Variance And Contentions

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

“Certainty is the mother of quiet and repose; uncertainty the cause of variance and contentions.”

-Edward Coke


Edward Coke was Chief Justice of the King’s Bench in the early 17th century. His aforementioned quote is dead on when I think about it in the context of modern central planning ideology.


Many want un-elected bureaucrats and benches (like the Federal Reserve) to deliver them the elixir of certainty, quiet, and repose. Unfortunately, markets and economies can’t be centrally planned that way. They are grounded in uncertainty and contention.


“Variance” was a thoughtful word for a judge to be using way back then. It’s too bad that the Fed doesn’t talk in these terms. Variance (how far a set of numbers spread out) and correlation risks are at the heart of what modern Macro Risk Managers think about every day.


Variance And Contentions - EL chart 2


Back to the Global Macro Grind


The variance between how political types talk about market risks and how practitioners on the buy-side explain them continues to widen.

That’s not a good thing. With time, humans aren’t supposed to get dumber.


That said, into both the almighty central planning decision tomorrow (Fed meeting) and Q3 GDP report this week, “should I be turned into a vegetable or a happy imbecile?” (Taleb, pg 61 of Antifragile)


Great question! I actually get asked some version of that question, a lot. Bob Brooke, Darius Dale, and I spent all of yesterday meeting with Institutional Investors in Boston. And one of the underlying questions remains – ‘what if it’s different this time?’


A: It’s not.


What we call #Quad4 deflation is like gravity – it occurs slowly, then all at once.


One of the best ways to observe which “Quad” the market is trending towards is through what modern day risk managers call Sector Style Factors (the variance of the stock market’s sector returns):


  1. When Sector Variance is LOW (like all-time lows in 2013) a monkey can be right on the long side (every sector goes up)
  2. When Sector Variance is RISING (like now), sector returns diverge, and momentum monkeys fall from the trees


Low-variance is the birth-child of compressed (low) volatility. And, to a large extent, that’s what the Fed is trying to promise you, in perpetuity. How else could an un-elected ideology live, unless it delivered political “certainty”, forever!


Then, non-linear market risks do what they do, and volatility rips +160% to the upside in 3-4 months (from the all-time #RussellBubble high of July 7th, 2014 to mid-0ctober) and the Fed needs to “smooth” that with the next central plan.


Or so they think…


And what happens when the next central plan loses credibility in delivering the one thing every political animal who has empowered the Fed is whining about when they stump about “inequality” (with the one thing being inflation)?


Oh, the #deflation.


Look at yesterday’s market action, in Sector Variance terms:


  1. Energy Stocks (XLE) down another -2.1% on the day to -7.53% for OCT to-date
  2. Basic Material Stocks (XLB) down another -2.1% to -4.68% for OCT to-date
  3. Healthcare Stocks (XLV) up another +0.1% to +2.14% for OCT to-date


Yep, since Healthcare (XLV) and Consumer Staples (XLP) are the only Sector Styles you’d be really net long of in Hedgeye #Quad4 terms right now (versus short the commodity #deflation sectors), it looks like Mr. Market is confirming a loss of the Policy To Inflate’s credibility.


And what happens after all 3 of the major central planning committees (Fed, BOJ, and ECB) have already cut to zero? Oh, it looks like Sweden is cutting to 0.00% (from 0.25% prior) this morning. Maybe European stocks can go up for another 4 hours on that.


As both volatility and variance risks are rising, the other big market risk that develops is called mean reversion risk.


In other words, now that Healthcare stocks (XLV) are +17.8% YTD (versus Energy -5.3%), prudent Portfolio Managers starts to ask themselves how much more they can pay up to chase Healthcare stocks.


Unless it’s different this time (it’s not), there are historical precedents for what people are willing to pay for things too. Enter the contentiousness of the “valuation” debate. How much are you willing to pay to not lose money?


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.12-2.31%

SPX 1841-1981

RUT 1057-1127

Nikkei 14503-15569

VIX 14.34-28.05

WTI Oil 79.79-81.84


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Variance And Contentions - Chart of the Day


Very low VIP hold - hold adjusted EBITDA beat our estimate slightly and grew YoY.  Still more aggressive than MBS, Genting has become more cautious issuing credit. VIP continues to significantly outperform MBS.   




  • Very unlucky in VIP:  just below 2% versus theoretical of 2.85%
  • VIP as a % of net gaming rev: +19%
  • Bad debt:  S$40m
  • Normal hold % used:  2.85%
    • Rolling chip volume:  61%
    • Mass volume (slots/tables):  44%
    • GGR:  49%
  • Japan: Still optimistic will pass in next session (starts in January and ends in June 2015).  Have been studying S'pore model.  Legislation will include ability for locals to gamble. Construction time likely 4 years. 
  • Per management, Genting is not buying VIP share
  • Outlook:  mass continues to do relatively well.  Optimistic that they can maintain VIP volume in 3Q into 4Q.
  • So far in 4Q, VIP is having a normal
  • Jeju:  pretty optimistic that they will get something done in 1H 2015; media has been positive about the development.  Jeju govt also support the development.  Will have an announcement in 1H 2015.  
  • Tax changes in Jeju:  will only invest if the project is profitable
  • Jurong hotel:  on schedule, on budget; start opening in May 2015 (160 rooms).  The rest of rooms (400 rooms) will open in June/July.  Want to target Malaysian market, leisure/mass punter.
  • Average spend USS: S$80
  • Average spend MLP:  S$30
  • Jeju changes:  want to expand MICE offerings  
  • Will be more cautious on extension of VIP credit
    • VIP RC lower than previous quarter
  • Why they outperform MBS on VIP?  Genting has good relationships with their high rollers.  
  • Less concerned about non-Chinese business.  They are a growing segment.
  • Rolling Chip Volume decline:  just above 10% YoY


Takeaway: If we had to pick one (we don't) Macau long, Galaxy would be it, owing to an earlier opening of Phase II and more defensible VIP exposure

Mostly in-line quarter on lowered expectations. Only operator to grow VIP YoY in Q3







  • Perfect storm in Macau
  • Only company in Macau to report gains in VIP revenues and volumes
  • Galaxy Macau
    • VIP bad luck reduced EBITDA by HK$50m
    • Win/table/day +27% YoY
    • Shifted 10% of mass capacity to VIP rooms
    • Slot:  reported record win
    • LTM ROI:  60%
  • Starworld 
    • Win rate:  2.66%
    • No bad luck impact
    • Closed 2 VIP rooms in 3Q and additional 2 VIP rooms in October (15% of capacity) to reallocate tables to higher yielding use (mix of VIP and MASS).
    • LTM ROI: 108%
  • Galaxy Macau PH2:  on budget, on schedule for mid-2015, excited to introduce Ritz Carlton and JW Marriott hotels to the market
  • Grand Waldo:  on schedule; will unveil plans in January; aim to re-launch in early 2015
  • Galaxy Macau Cotai 3/4:  will double area of Ph1/2 to 2 million sq meters
  • Debt:  $240m at end of 3Q 2014


Q & A

  • Smoking ban:  have fully complied with regulations
  • Mass premium tables reclassification into VIP:  working close with govt on clarity on this issue.  There is cash play in VIP direct rooms. 
  • Starworld/Galaxy Macau 99% occupancy:  everyone is running near full capacity; market is undersupplied
  • Japan/Taiwan/South Korea:  actively exploring partnerships in Japan
  • Corporate expense: will see some lift when PH2 opens but trying to do things as efficiently as they can
  • Junkets:  large guys are getting better; smaller guys are experiencing challenges
  • Galaxy Macau PH2:  
    • Will have additional smoking chambers in mass floors (have 4 in PH1 and developing some in PH2 to comply with regulations)
    • Retail:  Fully leased; rents are healthy
    • VIP rooms Galaxy Macau:  still sees strong demand and into PH2.
      • Combination of new and existing junkets into PH2
    • Will add 6-8k new employees (4-6 wks from openings); quite confident in getting the necessary labor
  • Table allocations for PH2 and Grand Waldo:  have certain expectations; still in dialogue with govt

Cartoon of the Day: Central Planning #Failure

This grand central planning experiment? It's failing where it matters most, in economic growth terms.

Cartoon of the Day: Central Planning #Failure - Growth cartoon 11.10.2014

We're Sticking with Our (Very) Successful Macro Call | $TLT

Editor’s note: This is a brief excerpt from CEO Keith McCullough’s morning research. Click here for more information on how you can subscribe.


The UST 10YR Yield is down hard on the October jobs report, and down again to 2.29% this morning after trading 10-12 basis points higher into jobs day on misbegotten hopes that the U.S. isn’t slowing like the rest of the world is.


Newsflash: It is.


We’re staying long the Long Bond (via TLT) and bond proxies. That’s where the fundamental performance is and has been all year. 


We're Sticking with Our (Very) Successful Macro Call | $TLT - 11.10.14 TLT Chart

MCD: October Sales Weak

MCD reported same-store sales for the month of October this morning.  Despite weak numbers across the board, they were admittedly better than feared:

  • MCD Global SSS -0.5% vs -2.2% estimate
  • MCD US SSS -1.0% vs -1.9% estimate
  • MCD Europe SSS -0.7% vs -2% estimate
  • MCD APMEA SSS -4.2% vs -6.1% estimate


Our take on October sales numbers were (1) estimates for the month were quite low after a disastrous September and (2) even after a small upside surprise this month there is no light at the end of the tunnel for a true recovery.  


Global, US, Europe and APMEA comps all accelerated meaningfully in October.  Comps in all four regions, however, remain negative on a two-year basis, suggesting there is still much work to be done; particularly when considering the strength we’ve seen in the industry over the past few months.  MCD continues to lose market share to BKW, JACK, SONC, WEN and others.


MCD: October Sales Weak - 111


Rhetoric showed no sign of direction, as CEO Don Thompson merely emphasized the need for change without much of a plan to get there.  Some initiatives to stem the company’s multi-year decline are underway, particularly in the US where the team is changing its marketing approach, simplifying its menu and creating a new organizational structure.  We expect these efforts, however, to fall short.


Despite positive results, on the margin, it is important to recognize that McDonald’s continues to face significant challenges across the globe.  The US struggled during the month due to “strong competitive activity;” Europe was hampered by “very weak” results in Russia; and APMEA continued to suffer from the ongoing impact of the supplier issue. 


As we’ve previously mentioned, it will be a long road to recovery for MCD and we're not convinced it is even underway.  It has yet to be proven that management’s initiatives will succeed and, at 17.5x NTM P/E, is difficult for us to support this stock.  We continue to stay on the sidelines here, with a bearish bias.


MCD: October Sales Weak - 222


MCD: October Sales Weak - 333


MCD: October Sales Weak - 444


MCD: October Sales Weak - 555


MCD: October Sales Weak - 666


Feel free to call, or email, with questions.


Howard Penney

Managing Director


Fred Masotta


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