TODAY’S S&P 500 SET-UP - August 25, 2010

As we look at today’s set up for the S&P 500, the range is 37 points or 1.13% (1,040) downside and 2.39% (1,077) upside.  Equity futures are trading modestly above fair value following Tuesday's sharp sell-off; the positive tone is being set by a steadier open in Europe.

Today's macro highlight will be July Durable Goods and July New Home Sales.

  • PERFORMANCE ONE DAY: Dow (1.31%), S&P (1.45%), Nasdaq (1.66%), Russell 2000 (1.17%)
  • PERFORMANCE MONTH-TO-DATE: Dow (4.07%), S&P (4.51%), Nasdaq (5.81%), Russell (8.50%)
  • PERFORMANCE QUARTER-TO-DATE: Dow +2.73%, S&P +2.05%, Nasdaq +0.69%, Russell (2.28)%
  • PERFORMANCE YEAR-TO-DATE: Dow (3.72%), S&P (5.67%), Nasdaq (5.12%), Russell (4.77%)
  • ADVANCE/DECLINE LINE: -1571 (-785) - continues erosion yesterday
  • VOLUME: NYSE - 1175 (+35%) - volume accelerated as stocks moved lower
  • SECTOR PERFORMANCE: XLU only sector positive and up the last three days; XLB breaks TREND
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: Southern Co +1.51%, Lennar +1.42% and Ameren +1.37%.  Medtronic -10.80%, Stryker -6.37% and Sandisk -6.04%


  • VIX - 27.46 +7.01%          
  • SPX PUT/CALL RATIO - 0.87 down from 1.78 (matching the 7/15 low)  


  • TED SPREAD - 17.16 0.913 (5.621%)
  •  3-MONTH T-BILL YIELD .16% unchanged
  • YIELD CURVE - 2.00 from 2.11


  • CRB: 262.46 -1.34% down 7 of the last 8 days
  • Oil: 71.63 -2.01%
  • COPPER: 326.20 -1.52% - biggest down day in a week
  • GOLD: 1,230 +0.34%


  • EURO: 1.26728 +0.03%
  • DOLLAR: 83.146 +0.03%


  • ASIA - Most markets closed lower. China closed down 2% following the move in the USA.  A pre-open report that the Bank of Japan is considering taking additional monetary easing steps before its scheduled policy meeting in early Sep provided a little support for Japanese markets but failed to counteract the effects of the strong yen. Yoshihiko Noda, Japan's finance minister, said he was considering “appropriate action” on what he described as “one-sided” moves in the yen
  • EUROPE - Most markets are flat to slightly higher; Ireland up 0.85% following S&P's downgrade of Ireland's sovereign rating to 'AA-' from 'AA'.  Germany's business confidence indicator has offered some support along with some solid corporate earnings. Construction sector outperforming, with oil & gas lagging.
  • LATIN AMERICA - Argentina and Mexico are down 3.1% and 2.4%, respectively.  Yesterday, in Mexico retail sales rose 1.5% in June from the same month a year earlier, the statistics agency said yesterday, below the median forecast in a Bloomberg survey for a 4.3% increase.
Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends













EARLY LOOK: Red Letter Day

This note was originally published at 8am this morning. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK in real-time, published by 8am every trading day.




“You can sneer or disappear behind a veneer of self-control.”
-Pet Shop Boys



EARLY LOOK: Red Letter Day - Red Letter Day


We have our British electronic dance music playing this morning in New Haven as the bulls are forced to sneer at the tail that’s been wagging this US growth dog since US Housing saw its cycle peak in April. As one of our three Hedgeye Macro Themes for Q3, we’ve called this Housing Headwinds.
The aforementioned quote comes from the Pet Shop Boys 1996 top ten hit, “A Red Letter Day.” What an appropriate quote and song name for a day like today where expectations for a bomb of an Existing US Home Sales report are finally being baked into this bear’s cake.
This day in 410 (AD) was also a Red Letter Day for the Roman Republic. Historians refer to this day as “The Sack of Rome” when the enemy (the Visigoths) took over the city for the first time in 800 years. This was a bad day for the professional politicians of Rome.
The US stock market has had a bad day for the last 3 days in a row. While our 2011 estimate for US GDP growth is still approximately half of the Bloomberg consensus, the Street is finally taking down its expectations for Q3 and Q4 of 2010. In recent weeks we’ve seen both Goldman Sachs and JP Morgan cut their estimates. There will be more of that to come.
Combined, with the prospective outlook for US unemployment, housing, and GDP growth finally getting a reality check, it will be interesting to wait and watch today as the SP500 finally takes a good hard look at our immediate term TRADE line of 1059 support.
Last week we penned this Red Letter Day on the calendar with both The Catalyst and The Line. While we do not think that the Fiat Republic will fall today, we do think that members of the risk management community will most certainly get paid on the short side.
To be crystal clear on this, today is not the day to be shorting stocks. Today is a day to book your gains and increase both your gross and net exposure. If you don’t run an asset management firm and you’ve gone self-directed, in Hedgeye Risk Management speak that means today is a day to invest some of the 61% we have allocated to Cash in the Hedgeye Asset Allocation model.
In terms of asset allocation, there’s an emerging and healthy debate about what percentage of your assets you should have in US “bonds versus equities.” This, of course, is born out of the last bubble that remains in global markets today – that which the Fiat Republic perpetuates by marking short term Fed Funds rates to model rather than letting the world mark them to market.
There will undoubtedly be a Red Letter Day for US Treasury bonds, we just don’t know when that will be yet. However, what we are comfortable saying right here and now is that it’s relatively safe to start shorting short term US Treasuries. The long end of the US Treasury market is not where we’d be focusing short positions. The 10-year yield could easily drop another 40-45 basis points from here and retest its prior lows.
On the short end of the curve, this morning you are seeing record lows in 2-year UST yields. At 0.46%, this may not be the lowest level of confidence global investors have had in US growth in 800 years, but the lowest US Treasury yields ever is still, by our calculations, a very long time.
So why is this so? Isn’t this ok? Yesterday while I was debating him on this topic on Bloomberg TV, Dean Baker of the Center for Economic Policy Research said it’s perfectly fine for America to keep on borrowing. He went on to say that “the bond market doesn’t have a problem with it.”
Admittedly, I think I was too surprised to absorb his summary conclusion on the spot. But after a good night’s sleep and some googling this morning, I am reminded of the partisan nature of Mr. Baker’s view point. After all, he does work at the center of modern day Rome in Washington, DC.
Rather than have barbarians hold professional politicians in the Roman Republic accountable, modern day risk managers have YouTube. For more Dean Baker and Paul Krugman thoughts on why we need to jack up government spending by another $800 BILLION dollars, please peruse the web.
Back to the question of whether you should buy US Treasury Bonds or US Equities - I don’t think you need to accept the preface of the question. Why not Brazilian or Chinese or Peruvian Equities? Why US Treasury Bonds? Why not cash?
Since 1997 when Paul Krugman told the Japanese to “PRINT LOTS OF MONEY”, you can pull up a chart of Japanese Government Bonds versus Japanese Equities and you’ll start to answer some of these questions on “bonds versus equities.” Foreign direct investment has been leaving Japan altogether for a very long time and Japanese bureaucrats are still trying to do more of what hasn’t worked.
On this Red Letter Day of August 24th, 2010, Japan will sell another 1.1 TRILLION Yen (that’s a lot of yens) in 20-year debt in order to attempt to boost expectations for another broken promise of “stimulus spending” still being the answer to their structural economic growth mess.
After losing another -1.3% overnight, Japanese equities have crashed, again, losing -21% of their already “cheap versus bonds” valuation since April the 5th.  Japan’s bond market “may not see a problem with monster debt levels” yet Mr. Baker, but her stock market sure does!
Best of luck out there today,


We've seen this movie before.




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As expected, WMS took the lead over IGT and Konami normalized.



With all the public companies earnings out of way we can step back and take a look a slot ship share trends.  Total shipments into North America decreased sequentially to approximately 16k in 2Q10 from an estimated 18.4k in 1Q10.

  • We estimate that new and expansion units decreased to 4,750 from 8,700 in 2Q09 and increased from 3,300 units shipped in 1Q10
  • Replacements in the quarter were about 11,200, up only 1% YoY and down from roughly 15,000 replacements shipped in 1Q10,
  • The June quarter is usually a seasonally stronger quarter for replacements than Q1.  As we discussed on “IGT: LOW QUALITY, LOW GUIDANCE, HIGH FCF” published on “07/28,” we believe that several factors in 1Q2010 pulled forward demand:
    • IGT’s Dynamix promotion
    • Konomi’s FY end March quarter is always seasonally much stronger than their June quarter.


Market Shares

  • IGT: 26%, down 1% from last quarter and down from 35% last year
  • WMS: 27%, a record ship share quarter for the company. This compares to 24% in 1Q2010 and 23% in 2Q09.
  • BYI: 16%, up from 13% last quarter and down from 20% in 2Q09
  • ALL: 1H2010 results were at 12%, up 1% from the same period last year
  • Konami: 8% down from 15% in 1Q2010; for 1H2010, Konami’s shipshare was 11%, putting it right behind ALL.  Konami’s share in 1H2009 was 10%.


Other “Trends"

  • The competition for floor share is higher than ever
  • For the first time since the 1980s (we think), another supplier recorded higher quarterly shipments than IGT.  WMS looks capable of maintaining its share in 25% range (+/- 2%)
  • Is 25% the bottom for IGT? Will ship share move converge back toward their floor share (52%) as many investors believe?  While they should retake WMS, they days of 50% share are long gone
  • BYI share should tick-up over the 12 months as the rollout of its new platform and content commences in 3Q2010.  We expect BYI share to stay in the 15-20% range.
  • ALL seems to be gaining modest traction with its new Viridian cabinet


The chart below summarizes slot ship share trends:



Shocker! Consensus Was Wrong On Housing

Conclusion: U.S. Existing Home Sales came in at well below consensus and inventory is at close to all time highs, which is just another supporting data point towards Hedgeye reducing its already Street low GDP growth estimate for 2011E of 1.7%.


Our Financials Sector will be up with their usual detailed post on the recently released U.S. Existing Home Sales, but in advance we wanted to give a quick overview.  The number for July came in at 3.83 million on an annualized basis, which is a 27.2% decline from June.


Not surprisingly, this was well below the median forecast of 4.65 million.  In fact, the low end of consensus was 3.96 million on an annualized basis.  So the reported number was 17.4% below the median consensus, and 3.4% below the lowest end of the estimates.  (It kind of makes you wonder about the math of the Perceived Wall Street Gurus, doesn’t it?)


In aggregate, the number of previously owned homes on the market rose 2.5% to 3.98 million.  Based on the current average sales price, it would take 12.5 months to sell the homes on the market.  In aggregate, there are 11.9 months of inventory of previously owned sales on the market which is the highest level since 1983.


Interestingly, interest rates domestically were at relatively high levels in 1983.  In fact, the Fed Funds rate in 1983 was between 9 ½ and 9 5/8, versus 0 – 0.25% now.  This is an important point, which we have emphasized repeatedly; this build up in inventory is occurring at a time when affordability from an in interest rate perspective is at all time lows.  Thus, which is obvious, there is no interest rate lever that can be pulled to reduce housing inventory as was available from 1983 onwards.


The key take away from inventory on the market is that housing prices need to go lower to catalyze more buying. Based on our models the downside in housing prices from here could be anywhere from ~10 – 50%. The data points today only solidify our case.  Even more encouraging for our case is that our estimates for prices are quite divergent from consensus estimates, which are outlined in the chart directly below.


 Shocker! Consensus Was Wrong On Housing - 1


Since consumer spending makes up 70% of the U.S. economy, the value of the consumer’s key asset, their house, has a direct impact on their confidence in spending.  As house prices go lower, so too does consumer discretionary spending.  Thus as we get more certainty that home prices nationally will go lower, we also get more certainty that GDP growth is going to be less than expected in 2011E.


We are currently at 1.7% GDP growth for 2011E and maybe it’s just having cleared my head after being on vacation for a week, but that number is starting to feel too high, even if at the low end of consensus.


Daryl G. Jones

Managing Director


Shocker! Consensus Was Wrong On Housing - existing

Bear Market Macro: SP500 Levels, Refreshed...

I’m getting a lot of questions as to why I am covering shorts on the housing news today. The answer is always the same answer – the math.


The same math that got us to making a Housing Headwind call for a down -20-30% existing home sales print this morning (it was down -27.2%) is the same kind of math that drives our entry and exit points in markets – mean reversion. We try use the newsy nature of markets as our backboard for contrarian investing.


Despite months’ supply of homes for sale shooting up to 12.5 months (versus 8.9 months in June), despite the market being down hard on the “news”, and despite our intermediate term Bear Market Macro call on the SP500, we can still see an oversold market for what it is – immediate term oversold.


As of our 11AM EST refresh of the macro model, we’ll call any SP500 price under 1053 immediate term oversold. We continue to flash lower-highs of resistance and this morning we’ll show in another one at 1077 – we’d like to re-short the SP500 on another low-volume rally up closer to that price.


The upshot of this risk management view is that bear markets bounce, and this one will too.


Keith R. McCullough
Chief Executive Officer


Bear Market Macro: SP500 Levels, Refreshed...  - 1

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