Bull/Bear Battle: SP500 Levels, Refreshed...



If the SP500 closes below 1170 today, this selloff heightens the probability of my compressed-crash call.


As a reminder, I’ve been calling for a 33% chance of what I called “A Heavier Crash” on September the 29th. This email is by no means is meant to be a victory-lap. Probable doesn’t mean likely… but heightening probabilities need to be monitored, acutely.


So what would a Heavier Crash look and feel like? I’m in print saying that “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%.”


Notwithstanding the bad karma that’s associated with any October 19th (1987’s crash), there is a very high probability that a TRADE line breakdown through 1170 puts the 1144 line back in play on the downside. From yesterday’s 1184 close, that would be a -3.4% correction – not a compressed crash – but… and there’s always a but… there are still plenty of days left in October… and bad US housing data is on the docket for next week.




Keith R. McCullough
Chief Executive Officer


Bull/Bear Battle: SP500 Levels, Refreshed...  - 1

The Electoral Scorecard . . . Democrats More Secure in the Senate

Conclusion: While the House looks like a runaway for the Republicans, the Senate is looking more and more secure for the Democrats.


We noted, with interest, Mark Zandi's (from Moody's comments on Bloomberg this morning that, "Washington is the center of the economic universe." While we certainly do not believe it should be, it is the sad truth that the policy makers in Washington have inordinate impact on the markets these days, especially as it relates to the potential for further quantitative easing.  As such, we wanted to update our predictions heading into the upcoming midterms.


From a top down perspective, not much has changed for the Democrats.  President Obama's approval rating, according to the poll aggregate at Real Clear Politics, is effectively as low as it has ever been with a 44.7 approval rating and a 49.2 disapproval rating.  The negative spread is -4.5. The approval rating of the President has worsened over the last couple of weeks as he has hit the campaign trail and is likely to deteriorate further in the coming weeks as Republicans ramp up advertising spending.  As it relates to the outcome of the midterms, this is about as good a leading indicator for the results as there is when it relates to party preferences.


This strong aversion to Democrat candidates is also seen in the Generic Congressional vote, which polls generic preferences.  Similar to the President's approval rating this poll, also according to the Real Clear Politics poll aggregate, is at close to its worst levels as well.  Currently, only 41.2 percent of those polled prefer a Democratic candidate, while 48.2% prefer the Republican candidate.  This is a positive spread of 6.9 for the Republicans.  These preference are also underscored by a Republican base that is very motivated to vote during these midterms.  As we've previously noted, more Republicans than Democrats voted in the primaries than in any period since the Great Depression!


In the House, a Republican takeover is all but a foregone conclusion.  Currently based on district level polling, it appears that the Republicans will safely win 213 seats and the Democrats will safely win 179 seats.  The remaining seats, some 43, are currently considered toss ups.  The Republicans will only need to win 5 of the 43 seats that are toss ups to gain the 218 seats needed to claim a majority, or just over 10% of the toss ups.  Looking at the underlying momentum, of the seats that have recently shifted, 12 seats have shifted to the Republican side and only 2 have shifted to the Democratic side.  If those trends continue 37 of the seats currently considered toss ups could go Republicans, which would mean the Republicans would have 250 seats.  The last time a party lost this many seats in the midterm was the Democrats under President Roosevelt in 1942 when the Democrats lost 55 seats.


Over in the Senate, the race is much closer and the Democrats have a good a chance of retaining control. This is, of course, partially due to the fact that only 1/3 of the Senate is up for re-election every two years.  Polling at the state level currently suggests that the Democrats will have 48 seats, the Republicans will have 45 seats, and 7 seats are currently too close to call. The race that most recently shifted was the Kentucky Senate race between Republican Rand Paul and Democrat Jack Conway, which shifted from leaning Republican to too close to call.  With this shift the Intrade contract, which allows speculators to bet on whether the Democrats will retain the Senate, has been trading close to the 60% line.


The wild card over the next few weeks will be spending and turnout and with the recent inflows of capital into Republicans coffers, we should see continued gains in the coming weeks.


Daryl G. Jones

Managing Director


Today’s announcement of China’s central bank raising rates seems to have spooked the Macau gaming stocks. Historically, higher rates have been good for gaming revenues in Macau.



The Macau gaming stocks listed in the US and the S&P are taking a bruising today following the announcement that China increased benchmark rates by 25bps.  We think WYNN and LVS are expensive and October growth may disappoint recently elevated expectations.  However, recent history shows that higher rates have been good for Macau gaming revenues, not bad.


This morning we took a look at the last three years of Macau revenue data and regressed it on the China 1-yr Lending Rate.  We found that the correlations between interest rates and total gaming revenue, Mass gaming revenue, and Rolling Chip volume were all around 0.75.  That is a positive 0.75, not a negative correlation.  Moreover, interest rates were statistically significant in explaining the changes in gaming revenues with the highest t-stat present in the Mass to Interest rate equation.




Our macro view at Hedgeye is that higher interest rates and currency valuations are conducive to higher consumer spending.  This would explain the positive correlation with Macau gaming revenues and especially Mass gaming revenues.  We understand the liquidity argument that VIP revenues are driven in part by the availability of credit.  Higher interest rates do not necessarily mean less liquidity.  China appears to be awash in cash with capital still flowing in.  We do think the liquidity certainly needs to be monitored closely but for now we are not worried about a 25bp increase in rates.


MPEL looks to be most unduly penalized today since it is a pure play on Macau.  However, recent market share gains and market growth should lead to significantly better Q3 EBITDA and EPS than currently projected by analysts.  This should finally be the quarter that MPEL beats, and estimates move higher.

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R3: JCP, Uniqlo and Handbags


October 19, 2010


Against a backdrop of increasing M&A chatter, a study out of the NRF suggests a 2% increase in consumer spending this holiday season – sounds optimistic to us.





- With luxury leather goods in short supply, it’s not terribly surprising to also note that prices may be on the rise.  Rumor has it that Chanel is raising prices a second time on the Jumbo handbag by about $300, taking the price to $4,000.  Price changes are expected to take effect in February.


- Like it or not, Uniqlo is selling men’s jeggings this fall season.  The 100% cotton, tapered and stretchy pants look like jeans from afar but like sweatpants up close.  Given that Uniqlo is a one store operation here in NYC, it will be interesting if ANY other retailer picks up on this trend.  Chances are this one stays in Manhattan.


- The NRF estimates that the implication of a VAT would decrease retail spending by $257 billion in its first year of implementation.  They also estimate it would negatively impact retail sales by 2.5 trillion over the following 10 years.  Recall that the VAT idea is being discussed as a means to close the budget gap.





JCP Fights Back With Poison Pill - J.C. Penney Co. Inc. chairman and chief executive officer Myron E. “Mike” Ullman 3rd and the rest of its board sent a missile back to activist investor William Ackman on Monday by adopting a shareholder rights plan, or poison pill, that would make it prohibitively expensive for anyone to take over the retailer without the consent of the board. If Ackman ups his stake or if anyone else hits the 10% mark, the rest of the shareholders would get the opportunity to buy a portion of a preferred share of the company for $130. The effect would be to lessen the stake of the would-be acquirer, who can’t participate in the plan, and to jack up the overall price tag by astronomical proportions.With a poison pill in place, Ackman can no longer simply offer to buy shares from other stockholders and gain control at the firm. He would have to come up with an offer that was sweet enough to get the board to remove the poison pill. <>

Hedgeye Retail’s Take: As we stated from the very beginning we believe this will be a long drawn out process which could last for a year.  Score one for JCP and its advisors, but we are sure there is more to come.  Next step is likely Ackman reaching out the board with some sort of strategic plan or proposal.


Golden Gate Capital PE Explores Orchard Brands - Private equity firm Golden Gate Capital is exploring options, including a possible sale, for its portfolio firm Orchard Brands, which operates a slew of apparel brands sold mostly in direct channels. Based in Beverly, Mass., Orchard Brands, which generates more than $1.1 bn in annual revenues, is the umbrella firm that owns catalogue and Internet brands including Blair, Haband and Norm Thompson. Two nameplates, Appleseed’s and Draper’s & Damon’s, operate retail locations. <>

Hedgeye Retail’s Take: While the aggregate sales of the combined entity is impressive (if not surprising) and the company has expertise in the direct channel, it’s exposure to catalog business is noteworthy if not concerning. For the first time in a while we’re actually seeing a sale by a PE firm and not a purchase (or rumor of).  With CWTR having trouble, now might be as good as any time to sell yet another business catering to an older female demographic.


Sugar Inc. Buys A Private Sale Fashion Site - Sugar Inc., which operates web sites that sell apparel, shoes and beauty products, has bought, a private sale site with 500,000 registered members focused on sales of high-end designer apparel and accessories. The purchase price was not disclosed. Sugar Inc. will keep as a separate brand. Sugar operates, where consumers can shop for apparel and related items sold by various retailers. <>

Hedgeye Retail’s Take: With more than 17mm unique visitors monthly, this ‘diversified women’s media company’ has the platform to make a discount luxury sale concept work – particularly one that offers only premium luxury brands like Keep an eye on Gilt which remains the largest, most established private-sale brand that has yet to change hands from the original investor group.


US Shoppers' Holiday Spending Plans Offer Glimmers of Hope - Americans will increase holiday- season spending by 1% this year as they shop less at discounters and focus more on quality and service, a trade group said. U.S. consumers plan to spend an average $688.87 on holiday- related shopping, more than last year’s estimated $681.83, according to a survey conducted for the National Retail Federation by BIGresearch. Of the total, $518.08 will be spent on gifts, up 2.1 percent from 2009, the survey showed. The findings are consistent with Washington-based NRF’s prediction for a 2.3 percent gain in U.S. holiday sales.


Hedgeye Retail’s Take: Prospects of increased buying on tighter inventories suggests a backdrop for a more benign promotional environment – reality might be a different story. By the time consumers hit main street for holiday shopping the market is unlikely to be at new highs since April. In fact, in light of our Consumer Cannonball theme here at Hedgeye, we wouldn’t be surprised to see to spending down yy once the consumer is saddled up at the register.


UK Retailer Blacks Leisure Approached by PE Firms for Possible Takeover - Black Leisure has reportedly appointed corporate finance advisory firm McQueen to oversee a potential bidding process from two possible takeover approaches by PE firms. <>

Hedgeye Retail’s Take: The company’s posted a brief letter from the board this morning confirming takeover speculation surrounding the UK’s leading outdoor retailer. This hardly comes as a surprise. After embarking on an aggressive turnaround plan in early 2008, the company appears to be at an inflection point having exited its unprofitable Boardwear business and now seeing better than corporate average sales at its new concept stores. Given its leading position in the UK market, the question now is if domestic U.S. based sport retailers are among those inquiring.


Fujian Tanneries to Shut Down - China’s Fujian provincial environmental protection authority said a new pollution control program will be soon launched in the region, causing a number of small tanneries in the cities of Fuzhou, Zhangzhou, Quanzhou and Putian to face closure in the near future. Polluting tanneries with a production capacity of less than 30,000 pieces of cow leather or equivalent will be the first to be shut down. Factories producing fewer than 100,000 pieces will be eliminated by 2012 and those produce fewer than 300,000 pieces will be closed by 2015. The authority is trying to persuade tanneries to move to specially designed leather zones where proper effluent systems have been established so that the pollution level can be easily monitored. <>

Hedgeye Retail’s Take: Few manufacturing processes have such a devastating environmental impact as tanning. As China cleans up its production facilities i.e. tightening capacity and demand continues to shift toward India, there is little indication that leather is likely to see a deflationary environment in the short-to-intermediate term.



We had a conversation with Genting Singapore management last night and our notes are summarized below.



Management seems to be trying to manage expectations for the quarter.  They are aware that the stock has gotten “expensive” and want to make it clear that they don’t see a ton of growth on the gaming end of things until there is clarity on junkets getting licensed.  We think their comments may be posturing and “managing expectations” because there should be some growth even without junkets.

  • Q3 tends to be the slowest period in Asia.  August is called “Hungry Ghost Month” for the Chinese in Singapore as they don’t really do much that month and this year, it also corresponded with Ramadan.  This holds true for their lodging and casino business.  Usually Q1 & Q3 are the weakest quarters and Q2 & Q4 are the strongest.
  • Flat earnings is the goal for Q3.  Although we pointed out that that would imply an increase sequentially and that if trends were truly flat, then things should be down and they agreed.  We’re a little confused on what they are trying to signal.
  • Universal is continuing to run at 8,000 capacity until they open their 2 new rides in the 1Q2011.  Given the existing rides, they can’t increase capacity without making the queue lines too long.  They are currently sold out every day.  Otherwise the queue lines will be too long.  Once Journey to Madagascar and Battlestar Galactica open, they will be able to run at full capacity – 12-13k/day.  They won’t be able to run at full capacity (25k) until Transformers opens and they don’t have a date set yet for that ride - although they are thinking late 2011/early 2012.
  • Won’t comment on any client activity (i.e. the articles about rich businessmen losing lots of money at the 2 IRs).  Henry Kwack – already settled with them though. The media tends to sensationalize the rest.
  • On the gaming side - thinks that things are getting a little softer – especially on the Mass market where people are trying both casinos. Some of the novelty factor is wearing off.  Expect Mass Market to flatten out for the next few quarters and don’t expect the VIP market to grow until the junkets get licensed.  They have sponsored about 20 junket applications.  Some of them have moved onto the interview stage. Should be hearing from the government on licensing by early next year.  As far as they know, Sands doesn’t have any junket applications pending.  Since the licensing process takes 12-16 months, even if Sands wants junkets, they will be about a year behind RWS.
  • 3Q2010 results will be published on Nov 11th
  • Expect Q3 to be 50/50 VIP/ Mass
  • They are indeed taking on more risk than usual on the credit side since they don’t have junkets. When their junkets come into the market they will give them 1.4% all in commission rate. They aren’t experiencing substantial collection issues.  Giving 90 days credit.
  • The impact of Golden Week is a lot more pronounced in Macau than it is in Singapore given that it's driven by Chinese players.  It’s not as “off the charts” as Macau.  38-40% of business from Malaysia, followed by Indonesia, HK/ China.
  • If there are no junkets, they think that growth will come mostly from non-gaming. 
  • MBS rumors:  Big issue they have is that they don’t understand the market as much as RWS does.  Have a little problem with accessibility – infrastructure around the area is still being developed and it’s very hard leaving the casino – there just aren’t enough cabs.  Thinks that they have management issues – there have been a lot of changes on the senior level. 
  • Think that in the 3rd quarter they will still have a slightly larger share than MBS - but it will even out by 4Q2010/ 1Q2011.

Quantitative Guessing

“Time and persecution brings many wonderful things to pass.”

-George Washington


One of my thought partners here at Hedgeye is our head of everything compliance, Moshe Silver. In our final days of being paid by the establishment, we worked closely together at Carlyle. I’d manage daily P&L risk and he’d manage the risk surrounding how our hedge fund teams were driving that P&L.


Moshe writes a must-read Weekly Compliance Screed that we publish on Mondays to our exclusive network of clients. Yesterday’s was titled, “Qualitative Easing” and it was one of Moshe’s best. He provided the historical context for America’s present season of discontent by citing Ron Chernow’s new biography of George Washington.


This is as much a point about leadership than anything else. America’s markets are turning into the sort of soft and qualitative excuse making zones where losers find comfort and coddling. If you aren’t raising children you may not see this as clearly as the rest of us parents do, but this “no one loses” and “my little Johnny just wants to be happy” stuff is becoming pervasive in American culture.


What happens when little Johnny runs into a Chinese kid who crushes him like a bug? Should we call for a time-out and some quantitative easing? If Apple doesn’t beat on iPad sales, should we invoke the deflation Gods for QE3?


Moshe suggests that “today, the underlying issue is a total abdication of responsibility on the part of those invested with the Public Trust. The reason that it has become compelling as an ongoing policy matter to debauch the once-proud Dollar is that our society has established a pattern of behavior.”


“The rest of the world recognized US indebtedness as a nascent problem as far back as the early 1980s. Is it realistic for Washington (the DC kind) to push back on generations of excess? We search in vain for anyone in a position of Public Trust to take a stand against this madness.”


How about the Manic Media? Could its core competency in taking the sell-side’s word for missing virtually every crash until after it has occurred proactively protect Americans and their hard earned savings? Or does the financial media stand in awe of revisionist Big Broker analysts whose tongues lick the Greenspan grounds of taking academic dogma’s word for it?


This morning even one of the most admirable American media platforms fell into the trap of time and persecution. Bloomberg’s Ian Katz opened his review of Timmy Geithner’s currency remarks by suggesting that “a weak dollar may now be in the national interest.” Are you kidding me, man?


If you dig into the financial editorials this morning, Dartmouth’s David Blanchflower recaps his Groupthink Inc. sessions with the finger pointers of America. I couldn’t paraphrase this if I tried:


“I was at the Fed last week in Washington for one of its occasional meetings with academics. Half a dozen labor economists, including myself, met with Fed Board members to discuss the labor market. Of particular importance was a paper by John Haltiwanger, a professor of economics at the University of Maryland, who showed there has been a big decline in the job-creation rate over the past decade. The current obstacle is the lack of credit for small firms.”


Right, right guys. The “current obstacle”  couldn’t be staring you right in the mirror could it? It must be that banks aren’t lending. Right, right… back to debauching the currency then.


Who is going to stand against Quantitative Guessing during this political season? Who is going to stand up and lead? I think it might just be the Chinese. They are proactively RAISING interest rates this morning. Why? Take a wild and crazy guess. You got it Pontiac – QE2 is stoking the bonfires of global inflation.


Don’t ask Fed Chairman Bernanke to stand up for 43 MILLION Americans (the # of Americans on the Food Stamp program) have to put gas in their cars and, God forbid, eat. On Friday, Bernanke said that “we are still learning about the efficacy and appropriate management of non-standard policy tools that do not rely on interest rate deductions.”


In plain English, Americans need to know what that means. Like his predecessor at the Fed, Arthur Burns, who perpetuated Jobless Stagflation in the 1970’s by monetizing US Treasury Debt, Ben Bernanke has no idea how this is going to play out and he’s not allowed to say it could play out Japanese.


Ask a man you can trust – Moshe: “Bernanke is effectively saying we haven’t quite gotten the knack of handling your money, but we are making progress. Another few TRILLION and we should really have it down to a science.” Like journeymen stock brokers and money managers who learn this craft by losing large quantities of other people’s money, those charged with managing the economy have resorted to Quantitatively Guessing…


As George Washington observed, if people are persecuted long enough by their government, they will change their behavior. And change is not a “crisis” until someone gets fed up with it all and punches your little Johnny’s qualitative whining in the face.


My immediate term support and resistance levels for the SP500 are now 1170 and 1186, respectively. On September 19th the cash position in the Hedgeye Asset Allocation model was 46%. A month later, on this fine day of defending ourselves (October 19th), we’ve raised that cash position to 64%.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Quantitative Guessing - QG

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