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Learning From Mr. Macro Market

“Learn all you can from the mistakes of others.  You won't have time to make them all yourself.”  
-Alfred Sheinwold
“Freddy” Sheinwold was born in London, emigrated to the US, and became one of America’s most famous bridge players. He was also a writer and, at one point during World War II, the Chief Code and Cipher Expert for the US Government.
Freddy learned that there is a lot to learn in terms of the ‘what not to do’s’ in both games and war. I have a great deal of respect for this approach to investing. That’s really what managing risk from a global macro perspective is all about.
Take, for instance, what’s happened to consensus expectations on Chinese growth and stock market returns in the last 24 hours. This is how Bloomberg news summarized why Chinese stocks got hammered overnight: “an unexpected shift by China’s central bank to restrain lending may foreshadow higher interest rates and a relaxation in the nation’s currency peg against the dollar.”
Obviously, those of you who have been going through your global macro paces for the last 6 weeks know that these proactive moves by the Chinese government are not “unexpected” at all. All you needed to have was a repeatable (daily) global macro process and you would have already positioned yourself for this. China explicitly told us they were going to tighten the screws on speculative investment. Making that call wasn’t rocket science.
Rocket science is what some investors consider their super special views on bottoms up investing. Sorry to break it to you Captain stock picker, but figuring out that a company is cheap with pending positive investment catalysts is something that all great investors should be able to do. If it was a God given talent set aside for a select few, why do we have so many money managers in this world purporting it to be their secret sauce?
I believe that you need to wake-up every morning with an all-star bottoms up investing process and a disciplined, but malleable, top down global macro risk management process to augment it.
Having been a “I know everything about this company” hedge fund Jedi of doing one-on-ones (I did over 256 of them in 2004) with corporate management teams, I have the perspective to tell you this because I have made plenty of mistakes. At least two-thirds of my company specific investment blowups have been due to missing Mr. Macro Market moves. That’s why I wake-up early every morning trying to stay one step ahead of the macro oriented mistakes of others.
China closed down -3.1% last night, taking the Shanghai Composite below its immediate term TRADE line of 3220. The Chinese have raised rates twice in the last 2 weeks and have now explicitly tightened the reserve requirements on their domestic backs to much higher levels than what you currently see here in the US banking system. China wants “quality” growth, not speculative levered-up growth.
On the heels of the unprepared reacting to the “unexpected”, the Hang Seng Index in Hong Kong broke its critical intermediate term TREND line of 21,829, closing down -2.6% on accelerating daily trading volume. Korea, Japan, and Indonesia saw their stock markets down in reaction to the wall of China worry, trading down -1.6%, -1.3%, and -1%, respectively.
The New Reality remains. Mr. Macro Market waits for no one. Global markets are increasingly interconnected and demand that money managers learn from the mistakes implied by consensus not having a global risk management process.
Another major global macro risk that continues to weigh on my mind is sovereign debt. I touched on this yesterday, so here’s the update. Indonesia tried to plug the market with $4B in debt yesterday, and the demand was only there to get half of that done. So the government issued $2B in 10-year sovereign notes at 6%. That’s +225 basis points higher than what He Who Sees No Inflation (Bernanke) is willing to issue prospective US Treasury investors on the same duration.
What a deal right? Since the beginning of 2010 we have now seen the Philippines, Mexico, Poland, Turkey, and Indonesia issue $10.86B in debt. To put that in context, that’s the highest level of debt issuance for emerging markets since the Tech bubble days of 1999. Again, I don’t think we have massive equity market bubbles in the world like we did in 2007, but we definitely have a Debtor Nation bubble.
As our mentor Herb Brooks beats into our thick hockey skulls, Again! Learn from other people’s mistakes. Nations piling debt upon sovereign debt is not new folks. Neither is Moody’s giving a country like Japan an absurd debt rating of Aa2 (their 3rd highest rating, whatever that is) when the they have pushed their debt balance over 200% of GDP. Players and pundits alike are constantly making macro mistakes in this game. Use that consensus backboard to your advantage.
My immediate term support and resistance lines for the SP500 are now 1118 and 1153, respectively. We were a buyer on weakness in US equities yesterday. We covered our short position in gold (GLD) on the biggest down day it’s had in 3 weeks. We remain out of China (and all emerging markets other than Brazil), for now.
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 Healthcare
Buying 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, prompting us to add to our position on VXX.

EWG - iShares Germany Buying 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 mispriced and that TIPS are a efficient way to own yield on an inflation protected basis.



IEF – iShares 7-10 Year Treasury
One of our Macro Themes for Q1 of 2010 is "Rate Run-up". Our bearish view on US Treasuries is implied.

FXE – CurrencyShares EuroWe shorted the Euro ETF on strength on 1/11/10. From an intermediate term TREND perspective we remains bullish on the US Dollar Index.

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 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.

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.


Yesterday, all of the major indexes posted their biggest one-day losses for 2010 on accelerating volume.  The Hedgeye Risk Management models are still showing that the TRADE and TREND for the S&P 500 is BULLISH, while the Utilities (XLU) is the only sector to be broken on TRADE.


We woke up to another round of the Chinese withdrawing stimulus yesterday, which contributed to markets posting their biggest one-day losses in 2010.  Also, the People’s Bank of China raised the proportion of deposits that banks must set aside as reserves by 50 basis points starting Jan. 18.




On the MACRO front it was another quiet day which means there are no vapors to help push the RECOVERY trade higher.  The VIX also had its biggest one day move in 2010 rising 3.9%.  With the VIX down 15.8% so far in 2010, investor complacency has crept into the market.  The Chinese can clear that up quickly if you are not paying attention. 


The best performing sector yesterday was the Consumer Staples (XLP).  The grocers and food stocks were the bright spot in the staples after the Q3 earnings beat and upwardly revised guidance from SVU and KFT.   HSY was the best performing packaged food stock on reports that Ferrero ended talks with the company regarding a rival bid for Cadbury.


Yesterday in the US the Materials (XLB) was the worst performer.  The XLB is one of the sectors with the most leverage to the recovery trade, as the CHINESE OX IN A BOX theme will work against the XLB.  In addition, aluminum stocks were hit hard in the wake of the earnings miss from AA.  The fertilizer, steel and precious metals stocks all finished lower on the day. 


The Financials have seemed to run into a brick wall on the back of increased regulatory concerns.  The renewed regulatory concerns were grounded amid reports that the Obama administration is considering assessing some kind of tax on banks to help close the budget deficit and recoup TARP losses.  The banking group finished lower for just the second time this year, with the BKX down 1.7% on the day.  Within the XLF, the large-cap names BAC, C, WFC and JPM were among the worst performers.  The weakness in the XLF also included the brokers, with MS down 2.84% and GS down 2.18%, the latter of which finished down for a third straight day.


The Technology (XLK) underperformed the S&P 500 by 20bps, as the SEMI stocks weighed heavily on the sector with the SOX down 3.59%.  The SOX suffered its biggest one-day pullback since 10/1/09. 


As we wrote about yesterday, living up to expectation is difficult to do.  The selloff in the SOX might be discounting that the stocks are already pricing in upside to current December quarter earnings season.  Outside of the semis, ERTS declined 7.8% after the company's disappointing Q3 pre-announcement and decreased full-year guidance.


The range for the S&P 500 is 35 points or 1.5% (1,153) upside and 1.5% (1,118) downside.  At the time of writing the major market futures are trading up slightly.    


Yesterday the CRB declined 1.68% on the back of the Grains and Energy.  The soft commodities Orange juice, Sugar and Coffee were the best performing on the day.   


In early trading today Copper is trading near a two week low on the back of the news out of China.    The Hedgeye Quant models have the following levels for COPPER – buy Trade (3.26) and Sell Trade (3.49).


Yesterday, gold declined by 1.9%, its biggest drop since 12/17/09.     The Hedgeye Quant models have the following levels for GOLD – buy Trade (1,123) and Sell Trade (1,160).


In early trading Crude oil is trading down for the third day in a row.   The Hedgeye Quant models have the following levels for OIL – buy Trade (78.88) and Sell Trade (84.28).


Howard Penney

Managing Director















The Macau Metro Monitor.  January 13th 2009.



NON-STOP WUHAN-MACAU SERVICE chinaeconomicreview.com

Air China will fly between Wuhan and Macau four times a week, starting January 15th.  It will operate an Airbus A320 aircraft on the route.

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Yeah the hold percentage was a touch higher than last year and some of October’s slot revenue were included in November, but this was a pretty good month for the Strip.



The state of Nevada released a shocker today.  Strip gaming revenues increased 8.3%.  Digging deeper into the numbers, it is clear that the quality of the numbers was less than the headline would indicate.  Nevertheless, November was a pretty good month for the Strip considering the environment and recent trends. 


The Baccarat business continues to shine.  Despite a huge Macau market in their backyard, the Asians keep coming to Las Vegas.  Strip Baccarat revenue increased 136% y-o-y in November.  A higher hold percentage certainly contributed but Baccarat drop still increased 84%.  The following chart shows the fairly consistent outperformance of the Baccarat segment.




Pardon the pessimism – this was a good month after all – but there is still plenty of evidence of softness.  The following chart shows year-over-year growth a few different ways.  As we indicated, total Strip revenue increased 8.3%.  However, the casinos played a little luckier so if you use a constant hold percentage, Strip revenues would’ve only increased 2.5%.  Since Baccarat was so strong and can be very volatile month to month, we show revenue excluding that segment which actually declined 4.3%.  Finally, excluding Baccarat and adjusting the hold percentage yields a revenue decline of 10.7%. 




The Baccarat performance is encouraging but we’d feel better if the improving trend was more broad based.


We are below the Street for Q4 and now also for 2010.  The offsetting variable in our LV Locals Macro Model had been population growth and now that variable looks like a non-factor at best.



Q4 Preview

Q4 looks like it was tough one for a lot of the regionals, including BYD.  BYD’s exposure to the difficult Las Vegas Locals, Atlantic City and Louisiana (lately) markets probably positions the company to miss near and intermediate term estimates.  For Q4, we are projecting net adjusted EBITDA of $92.5 million which includes half of Borgata’s EBITDA.  On a consolidated EBITDA basis, EBITDA is estimated to be $82.6 million versus the Street at $88.0 million.  Our EPS estimate is $0.01, lower than the Street at $0.04.




The ace in the hole of our Las Vegas Locals Macro Model was always population growth.  With continued population growth, the model spat out positive gaming revenue growth for 2010.  Now however, population and the labor force are flat at best and may even be declining.  Combine flattish population growth with stagnant unemployment and housing prices, the locals LV gaming market may struggle to expand in 2010, better than expected November numbers notwithstanding.


With the macro backdrop in place, we are now projecting adjusted EBITDA of $432 million and consolidated EBITDA of $392 million, essentially flat with 2009.  Our EPS estimate is $0.45 versus the Street at $0.49.


The Long-Term

Beyond 2010, the locals LV outlook is bright.  Given Nevada's low tax structure, the favorable climate, and cheap housing, we believe the market has significant long-term growth potential.  We may be one of the few in the investment community to view a potential acquisition of some or all of the Station Casinos assets favorably.  2010 should be the trough and could be the right time to double down on the LV locals market. 

Inflation Chart of The Day

Please don’t submit this chart to He Who Sees No Inflation (Bernanke). He’s about to be re-confirmed by the Senate, and he doesn’t want these 1970’s style y/y price charts messing with this 1930’s gig. Gotta keep your politics local Ben. No need for this global macro stuff.


The chart below outlines the recent run-up in India’s weekly Wholesale Food Inflation to +18.2% y/y.


This morning we also saw India’s industrial production growth rate hit +11.7% y/y. That was up +140 basis points from October and also a 25 month high. While Bernanke pretends this country is some form of a depressed 1990’s Japan, the rest of the world’s economic leaders seemed poised to continue raising rates.


China has raised rates twice in the last 2 weeks. Altogether, Chinese + Indian growth combined with these recent inflation reports provide plenty of support for those who aren’t being paid to be willfully blind to real-time data.



Keith R. McCullough
Chief Executive Officer


Inflation Chart of The Day - india

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