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The Russian Bear Hunter Does Judo

The Russian Market has been shuttered until the 10th of this month, as the Kremlin tries to stop the bleeding. This is not capitalism folks.

With a rusted-out war fleet en route to visit Hugo Chavez, a potential bailout for the Icelandic Banking system, a few bomber incursions into Japanese airspace and the announcement that he has a Judo instructional DVD about to come to market, Vladimir Putin is doing his utmost today to project the image of a strong, resurgent Russia to the world. When you consider the fact that the Russian equity markets have been closed more than they have been open over the past two weeks as stocks there have continued their plunge despite repeated attempts by the government to inject more liquidity into the local credit system (a total of $186 billion in government funds have been earmarked for the bailout to date) this bear suddenly looks sickly.

As any hunter will tell you, a wounded bear can be much more dangerous than a healthy one –an animal in pain is less likely to behave rationally. As such Putin & co. must still be approached with absolute caution. If the Russian government leaders can’t get their way in free markets, they will be more than happy to take a page from their old KGB training manuals.

Ignore Mark Mobius and the other emerging markets “gurus” who have been crushed here. With a meltdown this severe and this global there will be LOTS of opportunities to find equal value in better markets - markets where the referees don’t change the rules halfway through the game.

Who knows, if the SEC’s Chris Cox & Co. are removed from power, the US might even become one of those markets.

Andrew Barber
Director

"Heli-Ben" Cash: A sad day for Japan, and for Capitalism...

I am finally getting time here to circle back and re-read the joint statement made by the consortium of central bankers who dropped cash from “Heli-Ben” choppers this morning...

Repeating what they did is not the point of this note. Reminding you what Japan COULD NOT do is, however.

The Japanese central bankers "welcomed changes, but kept rates unchanged."

I bet they “welcomed change”. The Japanese are in a politicized box of negative real rates and have zero flexibility to do anything else. This is the central problem associated with the market’s respective US Fed and global central banking manias altogether. Market participants do not respect history. Cutting interest rates to zero (or negative) on a real basis ends up putting your country in a sad sad place.

I don't have to have my office across the street from the Yale Economics department to remind you of Economics 101 here. If you are Japan, you are the equivalent of a man standing on the shore waiving aimlessly at capitalist boats as they engage in free market trade warfare. No one is going to come to your shores and invest if you don’t issue them some positive rate of return.

Having a compromised and constrained country balance sheet is the result of this manic behavior. That's why the USA needs to wake up and smell the coffee here and raise interest rates, or else our Titanic lender (China) is going to be leaving Americas shores for good.

The current Bush administration clearly doesn’t get this. They are too busy reacting to economic scenarios that they didn’t proactively prepare for. Obama is going to have to bring in Volcker and get all hands on the USS Capitalism’s deck again.
KM

Thailand: Brink of Anarchy... Not all Asian Economies Are Created Equal

The political crisis in Thailand is spiraling out of control.

Thailand’s central bank left the one day repo rate unchanged at 3.75% at today’s Governors meeting. The decline of inflation numbers in recent months had left conjecture that rates might be eased to help stimulate growth in light of the current global credit meltdown, but Bank of Thailand Governor Tarisa Watanagase –a career bureaucrat who was with the bank during the late 90’s currency crises, has focused on defending the Baht and the domestic risks brought by civil unrest.

Calm heads prevail inside the central bank, but in the streets of Bangkok anarchy reigns. Yesterday 400 protesters were injured (including 2 that required limb amputations) and 2 killed in clashes with military security forces as they attempted to halt the inauguration of the new government of Prime Minister Somchai Wongsawat -regarded as a puppet of ousted leader Thaksin Shinawatra by many (Somchai is the brother in law of Thaksin). An explosion near the capitol building is believed to have been a car bomb.

In the face of a global market meltdown and spiraling violence in the streets, equity investors ran for the exits taking the SET Index to its lowest level in five years.

Andrew Barber
Director

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Enjoy the ‘Trade’, Prepare for the ‘Trend’

We went bullish on the market on Mon. Add ‘less than toxic’ retail sales and a global rate cut, and the ‘Trade’ is no surprise. But the “Trend’ is a different story. Prepare to revisit core shorts…

Slice and dice today’s retail sales results any way you want. I’m not even going to try to drill down how much of retail’s price reaction was due to ‘less than toxic’ sales numbers, or the fact that they came in conjunction with a coordinated global rate cut. Either way, the ‘Trade’ here is a good one. That synch’s well with my partner Keith’s bullish call into the turmoil early this week and started, when he started to deploy cash and buy stocks again.

What we can’t hide, however, is that the ‘Trend’ across channels is not only negative, but is eroding relative to prior months. I’m not trying to be a downer by any means. I just tell it like it is. Discount stores? Ok performance, but rolled over by a full point on a 1, 2 and 3-year basis. Multiply that by 3 and you get the rate of erosion for the department stores.

We’ve had 64 consecutive quarters of growth in consumer spending in the US. Our team here at Research Edge collectively thinks that not only is it going negative, but the duration will be well over a year. Through 2010 is not that tough to model. If consumer spending is negative, core inflation and higher interest rates (impacting housing costs – a component of PCE) eat into the consumer’s wallet then the reality is that the magnitude of a consumption decline is magnified by at least 2-3x for discretionary spending.

Bottom line, I still think that margin, earnings, and cash flow growth expectations for US retail are too high for next year, and unlike other consumer spaces, this one is not particularly cheap. If these names bounce with the market ‘Trade’ then look to step on the gas with key short ideas – DSW, GIL, GES, WRC, BWS, TJX, and ADS, to name a few.

UK BAILOUT, debunked...

Briton’s Government takes action

The UK government bailout plan unveiled tonight will allow the government there to invest 50 Billion into preferred equity in domestic banks while the Bank of England will increase a short term credit line by 100% t0 200 Billion GBP (in addition to up to 250 million in loan guarantees intended to stimulate the commercial lending market).

This sweeping plan will partially nationalize the UK banking system and takes the fifth largest economy into uncharted territory. So far Abbey, Barclays, HBOS, HSBC, Lloyds TSB, Nationwide Building Society, Royal Bank of Scotland and Standard Chartered have indicated that they will participate in the program. Similar to the US bailout plan this action will comes with strings attached. Financing is available conditional on executive compensation caps, dividend restrictions for common stock and new consumer lending standards.

It is important to note that the UK has been facing rapidly increasing consumer inflation in recent quarters –leaving BOE head Mervyn King in an unenviable position with respect to rate policy in the current liquidity crises.

Andrew Barber
Director

YUM – THE MASTERS OF DECEPTION

YUM’s 3Q08 is the single worst quarter they have had as a public company and you would never know it by reading the press release. U.S. operating profit declined 16%!! We all know China is a big market and YRI is using other people’s capital to grow, which is a good thing, but both China and YRI fell off rather significantly too...

In China, 3Q08 currency-neutral operating profit growth of 8% follows 23% and 26% growth in 1Q and 2Q, respectively (slowed on a 2-year basis as well). The same holds true for YRI. On a consolidated basis, including the benefit of currency, YUM reported 2% operating profit growth or $6 million. In 3Q08, foreign currency translation to U.S. dollars benefited operating profit by $21 million. While the currency benefit was still significant, it slowed sequentially from 2Q for both China and YRI, and management said that the foreign currency benefit would reverse to an unfavorable impact in 4Q for YRI.

On its 2Q08 earnings call, YUM guided to U.S. commodity inflation of over $100M for the fiscal year – now they are saying about $120M. As a result of higher cost inflation combined with continued weakness at KFC (KFC 3Q same-store sales declined 4%), YUM now expects FY08 U.S. operating profit to decline 8% versus its 2Q guidance of down about 3%. There was no change or update to YRI and China’s fiscal year operating profit growth targets.

  • This is the best part, the tax rate helped by $0.03-$0.05. YUM had guided to a 26% rate for the full year and they reported 21.6% in the quarter versus 25.5% last year. Additionally, the lower share count helped EPS growth by 10% - if I modeled a 26% tax rate and kept shares outstanding even with last year’s level, YUM would have reported EPS down about 1%.
  • On 8/21 I posted a note titled “Levering Up to Get Paid.” For YUM to reduce its share base by 10% it needed to borrow $1.0 billion. Senior management does not get paid unless YUM puts up 10% EPS growth. Does it create shareholder value to use additional leverage to grow EPS by 10% so management can get paid?

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