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US$: Bullish Macro Chart Of The Day

We continue to evolve as our business does. Below we have attached a chart of the US Dollar Index alongside our "Trade" and "Trend" strike prices.

This should help you put both the immediate term ("Trade") and intermediate term ("Trend") in context. As a reminder, as the facts change (i.e. the numbers in the model), our price levels change. These are point in time charts that refresh their levels every 90 minutes of trading.

If the US$ can hold this bullish "Trend", it should continue to deflate other asset classes from foreign currencies to commodities, globally. US denominated cash remains king.

KM

NOT EXACTLY THE BEST MARKETING SLOGAN

It looks like Japan needs a new tourism slogan. "We hate foreigners but come anyway" just isn't cutting it. As reported in the Syney Morning Herald, Nariaki Nakayama, the new tourism minister, stated that the Japanese were "ethnically homogenous" and "definitely … do not like or desire foreigners".

The Japanese government probably needs to stay out of its economy. This is another example why.



BYD/MGM ON OPPOSITE SIDES OF THE LIQUIDITY TRADE

I’ve been hitting on the free cash flow/liquidity/balance sheet theme for quite some time. With this in mind it should be quite clear why I’ve been negative on the industry. A few companies do stand out favorably through this prism: PENN, WYNN, and now BYD. BYD recently suspended construction on Echelon, its huge development on the Las Vegas Strip. With one smart IRR decision, BYD management created huge liquidity, strong free cash flow, and put the company firmly in a position to deleverage. With its new found liquidity and cash flow BYD is in a strong position to maintain its dividend, currently yielding an industry high 6.8%. BYD should be able to generate at least $2 in free cash flow per share (after all capex), for a FCF yield of 22%.

Contrast this with MGM MIRAGE, which pays no dividend but is also building a multi-billion project on the Strip: CityCenter. MGM has been struggling to raise project financing for CityCenter at the same time it is forced to consider its options to fund huge debt maturities on its own balance sheet in 2009 and 2010.

The liquidity line has clearly been drawn.


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Restaurants – What to do –Quick Service!

From a macro stand point we are at 96% cash. From a sector stand point we suggest that cash is also king but staying with low expectation names is a must. The largest players in the QSR segment have been an island in the storm for most market participants. They are also the names with the biggest expectations; growth had been driven by the strong international markets and the weak dollar. Those that have been hiding in a China story are about to see the other side of that trade. The other big negative for the larger QSR names is valuation. YUM and MCD are trading at or near historically high multiples. One last thing, the credit crunch will hurt most of these companies, as franchisees will have a more difficult time getting capital and the cost of capital is rising.

Once again, I am ranking the names in order of yesterday’s stock price performance worst to best:

TAST – A BKC franchisee that owns two regional brands with significant exposure to Florida. TAST has a leveraged balance sheet, with rising food and labor costs. On current numbers the stock is trading at 7x NTM EPS.

WEN – Looking for more clarity as we move into 2009, but it will face some challenges getting incremental customers in 2009. Could be a good place to hide, as expectations are low and the brand is strong

CKR – A regional player with a management team more concerned about the luxuries in life, like a private plane. CKR will be fine but will never get any respect because of management.

JBX – A strong, well run company. Unfortunately, $0.40 to $0.50 of JBX’s EPS growth comes from selling stores to franchisees. Once management get off this drug it’s safe to get in.

KKD – The shrinking violet…..

DPZ – Anything with leverage will get crushed and they have got it. Top line trend appear to be improving.

BKC – The best days are behind them and the street is universally bullish. I’m not a fan. A large part of the company’s success is the resurgence in the advertising campaign and that is definitely cyclical.

YUM – Where do I begin with this one? Without China there is not much here, because the U.S. business is a disaster. Management has leveraged the balance sheet at just the wrong time!!

SBUX – It’s been beaten and beaten again. We are closer to the bottom than the top. Not much management can do to offset the macro. Definitely low expectations

MCD – I still contend that 2009 is shaping up to be a disappointment for MCD. Definitely high expectations!

RESTAURANTS - WHAT TO DO WITH CASUAL DINING!

My first year in the business was 1987. I started at Morgan Stanley in March 1987 on the program trading desk. It was the part of the firm that was somewhat to blame for the crash in October of that year. I will never forget that fateful day in October 1987, just like I will not forget yesterday. The worst part about days like these is trying to sleep at night while thinking about what to do next. This time I have perspective and plan to put it to use.

Following the crash, the next two to three years were very difficult and a shallow recession followed in the early 1990’s. Back then, the term depression never entered anybody’s thought process. Today, we are going to wake up knowing a recession is inevitable and people are going to be asking the question can we avoid a depression. As a consumer analyst, those terms are just a technical definition, the government will step in at some point, but how much of the damage is already done?

The end of the great consumer credit cycle has led to a consumption recession, to a magnitude of which nobody has ever seen. Ironically, the Casual Dining industry as we know it today did not really exist back in 1987-early 1990’s. Most if not all of the publically traded casual dining companies did not trade back then. Brinker International (EAT) went public in 1984, but that could be the only one. It’s not to say that the concepts did not exist back them, they were just not operated as a public company. Importantly, none of the companies have a process to think about the macro environment and operate in a silo.

Needless, to say the much needed shake out in the restaurant industry is not far off. The following is a brief assessment of the prospects for companies in the industry, starting with Casual Dining. The names are ranked in order of yesterday’s stock price performance worst to best:

CHUX – There are a core group of stores in the South East and New England that will survive. My guess is it will need to close 30%+/- of its total store base. Management is in denial at this point!

DIN – The odds are better than 50% that DIN will be the largest bankruptcy in the history of the industry.

RT – It may not file for bankruptcy, but it will be close. Like CHUX it will need to close 30% or more of its store base.

RUTH – The banks are already calling the shots. B of A will likely give them a waiver, but they shouldn’t. A very ill-timed acquisitioned earlier this year ruined the company.

CAKE – CAKE will be ok, but will need to close 10-20% of its store base. It should close the smaller stores it has been opening over the past three years as the company was pushing the envelope of growth.

LNY – Tilman tried to buy the company, it’s a good thing for him it did not happen. Tilman is a survivor, it just depends on what form the company takes. LNY also needs to shrink.

RRGB – They just recently spent $50 million buying back stock and they borrowed the money to do it! I have little confidence in the management team and the staying power of the concept.

MRT – They just announced on Friday that Wachovia upped its credit line with MRT so they could buy back stock. Are you kidding me!

CPKI – At $14 it looks like a great sale. The business model is better that most in the casual dining space and the balance sheet is strong.

CBRL – A brand that has proven the test of time. Its core consumers remain under significant stress and the fatty nature of the menu will not allow it to broaden its appeal. Balances sheet is stretched, but manageable.

PFCB – A good company, but management has been in denial for the past two years. Pei Wei needs to shrink significantly and might just close completely. The rest of the business is fine, but will take time to get traction again.

DRI – DRI will be fine and gain market share as we come out of the cycle. Unfortunately, they have been slow to adjust to the current cycle, as management continues to add significant capacity. They are starting to hedge commodity costs aggressively, an accident waiting to happen.

EAT – biding time. They have been preparing for this for the better part of two years.

SNS – Not much left here but the real estate.

BWLD – We will all be eating chicken wings and drinking beer. At this point expectations are high for BWLD.

KONA – A survivor, because they have good food and no funded debt.

Cash Only

The Definition of Insanity: “Doing the same thing over and over again, and expecting different results”
-Albert Einstein

“The Question” is, who is that quote more appropriate for this morning, the buy side, sell side, US government, or financial network media? From the hallowed halls of the hedge fund community to some of the squirreliest of squirrel hunting market pundits with an internet connection, I have seen my fair share of emails over the course of the last 9 months, suggesting that I was the one losing my mind out there. I guess that’s what makes a market.

At the counter of Dunkin’ Donuts in New Haven this morning, there is a sign that reads “Cash Only!”, and that’s about as appropriate a summary of this morning’s note that I can come up with. I issued an exposure update on the portal yesterday outlining my portfolio positioning: 96% Cash, 3% Gold, 1% Stocks. That didn’t change into the market’s close. That position made money in the largest US stock market crash day since 1987, and since that cash position pays month end interest today, it will again by the time the game clock runs out at 4PM EST. US Dollar denominated cash remains king.

Proactively preparing for risk is what we do, and whether or not my team gets credit for stepping up and taking the shot that few had the platform or conviction to take, at a bare minimum, my son Jack will be able to tell his buddies one day that his Dad protected and preserved his family’s capital on September 29, 2008. The best things in life are worth a lot more than money. A healthy family and home head up my list.

So what next? Let’s take a walk down the risk management path and keep doing what we do, proactively preparing for potential outcomes, rather than reacting to them. In the US, with the “evil doer” short sellers out of the market, market players still blew through my downside S&P target yesterday. As a result my levels of downside support are now as follows: S&P 500 (SPX) 1,074, Nasdaq (COMP) 1,931, and Russell 2000 (RUT) 627.

Volume and volatility shot straight up yesterday, so if you are freaking out with a VIX level of 47, you are giving in like most did in 1987 - at precisely the wrong time. Proactively prepare. Stay focused. Don’t do the same thing over and over again, and expect different results. Flexible and objective minds will prevail as the proverbial tarp of negative energy lingers overhead. Get yourself into a position of confidence and strength. Now it’s time to play offense. Take your competition right out of the game.

Asian trading closed pseudo constructively. Don’t forget that Asian stock markets have, in some cases, lost 1/2 to 2/3 of their value since the “it’s global this time” Investment Banking Inc. peak. The US market has only dropped -29% since October 10th, 2007, and organic growth prospects here are considerably darker than in countries whose per cap GDP is under $1,500/person.

Japan hit a three year low last night, closing down another -4.1%, and I’ll be locking in that gain on the short side sometime today, prices pending. Hong Kong rallied into the close and finished up on the day. With China closed, this was a positive divergence that the global equity market needed to see. We’re looking to get invested again and we’re revisiting China as a potential opportunity on the long side. The Chinese stock market has lost almost 70% of its value in less than a year, and they moved to the capitalist side of the global market share ledger last week by both cutting interest rates and allowing short selling. Additionally, China’s primary input cost, commodities, had their biggest down day yesterday since 1956.

Back to the US, the short sellers come back to the market on Friday as the short selling ban is lifted. That reality, alongside the US unemployment report and post quarter end hedge fund redemptions, provided the basis for the “Beware October 3rd, 2008” (www.researchedgellc.com, 9/19/08) note I went out with. The S&P 500 has dropped -12% since the market closed that day. For the 1st time this year, I am hoping that my call for an October Friday crash was 3 days too late.

Good luck out there today,
KM



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