. he divestiture is structured as a 338(h)(10) transaction. The book carrying value for Lumiere Place Casino and Hotels was $401.5 million at June 30, 2013
TAKEAWAY: Transaction appears on track. We note PNK should generate a significant NOL at closing.
WYNN / 1128.HK - Ltd will offer shares in the company to all 7,500 of its employees. The company announced that it would offer each employee 1,000 shares. Wynn Macau also said it would pay its employees two bonuses a year from this year until 2017 – one in the summer and one in winter.
TAKEAWAY: A creative way to hand cuff workers in a tight and getting tighter labor market as the new Cotai properties begin to recruit for their 2016 and 2017 openings.
WYNN - Garth Brooks, the best-selling solo musician in U.S. history, ended his semi-retirement on Thursday when he announced 15 concert dates at Wynn Resorts Ltd’s Encore theater in Las Vegas. Brooks will perform on three consecutive nights beginning December 11, with another six dates in January & six in February at Wynn Resorts’ hotel, casino & performance complex, which opened late last year.
TAKEAWAY: Given the long history between Garth Brook and Steve Wynn we are not surprised. Bringing Garth Brooks back just prior to and just after the very busy Christmas/New Year Holidays is a creative way to create incremental room and casino business.
An Illinois Senate committee has passed a bill (SB3144) upping the number of VLTs allowed at truck stops from five to 10.
TAKEAWAY: A plus for the suppliers if it goes through the process. Meanwhile, the number of new VLTs approved dropped to a monthly low in February.
Hedgeye remains negative on consumer spending and believes in more inflation. Following a great call on rising housing prices, the Hedgeye Macro/Financials team is turning decidedly less positive.
TAKEAWAY: We’ve found housing prices to be the single most significant factor in driving gaming revenues over the past 20 years in virtually all gaming markets across the US.
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This note was originally published at 8am on March 14, 2014 for Hedgeye subscribers.
“We fear things in proportion to our ignorance of them.”
-Christian Nestell Bovee
All week I’ve been putting the finishing touches on what we think will be a revolutionary dynamic asset allocation model/global macro signaling platform; as such, I haven’t had much time to consume my “fair share” of financial news media in the week-to-date.
When I was able to perk my head up for a brief moment, I was somewhat startled to see the SPX down ~20 handles on “China jitters” yesterday.
Like many other financial news media headlines, I’m not quite sure how to interpret that one. Granted, no one is paying such platforms for differentiated, cutting-edge analytical insights, but sometimes I think their need for speed and coherent storytelling in a globally-interconnected, nonlinear ecosystem can get the better of them.
HEDGEYE POLL OF THE DAY: please reply “yes” to this email if it’s news to you that Chinese economic growth is slowing.
It’s worth noting that in the 15 quarters since Chinese real GDP growth hit a cycle-peak of +11.9% YoY in 1Q10, Chinese economic growth has accelerated sequentially only three times. It’s basically been a straight leg down for four consecutive years – so much so that on a trailing 3Y basis, the z-score for this series is (0.6x), which is actually up from trough of (1.6x) in 2Q12. In non-statistical speak, this implies that the “surprise factor” of Chinese #GrowthSlowing is burning off.
That isn’t to say that Chinese economic growth is not still slowing. In fact, the broad swath of high-frequency economic data (including yesterday’s releases) points to a continued slowdown. The current risk range in our predictive tracking algorithm has probable downside to +7.3% YoY for Chinese real GDP growth here in 1Q14, which would: A) be the slowest growth rate since 1Q09; and B) imply that the Chinese economy is not taking advantage of extremely favorable base effect tailwinds – a sign that sequential momentum is indeed decelerating.
For those of you who do not follow China closely, below we’ve compiled the relevant data points for your review, color coding them appropriately for ease of interpretation:
- Fixed-Assets Investment: +17.9% YoY in JAN-FEB from +19.6% in DEC; +17.9% is the slowest growth rate since DEC ‘02
- Industrial Production: +8.6% YoY in JAN-FEB from +9.7% in DEC; +8.6% is the slowest growth rate since APR ‘09
- Retail Sales: +11.8% YoY in JAN-FEB from +13.1% in DEC
- Total Social Financing: +938.7B CNY in FEB from +2,584.5B in JAN
- New CNY Loans: +644.5B CNY in FEB from +1,320B in JAN
- Non-traditional Financing (i.e. “shadow” banking): +17.2B in FEB from +993B in JAN
- Ratio of Non-traditional Financing to Total Social Financing: 1.8% in FEB from 38.4% in JAN
- Official Manufacturing PMI: 50.2 in FEB from 50.5 in JAN; 50.2 marked an 8M-low for the index
- New Orders declined 40bps to an 8M-low of 50.5
- Export Orders declined 110bps to an 8M-low of 48.2
- Official Non-Manufacturing PMI: 55 in FEB from 53.4 in JAN
- HSBC Manufacturing PMI: 48.5 in FEB from 49.5 in JAN; 48.5 marked a 7M-low for the index
- New Orders and Output both fell below 50 (i.e. contracted) for the first time in 7M
- Employment dropped to 47.2, which is its lowest reading since MAR ‘09
- HSBC Non-Manufacturing PMI: 51 in FEB from 50.7 in JAN
- Exports: (18.1%) YoY in FEB from +10.6% in JAN vs. a Bloomberg consensus estimate of +7.5%
- Imports: +10.1% YoY in FEB from +10% in JAN vs. a Bloomberg consensus estimate of +7.6%
- Trade Balance NSA: ($23B) in FEB from $31.9B in JAN vs. a Bloomberg consensus estimate of $14.5B; ($23B) marked the largest trade deficit since FEB ‘12
- Trade Balance YoY: ($37.8B) YoY in FEB from +$3.8B YoY in JAN
Lots of red indeed…
Back to the Global Macro Grind…
So what do you do with all of this? Like we’ve been saying since the start of DEC, you should simply allocate assets to “New China” plays in lieu of “Old China” plays. Refer to the Chart of the Day below for an example of how to implement this investment strategy.
The worst thing you can do as a fiduciary of other people’s capital is freak out about China ~4 years into a well-telegraphed, policy-induced growth slowdown.
That’s not to say the Chinese economy and its banking system won’t have its day of reckoning (it will; it has twice before in the last ~20-30 years after the popping of two credit bubbles that were also policy-induced); it’s merely to suggest that it might not be tomorrow. At any rate, we’ve done a ton of work on such risks over the past 6-9M, so please ping us if you’d like our help getting up to speed.
One key catalyst on the horizon is a potential shift to a monetary easing bias by the PBoC. To some degree, they’ve done this already: selling CNY in the open market to lower the reference rate – as they have done in recent weeks – floods the domestic banking system with liquidity. On the surface, they’ve mopped up this liquidity by issuing repos, but money market rates falling to near 2Y-lows suggests there is ample excess liquidity in the Chinese banking system.
Two additional points to consider regarding this potential catalyst:
- The Chinese yuan’s recent decline is not because of panic selling, but rather deliberate policy adjustments after speculative capital inflows helped fuel the fastest sequential rate of credit growth ever in JAN.
- Yesterday, for the first time since mid-2012, the State Council rhetorically supported the prospect of policy stimulus. This is in stark contrast to the “proactive and prudent” fiscal and monetary policy bias they’ve held for much of the past 18+ months.
While we all know they cannot stimulate indefinitely, there’s little-to-no denying the short-to-intermediate term impact increased government investment or a lower WACC could have on a Chinese economy that remains levered to fixed capital formation at roughly half of GDP. It’s worth noting that real interest rates (i.e. the benchmark 1Y lending rate less headline CPI) in China have backed up from a then-3Y low of ~0% in mid-2011 to near-4Y highs just north of 4%.
As always, time will tell on this catalyst. For those of you who crave a higher degree of analytical color at the current juncture, please refer to our latest report titled, “IS THIS THE BEGINNING OF THE END FOR CHINA?” (3/10).
Our immediate-term TRADE risk ranges across Global Macro are now as follows:
UST 10yr Yield 2.59-2.75%
Keep your head on a swivel,
Associate: Macro Team
Hopefully, IGT cleared the decks this week on estimates but there is at least one more issue out of their control
On October 10, 2013, we published a Black Book: SLOThy Growth. Since that date, IGT stock is -26% and the S&P 500 Index is +10% on a total return basis. While much has been written about this week's re-organization plan and the subsequent stock devaluation, we feel compelled to warn investors who might be nibbling at the apple at these price levels of an additional negative headline which will cause additional downside pressure on IGT's stock price.
Call to Action:
IGT will likely be removed from the S&P 500 Index due to a market cap shortfall. At present, IGT's equity market capitalization is $3.33 billion making IGT constituent #499 in the S&P 500 Index but will be #500 after Cliffs Natural Resources Inc gets booted from the Index effective April 1.
The Index Committee is constantly reviewing Index composition for addition and deletions based on various criteria - mergers, spin-offs, too small capitalization (see below). IGT clearly falls below the $4 billion threshold. Ten out of the 17 removals from the S&P 500 in 2013 were due to insufficient market cap including recent removals: JCP, JDS, and ANF.
Current Index Activity:
- Cablevision has proposed acquiring Time Warner #111
- Actavis has proposed acquiring Forest Labs #181
- Avago has proposed acquiring LSI Logic #452
Past Studies On S&P 500 Index Deletion Effects
Chen, Noronha and Singal (2004) concluded that companies deleted from the S&P 500 between 1989 and 2000 declined 8% upon announcement followed by an additional 6% between the announcement day and the effective deletion day. This study further referenced several earlier studies including Lynch and Mendenhall (1997), Dash (2002) and Beneish and Whaley (2002). All three of these studies found an average loss of +10% between announcement date and effective date, but that there were no long-term effects on share price due to deletion from the S&P 500 Index
The S&P 500 is maintained by the Index Committee, a team of S&P Dow Jones Indices economists and index analysts, who meet on a regular basis. The goal of the Index Committee is to ensure that the S&P 500 remains a leading indicator of U.S. equities, reflecting the risk and return characteristics of the broader large-cap universe on an ongoing basis. The Index Committee also monitors constituent liquidity to ensure efficient portfolio trading while keeping index turnover to a minimum.
The Index Committee follows a set of published guidelines for maintaining the index. Complete details of these guidelines, including the criteria for index additions and removals, policy statements and research papers are available on the website at www.spindices.com/sp500.
The Criteria for Index additions include:
U.S. Company - Determining factors include location of the company’s assets and revenues, its corporate structure, its SEC filing type, and its exchange listings.
- Market Capitalization - Companies with market cap in excess of USD 4 billion. This minimum is reviewed from time to time to ensure consistency with market conditions. This is where IGT fails the sniff test.
- Public Float - There must be public float of at least 50%. For people wondering why LVS isn't in the S&P 500, well, now you know.
- Financial Viability - Companies should have four consecutive quarters of positive as reported earnings, where as-reported earnings are defined as GAAP Net Income excluding discontinued operations and extraordinary items.
- Adequate Liquidity and Reasonable Price - The ratio of annual dollar value traded to float adjusted market capitalization for the company should be 1.0 or greater. Very low stock prices can affect a stock’s liquidity.
- Sector Representation - Companies’ industry classifications contribute to the maintenance of a sector balance that is in line with the sector composition of the universe of eligible companies within the defined market cap range.
- Company Type - All U.S. common equities listed on the NYSE and the NASDAQ stock market.
Criteria for Index Removals
- Companies that substantially violate one or more of the criteria for index inclusion.
- Companies involved in merger, acquisition, or significant restructuring such that they no longer meet the inclusion criteria.
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