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THE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - August 26, 2010

As we look at today’s set up for the S&P 500, the range is 28 points or 0.88% (1,040) downside and 1.77% (1,077) upside. 

Equity futures are trading modestly above fair value in a follow through to yesterday's late day rally and break a four-day losing streak.  Today's macro highlight in an otherwise quiet schedule will be the weekly jobless reading with consensus looking for a (10K) decline.

  • PERFORMANCE ONE DAY: Dow +0.20%, S&P +0.33%, Nasdaq +0.84%, Russell 2000 +1.56%
  • PERFORMANCE MONTH-TO-DATE: Dow (3.88%), S&P (4.20%), Nasdaq (5.02%), Russell (7.10%)
  • PERFORMANCE QUARTER-TO-DATE: Dow +2.93%, S&P +2.39%, Nasdaq +1.53%, Russell (0.79%)
  • PERFORMANCE YEAR-TO-DATE: Dow (3.72%), S&P (5.67%), Nasdaq (5.12%), Russell (3.31%)  
  • NCE/DECLINE LINE: +649 (+2220)
  • VOLUME: NYSE - 1115 (-5%)
  • SECTOR PERFORMANCE: 6 sectors traded higher - recovery trade lagged the market
  • MARKET LEADING/LOOSING STOCKS YESTERDAY: Harman +5.53%, Sears +4.95% and DR Horton +4.61%/Massey -3.38%, Dominion -2.84% and Cabot Oil/Gas -2.48%

EQUITY SENTIMENT:

  • VIX: 26.70 -2.77%            
  • SPX PUT/CALL RATIO: 1.97 up from 0.87  

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD: 15.57 0.203 (1.321%)
  •  3-MONTH T-BILL YIELD .16% unchanged
  • YIELD CURVE: 2.01 from 2.00

COMMODITY/GROWTH EXPECTATION:

  • CRB: 261.80 -0.25% down 8 of the last 9 days
  • Oil: 72.52 +1.24% looking at a 2 day rally?
  • COPPER: 323.15 -0.94%
  • GOLD: 1,239 +0.77%

CURRENCIES:

  • EURO: 1.2665 -0.06%
  • DOLLAR: 83.261 +0.14%

OVERSEAS MARKETS:

  • ASIA - Most markets rose modestly on bargain-hunting and on the heels of the late session rally in the US, but gains were restrained by worries about US new-home-sales data. The weaker yen gave a boost to technology shares in Japan. 
  • EUROPE - Major indices are higher in a broad based recovery in response to Wall St's late session rally which has encouraged some short covering and a little bargain hunting although volume is light.
  • LATIN AMERICA - Argentina and Peru trading higher, while Chile and Brazil are trading down
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


INITIAL CLAIMS FALL BUT ROLLING AVERAGE HITS A NEW YTD HIGH; SPREADS COMPRESS FURTHER

Rolling Claims Hit a New YTD High Despite Improvement in Reported Claims

Initial unemployment claims fell 31k last week (27k net of the prior week's revision up to 504k).  Rolling claims rose to 486.75k, an increase of 3.25k week over week and a new year-to-date high.  While the raw claims number today was a step in the right direction, there is a long way to go before reaching the range of 375-400k where unemployment can begin to meaningfully improve.

 

To reiterate, our firm is of the strong view that US economic growth is going to slow markedly in the back half of this year and into 2011. We think this will keep a lid on new hiring activity as management teams focus on cost control. All of this raises the risks that a prospective slowdown in GDP will precipitate an incremental slowdown in hiring/pickup in firings, which will, in turn, further pressure growth. We continue to look to claims as the best indicator for the job market, as they are real time and inflections in the series have signaled important turning points in the market in the past.

 

INITIAL CLAIMS FALL BUT ROLLING AVERAGE HITS A NEW YTD HIGH; SPREADS COMPRESS FURTHER - rolling

 

INITIAL CLAIMS FALL BUT ROLLING AVERAGE HITS A NEW YTD HIGH; SPREADS COMPRESS FURTHER - raw

 

2-10 Spread Compresses Further

The following chart shows 2-10 spread by quarter while the chart below that shows the sequential change. The 2-10 spread (a proxy for NIM) has been collapsing in the past two quarters.  The current value of 201 bps compares to 214 last week.  

 

INITIAL CLAIMS FALL BUT ROLLING AVERAGE HITS A NEW YTD HIGH; SPREADS COMPRESS FURTHER - spread

 

INITIAL CLAIMS FALL BUT ROLLING AVERAGE HITS A NEW YTD HIGH; SPREADS COMPRESS FURTHER - spread QoQ

 

The table below shows the stock performance of each Financial subsector over four durations. 

 

INITIAL CLAIMS FALL BUT ROLLING AVERAGE HITS A NEW YTD HIGH; SPREADS COMPRESS FURTHER - perf table

 

Below we show the correlations between initial claims and each of the 30 Financial Subsectors. We have refreshed this table to reflect prices through the end of July. Using this updated measure, Credit Card and Payment Processing companies remain the most correlated to initial claims, with R-squared values of .63 and .65 over the last year, respectively. Surprisingly, some subsectors show a positive correlation coefficient to initial claims - i.e. Financials that go up as unemployment claims go up.  These names are concentrated in the Pacific Northwest Banks and Construction Banks, though these correlations are usually not very high.  

 

INITIAL CLAIMS FALL BUT ROLLING AVERAGE HITS A NEW YTD HIGH; SPREADS COMPRESS FURTHER - init. claims subsector correlation analysis as of 8.4.10

 

Astute investors will note that in some cases the R-squared doesn't seem to reconcile with the square of the correlation coefficient. This is a result of finding the correlation and then averaging. For example, Pacific Northwest Banks have an average correlation coefficient of .33 and an average R-squared of .52 (with CACB, CTBK, FTBK, and STSA strongly positively correlated and UMPQ strongly negatively correlated). The different directions have the effect of canceling out each other out when finding the average correlation coefficient, but do not cancel out when finding the average R-squared. 

 

The following table shows the most highly correlated stocks (both positively and negatively correlated) with initial claims. Note that the top 15 negatively correlated stocks have a much stronger correlation on average than the top 15 positively correlated stocks - as you would expect, given that most of the Financial space is pro-cyclical. 

 

INITIAL CLAIMS FALL BUT ROLLING AVERAGE HITS A NEW YTD HIGH; SPREADS COMPRESS FURTHER - init. claims company correlation analysis as of 8.4.10

 

As a reminder, May was the peak month of Census hiring, and it should now be a headwind through September as the Census continues to wind down.

 

INITIAL CLAIMS FALL BUT ROLLING AVERAGE HITS A NEW YTD HIGH; SPREADS COMPRESS FURTHER - census chart

 

Joshua Steiner, CFA

 

Allison Kaptur


Channeling Hammy

“Those who stand for nothing fall for anything.”

-Alexander Hamilton

 

Keith is out this morning teaching a Risk Management class to MBA students at New York University’s Stern School, so I’ve been handed the quill on the Early Look.  I was fortunate to enjoy a week off last week, which afforded me some time to clear my head and do a little pleasure reading.  The first book I knocked off the list was Ron Chernow 856 page tomb, “Alexander Hamilton: A Biography”.

 

The story of Alexander Hamilton’s, or Hammy as his close friends affectionately called him, rapid rise from a dysfunctional family in the West Indies to becoming a confidant of General Washington during the Revolutionary War, to publishing the Federalist Papers, to finally becoming the first Secretary of the Treasury, is as rapid an ascension to influence that will likely ever be recorded in the annals of American history.

 

Hammy certainly had his faults, as we all do, but he was a learning machine that devoured books.  He also had a strong sense for right and wrong.  That is, he knew what he stood for.  In fact, he was so convicted in some of his beliefs that he ultimately died prematurely in a dual defending his honor against Aaron Burr.

 

Anyone that reads the missives coming out of the Hedgeye Research Juggernaut certainly understands very quickly that we know where we stand on our processes and our investment positions.   The goal in the investment business, though, is to be right, not obstinate.  The equivalent in our business of losing a dual is bad performance and client loss, so having conviction is fine if you are alive to trade another day.

 

While we have strong opinions, we aren't wedded to them and I think our track record speaks for itself on this intellectual flexibility. Since inception we've recommended 978 stock and ETF positions, 499 longs and 479 shorts, and have been right 85.6% on the longs and 83.9% on the shorts. But, I digress. Back to Hammy.

 

As Secretary of Treasury, Alexander Hamilton’s first objective was to pay back the heavy debt incurred to win the Revolutionary War.  As Hammy said, “The debt of the United States . . . was the price of liberty.” So, while this debt had its purpose, Hamilton also quickly realized that paying the debt back was critical in establishing confidence among other nations in the economic future of the United States.  This confidence would lead to support of the new American currency and a willingness of other nations to become trading partners.

 

We have been quite vociferous as to our thoughts on some important metrics relating to the national debt of a nation, specifically debt as percentage of GDP and deficit as a percentage of GDP. Another metric we would like to introduce today is debt as percentage of revenue. On a go-forward basis we will call this the National Coverage Ratio. That is, what is the ability, based on revenues generated, of a nation to both pay down its debt and cover its interest and principal payments, or cover these financial commitments.

 

In the chart below, we've highlighted the National Coverage Ratio for some relevant global economies.  While the United States screens negatively on the other debt ratios, especially on a projected basis, on this ratio it is actually an extreme outlier to the negative.  This tells a few things about the economic future of the United States from a policy perspective.  First, given current debt balances and revenue projections of the United States, it will be very difficult for the nation to support higher interest rates.  Second, and while we don't necessarily support this from an economic growth perspective, it seems likely that government revenues, i.e. taxes, will have to go higher. Neither of these points are very encouraging.

 

There is of course another option, an aggressive cut in future entitlements.  This is  perhaps what former Senator Alan Simpson, who is the co-chair of President Obama's Bi-partisan Debt Commission, meant when he described Social Security as a "milk cow with 310 million tits!" in an email.  Indeed.

 

As it relates to the shorter term though, over the past couple of days we have been covering our shorts and adding long exposure to the Hedgeye Virtual Portfolio.  This is not because we have become overly bullish on equities, but rather the market has sold off dramatically over the past seven weeks and our key economic catalyst is now behind us, which was the abysmal housing numbers of the past couple days.

 

While we aren't wedded to our bearish views, both the fundamentals and quantitative set up continue to support this stance. So, perhaps the best way to think of it is that we've gone from being Growling Loud Equity Bears to Cuddly Bears.  As a result, we currently have 14 longs and 8 shorts in the virtual portfolio, which is great positioning for a Cuddly Bear.

 

If you are looking for an equity Bull to support your investment positioning through year end, look no further than Lazlo Birinyi.  This morning he is out with the call that the S&P500 will rally 16% into year-end to the level of 1,225.  Interestingly, that is below his March target of 1,325. Since this morning we are being Cuddly Bears, we aren't going to challenge Lazlo to a Hamiltonian Macro Economic Dual. Albeit we do question any process that produces a round target for an equity index through an arbitrary time frame, but perhaps that is just us.

 

As we look forward though, we are not sure how cuddly we will remain.  The combination of initial jobless claims this morning at 830 a.m., Chairman Bernanke speaking at Jackson Hole tomorrow, and the second release of GDP for Q2 tomorrow will all combine to set the stage heading into September.  While we are not convinced these events will have a negative impact on the market in the short term, they will provide incremental data to inform our view through year-end.

 

And who knows, if the data is bad enough, perhaps we will drop our SP500 target by EXACTLY 100 points, just like Lazlo.   That is unlikely, however, given our macro models don't have a factor which incorporates licking your finger and holding it up to see which way the wind is blowing.

 

In the chart of the day, we have inserted a cute picture that shows President Obama inadvertently giving Treasury Secretary Timmy Geithner the middle finger.  This is not what President Obama really thinks of Timmy, but the President would probably like to Channel Hammy.

 

Yours in risk management,

 

Daryl G. Jones

 

Channeling Hammy - hamm2


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THE M3: GALAXY MACAU RECRUITMENT; MORE PROPERTY CURBS

The Macau Metro Monitor, August 26th 2010


 GALAXY WILL RECRUIT 7,700 WORKERS Macau Daily News

Galaxy said 7,700 workers will be recruited for the new opening of Galaxy Macau next year.  Recruitment will mainly be in gaming, F&B and hospitality sector.


NDRC SAYS TO FURTHER IMPLEMENT PROPERTY CURBS, NEWS REPORTS Business Week

According to China News Service, Zhang Ping, head of NDRC, said the nation will further implement property measures to control the real estate market and curb speculation. Zhang also believes home supply will continue to rise and that some real estate prices are still too high.


RT – IMPROVING BUT THINGS SHOULD SLOW

Although RT’s momentum may continue into fiscal 1Q11, the balance of the year looks less promising.

 

Fiscal 2010 (ending May) was a transformational year for RT.  The company was able to maintain its top-line momentum from late fiscal 2009 with same-store sales declining only 1.3% for the full year versus -7.9% in FY09.  Comp trends improved sequentially each quarter of the year on both a one-year and two-year average basis and turned positive in 4Q10 for the first time in 15 quarters.  Despite the company’s promotional tactics, restaurant-level margin increased slightly for the year while operating margin improved about 130 bps to 6.5% (before reported closure and impairment charges).  Earnings grew about 30% (again before the closure and impairment charges) after declining for three consecutive years.  Free cash flow was up 44% and the company paid down $204 million in debt, leaving the company with a much healthier balance sheet at the end of fiscal 2010.

 

Given these sharply improved results, RT’s stock price has climbed 53% since the end of the company’s fiscal 2009.  And, investor sentiment has shifted with short interest declining to just under 8% currently, from 10% in May 2009 (end of RT’s fiscal 2009) and as high as 13.5% in February 2010.  Sell-side love for the name has also grown with about 50% of analysts now recommending the stock as a buy relative to only 10% at the end of the company’s FY09.

 

RT – IMPROVING BUT THINGS SHOULD SLOW - rt short interest

 

RT – IMPROVING BUT THINGS SHOULD SLOW - rt ratings

 

Although RT seems to be doing a lot of the right things to increase the number of people in its restaurants, I don’t think the company will be able to maintain this momentum in fiscal 2011.  Given the current economic backdrop, I am expecting sales trends to slow across the industry.  To that end, RT’s full-year same-store sales guidance of flat-to-plus 2%, which implies a fairly steady improvement in two-year average trends throughout the year, seems unrealistic.  For now, I am modeling a 0.5% decline in same-store sales for the full year, which still implies some improvement in two-year average trends so it could prove aggressive.  On an earnings basis, I am at $0.78 per share for FY11, lower than the street’s $0.84 per share estimate and at the lower end of management’s full-year EPS guidance of $0.76 to $0.86.

 

Getting the timing right on this name will be important, however, because despite my bearish view on RT for fiscal 2011, the first quarter could potentially show further improvement.  This is how we view the set up for RT next quarter, based on my numbers right now:

  1. Same-store sales could improve again on one-year and two-year average year basis in 1Q11 (I am modeling +0.5%).
  2. Restaurant-level margin and operating margin could once again be up YOY (so potentially in Hedgeye Nirvana for the second consecutive quarter in 1Q11, as shown below).
  3. However, I have them missing on an EPS basis…I am at $0.14 per share versus the street at $0.16 per share.

 

For reference, RT held its fiscal 4Q10 earnings call on July 22 and the company’s fiscal 1Q11 ends in August so management had relatively good visibility on quarterly trends and they sounded quite bullish, which is why I would not be surprised to see the company post another quarter of positive same-store sales growth.

 

From there, I see momentum slowing for RT.  It will get increasingly difficult for RT to continue to achieve stronger comps on a one-year basis and my full-year same-store estimate of -0.5% implies negative comps for the remainder of the year.  I would also expect restaurant-level margin to come under pressure after the first quarter and decline for the balance of the year as the company laps its improvements from the prior year and food costs as a percentage of sales likely move higher in the back half of the year.   I am modeling a nearly 80 bp decline in full-year restaurant-level margin relative to management’s guidance of a slight decline YOY.  Based on my assumptions, which include negative same-store sales and declining YOY restaurant-level margin after the first quarter, RT could be headed for the Hedgeye Deep Hole as early as its fiscal second quarter of 2011.

 

RT – IMPROVING BUT THINGS SHOULD SLOW - rt sigma

 

 

Howard Penney

Managing Director


Bear Market Macro: SP500 Levels, Refreshed...

Position: longer, for now.

 

Maybe now I’ll pretend I am bullish, beg for QE3, and then sell into it.

 

In all seriousness, the last 48 hours have definitely tested the this market’s immediate term TRADE pain thresholds. I outlined these levels in this morning’s Early Look, but they are worth revisiting - anything sub 1053 would be 2.5 standard deviations oversold on our most immediate term risk management duration (TRADE, which is 3-weeks or less) and 1040 would be a 3 standard deviation event, which rarely occurs.

 

Fundamentally, we are chaos theorists. Therefore today’s intraday low of 1041 being a point away from the line we’d consider max-immediate-term-pain isn’t entirely surprising. We’ll call today’s action proactively predictable.

 

My immediate term support and resistance lines for the SP500 are now 1046 and 1074, respectively. Manage risk with a bearish bias around that range.

KM

 

Keith R. McCullough
Chief Executive Officer

 

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


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