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US STRATEGY - DON'T GET FOOLED

Yesterday, the S&P 500 finished lower by 0.33%, while breadth continues to deteriorate and volume spiked nicely (up 26% day-over-day).  Despite this week's holiday shortened week, volume was slightly better than the average over the last 100 days of trading.  While it’s hard to quantify, quarter-end dynamics also played a role in yesterday’s performance. 

 

On the MACRO front the weaker-than-expected ADP private payrolls data, was a slight headwind for the market.  ADP private payrolls fell 23,000 in March vs. consensus expectations for a 40,000 gain. The decline was completely driven by the goods-producing sector, which shed 51K jobs last month, while service sector payrolls rose for the second consecutive month.  The data presented a headwind for the broader market, and especially the Consumer Discretionary (XLY) names.  The XLY was the worst performing sector yesterday, declining 0.7%.   Ford, Limited and AutoNation were the three worst performing stock in the XLY.  Retail was also a laggard on the day. 

 

Energy (XLE) was the best performing sectors yesterday, as oil continues to rally up 4.4% so far this week.  In early trading today, crude is trading 0.9% higher, to $84.54 a barrel - the highest since Oct. 14, 2008. The Hedgeye Risk Management models have the following levels for OIL – Buy TRADE (81.08) and Sell TRADE (84.43). 

 

Yesterday dollar weakness also helped the REFLATION trade.  The Dollar index corrected 0.49% yesterday and 0.79% so far this week.  The Hedgeye Risk Management models have levels for the Dollar Index (DXY) at:  buy TRADE (80.67) and sell TRADE (82.30). 

 

Along with the XLE, the Financials (XLF) was the only other sector to be up on the day.  The XLF benefited from a big run-up in the mortgage insurers.  Notable under-performers were the regional banks.

 

Also on the MACRO front the Chicago PMI fell to 58.8 on March from 62.6, below consensus expectations for a slight decline to 61. New orders slipped to 61.8 from 62.2, while production fell to 60.5 from 65.2. Employment held roughly steady at 53.1, while the order backlog dropped to 54.3 from 58.5 and the supplier deliveries index fell to 57.8 from 62.6.  The Industrials (XLI) was the second worst performing sector despite an upside pre-announcement from HON.

 

The VIX rallied 2.69% yesterday, but remains broken on all three durations - TRADE, TREND and TAIL.  The Hedgeye Risk Management models have levels for the Volatility Index (VIX) at: buy TRADE (16.23) and sell TRADE (18.14).  We are currently long the VXX.

 

In early trading gold is trading unchanged, but near a two week high.  The Hedgeye Risk Management models have the following levels for GOLD – Buy TRADE (1,086) and Sell TRADE (1,119).

 

Copper is trading at a 20-month high as China’s manufacturing expansion and shrinking global inventories helping drive copper higher.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy TRADE (3.38) and Sell TRADE (3.60).

 

In early trading, equity futures are trading above fair value in response to strong gains seen across Asian and European markets today.  As we look at today’s set up the range for the S&P 500 is 18 points or 0.9% (1,159) downside and 0.7% (1,177) upside. 

 

Today's MACRO highlights are:

  • March Challenger Job Cuts
  • Initial Jobless Claims
  • March ISM Manufacturing
  • February Construction Spending
  • Natural Gas Inventories

Howard Penney

Managing Director

 

US STRATEGY - DON'T GET FOOLED - S P

 

US STRATEGY - DON'T GET FOOLED - DOLLAR

 

US STRATEGY - DON'T GET FOOLED - VIX

 

US STRATEGY - DON'T GET FOOLED - OIL

US STRATEGY - DON'T GET FOOLED - GOLD

 

US STRATEGY - DON'T GET FOOLED - COPPER




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THIS WEEK IN MACAU

Thoughts on March, the VIP outlook and market share, and how much growth is too much?  Negative catalysts seem to be piling up.

 

 

The near-term hurdles seem to be piling up for WYNN and LVS:  high investor expectations, sequential monthly slowdowns, less liquidity on the mainland, potential visa tightening, tough 2nd half comparisons, and VIP market share shifts.

 

VIP

Based on our statistical work, we believe tightening and sequentially slowing growth in China constricts the Macau VIP business.  We haven’t seen it yet, unless March was a major disappointment, but we did get the first, albeit very preliminary, indication that liquidity could be an issue.  One of the largest junket operators noted that some customers are asking for longer repayment terms.  This could be completely anecdotal and we will be researching this further.  However, this scenario would be a logical first step in a liquidity fueled VIP slowdown.

 

The Triads and VIP Market Share

The Macau media was all over the alleged association between a “known” Triad member/junket operator and LVS.  LVS quickly responded that there are no junket operators with known associations with organized crime and/or shady organizations that are “on the books”.  The Macau government is likely to back up this assertion.  We also don’t think the Nevada Gaming Commission will want to open up this can of worms so the direct impact of the allegation is likely to be contained.

 

The general consensus of people on the ground in Macau is that the US operators do business with “shady” junkets unofficially.  While the direct impact may be minimal, the controversy from the LVS/Cheung story may draw scrutiny to the US operators and force them to distance themselves from these junkets.  Moreover, the junkets don’t like the media attention either, which may lead them to move their business voluntarily to the non-American owned properties.  Either way, the pressure on VIP market share at the LVS and WYNN properties may accelerate as we can see in the chart below.

 

THIS WEEK IN MACAU - VIP Volume

 

March Revenues

There has been much debate about where March will shake out.  We think revenues will total around HK$14.0-14.5 billion, higher than the lowest estimate of HK$12.8 billion, but at the low end of consensus of HK$14.0-15.0 billion.  It didn’t help expectations that some analysts recently threw out projections of 60-80% versus our 52-57%.

 

So HK$15 billion would be great, right?  Well, not so fast.  I hate to bring up the dreaded V-word but the Chinese government has, in the past, tightened visa restrictions with less growth than this.  There has been very little talk in the investment community about visa tightening lately, but it is being discussed among the operators.  


The Coming Inflation Wave

Whether the American economy is in an inflationary or deflationary environment sounds like it should be a fundamental and settled question. But due to the unprecedented financial crisis, the answer is actually subject to intense debate among economists.

 

Making economic projections is far from a scientific process, so it's not surprising to find valid arguments on both sides of the divide. The economists who are right will help investors drive returns over the next three years.

 

Inflation can be a positive or negative, depending on the level and duration of it in our economy. The main negative associated with inflation is a drop in purchasing power of money, and therefore, consumers. In extreme cases, consumers may actually start hoarding if they fear continued and aggressive price increases. The positive side of inflation is to decrease the real value of debt, or essentially provide debt relief.

 

How do we measure the level and duration of inflation, to know whether it will help or hurt? In basic terms, inflation is a rise in prices of basic goods and services over a given period of time. In the United States, the government generally tracks inflation using the Consumer Price Index, or CPI.

 

Besides measuring inflation, CPI is also used to set income rates for more than 80 million people on entitlement programs. 48 million people on social security, 22 million food stamp recipients, and 4 million civil service retirees, have benefits tied to the CPI.

 

When inflation increases, so do their benefits. These payments are among the largest non-defense obligations in the federal budget. Not surprisingly, then, the government tends to understate inflation and has changed the way the CPI is calculated nine times since 1996.

 

Another common inflation metric is the Federal Reserve's core inflation, which it uses to measure overall inflation. The Fed excludes food and energy prices to smooth out short-term volatility. However, based on government data, food and energy purchases make up 36% of the average consumer's budget. The Fed's inflation graph might look nice and smooth, but it's probably not the best indicator for how your wallet feels when paying bills or buying groceries.

 

The Coming Inflation Wave - 1

 

So, conventional measures of inflation are imperfect at best. Which may embolden economists who dispute the idea that we are in an inflationary environment. They argue that our economy is too slack to be inflationary.

 

With a 9.7% February unemployment rate (the worst for February since 1983) and capacity utilization is at 72.7% (7.9 percentage below the average from 1972 to 2009), the thinking is, what's there to inflate? If employment and utilization of industry are low, then so are supply and demand which help set pricing levels. How, then, can prices possibly inflate?

 

Despite this argument, and primarily due to aggressively accommodative monetary policy in the United States and around the globe, we believe inflation is here, and poised to accelerate as all the slack in global economies begins to tighten. Measures of inflation for major nations around the globe give support to our conclusions: most of the G20 nations are reporting higher than normal inflation rates.

 

While we take some issue with the U.S. government's calculation of inflation, even federal economists have reported inflating prices this year. The January CPI came in at 2.6% and February reported at 2.1%. We expect March figures to accelerate even further.

 

The U.S. treasury and currency markets have also showed inflation signs for months, with the dollar up and the price of treasury bonds down. Also, as we recently noted to our clients, fixed versus floating interest rate swaps have turned negative for the first time in over a decade.

 

This means investors are aggressively betting that floating interest rates will increase, because the Fed, as it becomes more concerned about inflation, tends to raise interest rates to try and slow it down.

 

Back in the treasury market, 30-year treasuries have gone from yielding 3.73% to yielding 4.72% over the last year. That increase has happened for shorter-term treasuries -- the short end of the yield curve -- as well. And all these increases have happened despite the fact the Fed has maintained its target rate at 0 -- 0.25%. Bond yields, in other words, are already accounting for inflation.

 

The Coming Inflation Wave - 3

 

Finally, in the chart at the top of this page, we've plotted the Journal of Commerce Industrial Price Index over the last year. This index charts the price of key commodities that are used in industrial production. The chart is up and to the right, screaming inflation. Commodity inflation will likely lead China to report its first trade deficit in March in 6 years!

 

As they say, the markets don't lie, people do (or government statistics as the case may be). Based on the evidence above, we're sticking with our inflation call -- until the markets, and the data, tell us different.

 

Daryl Jones

Managing Director


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