Follow The Trail

“Do not go where the path may lead, go instead where there is not a path and leave a trail.”

-Ralph Waldo Emerson


A college hockey coach sent me a nice recruiting letter about fifteen years ago with the quote above handwritten on it.  Although I ended up not going to the college he coached at, he did catch my attention with the quote.  At the time, as a rangy defenseman from a small town in Alberta, I’m pretty sure I didn’t know who Emerson was and I had certainly never seen the quote before.  As a result, I was quite moved by the concept and idea embedded within the quote.


Emerson was known as a passionate individualist and a “prescient critic of the countervailing pressures of society”.  He spread his gospel via dozens of essays and many hundreds of public lectures across the United States.  According to Wikipedia, Ralph Waldo Emerson was an American philosopher, lecturer, essayist, and poet.  Were he alive today, I think he may have been a Hedgeye.


In the short history of our firm, we’ve been accused of many things.  On the political front, we’ve been accused of being both Republican and Democrat.   On the market front, we’ve been accused of being bullish and bearish, and sometimes both at the same time.  We’ve also been accused of being grumpy (well, mostly Keith before his coffee) and overly negative.  The bottom line is that we have opinions, which are sometimes offensive to people, but those opinions aren’t to make ourselves feel better.  They are based on data and analysis with the objective of producing high quality and accurate research.  We express that research with our opinions, and when the facts change, so too do our opinions.

Currently as we survey the global macro landscape, we see a number of markets making trails that both concern us and really inform our broader perspective.  This morning I want to highlight three of those: the yield curve, the Swiss Franc, and copper.

1. The Yield Curve - Yesterday in our morning call, our Financials Sector Head Josh Steiner noted that the yield curve was narrowing to a point where banks were going to potentially see an impact on their earnings.  Remember, banks borrow short and lend long, so as the yield curve narrows, so inherently do their margins. So it’s no surprise given this move in the yield curve that the financial sector ETF has been the worst performer of all the sector ETFs in the last three months (down 7.9%) and broken from both a Trend and Trade perspective.  

From a global macro perspective though, the yield curve narrowing is typically a leading indicator for slowing economic growth.  When we analyze the yield curve, we focus on two durations specifically - 10s and 2s. In the parlance of the nonfinancial world, that is 10-year treasuries and 2-year treasuries, or as we like to call it, The Piggy Banker Spread.  We've highlighted this point in the chart below, but the Piggy Banker Spread has narrowed dramatically through the course of the year from ~290 basis points at its peak to ~210 basis points now.  This narrowing provides further support for our view that global growth is going to slow as it is a real time indicator for which direction long term rates are going, and the answer seems to be lower.

As a side note, we read with interest quotes from Thirdpoint’s Dan Loeb's recent letter to his investors (Dan, if you get a minute, please email us a copy).  Dan's letter, from what we could tell, went off on the system being rigged and on government intervention generally.  Admittedly, this is a point we have been very vocal on and it does worry us as we analyze and try to infer research information from markets that are managed by the U.S. government because, to be frank, we don't trust the Fiat Fools in Washington.

Nonetheless, the yield curve is a trail that is leading us to slow growth. For now, we'll accept that for what it is.

2. Swiss Franc - We highlighted this point in a note to our subscribers yesterday and want to re-emphasize it today.  The Swiss Franc has had a massive move against the Euro in the last three weeks.  In fact, the Swiss Franc is up over 7% in the time period (that's a big move in currency land) and is now back at levels not seen since the May time frame when everyone and their mother was worried about sovereign debt issues.  Well, sovereign debt issues don't go away over night, or because of ECB interventions.

The rapid move in the Swiss Franc, in conjunction with widening of credit default swaps in Europe over the past few weeks, is signaling that we may be hearing and seeing more sovereign debt issues in Europe in the coming months.  The explicit buying of the Swiss Franc and selling of the Euro is a direct vote against the Euro, and an attempt by those institutions with large currency exposure in Europe to hedge or protect the relative value of those European assets.

3. Copper - Dr. Copper over the past three months is up 9.9%, while its global commodity brother, Oil, is only up 1% on the same duration.  This isn't surprising since copper inventories globally, most specifically measured by the London Metals Exchange, are at nine month lows.  Moreover, based on normalized demand patterns and underinvestment over the past couple of years, we expect a global copper deficit next year for the first time in four years. Most importantly, this price divergence is a trail that is leading us to China. For the first time this year we are long China in the Hedgeye Virtual Portfolio via the etf, CAF.

Copper is verifying its trail this morning as it is up another 2.1%.  That is not necessarily a surprise given the Purchasing Managers Index report from China, which is an indicator of industrial activity.  This report saw a small increase sequentially going from 51.5 to 51.7.  While this is by no means massive, it does indicate stabilization.  In a country with 1.3 billion people growing at north of 10%, stabilization is perhaps all we need to be comfortable from a growth perspective.

Taken together these paths are leaving trails that we need to contemplate before our own portfolio trails.

I'm not sure if Ralph Waldo Emerson ever traded a P&L, but I'm guessing if he did he’d have an investment notebook, and his quote inscribed on the inside:

"A hero is no braver than an ordinary man, but he is brave five minutes longer."

Sometime that's all we need in this interconnected global market place, five minutes.

Yours in risk management,

Daryl G. Jones


Follow The Trail - ELPiggy


TODAY’S S&P 500 SET-UP - September 1, 2010

As we look at today’s set up for the S&P 500, the range is 21 points or 1.08% (1,038) downside and 0.92% (1,059) upside. 

Equity futures are trading above fair value boosted by stable Chinese manufacturing data and tracking gains across European indices. The focus continues to be on economic news as the market looks for signs of an economic recovery.

  • Today's macro highlights include August ADP Employment Report, July Construction Spending and August ISM Index
  • Eli Lilly (LLY) won a court order banning sales of generic versions of Strattera until a patent appeal is decided
  • FormFactor (FORM) cut 3Q rev. forecast to $46m-$48m vs. est. $57.3m
  • PerkinElmer (PKI) agreed to sell illumination and detection solutions business to Veritas Capital Fund III LP for ~$500m
  • Sysco (SYY) approved a program to repurchase 20m shares, or 3.4% outstanding stock
  • Texas Instruments (TXN) and Spansion (CODE) entered agreement to make Flash memory chips through June 2012
  • PERFORMANCE ONE DAY: Dow +0.05%, S&P +0.04%, Nasdaq (0.28%), Russell 2000 +0.05%
  • PERFORMANCE MONTH-TO-DATE: Dow (4.31%), S&P (4.74%), Nasdaq (6.24%), Russell (7.50%)
  • PERFORMANCE QUARTER-TO-DATE: Dow +2.46%, S&P +1.61%, Nasdaq +0.23%, Russell (1.22%)  
  • PERFORMANCE YEAR-TO-DATE: Dow (3.96%), S&P (5.90%), Nasdaq (6.84%), Russell (3.73%)
  • ADVANCE/DECLINE LINE: 327 (+2014)
  • VOLUME: NYSE - 1402.70 (+71.41%) - Very strong volume on an UP day
  • SECTOR PERFORMANCE: 5 of 9 sectors traded up on the day
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: Sprint +4.62%, Dean Foods +4.39% and Cliffs Natural +3.66%/Broadcom -6.4%, Monsanto -5.81% and Textron -4.15%


  • VIX: 26.05 -4.26% - YTD PERFORMANCE: +20.2%               
  • SPX PUT/CALL RATIO: 1.82 from 3.04  


  • TED SPREAD: 15.87 -1.015 (-6.008%)
  •  3-MONTH T-BILL YIELD: .14% unchanged
  • YIELD CURVE: 2.00 from 2.04


  • CRB: 264.19 -1.33%
  • Oil: 71.92 -3.72%
  • COPPER: 337.00 -1.73%
  • GOLD: 1,248 +0.88%


  • EURO: 1.2689 +0.09%
  • DOLLAR: 83.202 +0.05%




  • Nikkei +1.17%; Hang Seng +0.43%; Shanghai Composite (0.60%) Regional indices ended higher, with the exception of Shanghai Composite Index which suffered from a profit taking. Good macro data from Australia and China helped boost investor sentiment.
  • Australia Q2 GDP +1.2% q/q vs. survey +0.9%
  • China August PMI 51.7 vs. survey 51.5.



  • Major indices are trading higher helped by good data. Construction & Materials, Basic Resources and Media are among the positive sectors.
  • France Aug Final Manufacturing PMI 55.1 vs. preliminary 54.7
  • Germany July Retail Sales +0.8% y/y vs. consensus +1.4% and prior revised 4.7
  • Germany Aug Final Manufacturing PMI 58.2 vs. advance 58.2
  • Eurozone Aug Final Manufacturing PMI 55.1 vs. preliminary 55.0 
Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends














With Q2 under our belts, we’re taking a look at the important Direct VIP business in Macau.  Why didn’t Wynn’s share go up with Encore?



Direct VIP is an important part of the Macau marketplace, representing 17% of total Rolling Chip volume.  The profit contribution is even higher.  Instead of paying an average of 1.25% of roll to the junkets, the operators rebate only 0.7% to 1.1% back to the players.  This results in a 1,200bps higher EBITDA margin from the midpoint given the differential.  The American operators are the most successful in this segment, particularly LVS, while Macau’s largest operator, SJM, does not participate in Direct VIP.


Following the end of earnings season, we are now able to back into the Q2 Direct VIP contribution.  The following chart shows the market shares in Direct VIP. 




LVS continued to grow its Direct VIP share – the only segment where its market share has grown.  However, LVS recently announced it would be refocusing its efforts on the junket business so we would expect Direct VIP share to decline.  The most puzzling market share move is Wynn.  Despite the April opening of the predominately Direct VIP marketed property, Encore, Wynn’s share declined slightly in Q2.  Combined with July/August overall market share sequential declines, Wynn’s Direct VIP share may further the narrative that Encore has not been additive.  The next chart shows each company’s percentage of Rolling Chip volume attributable to Direct VIP.  Again surprisingly, Wynn’s VIP % barely budged following the opening of Encore.  MGM still generates a higher percentage of its RC from Direct VIP than Wynn, although this is partly due to MGM’s woeful junket performance.



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The good news: the Conference Board Consumer Confidence index improved moderately in August from July - the Index now stands at 53.5, up from 51.0 in July.

  1. The Present Situation Index decreased to 24.9 from 26.4.
  2. The Expectations Index increased to 72.5 from 67.5.
  3. Consumers are less confident today as they were a year ago – consumer confidence was at 54.5 in August 2009.
  4. The proportion of respondents saying jobs are “hard to get” increased to 45.7% from 45.1%, while those claiming jobs are “plentiful” declined to 3.8% from 4.4%.

In summary, consumers’ expectations improved moderately in August, but overall most remain pessimistic and there is no improvement in the labor market.  There is nothing in today’s confidence reading that leads us to expect acceleration in consumer spending.


TRACKING THE 3Q GDP SCORE CARD - conf board con conf aug10


Also in the “good-news-for now-and-meaningless-to-3Q GDP” camp is the Case/Shiller data for the month of June.  The data came in strong with a non-seasonally adjusted increase of 1.0% sequentially (+0.3% seasonally Adjusted) and a NSA increase of +4.2% vs. last year, down from +4.6% last month. 


See Josh Steiner’s post for all of the details, but starting next month a roll over in the Case/Shiller data is all but assured.   June’s Shiller data point reflects contract activity for February, March, and April – strong months in the housing market going into the expiration of the housing tax credit.  From Josh Steiner’s post today: “Starting next month, however, February will be replaced by May and the month after that March will be replaced by June and finally April will be replaced by July. As demand dried up in those ensuing months and we would expect to see prices begin to reflect that.”


The bad news: Chicago PMI - the Chicago ISM number fell to 56.7 in August from 62.3 in July, the lowest since November 2008.  With new orders declining to 55.0 in August from 64.6 in July, so does the inventory correction.  Inventories fell to 46.5 from 50.8 in July.  As seen in the chart below, the ISM inventory Index track closely to the inventory contribution to GDP chart we published yesterday. 


Due for release on Friday is the August payroll employment change and unemployment rate, which are likely to be disappointing to current expectations.  According to Bloomberg, the current consensus estimate for the August payroll employment change is (100,000) – a slight improvement from 131,000 jobs lost in July.  As an aside, the news of the MON restructuring is a real-time indicator as to how difficult the job market remains for the unemployed.  The reporting risk to the downside of expectations is in place for an outright payroll contraction in August (net of census impact), with the total jobs lost likely to exceed 100,000.  The consensus also calls for the August headline unemployment rate to be 9.6%, up from 9.5% in July. 


TRACKING THE 3Q GDP SCORE CARD - gdp inventory pmi w 3q est


Howard Penney

Managing Director

Two Charts: Case-Shiller and Swiss Franc

Conclusion: Case-Shiller has hit an inflection point as improvement slows and the rise in the Swiss Franc may be signaling bad news for the Euro Zone.


Sometimes a picture is worth a thousand words.  In that vein, we have two pictures that we want to share this morning that highlight a couple of important, even if unrelated global macro trends.


First, the Case-Shiller data from this morning.  This data showed that prices rose for the third straight month in June and pushed prices up 4.4% on a year-over-year basis for the full quarter.  The second quarter data, obviously includes a benefit from the tax credit, so should be viewed with some reservation given that  the recent housing data has turned quite bearish (See our note on 8/25/2010 entitled “Where Are The Housing Bulls Now?”).  Most noteworthy though, was the June data was actually the first time that year-over-year increases declined sequentially in 16 months.  That is, the rate of improvement in home prices slowed in June from May.  This point is highlighted by the red arrow in the chart below.


Two Charts: Case-Shiller and Swiss Franc - 1


Second, we want to highlight the rapid rise in the Swiss Franc versus the Euro.  In the course of three weeks, we have seen a ~7% appreciation of the Swiss Franc versus the Euro.  Traditionally, this would be considered a safety trade as Switzerland is considered to be a nation that is well capitalized and has solid financial reserves versus the rest of Europe.  The last time the Swiss Franc saw such a rapid move was May and June of this year when European sovereign debt concern was at its frenzied peak.  Interestingly, the media seems less focused on Europe but the markets, as is evident in certain credit default spreads and the strength in the Swiss Franc, appear to be foreshadowing a renewed focus on issues in Europe and for the Euro.


Two Charts: Case-Shiller and Swiss Franc - 2


Daryl Jones

Managing Director


Disappointing numbers from ISLE; August trending similar to soft July.



"We have again demonstrated the agility of our business by increasing retail play, managing costs and maintaining our average customer spend and visitation.  We did experience a modest decline in our overall number of database customers, as residents in our markets have continued to feel the squeeze of the economic contraction and the unemployment and housing pictures have not improved.  We are confident that our branding and marketing programs have been successful in influencing customers across the portfolio during the quarter, which stands to have a positive impact on profitability upon economic recovery."


--Virginia McDowell, president and COO




  • Nemacolin Woodlands Resorts project: 1st of 2 hearings next week
  • Meeting tomorrow with Nevada Gaming Commission for opportunity in Nevada
  • Non-recurring expenses cost 7 cents per share: attempted equity offering, Rainbow acquisition, and interest rate swap expenses


  • Slot capex for 2011: $20MM (new machines, signage, conversions, etc.)
  • Capex expenditure for this year: $40MM (will spend $8.5MM on BYI system for Pompano and Waterloo)
  • Consumer spending trends:
    • Win per trip and win per guest flat
    • Not marketing to customers in lower-end of database hurt revenues
    • July--softest of the 3 months; in August, similar to July--"bumping along the bottom"
  • Florida
    • net effect of tax change was $545,000 (25 days law was in place)
    • change in tax rate resulted in $1MM in higher revenue but there was a $400,000 charge related to loss of tax benefit (due to lower tax rate) on progressive liability--which is an one-time item
    • Poker will take time to ramp up.
  • Iowa Market: Waterloo results were good; Bettendorf pressured by road construction
  • Increase in retail play--spent more money on broadcast marketing
  • Corporate expense: $8.5 MM run rate
  • Swap: $2MM will run off by end of FY2011 and will trickle down in FY 2012
  • Davenport run rate going forward is similar to FY1Q; road construction will be over in October
  • Vicksburg market: a lot of free play in this market
  • Cape Girardeau project: $125MM estimate; if license awarded, it will take 2 years to build it out
  • Opportunity for margin improvements and EBITDA growth will depend on when unemployment/housing turns around
  • Biloxi: any positive impact from Alabama shutting down?
    • Yes, lower local traffic was offset by more visitors from Alabama
  • No concerns with debt covenants (interest coverage: 2x)
  • Maintenance capital will be much higher this year compared with last year
  • Leverage ratio: 6.8x to 6.9x
  • More promotional allowances at Pompano in FY1Q
  • Available credit facility at end of FY1Q: $125MM