Sully's Don't Crash

Sully's Don't Crash - asset allocation011609

“I’ll study and get ready… and then, the chance will come.”
-Abraham Lincoln

“Sully” Sullenberger was the pilot of US Airways flight 1549. Sully is what America has always been about – achieving greatness when faced with the darkness of adversity. Make no mistake, this Californian proactively prepared for the risks associated with flying. In fact, he did so for 40 years -  a former U.S. Air Force fighter pilot, Sully served as an instructor and Air Line Pilots Association (ALPA) safety chairman, accident investigator, and national technical committee member. As the reactive investment bankers of horse and buggy whip thought processes past were crashing on Wall Street yesterday afternoon, Sully was landing safely just down the river.

At lunchtime yesterday, while Sully was going through the paces of his pre-flight process, the SP500 was credibly signaling a potential crash. As the US market broke down through what I had in my model as a 2 standard deviation 1 week move, trading down intraday to 818, my Partner, Todd Jordan asked me what I thought. With the SP500 -13% lower than where it had traded just one week ago, I said “Todd, if this market closes here, the only thing we have left is hope.” Todd said, well that’s not good, “because hope is not a process.” I agreed.

Hope is not an investment process, but that does not mean that it ceases to exist. When managing risk, you have to always consider both what no one thinks can happen and what people hope will happen. That’s the only objective way to move forward  - because no matter where stock market prices go, there you are.

With the SP500 breaking through my 825 level, I immediately ran the math on a 3 standard deviation move, and sent an intraday note to our Macro clients flashing that crash level being in play down at the 776 line. While that was only -5% lower versus where we were trading, it was a full -18% lower than where those late to the 1st Obama December rally got piggy chasing in the first week of January. Was 776 probable? All prices are – and having seen the financials (XLF) already having crashed in 2009 to date, I was very much worried.

In addition to my SP500 red alert, my other 2 macro lines in the sand (VIX 54.86, Gold $809/oz) were under assault. I haven’t been glued to my screens like I was staring at them yesterday since September. The big difference between January 15th and September, of course, was that I was no longer 96% in cash. If we broke, I was going to feel it, big time.

Fortunately, Sully landed the plane, and everyone survived. Metaphorically, into the close the SP500 felt like it was rising as fast as that plane was coming down. The VIX backed off my line, and gold revived itself. This morning the VIX is at 51 and gold trading comfortably above support at $824/oz. I feel better, because on the margin, I couldn’t have felt worse.

Is it tough waking up trying to call global markets every day? You bet your Madoff it is. When I was growing up, I always wondered what my Dad must be thinking when he was waking up for his 6am shift. He is a professional firefighter, and his priority is to serve and protect – while I never thought our careers would be similar, I guess I should always remind myself to never say never.

I haven’t been paid Wall Street compensation in the last 6 months, but I certainly feel blessed with the life lessons of accountability and responsibility. When I wake up today, I feel like some people depend on me to manage risk. Even if I am not the “smartest” man on Wall Street, and if only I do this for a certain few, I feel like I am doing the right thing.

Doing the right thing when nobody is looking is what “Sully” was doing. On one shiveringly cold New York City afternoon, his blue skies turned dark – but he didn’t panic - he didn’t dial in for a bailout either. He just did what he proactively prepared himself to do, and he executed. After the plane landed, he walked the plane, end to end, twice – just to make sure everyone was safe… that’s the kind of American I can trust in.

The #1 and #2 read stories on Bloomberg this morning are about planes that crashed – Bank of America and Citigroup. These two Destroyers of Capital are finally on the tape this morning with some of the worst numbers that you’re ever going to see. Pandit and Lewis have managed through this crisis as close to the antithesis as Sully’s process gets. Is this a surprise? No. This is what Wall Street groupthink trained these men to do. There never was a proactive risk management plan – and now Americans have to bail them out, or we are all going down hard.

On July 11th 2008, I wrote an Early Look titled “What Is  A Crash.” At the time, I took a lot of heat from people who I thought were my friends in this business – and in hindsight it all makes sense. A crash is what happens when something happens that no one can afford to predict. Never forget that most of Wall Street is a compensation structure – because the Street can’t afford to agree that the “improbable” is probable, doesn’t make their thought process right. When faced with the reality of the improbable occurring, people and compensation structures crash.

Other than Investment Banking Inc. having crashed, the Russians are crashing. As hard as it may be to swallow those two considerations in the same sentence, it remains The New Reality of 2009. Amidst a global re-flation of stocks worldwide this morning, there is only one market that is threatening to make lower lows, and that’s the Russian Trading System. Alongside the ruble having crashed (down -27% since oil peaked) at 566, the RTSE is testing its October 24th freak-out low of 549. Yes, America’s stock market narrowly avoided another crash versus expectations yesterday, but the XLF etf and RTSI index have not.

Meanwhile the Chinese stock market is up +5% in the last three days, making a bid for another breakout to new 3-mth cycle highs, and so are stocks on the Bovespa in Brazil, which close up another +3.1% yesterday.

Around the world, uncorrelated performance is manifesting itself across sectors and styles. If you are buying into the horse and buggy whip old boy network models of zero transparency and accountability past, I am proactively predicting that you will crash. If you are buying American - “Sully” style - you should be proud of what you own, and smiling as we head into Obama’s Presidency Day weekend.


Sully's Don't Crash - etfs011609



Earlier this week, PFCB’s Co-CEO Bert Vivian said that investors should not be surprised by comparable store sales results like the one reported by RUTH. On Monday, RUTH reported that its 4Q08 same-store sales declined 18.5%. Today, we learned that there is truth to Bert’s comment because RUTH just reported that the entire upscale steak segment experienced a 17.4% same-store sales decline in the fourth quarter, as measured by Knapp Track data. This significant 4Q decline compares to a 5.7% decline in 1Q08, a 6.0% decline in 2Q and a 7.9% decline in 3Q. Specifically, RUTH said that California’s results were in line with the system average but that Florida continued to underperform. We will have to wait to see if Bert’s comments about 1Q will hold true as well… “During the fourth quarter, particularly in December, people had a reason to go out shopping. When people are out, they occasionally also go out to eat. We see no reason for people to go out in 1Q. It is going to be a cold 1Q in retail and restaurants. There is nothing to change people’s behaviors in the next few months.” Please refer to my January 13 post titled “PFCB - New Co-CEO Provides a Dire Outlook for Casual Dining” for more of Bert Vivian’s colorful commentary on business trends.

WRC: Got Transparency?

I was sitting here listening to Warnaco's presentation at the ICR conference. I was stunned and amazed by the simple fact that the company did not issue a positive preannouncement, and then started off by saying (I am paraphrasing) "Our books are not closed yet, but December comps came in strong and we're pleased with our performance."

Note to management -- the people that did not have the chance to ambush you in the hallway at this event would have loved to get this little nugget as well and capture the subsequent 18% move in the stock.

Come on guys... how 'bout some accountability and transparency here???

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Obamerica: STIMULUS!

Obamerica: STIMULUS!

Following a number of weeks of discussions with President Elect Obama and his aides, House Democrats introduced their stimulus bill, The American Recovery and Investment Bill of 2009, which is large and broad based. The bill totals $825BN, which is comprised of $550BN in spending and $275BN in tax cuts.

The key components of the bill are as follows:

(1) $90 billion for national infrastructure investments

(2) $140 billion allocated to states to primarily spend on education improvements

(3) $66 billion in benefits for the unemployed, which is a combination of COBRA extension and general benefits extension

(4) $20 billion to provide nutrition assistance to low income families

(5) Tax cuts that would comprise of $500 per individual and families of up to $1,000 through a cut in payroll taxes

Interestingly, which we totally applaud, the bill is being framed with a component of accountability and transparency with the creation of seven member accountability board (comprised of the Inspector General and Deputy Cabinet secretaries) and a public website that will show how all the funds are awarded and spent.

Initial comments from House Speaker Nancy Pelosi suggests that they believe the bill will be passed by early February. Although House Republicans responded immediately calling the plan “disappointing”. Specifically, House Minority Leader John Boehner, R-Ohio, said, “The plan was developed with no Republican input and appears to be grounded in the flawed notion that we can simply borrow and spend our way back to prosperity.”

The Republican response isn’t surprising given the politicized nature of Washington. Interestingly, we are picking up in the blogosphere that President Elect Obama may have the river card in the way of one John McCain, who we are hearing may come out loudly supporting the plan in order to push it through congress.

Daryl G. Jones
Managing Director

WEN – Coming Out Party

I truly believe that Roland Smith, CEO of Wendy’s, has the opportunity to become a legendary CEO in the restaurant industry and that I have a ringside seat to monitor the progress. I can’t tell you how many times we have seen this story play out in the restaurant industry. For one reason or another a brand is mismanaged for an extended period of time and business deteriorates to disastrous levels. After a period of time the right CEO comes along and mixes the right combination of people and processes, throws in some clever marketing and the mismanaged brand is golden again. Taco Bell, McDonald’s, Burger King, Chili’s, Bob Evans, IHOP, Red Lobster, Jack-In-the-Box and Olive Garden at one time or another have felt the pain of mismanagement. Today, Wendy’s, Starbucks, KFC and Applebee’s are currently feeling the pain of mismanagement.

As an investor, there is huge upside in finding the next brand that is going to move from the mismanaged category to the operating flawlessly category. I really believe that Wendy’s is the brand with the most upside potential, but it will not come easy. Any brand turnaround has to start at the top in the executive suite, so confidence in Roland is key to this story. While my relationship with the new CEO is brief, my relationship with others in the Wendy’s community is deep and long. For now, the team seems to be behind the new CEO and the other executives he has brought on. Below are some of the changes he is trying to make and the metrics that need to be monitored. The one warning that needs to be emphasized is that if Wendy’s is going to be successful, another brand is going to lose. Right now, all eyes are on Burger King as the brand with the most risk associated with a resurgent Wendy’s.

Recently, WEN announced in its 3Q08 earnings release its goal to drive an incremental $100 million in operating profit at its Wendy’s concept and to reduce corporate G&A by $60 million over the next 2-3 years. This week, the company presented to the investment community a roadmap of how and when it expects to achieve these goals.

Improve Wendy’s store-level operations and margins:

In the next 3 years, the company expects to drive an incremental $100 million in EBITDA at its Wendy’s brand and improve restaurant level margins by 500 bps. For reference, Wendy’s company restaurant margins have declined by over 400 bps in the last 6 years. Additionally, there is currently a 600 bps difference between company-operated and franchise-operated store margins from an EBITDAR standpoint (with the franchise-operated units leading the system) so there is considerable room for margin improvement at Wendy’s company-operated units.

The company expects to increase its restaurant-level margins to 16%-17% by the end of 2011 from its depressed 2008 estimated 11%-12% level with a 160-180 bps improvement in both 2009 and 2010, followed by a 150-170 bps increase in 2011. About half of this margin growth, or 230-250 bps, should be driven by labor efficiencies. Another 90-100 bps of savings should come from lower food costs. Better management of repair and maintenance is expected to drive an additional 60-80 bps increase in margins with the remaining 80-100 bps of growth expected to come from reductions in other costs, such as supply synergies and occupancy.

Right-Size Combined Corporate Structure:

WEN expects to drive $60 million in G&A savings by the end of 2010. The bulk of these savings will stem from reduced headcount and the company’s new shared service center, which will eliminate replicated key functions at both brands. Importantly, the company has already achieved $20-25 million of these projected savings in 2008, largely from reducing redundant top-level employees. The remaining $35-$45 million of savings should result from the 2009 opening of the company’s new shared service center, the implementation of a purchasing cooperative at Wendy’s and the completion of an IT project.

These two goals alone are expected to increase WEN’s EBITDA by $160 million over 3 years. The company is also focused on driving improved same-store sales growth at both brands, which is integral to the company reaching its $160 million profit growth goal, particularly as it relates to significantly growing margins at the Wendy’s concept. WEN outlined two other key goals, which included reducing its company-operated unit growth to increase free cash flow and developing a long-term strategy for international growth.

SP500 Levels: Don't Be Shorting Obama Here!

Everything in markets has a price. Just to recap where my head has been at on pricing Obama into expectations, here’s what I wrote before I sold down our Asset Allocation to US Equities to 9%:
Fri 1/2/2009 2:46 PM

“At 928, the SP500 is riding the wave of her intraday highs here…. and this is a great spot to be making sales. We’d been making the call to buy them for over a month now, so with the SP500 +6.5% in less than 3 trading days, this is your payday. Not making sales anywhere north of the 922 line would constitute getting “piggy”.

Today, is Thursday Friday January the 15th, and that Mr. Market has issued us a -12% drop in the SP500’s price from the date of that note (“SP500 Levels: Making Sales”,, 1/2/09). As a result, I have built my Asset Allocation back up to 25% in US Equities, which is close to its highest level in well over a year. Like all Americans, I love a sale – why some money managers love to buy everything on sale other than stocks is entirely their issue to deal with, not mine.

As prices change, so do expectations. The only factor to solve for other than price and expectations is duration. Now that we are t-minus two trading days until Obama rebrands American credibility and attempts to rebuild the trust that we all believe she deserves, we have ourselves an opportunity to earn a positive return on the long side again.

Anywhere under the 836 SP500 level that I issued in this morning’s Early Look = BUY. If you want to get all crazy and call the end of the world like your average run of the mill member of the Groupthink society, go right ahead. I have outlined the SP500 levels associated with both a 2 and 3 standard deviation move versus my expectations in the chart below – those are very hard circumstances for me to see, but because they are less probable certainly doesn’t mean they cease to exist.

A 2 standard deviation immediate term meltdown in the SP500 gets me SP500 813, and a 3 standard deviation move takes me to 776. While 776 would still confirm the intermediate bullish “Trend” of the US stock market making higher lows (since the November bottom), I don’t think I will see that print.

If you’re shorting stocks here, you’re shorting Obama January 20th. I bought QQQQ yesterday for the first time since we opened the firm, so you know where I stand. To borrow a call from the beloved sell side, “ I am reiterating my buy rating” - BUY American, and be patient on price.

Keith R. McCullough
CEO & Chief Investment Office

Early Look

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