The first lesson I learned in this business was “don’t fight the Fed!”  Oh how quickly we forget some simple but important lessons about the market.  Don’t let the facts get in the way of a great bull run.  The bears are getting run over and it’s painful.   


Yesterday, the S&P 500 finished higher by 1.5% and closed at a new year to date high – that is bullish.  For the month the S&P 500 is up 7.1%.  Stocks moved higher on the back of the RECOVERY trade as the global stimulus flag is being carried around the world.  This current market dynamic is exacerbating the weakness in the dollar.  In addition, Fed Chairman Bernanke, who specifically addressed the dollar weakness yesterday in NYC, reiterated that “economic headwinds will dampen the pace of recovery and mandate an extended period of low interest rates.”


As you would expect, dollar weakness contributed to the outperformance of Energy (XLE), Materials (XLB) and Industrials (XLI); the three best performing sectors on the day.  On the MACRO front, the market benefitted from the headline retail sales number, while the Retail sales less Autos was 0.2% versus the consensus of 0.4%. 


The Dollar index (DXY) closed down 0.58% yesterday and the VIX declined by 2.0% on the day.


While every sector was up on the day, the three worst performing sectors were Financials (XLF), Healthcare (XLV) and Consumer staples (XLP). While the XLF lagged the overall market, the banking stocks snapped a two-day losing streak.  Citigroup rallied +3.2% on the news that John Paulson had taken a stake.   Credit-card stocks all rallied after reporting declines in net charge-offs in their October master trust data.  Despite the dampened risk aversion in the market, the bulk of the mortgage insurance names remained under pressure yesterday.


Consumer Discretionary (XLY) outperformed slightly, up 1.6% on the day. As I said above, October retail sales rose a better-than-expected 1.4%, though excluding autos, sales were up just 0.2% vs expectations for a 0.4% gain.  That said, the 0.2% ex-auto sales number represents three straight months of improvement, but down from the revised 0.8% (revised down from 1.1%) in August. 


Today, the set up for the S&P 500 is: TRADE (1,084) and TREND is positive (1,041).   The Research Edge quantitative models have 9 of 9 sectors in the S&P 500 positive on TREND and 8 of 9 sectors are positive from the TRADE duration.  The Financials (XLF) is the only sector broken on the TRADE duration. 


The Research Edge Quant models have 1% upside and 2% downside in the S&P 500.  At the time of writing the major market futures are poised to open down small.   


Howard Penney

Managing Director


US STRATEGY – OUCH! - sp11 17


US STRATEGY – OUCH! - svchart



“It is better to have less thunder in the mouth and more lightning in the hand.”
–Apache Proverb
Keith and Howard are flying to Western Canada this morning to meet me for meetings in Calgary and Vancouver, so I’ve been handed the duty of writing the Early Look this morning.  Over the course of the past week, I’ve spent a good deal of time in proximity to Native Americans. I’ve been down in Phoenix, Arizona, which is of course a bastion of Native arts and culture, and have visited my hometown of Bassano, Alberta, which borders the Siksika Nation, a Blackfoot Reservation in Southern Alberta.
The indigenous populations of North America are a proud and storied people.  Their traditions and culture have survived and thrived despite many hardships over the past few centuries.  Geronimo is perhaps one of the most well known Native Americans.  He was an Apache military leader, medicine man and the last Native to surrender to U.S. Army forces at Skeleton Canyon, Arizona on September 4th, 1886.

Geronimo was known for his bravery and fought both American and Mexico troops for over 26 years until his capture.  He lived until 1909 when, at the age of 80, he died after being bucked off a horse. Since his death, Geronimo has been given many honors, including having three towns named after him. Most notably though was the attribution of the slogan and motto of the 501st Parachute Infantry Regiment, the first airborne unit in the United States military, after him, hence the use of “Geronimo!” when leaping from high heights.  An expression that could also be used to describe a chart of the U.S. dollar . . . Geronimo!
The global macro news event of the day yesterday was, of course, Chairman Bernanke’s comments at the Economic Club of New York. The Chairman’s prepared remarks were somewhat predictable and defended the need for an emergency level of interest rates well into 2010, but one comment from the Q&A session in particular caught our eyes.  When asked whether he saw any misalignments developing in the U.S. economy (i.e. bubbles), Chairman Bernanke stated:
"It's extraordinarily difficult to tell, but it's not obvious to me ... that there are any large misalignments currently in the U.S. financial system."

The good Chairman likely has a different process than us lowly hockey heads at Research Edge, but one simple thing we do every morning is review market prices across asset classes and geographies.  Thinking about Bernanke’s comment above had me wondering if the asset class moves below could, perhaps, be classified as “misalignments”.

  1. The year-to-date performance of oil is +73%
  2. The year-to-date performance in copper is +124%
  3. The year-to-date performance of gold is +29%

These commodities have one thing in common, they are priced in U.S. dollars. On the margin, fundamentals may have improved for gold, copper, and oil year-to-date, although some would debate that point, but fundamentals certainly haven’t improved in line with the price performances.  While we smell a bubble, Chairman Bernanke sees no “misalignments”.  In honor of our difference of opinion, and as a tribute to our Native American friends, we have given the Chairman a Native nickname, “He Who Sees No Bubbles.”
From an investment perspective, the fact that Bernanke sees no “misalignments”, despite the massive move in some of the commodity markets outlined above, is supportive of an investment thesis that continues to see these global commodities priced in U.S. dollars inflate.  If I were able to read Chief Bernanke’s totem, he seems to be signaling that a continued weak and weakening dollar is not a bad thing, nor leading to any bubbles. So invest accordingly!
A couple of other quotes from "He Who See No Bubble’s" speech that provide a juxtaposition of what is happening economically in the United States are outlined below:
1. “In particular, borrowers with access to public equity and bond markets, including most large firms, now generally are able to obtain credit without great difficulty.”
2. “However, access to credit remains strained for borrowers who are particularly dependent on banks, such as households and small businesses.”
In the longer term, credit will have to start flowing again for households and small businesses for GDP growth to sustain.  While the Bankers, Debtors and Politicians are getting paid, the facts remain.  Small businesses comprise almost 50% of American GDP. A sustainable stimulus will have to reach households and small businesses and not just with “thunder in the mouth”, but also “lightning in the hand.”
Keep your head up and stick on the ice,
Daryl G. Jones
Managing Director


FXE – CurrencyShares Euro TrustWe bought the Euro on 11/12 on a down move against our short position in the British Pound. A bullish formation in the Euro remains and we think the ECB could hike before the Fed does.

XLU – SPDR Utilities We bought low beta Utilities on discount on 10/20. TRADE and TREND bullish.

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.   

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.

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.

EWY – iShares South Korea South Korea has joined Japan in the ominous position of broken TREND and TRADE. This is not China or Taiwan. This is an early cycle economy that we want to be short against China/Taiwan.

XLI – SPDR Industrials We shorted Industrials again on 11/9 on the up move as the US market made a lower-high.  This is the best way for us to be short the hope of a V-shaped recovery.   

EWU – iShares UK Despite areas of improvement, broader fundamentals remain shaky in the UK: government debt continues to expand, leadership in critical positions lacks, and the country’s leverage to the banking sector remains glaringly negative.  Q3 saw its GDP contract by -0.4%. Further bank stimulus and the BOE’s increase in its bond purchasing program suggest that this will not end well.

XLY – SPDR Consumer Discretionary We shorted Howard Penney’s view on Consumer Discretionary stocks on 10/30. TRADE and TREND bullish.  

FXB – CurrencyShares British Pound Sterling The Pound is the only major currency that looks remotely as precarious as the US Dollar. We shorted the Pound into strength on 10/16 and 11/16.

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.


The Macau Metro Monitor.  November 17th, 2009.



A document filed Monday with the SEC revealed that LVS has agreed to make an initial payment to the Macau government of MOP 700 million, or about US$90 million, for the land on which it is developing its new megaresort on the Cotai strip.   Construction on Lots 5&6 was halted last year but, under the terms of the new deal, the company now has 48 months to complete development of the site. 

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No real changes yet despite Dan Lee’s departure.  The potential is there for a higher ROI focus and possibly a sale of the company, in our opinion.  November a little sluggish.  Here are our notes.




Interim CEO

  • Temporary
  • Already met with the search committee.   
  • They want an operations backbone and cultural fit and there will be some development as well.  They believe that there is some value in the LA licenses given the low tax rate so development background is helpful.  
  • Wade Huntley (former COO) is the #1 name that has popped up - doesn't even know if he's interested.  Want both an operations and development guy (Kentucky/Massachusetts).
  • Interim CEO is doing a lot - making rounds to all gaming commissions.  The interim CEO was fairly involved in operations before.


No real changes since Dan Lee left.  The balance sheet is all Steve Capp anyway.  Operations are, of course, overseen by the COO.  Dan was really development focused and River City is in great shape.    


Credit extension by December - unclear how the Dan Lee issue affects this.  It was going very smoothly – it’s only 18mm drawn - and if they don't populate Sugarcane Bay gets stalled. 


What is the board's view on development?  There was always some push back.  River City should open in March or April. Sugarcane bay is really just piling work right now.  Baton Rouge is paper shuffling.  The new CEO will reevaluate everything that's going on.  Piling work will take them through 2Q2010.  They were targeting 2H2012.  


Even if they wanted to, it’s unclear whether LA will allow them to lower the budget on sugarcane. Need approval.


At River City slots are already there and some are being tested.


November trends have been typically slow and consistent with what they have seen over the last few months.  They are not worried about gas prices.


Admiral – the gaming commission told them they could repair the boat.  Trying to figure out how much that would cost. Probably somewhere in the mid-to-high single digit MMs.  Elections are in April - hull expires July 2010.  It’s too risky to wait till April when the guy in office gets kicked out.  Risk is where that boat goes - can't move license with gaming commission approval.  Rumor has it that Gene McNarry has ties to North County which is trying to get a casino.


It’s easier to get extensions on the backend.  Something as simple as getting the boat under construction which would cost $30mm and can always be moved. 


Will management now be required to actually own stock in the company rather than just options?

He does agree that they are in the dog house regarding this issue.  However no one has exercised any stock at a profit. Restricted stock - ISS dings them for owning restricted stock versus options.  Stupid answer, I think.  Issue of no downside from stock declines, just options.


He thinks that the property level management and capital allocation strategy could change.


The risks are numerous and real but so is the reward, long-term and potentially short-term.  Here we address the risk side of the equation.


As we all know, the Sands China IPO will begin trading on the Hong Kong stock exchange Wednesday/Thursday - depending on where you are.  This is not your father’s IPO.  In the blink of an eye, the Macau government has the power to essentially confiscate all of Sands’ Macau assets.  Of course, any sub-concession breach prompting such a drastic action would have to be “serious” but the seriousness would be determined by the Macau government.  We think this is highly unlikely but it remains one of many unusual risks associated with investing in this high profile IPO.




Lots 5 and 6

This project costs over $4 billion, with 6,000 new hotel rooms and a lot of new table supply (maybe – depending on the government) all opening up at the same time as Galaxy.  This probably equates to a low ROI.  We’re guessing around 10% for the first few years for the first two phases.  Development risk here is big but in reality, LVS has little choice.  Beijing and Macau want these sites developed and they will be developed.



Are we in a VIP bubble?  VIP has been a roller coaster.  The good news is we are still on the upswing.  However, business levels are highly dependent on liquidity, Chinese government stimulus, and the Chinese stock market.  As we saw earlier in the year, the peak-to-trough declines are severe.


Table Supply

LVS has a huge Mass business and, unfortunately, Mass table supply will be up 25% in the first half of 2010 - two years before Lots 5 and 6 and Galaxy open.  As we wrote about in our 10/16/09 note "MACAU: FOCUS SHOULDN’T BE ON VISA RESTRICTIONS", the Street may be underestimating the potential impact.  Furthermore, some of the supply increase will come from SJM’s Oceanus, opening in between the Macau Ferry Terminal and Sands Macau.  As discussed in “OCEANUS TO SINK SANDS MACAU” (06/28/09), the Street still projects EBITDA growth at Sands Macau in 2010 despite the opening of a direct competitor in a better location.



"The Macau Government can terminate VML’s Subconcession under certain circumstances without compensation to VML, which would have a material adverse effect on our business, financial condition, results of operations and cash flows"

In the event of a determined contract breach, the Macau government has the power to confiscate all of the company’s Macau assets.  The sub-concession contract also allows the Macau Government to request various changes in the plans and specifications of our Macau properties and to make various other decisions and determinations that will be binding on us.” Basically, Sands China is at the mercy of the Macau (and Beijing) government. 


Thus far, Sands has played with fire and taken on the government publicly in a few forums.  Not smart.  The company seems to have learned its lesson but it needs to keep learning.  We consider the doomsday scenario highly unlikely but it is a risk.  More likely, however, is continued government involvement in Sands’ development and operations.



"We may not be able to monetize some of our non-core real estate assets"

The LVS business model has always included building complementary but non-core assets to the company’s core hotel/casino operations.  According to the original plan, LVS would’ve already monetized its two retail malls and the residential assets.  Due in part to the company’s issues with the government they have been unable to sell of any of its non-core assets.  It is unclear whether the appropriate approvals will be forthcoming from the new Macau government.



"We are required to build and open our developments on Parcel 3 of our Cotai Strip development by April 17, 2013.  Unless we meet this deadline or obtain an extension, we may lose our right to the land concession or any properties developed under the land concession for Parcel 3"

LVS doesn’t have the financial capacity right now to build out Parcel 3.  On the surface, that is good news given the significant development by LVS and others already on the Cotai Strip.  However, LVS could forfeit the development right to Parcel 3, which means cannibalization by someone else.



"We operate a passenger ferry service between Macau (Taipa Temporary Ferry Terminal) and Hong Kong under an agreement with the Macau Government.  The loss of our ferry agreement or our ferry operator could have a material adverse effect on our business, financial condition, results of operations and cash flows"

LVS has the right to operate their ferry service from Hong Kong to the Cotai Strip per an agreement with the Macau government.  However, a lawsuit was filed challenging the agreement because there was no public bidding process.  LVS will only lose about $35 million a year on its Cotai Ferry service so who cares if they lose the operating license, right?  Wrong.  Venetian Macau (and MPEL’s City of Dreams) is a huge beneficiary of the significant traffic generated by the service and the company’s developments on Lots 5 and 6 will also benefit from the ferry service.


“Our Macau legal advisor is of the opinion that, although uncertain, the outcome of the decision of the Court of Final Appeal is more likely to be unfavorable than favorable”.  Translation:  LVS will lose the case.  However, LVS management claim they’ve been assured they will still operate the ferry and the government will resolve the dispute.  Stay tuned.



"Gaming is a highly regulated industry in Macau and adverse changes or developments in gaming laws or regulations could be difficult to comply with or significantly increase our costs"

We included this one because the Macau government is considering a review of the gaming industry that could conclude that there are too many table games right now and not enough regulations.  Table limits could impact Venetian Macau and Lots 5 and 6.  It’s already going to be a challenge for LVS to generate a decent ROI on Lots 5 and 6 without additional limitations and regulations.



"The Macau Government could grant additional rights to conduct gaming in the future, which could have a material adverse effect on our business, financial condition, results of operations and cash flows"

This has been a risk since the exclusivity of Law 16/2001 granting additional concessions in 2001 expired in April of this year.  We haven’t heard any credible talk of new grants but this remains a risk.


Best product they’ve had in years but still not as flashy as the other guys.  Flooding the market with Wheel games.  Solid long-term prospects.  Here are our notes





Canada replaces 20% of their games like clockwork every five years.


They went to one single platform from seven last year.


This year they have 100% more titles then last year.  ProSeries cabinet + Alpha 2.  Sold 140k iviews and now they have a lot of content coming on that: iview wheel, iview wizard.  Biometrics is going live this year.  Today BYI has 8% of the install base in North America of game opportunities and 13% of sold gaming devices.


They think that normalized replacement range is 80-110k /year.


Upside from new US jurisdictions: 125-150k.  Singapore: 2-3k, Italy: 40-50k, Australia 10-200k opportunity (not in Australia yet but looking for entry as if new regulations pass which would spur replacement cycle), Mexico 30-50, and Brazil 75-ish


The new Uspin touch screen game very cool.  They are going to flood the market with wheel games.  


New huge jumbo 3 wheel.  It’s a huge version of the legacy games.  They added a wheel version of “Hot Shots”.  Now all the wheels will spin.  30 titles on new V32, more Transmissives.  Cash Spin game looks great.  They have a rear projector that is the competition to MLD.  The Uspin touch screen is very cool and is rolling out March/April.  Loveseat "meet in the middle" with two screens.  There is more interaction between players.  New MLD-like product allows the casino to customize pay tables to different customers.  New game maker with progressive.  New “Hot Shot” gives you second chance to win.  


How do they balance more product variety and good product margins?  If volumes increase then they will be able to be able spread fixed costs over a larger base.  Also, they haven't sold a lot of conversions. 300-500 of labor and overhead per unit.  Higher volume allows them to get better pricing on parts.  Think that more volume adds a point and conversion kits is most of it. Doing more legal/accounting from India as well.


50% of their game operations is fixed pricing.  Uspin will be 80/20 participation - but not finalized. Integrating systems and games - touch screens/iviews.  Sold 140K iviews with little content before - now coming out with content - would drive the recurring revenue systems line.


Australia - regulatory changes? It is a mature gaming market with 200k units. If the proposed gaming legislation passes then all units would need to be replaced by 2016.  They may buy someone to get into that market.


Don't see that gaming becomes all software driven. 


Strategy in Italy?  Have done a lot - lots of operators have submitted Bally’s tech specs.  Have handshakes on sales.  In Illinois they will have a distributor.  Have to work on the 500 bet limit content. 





Cool new products: Bally’s live, cool sign, iview DM, biometric recognition.


Bally integration gateway allows for interoperability between all different products and vendors.


SDS 11: the largest slot system manager.  Same code basis globally, backward compatible, internationalized, open, scalable.


Business intelligence - captures data from the casino - reports/dashboards - allows you to track all metrics that you care about that are constantly updated.  Visualization/mapping - allows you to visualize the popularity of the floor and the market that people are coming from.


In FY09, they did 224 implementations (new installs: 46, add-ons: 88 like iview, BI, bonusing, upgrades: 90)


FY 08: did 193 installs - 49 new, 77 add-ons


Have 408,000 slots connected to their system.  600 locations.  240 locations are on high speed networks. 

28 of the largest 46 casinos world wide use Bally’s.


Competitive replacements:

  • Oneida - replaced IGT
  • Coushatta- ALL
  • South point BI - IGT mariposa
  • Greektown BI - IGT marisposa
  • SJM: ALL


ISLE came back to them from the IGT system that they replaced them with 4 years ago


BYI makes about 3k per slot device on a systems install - legacy - new are about 4k per device.  Average net competitive systems replacements - 8k slots: 32mm, new casino additions - average 17K units - new casino additions.


Canada is coming out with 100s of MMs of RFPs over the next few months.


Server based gaming:

  • Targeted marketing at point of play. 1) They will be able to customize second chance to win  2) Slot tournaments 3) customizing marketing content by gender and age 4) community events - however the operator defines them


Employee and customer self service:

1) Drinks ordering

2) Kiosk and POS


Game management:

1) Game configuration

2) Dynamic bet configuration

3) Peripheral management - for things like software upgrades/new bills/etc


Their iviews can talk to any system/any protocol/any manufacturer.  This allows customers to add new technology on old devices.


Showcased their server window.  Users can buy lottery tickets, place bets, order drinks (and save each customer's preferences). Can hide the window.


At City Center, the system isn't really stable.  BYI, ALL, Konami decided that it wasn't in their best interest at opening.  All their games will be there (22% of floor) but will have next generation and not SB. 100 WMS games will have SB windows and the rest will have Next Generation. All their games and ALL and Konami will just have Next Generation. Later on they will move to DM once the environment is stable.  Ask WMS why 450 of their games at city center won't have a SB window.  “Go check out Monte Carlo and see for yourself why".


Will have multiple properties committed to full DM view rollout before end of the year.  Also have a language option and ability to have a left hand screen pop out as well.

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