Mandelbrot Math

This note was originally published at 8am this morning, December 09, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“He doesn’t spend months or years proving what he has observed.”

-Professor Heinz-Otto Peitgen, on Benoit Mandelbrot


Benoit Mandelbrot was one of the most important contributors to my multi-factor, multi-duration, global macro risk management model. After publishing “The Fractal Geometry of Nature” in 1982, Mandelbrot eventually landed in New Haven as a professor in Yale’s math department. He finally earned his tenure as I was leaving campus for Wall Street in the late 90’s. Over time, he’s been recognized as one of the forefathers of fractal math.


On October 14th of this year, Professor Mandelbrot passed away in Cambridge, MA.  He was 85 years old. A few days later, one of our analysts, Matt Hedrick, sent me a nice tribute that Jascha Hoffman wrote for Mandelbrot in The New York Times. That’s where the aforementioned quote came from and it was followed by this one (which is taped on the insert of my notebook):


“But if we talk about impact inside mathematics, and applications in the sciences, he is one of the most important figures of the last 50 years.”

-Professor Heinz-Otto Peitgen (“Benoit Mandelbrot, Novel Mathematician, Dies at 85”, by Jascha Hoffman, NYT, October 16, 2010)


Amen Professor Peitgen. And thank you Jascha Hoffman. Benoit Mandelbrot was no one’s yes man. He wasn’t academically dogmatic either. He kept learning and re-thinking. As a result, I think the principles of Mandelbrot Math will be applied by global macro risk managers for decades to come.


I call this out this morning as I just got back from an investor trip that took me to Western Canada. The contours of the Rocky Mountain tops would most certainly fascinate Mandelbrot inasmuch as they would the fractal dimension of the Pacific Ocean’s coastline. Anyone flying across this world attempting to consider its deep simplicity from a top down perspective probably gets what I mean. It’s what make this game fun.


When you wake-up every morning trying to make a global macro market “call”, you need a place to start from. In order to attempt to know where you are going with that “call”, you most certainly need to know where you’ve been. By the time that market’s bell rings, you don’t have “month or years to prove what you have observed.” You have minutes. This is the game.


This morning’s global macro game is confusing. The US stock and bond markets are sending completely different messages as Asian stocks and bonds continue to break down.  All the while European sovereign risk premiums continue to fluctuate like twitter.


Let’s look at US markets first:

  1. The SP500 had its 1st up day in the last 3, making a bullish comeback from an outside reversal on the day prior, hitting a new YTD high at 1228.
  2. The SP500 is now up +81.7% from its March 2009 lows and down -21.5% versus its October 2007 highs.
  3. The immediate-term TRADE range for the SP500 moves to 1209-1245, with the daily downside risk being about equal with upside reward.
  4. Volatility (VIX) at 17.74 is testing a breakdown towards its April lows; while this is a bearish contrarian signal, the VIX could easily test 16.
  5. US stock market Volume and Breadth studies continue to flash bearish, despite higher prices, there is a very negative skew.
  6. In our SP500 Sector Studies, 2/9 sectors are bearish (XLV, and XLU) and 7/9 bullish from an immediate-term TRADE perspective.
  7. The US Dollar Index continues to flash bullish on both our TRADE and TREND durations, with intermediate term TREND support at $79.49.
  8. US Treasury Yields continue to boom to the upside with 2s, 10s, and 30s all busting out into what we call Bullish Formations.
  9. The Yield Spread (10s minus 2s) continues to widen at +10bps for the week-to-date, supporting the rally in Financials (XLF).

Overseas, the immediate-term game is much less confusing:

  1. Chinese equities were down another -1.3% overnight and remain bearish from an immediate-term TRADE perspective at -14.3% YTD.
  2. Indian equities got tagged for another -2.3% drop overnight as the BSE Sensex broke its intermediate term TREND line of 19,655.
  3. Japanese equities are the only bullish immediate-term TRADE market in Asia as the POSITIVE correlation to the USD reigns supreme.
  4. Australia’s central banking guru, Glenn Stevens, continues to prove that raising rates and seeing unemployment drop can work together.
  5. Germany, Russia, and the Netherlands continue to flash bullish TRADE and TREND signals in both stocks and bonds.
  6. Spain, Italy, and Greece continue to flash bearish TRADE and TREND in both stocks and bonds.
  7. Brazil looks like India, as stocks on the Bovespa are down every day this week and now bearish on both TRADE and TREND durations.
  8. The Euro continues to flash bearish on both our TRADE and TREND durations with intermediate-term TREND resistance = $1.34.

Global Commodities markets continue to confirm what almost every country’s central banker who has real-time quotes sees – inflation:

  1. The CRB Commodities Index closed at 316 yesterday = +21% higher than Bernanke’s decision in Jackson Hole to Quantitatively Guess.
  2. Oil is in a Bullish Formation with immediate-term TRADE lines of support and resistance of $87.17 and $91.47, respectively.
  3. Copper prices are testing ALL-TIME highs again this morning = +29% since The Ber-nank opted to sponsor inflation.

Gold, meanwhile, looks a little bit less-like most commodities all of a sudden. To a degree, if real-interest rates continue to push higher, the gold bulls will have to compete with that yield. That’s new. Tops are processes, not points, but Gold will need to get back above its immediate-term TRADE line of $1390/oz to get me interested in getting long it again (I sold our GLD position on Monday).


Altogether, if you take the beginning and end of 2010, you can draw plenty of conclusions that are now crystal clear. From my global macro model’s vantage point, the deep simplicity of all of these global macro factors and what they mean prospectively to the global markets remains as follows: Growth Slowing, Inflation Accelerating, and Interconnected Risk Compounding.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Mandelbrot Math - mandelbrot

NKE: Buying Titleist/Foot Joy?

I’ve just got my 7th request for my opinion about whether Nike will buy Acushnet, Fortune Brands’ golf division that Bill Ackman strongarmed to put on the selling block. Acushnet has about $1.2bn in sales and 6.5% EBIT margin, and its  core is Titleist and Foot Joy, which combined account for nearly 90% of cash flow. The remainder is split between Scotty Cameron putters, and Pinnacle.  After writing down 80% of the value of Cobra golf, FO sold that part of Acushnet to Puma earlier this year.


So should Nike buy Acushnet? When asked this question about other brands that compete with any of Nike businesses, my answer is usually “No”.


A good example is Callaway, where people grilled Nike all along to buy it, but their answer sounded something like “We have the athletes, we have the brands, and we have the capital. Why buy for a billion when we can otherwise build for $200mm?”  This posturing has served them well thus far. Remember Adibok? There was 80% overlap between their respective customer and product base. The cannibalization post-merger was almost comical. US share went from a combined 18% to 7% over 3 years. Nike get’s it. 


They’re NOT going to buy revenue, but there are certain merits.


When I put on my thinking cap and rationalize through reasons behind why Nike would buy Acushnet, here’s where I shake out…

1)      Titleist has a lot of athletes in its stable that Nike would inherit. But let’s be real…if Nike really wanted them it would have already bought them. Their pockets are very deep.

2)      With Tiger’s public persona having tanked, and his standing on the money list having dropped to #20, perhaps it’s time for Nike to broaden its reach. Again, I don’t buy this one. Nike will stand behind Tiger. Remember that Nike stood behind Tonia Harding after she played a role in attempting to crush Nancy Kerrigan’s kneecaps. Tiger will return, and Nike will benefit.

3)      Different price points? Nike only does acquisitions that allows the company to touch consumers it does not already sell to in the course of its base business. That’s not the case here as brand overlap is quite meaningful.

4)      One reason that makes sense is that Nike’s putters have traditionally been punk. Even Tiger uses a Scotty Cameron putter (owned by Titleist). 

5)      The same could be said about Foot Joy. Nike’s product has been very good there – but market share is second to Foot Joy – which is an exceptional brand. This is one business where Nike can leverage its existing infrastructure and take the 10% margins on Foot Joy to something closer to mid-teens.

6)      Defensive move? The only defensive move would be to get this out of the hands of Adidas. After all, Adi bought Cutter&Buck (golf apparel), and Puma bought Cobra. But Adidas has its plate full already in rebuilding its US business, and would likely not choose to add complexity by merging a powerful brand like Titleist into Taylor Made. The customer list is too close, and Adidas learned the hard way with the Reebok acquisition that this does not work.


Price tag? An extremely generous multiple of 8x EBITDA suggests around $675 million. Equipment businesses have such volatile cash flow year to year, so valuations are often looked at relative to sales. We’ve seen equipment businesses go as low as 0.3x sales – $675mm suggests 0.55x. Just because Nike has $5bn+ in cash it does not mean that it should overpay.


Our sense is that Nike has its hands full with its recently-reorganized product engine and ‘go to market’ strategy. Will it do acquisitions? Yes. But we’re inclined to think that Converse non-US licensees will likely come first.  Would I fall out of my chair if I saw a press release saying that Nike is doing this deal? Probably not. But I’d grill them pretty hard as to why it makes sense.



Contemplating Canada

“Debt and deficits are not inventions of ideology. They are facts of arithmetic.”

– Paul Martin, 21st Prime Minister of Canada


Conclusion:  The economic outlook for Canada is quite favorable, especially vis-à-vis the United States and other developed nations.  As such, we continue have a bullish stance on the Canadian Loonie and Canadian equity markets. 


Keith and I spent the last couple of days visiting subscribers in Western Canada, namely Vancouver and Calgary.  The trip also gave us a chance to revisit and contemplate our thoughts on the economy there.  From an anecdotal perspective, our trip verified one key point -- free market capitalism is alive and well north of the border.


 As we’ve discussed in past notes, there have been a number of inflection points in the Canadian economy that are unique to anything we’ve seen in recent history.


The first point to highlight is unemployment.  As the chart below shows, for the first time in 30 years Canada has a lower unemployment rate than the United States.  In fact, not only does Canada have a lower unemployment rate, but there is a meaningful divergence.  Based on the most recent economic data, Canada’s unemployment rate is 7.6% and has been ticking down consistently for the last 18 months or so.  Conversely, U.S. unemployment is currently at 9.8% and has barely ticked down since the start of the most recent recession.  We view this as a real and noteworthy inflection point in comparing these economies.


Contemplating Canada - d1


In the shorter term, the relative success of the Canadian economy versus the United States, combined with the fact that the Bank of Canada has raised rates 3 times in 2010 while the U.S. Federal Reserve has continue to ease, has led to a strengthening of the Loonie over the past 12-months.  In that time period, the Loonie is up almost 5% versus the U.S. dollar.  


Yesterday, the Bank of Canada highlighted this increase in the value of the Loonie as a risk to the Canadian economy and a reason to keep interest rate increases on hold.  As the value of the Loonie increases versus the U.S. dollar, it inherently increases the costs of Canadian exports to the U.S. and lowers demand for Canadian goods.   Currently, more than 70% of Canadian goods are exported to the U.S and ~57% of exports are in the commodity sectors (energy, forestry, and mining).


Interestingly, the Bank of Canada sounded a little Hedgeye-esque as they highlighted more broad risks to the Canadian financial system yesterday, with a particular focus on interconnected risk.  Specifically, the Bank of Canada notes in their statement:


“Four major interconnected sources of risk emanate from the external macrofinancial environment: (i) sovereign debt concerns in several countries; (ii) financial fragility associated with the weak global economic recovery; (iii) global imbalances; and (iv) the potential for excessive risk-taking behaviour arising from a prolonged period of exceptionally low interest rates in major advanced economies.”


Certainly we understand these risks and also understand that Canada’s close ties to the U.S. economy will continue to be an important factor when evaluating the economic outlook for Canada.  That said, similar to out point on unemployment above, Canada has also recently seen a divergence in growth versus the United States in the last few years.


In the chart below, we’ve highlighted relative GDP growth rates of Canada versus the United State going back to 1980.   In the prior two periods of negative growth (the early 1980s and early 1990s), the Canadian economy contracted more than the U.S. economy.  In this most recent recession, the Canadian economy contracted less and then accelerated to a higher rate of growth post the recession.  In fact, Canada had the lowest real GDP contraction of any member of the G7 from Q2 2008 to Q3 2009.


Contemplating Canada - d2


So, what is causing this divergence and our longer-term bullish stance on Canada?  We would point to three key factors: energy independence, a strong financial system, and the government’s balance sheet.

  1. Energy independence - Amongst the G7, and really most industrialized nations, Canada has probably the best energy position.   It is, obviously, a net exporter, but has also seen its spread of production versus consumption increase over time.  From 1980 to 2007, Canada’s total energy production (mostly natural gas and oil) grew 87%, while its total consumption only increased 44%.  With the inclusion of the vast Canadian oil sands, Canada has the second largest oil reserves after Saudi Arabia.  In an increasingly short energy world, this long energy position will continue to advantage the Canadian economy.
  2. Strong banking system – In contrast to the United States, where many U.S. financial institutions underwrote loans, particularly of the mortgage variety, during the boom year leading up to 2008, the Canadian banks kept lending standards high.  As a result, unlike the major and pervasive bank failures in the U.S. over the past couple of years, there were no comparable bank failures in Canada.  (In fact, Canada’s banking system has proven to be incredibly resilient over time.  The last major bank failure in Canada was in 1923.) Prospectively, we should see this benefit in the stability of Canadian home prices and the quality of loans held on Canadian bank balance sheets.  A good proxy for this is mortgages in arrears, which are running below 1% in Canada compared to +9% in the United States.
  3. Government balance sheet – In the 1990s, Canada was the poster child for poor fiscal management.    When Paul Martin took over as Finance Minister in 1993, the Canadian government was running a deficit of 6.6% of GDP and by the following year debt as percentage of GDP eclipsed 100%.  By implementing massive spending cuts and raising certain taxes, Paul Martin got Canada’s fiscal house in order.

Currently, Canada’s debt-to-GDP is estimated to be 77% by the IMF, which is substantially lower than the U.S. at 98% and well below real problem nations, such as Italy (121%) and Japan (227%).  While Canada is expected to run ~C$50 billion deficit in 2010 – 2011, this is just over 3% of GDP, which pales in comparison to the United States, whose deficit as percentage of GDP will be closer to 10.5% in 2011.  As it stands, Canada should not eclipse the 90% debt-to-GDP ratio, which correlates with slower growth.


While we aren’t quite ready to say this is the Canadian century (except in hockey of course), we are seeing a number of inflection points that point to and highlight some longer term and sustainable advantages north of the border.


Daryl G. Jones

Managing Director

Navigating the Brazilian Terrain

Conclusion: While we remain bullish on the Brazilian Consumer sector for the long-term TAIL, the confluence of slowing growth and accelerating inflation remain a headwind over the intermediate-term TREND. As a result of inflationary pressures, we see additional tightening on the horizon in 1H11.


Over the past day or so, a couple of nasty economic data points have come out of Brazil: 

  • While certainly a stale number, 3Q10 GDP growth came in a full 250bps slower than 2Q10 at +6.7% YoY (after a +40bps revision to 2Q10). We expect growth to continue to slow over the next 3-6 months, a call aided by incredibly difficult comparisons starting in 4Q10 (+5%  in 4Q09, +9.3% in 1Q10).
  • CPI accelerated to a 21-month high in November, coming in at +5.63% YoY – well above the government’s 4.5% target. On a MoM basis, November’s +0.83% rise was the largest increase since April 2005! The largest contributor to the increase (0.51) was from the Food Products category, which rose +2.22% MoM.

Navigating the Brazilian Terrain - 1


Our call for Brazilian growth to continue slowing coupled with having already received two months of accelerating inflation readings for 4Q10 suggests Brazil’s economy could be in a state of marginal stagflation as early as… well… now:


Navigating the Brazilian Terrain - 2


From Brazil, to China, to India and elsewhere around the globe, we see that Chairman Bernanke’s experiment with Quantitative Guessing continues to have unintended consequences, due to the impact of the equation highlighted below:


QG = inflation [globally] = monetary policy tightening [globally] = slower growth [globally]


The recent surge in Brazilian inflation from the August lows has had the Brazilian bond market anticipating rate hikes in the near future, with yields rallying to higher highs over the past three-plus months. In addition to the accelerating inflation readings, the locking-out of foreign investors from the bond market coupled with concerns that President-elect Dilma Rousseff will fail to curb spending and perpetuate inflation via loose fiscal policy has certainly had Brazilian bond investors demanding higher yields to hold government paper:


Navigating the Brazilian Terrain - 3


While not much has changed regarding inflation and the de facto blockade of international investors, we will give much-deserved credit to the current regime, as well as Rousseff and her team for taking meaningful steps to combat inflation and assuage investor fears of an inflationary tsunami of late.


On December 3rd, the central bank raised reserve requirements on cash and time deposits to slow consumer lending – the demand for which, coincidentally hit a record high in November, growing +20% YoY. The reserve requirement on time deposits rill rise to 20% from the current 15% and the requirement for cash deposits will rise to 12% from 8% currently. The measures are expected to remove R$61 billion ($36B) from the economy.


Rousseff’s choice to replace current central bank Governor Henrique Meirelles with Alexandre Tombini has been well-received by those calling for prudent monetary policy going forward. The 46-year old, who was just confirmed by the Senate, has served on the central bank board since 2005 and is credited with helping design the country’s inflation-targeting regime in 1999.


While Tombini sees eye-to-eye with his new boss on the need to lower Brazil’s G20-high real interest rates to spur long-term investment, the governor-in-waiting has repeatedly stressed the need for “full operating autonomy” to tackle any inflationary challenges along the way. Current trading in Brazil’s interest rate futures contracts suggest market practitioners are anticipating a +50bps rate hike when he takes over in January.


Elsewhere on the macro-prudential front, we have seen austere steps taken by Mrs. Rousseff and her team, which, on the margin, is a meaningful shift away from her campaign stance of maintaining continuity with current President Lula’s policies by continuing to spend more on social welfare programs.


For example, Finance Minister Guido Mantega has announced recently that there will be a “general cut” in expenditures during the Rousseff government, sparing only priority projects such as Bolsa Familia – Brazil’s highly-regarded transfer program. Even the beloved BNDES Bank will see its budget cut by ~50% next year. This is a major step toward combating inflation and toning down domestic demand, as the bank’s main role is to provide subsidized credit for long-term projects. BNDES’ lending rate has been kept at 6% since July 2009 – a full 475bps lower than the benchmark SELIC lending rate.


All told, we like the direction of Brazil’s fiscal and monetary policy; we do, however, caution that because Brazil has been slightly late with its response to inflationary pressures, quickening prices will likely remain a concern over the intermediate-term. As a result, we continue to anticipate rate hike(s) in 1H11, as the government looks to quash this headwind. The one caveat here would be that if growth comes in considerably slower in 1Q11, the ability of the Brazilian government to tighten in a way they perhaps should would likely be mitigated.


Let’s just hope for Brazil’s sake we don’t have to say, “I told you so.”


Darius Dale


Athletic Still Strong Post Holiday

Athletic apparel and footwear sales suggest that strong underlying sales have continued beyond Thanksgiving weekend. Most notably, positive sales came in despite facing the headwind of unfavorable comps for the first time since October in the case of apparel and September for footwear. Here are a few key callouts from the week:

  • Athletic specialty retailers continue to outperform both the family and mass/discount channels.
  • ASP increases decelerated considerably on a sequential basis following the holiday weekend for both footwear +1% vs. +8% in the prior week, and apparel which actually turned negative -1% vs. +8% on the week suggesting that in addition to potential mix shifts, promotional activity may in fact be picking up as well.
  • Importantly, athletic specialty retailers bucked the trend of eroding ASPs in apparel maintaining MSD price inflation offset by considerable declines in the discount/mass channel down -6% - positive for margins and DKS, HIBB, FL, and FINL.
  • New England continues to be one of the top performing regions each of the last 4-weeks.
  • Lastly, while the bifurcation in performance versus non-performance has narrowed materially over the past 2-weeks likely due to a pickup in boot sales, performance footwear continues to outperform by a wide margin.

Athletic Still Strong Post Holiday - FW App Ind 1Yr 12 9 10


Athletic Still Strong Post Holiday - FW App Ind 2Yr 12 9 10


Athletic Still Strong Post Holiday - FW Perf v NonP 12 9 10


Athletic Still Strong Post Holiday - FW Table 12 9 10


Athletic Still Strong Post Holiday - App Table 12 9 10

Casey Flavin



RL: RL Sucker Punched (CORRECTION)

EDITOR'S NOTE: This is a corrected version of a note published today at 11:47am. In the prior post, we included clips from YouTube, and mistakenly inserted one that is highly inapropriate, and inconsistent with our principles, research, and Brand. Please accept our appologies.



I was pretty amazed when I got this promo email from Bob's Stores this morning with a massive Polo Pony on the chest of the garment on sale.  About two seconds later I realized that it was the US Polo Association, and not Ralph Lauren.


The two parties have been in and out of legal battles for well over a decade. Much of it was noise, but my strong sense is that Ralph and Roger Farrah won't let this one go unanswered.


What's also interesting is that the consumer genuinely cares. In this YouTube society, we can now hear from the contingent that matters most. Type 'Ralph Lauren vs. USPA' into your Google machine, and you'll see about 13,000 hits. Do the same on YouTube and see consumers debating back and forth about the issue. Generally speaking, you'll see RL purists across many different age, ethnic and socioeconomic backgrounds standing behind Ralph.


RL: RL Sucker Punched (CORRECTION) - uspa


RL: RL Sucker Punched (CORRECTION) - rl


RL: RL Sucker Punched (CORRECTION) - rl3

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