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Spread Your Wings

“You need to be decisive, open- minded, flexible and competitive.”

-Stanley Druckenmiller

 

Our profession saw one of its all-time greats retire yesterday. Stan Druckenmiller, as one of his good friends told me, was one of the best at this game because “when he knew he was going to be right, he just spread his wings.”

 

After they get access to an interview, the manic media quickly comes to realize that hedge fund people aren’t Avatars. The most consistent hedge fund managers in this game are very matter of fact and common sense people. They have their own repeatable risk management process. They are as competitive as a professional athlete in executing it. And they are mentally flexible enough to change their positioning as the game changes.

 

Stan Druckenmiller likes to look at charts. I have a beauty that’s taped on the inside of my notebook that I often show clients to depict the correlation between hedge fund strategies going back to the early 1990’s. I use the early 90’s because that’s when we started to see the divergence between the real pros in this business and the monkeys in the hedge fund mafia who chase one another’s positions.

 

This chart demonstrates one very obvious fact: hedge funds used to have very low correlations to one another (0.3 in 1993) and now they have very high correlations to one another (averaging between 0.7-0.8 from 2007-2009). Therefore, you should invest with those hedge fund managers that can generate absolute returns in down markets. Druckenmiller was +11% in 2008.

 

From our skunk-works of chaos theory here in New Haven, CT, here are some deep simplicities associated with hedge funds who consistently drive absolute returns across bull and bear markets:

  1. Hedge funds that consistently find alpha in their idea generation.
  2. Hedge funds that maximize that alpha (spreading their wings) when they find it.
  3. Hedge funds that hedge.

What not to do: run 140% net long and cut your net your exposure to 107% when you realize it’s a bear market. That’s not what I call being hedged. That’s called being levered long. The nascent history of this industry has shown plenty of real pros who end up feeling like monkeys when they go there.

 

Another way that a real pro can start having performance issues is when they miss a big macro move. On top of the statistical reality that there are upwards of 10,000 hedge funds trading their gross and net exposures in a highly correlated way, you also have the institutionalization of asset management driving fund flows. When the macro wind moves from bullish to bearish, you need to be flexible.

 

Going back to 1993, when hedge fund returns weren’t correlated, the % of the US market controlled by “institutional investors” was running just inside of 45%. Today, that number is running closer to 65-70%, and there is an intense amount of pressure for asset managers to be “fully invested.”

 

Being “fully invested” means having a very low position in cash as a percentage of assets under management. After all, the art of managing money is actually having money to manage, so asset managers need to feed the beast. That doesn’t make it right.

 

If you look at the cash positions in US Equity Mutual Funds today versus the early 1990’s, the chart may or may not shock you. Cash as a percentage of assets under management has plummeted from 13% in 1991 to less than 4% today. Which way do you think this chart goes next?

 

And what do you do when long only investors are chasing relative performance bogeys on a monthly basis while levered long funds (disguised as hedge funds) are chasing them daily and weekly? I think those asset managers who are “open-minded and flexible” about thinking through this question of dynamic asset allocation to cash are going to continue to deliver to their clients what they really want – not losing their money.

 

I wake up every day with one risk management goal in my head – don’t lose our clients money. Maybe I should have been a goalie – or maybe I should have submitted my resume to a pro like Druckenmiller who could have taught me how to spread my wings when I get the hot hand. I have much to learn.

 

Our cash position in the Hedgeye Asset Allocation model is currently 61% (when we were bullish in August of 2009 it was 23%). We remain a short seller of both the US Dollar (UUP) and the SP500 (SPY) on strength and our best long ideas in global equities remain Utilities (XLU), Brazil (EWZ), and Indonesia (IDX).

 

My immediate term TRADE levels of support and resistance for the SP500 are now 1062 and 1099, respectively.

 

Enjoy time with your family and friends Mr. Druckenmiller. Your world class risk management performance will be missed, but never forgotten.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Spread Your Wings - EL st


MACRO: The Daily Outlook

RISK MANAGER subscribers receive the DAILY OUTLOOK every trading morning.  This is a one-off post for this morning.

 

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As we look at today’s set up for the S&P 500, the range is 37 points or 2.9% (1,062) downside and 0.4% (1,099) upside.

  • PERFORMANCE ONE DAY: Dow +0.09%, S&P +0.15%, Nasdaq +0.28%, Russell 2000 +0.28%
  • PERFORMANCE MONTH-TO-DATE: Dow (0.48%), S&P (0.68%), Nasdaq (1.73%), Russell (3.51%)
  • PERFORMANCE QUARTER-TO-DATE: Dow +6.56%, S&P +6.16%, Nasdaq +5.05%, Russell +3.05%
  • PERFORMANCE YEAR-TO-DATE: Dow (0.12%), S&P (1.88%), Nasdaq (2.36%), Russell +0.43%
  • ADVANCE/DECLINE LINE: 538 (-1221) Breadth was very negative
  • VOLUME: NYSE - 922.63 (-5.96%) - continues to be light
  • SECTOR PERFORMANCE: Three sectors negative - the safety trade - XLU XLV and XLE
  • MARKET LEADING/LOOSING STOCKS: King Pharma +8.88% and US Steel +4.8%; Safeway -4.52% and Sealed air -3.06%


EQUITY SENTIMENT:

  • VIX - 24.59 +1.07 - up 5 of the last 8 days.
  • SPX PUT/CALL RATIO - 1.92 up from 1.72 moving up for the last two days

 

 

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD 18.89 down 3.28%%
  •  3-MONTH T-BILL YIELD .16% down 0.01%
  • YIELD CURVE - 2.12 to 2.15

 

 

COMMODITY/GROWTH EXPECTATION:

  • CRB: 269.90 -0.11%
  • Oil: 75.42 -0.46%
  • COPPER:337.05 +0.36% - looking to up 5 of the last 6 days
  • GOLD: 1,231 +0.43% - up 5 straight days - Bullish formation

 

 

CURRENCIES:

  • EURO: 1.2875 +0.01% up for the last 3 days
  • DOLLAR: 82.223 -0.01%

 
OVERSEAS MARKETS:

  • ASIA - Most Asian markets moved modestly higher today, encouraged by the move in the USA China closed up 0.81%; Japan up 1.32%
  • EUROPE - European markets trading higher.
  • EASTERN EUROPE - Trading higher - Czech Republic and Russia leading the way.
  • MIDDLE EAST/AFRICA - Trading higher  - Jordan and the UAE up; Saudi Arabia down 0.66%

 

MACRO: The Daily Outlook - chart1

 

 

MACRO: The Daily Outlook - chart2

 

 

MACRO: The Daily Outlook - chart3

 

 

MACRO: The Daily Outlook - chart4

 

 

MACRO: The Daily Outlook - chart5

 

 

MACRO: The Daily Outlook - chart6

 

 

MACRO: The Daily Outlook - chart7

 

 

 

Howard Penney
Managing Director


THE M3: AUGUST GGR; PONTE 16 3RD PHASE; IDLE LAND; EMPLOYMENT SURVEY

The Macau Metro Monitor, August 19th, 2010

 

GROSS GAMING REVENUE SURGED TO MOP $7.9BN IN AUGUST Macau Daily News

From August 1st-15th, Macau GGR surged to MOP $7.9 bn (+51% YOY, +12.5% MoM).  Market share is as follows: SJM 29%; MPEL 19%; LVS 18%; Galaxy 14%;  Wynn 13%; and MGM 7%.


AMBROSE SO: PONTE 16 IS DOING BETTER NOW Macau Daily Times 

Regarding Ponte 16's third phase, Ambrose So said, “We are at the design stage and we have some legal things to settle with the occupant there...There is an appeal ongoing and it takes time for the court to assign a date [for the decision]."  Phase III will include an entertainment, retail and recreational complex and a waterfront promenade.  So also mentioned that Ponte 16 is ramping up and that its gaming revenues are much better than last year's.   

 

NO TIMETABLE TO TAKE BACK IDLE LAND: MACAU GVT macaubusiness.com

Jaime Carion, director of DSSOPT, said the government has no timetable on when it plans to take back idle land.  DSSOPT has received replies from 26 concessionaires explaining why they have left their land parcels undeveloped, which are being studied by the bureau’s legal department.

 

EMPLOYMENT SURVEY FOR 2Q 2010 DSEC

Total labor force was 326,000 in 2Q, comprising 317,000 employed and 9,300 unemployed. Compared with 1Q, total labor force registered an increase of 3,100, with number of the employed increasing by 3,300  and unemployed decreasing by 200.

 

 


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THE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - August 19, 2010

As we look at today’s set up for the S&P 500, the range is 37 points or 2.9% (1,062) downside and 0.4% (1,099) upside. 

  • PERFORMANCE ONE DAY: Dow +0.09%, S&P +0.15%, Nasdaq +0.28%, Russell 2000 +0.28%
  • PERFORMANCE MONTH-TO-DATE: Dow (0.48%), S&P (0.68%), Nasdaq (1.73%), Russell (3.51%)
  • PERFORMANCE QUARTER-TO-DATE: Dow +6.56%, S&P +6.16%, Nasdaq +5.05%, Russell +3.05%
  • PERFORMANCE YEAR-TO-DATE: Dow (0.12%), S&P (1.88%), Nasdaq (2.36%), Russell +0.43%
  • ADVANCE/DECLINE LINE: 538 (-1221) Breadth was very negative
  • VOLUME: NYSE - 922.63 (-5.96%) - continues to be light
  • SECTOR PERFORMANCE: Three sectors negative - the safety trade - XLU XLV and XLE
  • MARKET LEADING/LOOSING STOCKS: King Pharma +8.88% and US Steel +4.8%; Safeway -4.52% and Sealed air -3.06%

EQUITY SENTIMENT:

  • VIX - 24.59 +1.07 - up 5 of the last 8 days.
  • SPX PUT/CALL RATIO - 1.92 up from 1.72 moving up for the last two days

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD 18.89 down 3.28%%
  •  3-MONTH T-BILL YIELD .16% down 0.01%
  • YIELD CURVE - 2.12 to 2.15

COMMODITY/GROWTH EXPECTATION:

  • CRB: 269.90 -0.11%
  • Oil: 75.42 -0.46%
  • COPPER:337.05 +0.36% - looking to up 5 of the last 6 days
  • GOLD: 1,231 +0.43% - up 5 straight days - Bullish formation

CURRENCIES:

  • EURO: 1.2875 +0.01% up for the last 3 days
  • DOLLAR: 82.223 -0.01%

 

OVERSEAS MARKETS:

  • ASIA - Most Asian markets moved modestly higher today, encouraged by the move in the USA China closed up 0.81%; Japan up 1.32%
  • EUROPE - European markets trading higher.
  •  EASTERN EUROPE - Trading higher - Czech Republic and Russia leading the way.
  • MIDDLE EAST/AFRICA - Trading higher  - Jordan and the UAE up; Saudi Arabia down 0.66% 
Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends

 

THE DAILY OUTLOOK - S P

 

THE DAILY OUTLOOK - VIX

 

THE DAILY OUTLOOK - DOLLAR

 

THE DAILY OUTLOOK - OIL

 

THE DAILY OUTLOOK - GOLD

 

THE DAILY OUTLOOK - COPPER


IGT: MAINTAINING GAMING OPS

Gaming operations used to be a fantastic business for IGT.  Now, investment spend is essentially maintenance capex, at best.

 

 

IGT spends about 16-18% of its gaming operations revenues on gaming operations capex.  Since revenues haven’t grown, we’d have to characterize this capex as maintenance.  Maintenance at best, I should say.  We estimate that casino operators should spend 5-7% of revenues on average on maintenance capex.  IGT, on the other hand, is up to 18% on its gaming operations business.  Certainly, IGT’s gaming ops carries higher EBITDA margins, approximately 500-1,000 bps higher.  That’s not enough to offset 3x higher maintenance capex.  Dare we say, that gaming operations is not as good of a business as the casino business?  At least for IGT, that may be true.

 

IGT: MAINTAINING GAMING OPS - IGT1

 

As can be seen in the next chart, capex attributable to gaming operations has been remarkably constant.  The problem is that there is not incremental gross profit on the spend.  In fact, due to the tough macro environment and increased competition from other gaming suppliers, gross profit has been coming down since 2007.  Rolling four quarters gross profit is down $156.1 million or 18.7% from the peak with no corresponding decrease in capex.  Capex actually appears to be creeping up lately.

 

IGT: MAINTAINING GAMING OPS - IGT2

 

We like the 3-5 year outlook for the gaming supply industry but IGT's gaming ops business needs a boost.  The competition continues to get better and IGT remains very reliant on the Wheel line of products.  It is difficult to see how IGT will turn this segment into a grower again.


RESTAURANTS: THE DARLINGS OF THE XLY

One of the first screens we use to identify potential long or shorts is sell-side sentiment versus short interest, which is expressed via the days to cover ratio.

 

Looking at the data since I penned my DUPE (d) Early Look on June 29, 2010, it is clear that the trends for the American consumer are not getting any better.  We are getting closer to 4Q10, which is the quarter in which significant pressure on the consumer should become more evident.   We estimate that consumer discretionary spending could be down as much as 3% in 4Q10.     

 

As of the close yesterday, Consumer Discretionary was the second best performing sector year-to-date and one of only three sectors that is up year-to-date (XLY up 4.9%).  The other two sectors are Industrials (XLI up 7.4%) and Consumer Staples (XLF up 2.1%).   While easy comparisons and “corporate” fiscal austerity have helped the performance of consumer stocks, the best days of this cycle are behind us.

 

Today, the XLY is the best performing index, up 1.4% at the time of writing.  The positive consumer sentiment is being driven by the increase in mortgage applications, following a surge in refinancing.  In theory this should help consumer spending.  Also, restaurant sales trends are looking better with the Knapp-Track showing an increase of +0.9% (Traffic of -1.7%) vs. -8.3% last year; this is the first increase in 26 months.  Of the ten best performing names in the XLY today 6 are retailers.  Expedia is the worst performing stock in the XLY sector. 

 

As a reminder, the DUPE(d) thesis looks like this…

 

Double-Dip:  The housing market and the broader economy are on the precipice of a double dip; housing prices have already started to decline and the economy has slowed significantly quarter-to-quarter in 2Q10.

 

Unemployment:  Weekly Jobless Claims have not shown any material improvement over the past six months.

 

Prices Paid by the Consumer:  While reported inflation by the government looks to be under control, the Hedgeye Inflation Index tells a different story.  The Hedgeye Inflation Index focuses on the part of the economy showing inflation that impacts the consumer, specifically the spread between the prices of things they buy and what they earn.

 

Equity and Real Estate deflation:  We believe that the debasing of any currency (even the Almighty Dollar) ends badly.  A lack of austerity in government policies and our politicians’ aversion to facing facts are not helping the long-term outlook for equities.

 

Looking at the Hedgeye Sector Sentiment Monitor, the street has become more optimistic about the XLY relative to six months ago; sentiment on the XLY stands at 60.01 vs. 56.53 six months ago and 58.9 for the S&P 500. 

 

Within the Consumer Discretionary index, the three most loved sectors are Diversified Consumer, Hotels Restaurant & Leisure and Internet & Catalog Retail.  Narrowing it down further within those sectors, the most loves names are Darden (DRI), McDonald’s (MCD), Starbucks (SBUX), Expedia (EXPE), Amazon (AMZN) and Devry (DV).  Collectively, these stocks have a 16.2% weighting in the index, with MCD representing 7.8%.  YUM brands (YUM) is not quite as loved as the aforementioned names but sentiment is certainly strong versus most consumer discretionary stocks.  News pertaining to YUM today includes KFC franchisees suing over control of the advertising strategy (grilled chicken debacle continues) and Taco Bell is facing another salmonella lawsuit.  In terms of McDonalds, it seems to me that more positive news is on the horizon; beverage momentum looks set to continue against the backdrop of easy year-over-year comps.   

 

Malcolm Knapp released July casual dining same-store sales and traffic data today and the whisper-number was confirmed with same-store sales coming in at 0.9% and traffic decreasing 1.7%.   This was the first month in 26 months that casual diners saw an increase in comps. 

 

RESTAURANTS: THE DARLINGS OF THE XLY - FORMATIONS

 

RESTAURANTS: THE DARLINGS OF THE XLY - time series

 

RESTAURANTS: THE DARLINGS OF THE XLY - three xly subsectors

 

RESTAURANTS: THE DARLINGS OF THE XLY - knapp aug

 

RESTAURANTS: THE DARLINGS OF THE XLY - knapp traffic aug

 

 

Howard Penney

Managing Director


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