• run with the bulls

    get your first month

    of hedgeye free


Debunking the Short Selling Ban, Part I

The SEC’s short sale ban created a rally by removing free market checks and balances. The long term impact on the markets will be less positive.

The SEC short selling ban covers 779 financial stocks until Oct. 2 and imposes new penalties for clearing brokers that fail to deliver on shares sold short after t+3. The FSA ban covers only 39 UK financial stocks but the window extends to January 16 of next year.

Overall the impact on market liquidity is expected to be significant. According to a report released last week by my friend Joe Gawronski at Rosenblatt Securities:

“Bans on shorting financial stocks, combined with the new disclosure and fail-to-deliver penalties, should exert considerable downward pressure on volumes. Short selling by hedge funds and other investment managers, as well as by many smaller and medium-sized high-frequency trading firms (but not their larger brethren), is likely to drop off significantly during the terms of the emergency orders.”

The options markets could be hit especially hard by this move. Options market makers have enjoyed an exemption from borrowing stocks before shorting intended to allow them flexibility as they offset their exposures. If they can’t borrow shares to deliver short then they can’t sell protection to the markets. On Friday it was reported that an SEC staff recommendation had been put forward to amend the order to allow options market makers to keep their exemption. The SEC’s waffling on this point is understandable since, with traders at bank desks sitting on their hands for want of capital, the locals are suddenly the only game in town. Without them, buyers and sellers will only be able to transact if they happen to meet in the same strike and maturity.

Decreased liquidity is obviously not the biggest negative aspect of this order. The natural checks and balances that legal short selling provide allows greater efficiency in the marketplace as short sellers are incentivized to police the market for poor performing management teams, corporate malfeasance and unrealistic valuations. By removing this force from the market we are sending a message to the world that our financial firms are too weak to stand on their own and that we will protect them despite by changing the rules of the game if need be. To some investors, this will look like the first step down a slippery slope of market manipulations that have chased foreign capital out of other markets in the past. Even if more banks failed without the short sale ban, there would remain faith in the integrity of the US market system. With this solution, we demonstrate that our market has no more integrity than our bad banks.

Andrew Barber

Nike: Putting ROIC Before Ego

Nike but ego aside and made the right ROIC decision by getting out of the competitive swim business – but not without inflicting as much bodily harm as possible on its opponent.
I was initially shocked to see this one… After taking a blow during the summer Olympics by having to allow Nike swim athletes to wear Speedo suits, Nike s getting out of the competitive swim business.

Nike is finally seeing the light… After sustaining such a loss (in PR or in $$), the old Nike would have plowed capital into this business just for the sake of winning. That’s what they’ve always done. But an important point here is that Nike is getting out of ‘competitive’ swim – not ‘casual’ swim. For what it’s worth, 98% of swim-related sales come from the casual market. This is business that Nike licenses out to Perry Ellis. NKE brass asked themselves whether investing capital in this business would result in any boost in its casual business – and the answer is No. All in all, a wise move in my opinion. I’d rather see the capital go toward getting sport culture apparel right, or combating Under Armour in performance footwear. Apparently Nike Agrees.

One factor that really surprised me was that Nike was gunning for Michael Phelps. But something between the Olympics and now squashed chances of bringing him on. Could it be the sheer price, as nearly every endorser in the US has gunned for a piece of the MP enterprise?

To quote a sports agent representing most Nike swimmers (and most of his paycheck) "Nike getting out of the championship swimming market is the death of American elite swimming as we know it."

My view here is that Nike bid up Phelps just enough for Speedo (Warnaco) to keep him, but at a borderline painful price. In instances where Nike does not win, it inflicts as much bodily harm as possible.

Know When To Fold Em

“You got to know when to hold em, know when to fold em, Know when to walk away and know when to run.
You never count your money when you’re sittin’ at the table. There’ll be time enough for countin’ when the dealins done.”
-Kenny Rogers’, The Gambler

Feet on the floor and flush with cash - that’s where you need to be early this morning. This card game is over. Despite their fibbing to you for the past 9 months that “Investment Banking Inc.” is AOK, Goldman Sachs and Morgan Stanley faced the river card this weekend, and were finally forced to fold em’, turning over the keys to their leverage cycle castles.

You’ll read about yesterday’s Wall Street going away just about everywhere today, so I’ll save you the air time of the specifics. We hope we have been proactively preparing you for the inevitable. We now have more important things to do here this morning, like putting the client first. The bottom line is that the compromised, constrained, and conflicted “Investment Banking Inc” of 2007 is out of aces. Goldman Sachs and Morgan Stanley are now going to be regulated bank holding companies. They need commercial deposits to bail them out of this mess, so look forward to seeing Goldman ATM machines at a 7-Eleven near you.

Now to the markets and your money. Yes, that’s your money that tomorrow’s Wall Street will be managing, not the wealth associated with them levering up on it. Never mind the partisan bailout haggling of this weekend. Tomorrow is when both sides of the aisle are going to get at each other. Tomorrow is the Senate Banking session where Ben Bernanke, Hank Paulson, and Chris Cox will be on the hot seat, answering to the populist, conservative, and democrat cries of this fine nation. I am betting on black that Paulson doesn’t get his plan through the political process in the timeline he was pleading for yesterday on “Meet the Press” (see my note yesterday detailing Tom Brokaw’s intense interview).

During the short squeeze melt up on Friday, I moved to 96% cash, and that’s where I will likely stay until the dust clears on this mess on October 2nd, when free market capitalism’s rules come back to this game. That, of course, is the last day of the ban on short selling. While we can no longer rule out Paulson and Cox moving the goal posts on the fly, we can have confidence that this reckless government sponsored market volatility will continue into and out of that date.

Consider last week’s move in the Russell 2000 small cap index vs. the larger cap Dow Jones. The Russell was +4.6% on the week, and the Dow was down -0.30%. Why? Well, post the sandlot SEC rule change, all of the shorts had to cover, and the volumetric impact associated with small caps is much more powerful than in their big cap brethren. This is going to be a major problem on October 3rd, because illiquidity (no shorts) drives volatility – ask Dick Fuld what happens to a “Level 3” asset that doesn’t trade when it is forced to find a marked to market price. The US Government bailout team doesn’t get this.

Worse yet, John McCain is ranting and raving about replacing the SEC’s Chris Cox with the guy who suggested we ban short selling in the first place, Andrew Cuomo! People generally do not accuse McCain of being an economically intelligent man – this certainly is not going to get him any points from the free market capitalists today.

The “Trade” that you should be focused on this morning is the one that has been born out of the Paulson plan in the last 2 sessions of global trading – the devaluation of the US Dollar. The US$ is down a full percentage point so far this morning, taking its cumulative decline since John Mack’s “evil doer” short seller speech to -3%. If you follow the bouncing ball of interconnected global markets, you’ll notice that this has lit the fire underneath inflation related assets. Oil and Gold were +6% and 13% respectively last week. Food oriented commodity inflation remains sticky, and Dr Copper is hitting a 2 week high this morning as well.

Hank Paulson is a good and hard working man, but he himself noted on “Meet The Press” that he doesn’t know what the cost of bailing out his Wall Street investment banking cronies is going to be. He is also a smart enough man to not have answered Tom Brokaw as to whether he will be around at the US Treasury in 2009 to see his hurried decisions through.

Confusion in markets breeds contempt; crisis’ of confidence do not support recoveries; and governments do not mark bottoms in stock markets.

We’re rolling up our sleeves here. There is some heavy lifting to be done in re-building a Wall Street that we can all be proud of again. “There’ll be time enough for countin’, when the dealins done.”

Best of luck this week,

Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.


I thought this was an interesting turn of events. On Friday, MSD Capital (Michael Dell’s group) converted their friendly “G” filing into a not so friendly 13D filing. They own 14% of the common stock and a chunk of the preferred… As you read Item 4 of the filing, keeping mind that DIN is over 7x levered.

Item 4. Purpose of the Transaction.

"The Reporting Persons now intend to have further discussions and other communications with the Company’s management and members of its Board of Directors regarding debt repayment, changes in the Company’s capitalization and dividend policy, disposition of Company owned restaurants, composition of senior management including the hiring of a new Chief Financial Officer and the composition of its Board of Directors."

It goes on……

"The Reporting Persons may also have conversations with other stockholders. In the course of such conversations with members of management, the Board of Directors and other stockholders, the Reporting Persons may suggest actions that could result in, among other things: (a) the acquisition by the Reporting Persons of additional securities of the Company, or the disposition of securities of the Company; (b) an extraordinary corporate transaction, such as a merger, reorganization or liquidation, involving the Company or any of its subsidiaries; (c) a sale or transfer of a material amount of assets of the Company or any of its subsidiaries; (d) changes in the present board of directors or management of the Company; (e) a material change in the present capitalization or dividend policy of the Company; (f) any other material change in the Company’s business or corporate structure; (g) changes in the Company’s certificate of incorporation or bylaws or other actions which may impede the acquisition of control of the Company by any person;"

I have never met the people managing MSD Capital, but I’m sure their future plans will not include the current CEO of DIN.

Ukrainian Bear Hug

Ukraine leaders fight over how to handle economic and political pressure from Russia while their market tumbles, the fallout from this could spread…

The unilateral withdrawal of President Viktor Yushcenko’s Our Ukraine party from the ruling democratic coalition on Tuesday placed the already battered Ukrainian Stock market under further pressure as the hard line pro democracy leader (whose face is still scarred from a poisoning that he believes was the work of Russian agents) continues to accuse Putin’s cadre of attempting to destabilize his country and his former coalition partner Prime Minister Yulia Tymoshenko of pursuing a course of appeasement.

With political crises exacerbating the effects of global financial meltdown, the Kinto cap weighted Ukrainian index (KINDEX) reached levels this week more than 55% below where it started the year –prompting PFTS exchange President Iryna Zoria to call on Kiev to pursue stimulus measures similar to those adopted in Moscow. Zoria also decried the National Bank of Ukraine's policy of fighting inflation by withdrawing funds saying that it “impedes the fight against the liquidity crisis and is not in line with the measures of international financial regulators.”

Relations between Russia and Ukraine (never good) have been in steady decline since Kiev first stated its desire to join NATO, but the pace has accelerated sharply since the events of August. Yushcenko’s party issued a manifesto on Ukrayinska Pravda’s website yesterday which will do nothing to ease tension:

“…..Our Ukraine demands that possible coalition partners condemn the act of military aggression by the Russian Federation against Georgia, strive for the immediate restoration of Georgia's territorial integrity and the withdrawal of Russian troops from sovereign Georgia; condemn the use of Ukraine's territory for waging a military attack by the Black Sea Fleet of the Russian Federation against Georgia…………….
……………The Our Ukraine People's Union insists on the need to diversify energy sources and to ensure the pumping of oil via the Odessa-Brody oil pipeline from Odessa to Brody.”

Until now the Russian response has been limited to threats ranging from potential tariffs on Ukrainian exports to Russia (the Russian market currently accounts for 25% of the Ukraine’s total sales abroad) to the expulsion of diplomats but, as rhetoric heats up so does the possibility of sanctions from Moscow.

It is very important to note that roughly 75% of all of Ukraine’s natural gas supply either originates from, or passes through Russia. Additionally, Ukraine is also the conduit for an estimated 85% of the natural gas that Russia supplies to EU markets. Any move by Putin to use Russian energy supply as a means of punitive action against Kiev could help local instability spill into the broader European energy market rapidly.

Andrew Barber

Eye on Leadership: 'You Tubing' Hank Paulson ...

The following is my paraphrasing of this morning’s NBC “Meet The Press” interview, alongside my views.

Overall, I’d say that Hank Paulson is a good man who is trying hard, but that doesn’t make him the right person to be managing this situation. There never was a proactive risk management process in place. He continues to rush into decisions, reactively, without consulting a bi-partisan team of credible financial experts. I have seen this movie before. It doesn’t end well. We need someone to takeover, sooner than he can scare Congress into implementing these hurried decisions.

Tom Brokaw = TB
Hank Paulson = HP
Keith McCullough = KM


If you brought this deal to your Partners at Goldman, they’d send you out and say “come back when you have more answers”, wouldn’t they?

Tom, I don’t look at it that way. This is not something that we wanted to do, this is something that is very necessary… American companies were not able to raise financing, this is very serious.
Of course he doesn’t look at it that way. In 2005-2006 it was all about making as much money as he and his Partners at Goldman could. Now he wants to socialize
the downside of their losses. This is very serious, for the investment banking firms who are locked into these compromised operating structures. Very serious,


The cover of Newsweek calls you “King Henry”. Richard Shelby says you are jumping from crisis to crisis like putting out brush fires…

Tom, there are a lot of questions… and I can understand there are a lot of questions… let me address the first part, the cost… we can’t determine what the cost will be
today… this is not a position where I like to see the tax payer, but this is far better than the alternative… the average American watches the stock market; they watch
the market drop about 1000 pts, then recover on this plan… what they don’t see is what is going on in the credit market. This is a serious situation and we need to
avoid it.
This was the hardest answer to watch Hank stutter through. He doesn’t know the cost, and he won’t be around to be held accountable to it in the end anyway. He
says it’s all about the credit market, but at the same time, he only makes these hurry up offense decisions when the stock market is going down, and John Mack and
Llloyd Blankfein are crying wolf about evil doer short sellers. I don’t get it.


Is the stock market’s rally late in the week a false positive?

It’s not what we should be looking at… we need to be looking at what is going on in the credit market… it is very fragile and frozen… and we do something to deal with this, and do it quickly.
Right, right… don’t look at the stock market folks… c’mon Hank.


Are the fundamentals of the US economy staggering?

What I would say is I won’t bet against the American people… I would not bet against the long term fundamentals of this country…
In English the answer to Brokaw’s question is yes. See all comments from Paulson, including those back in April where he called the credit crisis being behind us, where his answer to this question has always been no.


You want this all to be run by the Treasury Dept – Warren Buffett says we need a non-partisan czar like Bloomberg to run it – why isn’t that a better idea than having Treasury run it, because you are going to leave Treasury in January?

Tom, what I am doing is reacting to the situation we have in front of us today… we have authority to move very quickly… the plan we have is one that will work… future administrations can run this anyway that they would like to run it…
This is very straightforward. Paulson wants nothing to do with a partisan decision making team that proactively prepares for the next 3-5 years, or 3 to 5 months for that matter. He is “reacting” to an economic crisis that he didn’t foresee. He asks his investment banking friends for help rather than building a team of credible experts (Buffett, Bloomberg, Griffen, etc...).


But why not start a new process, structure, and regulation now?

We need to manage these assets and manage them quickly – that is the situation we have in front of ourselves today…
Again, he didn’t have time to do it right, and he certainly isn’t taking the time to do it over properly. Rush, rush, rush…


And simultaneously develop new regulations?

No Tom, that’s not doable immediately… what’s going on here is terrible it’s inexcusable, and we need to deal with it… but that is going to take some time to figure that out and do it carefully and well… we can’t deal with that in a week, we need this legislation in a week, because we have a problem in our capital markets to deal with…
The problem in our capital markets is the people calling the shots. We have a crisis in both judgment and leadership in the US Financial System. These people rush into every decision, and use broad stroking alarmist rhetoric to strike a chord with politicians who readily support them.


Some people are concerned with your ad hoc approach. You let Lehman fail, but Hank Greenberg at AIG says he could have saved the company for $20B.

A lot of people are saying a lot of things Tom, and a lot of people want to rewrite history, but we have had some tough situations to deal with here, so let me go through them one at a time… there were no buyers for Lehman – it was a very sad situation… AIG was a few hours away from declaring bankruptcy – the government came in and avoided a real catastrophe in our financial markets… AIG created very much a hedge fund on top of insurance companies – something like this in my judgment should have never happened
If AIG is a hedge fund, what is Goldman Sachs?


Sophisticated investors are pulling their money out of money market accounts – the domino effect here is going to be a no growth economy isn’t it?

Tom, you made my case for me. That is why we need these powers. That is why we need Congress to move quickly… it pains me tremendously to put the American tax payer in this position, but it’s better than the alternative… but we need to do it
The alternative is to let free markets trade. Every time the brain-trust of Investment Banking Inc. intervenes, and/or regulate their clients rather than themselves, this creates a more protracted downturn. Governments don’t end bear markets. Investment bankers don’t either.

Keith R. McCullough
CEO and Chief Investment Officer
Research Edge LLC

the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.