Math Monkeys

“There are whole fields, like the financial world, where scientific thinking hasn’t greatly penetrated. It is mainly about assertion, personality, and salesmanship.”
-David Harding
David Harding runs London based hedge fund, Winton Capital Management. He is a British entrepreneur. He is a math guy. He is a market timer.
In 2009, Harding has not been getting the embarrassing Octopussy headlines of the Galleon crowd. He doesn’t need a woman in hiked up attire posing as an analyst to be his aggregator of executive Wall Street “edge” either (Bloomberg article: “Woman Who Sank Galleon Was Beauty-Queen-Turned-Analyst Insider”). His Research Edge involves anticipating market direction, mathematically.
People say they can’t time markets. Take their word for it – they probably can’t. I understand that it’s not ok for a hockey head who gets up early every morning calling markets to say that. However, it is ok to say that if you run a $12 Billion dollar hedge fund. This is the way that our sometimes disillusioned business of perceived wisdom works. It’s about how much money you make that makes you a real man on Wall Street, right?
On the compensation score, Harding is plenty real. He made $250 million for himself last year. No, he didn’t need the almighty “one-on-one” with an executive management team or a government bailout to earn his bonus. All he needed was us - the monkeys of consensus.
Are you a monkey? Did you call the 2009 bottom forming? How about the 2007 top? Tops and bottoms are processes, not points. From the Top, to The Bottom, and Back Again (maybe a good name for a book), they can be proactively managed towards, mathematically, as opposed to being reacted to, emotionally.
Let’s grind through some math. Yesterday, as the US Dollar Index burned -0.75% lower, the SP500 was up another +1.4%. The most powerful mathematical inverse correlation affecting the daily movements of global markets continues to prove itself out (the r-square is still 0.8). This won’t last forever. Correlations that are this high are never perpetual – but fighting them while they are this dominant is for men and women with salesmanship that’s far more impressive than mine.
The antichrist of market timing is the Alan Abelson (Barron’s) love story with David Rosenberg (Gluskin Sheff). Abelson was at it again this weekend, all perma-beared up and bitter for missing another massive meltup, citing Rosie’s views. Using a Monday Night Football one liner, all I have to say is “C’mon Man!” Rosenberg is the Toronto Maple Leafs and Abelson the Washington Redskins of their respective 2009 seasons – but they won’t admit the score!
This is sad and funny, all at the same time. That’s why a lot of these cats would get run-over in a real-life arena of professional sport. If you aren’t into the sports/accountability analogy, I still don’t think that the rest of the Great Depressionistas would fare too much better in a math combine this year either.
Here’s the 2009 score since March:
1.      US Dollar Down -16%

2.      SP500 Up +64%

For those who say this rally hasn’t been on “fundamentals”… once again, I submit a basic question – isn’t math fundamental?
Our industry is finally going to flush out the weak and make the strong, stronger. The Wizard of Oz storytelling is over. It’s about time. We still have way too many monkeys jumping on the bed. The math associated with client returns over the last 24 months will hopefully expedite the curtailing of asset management supply.
Admittedly, I have been getting ready to join the bearish camp for the last month. Our firm’s views from September of 2008 seem so long ago. Recently, I have taken down my invested exposure in the Asset Allocation Model, but I have yet to short the SP500. Timing - dear Rosie, matters.
Here are some smoke signals that came out of the Hedgeye math machine overnight:
1.      The SP500 had an Outside Reversal yesterday, making a lower-high on the close at 1106 (the prior closing high was 1110)

2.      The US Dollar made another higher-low yesterday, and is recovering +0.22% this morning to $75.22

3.      Volatility (VIX) was almost 2.5 standard deviations oversold yesterday, and looks to be setting up to lock in an immediate-term low

4.      Volume/price/volatility studies, when using them as a 3-factor model, continue to flash bearish

5.      Japanese equities were down another -1% overnight, taking the correction to -11.6% since they peaked in August

6.      South Korean equities were down another -0.8% last night and remain broken from an intermediate term TREND perspective

7.      Chinese stocks had their worst down day in the last 3 months last night, closing down -3.5% on fears of banks issuing equity

8.      Russia cut interest rates by 50 bps to 9%, and equities backed off hard on the news, trading down -1.5%

9.      The price of oil, in US Dollars, is starting to break down across our immediate term TRADE lines with the most important line being $79.09/barrel

I use a multi-factor macro model. It’s all math. It’s weight adjusted. It changes dynamically as R-squares and real-time prices do.
What does that mean? Well, quite simply – it means that as the facts change, I do, because I believe that prices rule as leading indicators and people are constantly lying about why prices are doing what they do.
Chaos Theory submits that there is a deep simplicity that governs all patterns of behavior within a dynamic ecosystem. Since this is the most relevant mathematical discovery since relativity, I study it. I know that it is barely applied yet to the most dynamic of all systems – global markets. David Harding is early.
Before I sign off this morning, here’s a very simple 2-factor correlation model to have front and center on your screens.
1.      US Dollar Index = $75.51 or greater

2.      SP500 = 1083 or less

If those lines confirm one another, my submission is that Abelson, Rosenberg, and whoever else has been bearish for this entire move up will finally start being right. Until then, throw them a banana. When it hits them in the noggin, call that feeling “fundamental.”
Best of luck out there today,


VXX – iPath S&P500 Volatility With the market hitting its YTD high on 11/23 we bought volatility.

XLK – SPDR Technology We bought back our position in Tech on 11/20. Rebecca Runkle has an innovation story in Mobility and Team Macro has an M&A story in our Q4 Theme, the “Banker Bonanza”. We’re bullish on XLK on TREND (3 Months or more).

EWT – iShares Taiwan We see a pending trade pact with the Chinese as the next positive catalyst. We bought back the bullish TREND position we continue to fundamentally see in Taiwan on 11/20.

EWA – iShares Australia We remain bullish of Glenn Stevens at the RBA and how Australia is issuing its citizenry a rate of return. With growing confidence in domestic demand recovery and a commodity export complex with strategic proximity to China’s reacceleration, there are a lot of ways to win being long Australia.

XLU – SPDR Utilities
We bought low beta Utilities on discount on 10/20.

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.

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 24th, 2009.


Macau has eased entry requirements for Hong Kong residents, according to the government there.  A memorandum signed by Hong Kong Financial Secretary John Tsang Chun-wah and Macau Secretary for Administration and Justice Florinda da Rosa Silva Chan will “facilitate travel convenience between Hong Kong and Macau”, according to a government official.  From December 10th, holders of certain Hong Kong identity cards do not need to fill out arrival and departure cards when passing through immigration.  Hong Kong residents will also be allowed to enter Macau through e-channels after pre-registering at ferry terminals.


On Monday the market was higher across the board on DEAD volume.  The S&P 500 rose 1.4% (in line with the NASDAQ), while the higher beta Russell 2000 rose 1.7%.  Overall, this was the first up day of the last four as a 0.75% decline in the Dollar Index provided a tailwind for the equity market.


The MACRO calendar put the housing RECOVERY theme back in play.  After a series of disappointing headlines last week, existing home sales jumped 10.1% month-over-month in October to an annualized 6.1M units.  This represents the highest level since February of 2007. In addition, month's supply fell to 7 in October from 8 in September, with total inventory down 3.7% from September's levels.   From an equity perspective, with the exception of DRH, there was no follow through as most of the homebuilders finished lower yesterday; the extension of the homebuyer tax credit is only a temporary band aid to the issues facing the housing market.


Today’s MACRO calendar is full with a GDP revision at 8:30am (consensus is looking for 2.8%), followed by Case-Shiller at 9:00am (consensus is looking for -9.1%) and consumer confidence at 10:00am (consensus is looking for 47.5). 


On Monday, the VIX declined 4.6% and has now declined 7.6% over the past week.  Yesterday we bought the VXX.  Now that the market is hitting its YTD high it is as good a time as we have seen all year to buy some volatility. Our oversold line for the VIX is 21.03.


Every sector was up on Monday, but only three sectors outperformed the S&P 500 – Industrials (XLI), Technology (XLK) and Financials (XLF).  The best performing sector was the XLI, up 1.8%.   GE led the XLI higher by 2.8% yesterday.  Within the XLF, the banking group was one of the best performing subsectors.  The regional names were among the best performers as ZION rose +12.5%, STI up 5% and RF up 4.4%. 


The worst performing sectors were Healthcare (XLV), Consumer Discretionary (XLY) and Consumer Staples (XLP).  While the XLV underperformed the S&P 500 by 0.5%, managed care was a bright spot as JPMorgan upgraded CI and WLP.  The difficulties of Healthcare reform remain as the Democrats face an uphill battle gathering sufficient support to approve the legislation in its current form.


From a risk management standpoint, the ranges for the S&P 500, the Dollar Index and the VIX are seen in the charts below.  The range for the S&P 500 is 33 points or 1% upside and 2% downside.  At the time of writing the major market futures are basically flat on the day.


Crude oil is trading basically unchanged around $77.00 in early trading today.  The U.S. Energy Department will report tomorrow that stockpiles grew by 1.5 million barrels for the week ended Nov. 20, according to a Bloomberg survey.  The Research Edge Quant models have the following levels for OIL – buy Trade (76.21) and Sell Trade (79.09).


The lead story in the WSJ today – “HSBC Holdings Plc asked retail customers to remove their gold from its vaults on Fifth Avenue in New York to make room for institutional investors.”  Gold rose to a record $1,170.25 an ounce in the morning “fixing” in London.  The Research Edge Quant models have the following levels for GOLD – buy Trade (1,139) and Sell Trade (1,177).


Copper fell from a 14-month high (first down day in the past three) in London as the dollar strengthened; the U.S. Dollar Index traded as high a 75.44 in early trading today.  Copper for March delivery lost 0.4% percent to $3.14 a pound.  The Research Edge Quant models have the following levels for COPPER – buy Trade (3.01) and Sell Trade (3.21). 


Howard Penney

Managing Director














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Cannibalization is a big risk for the MGM Strip properties. The Bellagio/Mirage history is instructive. CC may do well but it probably won’t grow the market enough to push up Strip ADR as projected by the Street.



MGM management sure is projecting an aura of positivity when it comes to 2010 in Las Vegas.  “Strip room supply growth next year is only 5%.”  “The back half of 2010 looks strong.”  "MGM room rate premium will continue to grow in 2010.”  I’m paraphrasing but these are generally the comments I’ve heard.  The problem is that none of these comments give me comfort that 1) there won’t be serious cannibalization from CityCenter next year, 2) RevPAR won’t be down, 3) the Street’s MGM projections are not too high, 4) the increase in premium room supply isn't more like 57% (see "PLENTY OF ROOM AT THE STRIP INN IN 2010" 07/17/09) and 5) the first quarter isn’t under pressure already.  Never mind that no Vegas operator ever has visibility beyond the next quarter and certainly not into the back half of the next year.


MGM should be commended for its balance sheet work this year (although they did get themselves into this mess).  However, there is still a lot more work to do given the funding gap and debt maturities over the next two years.   So anything they say must be taken with a grain of salt.  We’ve seen this rerun before.  I’d prefer to look at the data, both anecdotal and historical.


CityCenter opens on December 16th.  Yes, the property only increases Strip room supply by only 5%.  This is misleading because CityCenter will open with 5,900 rooms at “premium” pricing.  Some of those rooms may or not set the price ceiling (MGM management thinks so) but combined they will increase the Premium room supply by 30%.  See the chart below.  Who is most at risk?  MGM is, of course, with 34k Strip rooms before CityCenter even opens.



Anecdotally, we’ve been hearing Aria and Vdara average daily rates may come in below $160 for January, well below our estimate of $225.  Moreover, in direct contrast to management’s assertion that Aria is pricing above Bellagio 80% of the time, our room rate survey prices Bellagio slightly above Aria in January.  Our recent conversations with industry participants indicate that the Strip in general is under pressure in January.


So the supply/demand and market exposure pictures are not too appealing for MGM and the anecdotal suggests a tough start to 2010.  What does history show us?  We dusted off our old Mirage Resorts model and discovered that The Mirage took a big hit from the Bellagio punch.  As shown in the following chart, The Mirage experienced a 32% hit to EBITDA in the quarter that Bellagio (Q4 1998) opened.  For the four quarters following Bellagio’s opening, EBITDA at The Mirage fell less, -24% which was still severe, but included a quarter with significantly higher hold percentage.  Even Treasure Island was cannibalized as its EBITDA fell 27% in Q4 1998.  This suggests that Bellagio, Mirage, Mandalay Bay, and MGM Grand could all be under pressure from CityCenter.



Surely, the cannibalization is captured in Street estimates?  Not so fast.  The consensus 2010 EBITDA estimate for Bellagio is north of $300 million, up from 2009’s $297 million.  With history as a guide, the huge supply addition right in Bellagio’s sweet spot, and the anecdotal feedback discussed above, this seems highly unlikely.  As shown in the following chart, we are projecting Bellagio EBITDA of only $236 million, approximately 20% below our 2009 estimate.  For all of MGM’s LV properties excluding CityCenter, the EBITDA projection is $1.13 billion, UP 7% from the 2009 projection.  We fear the Street is falling into the old trap of projecting a quick recovery after a bad year.  “It can’t be worse than this year.”  Supply growth be damned. 




High-end gaming is a wild card and whether Aria can grow that segment where Bellagio failed in 1 will be key to suppressing cannibalization.  The room side is more predictable.  It looks bad for MGM.  Excluding CityCenter, every $5 move in Las Vegas ADR moves the company-wide EBITDA needle by approximately $55 million, or 4% of total projected 2010 EBITDA.  Including CityCenter, the impact from our estimate would be $60 million.

Natural Gas Storage Update: Ever Is A Long Time

We’ve been somewhat silent on natural gas in terms of the virtual portfolio this year.  On the long side, we’ve been focused on those commodities that are global and priced in U.S. dollars – copper, oil, and gold.  Natural gas is a local market and, therefore is priced based on local supply and demand dynamics.


We were reviewing the weekly reports this morning from the Energy Information Administration and wanted to highlight one point relating to storage.  There is currently more natural gas in storage in the domestic United States than there has ever been.  And ever, as they say, is a long time.  This point is highlighted in the chart below.


Technically it is not ever, but only as long as the data goes back, which is to 1994.  As of November 13th, there were 3,833 Bcf in storage, which is the largest storage number recorded since the EIA began keeping the data and, obviously, well above the five year trend.    This also represents a 10.0% YoY increase.


Obviously, what ultimately matters is the next data point and if we could make the case that storage will begin to decline, we could, on the margin, get more positive.  Unfortunately, recent data points from large producers suggests just the opposite.  Chesapeake Energy provided an operational update on October 29 and stated:


“For the 2009 third quarter, daily production averaged 2.483 billion cubic feet of natural gas equivalent (bcfe), an increase of 30 million cubic feet of natural gas equivalent (mmcfe), or 1%, over the 2.453 bcfe produced per day in the 2009 second quarter and an increase of 162 mmcfe, or 7%, over the 2.321 bcfe produced per day in the 2008 third quarter. Adjusted for the company’s voluntary production curtailments due to low natural gas prices and involuntary production curtailments due to pipeline repairs (which together averaged approximately 45 mmcfe per day during the 2009 third quarter), the company’s 2009 and third and fourth quarter 2008 volumetric production payment transactions (which combined averaged approximately 125 mmcfe per day during the 2009 third quarter) and the estimated impact from various divestitures (which would have averaged approximately 105 mmcfe per day during the 2009 third quarter), Chesapeake’s sequential and year-over-year production growth rates would have been 2% and 14%, respectively, after making similar adjustments to prior quarters.”


The company currently produces 2.286 bcf/day and operates 105 rigs.  In terms of national rig activity, Chesapeake is currently operating 14.4% of all active rigs in the United States and is estimated to be the largest domestic natural gas producer.  Clearly, the decline in rig activity we have seen year-to-date will have an impact on future production, but with storage at all time highs and the country’s largest producer, Chesapeake, forecasting 7% y-o-y production growth for Q3 (which would have been 14% if it hadn’t been for curtailments), it is difficult to be overly bullish on price with these production and storage overhangs.


Daryl G. Jones
Managing Director


Natural Gas Storage Update: Ever Is A Long Time - UNG Storage3


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