Dollar Down, Stocks Down?

“Man has made some machines that can answer questions provided the facts are profusely stored in them, but we will never be able to make a machine that will ask questions. The ability to ask the right question is more than half the battle of finding the answer.”
-Thomas J Watson
The Research Edge client base is constantly peppering us with questions on numerous topics every day.  The challenge of addressing them helps to build the quality of the Research Edge team and the product we produce.  
Yesterday, we were asked the following; “At what point does a burning buck get to the point that it's just BAD for everything, especially the equity markets?  What are you watching to gauge this risk, and what could be the potential tipping points that kick the correlation the other way...Down Buck, Down Equity Markets?”
The question is very topical but also a very scary one.  While we are very happy to have coined the phrase “burning the buck,” the real world implications of a BURNING BUCK are not good! The bottom line - a “burning buck” can only end badly for every one!
We have been saying for months that the most dominant driver of the market is a simple two factor model - the US dollar down and Chinese demand up - REFLATION.  Much to my dismay, these factors have trumped any fears of a weak consumer here in the USA.   
Yesterday was a classic two-factor day.  We saw the US Dollar once again lose its early morning bid!  As the dollar lost ground, the S&P 500 recouped most of the day’s losses and finished around the best levels of the day.   
This relationship can’t go on forever so what are we watching to gauge this risk that the correlation might end?
(1)    A breakdown to the $72-74 range for the US Dollar index only has one precedent (a US stock market crash in Q3 of 2008), so watch for that

(2)    Volatility (VIX) breaking out above the $27.13 level combined with an expanding TED spread (haven’t seen either yet)

(3)    A breakdown in the SP500 below the TRADE line at 1014 combined with the Nasdaq cracking 2,008

“What could be the potential tipping points that kick the correlation the other way?”  That is a much harder question to answer because we could easily see the dollar up and stocks down as we head to Q4 and our REFLATION ROTATION theme continues to play out.
We need to look to the Chinese as a critical factor to understand if we will see “dollar down and stocks down.” Right now Washington is doing everything possible to make the Chinese officials hate us more than they already do.  Despite the administration’s moves over the weekend, President Obama said yesterday “we are not going to see a trade war.”  He is right there will not be a trade war because we can’t afford it.  
While there may be “rules on the books” that sparked the recent trade issues, the Chinese have us over a barrel when it comes to more important issues like funding our deficits.  
I understand that the president is a politician first, and that he needed to throw the UAW a bone to help pass his healthcare reform plan, but this is not a good situation.  Clearly, this is a dangerous road the Obama administration is going down and I’m very surprised that it has not set off a correction in the equity markets.  
On the contrary to the market selling off yesterday, the Research Edge quant models moved back to a perfect nine of nine sectors positive on both TRADE and TREND.      
What do you think will happen to the dollar and the markets if the Chinese send another message next week at the G20 meeting that they are “worried” about the safety of its investment in U.S. debt, as the BURNING BUCK erodes the value of their holdings?  That’s right there is no trade war!
Keep the questions coming!
Function in Disaster; Finish in style
Howard Penney


GLD – SPDR Gold We bought back our long standing bullish position on gold on a down day on 9/14 with the threat of US centric stagflation heightening.   

FXC – CurrencyShares Canadian Dollar
With the USD continuing to Burn we added to our International FX exposure (we’re also long the Chinese Yuan) on 9/14 via the Canadian Dollar.


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 Kong
The 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.  

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.

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.

EWU – iShares UK We’re bearish on the UK’s leadership and monetary policy to weather its economic downturn. Although we’re seeing improved fundamentals within the country and across Europe we continue to see the country’s financial leverage as a headwind and increasingly the data suggests that inflation is getting ahead of growth. With the FTSE reaching a YTD high on 9/9, we shorted EWU.

DIA  – Diamonds Trust We shorted the Dow on 9/3.  In the US, we want to be long the Nasdaq (liquidity) and short the Dow (financial leverage).

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.



Three senior officials at the Administration of Macau are in danger of being dismissed for abuse of power during their tenures at the Financial Service Bureau, according to Lusa.  Carlos Avila, former director of the Finance Service Bureau, Orieta Lau, the bureau’s current director, and Joao Janela, advisor to the Secretary for Economy and Finance face allegations of abuse of power leading to the Macau government unnecessarily spending more than MOP 3.4 million corresponding to an excess of compensation paid to the men for gratuitous meetings.





A detailed plan for Hengqin Island was revealed by Zhuhai authorities yesterday.  The island will be jointly developed by Zhuhai and Macau and, according to the plan, the gross domestic product of the island should be 56 billion yuan (HK$63.5 billion) by 2020.  The island currently has a sparse population and recorded a GDP of 128 million yuan last year.


The new campus of the University of Macau will span one square kilometer and will be operated according to Macau laws, separated from the rest of the island, and a tunnel will allow free movement of people between the campus and Macau proper. 


Other projects on the island include a huge China National Offshore Oil Corp gas terminal; gas-engine generator projects costing 12 billion yuan; and a massive ocean-themed entertainment centre, said to be the largest in Asia.





Despite major political activity in Taiwan, the plan to develop casinos on the outlying islands of Penghu is still on track.  Taiwanese Premier Liu Chao-shiuan and a slew of Cabinet officials quit en masse on September 10, following the government’s slow response to Typhoon Morakot, which lashed the island from August 7 to 9.


The political events should have no impact on gaming plans”, said Michael Tsai, president of ASTech Corp., a Taiwan-based gaming industry consultancy. “The key person who supports gaming industry development is President Ma himself — as long as he’s in office, everything should remain on track.”  Furthermore, replacing Liu is Wu Den-yih, a staunch political ally of Ma.


Penghu itself was largely unaffected by the typhoon and the timetable for issuing casino-related tender notices is unchanged.  

Chinese Tire Biters

“It’s obviously a measure that does not help recovery and does not help increase world trade.”

-          Alejandro Jara, Deputy Director-General of the WTO referring to the U.S. Government’s tire tariffs


President Obama took an aggressive stance on Chinese tire imports this weekend, announcing duties of 35% on $1.8 billion of automobile tires from China that are imported into the United States every year.  In the scheme of total Chinese exports to the United States, tires are only a small component at just over 0.5% of the entire $252 billion.  As a result, this only has a marginal impact on the overall flow of trade, but it certainly does, in the short term, create some bad blood with The Client (or China as we like to call her).


The immediate response from the Chinese was an official announcement to investigate whether the United States government was unfairly subsidizing both the chicken and automotive industries.  The estimated export value of those industries is approximately $957 million and $2.9 billion respectively, which could make this a much more than zero sum game if the Chinese were to take specific actions against these U.S. industries.


The ultimate question, though, is whether this is merely a tactical move by President Obama, or whether this is potentially the first move in a broader trader war with China.  If the answer is that it is a tactical move, this would dove tail with initial moves by other Presidents harkening back to Ronald Reagan.   President Reagan imposed duties and quotas on steel imports and President George H.W. Bush extended them in 1989.  President Clinton limited auto part imports from Japan and President George W. Bush attempted to protect the U.S. steel industry.  While all of these moves were protectionist in nature, all of the prior four Presidents also went on to cut trade barriers and tariffs. 


The unique aspect of President Obama’s tenure, as it relates to trade, is that China is now the primary creditor of the United States.  As a result, there are important considerations beyond safeguarding the domestic tire industry.  The New York Times reported today on the reaction by Chinese nationals to the Obama administrations, which were quite emphatic.  According to the article:


“The Chinese government’s strong countermove followed a weekend of nationalistic vitriol against the United States on Chinese Web sites in response to the tire tariff. “The U.S. is shameless!” said one posting, while another called on the Chinese government to sell all of its huge holdings of Treasury bonds.”


While obviously these comments are anecdotal and not indicative of broader Chinese government policy, there are, nonetheless, important to monitor as a measure of sentiment of the Chinese populace.


There is likely some merit to the U.S.’s actions, and as we are seeing via the stock prices of Goodyear Tire and Cooper Tire being up roughly 4% and 12% today, that there is immediate economic benefit to the domestic tire industry.  Given the importance of the broader economic ties with China, President Obama will have to be very cautious in ensuring moves such as the tire tariff are tactical in nature and not indicative of a broader shift in U.S. trade policy.  If it is the latter, all bets are likely off as it relates to the reciprocal actions from China . . .


Daryl G. Jones
Managing Director

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BYI bags the Trop


Late last week, Bally’s announced another systems win.  At end of this month, Bally’s will be installing Bally’s CMS/400 player-tracking and marketing system along with Bally’s Business Intelligence Solutions at Tropicana Las Vegas. Bally’s system will be replacing a “home grown” system rather than a competitor’s product.  Tropicana Las Vegas has about 1,400 slots and we estimate that the system will yield roughly $4MM of revenues and $0.03 of EPS for BYI.  Recurring revenues should be in the ballpark of $750k of revenues per year with EPS of a little less than 1 cent.



    NPD released August Video Gaming results on Friday and the data looks less bad.  To this I ask, "Is the consumer spending more or are easy compares providing a mirage of health that doesn't really exist?"  Unfortunately, it is the later not the former and as we head into 4Q09/2010 consumer-based headwinds only get worse.


    Last year, August was the slowest month of the year in terms of absolute sales data captured by NPD - $1.08Bn.  This year, August data improved sequentially but it still trailed last year by a solid margin at just $0.91Bn.  August marks the 3rd month this year that consumers spent less than $1Bn on the sector.  The bears are claiming victory while bulls hide in their offices or point to "it's always this bad right before the cycle turns".






    Where do we go from here?  Frankly, I am torn.  On the one hand, console price cuts are already driving some elasticity in the market and that should continue to help between now and year end.  On the other, I can't help but worry about a toxic set-up that increasingly looks likely to pressure consumer spending over coming months and years. 


    My colleagues are among the best I've had the opportunity to work with and below are relevant excerpts from their work over the last few days.  Their points are valid and surely technology-based consumer spending is not immune to these factors.  Taken in this vein, it is hard to imagine that console price cuts are going to be enough to counter the mounting pressures that exist.



    First, from Andrew Barber - a great post on Consumer Spending headwinds:


    Keith likes to remind us that everything that matters in macro happens on the margin – and that being good at what we do means being vigilant for signs of change and that, while we invest in the present we must keep an eye on the horizon at all times. The horizon for US consumer spending looks bleak based on multiple overlapping demographic factors.


    In the charts below I have illustrated two potentially peaking long-term drivers for consumer spending. In the first chart, we see the age breakout of the work force estimated by the Department of Labor. The imprint of the baby boom is clearly seen, cresting in successive peaks roughly a decade apart.  






    The second chart shows the long term view of US consumer leverage. The Federal Reserve reported Tuesday that consumer credit declined in July by a larger-than-anticipated $21.6 billion from June, the most on records dating to 1943. In the midst of the great recession it’s clear that consumers are accessing fewer loans (whether by design or because of reluctant lenders) and spending less.






    Taken in unison, the two illustrations indicate an easy to understand trend for the coming years: the number of people in the US labor force who are at optimal earning age has peaked and will be steadily decreasing while, simultaneously, consumer credit is declining. If you combine this long tails data with the points we hammered on in our unemployment post on Wednesday (“Stagflation: Where the Pain is”) in which we discussed how current unemployment trends were being felt most heavily by the oldest and youngest components of the work force, the picture becomes increasingly grim. Not only are there fewer young people entering the work force, they are having difficulty finding employment and when laid off are taking much longer to find new positions.


    As Todd Jordan pointed out in a recent post on gaming industry trends, prior to the consumer downturn beginning in the fall 2008 personal consumption expenditures were on a steep twenty-year incline.  With consumer spending accounting for roughly 70% of GDP the implication is clear: the higher one goes, the more pertinent gravity becomes and keeping rates at zero or buying clunkers can only delay the inevitable. Gravity always wins. 



    Second, a related and especially well-written piece by Todd Jordan:


    “The better part of valor is discretion”

    – William Shakespeare


    Thanks Bill, and the better or necessary part of consumer spending is the staples.  Necessity is why staples are also called non-discretionary.  With their discretion, will consumers be so valorous as to empty their wallets for things they want, rather than need?  The almost vertical trajectory of discretionary consumer stocks suggests yes.  On the contrary, sound analysis indicates that consumers face an almost impenetrable ceiling, triple fortified by the Three S’s:  Savings rate, Stagflation, and Share of wallet.  I’d add consumer credit (bad) to the mix but it doesn’t begin with an S, we like 3s, and our macro team will be addressing this topic shortly.


    So while Geithner may say that “things are better than 3 months ago, 6 months ago, before this recession began”, I would ask two questions:  By what metric and for whom?  Geithner’s preferred metric lately, it appears, is the rate of change or the “less bad” thesis that Research Edge was espousing when everyone else thought the world was falling apart (March 9th ring a bell?).  The stock market has already discounted “less bad”, then “stability”, and now is viewing the consumer as in “recovery” mode.  This is what scares me.


    “Recovery mode” implies, well…recovery.  I’m certainly not seeing it in the consumer discretionary sectors of gaming, lodging, and leisure that comprise my analytical vertical.  Is business less bad?  Maybe, but I think the comparisons are just getting easier.  The consumer is not necessarily getting stronger.


    “Recovery mode” also implies some lasting duration.  We are very worried about Q4 from a macro and consumer perspective.  The threat of stagflation is real, maybe coming as soon as Q4.  Stagflation is a consumer killer.  In a stagflation environment, fewer consumers have jobs and the ones that do can’t buy as much as before.  Will you take credit for that too, Mr. Geithner, when it happens?  Your policies and your predecessor’s policies (as well as the Bernanke constant) have created a fertile environment for potentially massive inflation, yet unemployment continues to grow.  Sure unemployment is growing at a slower rate (10% but it could’ve been 10.5%!). Congratulations - pop the champagne – at least the French consumer discretionary industry will benefit.


    So if I’m out of work (thankfully I’m not) and my purchasing power begins to decline at an accelerating rate (rate of change cuts both ways Tim), am I really going to buy that 2nd boat, 8th Coach bag, or book that 3rd cruise this year, or will I feed my family.  Want versus need.


    This also gets us to the share of the wallet question. In an inflationary economy, a larger part of consumer spending will go to non-discretionary items.  With stagflation, the size of the wallet shrinks.  One of my industries has a third problem:  even within the consumer discretionary segment, casino spending is shrinking as a % of Personal Consumption Expenditures (PCE) for the first time in 25 years.  Now that’s a triple whammy!


    So what do we do?  Be careful and manage risk.  We can’t ignore the warning signs just because the stock market and consumer stocks are going up.  Timing, as always, is critical.  This is where I defer to our timing tutor, Keith McCullough.


    Conclusion:  Both of these pieces are thoughtful and proactive given recent stock market performance.  As bullish as I am on Technology, consumer-based headwinds are not something to ignore.  And as it relates to video-gaming spend in particular, I like the secular shifts transforming the group, but even I must admit that spending on games is pure want versus need.



It has come to our attention that many of the LVS sell-side models and price target derivations are failing to account for about 157 million shares related to in-the-money warrants.


As a reminder, LVS completed a $2.1BN stock preferred and warrants issue in November 2008. LVS issued 10,446,300 shares of 10% Series A Cumulative Perpetual Preferred Stock and warrants to purchase up to an aggregate of approximately 174,105,348 shares of common stock at an exercise price of $6.00 per share and an expiration date of November 16, 2013.  During the 1H09, 1,106,301 warrants were exercised to purchase 18,438,384 shares of common stock at $6.00.  Currently, there are still 9.4MM warrants outstanding and at $16.73 per share, those warrants are certainly dilutive and should be counted in LVS’s share count adding 155.7MM to the 659MM shares outstanding at the end of 2Q09.  Even if we exclude options that are in the money, LVS’s share count should be at least 815MM – not the 660MM that most analysts are using.


So check the model of your favorite, non-Research Edge analyst for the proper diluted share count in both their EPS calculation and price target derivation.  Both could be materially overstated.

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