"A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty."
- Sir Winston Churchill

I have worked on Wall Street for twenty years, I have three kids, I love sports (although getting a little tired of hockey analogies), I would pay big money to run The Ironman World Championships, I’m a consumer analyst, I’m a pessimist and I’m working through my 12-step program to seize the opportunity to make clients money on the long side – I work at Research Edge LLC.

In this market you don’t want to be early, but you definitely don’t want to be late either.   I remember the day when stocks moved 5% in a day and the phone would ring off the hook.  Today, 30-50% moves are the upper end of the range.  How can anyone manage for risk with that type of volatility? The current market environment calls for an intense focus on companies with strong brands, stable cash flow and a strong balance sheet.  Did I mention cash?  Cash is king, but you know that.

A true pessimist on the consumer believes that consumer stocks are dead for the next five years.  I think that is extreme.  In the context of other “market crashes” the consumer index has experienced a crash.  From the peak the Consumer discretionary Index (XLY) set in June 2007, the index has declined 56%.  I’m not trying to argue that the issues that have driven consumer spending lower are behind us, but that the rate of change may show a positive improvement in 1H09.  Improving consumer sentiment will be an important factor contributing to the bottom in consumer spending.  Among other things, the new administration and more confidence in Washington are critical.  But lower gas prices put real “cash” in the pockets of the consumer.

That being said, gas prices are now down nearly 60% from the peak levels experienced in July, down 40% YOY and have moved below 2005 levels.  Although gas prices account for only one factor among many (unemployment, declining house prices, etc.) that have impacted consumer demand, at some point, these lower gas prices will help to stabilize and reverse spending trends just as they played a major role in pulling down demand on their upward climb. In fact, every $0.01 change in the retail price of gas impacts annual consumer spending by about $1.5 billion.  Based on the current U.S. average retail price of regular gas of $1.70 per gallon and the 2007 average price of $2.81 per gallon, this equates to a $1.11 change or an additional $166.5 billion of annualized consumer spending injected into the economy (or about 1% of consumer spending in 2009), not an insignificant amount.

Today we are waking up to the reality that the US auto industry will be nationalized, but at some level this is good news as it will limit the losses the industry was facing in 2009.  There is also news that the airlines will not lose as much money in 2009 due to lower oil prices.  I could write another 5,000 words on the fact that lower oil prices will positively impact nearly every company in the S&P 500 in 2009, but I’ll save that for the industry experts.  Keeping me grounded is the fact that Sony joins a growing list of companies cutting jobs.  This trend implies that news on employment will not be good in early 2009, but that rate of change will also likely improve in 1H 2009.  The issue of employment raises interesting questions about what consumers will do with any incremental cash they may receive from lower gas prices or another stimulus program.  With the personal savings rate at 0%, a 1% move higher could mitigate any benefit seen from lower gas prices. 

Any real change in economic activity in 2009 will be closely related to growth in consumer credit and the biggest driver of that will be growth in residential mortgages.  Given the actions the government has taken, you can also argue that the appropriate steps have been taken to stabilize the financial system, which should invigorate the credit markets and allow businesses to lend so consumers start spending again. 

Again, all of these events are happening at the margin and are not having a big influence on how consumers feel today.  At Research Edge we focus on events that happen at the margin and today, this implies that being slightly more optimistic will allow us to see the opportunity in the difficulty of the environment.

Function in disaster and finish in style,

Howard Penney
Managing Director

Long ETFs
SPY-S&P 500 Depository Receipts –Front month CME futures contracts traded as high as 912.4 before 7AM this morning with the Auto sector bailout dominating media coverage.

XLV Health Care Select Sector SPDR – A Study released found that Cephalon‘s (XLV: 0.5%) non-Hodgkin’s lymphoma drug Treanda worked as well as standard chemotherapy and was associated with fewer side effects. Shares of the company closed down over 1% at 75.82.

GLD -SPDR Gold Shares – Front month COMEX gold contracts declined 0.51% to 766.1 in trading this morning.

OIL iPath ETN Crude Oil –Front month Light Sweet Crude contracts traded as low as 43.3 this morning as anticipation of the OPEC meeting on the 17th continued to dominate all media coverage of the market.

EWG – iShares Germany --Investor confidence rose unexpectedly in Germany with the ZEW economic sentiment index climbing to -45.2 from -53.5 last month. The benchmark DAX is up this morning 1.26% to 4775.07.

EWH –iShares Hong Kong -- Stocks fell for the first time in three days amid concern the government’s lowering of industry tax will not shore up the city’s economy.

FXI –iShares China – The CS1300 fell 2.59% to close at 2040.85. November’s export figures are expected to show a contraction.

Short ETFs
EWU – iShares United Kingdom –The FTSE100 is up 69.34 points this morning, or 1.61%, to 4369.40. UK manufacturing output fell 1.4 % from September, reports the Office for National Statistics in London. Economists predicted a 0.5 % decline.

UUP – U.S. Dollar Index – The Pound declined by over 1% reaching 1.474 in trading this morning while the Euro declined to 1.286.

FXY – CurrencyShares Japanese Yen Trust – Preliminary GDP figures for Q3 released by the cabinet office today showed a contraction of 1.8% seasonally adjusted over Q2, a larger than anticipated decline. The Yen rose to 92.46 USD in trading this morning.  

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