Keith moved to neutral (from bearish) on the SP500 on the week of February 22.   On Friday at 1139, for the immediate term TRADE, he moved back to bearish and shorted the S&P 500. This market is finally overbought!


The S&P 500 finished out last week on a strong note, with the S&P500 closing up 1.4% on Friday and up for six straight days.  On the MACRO front, the calendar offered a fairly strong tailwind Friday as February nonfarm payrolls fell less than expected.   In addition sovereign concerns continued to wane with the New Greek austerity package and the success of its 10-year bond sale. 


In addition, there were no surprises out of China, as Premier Wen reiterated his aim of supportive fiscal policy and appropriately accommodative monetary policy.  As a result, the VIX continues to confirm the RISK AVERSION trade.  VIX declined 10.67% last week and today’s setup of the Hedgeye Risk Management models have levels for the volatility Index (VIX) at:  buy Trade (17.29) and sell Trade (21.54).  The VIX continues to be broken on all three durations – TRADE, TREND, and TAIL.


As we highlighted in our morning meeting, the Financials sector continues to provide leadership to the upside; the Financials were the best performing sector on Friday, rising 1.9%.  The banking group led the way with the BKX +2.5%; regional and money-center names both out performed. 


The employment data seemed to be a big catalyst for the Financials given the implications for the credit cycle.  On Friday, nonfarm payrolls fell 36,000 in February vs. consensus expectations for a 68,000 decline.   The unemployment rate held steady at 9.7%, while a Bloomberg survey was looking for 9.8%. Also note that the household survey showed a 308,000 increase in employment following the 541,000 gain in January.  Average weekly hours fell a less-than-expected 0.1 to 33.8 in February, though average hourly earnings rose just 0.1% month-to-month and 1.9% year-over-year.


On Friday, Technology (XLK) moved to positive on TRADE and TREND.  That leaves Utilities the only sector broken on TREND.  Within the Technology, AAPL was up +3.9%, a bell weather for the group, broke out to new all-time highs after announcing that the iPad will be available in early April.   We continue to be long the XLK.


Commodity-related equities largely outperformed on Friday.   The RECOVERY theme got a boost on Friday from the February jobs number as the Energy (XLE) and Industrials (XLI) outperformed the S&P 500.  Although, it should be noted that the dollar was down slightly on Friday and only up slightly for the week.  Today’s set up of the Hedgeye Risk Management models have levels for the Dollar Index (DXY) at:  buy Trade (80.08) and sell Trade (81.07). 


As we wake up today, equity futures are trading modestly below fair value in what appears to be a slow start to the trading week on the heels of last week's move in the S&P.  Today's MACRO calendar is void of any significant events.  As we look at today’s set up the range for the S&P 500 is 37 points or 2.3% (1,113) downside and 1.0% (1,150) upside. 


In early trading copper is trading higher for a second day as the weaker dollar and signs of improvement in the U.S. economy increased investor demand for copper.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (3.33) and Sell Trade (3.49).


Gold is slightly lower in early trading, despite the dollar trading slightly lower.    The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,122) and Sell Trade (1,149).


In early trading, oil is trading at a two-month high above $82 a barrel in New York amid growing confidence that the economic recovery is proceeding and set to increase demand.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (79.74) and Sell Trade (82.13).


Howard Penney

Managing Director














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The sell side brushed off muted near term outlooks given by the suppliers on their last conference calls and now they are lowering estimates. Stocks are underperforming but do the next few quarters really matter?



Three issues for Q1 CY2010, the last of which should’ve been expected given the last conference call commentary:

  1. Alabama
  2. Weather – impacts gaming operations
  3. Replacements suck


So Goldman Sachs did a survey that indicated casinos were not accelerating replacement buying as much as he thought.  He lowered estimates on the “Big Three” and cut his sector rating and the rating on BYI and IGT.  Other analysts followed suit and cut estimates. 


The question we have is what took you so long?  It’s not like these companies were bullish about the near term.  Each management team made cautious comments about the March quarter:  WMS actually gave revenue guidance below the Street but analysts maintained their estimates and IGT was challenged for sandbagging but it's now apparent they were being realistic.  Bullish analysts were apparently blinded by, well, their bullishness.


Here are some thoughts about each of the Big Three:



  • We remain at $0.17 for FQ3 (March) while the Street has come down to $0.20.
  • IGT probably has more exposure to both the Alabama issue and the bad weather.  IGT’s market share in gaming operations is much higher than it is for slot sales so weaker play in the regional markets hurts them more than WMS or BYI.
  • Stock has been pretty weak lately but we still think IGT has company specific issues to contend with.  While their new products are solid, market share remains under pressure (FQ1 was awful) and the company remains over reliant on the “Wheel” games.



  • We are at $0.61, below the Street at $0.63.
  • Like IGT, BYI will take a hit from Alabama and to a lesser extent, the bad weather.
  • BYI is less reliant on slot sales so they may have a little more cushion.  However, software sales are very difficult to project.
  • At less than 15x our FY2011 (essentially forward 12 months) estimate of $2.68 the stock is beginning to look attractive.  Without a near-term catalyst, however, BYI could continue to trade off.
  • The real story is new markets, the potential for even more new markets (thanks to out of control state governments), and a bounce off trough replacement demand.  We think we are at the bottom of a five year bull cycle in earnings and stocks.



  • We remain at $0.47 vs. the Street consensus of $0.49.  We have a higher level of conviction in the March quarter for WMS than the other suppliers.
  • Alabama will not affect WMS.
  • WMS has the highest play per participation game of any of the three suppliers so they should be less impacted by the bad weather.
  • We expect WMS replacements in FQ3 to exceed that of FQ2.
  • WMS at $38.36 trades at only 16x our FY2011 estimate.  The stock could get cheaper as earnings expectations continue to fall.  Again, we think earnings will be fine.
  • The real story is new markets, the potential for even more new markets (thanks to out of control state governments), and a bounce off trough replacement demand.  We think we are at the bottom of a five year bull cycle in earnings and stocks.


Recent surprises in weaker home sales, new jobless claims (not including last week’s number) and declining consumer confidence have not been of any consequence to restaurant stock performance.  Along with retail sales in general, restaurant sales trends (primarily casual dining) continue to make sequential improvement.  Sales trends have improved across the board, but growth has been most evident in the chains that are better positioned competitively and appeal to higher end consumers.


The nearly two year decline in consumer credit has been a big contributor to lower customer counts in the casual dining sector.  The Government data posted on Friday suggest that the bulk of the contraction in credit is behind us.  While significant credit expansion is not likely any time in the immediate future, the current numbers are indicating that sales trends could be stabilizing.


A trend worth watching…


RESTAURANTS – CONSUMER CREDIT VS CASUAL DINING - knapp vs consumer credit outstanding Jan


RESTAURANTS – CONSUMER CREDIT VS CASUAL DINING - knapp vs consumer credit outstanding 2 yr Jan



Howard Penney

Managing Director

Risk Management Time: SP500 Levels, Refreshed...

Hope is healthy (I do it every time I look into my baby girl’s eyes); but hope is not an investment process.


My macro model, which re-prices risk every 90 minutes, says anything north of 1138 in the SP500 is immediate term overbought (dotted red line in the chart below). At 1139 (where we just shorted the SP500 in the Virtual Portfolio) the market is up +7.8% from February 8th in as close to a straight line as you’ll see in a monthly data series.


In terms of Mr. Macro’s global interconnectedness, there is a mathematical reality that’s not ironic about February 8th. That was the day that the Athex Index in Greece put in her Freakout YTD low at 1806. Greek stocks are up more than 2x the SP500 (+15.3%) since.


While Selling Fear is easy for the Manic Media to do, getting bullish after markets run-up is even easier. Now is a good time to make sales and take advantage of its immediate term hope. Today’s employment data is explicitly hawkish. That’s why Treasury rates are busting a move higher (bonds lower). Bernanke can only pretend that he doesn’t see real-time economic data for so much longer before he has to remove the “extended and exceptional” language from the Fed’s currently compromised policy of zero percent American money.


In terms of lines of support, I think we could see a fast correction to 1113. You want to be buying/covering down there as the intermediate term TREND line of support (1106) that’s underpinning this market’s strength is real.


Have a nice weekend,



Keith R. McCullough
Chief Executive Officer


Risk Management Time: SP500 Levels, Refreshed...  - s p


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