Green Bananas

“Offer them what they secretly want and they of course immediately become panic-stricken.”
-Jack Kerouac
It’s no secret – monkeys want bananas. Get one of those qualitative “channel checking” Wall Street “consultants” to test that primitive theory. Green or yellow, when the monkeys are heated up in a panic, they’ll clamor for them.
Yesterday’s market meltup to new year-to-date highs (+11% SP500) was a real-time example of a Monday where humans were perfectly willing to inhale green bananas. With the advance/decline line as lopsided as 90%/10% at one point, there weren’t many green prices in that group-think cage that people weren’t willing to chase. The same 200-day Moving Monkeys who sold the red 879 close of July 10th (-14% lower!), couldn’t scarf down enough green. Hopefully you sold into them. I did.
While yesterday’s pre-open global macro setup looked great, this morning’s is a little less great. I know, that’s that hockey player turned zookeeper talking about changes on the margin again, but what happens on the margin matters most in markets. Everything has a time and price.
What’s changed in the last 24 hours? That’s easy - prices. If one of those super duper channel checker mall people were to start hiking prices while you were shopping, would you pant and pray for more of their wares? Of course not – only an ape would. So let’s all calm down and bring some semblance of sophistication to this profession.
The biggest global macro news in Asia overnight was that the Reserve Bank of Australia is done cutting interest rates. Aussi Central Bank Chief, Glenn Stevens, is in the midst of schooling Ben Bernanke on how the un-conflicted are allowed to think about monetary policy. Stevens marked a 55 year low in the RAB base rate at 3%, and his next move is going to be raising them.
Raising rates? Yes, you’re allowed to do that and pay your citizenry some level of return on their savings accounts. On this day in 1789, France abolished Feudalism. President Obama, your approval rating is hitting new lows as the markets hit new highs for a reason – the American people aren’t stupid. They get who is getting paid with a “Great Depression emergency” interest rate policy of zero - and it’s not them!
On the “news” that the Aussi’s are going to raise rates, what would Hank Paulson guess the stock market would do? Nope, sorry Mr. Squid Wrap, the market didn’t collapse into a calamity – it went straight up. In fact, Australia was one of the best performing stock markets in Asia overnight, closing up over +1%. Inclusive of that move, the Australian stock market up +18% for the YTD. Yes, this proves that you can have an interest rate that’s higher than zero and not be depressed.
At 3,471 on the Shanghai Stock Exchange Index, Chinese stocks hit another new YTD high as well. While everyone and their American monkey yelps about Chinese “loan growth” bubbles, those who are long China are now up +90.7% in 2009. Even a monkey like me can make money long China. Throw me a yellow one, eh!
Never mind China, I said this last week and I will say it again – on days that the US Dollar is down, simian primates can make money being “long of” pretty much anything priced in those once almighty US Dollars. At $77.57, the US Dollar Index hit another YTD low yesterday.
With the Buck Burning, the CRB Commodities Index (19 commodities) had a bright green day, closing +3.5%.  For any asset class, that’s a massive one-day move. In the US Equity market, the best performing SP500 sub sector was Basic Materials (XLB). Ironically enough, it’s green day also equated to +3.5%.
So as I was contemplating sending Mr. Commodity Bull Roubini a Tarzan loin cloth, what did I do yesterday? For those of you who get my real-time virtual portfolio moves at  you already know the answers to that, but here were the most important macro moves:
1.      Covered my short position in the US Dollar (UUP)

2.      Sold short the Dow (DIA)

3.      Sold short US Consumer Discretionary (XLY)

4.      Sold out of my long position in Germany (EWG)

5.      Shorted Italy (EWI)

6.      Shorted Apple (AAPL)

Yeah, I invited the Yale guys with the white coats over for lunch and we fired up our quant machines in a search of replicating the shorting of green bananas (these guys love concocting financial products). The best idea we came up with was shorting one of our favorite companies bearing the name of another fruit. If that AAPL is red today, I’ll probably cover it and book the gain. Never fall in love with a stock, her market, or a short position.
The risk in today’s market outruns the reward. I have immediate term resistance for the SP500 at 1,004 and downside support at 980. The US stock market’s overall setup remains bullish, but at a price. Don’t be panic-stricken. Don’t be a monkey.
Best of luck out there today,


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.

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.

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

EWI – iShares ItalyItalian 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 and 8/3, which is finally overbought.

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 DiscretionaryAs Reflation morphs into inflation, the US Consumer Discretionary rally will run out of its short squeeze steam. We shorted XLY on 7/9, 7/22, and 8/3.

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.





Casino magnate Stanley Ho has been hospitalized in Hong Kong, according to reports released on Tuesday.  The Chinese-language newspaper Apple Daily cited unnamed sources as saying that Mr. Ho had tripped and hit his head last week, resulting in him being rushed to hospital for surgery.  Apple Daily said that his condition had stabilized following the removal of a blood clot in his brain.  The long-term effects of the injury are not certain, according to the report.



Gross gaming revenues in July came to MOP9.5 billion, a year-over-year increase of 3.1%, according to the LUSA news agency.  SJM continues to lead the way in terms of gross revenues, with 23.36% market share, followed by LVS with 21.63%, MPEL with 17.77%, WYNN with 14.85%, and MGM and Galaxy with approximately 12% and 10%, respectively. 

Of the MOP9.5 billion, MOP599 million originated from slot machines.



Sheldon Adelson and Steve Wynn are both optimistic about the future political leadership of Macau.  The Chairmen of the Venetian and Wynn expressed confidence in newly elected Chief Executive Fernando Chui Sai On by touting his US-based education as a positive attribute. 

During a quarterly conference call last week, Wynn said, “in America, the creators of employment have a target on their back, that's not the case of Macau and the Peoples Republic of China. Maybe we could learn a lesson from what is going on there.”  Sheldon Adelson expressed hope that the gaming tax could be subject to “innovation” – specifically he seeks the removal of a 4% tax (on top of the 35% basic gaming tax) that goes to the Macau Foundation as well as an overall reduction to compete with emerging gaming markets like Singapore, Taiwan and the Philippines.



CIMB Investment Bank has said that Genting may open its S$6.6 billion resort in Singapore before the end of 2009 and earn more than previously estimated in its first year of operation.  Construction has been progressing at a “quick pace” and Genting may announce the resort’s opening date next month.  The resort is now expected to generate S$690 million in EBITDA in its first year, more than double CIMB’s previous estimate. 

Genting’s Singapore project is one of two casino resorts the government has allowed to be built in the city-state in order to triple annual tourism revenue to S$30 billion by 2015.  LVS announced on July 8th that its Singapore casino resort would open on schedule in January or February of next year.


We are bullish on the slot supplier segment, not so much based on 2010 but more so because there is a visible and developing domino effect with new markets, leading to neighboring jurisdictions needing to “keep up with the Joneses”.  It is fair to argue that WMS deserves a premium valuation given its stellar performance.  However, we believe that there are cheaper ways to play this trade, with stocks that have lower embedded expectations.



  • 13th consecutive quarter of meeting or beating guidance
  • Over the last 3 years WMS’s net income tripled, despite the decline in industry shipments
  • Results were achieved in the midst of the worst replacement market and weak new openings
  • Capital investment is targeted towards high ROI initiatives
  • Activity in multiple new jurisdictions and eventual replacement cycle makes them optimistic
  • Increased share repurchase program
  • High performing games is helping their gaming operations through more units and higher win per days
    • WAP footprint grew 38%
    • 171MM of gross profit
  • Estimate ship share will be higher than 21% achieved last year
  • International new unit revenue grew 5% for the year
  • CFFO was 179MM
  • Bluebird 2 platform saw some success  - 62% of new shipments, with 25% being mechanical reels (22% for the year), 20% higher price
    • Same gross profit margin % achieved in BB2 as BB1
    • They expect to further increase margins with cost decreases and price increases
    • Can deliver units faster, saving money
    • Aria – 23% of floor will be blue bird 2 – highest flow share for Vegas strip opening
    • 23% in Rivers Pittsburg, and 24% in River City – PNK (shares)

Outlook/ new products:

  • Growth from new international jurisdictions
    • Already shipped first units into Mexico and expect to recognize revenue in New Wales by 1H2010
  • Growth from new platforms like Helios (value oriented cabinets for international markets)
  • Growth from networked gaming contribution
    • Log on feature- player recognition
    • Time machine game/ monopoly games – first participation game on BB cabinet
  • Higher selling prices, despite depressed unit shipments domestically
  • Higher install base and higher average daily win per day in 2010
  • Entry into centrally determined markets – WMS games are already in those markets (like Oklahoma) through 3rd party distributors. Already shipped first units to Washington
  • They have a monopoly license through 2016 (and extension available through 2019)
  • Opened new lab in Seattle – to demonstrate new network gaming products
    • Launch wage-net enable products over the next 6 months (Aria & other casinos)
      • Received approval in Mississippi to conduct trials for downloadable
  • WMS assumes lower Native American expansion opportunities in 2010
  • They aren’t including any new markets that still have a lot of uncertainty around them
  • Lower margin on game ops from higher mix of WAP units
  • Benefit from higher mix of BB2, hurt by higher mix of lower margin product sales like used games and lower # of conversion kits –resulting in lower gross product margins
  • R&D: will continue to grow – ~14% of revenues
  • SG&A:  (June reflected higher headcount from global growth)
  • D&A:  increase modestly and decline as a % of revenues
  • Effective tax rate will be 36-38% (after R&D tax credit expires this year)
  • Remain optimistic given:
    • 18 consecutive quarters of double digit EPS growth
    • 2 week customer order turn around
    • Innovative culture and pipeline = special sauce for boosting demand for products in challenging times
    • “Future ready” for networked gaming

Quarterly highlights:

  • Other product sales (used) created a small drag on margins
  • Operating cash flow in 2009 was same as 2008   
    • Provided financing for more customers in the quarter
  • Inventory turns improved 35% to 4.2x from 3.1x turns
  • Cash grew despite $27MM used in investing activities


  • What are they seeing with their install base, is there more price resistance?
    • No – they continue to see pricing leverage
    • Units – tremendous success with Wizard of Oz not sure that they can replicate that growth
    • “There could be some upside if games are success”
    • Expecting a decline the rate of growth for participation business to slow
  • Assumptions for domestic / international
    • International mix to remain constant next year
    • See first 6 months of 2010 to continue current trends and pick up in back half
  • Why are they comfortable that back half replacements will help them in 2H2010?
    • Had a number of dialogues pre G2E and see a resurgence in demand from some clients that haven’t bought in a while (big players)
    • “loosening of purse strings”
    • Some of it is because there was pent up demand
      • I’m sure that the refinancings are driving this
  • Used games?
    • Great demand for BB1 product – not a lot of inventory so great demand for them… may start to see the BB1 come back to them and go to 2nd tier markets (internationally) so when their customers upgrade to BB2 they get more BB1’s back
    • No used games in their inventory today
    • Used games vs conversions kits moving in the opposite direction
      • NO
      • They are to venues outside the US vs. conversions are to US
  • Is IGT’s increased WAP footprint (BYD/MGM) impacting their guidance –NO
  • Growing excess FCF – above R&D needs – where are the opportunities to deploy that
    • Scour the globe for new technologies/ IT
    • Acquiring a company…
    • Board increased the buyback program by $75MM have $150MM under the program
    • Reinvest in the same range as 09 into gaming operations
  • Backlog?
    •  “healthy”
    • Very comfortable with their guidance
  • Class 2 & Australia cheaper… than BB2 – hence lower ASP growth given higher BB mix
  • Think they had a mid-high 20’s share – mid 30s replacement share
  • Majority of replacement units are competitor units- particularly in mechanical product – fresh market share for them
  • Taking “Price is Right” brand from a competitor
    • Thought they could leverage the brand – not about stealing competitor brands – it came to them  - given server based capabilities
  • Outperformance in operating margins driven by the gaming operations business- that’s where the beat can come from in 2010. On the product sales side, could have upside from new markets.  Replacement cycle improvement would be huge too.
  • Expanding video poker platform
    • Exciting opportunity in IL – but it’s not going to be just video poker. Expect to participate and have a commensurate share of that market
  • Idea behind internal casino Seattle to help sell their server based games – hard to sell on paper –easier to demonstrate
  • Are they sandbagging win per day for 2010?
    • July was the best month ever (June & Sept are seasonally the strongest quarter) but hard to forecast super strong trends continuing
    • Wizard of Oz – new placements – unclear if win per days will hold
      •  typically participation games have falling off win per days as games on the floor age
  • Any chance they get same share of games for new openings as replacements?
    • People forget that existing floor share is in the teens so 30% is getting them closer to new opening share in the low to mid 20s
  • Regional operations have been aggressively  replacing their  machines, and Native American casinos are on a normal 5/6 year cycle… it’s really the multi-property/ strip players  that haven’t been holding up orders
  • Comparing Wizard of Oz to Wheel of Fortune is a stretch …
    • I don’t think people realize how many WoF games are out there… probably about 25,000… whole other league – not to take anything away from WMS
  • Long term – where can margins go:
    • 60% product margins (will depend on conversion kits and software success of “networked gaming”)
    • 25% operating margins

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Reflation's Rotation: ISM Prices Paid

If there is one question I have been getting most consistently from investors as of late, its ‘why do you think we see inflation in Q4?’…


Generally speaking, until macro numbers are on the tape, “private forecasters” won’t believe they are possible. Maybe that’s because groupthink is so dominant right now. Maybe it’s because you can’t get these forecasts with in a “one on one” with your favorite economist. Otherwise, I have no idea. This call isn’t that complicated.


When I measure risk, I measure ranges, deltas, and spreads. One way to measure the risk of reflation rotating into inflation in Q4 is through the delta of the Prices Paid component of the ISM Manufacturing survey. Last month I called this out as an eye opener. This month’s number is a flat out moon-shot (see chart).


A lot of economists are calling for perpetual deflation because that’s what the lagging indicators (reported CPI and PPI) are telling them. Looking at the smack-down of this chart from July of 2008 until the end of Q408’ will give you a great summary of what’s in that rear-view mirror.


At a reading of 55 for July of 2009, this horse has already left the barn. If these price levels hold, year-over-year inflation accelerating in Q4 is as close to a mathematical certainty as I can find. People have to pay for things in US Dollars – the Buck is Burning.


And Reflation’s Rotation is finally underway…



Keith R. McCullough
Chief Executive Officer


Reflation's Rotation: ISM Prices Paid - ISMCHART


Obama Down, Market Up

As we were going through our weekend reading, the cover of the Economist jumped out at us.  For those of you who didn’t get a chance to read the Economist, the cover had a picture of President Obama with the title, “Crunch time”.  We typically consider the covers of most major financial publications as contrary indicators, or at least derivatives of such.  This cover actually seems to be an apt description of the President’s current predicament.


As the Economist notes:


“If the opinion polls are to be believed, Barack Obama is now, six months into his presidency, no more popular than George Bush or Richard Nixon were at the same stage in theirs.  His ratings are sagging particularly badly with electorally vital independent voters: two-thirds of them think he wants to spend too much of their money.”


We have previewed this shift of the middle moving away from President Obama, and it now seems to be occurring in a substantial way.  We have inserted a chart below of the Rasmussen Daily Presidential Tracking Index (difference between strongly approve and strongly disapprove), which shows the inverse relationship between President Obama’s approval rating and the stock market.  The internals of the Rasmussen highlight a number of key points in regards to President Obama:


  • Only 11% of voters believe taxes will go down under President Obama;
  • Only 29% of voters trust President Obama on the economic crisis; and
  • Almost 76% of voters believe President Obama is too liberal.

Rightly or wrongly, President Obama is very vigorously being categorized as a leftist President who will raise taxes and can’t handle the economy.  These characteristics are what seem to be directing Obama’s weak polling numbers as of late.  Two additional polls from Rasmussen offer evidence as to why this is the case:


  • 30% of voters believe that increases in government spending will help the economy and 50% believe that it will hurt the economy; and
  • 54% of voters believe tax cuts will help the economy and 19% believe they will hurt the economy.

Unfortunately, for his approval rating, President Obama is doing the one thing that voters broadly disapprove of, which is he is increasing government spending.  The implication of this increase in government spending is that taxes will likely have to go up.   According to Associated Press reports over the weekend:


“Treasury Secretary Timothy Geithner and National Economic Council Director Larry Summers both sidestepped questions on Obama's intentions about taxes. Geithner said the White House was not ready to rule out a tax hike to lower the federal deficit; Summers said Obama's proposed health care overhaul needs funding from somewhere.”


It doesn’t take a group of knucklehead hockey players from Yale to figure out the obvious here, taxes are going higher, which is what President Obama’s approval rating is starting to discount.


Perversely, the benefit of a declining Presidential approval rating is that it is positive for the stock market.  Ned Davis Research has done extensive work on this idea, and we conceptualize it in the chart below, but “in weeks when the presidential approval rating sagged below 50 percent, stocks rose at an annual rate of 9 percent -- versus only 2 ½ percent when the president in office sported a wildly popular 65 percent approval rating in the polls.”  No surprise, that when a President’s approvals declines too far, typically below 38%, stocks tend to fall on average 2% annually. This is not unlike our thesis on the dollar, which is that a weak US$ is positive for the stock market, to a point.


President Obama’s Chief of Staff Rahm Emmanuel famously said, “Never let a serious crisis go to waste.”  For investors, the rule may be more aptly characterized: never let a serious crisis in Presidential approval go to waste.


Daryl G. Jones
Managing Director


Obama Down, Market Up - djchart2


Chart of The Week: Volatility Breakdown

One of the main lessons from what is becoming as forceful an up move as we had on the way down is that Wall Street continues manages risk on a revisionist basis. This is not a proactive investment process. It’s reactive, and you should capitalize on its outputs.


Prior to Q2 of 2008, for most 30-year old hedge fund managers a VIX above 30 was unheard of. Although I’m using that age to be cute, the reality is that there are very few institutional managers who managed their portfolios in a 30-80 VIX environment prior to 2008. Today, there are equally as many PM’s who are being told to manage their exposures towards a 30-80 environment AFTER the fact.


The probabilities of seeing a VIX over 30 anytime in the immediate term are very slim. That, of course, makes the 30-80 range a tail risk that we should perpetually consider. But it also means that you’ll get crushed on 97% of the days in this current trading environment by hedging towards that tail risk scenario. Tail risk is exactly that – not in the heart of the bell curve of daily price distributions.


Across all three of our key durations, the VIX remains broken. While it’s nowhere near as nasty as the US Dollar chart, this is one of the most bearish charts in all of global macro right now.


The long term TAIL line = $41.29 and the intermediate term TREND line = $30.57. Until you see these lines penetrated to the upside, you’ll be paid to buy low and sell high.


Trade the range confidently, rather than in fear. The days of calling for crashes and squeezes are behind us… for now…  simply because everyone continues to look for them.



Keith R. McCullough
Chief Executive Officer

Chart of The Week: Volatility Breakdown - kmchart1

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