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Prospect Theory Wins

This note was originally published at 8am on April 08, 2014 for Hedgeye subscribers.

“One of the main tenets of prospect theory is that people don’t evaluate things in absolute terms.”

-Jonah Berger


Prospect Theory was originally developed by Dan Kahneman and Amos Tversky in 1979 (i.e. after all the Keynesian economic policy makers who worked for Nixon and Carter failed). But Kahneman didn’t win his Nobel Prize for #behavioral economics until 2002. And one of the most important books you’ll ever read, Thinking, Fast and Slow, wasn’t published until 2011.


All the while, this thing called the US economic and policy crisis happened. And linear (Keynesian) economic theorists working for Bush and Obama didn’t change a damn thing. There is no #behavioral or non-linear chaos theory embedded in what they do. Almost every lick of what comes out of the US Treasury and/or Federal Reserve deals in absolutes, on a lag – not forward looking rate of change.


While that is a national embarrassment for a country that hangs its entitled hat on meritocratic evolution and technological change, it remains your opportunity. Whether it’s Jonah Berger teaching social influence (marketing) at Wharton, or me ranting about macro every morning – it’s what happens on the margin that matters most. Prospect Theory is winning.


Back to the Global Macro Grind


Rate of change, or the accelerations/decelerations in the slope of a line measuring momentum, is easy to understand; especially when you show it in pictures. This is why a lot of people in our profession look at charts.


Prospect Theory Wins - Its not where you look that matters its what you see


But, as Henry David Thoreau wrote, “it’s not what you look at that matters, it’s what you see.” And, in a general sense, that is the Hedgeye Risk Management process when I talk about considering multiple factors and multiple durations, all at the same time.


In other words, it’s easier to see what’s going on in this globally interconnected macro marketplace of colliding factors, policies, and prices if you take a step back and look at the big picture. So let’s do that this morning, and take a look at 3 big places:

  1. JAPAN – on both our immediate-term TRADE and intermediate-term TREND durations the Japanese stock market remains bearish. From a GIP (Growth, Inflation, Policy) modeling perspective, Japanese #GrowthSlowing continues to be our call.
  2. EUROPE – mostly every major European stock market is still bullish on both our TRADE and TREND durations - in sharp contrast to the Dow (-2% YTD), the Italian stock market is +17% YTD (they don’t have social media or biotech bubble stocks). From a GIP modeling perspective, the Eurozone growth recovery is lagging what was the US one in 2013 by 6-18 months.
  3. USA – both the Nasdaq and the Russell 2000 have recently broken both @Hedgeye TRADE and TREND support levels. The SP500 is bearish on our immediate-term TRADE duration (1869 resistance) and barely bullish TREND (1830 support). In our GIP model, US #InflationAccelerating still sets up to slow US growth until at least the end of the 3rd quarter.

Accelerate and decelerate, fast and slow. That’s what centrally planned economies do. Get used to it.


Considering macro markets across multiple-factors also helps. I still can’t for the life of me understand how you’d have an informed opinion on multiple expansion or compression in stocks, if you don’t have a repeatable process considering:

  1. Currencies
  2. Commodities
  3. Interest Rates

But that’s just me. And to be crystal clear on this, I didn’t get that I needed to develop a process to consider all of the non-linear factors within the dynamic ecosystem that I invested in until I got run-over in my “best stock ideas.” Macro phase transitions can crush alpha, fast.


What is a phase transition?

  1. It’s a term used to explain thermodynamic systems
  2. “the transformation from one phase to another by heat transfer” (Wikipedia)

I realize that the alternative to considering market risk this way is using a 50-day moving monkey average. I also get that the guys who taught me about this business used to hold up pieces of paper to their trading screens trying to delineate higher-lows and higher-highs.


But guess what, without considering multi-factor, multi-duration global macro, they were still right in considering rate of change:

  1. Higher-lows + higher-highs = bullish momentum
  2. Lower-highs + lower-lows = bearish momentum

That said, that’s only considering 1-factor (price). And while it’s a good one to start with if only considering price momentum, you don’t have to stretch too far to start adding other factors, like volume and volatility, in order to front-run #OldWall’s behavior.


I’m not saying I have all the answers. I’ve made more mistakes with live ammo than almost anyone my age in this business. I have seen people lie, cheat, and lose. I have seen others evolve, learn, and win.


So I wanted to thank you for the opportunity to learn from all my mistakes out loud. Sometimes I learn fast; sometimes it’s slow. Building Hedgeye in an open, transparent, and accountable environment has helped us improve our process. I’m grateful for that.


We’ll be hosting our Q2 Global Macro Themes conference call this morning at 11AM EST. If you have time, we’re looking forward to your questions about what our risk management process is signaling next.


SPX 1830-1867

Nasdaq 4051-4166

Nikkei 14366-15083

VIX 14.11-16.52

Gold 1278-1322


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Prospect Theory Wins - Chart of the Day


Prospect Theory Wins - Virtual Portfolio

Vanishing Volume

“Nothing entirely disappears in history.”

-T.J. Stiles


But the US stock market’s volume in the last 5 trading days almost has…


#History, as eloquently defined by T.J. Stiles in The First TycoonThe Epic Life of Cornelius Vanderbilt, is “threads of tattered old fabric – especially social fabric – ever woven into new tapestries.” (pg 79)


Especially on the Old Wall, what’s stale to you and I eventually becomes the new. More commonly called consensus, it’s the art of front-running storytelling that makes us money. No pattern of predictable market behavior entirely disappears; especially with the benefit of looking in the rear-view mirror.


Back to the Global Macro Grind


So let me tell you a story this morning about Vanishing Volume. As with any good story, you need a good headline. After I effectively failed my first creative writing course in New Haven, a nice young professor taught me alliteration. Two v’s. Yep, so easy a Mucker can do it.


Vanishing Volume - vol1


What’s not easy for the financial media to tell you are original content stories that require a basic level of algebra and a contextual overlay (you know, something like, say, a time series… so that you can see something meaningful, like the rate of change).


Usually, it’s easier to show these historical matters in pictures. So, instead of reading my rant, you can just skip to Christian Drake’s Chart of The Day and get the point. What we’re showing you here is the lack of buying conviction (i.e. total US equity market volume, across all exchanges):

  1. Volume on DOWN DAYS = +8% versus the 1 month average
  2. Volume on UP DAYS = -5% versus the 1 month average
  3. Yesterday’s volume (an UP DAY) was -18% versus the 1 month average

Fair enough. Since it feels like half of America took the day off again yesterday, you can accuse me of cherry picking that one nasty day of no-volume. So I’ll broaden my horizons to the last 5-days. UP day volume was -14% versus the average.


Now, if you only use a Moving-Monkey (more commonly called a simple 50 or 200 day moving average), you don’t care about risk factors like this. Single-factor (price only) models are point and click. My 6yr old can do it on Yahoo Finance. No underneath the hood analysis of volume or volatility required.


Vanishing Volume - Volume Total Mkt

In my process (studying fractal patterns, returns, draw-downs, etc. of US stocks), using a multi-factor model is critical. And to be clear, it’s not that I have anything against monkeys… I used to use those things too (newsflash: they don’t work).


What’s the alternative? As a basic predictive signal, what works?

  1. Price UP, Volume ACCELERATING, and Implied Volatility FALLING = bullish
  2. Price DOWN, Volume ACCELERATING, and Implied Volatility RISING = bearish
  3. PRICE UP on DOWN VOLUME and Implied Volatility unchanged = bad

And really bad if you go all multi-duration and cross-asset-class (more factors) in your analysis!


So let’s go there.

  1. SP500 broke out (on no volume) above its intermediate-term TREND support of 1834, but failed at immediate-term TRADE resistance of 1887
  2. Nasdaq didn’t breakout above either my TRADE or TREND lines (bearish TREND with no support to fresh YTD lows)
  3. Russell2000 didn’t breakout above my TRADE or TREND lines of resistance either
  4. US Dollar Index bounced to lower-highs but remains below my TAIL risk line of $81.17 resistance
  5. US Bond Yield (10yr US Treasury) bounced to lower-highs but remains below my intermediate-term TREND resistance of 2.81%
  6. Nikkei (which is the upside down of the UP Yen vs USD move) failed at 14,835 TRADE resistance overnight = bearish TREND (-11% YTD)

I can keep going deeper and delve into the depths (more alliteration – see, I can do this without Janet – Yes I Can!) of the non-linear ecosystem that is the Global Macro Market – but I will not… because every good line of storytelling needs to simplify the complex.


What will be extra complex is seeing how Goldman and Credit Suisse explain their “buy Facebook (FB)” call from yesterday if my WhatsApp! man Zuck doesn’t deliver the 14x revenue bacon tomorrow. As for the buy Apple (AAPL) ahead of the quarter thing, that’s not how I roll.


I’m a macro man, so my main focus into and out of earnings events will be how the bubbles (Biotech and Social Media) trade after making lower-highs on lower-volumes. Biotech (IBB) was +2.3% yesterday but remains below @Hedgeye TREND resistance.


Oh, and Housing stocks (ITB) made fresh 2014 lows yesterday (-5.3% YTD), but let’s not story-tell about vanishing housing demand (while rates are falling) until tomorrow…


Our immediate-term Global Macro Risk Ranges are now (12 Big Macro ranges in our Daily Trading Range product):



VIX 12.39-15.90

USD 79.32-80.15

EUR/USD 1.37-1.39

Pound 1.67-1.69

Gold 1


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer

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TODAY’S S&P 500 SET-UP – April 22, 2014

As we look at today's setup for the S&P 500, the range is 53 points or 2.02% downside to 1834 and 0.81% upside to 1887.                                             












  • YIELD CURVE: 2.33 from 2.32
  • VIX closed at 13.25 1 day percent change of -0.82%

MACRO DATA POINTS (Bloomberg Estimates):

  • 7:45am: ICSC weekly sales
  • 8:55am:Redbook weekly sales
  • 9am: FHFA House Price Index m/m, Feb., est. 0.5% (prior 0.5%)
  • 10am: Richmond Fed, April, est. 2 (prior -7)
  • 10am: Existing Home Sales, March, est. 4.56m (prior 4.60m)
  • Existing Home Sales m/m, March, est. -0.9% (prior -0.4%)
  • 11:45am: Former Fed Chairman Ben Bernanke speaks at Economic Club of Canada on crisis management at Federal Reserve
  • 4:30pm: API weekly oil inventories


    • 8:30am: Dow Jones holds the 2014 Global Compliance Symposium
    • 11am: Supreme Court hears arguments in copyright case between Aereo, broadcast industry
    • House, Senate not in session
    • Congressional delegation, Vice President Biden in Ukraine
    • President Obama travels to site of Washington mudslide
    • Primary for special election to replace Rep. Radel in Fla.
    • U.S. ELECTION WRAP: Radel Seat; Billionaires Max Out


  • Novartis buys Glaxo cancer unit, sells animal drugs to Lilly
  • Valeant, Pershing will bid for drugmaker Allergan
  • Allergan says had no talks with Valeant, Pershing Square
  • HCA said to consider offer for Australia’s Healthscope
  • Samsung says $2b for Apple patents 57 times too much
  • Diller goes big in U.S. high court gamble on Aereo’s future
  • Pfizer agrees to pay $190m to settle Neurontin case
  • LinkedIn said to fully lease Tishman’s SF skyscraper
  • Amazon sales take hit in states with online tax, study says
  • Icahn, Starboard’s Smith at Active-Passive Investor Conf.
  • BlackRock seeks buyers for Malaysian office towers, mall
  • JPGoldman Stanley intact as Basel change leaves banks entwined
  • Ukraine accord nears collapse as Biden meets leaders in Kiev
  • Samaras sees bond yields falling as Greek economy rebounds


    • AK Steel Holding (AKS) 8:30am, ($0.43)
    • Allegheny Technologies (ATI) 7am, ($0.07)
    • Arch Coal (ACI) 7:45am, ($0.43)  - Preview
    • Bank of New York Mellon (BK) 6:30am, $0.54
    • Canadian Pacific Railway (CP CN) 7:30am, $1.41  - Preview
    • Carlisle Cos (CSL) 6am, $0.51
    • Centene (CNC) 6am, $0.41
    • Comcast (CMCSA) 7am, $0.64  - Preview
    • FirstMerit (FMER) 7:30am, $0.36
    • Genuine Parts Co (GPC) 8:34am, $1.02
    • Harley-Davidson (HOG) 7am, $1.08
    • Hubbell (HUB/B) 7:13am, $1.07
    • Illinois Tool Works (ITW) 8am, $0.98
    • Interpublic Group (IPG) 7am, ($0.08)
    • Janus Capital Group (JNS) 7am, $0.16
    • Lexmark International (LXK) 6:30am, $0.87
    • Lockheed Martin (LMT) 7:25am, $2.54  - Preview
    • McDonald’s (MCD) 7:58am, $1.24  - Preview
    • MGIC Investment (MTG) 7am, $0.11
    • Omnicom Group (OMC) 7am, $0.79
    • Pentair (PNR) 7am, $0.73
    • Prologis (PLD) 8am, $0.05
    • Regions Financial (RF) 6:51am, $0.20  - Preview
    • Simon Property Group (SPG) 6am, $0.96 - Preview
    • Synovus Financial (SNV) 7am, $0.05
    • TCF Financial (TCB) 8am, $0.23
    • Travelers (TRV) 6:57am, $2.16 - Preview
    • United Technologies (UTX) 6:59am, $1.27  - Preview
    • Xerox (XRX) 6:45am, $0.24


  • Amgen (AMGN) 4pm, $1.94 - Preview
  • AT&T (T) 4:01pm, $0.70 - Preview
  • Canadian National Railway Co (CNR CN) 4:01pm, C$0.62 -Preview
  • Covanta Holding (CVA) 4:01pm, ($0.15)
  • CR Bard (BCR) 4:05pm, $1.86
  • Cree (CREE) 4:01pm, $0.38
  • Cubist Pharmaceuticals (CBST) 4pm, $0.04
  • Discover Financial (DFS) 4:05pm, $1.25
  • FMC Technologies (FTI) 4pm, $0.50
  • Fulton Financial (FULT) 4:30pm, $0.21
  • Gilead Sciences (GILD) 4:05pm, $0.91 - Preview
  • Hatteras Financial (HTS) 4:30pm, $0.49
  • IDEX (IEX) 4:35pm, $0.84
  • Illumina (ILMN) 4:05pm, $0.44
  • International Game Technology (IGT) 4:15pm, $0.19
  • Intuitive Surgical (ISRG) 4:05pm, $2.70
  • Juniper Networks (JNPR) 4:05pm, $0.29 - Preview
  • Nabors Industries (NBR) 4:067pm, $0.15
  • Packaging of America (PKG) 5pm, $1.00
  • Sanmina (SANM) 4:02pm, $0.39
  • Skyworks Solutions (SWKS) 4:30pm, $0.59
  • Torchmark (TMK) 4pm, $1.51
  • Total System Services (TSS) 4pm, $0.43
  • Trustmark (TRMK) 4:15pm, $0.42
  • VMware (VMW) 4:01pm, $0.79
  • Woodward (WWD) 4pm, $0.50
  • WR Berkley (WRB) 4:01pm, $0.79
  • Yum! Brands (YUM) 4:15pm, $0.84


  • El Nino’s Arrival Is Forecast by All Models Tracked by Australia
  • Nickel Rises to 14-Month High as Ukraine Adds to Indonesia Cuts
  • Zinc-Output Deficit Widens as China Buys More Stuff: Commodities
  • WTI Falls From Seven-Week High Before Supply Data; Brent Slips
  • Nickel to Swing to Deficit on Indonesia Ban, Sumitomo Metal Says
  • Gold Trades Near 2-Week Low as U.S. Outlook Weighed With Ukraine
  • Wheat Rebounds From Biggest Drop in a Year on Ukraine Flare-Up
  • Rebar in Shanghai Rises From One-Month Low as Inventory Declines
  • Coffee Advances on Brazilian Weather Concerns; Cocoa Also Climbs
  • Goa Miners Hoping for Boom After Bust Turn to Guevara Fan
  • Keystone Route Ruling Should Be Overturned, Nebraska Tells Court
  • Ex-Goldman Banker Emerges as Barrick Dealmaker on Newmont Talks
  • Rubber in Tokyo Settles Near Four-Year Low on Oversupply Concern
  • Indonesia Seizes Tin Cargo on Ship Heading to Singapore
























The Hedgeye Macro Team















April 22, 2014

April 22, 2014 - 1



April 22, 2014 - Slide2

April 22, 2014 - Slide3

April 22, 2014 - Slide4

April 22, 2014 - Slide5

April 22, 2014 - Slide6

April 22, 2014 - Slide7

April 22, 2014 - Slide8


April 22, 2014 - Slide9

April 22, 2014 - Slide10

April 22, 2014 - Slide11
April 22, 2014 - Slide12


In preparation for IGT's F2Q earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.




  • Total revenues $499 million
  • EBITDA $167 million
  • EPS $0.19/share


  • 2014 FY EPS Guidance:  $1.00-$1.10
  • FQ2 EPS Guidance: $0.17-0.19



Demand Environment

  • Declines have been greater than anticipated. Certainly weather has contributed to that, but likely not weather alone.
  • Seeing some signs in March that make us feel a bit better about the business.


  • Had assumed in 2014 that the restrictions would not improve.
  • In fact, the importation situation has tightened in Argentina
  • See a fraction of those units shipping into Argentina in 2014.

Cost Cuts

  • $30MM cost reduction in 2014 ($50MM annualized)


  • Nevada, New Jersey, South Dakota and Canada opportunities


  • Growing 20%


  • Will experience the same sort of growth (as DoubleDowns) 

Replacement Cycle

  • Coming into the year, replacement units were expected to grow. It looks now like they will not grow.

Product Sales

  • Product sales is probably been disproportionately impacted given the effects now that we see on the market on replacement demand, on international market demand.

Game Ops

  • Increased pressure on MJP (Megajackpots)

Stock Repurchase

  • Concluded the previously announced accelerated share repurchase in January. That actually is an impact in the quarter. But in terms of material repurchase, activity was largely concentrated in the first quarter.
  • IGT will be less aggressive on the buyback front in the short term


  • Expect to deliver earnings growth in both 2015 and 2016 at this point.


  • Facing a bit of a forex headwind.  Three major external currencies outside the euro in South Africa, in Argentina and Australia have all moved against IGT, Argentina obviously very dramatically in the year. There will be a devaluation charge in the quarter associated therewith. IGT expect those to moderate at some level.

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