China'a Adam's Apple

“The tighter you squeeze, the less you have.”

-Thomas Merton


China is tightening reserve requirements on its banks by another 0.5% this morning. This is not new. This is a longstanding reminder that the tighter you squeeze a banker’s lending terms, the less he has.


In sharp contrast to Western politicians, the Chinese government doesn’t seem too keen on bailing out bankers or juicing up the pre-market futures of its stock market. China’s strategy in dealing with lenders appears to be far less diplomatic.


After seeing that moon-shot Chinese loan growth number of 1.39 Trillion Yuan for the month of January (reported yesterday), Big Brother China appears to share the tactical view of one of America’s Three Stooges, Moe Howard, telling their local lenders that, “I’ll squeeze the cider out of your Adam’s apple.”


With that, we enter the waning hours of China’s Lunar Year – the Year of The Ox – and, oh, what a year it was. By the end of the Western world’s calendar year, the Shanghai Composite was up +80%, GDP was running double digits at +10.7%, and China was still reporting year-over-year deflation in its Consumer Price Index (CPI). Economic nirvana, in the rear-view. Then, after Goldman said “buy China” in early January, the music of free moneys stopped.


Alongside Buck Breakout and Rate Run-up, this has been one of our Top 3 Macro Investment Themes for Q1 of 2010. We called it Chinese Ox In a Box. We will be reviewing these 3 Macro Themes on a special intra-quarter conference call after this long weekend. If you’d like to participate in that call, please email . As usual, our subscribers will have some great questions and we won’t have Investment Banking Inc. auditing our answers.


We were bullish on China for most of last year, and our long term TAIL (3 years or less) call on China’s economy remains intact. However, our call for the Chinese Ox In a Box here in Q1 has us short China (CAF) for both immediate and intermediate term durations. We call these durations TRADE and TREND.


Conceptually, we do not like to think within the sell-side box. We pressure ourselves to consider multiple durations and multiple price outcomes across those durations. Some investors have one duration – long term - and are willing to remain long something like China’s stock market for 10-20 percent corrections. As Real-Time Risk Managers, that’s definitely not what we do.


Currently, because we are bearish on China doesn’t mean we are calling for a crash. We are simply calling for what the Chinese government has told us it is going to do – slow speculative growth. There are plenty of places to quantify Chinese speculation, but here are 3 factors we have been proactively anchoring on:


1.       Money supply growth

2.       Chinese Yuan-based loan growth

3.       Chinese stock prices


Money supply growth (M2) is already slowing (from +29.7% y/y growth in November to +26% y/y just reported for January). Chinese Yuan based loan growth is accelerating (the January print of 1.39T Yuan implies y/y growth of 73%! versus last year’s record +52% annualized pace). And Chinese stock prices are some of the worst performing, globally, for 2010 to-date.


So, all in, 2 of 3 fixes are in motion and the last one to fix is most likely to correct most abruptly. To some extent, seeing a final rip higher in Chinese loans this past month makes sense. If you know Big Brother China is going to tighten, you probably clamor to borrow as much as you can before he actually does good by his promise.


You see, in China, they mean what they say, and they do what they mean. While the Chinese have yet to raise interest rates on their benchmark lending rate or allow the Chinese Yuan to appreciate, those two things are coming to a CNBC pre-market open theater near you as well. So, again, that’s a foreseeable global macro risk that you shouldn’t wake up surprised to like people are, evidently, here in the US this morning.


From a risk manager’s perspective, I can simplify all 3 of the aforementioned research factors by correlating them with the lines of support and resistance in my 3 factor duration model (TRADE, TREND, and TAIL). For the Shanghai Composite, here are those lines:


1.       TRADE line resistance = 3098

2.       TREND line resistance = 3176

3.       TAIL line support = 2881


Put another way, I will cover my short position in China (CAF) as the real-time market price approaches my long term TAIL of support at 2881. Last night, the Shanghai Composite closed at 3018 (down -7.9% YTD), so that gives me another -4.5% of downside from here.


Again, I am currently not calling for a crash, nor am I saying I may not start to call for a crash. What I always say is 1. that as the game changes, I will, and 2. that as people start to freak-out about China, I have a proactive plan to cover my short position and consider the long side again. Everything has a time and a price.


A drop to 2881 would equate to a -13.7% correction in Chinese equities versus the recent cycle-peak made of 3338 on November 23, 2009. As the crowd rolls in here worrying about Chinese tightening, you want to roll out. Understand that this situation is A) not new and B) likely to continue, to a point.


Chinese property stocks peaked in July of 2009. The healthy correction in those stocks obviously isn’t new either. Yes, “the tighter you squeeze, the less you have,” but markets move on expectations, not yesterday’s news.


Expectations for Chinese bankers and levered long only stock market speculators alike are well entrenched. They expect to have the “cider squeezed out of their Adam’s apple” if they don’t tone it down. Just remember that as CNBC scurries away from focusing you on Greece.


Best of luck out there today and have a great long weekend,





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 — We added to our position in Germany on 2/4/10 on 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.  

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 We re-shorted Gold on this dead cat bounce on 2/11/10. We remain bullish on a Buck Breakout and bearish on Gold for Q1 of 2010, as a result.


CAF – Morgan Stanley China The Chinese Ox Remains In A Box. We shorted CAF on 2/10/10 ahead of another inflationary report that registered China’s CPI at +1.5% in January Y/Y, and PPI at +4.3% Y/Y.


RSX – Market Vectors RussiaWe shorted Russia on 2/9/10 and maintain our intermediate term TREND bearish view on the price of oil.


XLP – SPDR Consumer Staples The Consumer Staples sector finally broke both our TRADE and TREND lines on 2/8/10. Given how many investors own these stocks because it was a "way to play the weak US Dollar" last year, we have ourselves another way to profit from a Buck Breakout with this short position.


EWW – iShares Mexico Mexico short is a solid compliment to our concerns about sovereign debt risks and our bearish intermediate term view on oil.


EWJ – iShares Japan We re-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.


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.


Yes, the numbers were in-line with our projections but the underlying metrics were not encouraging. Same store volumes were awful as CityCenter actually took a big bite thanks to Baccarat and luck.



We were surprised by the positive reaction the Street had to the positive growth in the December Las Vegas Strip revenues yesterday.  A deeper analysis indicates that they underlying metrics were not good with the possible exception of MGM’s CityCenter. 


In the Nevada Gaming Revenue Report released yesterday, CityCenter numbers actually fell in a different category than those of the rest of the mega properties since it was open for about half of the month.  Nevada groups casinos into revenue categories of $36-72 million and greater than $72 million.  CityCenter would normally be grouped in the latter but for this month only, it fell into the former category.  This allows us to approximate CityCenter’s revenues since there was no other major supply in the $36-72 million category.  Here is what we found.


CityCenter generated about $57 million in gaming revenues for the 15 days it was open in December.  Before people get too excited about the annualized $1.3bn in gaming revenues this number implies, we have a couple of comments.  First, over 80% of that revenue came from Baccarat which always spikes during the Christmas to New Year’s season.  Second, with MGM’s database of high end Baccarat players, it is very easy to concentrate players at one property while cannibalizing its other high end properties such as MGM Grand and Bellagio.  Finally, CityCenter played very lucky which contributed around $15 million in additional revenue – over 25% of the total.  Until we see how MGM’s other properties performed it is impossible to draw any lasting conclusions from the initial CiityCenter results.


Unfortunately for MGM, the same store metrics suggest that December was not a good month for the existing properties.  Our discussion here will be concentrated on volumes (slot handle and table drop) because revenue can be swayed significantly by luck.  We focus on volumes in the greater than $72 million category because that is where most of the major properties fit and CityCenter, at least for December – is not included there.  The major properties of WYNN, LVS, and MGM all fall into this category.  The following chart details the important same store metrics (>$72m) versus the Strip total.


DECEIVING DECEMBER ON THE STRIP - dec strip ss metrics


The clear takeaway is that same store volumes were not good.  Probably the purest, highest margin, and most stable indicator of Strip health, same store slot volume, fell 15%.  Despite the boost from China Baccarat players, same store table drop declined 12%.  Adjusting for the much higher slot hold percentage, total same store revenue in the category would’ve fallen almost 14%.


Yesterday, MGM, LVS, and WYNN, climbed 9%, 7%, and 6%, respectively.  Some of it was beta to a strong market but these stocks really took off when the Nevada numbers hit the tape.  Expectations for Macau are already high – justifiably so – and now it looks like they are for Las Vegas too.  We’d fade that optimism.

US STRATEGY – Dr. Jekyll and Mr. Hyde

"Any change is resisted because bureaucrats have a vested interest in the chaos in which they exist."     

-Richard M. Nixon


From a MACRO perspective there were a number of undercurrents that put a bid under the market yesterday.


(1)    Getting past the Greek contagion issue improved the RISK AVERSION trade

(2)    A below-consensus January CPI print out of China buoyed the REFLATION trade

(3)    Initial jobless claims fell sharply in the first week of February helping the RECOVERY trade

(4)    The earnings season is supportive of the RECOVERY trade


That said the S&P 500 rallied by 0.97% yesterday, albeit on light volume.  The VIX declined 5.67% yesterday and has now declined 9.9% over the past three days.  The VIX remains positive on TREND at 22.43.  The Hedgeye Risk Management models have the following levels for VIX – buy Trade (22.43) and Sell Trade (28.28).  Yesterday, both the Consumer Discretionary (XLY) and Industrials (XLI) joined Healthcare (XLV) as positive on TREND.


As we are waking up today, equity futures are currently trading below fair value as China's Central Bank raises reserve requirements by 0.5% and Germany Q4 GDP data was disappointing.  This has the Dollar index up by nearly 1% in early trading.  The Hedgeye Risk Management models have levels for DXY at – buy Trade (79.69) and sell Trade (80.69). 


On the MACRO calendar today are retail sales and the University of Michigan consumer confidence.  In a post yesterday we suggested that the confidence number is likely to be disappointing, given an independent survey we look at that tracks closely the more widely disseminated University of Michigan.


Yesterday, initial claims fell 43,000 to 440,000 to the lowest level in a month and compared with consensus expectations for a decline to 465,000. This brings the 4-week rolling average down 1.5k to 468.3k from 469.8k last week. This is an important print as it reverses the negative trend of the last three weeks, and keeps the trajectory in-line with the data trends since March 2009.


The two best performing sectors yesterday were those that benefited from the REFLATION trade - Materials (XLB) and Energy (XLE).  Commodities and commodity equities benefitted as the dollar index gave back all of its earlier gains and ended down slightly.  Steel stocks led the XLB; US Steel was the standout in the group after a sell side upgrade. Coal stocks and an outsized rally in natural gas were the bright spots in the XLE. 


The Financials (XLF) are like Dr. Jekyll and Mr. Hyde.  Over the last three days the XLF has gone from worst, to best, back to the worst performing sector yesterday.  There was no overriding catalyst behind the underperformance, as the Insurance names were mixed following earnings from Prudential and the big investment banks were moving in opposite directions. 


As we look at today’s set up the range for the S&P 500 is 53 points or 2.9% (1,046) downside and 1.9% (1,099) upside. 


In early trading, copper dropped in London after the biggest weekly rise in more than a year, on concern that a surge may have been overdone.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.80) and Sell Trade (3.14).


In early trading gold fell in London with a stronger dollar and China’s move to cool its economy.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,045) and Sell Trade (1,112).


Oil is trading down with the rest of the commodity complex and a stronger dollar.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (70.37) and Sell Trade (77.23).


Howard Penney

Managing Director


US STRATEGY – Dr. Jekyll and Mr. Hyde - sp1


US STRATEGY – Dr. Jekyll and Mr. Hyde - usd2


US STRATEGY – Dr. Jekyll and Mr. Hyde - vix3


US STRATEGY – Dr. Jekyll and Mr. Hyde - oil4


US STRATEGY – Dr. Jekyll and Mr. Hyde - gold5


US STRATEGY – Dr. Jekyll and Mr. Hyde - copper6


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CMG reported better than expected 4Q09 earnings of $0.99 per share relative to my $0.84 per share estimate and the street at $0.81 per share.  The reported 2.0% same-store sales growth also beat the street’s 1.4% estimate, but fell 30 bps shy of my estimate as traffic, though positive in the quarter (+0.6%), did not improve to the magnitude I was expecting on a 2-year average basis. 


CMG margins improved much more than I anticipated in the quarter, enabling the company to post record level margins in 2009.  In the Q&A, management stated that current margins were sustainable, which was surprising given that its earlier comments signaled there would be increased pressure on margins in 2010.  Specifically, management maintained its guidance for flat same-store sales, saying that it does not currently have plans to take any pricing in 2010; though management did make a point of saying that it does have pricing power.  Additionally, when outlining its outlook for 2010, management said that it expects labor leverage to end or de-lever slightly.  It does not anticipate occupancy leverage as the majority of new restaurants will continue to open in more expensive areas with higher rents. Marketing expense as a percentage of sales should increase to 1.75% from 1.4% in 2009 and the company does not anticipate any G&A leverage.  To maintain margins in 2010, based on these expectations, would imply a lot of leverage on the food cost line, but management stated that it expects food costs to be relatively flat. 


When questioned directly about its statement about maintaining margins, management said that “when we talk about largely sustainable we are talking at more of a strategic level…. And so we think that largely these margins, we can sustain them.  Now it doesn’t mean we’ll sustain them each and every quarter, doesn’t necessarily that means that we’ll sustain it for the full year of 2010, but strategically these margins are things that our business model would allow us to hold on to.”  This response left me less surprised as I don’t see the company being able to sustain these peak margins in 2010, largely as a result of the cost pressures outlined by management, combined with the fall off in pricing. 


As I said earlier, management did say that CMG has plenty of pricing power and although no price increases are planned right now, if the company experienced food or wage inflation creeping in, it could take pricing.  These comments leave me thinking that CMG will take pricing in 2010 because wage inflation is likely and the company will be lapping the labor initiatives from 2009.  And, if traffic does not come back quickly, management will take pricing to offset any higher costs.  Despite management’s confidence in its pricing power relative to its competitors, increasing prices will only be a detriment to transaction growth.  That being said, even if management can take pricing in 2010, it cannot afford another 6% price increase to support margins.


Other interesting takeaways:


-Regarding early trends in 1Q10, management said, “We ran slightly positive transactions [in January] and then we hit the severe snowstorms in February and so it’s not possible for us to tell what the sustaining underlying trend would be. We have to let the weather clear and then see what happens.”


-Management also talked enthusiastically about its new marketing campaign, which it is set to launch in 2Q10.  According to management, the campaign will “speak more directly to Food With Integrity and our food culture but in a tone that our customers will recognize as Chipotle. This campaign will appear in print, outdoor, on radio and online in markets around the country beginning in the second quarter.”  I am less enthused about the prospects of this campaign as brand-specific messaging typically has little impact, but rather, advertising specific price points is necessary to really drive traffic.  The company is also developing a loyalty program, which is more interesting; though management did not provide too many details.






Tomorrow we get the preliminary University of Michigan Confidence number for February. 


We get an early look at consumer confidence for the month of February from BIG Research.  Their survey reaches out to over 8,000 consumers each month.


As you can see from the chart below the two surveys very closely mirror each other.  In the Big Research survey, the wintery weather is dragging down consumer confidence.  Those consumers that are very confident/confident in chances for a strong economy dropped to 27.2% in February 2010, nearly three points lower than January 2010 (30.0%), and the lowest reading recorded since Jul-09 (also 27.2%). While confidence has improved from a year ago (19.4%) as well as Feb-08 (26.2%), keep in mind that the majority (53.2%) was confident back in Feb-07. 


If the relationship between the two surveys holds for the preliminary number tomorrow, we could be reading about a 3-4 point drop in the University of Michigan consumer confidence number.


The market stumble in late January and early February, coupled with a President whose approval ratings is uninspiring.  Given the surprising drop in the unemployment rate, a decline in consumer confidence could be unwelcome news.    


Howard Penney

Managing Director







Given the positive stock market reaction, investors were surprised by the 6% increase in Dec Strip gaming revs. Due to low table hold %, the Strip actually missed our +8% projection.



In our 1/25/10 post, "AIRPORT TRAFFIC DOWN BUT REVS MAY BE UP", we had predicted +8% growth in Strip gaming revenues for December based on expected strong Chinese Baccarat play and easy hold percentage comparisons with December 2008.  Of course, our projection assumed normal hold.  Table hold percentage was below normal in December 2009 once again, although slot hold was a little better.  Normalizing both provides a +8% increase in Strip gaming revenues, exactly in-line with our projection.


Baccarat continues to be the story with win up 102%, and while hold percentage was better than last year, volume was still up 23%.  It will be interesting to see if the Baccarat segment can maintain its recent explosion, similar to Macau VIP, as the liquidity and credit tightens in China and GDP slows sequentially.  On the negative side, slot volume declined 11.5% while slot volume per visitor declined 12.8%. 


Here is a 2 year monthly chart of the performance of these very important metrics:



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