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You've Got It In You

“I definitely know I’ve got it in me. I’ve just gotta focus on what I can control.”

-Stephen Strasburg


Winners just win. There are plenty of great leaders in this country who prove that where it matters every day. From Washington to Chicago this morning, they’ll be putting their Professional Politicians on mute. This is progress.


The Chicago Blackhawks won the Stanley Cup and in his MLB debut 21-year old Stephen Strasburg struck out 14 batters leading Washington National fans to hope that the future in the Capital could be brighter than the present.


Hope, as we like to say, is not an investment process however. Until we change the said leadership of everything American finance, we are going to be hostage to the gravity of analytical mediocrity.


I was on a flight to Los Angeles while Ben Bernanke was testifying yesterday. Between his reckless forecasts and the Manic Monkeys on CNBC taking his word for it, I was left with one option – re-short the SP500 (SPY) on strength.


Not unlike professional athletes, our Hedgeyes believe in putting our market view on a tape for everyone to see, real-time. Our clients love it. Our detractors hate it. This is the New Reality of finance. I think Americans are sick and tired of pretend portfolio managers blowing their capital up in smoke and saying “everyone missed it” every time there is a major loss to reflect upon.


This isn’t to pump my own tires. This is to challenge any of these mouth pieces in the Manic Media to simply put it on the tape. Caution to the Jim Cramers of the world who tell you to buy Bear Stearns or BP obviously - a time stamp on everything you recommend will be held against you every day. There is nowhere to hide.


This is how a practical firm’s interpretation of Transparency and Accountability works. At 12:27PM yesterday we sent a message to our clients that said:


“Re-shorting what we covered profitably. We remain bearish and today's rally reminds me that consensus belief in Bernanke's forecasting ability is not yet Bearish Enough. KM”


You can look at the intraday chart from there and hold me to the score associated with that “call” – whether the call is right or wrong, no matter where I go at 230AM here in California as I write this, there it is…


“I definitely know I’ve got it in me. I’ve just gotta focus on what I can control.”


Think about that winner’s attitude. That’s what we need in this country. Not a bunch of group-thinkers who don’t do their own work and can’t focus on anything other than what the guy focusing on his job security next to him imputes in his forecasts. Do your own work. Have a process. Plan to change it when the plan is not working.


Back to Bernanke…


Here’s the written YouTube version of what he was forecasting yesterday, and we are going to hold him accountable to it:

  1. Double Dip? - “unlikely, but it can’t be ruled out”
  2. 2011 GDP forecast? - “3.5-4%, but it’s difficult to say”
  3. European Debt impact on USA? - “modest impact, but we will monitor it”

Ben, are you kidding me, man? You hold the precious value of the world’s reserve currency in the palm of your hands and everything you forecast is not only infrequently accurate from a risk management perspective, but everything you forecast has a sheepish “but”…


I haven’t had enough sleep, so take my tone for what it is this morning. I’m human too and I am finally at wits end with where the Perceived Wisdoms of Officialdom in this country is taking us. We are headed down a European road to perdition and someone needs to block the road.


Enough of my rant, here are the global macro Risk Manager’s answers to the same questions:

  1. Double Dip? - Post last week’s employment report and the SP500 losing -13.3% of its value since April 23rd, the probability of a rollover in the US economic cycle has gone up considerably. In probability speak, we’d call a double dip much more likely.
  2. 2011 GDP forecast? - I can say that it’s not difficult to say that Bernanke’s estimate is way too high.
  3. European Debt impact on USA? – It’s already marked-to-market so I’ll let Mr. Macro Market speak for himself on this front day-to-day. The answer to the question is obviously that there has been considerable impact and that rather than adhering to a Buy-And-Hope model based on Bernanke’s definition of “monitoring”, we maintain our ZERO percent asset allocation to US Equities in the Hedgeye Asset Allocation Model.

ZERO is the level of respect that Bernanke and the Fiat Fools from Japan to Europe have for the cost of capital. ZERO is the respect you get when you come to the game unprepared and then don’t hold yourself accountable to your performance.


Look on the bright side - if the European version of TARP turns out to be as big a loser as Hank Paulson’s was coming out of the gates, this is what the President of The European Fiat Union has to say about that:


“And if the plan were to prove insufficient, my answer is simple: in this case, we’ll do more.” –Herman Van Rompuy


Obviously Van Rompuy and Bernanke share the same views of accountability. Good thing they didn’t play sports. Ignore these losing ideologies and focus on what you can control this morning. You’ve got it in you.


My immediate term support and resistance levels for the SP500 are now 1037 and 1077, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


You've Got It In You - S P


Despite the fairly dovish comments from Fed Chairman Bernanke during his testimony in Washington yesterday, the S&P ended the day down 0.6%.  The weakness was concentrated in two sectors: Energy (XLE) and Financials (XLF).


The move in XLE was not that surprising given the weakness in the Energy (XLE), with a sharp selloff in BP down 15.8%.  Pressure from the Obama administration on BP to suspend its dividend was one major factor in the steep decline.  Other names leveraged to the Gulf of Mexico disaster such as APC (down 18.6%) and RIG down (8.1%) came under meaningful pressure as the market focuses on the potential for bankruptcy. 


The Financials were actually the worst performing sector on worries that Senator Lincoln's derivatives legislation will remain part of the financial regulatory overhaul; this put pressure on the money-center and investment banks.  In addition, the fundamentals surrounding the housing market continue to erode.  As our financials analyst Josh Steiner wrote yesterday “mortgage applications have done a base jump off their April levels and haven't hit bottom yet in the wake of the April tax credit expiration pull-forward. “  The MBA Mortgage Purchase Application Index, a leading indicator for home sales activity, declined 5.7% from last week bringing the decline since April to 32.8%. The month of May was down 18% vs. the month of April.


There is some level of uncertainty surrounding today’s ECB meeting, but the Euro has rallied for three days and is currently trading just above $1.20 versus the U.S. dollar.  We will see if it can close higher today.   The consensus is that Jean Claude Trichet will leave the benchmark rate at a record low of 1%.  The Bank of England, also meeting today, will likely keep its emergency stimulus in place and maintain the benchmark interest rate at a record low of 0.5%.  The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade (1.18) and Sell Trade (1.21).  A higher Euro will help to put a bid under the RISK trade. 


Treasuries finished well off their worst levels on the day with the pickup in the risk aversion trade.  The dollar index was down 0.56%.  The positive correlation between the USDEUR and the TED spread (on a trailing three month basis) tightened yesterday to 0.98.  The inverse correlation with the EURUSD and the TED spread tightened to -0.97.  The Risk Management models have the following levels for the USD – Buy Trade (87.40) and Sell Trade (88.21).  The VIX was flat on the day, closing at $33.73.  The Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (32.34) and Sell Trade (38.04).


Materials (XLB) and Consumer discretionary (XLY) were the two best performers yesterday with retail and media as the bright spots in the sector.  The S&P 500 Restaurant Index climbed 1.2% on the day. 


Technology (XLK) was unable to sustain its early outperformance that came on the back of upwardly revised guidance out of TXN.  The S&P Software index closed down 0.8% on the day. 


The voices of corporate stability are helping to provide some support for the market:


(1)    VIA.B rallied after announcing the resumption of its share buyback program; the company increased the funds available to repurchase shares to $4B.

(2)    BF.B said that it would buy back up to $250M worth of shares.

(3)    CAT +0.4% raised its quarterly dividend by 5%.

(4)    KBR up 10.1% after the company announced plans to repurchase up to 10M of its shares.

(5)    Monsanto announced a three-year, $1B share repurchase program. 


The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.66) and Sell Trade (2.94). 


Oil is moving higher for a third day on expectations of stronger demand after China’s crude imports increased and a weaker dollar.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (71.01) and Sell Trade (74.68).


Gold is indicating lower for a third day as a stronger Euro and better-than-expected economic data in China is mitigating some of gold’s safe haven status.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,202) and Sell Trade (1,246).   


As we look at today’s set up for the S&P 500, the range is 40 points or 1.8% (1,037) downside and 2% (1,077) upside. 


Howard Penney















According to the Xinhua news agency, KFC employees in northeast China will see minimum wages rise to 900 Yuan ($132) a month, from 700 Yuan, after the company agreed to demands from the local trade union; employees of YUM operations in the Shenyang, Liaoning province, will also receive an annual pay rise of 5%.  Yum! Brands in Shenyang manage 57 KFC outlets and 11 Pizza Hut restaurants.  The returns for YUM China are so strong due in part to very low labor costs.  Recent wage hikes, combined with rising prices, mean the China return dynamics are changing.


China generates 37% of 2010 estimated segment operating income.  Prior to Q1, trends had been steadily declining, but the YUM management team pointed to improving consumer confidence as part of the reason for the return to better trends. 


Year-to-date, the Chinese market is down 21% and it appears to be taking a toll on consumer confidence.  In April, Chinese consumer confidence declined to 106.6 from 107.9 (though still up YOY).  Management highlighted on its 1Q10 earnings call that consumer confidence in China had increased year-over-year the last three months.  The absolute direction of consumer confidence, however, will take its toll on trends on a sequential basis.


For YUM to maintain its same-store sales momentum on a 2-year average basis from Q1, YUM China needs to post a 10% same-store sales number in the second quarter.  In this environment, a sequential slowdown in 2-year average sales trends is the more likely outcome.  The company guided to a similar magnitude of same-store sales growth in China in 2Q10 as reported in 1Q10, which would imply a 300 bp decline in 2-year average trends.






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Over the near term, the prospects for a recovery in replacement demand are likely to drive IGT’s stock. The sustainability of IGT’s still high participation share remains a longer term risk.



Take a look at the charts below.  IGT’s slot ship share has been around the historically low (at least since the 80s) 30% for the last few quarters including 29% in the March quarter.  IGT’s market share of high margin participation units was almost twice its ship share at 51%. 




As we showed in our WMS Black Book (released in April), IGT’s market share of gaming operations revenue has been on a steady decline but can still fall significantly further.  If participation share declines to ship share levels tomorrow, it would mean $350-400 million in lost revenues.  Of course, we are not projecting this in short fashion, but over time, IGT is unlikely to participate in this segment's growth and will likely see declining revenues over the long-term. 


The other overlooked aspect of its gaming operations segment remains the over-reliance on the Wheel of Fortune line of products.  As we wrote about in our 11/27/09 post, “HOW LONG WILL THE WHEEL KEEP TURNING”, the “Wheel” generates almost 50% of the company’s profits.  Last year’s patent invalidation opened the playing field and created one more hurdle for IGT in this segment.


The current outlook on summer job opportunities for teenagers does not bode well for QSR demand.


The 16-19 year old age group is an extremely important demographic for QSR operators and the increasing rate of unemployment among this age group since 2Q08 has taken its toll on QSR demand.  Restaurant management teams across the industry have cited higher unemployment as the primary cause of weaker demand, but QSR operators have been more vocal about how the even higher rate of unemployment among its younger, core users has hurt trends. 


Specifically, JACK management stated on its fiscal 4Q09 (period ending September 27, 2009) earnings call, “In addition, unemployment rates for our core customer demographic which skews towards young males and Hispanics are substantially higher than the overall rates.  According to the Department of Labor, on a seasonally adjusted basis, 16 to 24 year olds had a very rough summer in 2009, with fewer than 50% working.”   Judging by the significant year-over-year decrease in the number of jobs added for 16-19 year olds in May 2010, as reported by the Bureau of Labor Statistics, this summer could prove even more difficult. 


In May, employment among 16 to 19 year olds grew by only 6,000 sequentially from April relative to the 110,000 increase in May 2009 and the 116,000 increase in May 2008.  As the chart below shows, the magnitude of jobs added typically increases in June and July from May levels so it will be important to watch how the rest of the summer plays out to get a better read on the current teen employment picture, but May points to a rough start and could put increased pressure on 2Q and 3Q QSR sales trends.


QSR INDUSTRY – TEEN UNEMPLOYMENT - 16.19 summer employment growth


QSR INDUSTRY – TEEN UNEMPLOYMENT - 16.19 may employment growth


QSR INDUSTRY – TEEN UNEMPLOYMENT - 16.19 unemployment rate


Howard Penney

Managing Director


The Street tends to be way off on its Macau estimates for a variety of reasons. Direct play is an important missing variable in their models.



Direct play is better than junket play.  That is a fact for the Macau operator.  If Wynn Macau/Encore could convert the 85% of its VIP business that is junket-related to direct play, it would result in an incremental $280-325 million in EBITDA.  Obviously, if it was that easy, a smart guy like Steve Wynn would’ve already done that.  The point is there is a lot of margin out there to capture given the 0.4% to 0.5% spread between the junket commission rate and the direct player rebate.


With the opening of the predominately direct play Encore, Wynn is poised to grow its direct play business from 10% to 13%.  That number should grow over time as should Wynn’s margins.  Wynn still falls behind LVS in terms of direct play market share but directionally, Wynn (thanks to Encore) and MPEL are moving higher while LVS’s share is declining.  LVS share should ramp back up when Lots 5 and 6 finally open.  The following chart details direct play market share by company.




To look from a different perspective, we also track the amount of direct play volume as a percentage of total Rolling Chips (VIP volume).  LVS remains the market leader here but MPEL and Wynn look like they have the most to grow.




Direct play is an important factor in determining margins in Macau which is why the Street seems to be consistently off in projecting EBITDA.  Other important details that some on the Street fail to model separately are Mass vs VIP, both volume and hold, and junket commission rates.