The Discrimen

“I will either find a way, or make one.”



One of our most successful European clients recently sent me a book that I can’t put down: Tom Holland’s “Rubicon – The Last Years of The Roman Republic.” As a behavioral study, the parallels of power and politics between then and now are interesting to consider.


The Rubicon is the river in northern Italy that Julius Caesar infamously crossed in 49BC to officially declare what was considered the unthinkable – war against the Perceived Wisdoms of officialdom in Rome.


Holland captures the moment ominously: “Gaius Julius Caesar instead gazed into the turbid waters of the Rubicon, and said nothing. And his mind moved upon silence. The Romans had a word for such a moment. “Discrimen,” they called it – an instant of perilous and excruciating tension.”


Whether it was how you felt at 830AM Friday morning when you saw the US Government’s employment report or how you’ve been feeling for the last 3 years in trying to manage the market risks associated with US Government Sponsored Volatility, “The Discrimen” summarizes both, across durations – the turning point.


The Discrimen for the heavy hand of Big Keynesian Deficit Spending and Debt Financing has reached the proverbial Rubicon of economic debates. Not unlike the legendary Rome that Holland depicts in 140BC, the blood, sweat, and tears of the United States of America still stands on the principles of meritocracy, liberty, and competition. Whether the willfully blind realize it yet or not, Americans will find a way to make this economy American again.


When I talk to the grinders of this business – the people who aren’t professional politicians - the men and women who fight it out every day in this marketplace for their clients, firms, and families – I hear the same thing over and over and over again: “this isn’t working.”


Like the Romans back then, we reserve the right to change this country’s direction. As Holland writes in his chapter titled “The Paradoxical Republic”, “the Romans judged their political system by asking not whether it made sense but whether it worked. Only if an aspect of their government had proven to be inefficient, or unjust, would they abolish it.”


You tell me if you think making the “risk free” cost of capital in this country ZERO percent has done anything but amplify the cyclicality of both employment and market volatility. Bad actors in bad economic systems compound bad decisions. Either I will find a way to make this point clearer or I’ll make one.


The modern day Triad of Groupthink hasn’t changed a thing about how it analyzes market risk. Wall Street, Washington, and the Manic Media have once again completely missed the boat on delivering to Americans what they really want – a proactive risk management system that works. I don’t know if I run a media company or a research firm that competes with some of the aforementioned outlets of analytical incompetence. But I do know that we are evolving as markets do.


What would be my approach to fixing this mess?

  1. First, stop. Just stop what we are doing with this Bernanke-Geithner/Keynes/Japan experiment.
  2. Then, start over. Start empowering new/competing risk management strategies. Start by respecting the cost of capital and future liabilities.
  3. Finally, plan on changing this plan if it’s not working.

I have been promoting this Bull vs. Bear debate for the last few months because we need a Forum of Transparency & Accountability where we can settle this score once and for all. There will be winners. There will be losers. There will be no more finger pointing by losers who won’t accept change.


This isn’t about egos. This isn’t about me turning into some broken clock perpetual bear either. This is all about finding a better way – a way that works. The market isn’t lying; politicians and people are.


Into Friday’s market close, I covered our short position in the SP500 (SPY). This doesn’t mean I’m not bearish. It simply reflects our strategy of booking gains for the winning side of this current debate. Stanley Cup Playoff style: Backcheck. Forecheck. Paycheck. We remain short the Nasdaq (QQQQ).


At a price, the market will be Bearish Enough to come to grips with the reality that our debts and deficits are heading down a European style road to perdition. Markets like Spain are now down -27% for the YTD, so we need to play this game with a renewed sense of urgency. Unfortunately, we have not reached The Discrimen of change yet, but markets see something not so funny happening on the way to this Investment Forum – to the professional politicians of modern day Rome that is…


My immediate term support and resistance lines for the SP500 are now 1153 and 1182, respectively. What was the long term TAIL of support at 1078 is also now a critical line of resistance. My position in US Equities remains much like the return on American capital that Bernanke is promoting – ZERO percent.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The Discrimen - Day


The S&P 500 finished at the low of the day on Friday, after opening sharply lower on the pre-market release of May nonfarm employment data.  The Industrials (XLI), Financials (XLF) and Materials (XLB) were among the worst performers, as the lower beta sectors outperformed. 


On Friday, the May nonfarm payrolls reported 431,000 vs. consensus 536,000 – a huge disappointment.  In a post on 6/2 (“Friday’s Jobs Report - Great Expectations”), we noted the spread between what the economists were saying and what reality turned out to be since 2008 and 2009, when nobody saw the recession coming.  Temporary census workers reflected 411,000 of the gain, perhaps the key concern in the figure; April payrolls were unrevised from 290k. The unemployment rate dropped to 9.7% vs. consensus 9.8%, and prior month 9.9%.


The DXY rallied 1.3% on Friday and the Risk Management models have the following levels for the USD – Buy Trade (86.90) and Sell Trade (88.29).  The VIX rose 20% on Friday and 10% last week.  The Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (30.77) and Sell Trade (39.29).


Comments made by a spokesman for Hungarian PM Orban served to increase fears of contagion in the Eurozone on Friday and only added to Thursday’s talk of a Greek-style scenario unfolding in Hungary. The CDS spread on government debt widened significantly, and the forint traded lower on Friday. The Euro also fell sharply, and broke thru a key quantitative level of $1.21, as European markets closed lower on the day.  The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade (1.19) and Sell Trade (1.22).


The Industrial sector (XLI) was the worst performing sector on Friday, declining 4.7%.  Concerns over the jobs release and the pace of the economic recovery put pressure on the RECOVERY trade.  The transports index declined 4.84%; the S&P Railroads index declined 5.54%; the Airlines index declined 4.68%.


Energy (XLE) and Materials (XLB) rounded out the bottom three performing sectors.  The XLB was led by the S&P Steel index declined 5.95%.  The sector came under pressure following price cuts at Chinese steelmaker Baosteel.   The XLE declined with the market amid continuing uncertainty around the ongoing situation in the Gulf of Mexico and the pace of economic recovery.


On Friday, the CRB declined 2.5% and finished down 2.4% for the week.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (68.55) and Sell Trade (72.39).


On a relative basis, Consumer Staples (XLP) and Healthcare (XLV) were the two best performing sectors on Friday.  Last Friday, UNH and WLP outperformed following a NYT article summarizing the evolving relationship between insurers and the Obama administration. 


The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.76) and Sell Trade (3.03). 


The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,203) and Sell Trade (1,232).   


As we look at today’s set up for the S&P 500, the range is 29 points or 1.1% (1,053) downside and 1.6% (1,082) upside.  Equity futures are trading mixed to fair value in the wake of Friday's more than 3% drop.  Weekend news flow was light and there are no major economic or corporate releases due out today. 


Howard Penney














PENN isn’t the cheapest stock we’ve ever seen but on a relative basis, the valuation doesn’t seem to make much sense. So what’s the explanation?



In an era when debt is considered a liability (no pun intended), one would think that PENN’s low leverage would be rewarded.  Looking at its EV/EBITDA multiple, it is clearly not.  PENN trades at under 7x 2011 EBITDA, slightly below the peer group average.  We’ve seen regional gaming stocks trade down to 6x EBITDA, so there is precedent for downside.  However, EBITDA is depressed and PENN’s story is much more compelling than the stocks we’ve seen trade at 6x.  Moreover, compared with other regional gaming operators, PENN maintains much more positive investment attributes:

  • Best management among the regionals and maybe all of gaming – history and commitment to ROI
  • Best balance sheet among all operators
  • More growth – more development opportunities
  • Self-funded growth – leverage stays around 2x during the construction phase of Columbus, Toledo, and Cecil County
  • Growth mostly in new markets – much higher ROI than building in an existing market

So what gives?  I guess PENN is not the most exciting story over the near term but neither are any of the other regionals.  Unless you are expecting a sharp recovery in regional gaming revenue which would benefit the earnings of highly leveraged companies disproportionately.  In this uncertain environment, investors seem afraid of capital driven growth and the perception is that PENN will be levering up to drive investments in risky projects.  Other than PNK and its Baton Rouge project, PENN is the only company investing in new casinos.  There is also acquisition risk.  PENN maintains a ton of liquidity to buy assets or companies and, again, investors may not want to see capital put at risk. 

  • Growth fueled by investment spend - people may want to play recovery growth
  • Exposure to additional supply – Lawrenceburg will be hit hard by a new casino in Cincinnati but the net Columbus/Toledo/Lawrenceburg should still be high ROI
  • Acquisition risk

We recognize PENN isn’t the most non-consensus call on the sell side.  Most analysts have buy ratings.  However, even a broken clock is right twice a day.  Downside appears limited – numbers look better than they did when the stock fell through $23 – and we think the sell side may have this one right.

investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

The Week Ahead

The Economic Data calendar for the week of the 7th of May through the 11th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - c1

The Week Ahead - c2

PSS: CompBusters

PSS: CompBusters


You ever see ‘MythBusters’ on Discovery Channel? We dug into the facts surrounding PSS comps, and think that the myth of management overstating its comp exposure to weak parts of the country is Busted.


We’ve had several requests since PSS conference call about clarity on comp store sales, and whether management overstated a) PSS’ exposure to California and the Southwest, and b) the relative weakness in those particular states. Several companies noted yesterday with same-store-sales results that the Northeast, Midwest, and Southeast were the strongest regions. Furthermore, we plugged the lats and longs of all of the Payless US stores into our mapping software, and it spit out the results below. You ever see that show ‘MythBusters’ on Discovery? It’s the one where they test myths, movie stunts and legends to see if they are plausible according to the laws of physics. Well…we can pretty safely say that the myth of management overstating its exposure in states that were particularly weak in the quarter is officially ‘Busted.’


PSS: CompBusters - PSS Store Dist 6 10



Topline trend will be difficult to sustain.


McDonald’s is expected to report its May sales numbers before the market open on Tuesday.  On a year-over-year basis, May 2010 has one less Friday, and one additional Monday, than May 2009.  


Today McDonald’s announced that it is recalling the “Shrek Forever After 3D” collectable drinking glasses due to potential cadmium risk; the impact will be felt in the June 2010 sales data. 


Getting past top line trends and looking at cost trends in 2Q10, the focus will be on commodity prices.  On the margin, the biggest benefit the company has seen from lower commodity prices is behind them.  In 1Q10, MCD’s basket of goods in the U.S. decreased 5% (this compares to the 6.7% increase in first quarter 2009). For the full year 2010, the outlook in is for costs to be down 2-3%.


Below, I am providing my view on comparable sales ranges for each of MCD’s geographic segments as indicators of what I would rate as GOOD, NEUTRAL, or BAD results based largely on 2-year average trends.



U.S. (facing a 2.8% compare, including a calendar shift which impacted results by -0.4% to 1.4%, varying by area of the world):


GOOD:  Any result greater than approximately 5.5% would be perceived as a good result because it would imply that the company was able maintain U.S. 2-year average same-store sales only slightly below those of March and April but considerably above the lower levels of the preceding months.  While usually I look for 2-year average trends to be maintained or surpassed for a “GOOD” result that would demand a print of 7% for May.  In light of the current unemployment picture, and given that a 7%+ print has not been attained since February ’08, I am looking for levels clearly above the 2%-3% region that MCD’s U.S. same-store sales languished in – on a 2-year average basis – from August ’09 through February ’10. Last month’s number resulted in a 2-year average trend of 5%, which equaled that of March, the best 2-year number since February 2009.  In order for May’s number to imply a 2-year average trend that sustains the divergence from August-February’s slump, a 5.5% print will be needed. 


NEUTRAL:  Roughly 4.5% to 5.5% implies 2-year average trends that are not reverting to the pre-March slump, but are still below those seen in March/April.


BAD:  Any comparable store sales number below 4.5% would imply a significant sequential slowing from the 2-year average numbers of March and April and would also indicate business trends declining towards the level seen during the difficult months at the end of 2009 and beginning of 2010. This would be a meaningful disappointment and would likely be received negatively by investors.



Europe (facing a 7.6% compare, including a calendar shift which impacted results by -0.4% to 1.4%, varying by area of the world):


GOOD:  Above +6% would signal a 2-year average trend equal to that seen in April; this would solidify the significant sequential jump in 2-year average sales numbers seen from March to April.  For Europe I am maintaining the usual standard because 6% comparable store sales results have occurred as recently as March 2010.


NEUTRAL: +5% to +6% would signal that 2-year trends are slightly below April levels but still above the +6%.  


BAD:  Below +5% would indicate that trends have sequentially deteriorated from April levels. 



APMEA (facing a 6.4% compare, including a calendar shift which impacted results by -0.4% to 1.4%, varying by area of the world):


GOOD: Better than 5.0% would signal that 2-year average trends have improved sequentially from last month’s rebound from the dip seen in March (adjusting for the calendar impact).  This would instill further confidence that March was an anomaly and that the strong performance seen at the start of the year is sustainable.


NEUTRAL:  Roughly 3% to 5% would indicate that 2 year-trends were level on a sequential basis from April.


BAD: Below 3% would imply 2-year average trends that have slowed further from the level seen in April.  Below 1% would point to trends in line with the trough 2-year average trends indicated in December.



Howard Penney

Managing Director




get free cartoon of the day!

Start receiving Hedgeye's Cartoon of the Day, an exclusive and humourous take on the market and the economy, delivered every morning to your inbox

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.