Fiat Fools

“Any intelligent fool can make things bigger, more complex, and more violent. It takes a touch of genius - and a lot of courage - to move in the opposite direction.”

-Albert Einstein


At this stage of the Sovereign Debt Dichotomy, it’s fascinating to observe how little professional politicians know about what they don’t know. From Athens to Albany, finding resolve in Piling Debt Upon Debt Upon Debt via fiat currencies is not going to end well. Anyone who isn’t paid to be willfully blind gets this by now.


With Ben Bernanke and Jean-Claude Trichet printing moneys from the Keynesian heavens, we thought we’d do some minting of our own this morning and introduce Fiat Fools as our new Hedgeye nickname for politicians running European and American monetary policy.


Adam Smith be damned - there is nothing invisible about the heavy hands of these governments. When it comes to their latest storytelling of a “fat finger” causing volatility in the US stock market, take their word for it. It’s a big fat middle finger from the creditors of our broken promises.


In Latin, the word fiat means “let it be done” … and so our modern day Roman Gods of finance will do exactly that. Let us debauch the value of our currencies and inflate our way out of this colossal mess. All the while, let us hope that our creditors and citizens alike don’t notice Main Street inflation while Wall Street gets paid to underwrite it.


Alas, we all know that hope, unfortunately, is not an investment process for anyone other than the Fiat Fools. The inconvenient truth of history reveals that debtor nations who become hostage to foreign lenders are just that – hostages. As David Walker points out in his latest book “Comeback America”, “the British Empire learned this in 1956, when Britain and France were contesting control of the Suez Canal with Egypt.” All US President Eisenhower needed to do was threaten to sell the British Pound.


What if the Chinese or Japanese imposed that credible threat on the US? Up until Greenspan went global with the Fiat Fool system of US economic policy, US public debt held by foreigners was less than 20%. Now it’s pushing north of 50%, and that’s the point. The Buck stops there - and don’t think for a New York minute that America isn’t setting herself up on the trolley tracks to get run right over by the same oncoming train that European pigs have.


This is why we call it the Sovereign Debt Dichotomy. There is simply a Duration Mismatch between when the Fiat Fools of Europe and America will see their debts come due. There is absolutely no irony that Greece started to unwind before Spain did. Nor will there be as Spain starts to unwind before France and the US do. The timing of debt maturities matters. Only a Fiat Fool who has never traded a market in his life couldn’t tell you that.


As our head of US Strategy, Howard Penney, recently wrote, America has to roll over 40% of US Treasury debt by 2012. Even compared to a country like the UK that has already been forced to devalue its fiat currency, that’s more than a double versus UK gilt maturities as a percentage of the total outstanding!


Altogether, this is the #1 reason why we have sold into US stock market strength this week. The duration gap is finally starting to narrow between the Fiat Fools of Europe having their pants pulled down in front of the world and the tide rolling out on our professional US politicians.


This morning the Euro is making another lower-low, and remains broken across all 3 of our investment durations (TRADE, TREND, and TAIL). As a result, since 58% of the US Dollar Index is Euros, the Buck Breakout that we have been calling for since the beginning of 2010 continues as the US Dollar hits higher-highs.


At a point, and we are not there just yet, the US Dollar is going to be a raging short again. There is a reason why we called for the Burning Buck last year. That reason hasn’t gone away. The European Fiat Fingers are simply taking their turn at the wheel. Unless Ben Bernanke stops behaving like Arthur Burns did between 1, and gets this US currency and the sovereign debt that underpins it under control, we are going to go to a very scary societal place.


From a risk management perspective, the US Dollar Index looks like a short again up at the $86.97 level. As both the US Dollar and gold push to higher-highs as a refuge away from a Euro that continues to make lower-lows, I don’t see why we don’t test that upward boundary. The Buck Breakout will continue until the Euro finally becomes the most consensus trade in modern day Rome.


Our immediate term TRADE range for the Euro is now $1.24-1.28 and until Spain has its Greek moments in June/July, I’d stay with the Euro short bias as the most obvious way to be short the decision making process of the Fiat Fools. In terms of the capitulation zone, I am now looking at an ultimate 2010 bottom for the Euro at $1.21. That quantitative risk management view lines up pretty well with where I see the US Dollar Index finding its final crescendo.


Politics may indeed be local. Fiat Fools, unfortunately, have gone global.


My immediate term support and resistance lines for the SP500 are now 1144 and 1186, respectively.


Best of luck out there today,



Fiat Fools - TR


Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble... to give way to hope, fear and greed.

- Benjamin Graham


The issues that surround one of our three key themes for 2Q10 (Sovereign Debt Dichotomy) are not going away despite a $1 trillion bail out of the PIIGS in the EU. Although our conclusion has been that it will bring May showers (another 2Q10 theme), the prevailing market structure is bullish and is begging us to speculate once again.


Yesterday, US equities finished higher, the move was muted with volume down 13% day-over-day and down sequentially for the past four days. The S&P 500 rose 1.37% yesterday, while the Russell 2000 rose 2.97%. Globally, equity markets continue to be focused on macro developments in the EU, particularly as additional austerity measures adopted by Spain helped to dampen some of the moral hazard concerns that had have dominated the market since the beginning of May. This too shall pass, as Spain’s underlying fundamentals suggest an even rockier road ahead (email if you’d like to take part in our Monthly Strategy Call on May 18th: Sovereign Debt: Bearish Enough on Spain?). While these austerity measures are needed, the monstrous amounts of debt being taken on by European governments continues to debase the Euro.


At the time of writing, equity futures are trading below fair value, giving back some of yesterday’s gains. In Europe, Greece, Spain, France and Italy (all problem deficit countries) all trading lower again this morning. Since the market close yesterday, CSCO reported numbers above estimates (but trading lower) and the SAP bid for Sybase (SY) is now official. As we look at today’s set up, the range for the S&P 500 is 42 points or 2.4% (1,144) downside and 1.2% (1,186) upside.


On the MACRO calendar we have:

  • April Import Price Index,
  • Initial jobless claims
  • Treasury Auctions in 30-yr bonds 

The reduced level of moral hazard concern can also be seen in the VIX, which was down 9% yesterday and has declined sequentially for the past three days. It should be noted that the VIX is still up 63% over the past month. The Hedgeye Risk Management models have levels for the VIX at: buy Trade (20.41) and sell Trade (39.39).


The Dollar bullish TREND remains (up 0.43% yesterday) and is trading higher today. The Hedgeye Risk Management models have levels for the DXY at: buy Trade (83.85) and sell Trade (84.99). In contrast, the Euros bearish TREND remains as the Hedgeye Risk Management model registers its lowest low of immediate term support YTD at 1.24. The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade (1.24) and Sell Trade (1.28).


The XLK was the best performing sector yesterday after selling off on Tuesday. M&A and the credit-card names were among the standouts in the sector. SY was up 35.1% on reports that the company will be acquired by SAP. IBM (up 4.6%) was one the best performers in the hardware space after the company said it expects to double its earnings to at least $20 a share by 2015. The SOX also rallied 2.8% yesterday.


The Industrials (XLI) and Materials (XLB) outperformed the broader market today. Both sectors have been significantly impacted the macro influences that have been driving the market over the last couple of weeks. The Machinery group and Transports were big gainers yesterday with the S&P Machinery Index +3% and the Transports up 2.1%.


The low beta Utilities (XLU), Healthcare (XLV) and Consumer Staples (XLP) were the bottom three performing sectors yesterday.


In early trading, Copper rose for the first time in three days in London as concerns about European budget deficits eased as Spain announced its biggest round of budget cuts in 30 years. The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (3.07) and Sell Trade (3.21).


Oil is looking lower for a third straight day as U.S. crude inventories grew and the dollar is stronger. The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (74.99) and Sell Trade (80.34).


Gold’s safe-haven status continues with Gold up 1.8% yesterday and is now up 12.4% YTD. The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,199) and Sell Trade (1,246).


Howard Penney

Managing Director













Brazilian Shopping Spree

Conclusion: While we do question the sustainability of peak sales growth, we’d be remiss not to call out Brazil’s ability to manufacture domestic demand in lieu of Chinese’s tightening. Moreover, domestic demand in Brazil will continue to influence the Bovespa apart from the Chinese demand story. This is in contrast to Europe, which is struggling with internal demand.


Brazilian retail sales grew at the fastest pace since 2001, as surging consumer demand augments an economic recovery that has largely been linked to China. We’ve been vocal in recent weeks saying that the outlook for the Brazilian economy is leveraged to Chinese demand and to the extent we see further tightening by their government. Although lagging, today’s Brazilian retail sales release moonshot sent the Bovespa up 1.2% in on the day and tells a tale of domestic strength - at least for now.


Brazilian retail sales sequentially accelerated to +15.7% y/y in March, up from a revised +12.2% y/y in February. The +15.7 % yearly increase is the most since at least 2001, according to the IBGE. Even more impressive, the jump was recorded in the same month real wages declined -3.01% y/y (March inflation more than doubled nominal wage growth at +5.16% y/y vs. +2.15% y/y), suggesting that March’s shopping spree was likely the result of a sequential improvement in the real wage growth rate. A pickup in consumer credit may have also occurred, as Cia Brasileira de Distribuicao Grupo Pao de Acucar, Brazil’s largest retailer, reported a 33 percent jump in quarterly profit citing a measured increase in consumer demand for electronics as the nation’s citizens prep for the World Cup.


While we do question the sustainability of peak sales growth, we’d be remiss not to call Brazil’s ability to manufacture domestic demand in lieu of Chinese’s tightening. Furthermore, with food inflation being the largest driver of price increases for the month of April, we may see consumer demand stay for a little while as this year’s forecasted record harvests will exert downward pressure on food prices.


Darius Dale



Brazilian Shopping Spree - Brazil Retail Sales

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Wynn's revenue share in Macau share looks good on a preliminary basis.



Our Macau sources are telling us that Wynn’s market share of gross gaming revenues month-to-date has jumped to 18% due to strong VIP turnover and decent hold.  Obviously, Encore is fueling the increase but, if our sources are correct, Wynn would be adding more share than supply which would be a positive.  One source even suggested that Wynn overtook LVS in market share, although it could be due to just low hold. 


As we wrote about yesterday in “MPEL: TOO BIG OF A MOVE DOWN”, we think Macau is having a very good May, driven by very strong VIP volumes.  Our best guess is that May revenues should increase +60% y-o-y.  Wynn has materially higher market share in VIP and to get to 18% total GGR share, they would need to capture over 20% of VIP revenue – which is a nice jump over April and 1Q2010.  In April, VIP revenues grew 89% y-o-y to almost $1.27BN, and if May comes in at similar or slightly higher levels and if Wynn’s Mass share creeps up a few bps to 10%, that would imply a whopping $274MM of gross table revenue for Wynn.  We’ve also heard that all of the Encore tables are direct play tables which means lower blended commissions and higher margins.


To put things in context:

  • Wynn added 37 VIP tables and 24 Premium Mass tables, representing a 2.3% and a 70bps addition to the market as a whole, respectively. 
  • Wynn’s market share in April:
    • 14% ($239MM) of total table revenues
    • 16% share of VIP revenues
    • 14.4% share of Junket RC
  • Wynn’s market share in 1Q2010:
    • 13.5% ($663MM) of total table revenues
    • 15% share of VIP revenues
    • 16% share of Junket RC

TSA: File the Dang IPO Already!

TSA: File the Dang IPO Already!


Yet another announcement from TSA lighting the path to an IPO later this year. It’s all good for the industry for now. We’ll see competitive tension, no doubt. But without it we’re left with atrophy, which has hurt for the past 3 years. The cycle is turning positive.


It’s like torture waiting for The Sports Authority to come back to market. We’ve been watching and waiting since we made our view clear in January. Since then, the company has announced an acceleration in square footage growth from 0% to a high-single digit rate.   And then this morning it announced a new concept called S.A. Elite. I’m going to realistically assume that this new concept was embedded in the company’s prior growth acceleration plans. But the noise is getting louder.


Comps are looking better, capacity has been pulled out of the industry, the athletic cycle is just starting to turn up due to elevated levels of R&D out of the vendors, and this happens to be a window where private equity firms can jettison levered businesses they’ve been sitting on through the recession and credit crunch.


This will be Dollar General all over again. Also watch Toys R Us, PetCo…You get the drift.


The S.A. Elite idea is actually pretty interesting. The boxes are about 80% smaller than existing TSA box, and will be geared toward very high-end product from only the top brands. TSA is highlighting how ‘brand presentation’ will be key, and it is investing in things like lighting, high-end fixtures, and just about anything else needed to get brand CEOs’ juices flowing. The first one opens in August in Denver, with opportunity for ‘200-300 over 5-10 years.’


One point I don’t get is that it’s pretty clear based on what we see out of this space is that you need to be super-aligned with how the brands want to approach the market – otherwise you’re hanging on by a thread. We’re seeing Foot Locker close and consolidate its base of stores, and open up more category-specific (i.e. run, hoops) and brand-specific (Nike) stores. TSA is going out there with more multi-brand stores. It seems to me that the path to success here will be to make the experience heads and tails above everything else out there, which will be costly with an unproven return on capital. I wonder if Leonard Green is going to fund this, or if they’ll ask you to do so when it’s a stand-alone company?


The most commonly asked question of me is whether this is good or bad for the industry. The bottom line is that if the growth is going to come from a high-end concept where the formula works for both the retailer and the brands, then it is quite healthy. Tension in this business is good. It keeps people on their toes, and it keeps R&D checks flowing. Inactivity is bad. Complacency = no spending = weak product cycle. So longer term, I’m torn on this specific transaction without knowing more facts.


But near-term, it’s a positive. More hype, more press, better product flow, better comps, etc…will keep a halo around the athletic space well after the rest of retail enters its ‘show me’ stage of earnings growth (which it is just kicking off now).


- Brian McGough

Watching the IRS

Conclusion: Keep your Hedgeyes on the IRS and how 2011's tax rate increases will affect the economy at large. Expect more attention to be paid to this as we progress through the year, and for it to be priced into the markets as early as this summer. 


With sovereign debt concerns, the EU bailout package, accelerating inflation, and fat fingers garnering so much investor attention globally, we thought  we'd give you a quick global macro break and focus you on a domestic issue that will become increasingly important as 2010 progresses - 2011 tax hikes.


Since I collected my first paycheck some 8-9 years ago, I've been duly focused on taxes - i.e. how much of the money I made I wasn't actually going to be able to spend. After all these years (joke), the only thing I've come to learn about taxes is they don't get less annoying with time. And in 2011, I expect to become even more annoyed (along with a lot of other taxpayers).


Changes to be enacted in 2011: 

  • Income tax brackets are scheduled to change for 2011, with the highest rate increasing from the current 35% to 39.6%. Each of the lower brackets will also be increasing. It has yet to be determined where the income threshold will be for each bracket, but taxpayers can rest assured that their federal tax burden will be increasing for 2011; 
  • Capital gains tax rates are also scheduled to change. The top rate for long-term capital gains is expected to rise from 15% to 20%; and 
  • The preferential qualified dividends tax rate of 15% is scheduled to expire, so all dividends will be taxed at ordinary income tax rates. 

Obviously, this will be a headwind for the American consumer and will have negative implications for discretionary spending in 2011 (we may see a marginal pull-forward in spending on larger-ticket purchases this year as consumption is all but sure to decline next year). Less obvious, however, are the implications the tax rate hikes will have on the certain markets and M&A activity.


Under the new tax structure, we could see investment money flow towards capital gains away from equity income - especially those monies that will be taxed at or near the highest rate (39.6%). With so many retirees dependent on dividend funds, however, Congress may be inclined to level the playing field by either raising capital gains taxes or lowering the tax rate on dividends. Time will tell on that matter.


The far right column of table below shows the Y/Y percentage change in the after-tax income from a variety of investment sources. We have used the top tax bracket as a proxy for wealthy investors, simply because the flow of their monies will have greater impact on the overall investment community.


 Watching the IRS - Taxes


It is important to also note that municipal bonds and municipal bond funds will become more attractive on the margin vs. taxable bonds and taxable bond funds. While we believe the state budget and U.S. sovereign debt issues will have a greater impact on municipal bonds inflows, we'd be remiss not to call out this additional tailwind for the investment vehicle.


Regarding M&A activity – which should pick up with capital gains taxes headed higher – private businesses will be looking to sell prior to the tax rate hikes, and, as the year progresses, those looking to acquire with cash will have a more favorable environment. Sellers will certainly feel the pressure to unload by year's end rather than face a 33.33% higher effective tax rate in 2011. Aware of this selling pressure, buyers equipped with cash will be hunting for discounts late in the year. As an aside, buyers looking to acquire with deferred payments may be subject to a premium to offset the seller's increased 2011 tax burden.


In short, keep your Hedgeyes on the IRS and how 2011's tax rate increases will affect the economy at large. Expect more attention to be paid to this as we progress through the year and for it to be priced into the markets as early as this summer.


Darius Dale


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