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Traversing Peaks

"In the mountains, the shortest way is from peak to peak: but for that you must have long legs.”
-Friedrich Nietzsche
After the most expedited US stock market rally in modern history, how are we going to come off of this immediate term peak? When? Why? These are the questions boggling the minds of plenty a Depressionista.
With the SP500 hitting another higher-high on Friday at 1144, this mountainous peak is +69.2% above the March 9th low. Luckily, we got long US Tech and Healthcare again (XLK and XLV) ahead of the latest leg of the rally. The SP500 has not had a down day yet for 2010!
I’ve been to these mountains of hope before. While hope is not an investment process, not respecting that it drives many of the minds who chase price momentum isn’t a risk management process either.
There was a time when I thought my short little legs could hop from peak to peak, without getting pricked. That was the mentality of a boy born in the tech bubble. Today, I’m simply a battle scarred man of bubbles. While I may have seen one coming in gold and US Treasuries, I do not see one here just yet in US stocks.
When my risk management process signals a peak, the first thing I do is wait. Peaks are processes, not points. You need to let them bathe in the sunlight of hope at the same time as the un-experienced climbers of the wall of worry fall on their swords. Peaks are patient. Peaks take their time.
Across all 3 of the durations in my risk management model, the US stock market remains in what we Hedgeye knights call a Bullish Formation.
A Bullish Formation is when the immediate term TRADE (3 weeks or less) underpins the intermediate term TREND (3 months or more) and the long term TAIL (3 years or less).
For the SP500, those 3 lines of support are currently as follows:
1.      TRADE = 1115

2.      TREND = 1087

3.      TAIL = 956

What the astute risk manager will immediately recognize from these levels is that they are -2.5% (TRADE), -5% (TREND), and -16.5% (TAIL), lower than the current SP500 closing price of 1144. If you are fully invested or levered long up at this market price, that’s your risk.
Provided that these 3 lines of support hold, we remain in a Bullish Formation. As you might suspect, all Bullish Formations do is frustrate short sellers. They tend to perpetuate a series of higher-lows and higher-highs. If you are net short this market price, that’s your risk.
I measure the risk that we pull back to my lines of support every 90 minutes of marked-to-market trading. I measure ranges, spreads, and deltas. I effectively risk manage within a band of probabilities. If you don’t manage risk like this, real-time, that’s your risk.
Peaks, valleys, and the market prices embedded therein, wait for no one. They frustrate us. They fascinate us. They are patient and, sometimes, unkind.
This morning’s setup I am measuring more risk than reward in buying US stocks. I have immediate term upside to the 1149 level (up +0.4%). I have Immediate term downside support at the 1132 level (down -1%).
My plan isn’t that complicated; but I stick to it, with one very important caveat – the plan is that the plan changes as market data and prices do. I’m not bullish this morning. I’m not bearish. I’m simply tasked with calling out these levels and probabilities as they are, and managing risk around them.
In summary, what I am saying this morning is that if my immediate term level of 1132 breaks, the market has a higher probability of sucking back to its immediate term TRADE line of 1115. If 1132 holds, there is a higher probability that we see 1149.
That’s the gravitational force of the math in my macro model. It doesn’t always work, but it definitely helps guide me as I attempt to traverse potential market peaks.
Best of luck out there today,

XLK – SPDR Technology
Buying back Tech after a healthy 2-day pullback. Next to Healthcare, this remains our favorite sector in the SP500.

UUP – PowerShares US Dollar Index Fund
We bought the USD Fund on 1/4/10 as an explicit way to represent our Q1 2010 Macro Theme that we have labeled Buck Breakout (we were bearish on the USD in ’09).

XLV – SPDR HealthcareBuying back the bullish position Tom Tobin and his team maintain on the intermediate TREND term for the Healthcare sector.

VXX - iPath S&P500 Volatility
The VIX broke down to our immediate term oversold line on 1/6/10 and the II Bullish/Bearish survey is far too complacent, prompting us to add to our position on VXX.

EWG - iShares GermanyBuying back the bullish intermediate term TREND thesis Matt Hedrick maintains on Germany. We are short Russia and, from a European exposure perspective, like being long the lower beta DAX against the higher beta RTSI as well.

EWZ - iShares Brazil
As Greece and Dubai were blowing up, we took our Asset Allocation on International Equities to zero.  On 12/8/09 we started buying back exposure via our favorite country, Brazil, with the etf trading down on the day. We remain bullish on Brazil's commodity complex and believe the country's management of its interest rate policy has promoted stimulus.

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.


As the gold price inches up toward the immediate term resistance line of $1137/oz, we’re going to take the other side of a long-standing bullish position.

RSX – Market Vectors Russia
We shorted Russia on 12/18/09 after a terrible unemployment report and an intermediate term TREND view of oil’s price that’s bearish.

EWJ - iShares JapanWhile 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.

XLY - SPDR Consumer Discretionary We shorted Howard Penney's view on Consumer Discretionary stocks on 10/30/09 and 12/2/09.

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.

US STRATEGY – The RECOVERY trade is in

While a worse-than-expected 85,000 decline in December nonfarm payrolls weighed briefly on recovery expectations, the S&P finished higher by 0.29% on Friday, closing up 2.68% for the week.  Volume declined 16% day over day, so the move on Friday was less convincing; breadth was also week on the day. 


ON the MACRO front, nonfarm payrolls fell 85,000 in December vs. consensus expectations for an unchanged reading.  However, November payrolls were revised to reflect a 4K gain vs. an originally reported decline of 11K. As expected, the unemployment rate held steady at 10% (largely due to a drop in the participation rate), while the 0.2% gain in average hourly earnings was also in line with the consensus. In general there were not many good things payroll to report.


On Friday the Financials (XLF) were the worst performing sector after rallying sharply for the balance of the week.  The banking group (BKX) fell for the first time on Friday, declining (0.2%).  The weaker-than-expected December employment report may have spurred some profit-taking in the XLF. 


Despite some weakness in the dollar the CRB was basically unchanged on the day.  The cold weather helped Orange Juice move up 7%, followed by Copper up 2.1%, Silver up 1.6% and Gold up 1.6%. 


The best performing sector was the Industrial (XLI), rising 1.6% on the day.  The RECOVERY trade got a lift from upwardly revised Q4 guidance from UPS +4.8%, and continued strength in recovery-leveraged pockets of the market such as steel, aluminum, copper, machinery and multi-industry/conglomerate stocks - GE was up 9.7% last week. 


The dampened risk aversion trade was evidenced by last week’s move in the VIX.  The VIX declined 4.7% on Friday and declined every day last week (the S&P 500 was up every day last week); and a bullish steepening move in Treasuries reflecting a pushback in tightening expectations.


The Technology (XLF) sector snapped a three-day losing streak on Friday, although the move was without much fanfare.  The semis were among the best performers with the SOX +1.5%.  Additionally, the memory names resumed their upside trajectory with SNDK up 2.5% and MU up 2.4%. 


The range for the S&P 500 is 17 points or 0.4% (1,149) upside and 1.0% (1,132) downside.  At the time of writing the major market futures are trading slightly higher.    


In early trading today Copper climbed for the first time in two days as a surge in Chinese imports boosted optimism that a global economic revival is under way.   The Research Edge Quant models have the following levels for COPPER – buy Trade (3.38) and Sell Trade (3.50).


In early trading today Gold is up for the second day in a row on the back of a weak dollar.  The Research Edge Quant models have the following levels for GOLD – buy Trade (1,115) and Sell Trade (1,156).


In early trading Crude oil is trading up 1% to $83.56 a barrel.  Last week oil rose 4.2% and has been up for 4 weeks in a row.  The Research Edge Quant models have the following levels for OIL – buy Trade (80.91) and Sell Trade (84.34).


Howard Penney

Managing Director


US STRATEGY – The RECOVERY trade is in - sp1


US STRATEGY – The RECOVERY trade is in - usdx2


US STRATEGY – The RECOVERY trade is in - vix3


US STRATEGY – The RECOVERY trade is in - oil4


US STRATEGY – The RECOVERY trade is in - gold5


US STRATEGY – The RECOVERY trade is in - copper6


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Wynn Macau's market share gain and overall growth in December was impressive. New junkets and higher direct play contributed to the upside.



Wynn Macau generated approximately $5.2 billion in VIP junket rolling chip volume in December of 2010, up 71% over December 2009.  This is a staggering number for one property and is the second highest month ever recorded by Wynn slightly behind only May of 2008.  And that's not all of it.  Wynn's house junket contributed another estimated $600 million in turnover.


Hold percentage was somewhat higher than last year, but not by much.  We also estimate that Wynn's direct play generated significant growth over last year.  Total VIP revenue (including the house junket) increased 85%.  Total VIP market share climbed a whopping 570 bps from November to 18.7%, while Wynn's overall market share (including Mass) grew to 16.5% from 12%.




So in addition to higher direct play, what drove the increase?  During December, Wynn Macau had 10 junket rooms at the property, operated by 9 different junkets (including Wynn's house junket).  Apparently, two of the newer operators moved quite a bit of business over from Starworld and some smaller Macau casinos.  Indeed, Starworld's VIP rolling chip market share declined 170 bps, Galaxy in total fell 140 bps, and SJM in total fell 170 bps.  Meanwhile, Wynn's two largest junkets maintained the current book of business at around $1.3 billion each.


Is the move sustainable?  Maybe, November also showed a marked sequential increase in VIP chips share, up 260 bps.  November stopped a fairly consistent share degredation following the 2009 peak in May. 

The Week Ahead

The Economic Data calendar for the week of the 11th of January through the 15th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - wkk1ab

The Week Ahead - wk1b


The Rear View Peak

In classic partisan style, political pundits are now debating whether or not the unemployment rate is a lagging indicator. Many politicians don’t do math. That’s why this is only a political debate. The peak unemployment rate is now in the rear view.


October’s 10.2% unemployment rate will be looked back on as just that, the peak for this part of the cycle. While this morning’s 10% rate was in line with November’s reported unemployment rate, the probability in our macro model continues to climb that we will be seeing a 9% rate in the coming months.


As our new Financials Sector Head, Josh Steiner, wrote in a note earlier this week titled, “Census Hiring An Added Credit Tailwind for 2010”:


The US Census bureau has begun hiring for the upcoming decennial census. Hiring in earnest will begin in March/April once it is known how many people will be needed to conduct the census. For those unfamiliar, the census survey is mailed out to every household in America, and census workers are needed to canvas those homes in which the census is not mailed back. So, from a hiring standpoint, it would be best if no one completed the mail-in version of the census. Census worker pay is $15-18 an hour if any readers are interested in moonlighting.


In the last census in 2000, the mail-in response rate was 67% and the census department is hoping for a comparable result this time around. This 67% response rate led to the hiring of 530k workers - or close to half Wal-Mart’s US workforce. The response rate in 1990 was 65%, roughly the same, and there were 335k workers hired for the job. This time around the expectation is that 1.2 million people will need to be hired to conduct the census, according to the head of census recruiting. With a number that large, expect census hiring to begin to generate a perceptible hiring tailwind this Spring and run through the summer.


If you are on the side of the bet that the unemployment rate is setting up to make higher-highs from here, that’s what makes a market. Both the bond market and stock market are telling you that the Depressionista bet remains the wrong bet.


Tops are processes, not points. However lagging this economic reality may be, it is far easier for me to see the peak point for America’s unemployment rate in the rear-view today than it was yesterday.



Keith R. McCullough
Chief Executive Officer


The Rear View Peak - unemplo

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