The Journey

“A cold coming we had of it, just the worst time of the year for a journey, and such a long journey.”
-T.S. Eliot
When T.S. Eliot wrote his poem, “Journey of the Magi”, he was not referring to either the stock market, or stock market operators, but rather his own personal journey towards Christianity.  Now with Keith on his way to Montauk this morning, it doesn’t mean things stop back here in the office in New Haven.  Just like usual, the team is in early, feet on the floor, and wearing our global macro pants interpreting the facts as they stream in from our contacts around the globe.
Now my ability to interpret poetry is limited at best (I’m a knucklehead hockey player after all), but what I do know is that we stock market operators have a journey ahead of us as well.  The journey is called September, which is historically the worst month for stock market performance.  We had a potential subscriber who interpreted this journey very effectively yesterday when he wrote to us and asked:
“I am a monkey waiting for a pullback before I put on more aggressive trades (seasonal issues, plus market has moved a bunch). Recently, bad news is good news and good news is good news, and this seems a bit irrational. We have decided to slowly add to a more aggressive position between now and end of September. We are trying to avoid going long and then have the market pull a big reversal. We are long only and do not actively trade the portfolio, but we are small enough to be a bit opportunistic. Do you have thoughts on approaching the market this way? As an fyi, we are not paying clients yet but are actively looking into a subscription.”
While we have been circulating our Early Look on a complimentary basis, we, of course, don’t dispense advice for free.  While free is cool, it is not a very lucrative business model. That being said, debating hypothetic views is not a process, so we will post our advice very directly.  It is August 14th, two weeks before the supposed worst month in stock market performance begins, and this is where we stand:

  • We have 27 long positions in our virtual portfolio and 8 short positions, for a more than 3 : 1 ratio of longs to shorts; and
  • In our asset allocation model, we are at virtually the highest invested position we have ever been in. As stock market operators, we can debate the hypothetical performance of September based on its historical performance.  Or we can play the game in front of us, and take a risk adjusted shot.  The game in front of us is not telling us to wait 7 weeks until September is in the rear view mirror, but rather it is telling us to take the shot, right here and now.

I’m not going to pretend I’m Keith this morning, but I will tell you what I see from my seat, which is consistent with his view.  First, volatility continues to make new lows and while it is not on its lows of the year, the CBOE volatility index is at 24.71, and that’s positive.  Second, 1-month LIBOR is at 0.27%, which means that monies, on a short term basis, globally continue to be almost free.  Finally, the U.S. government has made very clear their intention is to debase the currency, which is positive for the price of stock markets and commodities.
On the last point we held an in depth call on oil earlier this week, “Is Peak Oil Peaking?”  (If you’d like to see the slides or a replay of the call, let us know.)  For those non-subscribers who didn’t get a chance to dial in, I’ll cut to the chase on that call as well.  Oil is up 54% and we are still bullish on oil.  In fact in our virtual portfolio, we are long of the USO (the United States Oil Fund) and long of EWC (Canadian etf).
So, why are we continuing to take the shot on oil, despite the fact that it is up 54% YTD and the said “experts” don’t see much upside from here (consensus mean estimate for Oil in Q3 2010 for 34 analysts according to Bloomberg is $74.10, or less than 6% upside from here.)  To begin with oil over the last year has a -0.89 r-squared to the US Dollar, so dollar down equals oil up.  Also, and while we aren’t peak oil theorists, global supply continues to be constrained and the fall off in drilling this year by over -30% y-o-y is only going to exacerbate that fact.  The funny thing with a declining asset (the world’s oil supply declines between 5 – 8% every year naturally), is that you need to produce more of it to sustain supply levels.
Along with being a fabulously talented poet, T.S. Eliot was also an adroit observer of human nature and his peers.  He once noted, “Immature poets imitate; mature poets steal.”  The same thing could be said for stock market operators.  While we aren’t going to encourage our clients to steal, when the monies are free, don’t debate the semantics. The three Piggies are getting paid (bankers, debtors and politicians), so make sure you and your clients are getting paid as well.
Enjoy the journey,
Daryl G. Jones
Managing Director

XLK – SPDR Technology Tech and Healthcare remain the two sectors most primed for accelerating M&A activity in Q4. Both look great from an intermediate term TREND perspective, but at a price.

EWC – iShares Canada We bought Canada on 8/11 ahead of Bernanke’s pandering. Canada has what THE client (China) needs, namely commodities, which we believe will reflate as the buck burns.   

USO – Oil FundWe bought USO on 8/10. With Bernanke as the catalyst for the USD breaking down we want to be long oil.

QQQQ – PowerShares NASDAQ 100 We bought Qs on 8/10 to be long the US market. The index includes companies with better balance sheets that don’t need as much financial leverage.

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.  

EWG – iShares Germany 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 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, which posted a positive Q2 GDP number.

XLV– SPDR Healthcare Healthcare has lagged the market as investors chase beta.  With consumer confidence down and the reform dialogue turning negative we like the re-entry point here.

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.

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. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient 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.

VXX – iPath VIXAs the market rolled over and volatility spiked, we shorted the VXX on 8/13.

UUP – U.S. Dollar Index We believe that the US Dollar is a leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. Longer term, the burgeoning U.S. government debt balance will be negative for the US dollar.

DIA  – Diamonds Trust- We shorted the financial geared Dow on 7/10 and 8/3.

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.

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.


LVS jumps over another balance sheet hurdle. More hurdles to go, but as we’ve indicated in the past, they all look surmountable. 


Shortly before the close, LVS announced that it had completed its Second Amendment to its Macau Credit facility providing six quarters of covenant relief and certain other amendments for a cost of 325bps of incremental spread.  As we wrote about in our 7/31/09 post, “LVS: A DETAILED CREDIT ANALYSIS”, we thought an amendment was likely given that the maximum permitted leverage was stepping down to 3.5x in the quarter ending September 2009.


While the 325bps increase in spread is higher than most of the recent amendments we’re seen, we would note that LVS got a lot of other “goodies” with this amendment, detailed below, without having to give up any “goodies” like closing the loophole for Permitted Distributions back to the parent.


We believe that the next balance sheet related catalyst for LVS is going to be the filing of its IPO prospectus over the next one-to-three weeks.  Since LVS has about $1.2BN of “intercompany loans” between the VML and the corporate entity, LVS can divide proceeds from the Macau IPO back to the US in a tax efficient manner by classifying them as a loan repayment (while dividing back earnings generated in Macau would be subject to up a 35% tax rate).  A large enough dividend would permit LVS to avoid amending their US facility and allow them to keep borrowing at a rate of sub 3% for the next few years.


Below is a summary of the key changes under the Second Amendment.

  • 1.0x increase in the Macau Subsidiary’s Maximum Consolidated Leverage Ratio for the next four quarters, and a 0.5x increase for the September 2010, and Dec 2010 quarters.  Below are the new Maximum Consolidated Leverage Ratio covenant levels:
    • 3Q09 – 4Q09: 4.5x (vs. 3.5x)
    • 1Q2010- 2Q2010: 4.0x (vs. 3.0x)
    • 3Q2010-4Q2010: 3.5x (vs. 3.0x)
    • 2011- Maturity: 3.0x (vs. 3.0x)




  • Permits LVS to sell a minority interest in the Macau Subsidiary (“VML”), through an amendment of the definition of “Change of Control” to require the Company to own at least 50.1% of the common equity interest in VML from 100%.
    • Provided that following any Equity Sale an amount equating to the lesser of the net offering proceeds and $500MM must be applied to repay all classes of the Credit Facility on a pro-rata basis
  • Permits issuance by VML of up to $1BN of senior secured notes ranking pari-passu with loans under the Credit Facility, providing that net proceeds from the issuance of such notes are applied to prepay outstanding amounts under the credit facility
  • Permits issuance by VML of up to $500MM of senior unsecured notes ranking junior with loans under the Credit Facility, providing that, pro-forma for the issuance the consolidated leverage ratio is below 3.0x and, at the maturity of such notes, is outside the final maturity of the credit agreement (May 2013)
  • Allows VML to enter into a new delay draw R/C after the expiration of its current R/C portion of the credit facility (May 2011) in an amount not to exceed the current R/C ($700MM)
  • Amended the definition of Consolidated Adjusted EBITDA for the quarters ending 3Q09, 4Q09, and 1Q2010 to include certain identifiable cost savings up to $40MM, $19MM and $12MM, respectively, to the extent that such cost savings are not fully reflected in the applicable TTM period
  • Amends the definition of Permitted Liens to accommodate the amendment which permits the issuance of secured debt
  • Increases the applicable interest rate margins for all classes of loans by 3.25%, the Credit Facility is reduced by $500MM, after which the rate increase will drop to 2.25%
  • New spread is L + 550bps, (vs current rate of L + 225bps) and decreasing to L + 450bps pursuant to a $500MM reduction in facility size (to $2.8BN from $3.3BN)

We’ve been on the optimistic side of the LVS credit situation since the stock was at $2.  The remaining balance sheet issues should not be a problem.  Consistent with our call in “LVS: CHINA FORCING THE ISSUE”, LVS (maybe with Beijing’s help) will try and resume construction on Lots 5 and 6 on Cotai.  While we still don’t expect any cash flows from Singapore until May at the earliest, LVS will likely emerge from this cash crunch in decent shape next year. 

At long last, praise for our soaring loonie

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Q2 European GDP Released

European markets traded higher today on Europe’s Q2 GDP numbers. Today’s report from Eurostat helps confirm the improving fundamental landscape for the region that we have been reporting on, as Eurozone growth declined 0.1% on the quarter,  but rebounded substantially from Q1’s 2.5% contraction.


For more on our Western European view, see our post “Taking Cues from Europe’s Larger Economies” on 8/11, however as a call-out, today’s numbers on an individual country basis further substantiate the divergence among Western Europe’s larger economies:  Germany and France rose 0.3% in Q2 quarter-on-quarter, while Italy and the UK, though improving sequentially, still registered in negative growth territory at -0.5% and -0.8% respectively (See chart below). On an annual basis all countries lie firmly in negative territory, yet when comparing Q2 annual results with Q1 year-on-year, Germany and France saw improvement, while Italy was unchanged and the UK declined.


As we measure the relative winners and losers in Europe, GDP remains a lagging indicator, yet markets trade day-to-day on lagging indicators as our CEO Keith McCullough has alluded to many times.  The DAX closed up over a percent today and the Euro and Pound moved higher versus the USD. As a side note relating to our German thesis, today’s positive GDP number should provide further support for Chancellor Angela Merkel’s CDU party, who is polling over a 30% spread over her challenger Frank-Walter Steinmeier of the Social Democrats, as national elections approach on September 27th.


Matthew Hedrick


Q2 European GDP Released - MH1

When Bad News Is Good...

On a week over week basis, this morning’s jobless claims number was worse (see chart below -558,000 vs -554,000 in the week prior). Although its on a very tight duration, on the margin, this number is what it is – worse…


But, there’s this thing we have been following called the US Dollar. Yes, that thing that Bernanke is Burning…


The buck broke down on the “news”, supporting further strength in everything that’s priced in those Burning Bucks.


Chaos theory is a beautiful mathematical reality – it boils things down to a very deep simplicity.


Dollar down = everything else up.



Keith R. McCullough
Chief Executive Officer

When Bad News Is Good... - a1

Back to School, Back to Footwear?

We are beginning to see positive back to school trends develop within the sports apparel and athletic footwear data.  Footwear sales picked up measurably, breaking into positive growth territory for the first time in 17 weeks with a 4.9% increase.  Along with total sales, ASP’s improved sequentially from -4% to -3%. 


Total sports apparel sales fell 2.4% for the week as the Family Retail channel ended a 3 week run of positive trends.   This decline more than offset the improvement in the Sport Retail channel.  While the total industry experienced a slight decrease is sales for the week, ASPs grew 10% driven by dramatically higher prices in the Discount/Mass channel.  The West Coast continued to outperform the national trend for sports apparel with a positive high single digit increase. The East Coast declined in the mid to high single digits.   


Two interesting points pertaining to early Back to School can be pulled out of this week’s data: 1) price stabilization and 2) a notable sequential pick up in footwear (with a delta far greater than the build we saw last year at this time).


If you follow the table below, the last 3 week’s ASP trend has been very consistent for both footwear and apparel.  The overall trend while still slightly negative for footwear appears to be stable as we are now over one week into the key selling season.  While it is still early, this supports anecdotal evidence that the promotional environment remains unchanged at this time.  The current trend is in stark contrast to last year, where ASP’s were showing substantial increases and then decelerated sharply as back to school progressed. 


Footwear dollar sales had a very dramatic sequential delta from down high single to low double digits (which was a trend over the last 5 weeks) to +5% this week.  This uptick clearly marks the presence of BTS.  Interestingly, when we look at the back to school ramp last year we do not see anything as dramatic.  Over a similar period in 2008,  sales jumped from down -2% to +4%.  Again, it is still too early to declare a victory for the season, but the delta in sales cadence is notable as tax holidays and back to school marketing campaigns have kicked in.


Back to School, Back to Footwear? - BTS table


Back to School, Back to Footwear? - footwear and apparel dollar chart


Back to School, Back to Footwear? - ASP chart sports apparel


Back to School, Back to Footwear? - Sports Apparel channel table