27 Up, 27 Down

This note was originally published at 8am on August 28, 2014 for Hedgeye subscribers.

“Have no fear of perfection, you’ll never reach it.”

-Salvador Dali


Last night I enjoyed my first major league baseball game of the summer.  It couldn’t have been a more perfect night.  I had cute Southern gal on my arm and the weather was almost perfect.  Sadly, the hometown New York Mets lost in a 3 -2 heartbreaker.


Of course, perfect evenings, days, and stock market runs never last forever.  As sad as that is, in life, business, and as stock market operators our luck and performance will always ebb and flow and perfection, should it occur, happens oh so rarely.


In baseball perfection is often epitomized by the so called “perfect game”.   A perfect game occurs when the pitcher (or a combination of pitchers) retires 27 batters in a row through nine innings.  The pitcher cannot allow any hits, walks, hit basemen, or any opposing player to reach base for any other reason. 


Perfection in this sense is extremely rare.   In fact, the feat has only been achieved 23 times in major league baseball history and only 21 times since the modern era began in 1900.  The last time a perfect game was pitched occurred on August 15, 2012 by Felix Hernandez of the Seattle Mariners.


27 Up, 27 Down - EL chart 2


According to Wikipedia, the first known use in print of the term perfect game occurred in 1908 in the Chicago Tribune.  Report I.E. Sanborn wrote the following about Addie Joss’s performance against the White Sox:


“. . . it was an absolutely perfect game without run, without hit, and without letting an opponent reach first base by hook or crook, on hit, walk, or error, in nine innings.”



As it relates to global markets, what is perfection? Is it the SP500 at all-time highs? Is it German bund yields at all-time lows? Is it corporate debt issuance at generational highs and terms at generational lows?  Is it car loans at zero percent interest for a 9-year term? Or is it an all-time high in the number of uniformed market mavens appearing on T.V.?


Back to the Global Macro Grind


Those long of European equities this morning are not dealing with perfect portfolio performance.  Led by Russia down just under 200 basis points, European equities are red across the board this morning. 


Even as bottoms-up stock pickers in Europe continue to have edge, the U.S. based macro asset allocators seems increasingly concerned about European growth, which was the original reason for being long Europe coming into the year.  Clearly, eight months and a life time ago now!


In the Chart of the Day, we compare the interest rates of France to Germany and to the U.S.  As you can see, interest rates in these two key European  markets have been falling off a cliff versus the U.S.   This is probably the best real time market indicator of future economic growth that we know of but, as the Europe bulls would also argue, decelerating growth leaves the door open for more

aggressive easing by the European Central Bank. 


This, then, is the new, new bull thesis for European equities. Specifically, that by burning the Euro, Draghi will be able to inflate European equities.  But with German 10-year yields below 1.0% and France not far behind, how much incremental easing is already priced in? 


As the Wall Street Journal writes this morning, “some sell-side economists, including JPMorgan, Deutsche Bank and Nomura are now pricing in policy easing next week.”   Expectations will always be the root of all heartache, won’t they?

One of our favorite sovereigns on the short side continues to be France.  As my colleague Matt Hedrick noted yesterday:


“Just two weeks ago France’s government cut its GDP forecast in half (again) to 0.5% (from 1.0%) for 2014 and it will likely miss its FY deficit target of 4%.  News this week of President Hollande reshuffling his government (after Economy Minister Arnaud Montebourg stepped down on Monday), is confirming evidence to us that the policies of Hollande’s government are not on track to return growth to the economy over the medium term. That Hollande himself is wildly unpopular, with a paltry approval rating of 17%, furthers the outlook that the government’s pledge that the “recovery is there” is grossly disingenuous.”


Political upheaval and growth getting cut in half are as good a reason as we know to, at a minimum, invest elsewhere if not to get outright short.

Speaking of short ideas (one of Hedgeye’s favorite investment topics) our firebrand energy analyst Kevin Kaiser is adding a new short to the firm’s Best Ideas list this morning and will be hosting a call to discuss his thesis on September 3rd.   As Kaiser writes:


“VNR is a serial-acquisition / roll-up story that now sports a $2.5 billion market cap and $4.0 billion enterprise value after 22 separate acquisitions since 2008. It is owned primarily by retail investors for its outsized distribution yield (8.5%) and monthly distribution payments. VNR has actually trademarked the slogan, "The Monthly Distribution MLP.


But what unwitting investors don't realize is that VNR finances its distribution payments with capital raises - call that what you want to call it. In our view, VNR's "game" is at the beginning of its end. When VNR's distribution is ultimately cut, investors will discover that the Fair Value of VNR is substantially below the current market price.”


Vanguard is a whole lot of yield, with very minimal cash flow.  Usually a toxic mix!

Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.32-2.41%

SPX 1985-2013

CAC 4152-4439

USD 81.91-82.78

EUR/USD 1.31-1.33

NatGas 3.85-4.06


Keep your head up and stick on the ice,

Daryl G. Jones

Director of Research


27 Up, 27 Down - Chart of the Day

Oil Prices Lower, But Inflation Still Sticky

Client Talking Points


Oil continues to get smoked (WTIC $91.27 this morning is down -6% and -11% on a 1 and 3 month basis) and this is easily the top thing U.S. growth bulls are pinging us on. While its better than oil $100, we would remind you that the all-time high in U.S. cost of living (rent, food, education) remains firmly intact – companies aren’t cutting prices; inflation is sticky.


Bubbles bounce and we gave you the levels on SPX/RUT oversold vs. VIX overbought yesterday, but those were just immediate-term signals within what we think has developed into the most epic stock market bubble we have seen in our careers (AAPL, FB, and BABA will = $1 TRILLION in market cap!).


Hopes that our 2013 #RatesRising call will eventually be right in 2014 fails at yet another lower high (in July the UST 10YR topped at 2.59%), back down to 2.51% this morning and no immediate-term TRADE support to 2.31%.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). Now that we have our first set of late-cycle economic indicators slowing in rate of change terms (ADP numbers and the NFP number), it's time to really think through the upcoming moves of this bond market. We are doubling down on our biggest macro call of 2014 - that U.S. growth would slow and bond yields fall in kind.


Fixed income continues to be our favorite asset class, so it should come as no surprise to see us rotate into the Shares 20+ Year Treasury Bond Fund (TLT) on the long side. In conjunction with our #Q3Slowing macro theme, we think the slope of domestic economic growth is poised to roll over here in the third quarter. In the context of what may be flat-to-decelerating reported inflation, we think the performance divergence between Treasuries, stocks and commodities may actually be set to widen over the next two to three months. This view remains counter to consensus expectations, which is additive to our already-high conviction level in this position.  Fade consensus on bonds – especially as growth slows. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove.


Restoration Hardware remains our Retail Team’s highest-conviction long idea. We think that most parts of the thesis are at least acknowledged by the market (category growth, real estate expansion), but people are absolutely missing how all the pieces are coming together to drive such outsized earnings growth over an extremely long duration. The punchline of our real estate analysis is that a) RH stores could get far bigger than even the RH bulls seem to think, b) Aside from reconfiguring 66 existing markets, there’s another 19 markets we identified where the spending rate on home furnishings by people making over $100k in income suggests that RH should expand to these markets with Design Galleries, and c) the availability and economics on large properties for all these markets are far better than people think. The consensus is looking for long-term earnings growth of 28% -- we’re looking for 45%.  

Three for the Road


Only bad thing about $LULU print is that it buys current mgmt team time. We added LULU as a top long after the Street capitulated in June



The value of identity of course is that so often with it comes purpose.

-Richard Grant


The European Union has decided to slap new economic sanctions on Russia over its actions in Ukraine, diplomats said Thursday and the Russian ruble fell to an all-time low of 37.51 rubles against the U.S. dollar.

CHART OF THE DAY: At Some Point, Consumers Just Run Out of Breathing Room

CHART OF THE DAY: At Some Point, Consumers Just Run Out of Breathing Room - Chart of the Day

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Boom-Bust Cycle

“The Panic of 1819 was the first boom-bust cycle of the economy caused by government monetary policy.”

-Thomas Dilorenzo


It was an inevitable consequence of the Hamiltonian system of government debt accumulation combined with a government-run bank that prints money in order to fund the debt.” (Hamilton’s Curse, pg 68)


Sound familiar? It shouldn’t. Unless you’ve studied economic history, you might actually think that all of this won’t end in panic. Unless it’s different this time, it always has. Give it some time.


While a sub 2% US GDP growth economy could hardly be described as a “boom”, we have had some booming bubbles develop within the Fed’s 0% experiment. From real estate, to MLP #YieldChasing, to the latest Silicon Valley bubble, I think we’ll all look back and call it epic.


Boom-Bust Cycle - 45


Back to the Global Macro Grind


Forget about the bubble talk for a second, rewind the tapes (or just watch it trade in real-time today) and watch Apple’s (AAPL) volume and intraday price moves. That’s no bubble – that is a mania.


Manias are much more fun to watch than bubbles – people do the craziest things. Watch Go Bro (GPRO) trade, or watch the new squeeze quant algos jam these no-borrow-high-short-interest stocks. It’s pure, unadulterated, price momentum chasing.


While mo mo manias are entertaining, the bubble in momentum chasing US equity market cap is downright frightening. Pop Quiz: if you add up Apple, Facebook, and Alibaba’s proposed market caps, what do you get?


A: $1 TRILLION Dollars


Yeah, that’s normal. And so is paying $350 for an iUgly watch and, at the same time, telling the world there is no inflation “because there’s deflation in technology” (in other news, fully loaded with Oil’s recent decline, USA’s cost of living just hit another all-time high).


If you add Google, the Top 4 in the Silicon Valley bubble get you to $1.25 TRILLION. To be fair, BABA is not really a “valley” name – the “smart money” in there didn’t want to give Alibaba $20 million. It wasn’t a “good idea” back then. So they’ll give them $25 Billion now instead!


And if you back out Exxon (just to make my storyline better), here’s what you can get for $1.25 TRILLION:


  1. Berkshire Hathaway = $235B
  2. Wal Mart = $230B
  3. GE = $230B
  4. Chevron = $225B
  5. Johnson & Johnson = $210B
  6. Citigroup = $125B


Remember that while I am sure I am wrong on my $29.99 watch from WalMart not being as cool as the iWatch, Apple (AAPL) has $600 billion reasons (market cap) why that fashion statement has been discounted by the market, just a bit.


Now, to be fair (again, I am a fair guy!) for those of you who know everything about Apple (AAPL), you’ll recall that there is a precedent for this stock blowing up (split adjusted, it went from where it is today to $55 in less than a year). Never mind what the US stock market bubble would do if AAPL dropped 50% from here (still trading at a $50B premium to my preferred iBear watch outlet, WMT), what if it dropped 5, 10, or (deep breaths) 25%?


Just asking.


I know. Every boom-bust bubble call needs a catalyst. Here’s mine – US #GrowthSlowing.


Oui. C’est tout, mes amis. En Francais, that means that is it.


That’s all I think I need to get right from here in order to get both bonds (long the Long Bond and anything equities, like XLU, that looks like a bond) and the stock market bubble right. I think I need to get the rate of change in US growth right.


While I don’t think AAPL will get cut in half from here, US GDP growth could, easily, from this headfake Q2 bounce of 4%. More importantly, US GDP growth could be half of consensus expectations (Old Wall consensus = 3% GDP growth and +3.3% 10yr yield), for Q3 and Q4.


And that’s our bullish scenario. The bearish one, of course, is that 1/3 of America (you and I) figures out that 2/3 of Americans are already in another early cycle recession. After 63 consecutive months of US economic expansion, that’s what booming bubbles within the cycle eventually do – they bust.


Our immediate-term Global Macro Risk Ranges are now (I update my Top 12 Macro Ranges in our Daily Trading Range product, with intermediate-term TREND views, daily, as well):


UST 10yr Yield 2.31-2.53%


RUT 1154-1169

VIX 11.34-13.56

Pound 1.60-1.63

Gold 1


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Boom-Bust Cycle - Chart of the Day


Takeaway: Looking for the constructive pivot on Macau gaming operators, not yet - still too soon

Macau stocks still in decline – have we bottomed?




We were early and first to make the “Mass Deceleration” call (see our June 13, 2014 note). The sell-side has caught up to this second leg of the Macau bear thesis stool (VIP turning negative was the first) and the stocks are well off their 2014 highs.  We fear the third leg hasn’t yet played out which keeps us firmly in the negative camp despite valuations that are becoming more palatable.  Q2 margin disappointment wasn’t just labor related, as widely reported by analysts, but such is the Hedgeye view.  Mass margins, particularly in the premium segment, are being compressed as operators compete for a slower expanding pie – reinvestment rates are going higher.  Given our long term positive view, we are actively looking for the opportunity to pivot to a more constructive near term outlook for the stocks.  However, with no positive fundamental pivot in sight and our own models computing generally lower than Street estimates for Q3, Q4 and 1H 2015, we can only conclude that the Macau stocks are likely to retreat.  Our caveat to the negative sector outlook is Galaxy Entertainment where we are favorably inclined to buy despite our negative overall view.



As early as March 10, we pivoted to the sidelines when we removed LVS from our Best Ideas list - see our note “LVS: REMOVING FROM INVESTING IDEAS”- and shortly thereafter warned investors about junket issues, the Dept of State request to lower the threshold for reportable financial transactions, UnionPay, money laundering scrutiny, as well as the extreme sentiment indicator with the massive “buy” rating skew on MGM, LVS, WYNN, and MPEL.  Our view was that VIP would suffer under such scrutiny and a corruption clampdown by the Chinese authorities.  As VIP growth slowed dramatically in March and turned negative in May, the Macau stocks faltered but the sell side maintained their ratings citing continued 30%+ Mass growth expectations for the remainder of 2014.


On June 13, 2014 we laid out our “Mass Decelerating” theme as the second point of our bear thesis for a slowdown in gaming revenues, just as the sell-side was defending the gaming operators on the thesis of “mass segment growth of >30% remains healthy”.  Today, the sell-side has caught up to us with regard to the mass segment gaming revenue slowdown so the question is where do we go from here?



We apply a forecasting algorithm and process across all industries – gaming, lodging and cruise lines that incorporates both quantitative and qualitative factors.  This process has allowed us to be ahead of various trend pivots including the recent mass revenue deceleration.  Based on our model we believe Macau gaming revenue will trough sometime during Q1 2015.



Our forecasting algorithm is dynamic.  Recall from our June 13, 2014 “Mass Deceleration” note, we forecasted Mass Segment revenues to trough in October and November 2014, at +18% on a year-over-year basis.  At that time, we also forecasted VIP revenue growth of -5% to -8% during Q4 2014.


By comparison, today our forecasting model calls for Mass segment growth of +9% on a year-over-year basis during Q4 2014, nearly half the growth rate we forecast a mere three months ago – and a third of what the Street was projecting at the time.  As can be seen in the following chart, we believe Macau gaming revenues will trough during Q1 2014, maybe during January or February as noted by the green arrows. 





While we are looking for a pivot to become more constructive on the Macau gaming operators given our favorable long-term view, we are forced to reaffirm our negative view as we believe Q3 2014, Q4 2014 and FY 2015 earnings estimates are still too high. Our caveat to the negative sector outlook is Galaxy Entertainment where we are inclined to recommend long even today as a hedge.   With its strong VIP business that seems to be less volatile than the market, Galaxy looks safer.  Looking ahead, we still think the company will open Galaxy Macau Phase 2 before the May holidays – earlier than expected - thus have at least an eight month first mover advantage as Cotai supply explodes.  Unlike the other concessionaries, Galaxy’s 2015 Street estimates look conservative. 

September 11, 2014

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