Now "They" Are Bearish Enough! Moving to 76% Cash...

We have three views on stocks and markets here at Research Edge: Bearish, Bullish, and Not Enough of one or the other. I have been buying and covering stocks since 11:08AM today, and have moved from an 84% portfolio position in cash to 76%.

Three simple reasons:
1. The weekly Bullish to Bearish Institutional survey has finally moved to the decidedly Bearish side
2. The Volatility Index has hit my immediate target level of 35.11 today
3. Volume and Breadth are capitulating intraday on the negative side

Buy Low. Sell High.


Eye on Trust...

"Who do YOU trust?"
By Andrew Barber, Director
Research Edge LLC

The year has seen the major Wall Street banks squander generations of work spent building the trust of investors globally. Now the contagion is spreading.

Yesterday I spoke with a friend of mine who is a successful wealth manager in Greenwich. This friend is a savvy investor who has built a successful practice. When I called him he told me that he had gone to the bank where he keeps his personal saving and checking accounts and withdrawn funds to spread around among other institutions because he was paranoid about having his liquid cash accounts frozen in case his bank failed. This is a rational and informed person that I am describing who is almost at the point where he would rather bury his savings in a jar in his backyard than keep it in a bank. This represents the total markdown of the greater US financials system’s largest intangible asset – trust. Reserve Primary, the oldest money market fund in the country, had to take a big markdown on that asset today when they broke the buck and sent more people like my friend scurrying to the bank to withdraw their life savings.

The US does not have a monopoly on trust. As we all know, doing Business in China is impossible unless you have a partnership with a local firm. We talked about the potential dangers of Chinese JVs repeatedly in the first half of this year as companies like Danone and Caterpillar wrestled with bad Chinese marriages. None of the problems they experienced compare with the complete betrayal that Fonterra is feeling today. Fonterra is a 43% owner of the Sanlu group –a company that used a dangerous chemical to make baby formula. The allegations are not that this is an accidental situation caused by a mistake at the factory –this is believed to have been a heinous, deliberate decision driven by greed that has caused at least 6,200 infants to suffer kidney damage and at least 3 to die. Imagine waking up to find out that your business partner was poisoning babies. By the way; some of the early reports that came out from the Chinese media (the government is now reportedly controlling coverage now to avoid panic) mentioned that some families of sick children were pursuing legal action. Welcome to the newest consumer trend in China: litigation. It’s global this time.

The commodity markets are not immune from this crisis of trust either. Today at 1 PM the EIA will release crude oil stock data. Everyone in that market, already on edge over the fighting in the Niger delta, will be watching closely to see how much Ike disrupted supply. The data that is reported today will be the first report drawn from surveys conducted after it was announced that the CFTC is investigating whether energy firms have been supplying false inventory data to manipulate the markets. We will have to wait until the regulators finish taking depositions from more traders to see if any charges are filed –but the shadow of doubt has already been cast. How can you trust the fundamentals if the data is corrupt?

AIG has shaken my trust in my own judgment of risk. I regarded AIG’s derivative trading subsidiary, AIG Financial Products, as one of the greatest firms to ever operate in the risk markets. I have personal friends and trusted business associates there -people who are, without doubt, some of the most intelligent and honorable people in our business, period. With a massive “double-triple A” balance sheet as a foundation and an awesome concentration of intellectual firepower, AIGFP was THE counterparty of choice for the largest institutions on earth as they sought to modify their market risk. They could do trades for bigger size, in more markets and for much, much longer duration than any other player in their markets. At some levels they WERE the market. From pensions and endowments executing index swaps to bulge bracket investment banks lying off equity volatility –the success of AIGFP’s derivatives team in winning trust hardwired them directly into the US financial system’s central nervous system. I implicitly trusted any derivative contract they guaranteed as being safe as, well, milk.

So that is the question I find myself asking today is: who is left to trust?

Andrew Barber

DRI - There does not appear to be a Macro Process

My number one concern about DRI continues to stem from the company’s new unit growth targets, which I don’t think properly reflect the current environment. Management acknowledged the tough environment saying, “There's no question it has been a difficult quarter and given the difficult economic environment, it looks like it is going to be a challenging year. Our current sales and earnings outlook reflects that.” Despite these challenging times when operating profit growth declined at each of the company’s core concepts, Red Lobster comparable sales declined for the third consecutive quarter with traffic down about 5.5% in 1Q and LongHorn posted a 4.9% same-store sales decline with traffic down about 7%, DRI maintained its FY09 unit growth targets (75-80 new restaurants, or 4%-5% unit growth).
DRI management has been saying for some time now that the company’s plan to achieve sustainable growth at Red Lobster has three phases: first phase was to strengthen brand fundamentals. The second phase included refreshing the brand, broadening its appeal and building guest counts. The third phase included accelerating new unit growth. As early as 4Q07, DRI communicated that this plan included the expectation that phase 3, or new unit growth, would begin later in FY09. I would have thought phase 3 would have been contingent on phase 2 having been accomplished, but the company stated again today that it will resume meaningful unit growth in 2H09 and expects to open 10 net new restaurants. Management admitted that although operating fundamentals (phase 1) have greatly improved, that Red Lobster is still working to “broaden the appeal of their brand and recapture lapsed users,” which communicated to me that they understand that phase 2 has not been completed, but they are moving ahead with phase 3 regardless. Traffic continues to decline (again, part of phase 2), but management appears unwilling to back away from their initial forecast for growth in FY09.

Apparently, I am not the only one concerned about DRI’s growth outlook as management was questioned on its conference call this morning about its continued commitment to restaurant development at Red Lobster in 2H09 relative to the concept’s performing below expectations. CEO Clarence Otis replied by saying that from a traffic standpoint, Red Lobster has outperformed the industry in the last couple of years with a materially higher average check, which leads him to believe Red Lobster has performed strong competitively. I found this answer to be a little surprising because the industry has experienced negative traffic for the better part of the last three years so outperforming these negative metrics will not lead to enhanced returns.

Additionally, Mr. Otis said that the decision to add new Red Lobster units is more of a restaurant by restaurant and market by market type of analysis. “I don't know that we have a pace of expansion that we think makes sense versus we scour the country and look at the markets and decide market by market does this restaurant make sense from a return perspective. And so it is very much a bottom up driven expansion. Here's a market that's expanded, that is strong a trade area we think we can get X guests out of. It makes sense to open this restaurant. All that adds up to five one year, other years to ten. It is more about that, and to the extent that the guest count level that we start to make that restaurant by restaurant assumption from is lower and we scale out over 30 years, fewer trade areas will make sense. So that's a little bit of how we think about Red Lobster. I don't know that there's a master plan as opposed to a unit by unit investment decision.” I found this comment to be interesting because if the CEO does not know the master plan, who does? Given the trends in the quarter and the outlook for the balance of the year combined with the current level of unemployment, trends in macro factors would point to a different strategy.

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MCD – Coffee could be the tipping point!

Yesterday, at the Bank of America investor conference, MCD’s Chief Operating Officer Ralph Alvarez said MCD is working to renovate it’s drive-thus in the U.S. to accommodate making the new drinks. He went on to say that all of McDonald's Corp.'s U.S. locations should be able to offer espresso drinks by the middle of next year, with a new line of smoothies and frappes on all menus by 2010.

How is this possible!

To reiterate what I posted last month, here are is what we know so far:

4Q07 – No comment from the company when asked on the conference call about the number of stores selling specialty coffee, but they did not expect to see critical mass until later in 2009.

1Q08 – “We are currently in about 1300 restaurants and expect the rollout to accelerate and pick up pace later in the year.”

2Q08 – “Specialty coffees is just one element of the combined beverage business and it’s currently in more than 1600 restaurants.”

3Q08E - ???

If we assume the company accelerates the conversion process in 2H08 and converts 1,200 stores, the total number of McDonald’s stores with the ability to sell specialty coffee in the US would be 2,800. This represents only 25% of the McDonald’s system! McDonald’s senior management has set expectations for a national launch for the specialty coffee program in mid-2009. If it has not started already, the 2009 budgeting process needs to incorporate the national launch of the specialty coffee program. If only 25% of the store base has the ability to sell specialty coffee, how can the company justify spending the marketing dollars in 2009? More importantly, will the franchise system embrace the move?

I believe they need to reset expectations.

A "One on One" some didnt get - the masses are meeting TED today!

This TED spread that we have been ranting about for the past 3 months is finally finding mainstream groupthink. Facts are hard to ignore, particularly when they are flashed to your boss or bank, after the fact!

Below we have updated the reality of the situation on both a 3 month and 3 year basis. US Treasury yields look more and more like Japanese ones as of late. European bond investors are running for the exits. LIBOR continues to track higher.

The Fed Funds rate in this country needs to be raised. Creating cheap money leverage cycles is not the answer to this structural problem.

Focus Chart Of The Day: The US Dollar

After a massive +12% move in a compressed period of time (9 weeks), the US Dollar has indeed proven that cold hard American cash is king. But what next? Post the AIG deal, Bernanke and Paulson have the bailout balance sheet of the US Government taking on water again... this is US$ bearish, on the margin - and everything that matters in markets happens on the margin.
  • I had short term momentum support at $79.25. That broke today as the US$ Index weakens to $78.83. Next support is $78.21. If that levee doesn't hold, watch out below.
chart courtesy of

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.52%
  • SHORT SIGNALS 78.67%