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Trading Is Risk Mangement

“At the same time I realize that the best of all tipsters, the most persuasive of all salesmen, is the tape.”

-Jesse Livermore


Before someone indoctrinates your children into a “buy and hold” strategy for this stage of their life, make sure you have them read Edwin Lefevre’s ‘Reminiscences Of A Stock Operator.’ While the business of being bullish or bearish is cyclical, some of Jesse Livermore’s risk management teachings are timeless.


My move to sell my exposure to the SP500 (SPY) into yesterday’s market strength raised the predictable response from some of our subscribers that ‘hey, you trade too much.’ I understand that perspective. After all, I had only held the position for a day. That said, I don’t agree with the conclusion. It’s the equivalent of telling me I manage risk too much.


The last time I held a long position for less than 2 days was at least 3 months ago. So I’m not submitting that one needs to be in and out of markets maniacally all of the time. I am simply suggesting that one needs to respect the price momentum of the tape. Mr. Macro Market’s prices don’t lie; people do.


The last 6 days of US stock market trading have unearthed some obvious warning signals. No, I am not suggesting that the stock market is going to crash. However, I am saying that the benefit of the doubt no longer goes to the bulls. This is new.


Here are some risk management factors to consider:


1.       The immediate term TRADE lines for the SP500 (1025), Nasdaq (2271), and Russell 2000 (630) have been broken

2.       The intermediate term TREND line for the SP500 (1096) is being tested

3.       The Range in my immediate term probability model for the SP500 has blown out to 83 points wide (it averaged 24 points 3 weeks ago)

4.       The Volatility Index (VIX) has broken out above both my immediate and intermediate term lines of 20.12 and 22.51

5.       The S&P Sector risk management model that we run only has 1 out of 9 sectors in a bullish immediate term TRADE position (Healthcare)

6.       The US Dollar continues to breakout to the upside on both immediate and intermediate term durations


Directionally, all of these moves have been confirmed by bearish volume signals. Yesterday’s volume signal was one of the driving factors behind my decision to sell my long position in the SP500. The market was rallying, unconvincingly, on a down -19% day-over-day move in volume.


Down markets on accelerating volume are explicitly bearish. The during the -5.1% three-day down move from last Wednesday to Friday, that’s exactly what Mr. Macro Market registered. Additionally, Volatility (VIX) had a massive melt-up of +53% on a week-over-week basis. All in, I don’t get paid to ignore these 3 risk management factors (price, volume, and volatility); particularly when they occur simultaneously. I don’t think you do either.


So now what? I sit on my hands, and I watch, and I wait. I don’t have to justify being long the SP500 because I don’t have to justify a buy and hold strategy. Will the SP500’s intermediate term TREND line of 1096 hold? I think the probabilities are mounting that the answer to that question is no, but Mr. Macro Market works in mysterious ways. I’ll let him persuade me in the coming days as to which side of this line I need to be positioned on.


Globally, the risk complex doesn’t look any prettier. We have been calling for a correction in Chinese stocks, so this isn’t a surprise, but it certainly appears to be to the masses. One of the top read headlines on Bloomberg this morning is “Bank of China, Construction Bank Start Curbing Credit.”


This isn’t new. The Chinese government has been explicitly signaling a reduction in speculative loan growth for the last 6 weeks. What’s new is Mr. Macro Market making people pay attention to it.


China’s Shanghai Composite Exchange got tagged for another -2.4% down session overnight, taking it’s YTD losses to -7.9%. For the more institutionally traded “H-Shares” listed in Hong Kong, the news is no different. The Hang Seng lost another -2.4% last night as well, taking it’s YTD loss to -8.1%. Both the immediate term TRADE and intermediate term TREND lines in these very important Asian bellwether tapes remain broken.


If our Macro Themes continue to be right and the Buck Breakout continues alongside the Chinese Ox being in a Box, commodity prices will continue to weaken. We re-shorted Gold (GLD) in the Hedgeye Virtual Portfolio yesterday and we maintained a zero percent allocation to Commodities as an asset class.


In addition to respecting the tape, Jess Livermore taught me that “the game” teaches you this game. Trading is risk management. Risk management is trading.


My immediate term TRADE lines of support and resistance for the SP500 are 1080 and 1126, respectively.


Best of luck out there today.





XLV – SPDR Healthcare — We bought back our bullish intermediate term view on Healthcare on 1/22/10.


EWC – iShares Canada — We remain bullish on the intermediate term TREND for Canada. With a pullback in the ETF, we bought Canada on 1/15/10 and 1/21/10.


XLK – SPDR Technology — We bought back Tech after a healthy 2-day pullback on 1/7/10.


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).


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.



GLD – SPDR Gold Shares We re-shorted Gold on a bounce on 1/25/10. We remain bullish on the US Dollar and bearish on the intermediate term TREND for the gold price as a result.


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.
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.

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. January 26th, 2010



Amax accused Melco of breaching its contract by entering into individual agreements with junket promoters since Dec 2009 without their consent.  Due to the release of what AMA deemed sensitive information in Citigroup's Jan 13th report (see relevant text below) the company requested to suspend its trading in the shares on the HKSE from January 18 - 22.


“During the 4th quarter of 2009, Melco Crown Entertainment [“Gaming Operator”] has restructured its Gaming Promotion Agreement with AMA at Altira Macau given the current commission cap regime. Although the aggregator model now appears dead and buried, VIP rollings are already back to normal levels, with all junket commissions now set at 1.25%. Gaming Operator’s earnings will be hurt as it transitions from its super junket arrangement to dealing directly with junket operators”


On Jan 24th AMA announced that due to Macau's changes to fix the commission cap to 1.25%, AMA and Crown have signed a revocation agreement of their existing Gaming Promotion Agreement and entered into fresh agreement on December 23, 2009. 


However, despite an agreement to operate Atlira still being in place, AMA claims that Melco entered into separate agreements with junket promoters that are subject to a contract with AMA, since December 2009.  In response to an inquiry from Macau Daily Times, Melco's response was that it “will strive to maintain existing and build new relationships across our operations in Macau, so as to remain competitive and have full respect for the prevailing contractual and regulatory frameworks within which we operate,” but failed to confirm whether it entered separate agreements.


The S&P 500 finished slightly higher yesterday, +0.46% - on very light volume.  The government sponsored volatility that weighed heavily on the market last week remained largely on the front-burner.  The risk aversion trade showed some signs of relief with the VIX trading down 6.96% on the day.  The Hedgeye Risk Management models have the following levels for VIX – buy Trade (22.51) and Sell Trade (29.54). 


Some optimism did return as the prospects for Fed Chairman Bernanke's confirmation looked a little more like he would remain as the Chairman of the Federal Reserve. 


On the MACRO front, December existing home sales disappointed, dropping 17%.  I agree that the December existing home number is a statistical aberration, but that is not the point.  The issue remains that the current trend in joblessness is still a big drag on the economy and the government can’t prop up the housing market forever. 


The Materials (XLB) was the best performing sector yesterday after being the worst performing sector last week with some unwinding of the RECOVERY trade on concerns about an accelerated tightening schedule in China to combat bubble fears. Within the XLB, steel stocks recovered a bit of last week's 10% decline following the better-than-expected Q4 results out of AKS.


The second best performing sector was Technology (XLK), rising 0.8%.  The outperformance was driven by the semi space with the SOX rising 1.4%; TXN was one of the notable gainers ahead of its Q4 results after the close. Memory names were another bright spot with SNDK and MU outperforming on the day.  Lastly, AAPL was up 2.7% and a standout in the hardware space ahead of its December quarter results, which blew away expectations.


The Financials (XLF) was up in line with market yesterday.  The banking group was also higher on the day, though underperformed the S&P 500 by 30bps. The XLF is bearing the brunt of the government sponsored volatility following last week's proposal by the Obama administration to disallow proprietary trading and hedge fund and private-equity investing on the part of any financial institution that owns a bank.  The more defensive leaning trust names were mostly higher on the day, while the large-cap and regional banks were mixed.


As we look at today’s set up the range for the S&P 500 is 45 points or 1.5% (1,080) downside and 2.6% (1,125) upside.  At the time of writing the major market futures are trading lower on the day.  


Copper is trading lower in London trading on speculation that China will curb lending.  The Hedgeye Risk Management Quant models have the following levels for COPPER – buy Trade (3.32) and Sell Trade (3.45).


In early trading today Gold is trading lower, as the whole commodity complex is trading lower on the day.  The Hedgeye Risk Management models have the following levels for GOLD – buy Trade (1,081) and Sell Trade (1,104).


Crude oil is trading down on speculation that oil stockpiles are very high worldwide, while concerns persisted that China will tighten credit and slow growth.  The Hedgeye Risk Management models have the following levels for OIL – buy Trade (73.68) and Sell Trade (76.87).


Howard Penney

Managing Director














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This morning Fantini’s Gaming Report wrote about WMS’s foray into online gaming.  For those of you that missed it here’s what was written:


“WMS has set up shop in the United Kingdom to launch Internet gaming late next fiscal year, eGamingReview reported.  The company is hiring 25 employees in London in preparation for the launch of a UK-facing site, then will follow with sites aimed at France, Italy and Spain as those countries open their markets to competition beyond their state-granted monopolies. WMS will be the first major US slot machine company to go beyond licensing games to online operators. It also would give WMS experience to offer its games directly to Americans already familiar with them in slot machine form if I-gaming is legalized in the US. As such, it could start a trend of suppliers to brick-and-mortar casinos competing against them on the Internet, and opening whole new revenue streams.”


We spoke to the company and got some clarification on what’s really going on.  The online gaming effort in the UK is has been an ongoing part of WMS’s R&D efforts and is already reflected in the R&D budget – so the employees are not new hires.  The online strategy in the UK is an extension of what WMS showed in it vault at G2E this year, namely increasing customer loyalty to the casinos and WMS games by allowing them to continue their experience online on operator’s websites.  In the UK, regulation allows WMS to have a more direct strategy. The launch of their online gaming efforts in the UK will be a FY2011 event, and should not have any material impact on R&D or SG&A in the interim.  As far as the US is concerned, online gaming is not likely to get legalized in the foreseeable future, at least not until the federal government can figure out a way to tax online gaming.



Unfortunately, this party of acronyms may not be so happy.



With Delaware and now Maryland considering table games, the positive Atlantic City inflection point continues to move farther out on the horizon.  MGM may not have the patience to wait it out.  As reported in the Las Vegas Review-Journal yesterday, MGM may be looking at exiting the AC market through selling its 50% stake in Borgata.  It’s no secret that New Jersey gaming regulators have not been happy with MGM’s involvement with Pansy Ho given the alleged ties of her father Stanley Ho with the Chinese triads.


We cannot think of a worse time to sell an Atlantic City asset.  BYD, MGM’s 50% partner in Borgata, is sitting pretty in at least one respect.  Certainly, Borgata represents over 20% of the company’s property EBITDA so that’s not good.  However, BYD does hold the right of first refusal on any MGM agreement to sell.  So while it's a bad time to sell for MGM, it’s probably a good time to buy for a long-term investor such as BYD.


In the meantime, Borgata cash flow expectations probably need to be ratcheted down.  Pennsylvania slots have had a huge impact on AC and with table games just legalized, the market share shift will continue.  Maryland is not even built out yet but slots, and maybe table, are coming.  The Delaware House just passed table game legislation and the Senate is supposed to follow suit.  The Governor has indicated he will sign the legislation. 


The following chart shows that table games have outperformed slots in Atlantic City most of the last two years during which slots in Pennsylvania proliferated.  That is, up until recently as table game play fallen off the cliff, and that’s before the addition of tables in PA, DE, and MD.  The problem for Borgata is that it generates almost 40% of its gaming revenue from the tables, the second highest in the market.  Borgata's table dominance has partly attributed to its ability to outperform the market until recently.  Given the supply outlook, table revenue is probably more at risk over the next few years.


AC, PA, MD, DE, MGM, BYD - ac tables vs slots

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