“I may not be alive to see the crisis, but my soul will come back to haunt you.”
-Paul Volcker (February 2nd, 2010)
Hearing Paul Volcker speak his mind is always both a pleasure and a privilege. The man didn’t win any Washington Groupthink points while testifying to the Senate Banking Committee yesterday, but who really cares?
As the old battle axe of the American Financial System’s credibility-lost was attempting to beat some very basic points about how the conflicted and compromised business model of a “full service” investment bank works into the melons of paid off politicians, the US stock market rose like a phoenix.
At one point, Volcker told one financially illiterate politician, “my soul will come back to haunt you”, and the Bubble Boy who missed proactively preparing for the recent financial crisis actually snickered. At the same time I was being pinged by a few market players that “this Volker Rule is dead.”
Well folks, as our American patriot admitted yesterday, he may very well be dead by the time these reactive short term Washington decisions come home to roost. But as sure as you are waking up to a nice two-day pop in your 401k this morning, Bank of America is paying their bankers $4.4 Billion in bonuses. If you don’t know those bonuses were partly financed by a government sponsored Piggy Banker Spread – now you know.
The Stickler (Bank of America’s spokesperson, Robert Stickler) is seemingly empathizing with the 11% of Americans who are now on the USDA Food Stamp Program (up from 6% when Bernanke took over from Greenspan) saying this morning that, “we attempted to balance the need to pay competitively with our understanding of the general concern.”
Nice Stickler. Nice.
Again, for those incompetent political lemmings who don’t get the trade. Bernanke’s academic background (Great Depressionista) is being used as a political backboard to fear-monger this country into buying that we need an “emergency level of zero percent” interest rates on our hard earned savings accounts for an “extended and exceptional” period of time…
Then, the government supported bankers borrow moneys on the short end of the curve at zero percent, plug the citizenry with a higher lending rate, and keep the spread between what American citizens would have ordinarily kept as fixed income in their savings accounts.
Americans aren’t stupid, but most of the elected politicians using their short term job security duration to judge Paul Volcker’s long term wisdom must be. This morning’s ABC/Washington Post weekly consumer confidence reading dropped from minus -48 to minus -49. Nice Stickler. Nice!
Since no one running this country really gets paid to proactively prepare our children for the long term, let’s just go back to our immediate to intermediate term market views. Pavlov, if you are still out there, at 930AM, will you please ring the bells?
As the fleeting momentum of the “Volcker Rule” faded, so did the price momentum that was being built behind the buck’s credibility. After having a bang up week of +1.7% last week, the US Dollar is down for three straight days this week, and I am feeling the immediate term TRADE shame. Both Gold and the SP500 were up yesterday. I am short both.
I remain bullish on a continued Buck Breakout here in Q1 of 2010. A three-day -0.8% correction from the 5-month high the US Dollar reached on Friday certainly has my attention. So does a +3.4% bounce in the gold price. For now, irrespective of Volcker being put back in the closet, I am maintaining my intermediate term (3-month) view and the positions implied therein. The Fed needs to raise rates.
On US Dollar weakness yesterday, I upped my position in the US Dollar (UUP) to a 12% position in our Asset Allocation Model. Having had sold some into Friday’s strength, this is what I do. It doesn’t always work, but the idea is to buy on red and sell on green, actively managing exposures to my core positions.
On Friday, I titled my Early Look, “Red Light Risk”, and shorted the SP500 (SPY) when it was up a full percent on the rally associated with the Q4 GDP report. That made me look smart for a day, and not so smart yesterday.
I also highlighted the risk associated with what we call Duration Mismatch, using David Einhorn’s long position in gold as an practical example of a difference in opinion on duration. David kindly sent me a note in reply on Saturday morning, and it turns out the only thing we really disagree on is timing.
Einhorn wrote, “We are bullish on the dollar vs. the yen, euro, & pound. We like the dollar more than most everything but gold at the moment. Or maybe we just hate it less than the other currencies. We are long various European sovereign CDS.” My name is Keith McCullough, and I support that message.
I’ll post David’s full rebuttal on our Macro portal sometime today. It was one of the most even-handed and intellectually objective replies I think I have ever had since I started this firm.
If only America’s political leadership had the economic and financial understandings of the real players who wake up to play this game every day like David Einhorn does. Maybe one of the most thoughtful leaders of an American generation of finance wouldn’t have to threaten some crackberry politician with his soul…
My immediate term support and resistance lines for the SP500 are now 1071 and 1116, respectively.
Best of luck out there today,
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.
USO – United States Oil Fund — We have been waiting, patiently, to short the US Oil Fund on an up day, which we got on 2/2/10. We are bullish on the Buck and bearish on China right now. These factors contribute to our multi-factor (bearish) intermediate term stance on the oil price.
EWJ – iShares Japan — We shorted Japan on 2/2/10 after the Nikkei’s up move of +1.6%. Japan's sovereign debt problems make Greece's look benign.
UNG – United States Natural Gas Fund — Macro DJ (Daryl Jones) and I remain bearish on Commodities. Natural Gas had a healthy price pop on 2/1/10, prompting us to short it.
XLE – SPDR Energy — The Energy ETF was up +1.7% on 1/29/10 and we remain bearish on both oil and commodity prices for the intermediate term. Shorting green.
SPY – SPDR S&P 500 — The SP500 broke our intermediate term TREND line earlier this week and remains broken. The 4Q09 GDP report confirms that Bernanke has to raise interest rates. ZERO is not a perpetual policy unless the USA wants to become Japan. We shorted SPY on 1/29/10.
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. Russia’s GDP fell 7.9% in 2009.
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.
“I may not be alive to see the crisis, but my soul will come back to haunt you.”
Yesterday we sold our position in Healthcare; shorted the US Oil Fund and Carnival Corp (CCL). Todd Jordan doesn't see what consensus sees coming for Carnival in 2010. We think demand will continue to languish as the supply and debt issues refuse to go away.
Yesterday, the move in the S&P 500 to the upside was impressive. The S&P 500 closed up 1.3% on 13% day-over-day improvement in volume. The two-day move in the S&P 500 is now 2.73%. The SAFETY trade would be the overriding catalyst for the two-day move as Healthcare (XLV) and Consumer Staples (XLP) are the only two sectors back to positive on both TRADE and TREND.
Yesterday we sold our position in Healthcare. As Keith said yesterday, “As the Pelosi factor creeps into our craws, we are mindful of political risk. Healthcare is up +1.6% here, so Tom Tobin and I will get off the bus, for now.”
In addition, RISK AVERSION was fashionable for a second straight day with a positive data points from Greece (the European Commission's is expected to back a deficit reduction plan); the VIX declined 4.91%, to 21.48 and is now broken on TRADE and TREND. The Hedgeye Risk Management models have the following levels for VIX – buy Trade (20.63) and Sell Trade (22.26). With the earning season more than half over the trends from machinery, AG-products, personal care selected industrial groups are providing additional support to the market.
On the MACRO front, an improvement in December pending home sales coupled with better-than-expected earnings out of DR Horton set a more constructive macro tone to the housing sector and the RECOVERY trade. Pending home sales increased 1% month-to-month in December, in-line with expectations, but significantly better that the downwardly revised 16.4% plunge in November. It should be noted that consensus expectations are for pending home sales to strengthen into the spring on the back of low prices and mortgage rates and the extension of the homebuyer tax credit.
The Industrials (XLI) was the second best performing sector yesterday and Hedgeye Risk Management models have the XLI moving back to positive on TREND. A strong earnings number out of Emerson Electric (EMR) took the stock up 10.1% on the day. In addition, the machinery group outperformed for the 2nd straight day with the S&P Machinery Index up 1.9%. It also should be noted that there were better-than-expected January auto sales from F and GM.
The Financials (XLF) was the 3rd best performing sector yesterday, improving 1.7%. The improvement can be attributed to the belief that banking regulation will get severely diluted if it is ever passed into law. Within the XLF, the money-center banks (JPM, C and BAC) outperformed the regional’s.
Yesterday, Consumer Discretionary outperformed by 10bps and moved to positive on the TREND duration. The retail group was a contributor to the outperformance; the S&P Retail Index rose 1.35%. Department stores outperformed for a 2nd straight session day and Barnes & Noble was up 7.78% after Ron Burkle is looking to acquire a significant position in the company. The lower-beta names like the discount and dollar-stores underperformed.
As we look at today’s set up the range for the S&P 500 is 45 points or 2.9% (1,071) downside and 1.1% (1,116) upside. Equity futures are trading above fair value after yesterday’s strong performance. Today performance will likely be driven by more earnings which continue to be better than expectations.
The Dollar Index decline for the second day in a row and the Hedgeye Risk Management models have the following levels for DXY – buy Trade (77.94) and sell Trade (79.56).
In early trading Copper is extending its gains for a 3rd day, as the rally in RECOVERY trade and a weaker dollar is helping the demand outlook. The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.96) and Sell Trade (3.21).
In early trading Gold is up for the 4th straight day as the dollar has weakened. The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,076) and Sell Trade (1,119).
Crude oil rose in New York for a 3rd day before data that is expected to show that U.S. supplies of distillate fuels shrank last week. The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (72.21) and Sell Trade (78.31). Yesterday, we shorted the US Oil Fund. We have been waiting, patiently, to short the US Oil Fund on an up day.
We continue to be bullish on the Buck and bearish on China. These factors contribute to our multi-factor (bearish) intermediate term stance on the oil price.
The Macau Metro Monitor. February 3rd, 2010.
HOME PRICES GOING UP macaubusiness.com
According to a Savillis report published January 27th, home prices are projected to rise as much as 15% in Macau in 2010. In 3Q09, the average transaction price of residential units rose by 27.6% q-o-q to MOP24,154 per square meter of usable area in Macau and by 35.8% to MOP24,158 psm on the peninsula. Prices rose by 29.6% in NAPE to MOP51,296 psm and by 6.8% in Taipa to MOP23,897 psm.
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Will growing “until the cows come home” come back to bite em in the butt?
I want to be clear: Yum will continue to grow in China for years and years. What I’m focused on is the rate at which Yum is growing in China.
On the surface, it does not follow that a country where the economy is growing by 10% and consumer confidence is on the rise, that concepts like KFC would be having problems. I have been told many times by senior management at YUM that taking a traditional U.S. restaurant analyst approach to analyzing China business is just wrong. Call me stubborn, but here I go.
I’m trying to understand why Yum’s same-store sales in China have been coming down on a 2-year average basis throughout 2009 (and guided to come down again in 2010) when the MACRO backdrop is seemingly so positive. Why are the issues that KFC faces in China any different from any other country in the world? We see three major issues facing YUM in China: increased competition, over-building, and deteriorating brand perception among consumers due to health-related isses such as obesity.
As the chart below indicates, macro factors are providing somewhat of a tailwind. Overall consumer confidence is improving (though not reflected in sentiment towards fast food) and GDP is growing, yet YUM’s China same-store sales have gone in the opposite direction.
COMPETITION - Our contacts on the ground in China suggest that in the older, more mature cities where KFC has been for years there is significantly more local competition from smaller local players that can compete effectively on price. Not to mention that McDonald’s has made great strides in increasing its pressence in those cities as well. We have also heard that because the KFC brand is now much better known in China, when KFC opens in newer cities it has what I call the “Cheesecake” problem. The new units are so big and glamorous that they operate at peak volumes and then subsequently, struggle to grow same-store sales thirteen months later. This is not a bad problem to have until a chain begins to canabilize sales by increasing capacity in order to achieve economies of scale.
It is interesting to take our propietary comments in the context of what we heard from McDonald’s management on its most recent earnings call. “I think on an overall basis the pricing relationships in China in the quick service restaurant industry are in an interesting dilemma because of who you are competing against which is a very low price menu on the street from the non sort of chain restaurants and food available. We are not necessarily discounting but what we are doing is getting our price right in relationship to the economic time that we find ourselves in which is an ongoing pricing relationship as compared to a discounting of our food. And it moves up and down the scale depending on where we find ourselves in the consumer spending. As we’ve said, I think the environment of China which basically fell off a cliff after the 2008 Beijing Olympics. We’ve adjusted accordingly along the way to be relevant with our consumers and it’s worked well for us.”
MCD’s comments highlight that despite improving consumer confidence, YUM is not the only QSR player in China facing a slowdown in demand. The defining factor for YUM, however, is that the company is more leveraged to performance in China as management likes to point out that it continues to widen its lead in the Western QSR category with its approximately 1,700 KFC units in Mainland China relative to MCD’s 1,150 units. In 2009, MCD cut back on growth in China in response to what it called a marketplace that was not growing while YUM maintained the pace of growth it had outlined at the beginning of the year (500 new units).
SUSTAINABILITY - Sustainability issues are looking to be a big red flag in China. The issues stem not from growth alone, but rather from the company’s rate of growth. For the past three years, YUM has raised its level of capital spending in China (forecast to grow another 9% in 2010) to roughly 10% of sales in 2009. Over the same timeframe, operating margins in China have declined to close to 16%, based on my estimates, from nearly 18% in 2006. And, return on incremental invested capital (ROIIC) has come down every year since 2006, albeit from a very impressive level. In 2009, ROIIC should come in just better than 30%, but that compares to nearly 50% in 2007 and about 45% in 2008. Based on my numbers, both margins and ROIIC will continue down on their current trajectory in 2010. Focusing too much on same-store sales and on the fact that 2-year average trends will continune to come down in 2010 may be the U.S. centric way of analyzing trends in China (as management likes to talk about system sales growth), but I can’t disregard declining margins and returns.
YUM’s mentality in China is to grow “until the cows come home” - no matter what. When a majority of management’s compensation is dependant on “system-wide sales” growth and comps are negative, the only way to get a bonus it to grow units. Over the past four years YUM has taken its total number of units in China from about 2,300 in 2005 to almost 4,000 today , with the company first talking about canabilization in 3Q05. At the time, CEO David Novak was quoted as saying that the company was cannibilizing units because four years previously, in 2001, “we thought we were starting to see some potential cannibilization in China and…we put the pedal to the metal and look at the business we’ve built”.
While YUM has taken down its total capital spending in 2009, it is forecast to grow its spending in China by about 9%. This 9% rate of growth expected in both 2009 and 2010 is toned down from the 40%-plus growth in the prior two years, but it appears that current trends should dictate further slowing in the coming years.
The likelihood of YUM slowing growth in China any time soon is low as management has publicly stated, “We could drop our sales 20%-25% and open restaurants until the cows come home - so that's what we plan on doing.” I contend that if the issues of over capacity are real and YUM maintains an accelerated pace of growth, it will exacerbate the problem.
CONSUMER PERCEPTION - In the late 90’s and early 2000’s, McDonald’s had a major problem in the U.K. dealing with consumer perception, particularly around health related issues. Based on recent performance by both YUM and MCD in China, it appears that QSR in general is facing some consumer backlash in China. Concerns about obesity preoccupy Chinese citizens and authorities alike and an awareness campaign has been launched by the government to highlight the dangers of fast food with vivid images of children playing among oversize food laced with glass and scorpions. The article, posted on france24.com, was entitled, “China scaring kids out of fast food chains”.
Obesity is a growing concern in China, and it is clear that the association between U.S.-style fast food and child-safety is being emphasized by the government.
Even if consumer confidence and GPD numbers are rising, there appears to be some MACRO related issues at play in China, too, as McDonald’s made perfectly clear on its 4Q09 earnings call.
“Now China, although their economy is improving and we delivered an increase in comp sales and guest counts in December, we expect it will still be sometime before consumers regain confidence and are willing to spend more.” NOTE: this contradicts a study that we referred to earlier in this post.
MCD’s management also went on to say - “Regarding China, a couple of things, yes we did report positive sales and guest count movement in December. You won’t see that in January though because we have the shift of the Chinese New Year so last year that was in January and this year it will be in February so by comparison that will be a little bit choppy. But, we’re optimistic in what we’re seeing with the trends. We’ve talked about China in the south, and the central and the north so we saw all three of those areas improving in December and are kind of cautiously optimistic as the consumer starts to spend a little bit of money there that we will then be able to get a little bit more out of price and get a little more traffic moving there so that’s a perspective for you.”
Another potentially important MACRO focus-point is the urban youth of China. While I have been advised by YUM’s management not to apply American logic to Chinese scenarios, I would hazard a guess that younger people are a somewhat important demographic for fast-food chains. A telling piece on France24.com entitled “Beijing graduates crammed into slums like ‘ants’” shows the harsh reality for graduates living in urban China. It is clear that these graduates are not frequenting western fast-food chains.
The photo (shown below) is followed by a comment by one such graduate living in Beijing, “This is a place to eat. It’s cheaper than in the rest of Beijing. But people only eat out for breakfast – the rest of the time we cook in our bedrooms.” Local players, whether operating out of premises or off the street, are providing formidable competition for YUM.
MPEL missed by even more than we thought but the story was not Q4. Rather, market share and EBITDA rebounded in January and if the trend continues, 1Q2010 results will handily beat the street.
MPEL missed our revenue number by only $6MM or 1.5%, but missed our EBITDA which was roughly 50% below consensus by a mile. The miss was everywhere with the exception of CoD, which is where the potential value of MPEL really lies. We knew that hold would be bad, in fact, we had correctly estimated hold % at 2.4%. So what happened this quarter? While MPEL doesn’t give you the exact breakdown between CoD and Altira, we always try to piece together the numbers given the data. Below are the details.
City of Dreams
- CoD revenues were $5MM below our estimate of $243MM but EBITDA at $22MM was spot in line with our expectations
- Not unlike the Venetian Macau, now that CoD has been open for a few quarters they are realigning their gaming floor to match demand (ie. removing supply). In Q4, average tables were reduced by 22 and average slot machines were 38 lower than 3Q09
- RC volume and VIP win was higher than we estimated as a result of higher direct VIP play. We estimate that direct VIP was 19% of total RC vs. our prior estimate of 12%. Given the higher profitability of this segment, it is an encouraging trend.
- Mass win, estimated at $75MM was about $1MM light of our estimate. We think that hold at CoD was a little better than the 17.5% average hold on Mass
- Slot handle was $59MM better than our estimate, but this was offset by lower win % of 5.4% vs our estimate of 6% hold. Net net, slot win was $1MM better than we estimated
- Net casino revenues were $5MM below our estimate, while non-gaming and promotional expenses were in line with our estimates. The miss on revenues was made up by lower fixed costs and lower expenses on non-gaming revenues.
- Altira revenues were $5MM below our estimate of $138MM and EBITDA missed our estimate of -$6MM by $8MM
- In the quarter, average tables were reduced by 16 vs. 3Q09
- We suspect that slightly better table results at Altira were more than offset by higher discounts & promotional expenses. Normally we estimate “discounts & other” at .83% of RC for this property, however, this quarter that ratio ticked up to .96% of RC volume
- Net casino revenues were $5MM below our estimate, while non-gaming and promotional expenses were in line with our estimates. The miss on revenues was further exasperated by higher costs – some of which were temporary and associated with the switch away form AMA
- Given the strong January results, and the likelihood of strong February, we raised our EBITDA estimate for 1Q2010 to $95MM on estimated revenues of $583MM
- CoD: $330MM of revenue and $60MM of revenues
- Altira: $227MM of revenue and $28MM of EBITDA
- Mocha Slots: $27MM of revenue and $7MM of EBITDA
- For FY2010 we are estimating $2.25BN of revenues and $350MM of EBITDA
- CoD: $1.3BN of revenue and $268MM of EBITDA
- Altira: $825MM of revenue and $85MM of EBITDA
- Mocha Slots: $103MM of revenue and $27MM of EBITDA
Paul Volcker is reminding the willfully blind on the Senate Banking Committee right now that they live and operate in a Bubble of US Politics. His basic message is that everyone at Investment Banking Inc knows exactly what prop trading is, and that it shouldn’t be back-stopped by the government.
In the end, I think the Volcker Rule makes the American Financial System a less volatile and less cyclical place to transact. So, I support Volcker’s basic demand here – get London on board and get it done. That’s my long term (TAIL) view.
For the immediate term TRADE and intermediate term TREND in the SP500, the answer is less clear. I have basically been selling the entire way up this week, and now the SP500 is jumping above what I call the Shark Line (the 1099 line). A close above that line gives my short position in the SP500 pain until 1116, where I plan on shorting it again. All we are doing here is making a series of lower-highs.
A close below 1099 puts 1071 in play on the downside.
Keith R. McCullough
Chief Executive Officer
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