"The pressure not to lose has been replaced by the pressure not to miss out."
-Seth Klarman (Founder of Baupost)
I love airplanes. Other than in the shower and in movie theatres, it's one of the few places that no one can email or call me. It's a great place to think. As I was grinding through my pile of reading on a flight to Chicago last night, I came across that simple, but very timely, quote by one of Boston's investment managers, Seth Klarman.
There are many players in this game who operate with a one factor investment model - price momentum. They chase it down. They chase it up. That's not new - what is new is that we have a generationally high level of players in the game doing it. They all have tremendous pressure not to lose. Daily, weekly, monthly returns - this is the pressure cooker.
The pressure not to miss out is one of supply. As a result, we have created an institutional investment business in the USA that is setup for cyclical mean reversion. One of the very best mean reversion investors of this generation is another Boston based lad by the name of Jeremy Grantham.
In Grantham's recent July letter he called the current market levels a "Boring Fair Price." And this morning, with the SP500 at 979, I have to agree with that conclusion. While all of the 200-day and 50-day Moving Monkeys are pressured to chase one another around the group-think keepers cages, we continue to settle into a low volatility range bound tape. If you missed calling the crash or the squeeze, too bad. Get over it.
I know - now I have complimented 2 people in the same note and offended my beautiful wife for insinuating that I don't love her every cell phone call (I do Laura!). There must have been something in those world class Chicago ribs I had last night. There is also something about this pressure cooker that makes me a little itchy.
Itchy? Yeah, you know - scratching. How will it all end? We all know that it won't end well. This could be the toothpick industry and my conclusion would be the same. Like in any oversupplied industry, we need to reduce capacity. Since we've decided to socialize this game, the natural progression of supply coming down just happens at a slower pace. It's kind of like injecting a game of Monopoly with moneys from the heavens on the hour, every hour - keeping the levered alive.
So what's my call on the US market this morning? That's easy, Range Rover. Here are my immediate term TRADE levels of support/resistance:
1. SP500 962-994
2. Nasdaq 1
3. Dow 8
Unlike the "level 3" super "side pocket" gurus of everything Wall Street securitization, we manage risk on a marked-to-market basis. Every 90 minutes of trading our global macro models refresh risk management levels. As a result, when price/volume/volatility changes, we change our view.
On the US Equity side, I don't disagree with Grantham's take - he said he wants to "buy quality and short junk." I have expressed this view somewhat differently, but it gets me to the same place. I want to be long liquidity and short financial leverage. From a macro perspective, this is why I remain long the Nasdaq (QQQQ) and short the Dow (DIA). From a bottom's up stock picking perspective, this is why I remain long a 4 letter name in the Nasdaq with a great balance sheet like Yahoo (YHOO), and short the ole school house of leverage games past, General Electric (GE).
If you're on the other side of Grantham and I, congratulations. As the US Government has opted to Burn The Buck, all Debtors and owners of junk got paid. "Got" would be the most important word in that sentence. Be certain of this, if/when the US Dollar rallies, a lot of the debtor obligations that are denominated in US Dollars will start to underperform. Yes, the price of junk can be the recipient of a socialized process of REFLATION but, in the end, it's still junk.
The Lords of The Tops (Mega Private Equity Funds), will have plenty of junk to re-issue to Wall Street. This morning you are seeing KKR in the news again, floating the idea of bringing one of their pigs with lipstick back to the public market. Never mind those Chinese IPO's folks, we gotta get ourselves some of that overstored US Retail capacity ala Dollar General!
I am sure that Goldman will be leading the no growth "dollar store" stagflation deal, and my sincerest of congratulations to those bankers for gaming this system for what it is - a pressure cooker. People need to do what they need to do to get paid. We get it.
Whether it's the current US Private Equity overhang of $400 billion USD, the Chinese stock market having its biggest down day (-5%) in the last 8 months overnight due to a massive IPO overhang, or yesterday's 2-year auction for US Treasuries showing the demand of a dribbling catheter... it's all one and the same. We have a supply problem that's structurally here to stay - and as prices rise, we have the hyperbole of an increasinginstitutional "pressure not to miss out."
Best of luck out there today,
EWG - iShares Germany - We bought Germany on 7/28 on a pullback in the etf. Chancellor Merkel has shown leadership in the economic downturn, from a measured stimulus package and budget balance to timely incentives such as the auto rebate program. We believe that Germany's powerful manufacturing capacity remains a primary structural advantage; factory orders and production as well as business and consumer confidence have seen a steady rise over the last three months, while internal demand appears to be improving with the low CPI/interest rate environment bolstering consumer spending. We expect slow but steady economic improvement for Europe's largest economy.
XLK - SPDR Technology - Tech got smushed for the 2nd day in a row on 7/27. Buying red.
QQQQ - PowerShares NASDAQ 100 -With a pullback in the best looking US stock market index (Nasdaq) on 7/24, we bought Qs. The index includes companies with better balance sheets that don't need as much financial leverage.
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.
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.
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.
XLF - SPDR Financials - Shorted Financials on a bounce on 7/27 with the yield curve as good as it gets.
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 - As Reflation morphs into inflation, the US Consumer Discretionary rally will run out of its short squeeze steam. We shorted XLY on 7/9 and again on 7/22.
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 pressure not to lose has been replaced by the pressure not to miss out."
As they were hitting new intermediate term highs, I shorted the financials yesterday via the XLF at $12.62/share.
Howard Penney will walk through the bottoms up earnings expectations embedded in Q3/Q4 for the Financials in another note. Here are a few things to consider as to why my macro models flashed sell:
- Spread – the yield curve’s spread is within 3 basis points of being as wide as it has ever been. Ever is a long time, and lending spreads can easily compress if the US Federal Reserve ever opts for sobriety in their analysis of Q4 inflation.
- Range – with GS and JPM earnings out of the way, the Financials look to be setting up to trade in a proactively predictable range. This will provide opportunities to tactically short the group on up days, and cover it on down days (my new range for the XLF is $11.56-$12.71; see chart below).
- Duration – as shown in the chart below, the long term TAIL for the Financials remains broken. Unlike the unlevered factors embedded in the Nasdaq, the financials need leverage and a socialized yield curve to earn a return on capital – so this makes sense.
Since the XLF bottomed on March 5th, 2009 at $6.24 we have seen a generational short squeeze that only an CNBC rockstar turned independent research analyst could perpetuate. AFTER a group rallies for a double (+102%) is not the time to get hyped up about Goldman Sachs. They are the chosen ones, we get it – but we also get that there is a time and a price for every risk managed position.
Keith R. McCullough
Chief Executive Officer
While it was all good and fine for Howard Penney and I to get excited about this chart bottoming in Q1 (being long the MEGA Squeeze in Consumer Discretionary), everything that matters to our macro model continues to occur on the margin. This morning’s US Consumer Confidence report (see chart) of 46.6 for July was a downtick from last month’s reading of 49.
As importantly, this month’s reading flashes another lower-high on the US Consumer’s appetite to buy into Wall Street/Washington latest line of storytelling. As the story goes, there is no inflation that will be born out of our government Burning The Buck. Bernanke and Geithner can issue limitless levels of credit creation, saving the Debtors obligations and the Bankers bonuses alike, and the US Consumer shall stand in line taking it for the man.
*Editor’s Note: on a 30 year basis, the only chart US macro chart that I can find that looks this bad is that of the US Dollar.
As the Debtors get paid, the Creditors pay the bills. The US Consumer is not stupid.
Keith R. McCullough
Chief Executive Officer
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RCL recently gave revised 2009 guidance of $0.86; factoring in swine flu, a 45% increase in fuel prices, losses on ineffectual FX hedges, and cost of new debt issuance. The bad cat is out of the bag already for this heavily shorted stock.
The news has been so bad this year; it sets up for an easier comp next year, although we believe the key metric of Net Yields will still fall in 2010. The near term channel check from travel agents and feedback from both RCL & CCL (see the “U-tube” section below) are consistently positive on the margin. Despite the supply growth in Europe the ships are getting filled and the new ships are getting premium pricing. Despite awful credit markets, ships are getting financed at attractive rates and companies are issuing notes.
When we step back and think about the big picture in our space, leisure travel is doing better on the margin. The lodging companies have told us that leisure demand, which led the way into this recession, is now one of the few bright spots. Leisure demand has been elastic, while corporate travel just isn’t showing any signs of life. Positive CCL commentary a month ago surrounding booking volumes and firming pricing confirmed this elasticity.
When RCL reported 1Q09 earnings on April 23rd, 75% of 2009 bookings were in the bag. We bet that when they gave revised guidance on June 29th well over 80% of bookings were in the bag. The other theme that has emerged so far in 2009 is beating on the cost side. We expect this trend to continue for at least this quarter.
That leaves us with 2010. We have expressed our concerns for capacity coming online in 2010. Given the impact of swine flu, weaker USD, and benefit negative hedges continuing to roll off, RCL could very well show huge EPS growth in 2010. That doesn’t mean that our fundamental outlook for 2010 has changed; it just may look better.
RCL 1Q09 U-TUBE
“...some months ago the market had begun to stabilize and we are happy that the level of stability has continued to increase.”
“...volume is remaining surprisingly robust given the current economic climate.”
“Ticket in tour revenue came in slightly better than we had forecasted and onboard spending was consistent with our forecast.”
“Our onboard revenue challenges continue to be driven primarily by gaming and other auctions. Our areas of strength are phone, Internet, shore excursions....”
“The booking window is certainly more contracted that we had seen in 2007 and 2008 and much of the demand is being driven present by aggressive pricing.”
“... We have seen a little bit of uptick lately in the three to six months window... When you go beyond that six months market it's where we're seeing people really holding back in the high degree of uncertainty.”
“...second quarter departures are behaving much the same way that the sailings that occurred in the first quarter did... Since [January] then the volume of new business has improved significantly and year-over-year pricing changes have been very stable.”
“...we are still fairly early in the booking cycle ...But again, the same pattern that we witnessed in the first and second quarter seems to be developing in the third quarter and the momentum of new business for third quarter sailings has begun to accelerate.”
“... our best estimates have third quarter yield change on both in as reported basis and on a constant dollar basis to be slightly better than the second quarter”
Full year 2009
“European yields will be weak in 2009 on a year-over-year basis. Fortunately, however, our strategic expansion in Europe is delivering benefits to our brand as the number of Americans cruising in Europe has decreased. We estimate at about three-fourths of our guests in Europe this season will originate from European source markets.”
“I would guess [RCL is] just under three quarters all-in booked for the year.”
READTHROUGH FROM CCL 2Q09 CALL
- Better than expected pricing on close in bookings
- Slightly larger yield declines as the back half (‘09) of the year feels the full brunt of the recession and is impacted by the seasonal deployments in Alaska and Europe
- A weaker dollar may mask some of this impact
- Seem to have found a stabilization point between pricing and booking, and with the strong booking pace, some itineraries were showing price improvement
- Since March they have seen both volumes and yields starting to improve – have been tweaking pricing up
3Q09 outlook (June 1 – August 30):
- North American brands:
- Saw a modest improvement in premium NA product, but “contemporary” product was impacted by swine flu
- Resumed sailings to Mexico in June, with pricing rebounding (off of lows) and volume was strong
- Guidance for next 3 quarters:
- Pricing is lower across all itineraries with steepest decline in Alaska, and Mexican Riviera also impacted. European itineraries pricing down, but better less so than originally expected. Caribbean lower and also impacted by swine flu
- Occupancy lower y-o-y for Caribbean, Mexican Riviera and Alaskan itineraries and slightly higher for European itineraries
- Expect NA yields to be lower in the double digit range by the time the 3Q closes
- European Brands:
- Pricing held steady, little swine flu impact expect pricing down in the single digit range for the continental Europe brands, and with UK brands only down “slightly” (overall down single digit range)
- Overall net yields down 14-16%
4Q09 outlook (Sept 1- Nov 30):
- Fleet-wide occupancies and pricing are lower than 4Q08 levels but look sequentially better than 3Q09
- North American brands:
- Pricing commentary (y-o-y comparisons): Caribbean down similar to 3Q09, Alaska very weak, Europe is weak but better than Alaska. Long and exotic cruise also down considerably
- Occupancies lower but only modestly
- European brands:
- Pricing continues to be better than NA brands, although still lower (y-o-y) but better than 3Q09
- Expect yield declines in the 1Q2010; comps are difficult since a good % of 1Q09 booking were booked pre-crash. Expect occupancies to be flat
- North American brands occupancy and pricing is lower across all itineraries (sounds like the booking levels are a lot lower but pricing is ok on what’s booked?)
- European brand pricing is running about flat, but occupancies are lower
It seems like forever ago but 6 months ago we were calling for:
A) a MEGA Squeeze in Consumer Discretionary
B) a Q2 Bottom in US Housing
Over the past month the Consumer Discretionary (XLY) has been the second best performing sector rising 9.3%. Within the XLY, Home Builders and Household durable names have been the best performing names within the index.
Yesterday’s new home sales data and now the data from Case-Shiller provide some economic support for the move in the XLY. The S&P/Case-Shiller home-price index dropped 17.1% year-over-year, the smallest drop in nine months. The index increased from the prior month for the first time in almost three years. According to Bloomberg, consensus forecast suggested the index would drop 17.9%.
Helping to moderate the decline in home prices is the fact that distressed properties account for a smaller share of those sales. In three out of the last four months, the index has seen a sequential improvement in moderating home prices.
Stocks, fortunately, have discounted a lot of this news. They don’t care so much for the Rear View.
PENN reports tomorrow. The only cracks we see are the possibility for slightly lower guidance and limited visibility on cash deployment. Street 2010 looks a little high but we’re not yet at that bridge.
Ignoring potential insurance proceeds, we see Q2 EPS and EBITDA close to PENN guidance and our estimate of $0.36 and $147 million, respectively. The quarter should be a non-event. For all of 2009, we are projecting $1.47 and $611 million, respectively, both in-line with the Street.
Where we differ is 2010. Our estimates of $1.48 and $645 million fall $0.08 and $26 million, respectively, short of the Street. Numbers could go even lower, however, due to competitive conditions in many of PENN’s markets including Chicagoland, St. Louis, and Indiana (35% of property EBITDA in the aggregate). Beyond 2010, most of PENN’s properties will face new market entrants. We estimate over 80% of PENN’s EBITDA is generated in markets with increasing supply. We’ll cross that bridge when we get to it.
The PENN positives are clear: great management and a solid balance sheet and cash flow. The negatives are the lack of growth and dwindling acquisition possibilities. So what’s the right multiple? The stock trades at about 7.5x 2010 EV/EBITDA and a 9% FCF yield. Looks fair to us.
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