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Germany's Trade Balance: Boring Is Good!

Below, Andrew Barber, and I have attached a chart of the rolling sequential changes in Germany's import/export trade data. The German economy continues to hold up better than bad.

I am long Germany via the EWG etf in the Hedgeye Portfolio. The conservative monetary policy of the Bundesbank allows me to sleep more soundly at night on a relative basis to country etf's like Japan, which I continue to short. Germany's EWG security also pays a handsome 9% dividend yield, which I'm happy to collect in economic times like this.

*Full Disclosure: I am also long EWG in my personal fund.
KM

Remember, Have A Process

In my perpetual search to find those who “get it” this year, I often find myself looking back to the sage guidance of my old favorites. Yesterday I called out Jack Bogle of Vanguard. Often I look to Warren Buffett, Paul Volcker, and Larry Summers. This morning, I’d like to give some overdue keystroke time to Jeremy Grantham.

In Grantham’s “GMO Quarterly Letter” from July 2008, he highlighted marking assets to market, bailouts and accountability: “Marked to market 6 months ago, Bear Stearns and Lehman were bankrupt as are Fannie and Freddie today. The bailouts are really providing what amounts to capital to insolvent firms… These bailouts permit a shameful lack of accountability for reckless behavior”.

Compare this proactively prepared point of view to Hank Paulson comments yesterday: "We did not sit down and figure this out with a calculator," Paulson told consensus network, CNBC, “This is about our financial markets, confidence in our financial markets." You see, there is a big difference between reactive risk management and proactive prediction of possible risks. I have never met Mr. Paulson, but many of his former teammates tell me he is a good man. I don’t doubt that. That’s not the point. The point is that I don’t think he has a process.

Our investment process here at Research Edge is to combine bottoms up company findings with a global risk management process that perpetually considers tail risks alongside probable outcomes. One of the main risks to the US Financial system remains Asian growth slowing. Now that China has lost 65% of its stock market value since the October highs, people are paying attention. In fact, even Paulson’s ex/current colleagues at Goldman Sachs are starting to see reality on this front. This morning Goldman is downgrading the Chinese bank stocks to “neutral” from “attractive”. China’s banks stocks are down 50% year to date, and I am not sure whose process outlined them as being “attractive” throughout the swan diving competition. I am not sure I care either – I just want to stay as far away from it as humanly possible.

As the S&P Futures were spiking 24 hours ago, a real risk manager should have been looking to sell. That’s what we did all day long in the ‘Hedgeye Portfolio’ yesterday, and we’ll do it again this morning, if given the green lights of opportunity. Most investment students know that there is a proven psychological pressure in investing called the “endowment effect”. This simply reflects the propensity for investors to overvalue what they own. As Richard Peterson points out in ‘Inside The Investor’s Brain’, “one’s emotional state modifies the strength of the endowment effect”… so, provided that you “get” that the US market remains in a negative “Trend” position, you should be able to take advantage of that emotional market signal, and sell strength…

The last people who are going to agree with me on this are those who have a one factor investment process called price. That’s what “momentum investors” do; they chase price – they don’t fade it. Fading the squeeze up in Japanese stocks yesterday was one of the moves I made in the ‘Portfolio’ (shorting EWJ). Another was selling my trading long position in Australia (EWA). This morning, Asian equity markets opened down across the board – Japan closed down -1.8% and Australia down -1.7%. This isn’t magic. This is a proactively managed process.

Across Asia, currencies and stocks got hammered again last night. This is not new. This remains the fundamental “Trend”. This is occurring because Asian cost of capital is increasing in the face of slowing growth. Indonesia led market decliners last night with another -3.9% down move. Remember that they raised rates last week? Taiwan lost another -3.6% overnight – this was one of the consensus plays on “Chinese growth” that even the Harvard Endowment loaded up on, remember? I do…

Remember the geopolitical issues in Pakistan and Thailand? This morning, ex inmate and squirrel hunter extraordinaire, Zardari, is prancing around as Pakistan’s new leader. In Thailand, Prime Minister Samak was forced to step down for receiving benefits for a cooking show! No, you cannot make this stuff up. It’s happening, and if your broker still has you choking on every “its global this time” Asian ETF, remember that these cesspools of risk are what they have always been!

Good luck out there today,
KM



ANALYZING THE ANSWER

It’s pretty easy to see why I like the PENN story. CFO Bill Clifford and I share a similar view of the industry’s prospects. In my post on Sunday, I published Mr. Clifford’s response to The Question. His answer appropriately addressed the issues of falling ROIs and rising costs of capital. Mr. Clifford also opined that asset and casino valuations were still inflated. PENN certainly maintains a vested interest in seeing asset values fall. After all, they are the only buyer of assets/companies in the gaming sector. However, Mr. Clifford’s analysis that views valuation through the perspective of a potential private equity/strategic acquirer is spot on in my opinion. Cost of capital and required rates of return are now much higher and EBITDA remains unstable.

A very telling statement in the response relates to timing. If he believes “there are going to be some incredibly discounted gaming assets available over the next 12 to 24 months” then patience is truly a valuable virtue. PENN’s excess liquidity is certainly not burning a hole in their pockets like it was for most gaming companies over the past several years. What that says about the investment prospects in the rest of the sector is another question altogether. Pair trade anyone?
Not burning a hole in PENN's pocket

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LONDON CALLING, BUT WILL THEY KEEP COMING

We at Research Edge appreciate transparency and honesty so we couldn’t help but comment on the recent statement by the UK’s Minister for Tourism, Margaret Hodge. “I agree that hotels are expensive and I worry about the quality.” Ouch. Not exactly “What happens in Las Vegas, stays in Las Vegas” is it? I don’t disagree with either of her potentially damaging assertions, particularly the part about expensive.

What is really disconcerting is the macro. The macro drives demand in the hotel business. We do macro here at The Edge so we do have an opinion. Our opinion on global macro is not favorable. In fact, it is quite negative. Ms. Hodge can backpedal all she wants, but with so many macro global negatives, London and the UK will soon be in a “world of hurt” to quote our newest Vice Presidential candidate. I’ve outlined a few of our concerns below.

Unfortunately, continental Europe will face the same hurdles as the UK, but we have to start somewhere and the UK looks like one of the major sick men of Europe. The second chart provides profit exposure by companies with US listings to Europe. With the exception of MAR, all the hotel companies listed maintain material exposure to Europe, especially OEH. As I’ve opined in the recent past, estimates need to come down significantly based on US RevPAR and margins alone. When Europe starts to capitulate, the cut will be exacerbated and expedited.


  • Global economies slowing: As Keith McCullough has written extensively about, we are in the midst of a global economic slowdown. Tourism and travel will not fare well in this environment. While the recent rise in the dollar could attract some US visitation to London, the US consumer is pinched.

  • UK economy: flat GDP could go negative.

  • Inflation: While UK PPI down ticked in August, it is still up 10% YoY. Consumer inflation jumped 0.6% in July, an unprecedented increase. In addition to the inflation impact on the consumer, rising costs will eat into margins at the same time RevPAR growth is slowing.

  • Hotel asset values falling: We can guess at asset values but the transaction market is dead. Can’t mark to market without a market. Marylebone Warwick Balfour (MWB) is attempting to sell hotel chains Malmaison and Hotel du Vin for the third time in 18 months after knocking £50m off the previous asking price of £700m for the two chains. My industry sources in London are not expecting a decent price to be advanced. Robert Milburn at Pricewaterhouse Cooper‘s forecasts a correction of 10-20% before sales are made but even this prediction look conservative.

  • RevPAR comps get very tough: Summer events boosted recent RevPAR. As can be seen in the chart, comps get very difficult beginning in August. It won’t be long before RevPAR goes negative, possibly as soon as October.

  • Airfare going higher as capacity is reduced

  • UK housing market potentially worse than in US

Comps get awfully difficult
OEH and HOT maintain the most exposure to the sick men of Europe

Challenging My View On Margins

Trough to peak apparel margins more than doubled from 6% in 2Q01 to 13.2% in 3Q06. Impressive run indeed – almost as impressive as the six-point collapse to 7.1% over the ensuing 7 quarters.

When I objectively look at the chart below, I have to ask myself whether the industry has officially round-tripped it, and margins have bottomed. As much as I want to believe this to be true, I can’t bring myself to believe that the late 1990s serve as an appropriate proxy for what real margins in this industry should be. My long standing math suggests that after adding the $3-$5bn in annual sourcing savings as well as the favorable impact of the weakening dollar, real margins were actually down over the past 4 years.

We still have not seen a) the full impact of the raw material cost hit that will happen starting in holiday, b) FX benefit that will turn the other way and eat into the supply chain’s margin kitty, and c) the additional names likely to be added to the bankruptcy honor roll.

I truly think we’re getting to the bottom for some names, but the industry still needs a healthy session of blood-letting. On top of all that, expectations still call for up margins in ’09. Not gonna happen…Favorites remain KSWS, LIZ, RL, FL, TBL, PSS and ZQK. I don’t like GES, WRC, SKX, GIL, DKS, PVH, and VFC.

Lehman (LEH): No Government Bailout For Fuld...

With Paulson tying the US government's balance sheet up with the GSE's and a dance with the FDIC pending, investors are wondering when, where, or if there is capacity on the balance sheet to deal with another investment bank’s issues... LEH closed down -13% today on more than 2x average daily volume (using the last 10 days of trading as the avg). Someone knows something.
  • LEH's short term downside support now rests at $12.65
    KM
chart courtesy of stockcharts.com

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