The Macau Metro Monitor, September 29th 2010



The Lands, Public Works and Transport Bureau Director, Jaime Carion, yesterday said there is no law in Macau that prohibits Sands China from selling its Four Seasons apartment-hotel under a co-op scheme but Sands needs to gain government approval regarding giving the title of the apartment-hotel to a subsidiary company.  After this is approved, Sands can start implementing the co-op scheme without needing any further approvals from the government.



According to official figures, 460,000 tourists visited Macau during this year’s Mid-Autumn Festival, from September 22 to 24, a decline of 1.26% YoY.  The majority of visitors came from mainland China, entering Macau by the Zhuhai Border Gate.



According to Secretary for Transport and Public Works, Lau Sio lo, the goal is to increase affordable housing supply while raising the transaction costs for speculators.  Measures include: an increase in land supply for developers; full payment of the property transfer tax (ex. 1st-time buyers); and tightening of the LTV ratio for bank mortgages. More draft laws will be announced later this year.



According to Xinhua, China plans to expand the trial nationwide on a gradual basis.  China is also asking commercial banks to suspend the offer of loans to buyers of third homes and to increase the prepaid deposit requirement to 30% or higher, says Xinhua.


TODAY’S S&P 500 SET-UP - September 29, 2010

As we look at today’s set up for the S&P 500, the range is 19 points or -1.02% downside to 1136 and 0.64% upside to 1155. Equity futures are trading lower, tracking weak trading in European markets with doubts arising if the economic recovery can be sustained.

  • Boeing (BA) got a contract for 124 F/A-18 fighter jets worth $5.3b from U.S. Navy
  • Chelsea Therapeutics International (CHTP) plans $35m share offering
  • CryoLife (CRY) enters global manufacturing agreement with Starch Medical for PerClot
  • Green Mountain Coffee Roasters (GMCR) says SEC is conducting investigation, requested documents related to rev. recognition practices
  • ModusLink Global Solutions (MLNK) reported 4Q loss per share of $0.58 versus $0.09 Y/Y
  • Standard Microsystems (SMSC) forecast 3Q adjusted EPS of $0.42-$0.43 versus estimate $0.45


  • One day performance: Dow +0.43%, S&P +0.49%, Nasdaq +0.41%, Russell 2000 +1.07%
  • Month-to-date: Dow +8.42%, S&P +9.37%, Nasdaq +12.56%, Russell +12.19%
  • Quarter-to-date: Dow +11.09%, S&P +11.35%, Nasdaq +12.82%, Russell +10.82%
  • Year-to-date: Dow +4.12%, S&P +2.92%, Nasdaq +4.87%, Russell +8.00%


  • ADVANCE/DECLINE LINE: 1171 (+1656)
  • VOLUME - NYSE: 1025.35 (+11.39%)  
  • SECTOR PERFORMANCE: Only three sectors declined yesterday - the positive tone was largely fueled by the reflation sensitive sectors - XLE. Stocks showed some resilience today in the face of continued European sovereign credit contagion concerns and disappointing US economic data - consumer confidence.
  •  MARKET LEADING/LAGGING STOCKS YESTERDAY: Walgreen 11.40%, Boston Scientific +7.85% and Washington Post +5.08%/Monsanto -8.14, Flir -3.74% and E*Trade -3.46%
  • VIX: 22.60 +4.10% - YTD PERFORMANCE: (+4.24%)
  • SPX PUT/CALL RATIO: 2.36 from 1.73 +36.42%


  • TED SPREAD: 13.83 -0.913 (-6.195%)
  • 3-MONTH T-BILL YIELD: 0.16%
  • YIELD CURVE: 2.11 from 2.10


  • CRB: 284.35 unchanged
  • Oil: 76.18 -0.44%
  • COPPER: 363.70 +1.11%
  • GOLD: 1,309.50 +0.96% - up 5 days in a row


  • EURO: 1.3578 +0.73%
  • DOLLAR: 79.014 -0.41% - up 1 day in the last 8



  • European markets are trading back below breakeven despite a positive start
  • Meanwhile, reports in the FT said the Irish government will inject a further €5B into the Anglo bank and that they will also announce plans to restructure some of the bonds. The FT and the Irish Times this morning report that the Irish government’s estimate of the final cost of bailing out Anglo Irish Bank could reach between €28-30B, below the €35bn estimate by S&P.
  • Elsewhere, while much of Europe is struggling to work amid strikes across the continent. 
  • France Sep Consumer Confidence (35) vs consensus (39) vs prior revised (38) from (39)
  • Eurozone Sep Economic Sentiment Indicator (2) vs consensus (5) and prior (3) 


  • Asian Markets: Nikkei +0.7%; Shanghai Composite (0.03%)
  • Most Asian markets followed Wall Street up today, boosted by macroeconomic numbers released in the region.
  • Japan rose on a better-than-expected Tankan Survey release.
  • China gave up morning gains and finished flat, with rumors spreading that the country will raise the reserve requirement ratio this weekend.
  • China’s seven-day interbank rates have more than doubled since the beginning of Aug to 2.9% raising the prospects for fiscal tightening.
  • Technology stocks led South Korea up. Retailers advanced on expectations that Chinese tourists next week will result in increased sales.
  • ASX fell 1% in Australia on news that its CEO will step down in July when his contract ends.
  • Japan Q3 large manufacturer Tankan 8 vs consensus 6 and 1 sequential. Q3 large non-manufacturer Tankan 2 vs (2) consensus and (5) sequential. China September PMI 52.9 vs 51.9 prior. 

Howard Penney

Managing Director 


THE DAILY OUTLOOK - levels and trends














A Heavier Crash

“The lofty pine is oftenest shaken by the winds; high towers fall with a heavier crash; and the lightning strikes the highest mountain.” 



I haven’t considered a heightening probability of a US stock market crash in an Early Look note since 2008. I’ll go there this morning.


Before I look forward, allow me to take a step back. To fully appreciate the risk that is getting baked into this US stock market cake, we should respect history’s lessons. If you believe that the professional politicians of the Fiat Republics of modern day America and Japan have as much to lose as those in the Roman Empire did in 49BC, you’ll find my using a quote from the leading Roman lyric poet of that era appropriate.


I’m not a poet. I’m a Risk Manager. In probability speak, I am registering signals in my global macro risk management model that would consider an abrupt 1-3 day US stock market crash in October probable. To be clear, I’m not saying it’s likely – but I am saying it’s probable. There is a difference.


Probable is proactively predictable. Likely would be a better than 50% chance. What I see here is a 33% chance this happens, so let’s strap the accountability pants on and take a walk down that path. For a Heavier Crash to occur during a compressed period of time, we still need a few more things to happen:

  1. We need to see the SP500 get squeezed one more time in the next few weeks to a price north of 1164.
  2. We need to see volatility (VIX) get oversold towards 20.
  3. We need to continue to see the world’s said “reserve currency” lose its credibility.

The bad news is that all 3 of these factors are already in motion, big time (since late August the SP500 is +10%, the VIX is down over -20%, and the US Dollar has been crushed to lower-intermediate-term-lows). If these 3 factors continue to travel the path of least resistance (SP500 up, VIX down, and US Dollar debauched), we could have a serious short term problem.


Measuring time and space is a critical aspect of my profession. As a chaos theorist, I don’t expect to be taken seriously by the gurus of buying cheap P/E’s, nor do I want to be. If the Ken Fishers of the world didn’t realize they were going to get smoked in 2008, I don’t see why they’d see it coming now. Evolving the risk management process is a dynamic exercise in and of itself. We all need to change as the market’s ecosystem does.


So what would a Heavier Crash look and feel like?

  1. The most probable scenario that the perma-bulls would consider improbable is a 1-3 day correction on the order of -5.4% to -6.9%.
  2. The least probable scenario in my model is an October 1987 type day (down -23%); I’d still consider that improbable, for now.

Now isn’t that a correction rather than a crash? If we eliminated that one little critter that the market calls expectations, yes, it might be. But relative to the expectations in this market today (this morning’s Bullish to Bearish Survey from Institutional Investor is seeing a +2400 basis point swing to the bullish side since the week US stocks closed at their late August lows), this could feel like a Heavier Crash than it might be considered in nominal terms.


What immediate term bearish data and price information in the land of global interconnectedness am I staring at in my notebook?

  1. The SP500 is teetering on a critical line of support (my intermediate term TREND line of 1144); any slicing through that line on accelerating volume puts this bearish scenario back in play (again, that’s not what I would consider tail risk – it’s a probability to manage risk around)
  2. Volatility (VIX) continues to trade with an extremely high inverse correlation to the SP500 with TREND line support for the VIX at 20.96
  3. The SP500 is actually down for 4 out of the last 6 trading days and the market’s breadth is deteriorating
  4. Financials (XLF) remain the only sector in the SP500 (of the 9 we model top-down daily) that’s bearish from a TREND perspective
  5. Yield Spread (10s to 2s) continues to compress this week versus last and remains a bearish headwind for US Financial spreads and earnings
  6. High Yield is trading within 7bps of its April 2010 highs at 8.25%; this is a contrarian indicator, big time
  7. Levered Loan Index at 15.13 is 5bps away from its late April early May highs; another contrarian (bearish) indicator for equities
  8. Case-Shiller Prices (JUL) rollover again sequentially (month-over-month) and we forecast the October 26th Case-Shiller report to be a bomb
  9. US Consumer confidence comes in at a bomb, 48.5 for SEP versus 53.2 AUG, despite CNBC cheering the stock market higher
  10. “Republican House” finds its way onto the cover of Barron’s = consensus bullish catalyst now
  11. M&A rumors haven’t been this frothy since September of 2007 (we’ve counted 67 alleged “takeouts” that haven’t occurred)
  12. US Dollar Index continues to burn at the stake of QE hope; down now for the 15th of the last 18 weeks and Washington doesn’t care
  13. US Treasury Yields are in a Bearish Formation across the curve (2yr yield TRADE resist = 0.51%) = bearish signal for US economic growth
  14. Chinese stocks have closed down for 6 out of the last 8 days and the Shanghai Composite is now broken on immediate term TRADE duration
  15. Japanese stocks continue to be the armpit that is long term QE; Nikkei down 3 of last 5 days and down -10% for 2010 to-date
  16. Japanese exports (AUG) hammered sequentially down to +15.3% y/y vs +23.5% y/y in JUL; expect more Fiat Fool intervention from here
  17. Japan’s Bureaucrats calling for another 4.6 TRILLION Yen in stimulus and proposing to pay for it by raising taxes this time?
  18. Spain’s IBEX is breaking its immediate term TRADE line this morning (first time in months; support line could become resistance at 10,501)
  19. Italy’s CDS continues to push higher at 205bps and remains the country with the most downside relative to consensus (we’re short EWI)
  20. European CDS continues to push wider on the heels of Greek Equities getting smoked (down -13% since 1st week of September with SPY +9%)
  21. Russian deficit risk heightening in the face of Medvedev firing the longstanding (18 year) mayor of Moscow
  22. Romania’s Interior Minister resigns in the face of austerity implementation
  23. Sri Lanka is now issuing sovereign debt ($6B worth) and markets there are cheering it on?
  24. Dubai says “we are back”

Acknowledging that there are plenty of bullish data points on the other side of this ‘QE is going to save us all’ expectation (there better be with the SP500 up +9.6% in a straight line from its August 26th low), I can only count 15 of consequence this morning - and that’s less than what I’d need to see for me not to call for a buckling of your chinstraps.


Horace’s lightening has already struck some of the highest mountains of buy-side and sell-side exposures in the last 3 years, but the lofty pines of professional politicians and the highest ivory towers of academic dogma that support them are still in for their heaviest crash yet.


My immediate term support and resistance lines for the SP500 are now 1136 and 1155, respectively. It’s not October yet. The SP500 hasn’t touched 1164 yet. So I’m not short the SP500 yet. Measuring time, space, and probabilities matter.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


A Heavier Crash - heute

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Q3 is shaping up to once again prove that PNK is a secular growth story in an otherwise dismal space.



PNK should beat Q3 estimates for EBITDA, again.  Investor sentiment isn’t great for the US gaming operators.  In fact, it sucks.  For different reasons, PNK and PENN are the two bright lights in an otherwise dark and dreary sector.  PENN because of new development in new markets and PNK because it is playing catch up on cost cutting and marketing.


PNK looks inexpensive on estimates it will probably beat, starting with Q3.  We calculate a 6.5x 2011 EV/EBITDA multiple using the current stock price and a free cash flow yield of over 14%.  In terms of our estimates, we are at $54.4m for Q3 EBITDA versus the Street at $51.5m.  We are also higher for Q4, $48.3m vs. $46.3, respectively, and for 2011, $244.3m vs. $228.2.


You’ve heard of the phrase “victims of their own success”.  For PNK it’s more like “beneficiaries of their own failures”.  By failures we mean the poor operating performance of the prior management team.  New management began the cost cutting process in late 2009, about 18 months later than everyone else.  In our 07/07/10 note “PNK: MOVING INTO OVERSOLD TERRITORY,” we showed that PNK maintained some of the worst margins in the markets in which they operated.  We think PNK will continue to narrow that gap and be at maximum efficiency by mid next year.  Including Q3 2010, that is 4 quarters of secular margin improvement not available to the other US gaming operators.


Cost cutting is only part of the secular story.  PNK should be naming a new Chief Marketing Officer shortly – probably someone with Harrah’s ties.  The prior marketing head was let go earlier this year and he was a disaster.  As we've previously written, PNK not only lags its peers in margins, but also win per gaming position.  With former Harrah’s executive Anthony Sanfilippo now in charge of PNK, we expect significant marketing improvements both in terms of efficiency and effectiveness.  Look for the introduction of a serious database marketing effort.  The tail on that improvement is even longer than the margin story.

We acknowledge that the hurdles facing US gaming are high and we remain negative on the long term outlook for regional US gaming, but at least PNK maintains two levers of EBITDA growth not available to other operators.  We saw good results in Q2 and we think Q3 will be a repeat of that estimate beating quarter.

The St. Petersburg Paradox

This note was originally published at 8am this morning, September 28, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The mathematical expectation of the speculator is zero.”

-Louis Bachelier


Louis Bachelier was a French mathematician who was, well after the fact, credited with founding the Efficient Market Thesis.  In 1900 Bachelier published his Ph.D thesis titled “The Theory of Speculation.”  In his paper, Bachelier discussed the use of Brownian motion to evaluate stock prices.  Unfortunately, his thesis was “not appropriately received”, which resulted in academic black-balling and the concept being buried for more than sixty years.


Almost sixty-five years later Professor Eugene Fama from the University of Chicago was officially credited with developing the Efficient Market Thesis after publishing his Ph.D thesis.  His paper was titled “The Behavior of Stock Market Prices.”  The core tenet of his paper and the Efficient Market Thesis is that an investor “cannot consistently achieve returns in excess of average of market returns on a risk-adjusted basis, given the information that is publicly available at the time the investment is made.”


Is it not somewhat ironic that the determination of who founded the Efficient Market Thesis was not efficient?


Despite not having a Ph.D on staff at Hedgeye Risk Management, we have been performing our own experiment to test the Efficient Market Thesis over the past two years.  We call this experiment the Hedgeye Virtual Portfolio, and it is a culmination of our stock picks since inception.


In that time, we have closed 510 long positions and closed 490 short positions. 85.9% of the closed long positions have been winners and 83.5% of the closed short positions have been winners.  Obviously, these results are far from a “random walk”.  So, either we are good at our jobs, or the market is not quite as efficient as Efficient Market Theorists believe.  I would submit that it is a combination of both.   


Clearly, though, many stock market participants work hard, have processes, and are intelligent.  So, why do many stock market operators underperform even the basic broad market returns? Simply put, because of this little critter called Behavioral Economics that leads many market participants to act against their best interests. 


By way of example, let’s consider the St. Petersburg Paradox, which is as follows:


“Consider the following game of chance: you pay a fixed fee to enter and then a fair coin is tossed repeatedly until a tail appears, ending the game. The pot starts at 1 dollar and is doubled every time a head appears. You win whatever is in the pot after the game ends. Thus you win 1 dollar if a tail appears on the first toss, 2 dollars if a head appears on the first toss and a tail on the second, 4 dollars if a head appears on the first two tosses and a tail on the third, 8 dollars if a head appears on the first three tosses and a tail on the fourth, etc. In short, you win 2^k−1 dollars if the coin is tossed k times until the first tail appears.”


So, what would be a fair price to pay for entering the game?


I posed this question to our Research Team at Hedgeye yesterday and they came back with myriad of answers, which ranged from $1 to infinity.  This simple mathematical answer is that you should be willing to pay infinity (or your entire net worth) to play this game as your expected value is infinity.


 As one of our astute Analysts responded to me yesterday:


“Well, the series doesn’t converge …EV = (1/2)*($1) + (1/4)*($2) + (1/8)*($4) + …EV = ½ + ½ + ½ + …… the sum of which is infinite.  So, is the fair entering price infinite? Strictly speaking, I think the answer is yes – but no one on earth would take that deal (even if we cap the number of rounds such that EV = all your money, since no one has infinite money).”


Therein is another paradox, the paradox of the Efficient Market Thesis.  Specifically, most market operators do not make rational decision based on math.  They make emotional decisions based on arbitrary evaluations of risk. This, of course, leaves opportunities for the sneaky mathematicians to make profit.


So then, how do we account for valuation when considering an investment?  Surely, valuation is rational?


In my view, valuation is an indicator of sentiment around a security.  For instance, when a stock trades with a single digit P/E, its business is either declining, or the collection of market operators believe it is.  There are many studies that support the idea that value based strategies (i.e. buying cheap stocks) outperform over time, but I would submit that this is not because of the valuation, but rather because of the behavioral finance indicator embedded therein.


As we consider the stock market today, the first question many strategists try to answer is whether the stock market is “cheap”.  The simple way to make this determination is to pull up a long term price / earnings chart and look at it going back fifty years.  Today, at 15x current earnings and 13.7x forward earnings, the SP500 looks cheap versus history. 


The more important task though is determining what expectations are embedded in that valuation.  What is the correct earnings multiple for an economy that has crossed the Rubicon of Debt at 90% debt / GDP and has budget deficits projected for the next thirty plus years (I would say infinity, but that’s probably not fair)? Additionally, if growth rates are mired in the 1 - 2% range as a result of this fiscal situation, is the stock market “cheap”?


In the shorter term, setting those sneaky valuation metrics to the side for a second, what do you think is priced into the S&P500 up 8.8% in September?  Given the cover of Barron’s this weekend and the rapid rise in the S&P in the last few weeks, the catalyst of the Republicans winning more seats than expected in the midterms is likely priced in. (We called this out on our conference call with Karl Rove in early September - Could the Midterm Election Be A Major Stock Market Catalyst?)  So, what is priced in now?


Well, perhaps our friend George Soros said it best:


“The financial markets generally are unpredictable. So that one has to have different scenarios. The idea that you can actually predict what's going to happen contradicts my way of looking at the market.”


Or as we say at Hedgeye, the plan is that the plan will change.


Yours in risk management,


Daryl G. Jones

Managing Director


The St. Petersburg Paradox - PE

Bear/Bull Battle: SP500 Levels, Refreshed

In the last 6 trading days you could as readily have called the intermediate term TREND line of 1144 resistance as you could support – depends on what hour of the day that you need to call it names.


Government sponsored volatility like this is not going to end well, but that doesn’t mean the SP500 can’t continue to scale to lower-highs if 1144 holds. We have an immediate term TRADE line of resistance up at 1154 as of 3PM and we currently have no position in SPY.


The more I stare at this, the more I want to do nothing. I’m still waiting and watching as we approach month and quarter end.



Keith R. McCullough
Chief Executive Officer


Bear/Bull Battle: SP500 Levels, Refreshed - 1