prev

SEIZE THE DAY

"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.  


Casual Dining – Silver Lining?

The initial run up in retail gas prices in 2005 led to the precipitous decline in casual dining same-store sales and traffic growth trends. As gas prices increased at an accelerated rate in early to mid 2008, casual dining demand dropped at an accelerated pace as well. Casual dining operators posted their worst traffic declines in the July through October 2008 timeframe since at least 2000 with the October number falling 8.2%. And, based on recent comments from casual dining companies, we are expecting more of the same in November.

That being said, gas prices have been declining and 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 restaurant demand, at some point, these lower gas prices will help to stabilize and reverse traffic trends just as they played a major role in pulling down demand on their upward climb. In fact, SixthManResearch.com estimates that every $0.01 change in the retail price of gas impacts annual consumer spending by $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.

The charts below highlight the inverse relationship between retail gas prices and casual dining same-store sales growth and traffic trends. If gas prices continue to fall, restaurant operators should begin to see some relief from a demand perspective.

CBRL – A POSITIVE DATA POINT

The U.S. Department of Transportation reported that vehicle miles traveled on all U.S. roads and streets fell 4.4% in September on a YOY basis. This same metric has declined 3.5% year-to-date. On a regional basis, the South Atlantic states fared the worst in September with a 5.7% decline in miles traveled followed by the South Gulf states, which dropped 5.2%. The Northeast states held up the best, but still posted a 3.4% decline YOY.

Vehicle miles traveled have declined each month in 2008 so this not a new trend, but with gas prices down nearly 60% from the peak levels seen in July and down 40% YOY, I would not be surprised if this trend started to reverse. Although gas prices had already started their descent in September, prices were still over $3.50 per gallon and on average, were still 30% higher than the prior year, which might help explain why the number of miles traveled continued to fall. Lower gas prices and an increase in miles driven should benefit traffic trends at all restaurants, but CBRL should feel the benefit more proportionately as 86% of its restaurant base is located on the interstate highway system. That being said, its business is highly related to highway travel. Making matters worse is the fact that CBRL’s restaurant base is highly concentrated in both the South Atlantic states (33% of CBRL’s stores) and the South Gulf states (31% of CBRL’s stores), which experienced the biggest declines in vehicle miles traveled in September.

CBRL’s traffic trends have been weak and like other casual dining operators, deteriorated further in August, September and October, down 5.4%, 6.7% and 7.2%, respectively. For reference, even with the significant magnitude of those declines, CBRL actually outperformed the casual dining group as a whole which saw its traffic fall 6.1%, 6.8% and 8.2% in those respective months.

The chart below highlights the strong relationship between vehicle miles traveled and CBRL’s same-store sales and traffic growth. If gas prices continue to fall, thereby leading to an increase in the number of miles driven, CBRL should begin to see some relief from a demand perspective.

get free cartoon of the day!

Start receiving Hedgeye's Cartoon of the Day, an exclusive and humourous take on the market and the economy, delivered every morning to your inbox

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.

SP500 Levels Into The Close...

Of the last 14 position changes we’ve made in the last 3 days of trading, all of them have been buy or cover. This is good. This isn’t easy and I, for one, know what it feels like to be on the wrong side of a “Trade” like this.

Importantly, the SP500’s resistance was overcome today - now that resistance becomes support (down at the 884 line). This is why I covered my SPYs and went long them. The facts don’t lie in momentum modeling. As the facts change, I do.

See the chart below. There is plenty of runway left until we run into the big negative “Trend” line of intermediate resistance. We won’t go there in a straight line, but that line is +14% higher up at 1052. There is immediate term “Trade” resistance at 925, but that line is a moving target that moves higher every time I refresh my models.

I have moved my US Equity invested position up again today.
KM

WILL GRAVITY PULL PRICES DOWN TO EARTH?

The price of the average slot machine has rocketed up 45% over the last 6 years. The advent of cashless gaming, new casinos and expansions, and strong consumer demand for gambling helped fuel an environment for the suppliers to aggressively raise prices. Higher prices, of course, translated into gross margins taking off. Gross product margin for IGT climbed over 9% over the same time period. Good times indeed.

The times they-are-a-changin’. The big guy, IGT, has lost a lot of market share and is starting to flex his muscles. Right now IGT’s power is confined to committing its balance sheet to more aggressively help its customers finance their slot purchases. This effort should buy some market share.

Where IGT could really leverage its low cost manufacturing would be in the pricing arena. It’s debatable whether this would be a good move for IGT, but there is no question the rest of the industry would suffer. IGT is in the midst of a cost reduction program which could offset some of the gross margin pressure from lower pricing.

An aggressive pricing strategy combined with better game development could allow IGT to regain some of its lost market share, which has been considerable. However, as we pointed out in our 11/24/08 post, “SHARING THE MARKET”, IGT’s market share has actually stabilized the last few quarters. I expect IGT to continue to redirect R&D towards game development.

IGT may have an opportunity here to steal share through pricing which, successful or not, would likely be detrimental to the industry.

Pricing and gross margins have been on a rocket ship

Eye On The UK: Bad Math!

When I tried to download the Bank of England’s financial liquidity Index last week, the information spit out by my data provider looked incorrect.

The Index, which is calculated on a daily historical basis but only released twice a year for the BOE Financial Stability Report, is a measure of liquidity in the UK financial system drawn from a host of different capital market and credit data. When the numbers that my data program spit out didn’t add up I went straight to the source and downloaded it from the BOE website --only to discover that the files there were also incorrect. The statistical office at the bank was kind enough to have the Index recalculated and posted with the final level coming in slightly lower than when it went up initially on October 28th.

With the refreshed data charted against the benchmark rate, the conclusion is clear: lowering rates did not returned liquidity to the market prior to November. Last week’s abysmal HBOS house Price data -which came in down over 16% year-over-year, illustrates that the 150 basis points cut since then have not moved the needle either.

We are negative of the UK’s prospects, and will continue to remain so until the facts change. Currently, price momentum in the EWU is underperforming our long position in Germany (EWG), because the facts play to the negative side of the UK’s balance sheet position.

Andrew Barber
Director

Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.

next