Do or Die Time for Las Vegas Casino Operators?
(November 22, 2009)
Note: Since early March, the "reflation trade" has worked wonderfully for equity investors - especially those who bought into stocks of the stronger global, diversified financial services companies and even regional banks (with the glaring exception of Japanese banks). While banks that have taken market shares at cheap prices (e.g. JP Morgan and Wells Fargo) should continue to outperform the S&P 500 next year, I believe US financials should in general underperform as the US consumer continues to deleverage - restraining both the ability to take on credit and/or creating new financial products. Continuing on this theme, Morningstar's Stock Strategist discusses the prospects for many international banks, including those in Brazil, Japan, South Korea, the UK, and Switzerland in its latest report. It is a must-read.
Dear Subscribers and Readers,
Let us begin our commentary by reviewing our 9 most recent signals in our DJIA Timing System:
1st signal entered: 50% short position on October 4, 2007 at 13,956;
2nd signal entered: 50% short position COVERED on January 9, 2008 at 12,630, giving us a gain of 1,326 points.
3rd signal entered: 50% long position on January 9, 2008 at 12,630;
4th signal entered: Additional 50% long position on January 22, 2008 at 11,715;
5th signal entered: 100% long position SOLD on May 22, 2008 at 12,640, giving us gains of 925 and 10 points, respectively;
6th signal entered: 50% long position on June 12, 2008 at 12,172, giving us a loss of 1,853.84 points as of Friday at the close.
7th signal entered: Additional 50% long position on June 25, 2008 at 11,863, giving us a loss of 1,544.84 points as of Friday at the close.
8th signal entered: Additional 25% long position on February 24, 2009 at 7,250;
9th signal entered: 25% long position SOLD on June 8, 2009 at 8,667, giving us a gain of 1,417 points.
A liquidity update: The Federal Reserve has ended its purchases of Treasury securities under its credit easing policy instituted in March. Its purchase of agency debt and mortgage-backed securities, however, will continue until March, 2010 (with a goal of purchasing $200 billion of agency debt and $1.25 trillion of agency MBS). As of last Wednesday, the Fed has purchased a total of $997 billion in agency debt and agency MBS - with a whopping $74.5 billion purchased in the latest week, as shown in the following chart:
The $74.5 billion of agency debt and MBS purchased last week most probably supported the rally in global securities last Monday. But more importantly, its effects started wearing off later in the week, as the market stalled and volume dropped off. Based on the Fed's goal of purchasing $1.45 trillion of agency debt and MBS by the end of March, 2010, the Fed's rate of purchases should average $25 to $26 billion on a weekly basis from now until March, 2010. In light of the whopping purchase last week, I expect the Fed's purchases to be muted going into Thanksgiving and Christmas. In addition, the European Central Bank President, Jean-Claude Trichet, has already made it clear that its emergency loan support measures for Euro Zone's banks will be cut next year. That is, both the Fed's and the ECB's policies will be less supportive for global liquidity and commodities going into Thanksgiving and Christmas.
Let us now get to the gist of our commentary. As we discussed in last weekend's and other commentaries over the last six to nine months, we believe that major US casino operators will continue to suffer on many fronts in 2010 and even beyond. These include:
- The potential saturation of gaming venues as a vacation destination. According to Standard and Poor's and the Nelson A. Rockefeller Institute of Government at the State University of New York, state-local revenue from gambling (which includes lotteries) dropped 2.6% in the fiscal year ending June 30, 2009 - the first decline in at least three decades. Specifically, state-local revenues from commercial casinos dropped 8.5% in the latest fiscal year. With a 20% penetration rate of the total US leisure market (i.e. 20% of all vacation trips in a given year involve at least a visit to a casino), casino operators are definitely hitting against a very giant ceiling.
- The amount of supply in casino hotel rooms, casino tables, and convention space next month and in 2010 will put additional pressure on room rates and profit margins. In Las Vegas alone, the opening of CityCenter later next month will add 6,000 rooms to the local market (or 4.3%, out of a 140,529 room total as of December 2008). The Hard Rock Hotel expansion, the Golden Nugget expansion and the opening of the Marriott SpringHill Suites will add an additional 1,000 rooms to the Las Vegas market by the end of this year. Based on data from the Las Vegas Convention and Visitors Authority, the number of rooms in Las Vegas will increase by 6.2% (8,750 rooms) in 2009, compared with 8,661 rooms in 2008. Despite the ongoing slowdown in the number of visitors to Las Vegas, 2010 shows no signs of letting up in terms of room supply. The 3,000 room Cosmopolitan Resort & Casino is scheduled to come online in June 2010, while the (bankrupt) 3,815 room Fontainebleau Las Vegas is scheduled to come online in late 2010, assuming its acquirer completes construction on time. In addition, other projects that have been "mothballed" could very well come back online if casino traffic to Las Vegas improves (e.g. the 4,910 room Boyd Gaming Echelon and the 665 room Caesars Palace expansion).
- The addition of new supply in other casino areas and states, including Atlantic City, Illinois, and the Gulf Coast. With unemployment at double-digits and consumer discretionary spending still in a challenging environment, many potential gamblers will drive to casinos closer to their hometowns - saving on airfares and in accommodation costs (in general, accommodation in Las Vegas tends to be higher). According to Goldman Sachs, visitors to Las Vegas was down 2.5% year-over-year during 3Q 2009 (versus down 5% in 2Q and 9% in 1Q). Air traffic into Las Vegas, however, made up more than its fair share - declining by 10% on a year-over-year basis. Auto traffic, on the other hand, actually increased by approximately 5% (although with the Los Angeles unemployment rate at 14%, it is difficult to see how this could be sustained next year).
- As US consumers continue to deleverage his/her extended balance sheets, many attractions in Las Vegas (such as high-end retail stores, restaurants, shows, etc.) that cater to the free-spending US consumer will no longer be needed. We would not be surprised if the major casino operators go back to their 1990s business model - a model which involved heavily discounting rooms and other amenities (such as food) to attract gamblers. In other words - not only is the US gaming market saturated - but the potential for raising margins through higher room rates and charging more for food and other forms of entertainment has also hit a ceiling as well.
The $64 billion question is: Will the opening of CityCenter on December 16th will be a testament to a resurgence in Las Vegas as a premier tourist attraction, or will it end up cannibalizing other casinos in the Las Vegas Strip? We will find out soon enough. While valuations in the major operators have pretty much discounted an ongoing slowdown in 2010, I believe stock prices of major casino operators may take a hit again, especially if the projections for 2011 and 2012 decline below expectations (right now, not many analysts believe the "Las Vegas Model" from 2003 to 2007 is dead). At some point, the major US casino operators are worth buying - especially given the potential for growth in other global markets such as Macau and Singapore. Now is not the time, however.
Let us now discuss the most recent action in the U.S. stock market via the Dow Theory. Following is the most recent action of the Dow Industrials vs. the Dow Transports, as shown by the following chart from January 2007 to the present:
For the week ending November 20, 2009, the Dow Industrials rose 47.69 points, while the Dow Transports declined 15.05 points. While the Dow Industrials continues to make new bull market highs, the Dow Transports is still 2.5% below its rally high made in mid October (although there is strong evidence suggesting that the Dow Industrials is starting to become a leading index - which the Dow Transports has been since the bottom of the last bear market in October 2002). Combined with the drop-off in upside breadth and volume over the last few weeks, probability suggests that the latest rally may be short-lived. In addition, given the vulnerability of the European banking system, the state of US municipal finances, and US commercial real estate market, I continue to expect the US stock market to be mired in a consolidation phase going into the end of the year. For now, probability suggests that the cyclical bull that began in early March remains intact. We thus maintain our 100% long position in our DJIA Timing System.
I will now continue our commentary with a quick discussion of our popular sentiment indicators – those being the bulls-bears percentages of the American Association of Individual Investors (AAII), the Investors Intelligence, and the Market Vane's Bullish Consensus Surveys. The latest four-week moving average of these sentiment indicators increased from a reading of 5.9% to 6.4% for the week ending November 20, 2009. Following is a weekly chart showing the four-week moving average of the Market Vane, AAII, and the Investors Intelligence Survey Bulls-Bears% Differentials from January 1997 to the present week:
While this reading has declined from its 17-month high of 11.2% made four weeks ago, it is still a little overbought in the short-run. In addition, its relentless rise from early March suggests that individual investors have gotten too bullish, too quickly. We believe that there is enough "pent-up demand" for the rally to continue, but probability suggests that the stock market will need to consolidate further before the rally can continue. In addition, both the Federal Reserve and the European Central Bank are indicating that monetary policy may be tightened by early next year (the second quarter for the Fed, and the first quarter for the ECB) - meaning that liquidity creation will be constrained in the short-run (in the longer-run, however, I would not rule out the Fed extending its credit easing program to purchase more Treasuries or to include other securities, such as municipal bonds). For now, we will remain 100% long in our DJIA Timing System, as we believe the cyclical bull trend that began in early March remains intact.
I will now close out our commentary by discussing the latest readings of the ISE Sentiment Index. For newer subscribers, I want to again provide an explanation of ISE Sentiment Index and why it has turned out to be (and should continue to be) a useful sentiment indicator going forward. Quoting the International Securities Exchange website: The ISE Sentiment Index (ISEE) is designed to show how investors view stock prices. The ISEE only measures opening long customer transactions on ISE. Transactions made by market makers and firms are not included in ISEE because they are not considered representative of market sentiment due to the often specialized nature of those transactions. Customer transactions, meanwhile, are often thought to best represent market sentiment because customers, which include individual investors, often buy call and put options to express their sentiment toward a particular stock.
When the daily reading is above 100, it means that more customers have been buying call options than put options, while a reading below 100 means more customers have been buying puts than calls. As noted in the above paragraph, the ISEE only measures transactions initiated by retail investors – and not transactions initiated by market makers or firms. This makes the indicator a perfect contrarian indicator for the stock market. Since the inception of this index during early 2002, its track record has been one of the best relative to that of other sentiment indicators. Following is the 20-day and 50-day moving average of the ISE Sentiment Index vs. the daily S&P 500 from May 1, 2002 to the present:
For the week ending November 20th, the 20 DMA increased from 127.6 to 130.5. As mentioned on the above chart, the 20 DMA has now risen to near its 6-month highs. Combined with the relatively overbought condition in the markets, the technical divergence of the Dow Transports, and the lack of upside breadth and volume in the last few weeks, this does not bode well for the stock market in the short-run (from a contrarian standpoint). In addition, the macroeconomic backdrop - specifically the slowing liquidity creation by the Fed, the ongoing vulnerability of the European banking system, and the US commercial real estate market - is also suggestive of a further consolidation period for the stock market till Thanksgiving and most probably into the end of the year.
Conclusion: The short-term liquidity picture remains challenging, especially as the Fed wounds down its credit easing policy and as the European Central Bank wounds down its emergency loan support programs for banks in the Euro Zone early next year. That said - based on the challenging housing and employment environment - I would not be surprised if the Fed extends its credit easing program to purchase more Treasuries or agency securities, or to include the purchase of other securities, such as higher-rated municipal bonds or even AAA-rated corporate bonds. I also would not be surprised if the Obama administration provides more support measures for the housing market next year - since housing inventories remain relatively high (at 8 months supply, versus a normalized 6 months supply) and since that is where the financial crisis originated. While many indicators suggest a long consolidation period for the stock market into the end of the year – probability suggests that the cyclical bull market that began in early March is still intact. For us to turn very bearish on the market again (i.e. for us to enter into a short position in our DJIA Timing System just like we did in October 2007), many things would need to line up, including a potential fiscal policy mistake (i.e. higher taxes), economic policy mistake (i.e. major protectionist threats), or a monetary policy mistake (such as the failure of the ECB to assist the Euro Zone's banking system in raising capital). For now, our short-term belief is that the US stock market will be mired in a consolidation phase into Thanksgiving and to the end of the year.
We also remain bearish on the retail industry (as discussed in last weekend's commentary), as well as the major US casino operators. All gaming/casino operator analysts are now focused on the opening of MGM's CityCenter on December 16th. Subscribers please stay tuned.
Henry To, CFA