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The S&P 500 finished modestly higher on Tuesday.  The MACRO data points are few and far between ahead of earnings season next week and the issues that Greece faces are becoming less of a MACRO concern for the markets. 


Leading the market higher yesterday was the RISK trade, replacing the REFLATION trade of the past two days.  Yesterday the VIX declined 4.6% and continues to be broken on all three durations.  The Hedgeye Risk Management models have levels for the Volatility Index (VIX) at: buy TRADE (16.23) and sell TRADE (17.74).  We are currently long the VXX.


Along that theme, the Financials were the best performing sector yesterday.  Leading the XLF higher were the banks, with the BKX +2.4%; up for a fourth straight day.  The KBW regional index was up 3.4%, up only three straight days.  The minutes from the FOMC meeting provided support to the XLF, as there was nothing in the release that hinted at any shift in the central bank's thinking that interest rates will need to remain low for an "extended and exceptional" period.


With the dollar up yesterday and the CRB index down, both the materials and energy sectors were fairly resilient, especially in light of the outperformance over the past week.   The Dollar index closed at 81.387, up 0.36% on the day.  The Hedgeye Risk Management models have levels for the Dollar Index (DXY) at:  buy TRADE (80.70) and sell TRADE (82.24).


Yesterday Oil climbed above $87 for the first time since October 2008 on accelerating momentum in the global economy.  The Hedgeye Risk Management models have the following levels for OIL – Buy TRADE (83.56) and Sell TRADE (88.22). 


In early trading, gold is unchanged as it's trading near a one-month high, and looking to head higher as concern about Europe’s recovery hinders the RISK trade.  The Hedgeye Risk Management models have the following levels for GOLD – Buy TRADE (1,116) and Sell TRADE (1,143).


Copper is trading at its highest level since August 2008 and is slightly lower today on a stronger dollar.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy TRADE (3.53) and Sell TRADE (3.70).


In early trading, equity futures are trading modestly below fair value in a continuation to yesterday's late afternoon pullback.  As we look at today’s set up the range for the S&P 500 is 17 points or 1.3% (1,174) downside and 0.1% (1,191) upside. 


Today's MACRO highlights are:

  • MBA Mortgage applications - Refis drop 17% w/w
  • DOE Crude Oil Inventories
  • February consumer credit


Howard Penney

Managing Director













Momentum and Hope

“Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.”

 -George Soros


Price momentum is a powerful force and our decision to be short the S&P 500 stands in defiance of current price momentum and the trends in the fundamentals.  As we said yesterday, fear has been replaced by hope, and the arguments for being bullish are now worn-out and vulnerable to a deceleration in the momentum.


With the S&P trading at 1189, up 75% from the March 2009 lows, is market price momentum discounting the obvious that the economy has “recovered”?  Today, betting on the unexpected reflects a seemingly more conservative outlook that the economy is not yet out of the woods as there are some trends that can’t be maintained or policy makers will have serious issues to deal with.     


Take for example the recent ISM numbers.  The recent push higher in the S&P 500 was helped by the ISM index, which rose 3.1 points last month to 59.6. The March reading was just 1.8 points less than its previous high, reached in May 2004, and 1.5 points above a high in November 1999.  Are things so white hot that we will continue to see an acceleration in April?


How about the price of oil?!  Yesterday, oil prices bid up to an 18-month high and this is a positive for the REFLATION trade because global demand for oil will strengthen as the economy improves.  Wasn’t it in 2008 that oil was on its way to $140, forcing consumers to cut back on driving and eating out because it cost more to fill up their tanks?  Aren’t higher oil prices inflationary and a tax on the economy, rather than a stimulant?


I guess none of this matters because employment in March grew by the most in three years, representing a turning point for the labor market that will help broaden the U.S. economy. 


None of this matters to Ben S. Bernanke & Co. because he is still looking for “evidence of a sustained rebound” and his staffers reduced their 2010 and 2011 inflation forecasts excluding food and energy!  I know I need to skip a meal now and then, but I still need to drive to work.


With those thoughts in mind and knowing that the S&P is at 1189, up 6.7% year-to-date and up 46% over the past 12 months:

  • Fear has been replaced by hope.
  • In the upcoming earnings season, EPS surprises are now the “norm” and “expected” and no longer a “surprise.”
  • The Financials are in a bullish formation because the government can’t afford to raise rates.
  • The rally is now about accelerating momentum in the economy.
  • Copper and oil prices are up 88% and 37% year-over-year, respectively, and there is no inflation according to FED officials.

We are also reminded today that the poster child for everything leveraged, Greece, is down 1.4% on the news that it will revise its 2009 budget deficit to around 12.9% of GDP from 12.7%.  But don’t worry, even with the downward revision, Greece will achieve its target to cut the deficit to 8.7% this year and there is no need for additional budget cutting measures.   


The hard part to understand is what represents the unexpected.  As I sit here this morning, it seems that the unexpected will be driven by the fact that policy makers in Washington can’t see (or don’t want to see) what the consumer feels.


Function in Disaster; Finish in style


Howard Penney

Managing Director


Momentum and Hope - HE Inflation Index EL


The UK’s got Talent?

“From now until polling day I will travel the length and breadth of Britain with one clear message: Britain is now on the way to economic recovery. And now is not the time to put it at risk.”

–Gordon Brown


The quote above comes from the Labour Party’s official website, and is noteworthy insomuch as it appears Brown’s only real chance of winning the General Election (which he called today for May 6th) is to convince the people to stay the course his government has set out to revive the ailing economy. In contrast to Brown is the much younger conservative David Cameron who, like US President Obama, is promising a change of guard and policy to fix what he’s named “broken Britain”. 


While Brown and Cameron don’t differ substantially over social issues, on the economic front Cameron has firmly stated that the Tories would cut spending now to address the country’s record budget deficit and federal debt, while Brown and Co. say they won’t reduce spending until at least 2011 to prevent a “double-dip” recession. Brown has anchored his call on the economic improvement he’s seen in recent months, noting the technical end of recession with an upward revision of GDP to 0.4% in Q4 quarter-over-quarter (a “victory” of sorts after the UK lagged peers like Germany and France who saw quarterly GDP expansion in Q2 ’09), unemployment holding steady around 7.8% over the last months (ILO), and CPI that has abated to 3% Y/Y (target = 2%).  


Suffice it to say, Brown’s economic creds don’t stack up to “victory” in our book, but maybe stale is the new normal.


Already political experts forecast the strong possibility of a hung parliament or one that lacks a majority, in which case Brown’s best hope would likely be to form a coalition (last seen in 1964) with Nick Clegg and the Liberal Democrats.  As Brown and Cameron ramp up their respective campaign tours, recent polls suggest inconclusive results:


The Sun/YouGov Poll sees the Tories leading Labour with a 10% spread, (or 41% to 31%), an increase over the last weeks, while the more liberal Guardian/ICM Survey shows the Conservatives with a 4% lead over Labour, or 37% to 33%, with Labour enjoying a forward push over the past week.


In the coming days we’ll have more out on the implications of this election. For now, the UK has not yet voted!


Matthew Hedrick



The UK’s got Talent? - Cameron and Brown


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IGT's declining slot ship share has been a major topic of discussion for some time. Less talked about is participation revenue share, and how much more room there is for IGT to fall.



A frequently asked question in this space is whether IGT can maintain its severely depleted ship share, now hovering around 35%.  A more important question may be how IGT is going to maintain its participation revenue share of 65% among the Big Three (it's probably around 60% in total)?  The answer is probably the same as it was for ship share 6 years ago when it was 60%:  it won’t.  What is amazing is that it was actually 90% six years ago.  Certainly, IGT's new participation games seem to be getting warm reception.  However, holding participation share significantly above its ship share may be difficult to maintain over the long-term.  See the chart below and note IGT’s steady decline that doesn’t look like it will abate. 


PARTICIPATION SHARE UP FOR GRABS? - Participation Games  revenue 6


Due to its superior content, WMS is the most likely thief of IGT's participation share.  Moreover, up until now, WMS hasn't participated in the Class II market which will boost their market share going forward.  BYI could also be in a solid position since IGT is overly reliant on the Wheel games (See our 11/27/09 post, HOW LONG WILL THE WHEEL KEEP TURNING?) and BYI has developed a whole new wheel product line since the IGT's wheel patent was ruled invalid.  However, our long-term bet would remain with WMS.

HIBB: It’s Just Different

HIBB: It’s Just Different


We stirred the pot a little this morning with our detail on Sports Authority, and evidence that we’re starting to see that they’re dressing up the pig to take it public. It led to a nice little validation on HIBB’s competitive positioning.


We peeled back the onion on management’s comment about giving the Texas market ‘special attention’ due to a share battle with DICK’s and Academy. In looking at a map, however, check out how well positioned Hibbett is relative to the others that are literally sitting on top of one another. HIBB stores are so evenly spread across major AND minor MSAs. This is not to say there’s anything incrementally positive about owning HIBB today (though we are more inclined on the long side), but serves as a good nugget to delineate HIBB from its big-box big-market competition.


HIBB: It’s Just Different - HIBB map




Two weeks ago we highlighted three incremental positive datapoints for the housing market: (1) California's $10k homebuyer tax credit, (2) Bank of America's plan to roll out principal forgiveness on a limited basis, and (3) the White House's renewed plan to combat foreclosures under new HAMP initiatives. Today, we are highlighting a few additional positive datapoints, combined with a word of caution in looking ahead.


First, yesterday's February pending home sales report was decidedly positive. Remember, pending home sales are a better leading indicator than existing home sales. While both measures are released with roughly a one month lag, existing home sales reflect contract closings, which reflect activity from 1-2 months prior. In other words, February existing home sales reflect buying activity from December/January. In contrast, February pending home sales, which was released yesterday, reflect contracts being signed, which will close in one to two months. In this respect, pending home sales lead existing home sales by approximately 1.5 months, which is why this is where the focus should be. The February pending home sales index rose to 97.6 from 90.2 in January, a month-over-month increase of 8.2% and an increase of 17.3% from the prior year. The following chart demonstrates.




Some context is necessary here. When the original homebuyer tax credit was set to expire on November 30, 2009 it pulled forward significant pending home sales volume into September and October. As the following chart shows, September volume rose 18.6% yoy while October was up 29.8% yoy. November then dropped to a yoy rate of 16.7% (down 13.7% mom) and went on to drop further in the months of December and January. Remember, all this data is seasonally adjusted, so winter vs summer should be irrelevant. From a timing standpoint, we think February corresponds with September (i.e. both 2 months prior to the tax credit expiration, and March will correspond with October (one month prior). We expect to see a significant uptick in March sales once the data comes out a month from now. Between now and then we wouldn't be surprised, and in fact would expect,  to see the broad-based housing-related credit tailwinds persist.




Second, HUD announced that it is changing its definition of foreclosure to now include loans that are 60 days delinquent. This will enable HUD to more aggressively deploy funds under its Neighborhood Stabilization Program, which require that homebuyers seeking grants use that grant money only for "foreclosed" homes. The program has disbursed some ~$6 billion to date, and it is expected that this number could increase materially with the new definitional change that will allow buyers to step in earlier than they otherwise would be able to. The White House has been using the housing-related government agencies (HUD, FHA, Ginnie Mae) and quasi-government agencies (Fannie Mae, Freddie Mac) to shoulder much of the heavy lifting in repairing the housing market, separately, and in addition to, Congressionally legislated initiatives such as HAMP and HAFA. We think the move by HUD represents yet another step in this direction.



While these datapoints are undeniably positive for the housing market, we remain skeptical of investors' exuberance around the recovery in the housing market for three reasons.


First, after the March pull-forward of activity ahead of the tax credit expiration on April 30, 2010 has passed, we expect to see a significant fall-off in buying activity just as we saw in the late Fall following the November 30 expiration.


Second, mortgage rates are rising. 30-year conventional rates are up 25 bps in the last few weeks. This is principally due to the 40 bps backup in 10-year treasury rate, and we expect the 10-year to continue to rise over the next year, and mortgage rates to rise with it. We expect additional pressure on mortgage rates to come from the Fed's exit from the Agency MBS purchase program last week. While it's unclear whether this will pressure mortgage rates directly through reduced Agency MBS purchasing, or indirectly through reduced Treasury purchasing (which drives Treasury rates higher in turn pushing mortgage rates higher), we think its clear that the end of the Fed's program will adversely effect mortgage rates. Further, once Fannie and Freddie complete their $200 billion repurchase program in a few months, we think that could add further pressure to the market, pushing rates higher. We've published in the past the significant sensitivities of buyer's purchasing power to even small changes in mortgage rates. We think this will be an overhang as we move further into 2010.


The third risk we're highlighting this morning is the official rollout of the HAFA program yesterday. The HAFA program is the Home Affordable Foreclosure Alternative program. For those borrowers who don't qualify for a HAMP loan modification, they may qualify for assistance under the HAFA program, which provides incentives to servicers to allow short sales and deeds-in-lieu (DIL) of foreclosure. While this may ultimately be preferential to the alternative of foreclosure for both the lender (or asset-backed investor), the reality is that foreclosure volume has been held back from hitting the market for some time now through a combination of HAMP, lender modification programs, state moratoriums around foreclosure and various other incentives lenders have to kick the foreclosure can down the road. HAFA may provide a significant boost to an already bloated unsold inventory of housing stock. Remember, HAFA has been in place for several months, but hadn't yet gone effective until yesterday meaning that servicers have already built up pipelines of eligible HAFA borrowers - many of whom are in the system already, paperwork complete, because they applied, but didn't qualify for HAMP. This inventory should hit the market in the next few months as HAFA ramps up, right at the time when we envision both natural demand diminishing because of the pull-forward and mortgage rates rising.


The key to this call is understanding the duration differences. To reiterate, we expect that in the near-to-intermediate term (1-3 months) the data will get better before it then gets worse over the intermediate-to-long term. Along these lines, we would expect the trends and the rally to continue as long as housing is improving. However, once we move beyond the near-to-intermediate term, we see the headwinds starting to pile up.


We have been working for the last several weeks on a robust housing industry model to try and make more quantifiable sense of these moving pieces, and until the model is complete we consider our conclusions preliminary. That said, we do see a number of potential cross currents, if not outright headwinds, converging around housing in the not too distant future. The question is whether they will be more or less powerful than the onslaught of new government and private sector initiatives to combat the housing crisis.


Joshua Steiner, CFA

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