Danger Ball

“A little knowledge is dangerous. So is a lot”

-Albert Einstein


My beautiful wife, Laura, played lacrosse in college… so in addition to a lot of pucks kicking around our house, we have lacrosse balls. My son, Jack, likes to throw these balls around. I’ve finally instilled risk management in his head however. He recently started acknowledging that these are “Danger Balls.”


For those of you who were in the game yesterday, I sincerely hope you saw the Danger Balls that we were calling out intraday. There were more of them in one day’s game than I’ve seen in my notebooks going all the way back to February.


Last week I titled a note, “Ball Underwater.” That Ball is the US Dollar. After Buffett, PIMCO, and their tail chasers rolled out the consensus barrel of US Dollar bearishness, that Ball had nowhere to go but up, so I covered my US Dollar short position and started selling down my exposure to commodities and reflation oriented equities (currently I have only a 3% Asset Allocation to Commodities, and it’s all in Gold, GLD).


When you hold a dominant global macro factor underwater for an extended period of time, now you know what happens. That ball shooting straight up yesterday was a Danger Ball! Dollar up = mostly everything priced in Dollars straight down.


As I watch the “everyone is out this week” C-team on CNBC this morning attempt to explain why the US market got hammered intraday (no one on their A-team would make my practice squad), I can only shake my head at what the Chinese must be thinking. If this is what American financial analysis is considered to be, this is embarrassing.


Last night, Larry Kudlow, who was a B-team sell sider way back when to begin with, wasn’t any better. It’s both shocking and sad that I have yet to see one of these manic media mavens actually call out the reason why we rolled over, hard, intraday. That reason was US Prices Paid.


Within the ISM Manufacturing report for August (which by the way, Depressionistas, was expansionary) is this leading indicator that we macro people use called the ISM Prices Paid report. Yes, that’s what real American companies do when they buy stuff. They pay for things in US Dollars.


The Prices Paid reading came in at what we titled in an intraday Macro note as a “moon-shot.” At a report of 65, not only was this an +18% sequential monthly acceleration from July, but a 260% year-over-year reading versus Q4 of last year!!


Who cares about Q4? Surely anyone who is attempting to invest ahead of it! While we are still in Q3, and a lot of market players want to believe that because they are on vacation that the market “isn’t doing much”, yesterday was a stiff reminder that Mr. Market waits for no one.


Danger Ball can also be subbed for what we have called a Reflation Rotation. This is simply the morphing of year-over-year deflation readings into absolute year-over-year INFLATION readings. While I don’t think you see those in the US CPI or PPI reports until October, yesterday’s Prices Paid report was one more leading indicator as to the probability of my call coming to fruition. Yesterday’s stock market move was discounting the probability of one word – stagflation.


At Research Edge we subscribe to the principle of responsibility in recommendation. An ex-Goldman Partner actually told me that’s what we do, and I’d like to thank that fine gentleman for giving us the compliment. For those of you who don’t get our intraday Macro calls, email . They aren’t free, but they are good at telling you what winning teams see, real-time, in the marketplace.


After the 10AM ISM release, here are the headlines that came out of our Research Edge Black Box:


  1. Just Shorting
  2. The “V” I don’t See
  3. VIX: That Ball Underwater Pops
  4. The Buck: That Ball Underwater Pops


The point here isn’t to take a victory lap. The point is to remind you that there are plenty of teams in this business who have a real-time risk management process. Managing risk doesn’t stop with Wall Street’s vacations. Subscribers to our exclusive network knew exactly what we think and when. They have a proactive plan that they can trust. They know I’ll be accountable to it at 4AM every morning.


Again, this is not a victory lap. It’s our simpleton submission that we are here to help manage risk. So let’s roll through the You Tube replay of yesterday.


  1. We started shorting stocks after that ISM report, when the stock market was up
  2. The “V” I don’t see, was that which the same revisionist economists who called for a Great Depression 6 months ago are calling for now
  3. The VIX (volatility) Index popped; breaking out intraday about both my immediate term and intermediate term TRADE and TREND lines
  4. The US Dollar Index popped; breaking out intraday above my immediate term TRADE line


Since 2 of the most bearish charts in all of global macro that supported one of the sharpest 6 months rallies in US stock market history were the VIX and the US Dollar, these 2 Danger Balls mattered, big time.


The confluence of the aforementioned fundamental catalyst (ISM Prices Paid), a breakdown of the SP500 through immediate term TRADE support for the 1st time since June, and breakouts in both Volatility (VIX) and the US Dollar is what it is. I have no idea how the manic media can wake up this morning dazed and confused by this.


Mr. Market got the Danger Ball memo, real time. Yesterday’s volume was a monster. My daily broad market volume study registered a +33% meltup in day-over-day volume! Market smack-down day on accelerating volume = Danger Ball.


Here are the Danger Ball levels, refreshed for last night’s closing prices:


  1. SP (TRADE resistance)
  2. Nasdaq 1991 (TRADE resistance)
  3. VIX 27.77 (TREND support)
  4. USD $78.54 (TRADE support)


Again, that’s a simple 4-factor risk management model to use as your heat map. Yes, everything can change and become rosy again, but I don’t get paid to be bullish or bearish. Our subscribers pay me to manage risk.


The right call in August was to buy every dip. That’s no longer my call. That said, I’m not bearish like I was in September of last year either. Our most invested position in the Asset Allocation Model came in August when we dropped our position in US Cash down to 23%. Today we have a 54% Cash position. Today may be a beach day for some, but when Jack wakes up in an hour, his Dada is going to be telling him it’s a Danger Ball day. No beach.


Best of luck out there today,






XLV– SPDR Healthcare We’re finally getting the correction we’ve been calling for in Healthcare. It’s a good one to buy into. Our Healthcare sector head Tom Tobin remains bullish on fading the “public plan” at a price.


EWH – iShares Hong KongThe current lower volatility in the Hang Seng (versus the Shanghai composite) creates a more tolerable trading range in the intermediate term and a greater degree of tactical confidence.


QQQQ – PowerShares NASDAQ 100We bought Qs on 8/10 and 8/17 to be long the US market. 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. 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.





LQD – iShares Corporate Bonds – Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates that bonds will give some of that move back. Shorting ahead of Q4 cost of capital heightening as access to capital tightens.


EWJ – iShares Japan –While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. 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.



Macau’s six gaming concessionaires generated US$1.5 billion or MOP11.27 billion in gross gaming receipts last month, the highest gaming revenue ever recorded locally, according to a source of the Gaming Inspection and Coordination Bureau (DICJ).  Last month’s gaming revenues rose by 17.3% compared with the same month as last year.  On a year-to-date basis, gross gaming receipts are down 6.8% on a year-over-year basis.

According to the cited DICJ source, SJM was again the leader with 26% of the market share.  LVS and MPEL followed with shares of 24% and 16%, respectively.  Wynn’s revenues amounted to 13% in August, with MGM and Galaxy taking 11% and 10%, respectively.

The Macau Post Daily also cited the Xinhua News Agency as stating that travel agencies in Guangdong had indicated that the mainland’s current travel-permit curbs for travel to Macau “will be relaxed in the coming months”.



The Hong Kong Economic Journal reported today that Wynn Resorts Ltd. plans the raise US$1 billion in an initial public offering of its Macau assets on September 25.  The Journal cited an unnamed source.  Wynn plans to start a roadshow for the IPO on September 21, after receiving approval from the Hong Kong stock exchange next week.

Dow Jones Newswires reported that investment banks Morgan Stanley, J.P. Morgan Chase & Co. and UBS AG have been appointed to handle the IPO. 


Darden is scheduled to report fiscal first quarter earnings on September 29 after the market closes and sales trends will not look good.  The company’s same-store sales growth had fallen off rather significantly on a 1-year basis in May (last month of fiscal 4Q09) at its two biggest brands, Red Lobster and Olive Garden.   Judging from what we have heard from other companies about trends in June and July and Malcolm Knapp’s numbers, which show that casual dining comparable sales growth got sequentially worse in June and July (approaching December levels), DRI’s sales results may come in worse than expected.  DRI did not provide same-store sales guidance for the first quarter, but said that comparable sales growth at Olive Garden, Red Lobster and LongHorn Steakhouse on a blended basis would be flat to down 2% for the full-year.  Fiscal first quarter numbers are likely to come in below that full-year guidance range. 


On its fiscal 4Q earnings call in June, management stated that from a sales perspective that it was seeing some variation in trends from month to month but that it was not experiencing any deterioration in June.  In making that comment, I think the company was referring only to 1-year trends because DRI faced difficult sales comparisons in May, particularly at the Olive Garden, as a result of the stimulus checks that went out in May 2008.   Management pointed out that in June 2008, gas prices spiked north of $4 so easier comparisons are at play in June relative to May.  On a two-year basis, however, I would expect sales trends to show a sequential slowdown from both May and the fourth quarter across all of DRI’s concepts.  With overall casual dining sales trends approaching December levels, no concept is immune.  Even the Olive Garden, which has significantly outperformed its peers, experienced a 4.5% decline in same-store sales growth in December 2008, and the Olive Garden’s gap to Knapp had already narrowed rather substantially in May.


This weak sales performance will not be unique to Darden, but Darden is one of the first casual dining companies to report June, July and August numbers (CBRL will report its 4Q09 numbers for the period ended July 31 two weeks earlier).  Even with sales slowing on a sequential basis, I do not think DRI will report an earnings miss relative to the street’s expectation for Q1 EPS of $0.66.  But, if we continue to follow the calendar 2Q earnings season trend, including the reaction to DRI’s fiscal fourth quarter results (ended May), of stocks going down despite positive earnings surprises, we could see DRI take a hit. 


The good news for DRI, however, is that the company provided such a wide full-year 2010 EPS guidance range of -2% to +8% that even if sales come in worse than expected, I do not think the company will have to take down its sales or EPS projections for the year.  That being said, I would not be surprised to see the street’s full year EPS expectation of $2.80 come down.  Given that we don’t experience a dramatic recovery in restaurant demand, a number in the $2.70-$2.75 range seems more reasonable. 


In fiscal 2009, DRI captured about $45 million of cost acquisition synergies and generated about $35 million of savings from business strengthening initiatives.  In fiscal 2010, the company expects to capture another $10 million of acquisition synergies and an additional $5 million of cost savings (primarily in the first quarter).  Although these cost saving initiatives will benefit earnings, the incremental savings are coming down on a year-over-year basis so it will become more difficult for the company to offset continued sales weakness in fiscal 2010.  This inability to continue to offset sales deterioration with an accelerated pace of cost cutting highlights one of the biggest headwinds for casual dining operators in the coming quarters.  

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The Buck: That Ball Underwater Pops!

This is the most dominant driver of today’s macro market move. It’s driving the VIX higher and the SP500 lower.


Right after the ISM Prices Paid report (accelerating inflation) was released this morning, the US Dollar began to strengthen. Then, like our old friend Jimmy Braddock (Cinderella Man) coming back from the ropes, Pop, Pop, Bang! The US Dollar has put on quite a move. The Buck was a Ball Underwater.


In the chart below, we have painted the lines that matter:


  1.     Immediate term TRADE = $78.54
  2.     Intermediate term TREND = $79.81


While we respect that bottoms are processes, not points. We understand what it means when a fighter like Braddock starts to ring the market’s consensus bell. Reflation traders, it’s time to get out of the way. Dollar up = everything else down. Let this Ball Underwater go to where its inertia takes it. This is not a TREND, but it packs one heck of a TRADE punch.




Keith R. McCullough
Chief Executive Officer

The Buck: That Ball Underwater Pops! - usdi1

VIX: That Ball Underwater Pops!


Alongside an immediate term TRADE breakout in the US Dollar Index today, you are seeing one of the only other glaringly bearish global macro charts give the consensus shorts a headache – the Volatility Index (VIX).


 Importantly, the VIX is also testing a breakout of the much more relevant intermediate term TREND line which sits at 27.81. Both of these quantitative factors (TRADE and TREND lines) are outlined in the last 2 of the charts attached which will give you both an immediate term and long term perspective on today’s critical move.


The VIX has held above 23 since late July, despite the fact that realized volatility on the S&P 500 has been steadily declining (see charts below and further discussion below).


VIX: That Ball Underwater Pops! - a1


As a refresher: the VIX index is a measure of the volatility implied by the premium that people are willing to pay to purchase options on the S&P500. As such, a divergence between the actual historical volatility and the anticipated future volatility extrapolated from the options market provides a market sentiment indicator of sorts. With the VIX outpacing realized volatility since April, the implication is that options speculators are expecting greater volatility going forward, that equity investors are nervous and anxious to buy downside protection or both (see chart below).


VIX: That Ball Underwater Pops! - a2


VIX: That Ball Underwater Pops! - a3


VIX: That Ball Underwater Pops! - a4


The only "V" I see...

As America’s run of the mill economic revisionist historians start to talk about a “V” shaped economic recovery (no less than 6 months after they allegedly saw a Great Depression), the only “V” I see is that of sequential inflation readings accelerating.


Evidence of as much today came on two fronts:


  1. The chart below, which is the Prices Paid component of the August ISM Manufacturing survey = moon shot to the upside
  2. The US stock market’s intraday test of the YTD high, and subsequent intraday rollover = bearish


At 65 for August versus the 55 reading we saw printed in July, the Prices Paid inflation reading is up over +260% versus the lows we saw in Q4 of last year. You want to know why revisionist economists were whining about depressions? Look at the chart – those Prices Paid were depressed!


The market read-through here is straightforward. Inflation expectations continue to climb. Inflation = higher interest rates than zero. Higher interest rates than zero = bottoming process in the US Dollar.


Who wasn’t long REFLATION at the top and short the US Dollar at the bottom? I have no idea, but I am happy to say that I was out of the way. We’ve called this Reflation’s Rotation. If you want to know where the buck stops going down, ask the guys who called the Burning Buck.



Keith R. McCullough
Chief Executive Officer

The only "V" I see...  - a1

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