This note was originally published at 8am on May 22, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“Organisms that treat threats as more urgent than opportunities have a better chance to survive.”
If you only have time to read one chapter of Dan Kahneman’s Thinking, Fast and Slow this summer, I’d go with Chapter 26, Prospect Theory. It helped me bridge some gaps between the fractal dimensions in our models (math) and behavorial factors.
Prospect Theory is a behavioral economic framework that will be much more relevant to the next generation of economists than this one. It will take time to pound the Keynesianism out of our system. Sadly, seeing centrally planned economic systems in Europe and Japan (maybe at some point in the USA) fail, will be the only way to expedite this evolution.
On pages 282-283 of Kahneman’s latest book, you’ll get Prospect Theory both with a simple picture and three bullet points of prose:
1. “Evaluation is relative to a neutral reference point.”
2. “A principle of diminishing sensitivity applies to both sensory dimensions and the evaluation of changes in wealth.”
3. “The third principle is loss aversion… losses loom larger than gains.”
And that brings me right back to the top of this morning’s Early Look quote, to the bottom of your gut feeling at Friday’s lows, and back again to yesterday’s biggest market rip in 2 months. Your Prospects of Survival in this business depend on your process.
Back to the Global Macro Grind …
Losing other people’s money isn’t cool. Losing your own money is even less cool. If you are doing both at the same time, my sense about the matter doesn’t really matter – where your emotions fit on the slope of the loss aversion curve does.
That’s why we bought red on Friday and sold green into yesterday’s close. When it comes to your decisions to buy or sell something, there really are no rules about reversing everything you did in the prior day. I am not Warren Buffett. I am your Risk Manager. The only rules in our profession are self imposed by the institutions who think they are managing our risk.
But what is risk? What are these institutional investing styles? Why are either measures relevant to what’s happening in your portfolio today as opposed to risk measurements and style factors you may have used in 2005-2007?
There are many more questions here than answers. My goal, at the top of every risk management morning, is to Embrace Uncertainty and have markets pick me. The more I try to pick markets, the more risk I impose on myself. What is supposed to work, rarely works. And what shouldn’t happen, usually happens. Either accept that, or whine about it – it’s reality.
I sold my SP500 (SPY) long position yesterday – here’s why:
- Immediate-term TRADE upside resistance into the close = 1329 (so I only had 1% upside left)
- Immediate-term TRADE downside support into the close = 1288 (2% downside makes my risk vs reward 2:1)
- Immediate-term RANGE of risk (3 day probability model) = 89 S&P points (that means volatility will be real)
- US Equity Volatility (VIX) was down -12.3% on the day but holding my TRADE and TREND lines of support
- US Equity Volume was down -17% versus the average volume of last week’s down days
- US Equity Correlation Risk to the US Dollar Index remains wacky elevated at -0.96 (USD vs SPY)
Multi-factor, Multi-duration Risk Management – that’s how I roll. On the immediate-term TRADE duration (3 weeks or less), those were the 6 glaringly obvious reasons to be at least a lot less net long. Catalyst wise, I gave you my calendar ones in yesterday’s note.
In the Hedgeye Portfolio, we opened the day with 16 LONGS, 4 SHORTS and closed the day with 10 LONGS, 8 SHORTS. That’s easily the most aggressive 1-day swing in what can be considered a proxy for my “net” exposure in 2012.
But was it aggressive? Or wasn’t it aggressive enough? Maybe I should have sold everything and gone to 100% Cash. Maybe I should have shifted to net short. Maybe I shouldn’t have done anything at all.
Maybe I should just stick with the process and take the high probability cut at the ball, and live with it.
And I will.
With the US Dollar Index down for the 2ndday in a row, we bought that long position back yesterday on red. That position is one we have been pounding the pavement on with clients as the most asymmetric long-term long idea in Global Macro (email Sales@Hedgeye.com for Theme #3 in our Q2 Macro Themes called “Asymmetric Risks” and you’ll see the long-term mean reversion case for Strong Dollar).
In addition to the aforementioned Correlation Risk of staying long the SP500 (SPY) in the face of a -0.96 USD/SPY correlation this morning, here’s a refresh of the other big immediate-term USD correlations jumping off the page:
- Commodities (CRB Index) = -0.92
- Euro Stoxx600 = -0.97
- Gold = -0.89
That’s why I re-shorted Gold (GLD) yesterday too.
There’s rain in Connecticut, but Prospects of Survival out there this morning look better than bad.
My immediate-term support and resistance ranges for Gold, Oil (WTIC), US Dollar, EUR/USD, and the SP500 are now $1573-1618, $90.57-94.12, $80.82-81.97, $1.26-1.28, and 1288-1330, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
The Macau Metro Monitor, June 5, 2012
WYNN COTAI TO BE READY IN 48 MONTHS: STEVE WYNN Macau Business
Wynn Cotai will take between 46 and 48 months to be fully ready and open. Steve Wynn said the new casino resort will cost around US$4 billion (MOP32 billion). Wynn is confident that the government will facilitate the hiring of imported labour given that Macau’s unemployment rate is virtually non-existent. He also said the company will issue in the future more dividends but refused to give more details
PONTE 16'S THIRD PHASE TO GET GOV'T OK SOON: HOFFMAN MA Macau Business
Hoffman Ma Ho Man, the deputy CEO of Ponte 16, says the third phase of the casino hotel should get government approval soon. “We hope it arrives in June. We want to start construction still within this year.” The third phase of Ponte 16 will feature a riverside commercial complex with a total floor area of approximately 40,000 square metres. The complex will also include space for the expansion of gaming areas and car parks, with construction expected to be completed by 2014.
Pier 16 – Property Development Ltd, the owner of Ponte 16 casino resort, announced in April the signing of HK$1.9 billion (US$245 million) and RMB400 million (US$63.6 million) five-year syndicated loan facilities with 11 financial institutions. Part of the proceeds are to fund the construction of the third phase of the Ponte 16 development.
Ponte 16 is a joint venture between SJM Holdings Ltd and Success Universe Group Ltd at the ratio of 51% and 49% respectively.
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“The fact that this policy had failed spectacularly in 1973 did not deter the weak dollar crowd.”
Between today’s G-7 meeting, tomorrow’s ECB decision, and Thursday’s Bernanke testimony, there will be plenty of opportunity for politicians and their pandering economists to beg and fear-monger for more of what simply has not worked.
That’s the short-run. The conflicted and compromised will do whatever it takes for their short-term political survival. In the long-run, apparently Keynes had the duration of the policy trade wrong – the rest of us aren’t all yet dead.
Taking a step back, the last 60 years of history are obviously littered with examples from Charles de Gaulle to Richard Nixon where sovereign currency devaluation and debt monetization did not work. If you’d like to get back up to speed on that, Jim Rickards does a great job walking through part of this history in Chapter 5 of Currency Wars (1).
Back to the Global Macro Grind…
Real-time market prices don’t lie; politicians do. Within hours of last week’s US Growth Slowing double-header (US GDP slowed to 1.9% in Q1 versus 3% in Q4, then the May Employment Report bomb detonated), the US Dollar stopped going up.
Why? Because the rest of the world fully expects an un-elected central planner in Washington (Ben Bernanke) to launch an iQe4 Upgrade. He did it on January 25th (pushing 0% rates out to 2014) and there’s no reason to expect he doesn’t do something again between Thursday’s Joint Economic Committee meeting and the FOMC meeting on June 20th. He’s fighting for his political life.
All that said, we have no idea what he is going to do. So don’t look for us to give you the super-secret whisper on that. Our strategy remains playing the game that’s in front of us, Embracing Uncertainty. We think the US Election puts him in a box.
Right, the man walked on water during 2008 and we should perpetually give him thanks and praise. But seriously, what Bernanke should have done and what he did have been 2 very different things since 2010.
By the summer of 2010 Bernanke had bi-partisan support (the Republicans wanted to win the mid-term elections) to move to Quantitative Easing (Policy To Inflate). Both parties wanted the stock market up. Now only one of them do.
What Bernanke does next must also be contextualized on a relative basis. This is not 2008 or 2010 in that regard either. Today you have a currency war between the 3 major currencies of the world (Dollar, Euro, and Yen). They trade relative to the expedience of the latest Fiat Fool (failed) Policy that is designed to debauch them. The Fed, ECB, and BOJ don’t get paid to act unilaterally.
So what are currency markets signaling happens next?
1. The US Dollar – remains in what we call a Bullish Formation (bullish across all 3 of our risk management durations, TRADE/TREND/TAIL) with immediate-term TRADE support at $81.55 and next resistance = $83.31.
2. The Euro (vs USD) – remains in what we call a Bearish Formation (bearish across all 3 of our durations) with an immediate-term TRADE support/resistance range of $1.22-1.25.
3. The Yen (vs USD) – is in a neutral position with long-term TAIL resistance at $77.68 and immediate-term TRADE support at $79.05.
In other words, if we had to pick one and #TimeStamp our highest probability scenario right now (we do), we’d be long the US Dollar and short the Euro (which we re-shorted on yesterday’s bounce).
It’s another way of saying that both Hedgeye and Global Macro markets think that the Europeans are in a much more dire situation (for now) than the United States of America is.
That could change at literally any minute of any day now – and that, of course, is why most sane people don’t trust these markets or the politicians attempting to centrally plan them.
Back to the ‘for now’…
We still aren’t all brain dead, and we have to deal with whatever tomorrow’s European move to debauch the Euro back down to $1.22 brings. Then we have to react to Bernanke’s reaction to the reaction. Then we all have to pray.
Prayer, in markets, is obviously not a risk management process. Neither is hope. That said, my only long-term hope for this country and the free-market economy that we used to have is to get Ben Bernanke out of the way of expectations, let prices at the pump clear, and let US Consumption Growth recover again.
With Bernanke having not been able to really do anything for the last 5-6 weeks, the US Dollar has risen steadily and Oil, Gold, Copper, etc. prices have fallen precipitously. That’s good for American consumers.
That’s bad if you are long Energy stocks (the Energy ETF (XLE) is down -10.3% for the YTD). That’s good if you are short them and long Consumer Discretionary stocks (the Consumer ETF (XLY) is +7.4% for the YTD).
Strong Dollar = Strong America (via Stronger Consumption). That’s not more of a 1973 like Failed Policy. That’s a new idea.
My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1, $97.21-102.78, $1.22-1.25, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
If I had a rating to change on Starbucks I would downgrade it today.
After the market close yesterday, Starbucks announced that it has agreed to enter into a definitive agreement to purchase La Boulange Bakery for $100mm. Investments pertaining to the acquisition will dilute earnings by $0.02 per share in 2H12. Further dilution is expected in FY13.
The target of this $100mm acquisition, La Boulange Bakery, operates 19 retail locations in the Bay Area and sells its products to several upscale restaurants, hotels, and specialty grocery stores in the region. The acquisition is aimed at improving the baked goods that Starbucks offers within its stores and represents, in our view, a significant gamble on the part of Howard Schultz and his team.
This move, along with the Evolution Fresh acquisition, is based on the Starbucks’ “multi channel strategy” of introducing the product through the national network of stores and then expanding the offering into the CPG channel once the brand gains traction. This rationale behind this strategy seems to be based on the success of the Starbucks VIA product. The risk, in the case of La Boulange products, is that the VIA strategy was successful as a Starbucks product and that that success will not transfer over to a non-Starbucks branded offering or that it will take longer than expected for the brand to resonate with consumers on a national level. In terms of the schedule of rolling out the La Boulange offering, the company only said that the products will first show up in Starbucks’ San Francisco stores in 2013. The offerings will initially focus on pastries and bread.
While we understand the appeal of the multi-channel strategy and can see the potential benefits, assuming that all of Starbucks’ initiatives are going to be successful is unlikely to be the right stance, if history is any guide. Starbucks is an impressive organization and we have been behind the stock for over three years. However, the company seems to have entered into an investment phase and that does change the outlook for the stock. Entering into two significant initiatives (juice and food) at once increases the risk of setbacks for the stock; the consequences, for EPS, of any slowdown in the top line are larger going forward than they would have been over the past few years.
The Evolution Fresh strategy, while still unproven, could be more of an immediate-term positive given the limited capital investment required to get the product into the stores. Applying the multi-channel strategy to food implies more risk to EPS over the next few years. There is also the additional risk that, in quickly scaling the La Boulange offerings across the domestic store base, the company may compromise the integrity of what made La Boulange successful to date.
Based on the conference call held this afternoon by management, our view is that the La Boulange strategy will likely require significant capital investment on the part of Starbucks. More detail will emerge in the coming weeks but currently we believe that the near-term investment could be significant and the reward, while possibly substantial but not guaranteed, could take years to materialize.
Here are the primary takeaways from the call:
- Food currently accounts for $1.5 billion in revenue at Starbucks’ domestic, company-owned locations and grew 14% year-over-year during the first two quarters of fiscal 2012. Management expects this acquisition to help drive that growth over the longer term but few details were provided on the call.
- Management will first introduce La Boulange products to Starbucks locations in the San Francisco area, beginning in 2013. The offerings will focus on pastries and bread at first.
- The product will be prepared in company-owned facilities and management intends to build the La Boulange brand into a national presence. Both of these will require significant capital investment.
- Once the La Boulange branded products are being distributed to Starbucks stores nationally, management intends to leverage the brand through the CPG channel.
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