Eye On Our Subscribers...

One of the most compelling "Trends" in our business here at Research Edge is the quality, knowledge, and experience that continues to be communicated to us from our subscriber base. The power of networks is viral, and we are grateful for ours. Below is one note that I was given permission to post on the Crash of 87' by Carolyn Leonard:

I have been reading your Research Edge morning take on the market since early summer. I have really enjoyed your advice and your call to cash has saved me some money. I wish I had gone to 97% cash but I did go to 35% which was due to your call.

I am writing to you in response to today's article. I traded at the CBOE as an independent market maker from "76" to "97" I trade the OEX from 1985 to 1995. I was in the pits thru the 87 crash and I can tell you that the pit on a busy day would have about 600 traders, plus clerks, brokers and quote operators. On Black Monday when volatility exploded the pit had about 50 market makers after the opening plus brokers to fill paper plus exchange staff. There was plenty of room to roam the pit if you weren't frozen in your spot by fear. Our markets on the Put side were $10 points wide. The black box traders i.e. Timberhill, Hull trading, the Ritchie group etc. were pulled from the pit because the firms couldn't keep up with the quickly changing vols. The biggest trader in the pit that day was John Stafford. Brokers who had mkt. orders would come into the pit to buy puts and hunt for traders to fill their orders. Stafford stood in the back of the pit near where I stood and in desperation they would come to were we were standing and ask that we change the market to a price we would be willing to sell the puts. We could sell an out of the money put at $60.00 and then make the market $60.00 bid at $70.00 hoping someone would hit our bid. Very quickly with little changing our market became $70.00 bid at $80.00 and so it went until the end of that day. The most egregious pricing anomaly occurred the next day. There was a market order on the opening to buy 500 far out of the money puts, the book had the order and filled it at $65.00 which based on the pricing the market would have had to go down another 800 points. When we came out of opening rotation those puts were trading at $50. I don't know what volatility those puts opened at but I doubt anything has ever traded at that high volatility. It was nothing to sell a 5 point box for 6.50-7.00. Everyone was afraid of being caught either long extra puts or short puts.

I covered some puts on the opening on that Black Monday with the market down 200 some points at $35 the same puts closed with the market down 505 at $120.00 bid -130.00 offer. That's volatility!!!

Best regards,

Carolyn Leonard

Oil : Has "peak oil" peaked?

The International Energy Agency (“IEA”) slashed its 2008 oil demand projections by 240,000 barrels a day and its 2009 oil demand projections by 440,000 barrels a day late last week. Clearly, we didn’t need the IEA to tell us that demand for oil has declined since the price of Oil is over $60 per barrel off its June 2008 peak based on WTI’s close of $77.99 on Friday. The obvious question is, where does Oil go from here?

We believe the longer term supply side argument remains intact. Despite the massive investment over the last five years in exploration, worldwide oil production has not been able to keep pace with demand growth, which ostensibly (along with a weak US$ and inflationary global monetary policy) drove the price of Oil well above its marginal cost. Nonetheless, it is likely that the “Trend” in oil remains lower, in the intermediate term.

In theory, commodities should be priced based on their marginal cost and we believe fundamentally that oil will trade back to that level of $60/$65 per barrel. There is also a case to be made that in a recessionary scenario and in an environment where investors are seeking liquidity due to margin calls, that oil overshoots to the downside.

As oil and other commodities decline, many opportunities will arise that you should be proactively focused on. Howard Penney has been discussing on his portal, and in our morning meetings, the potentially massive benefit on year over year cost comparisons for restaurants. Other industries that are key beneficiaries to declining energy costs are airlines, chemicals, and energy intensive manufacturing industries like paper and packaging, etc…

Attached below are our new levels for Oil:
1. Friday’s closing price of $77.99 is immediate term “Trade” oversold
2. Oversold bounce resistance to be sold into = $90.88
3. Downside “Trend” (intermediate term) target = $71.57

Daryl Jones
Managing Director
Chart courtesy of

State of The Consumer II: Numbers Don’t Lie

By my math, the year/year deficit in consumer spending in 2009 rivals the size of the US apparel/footwear industry in its entirety. Here’s how I get there…

Seems rough out there for the consumer, huh? I’m really sorry to say this, but you ain’t seen nothin’ yet. I know this seems like my typical ‘doom and gloom, margins are going away’ rant. But I spent the better part of this weekend going through the math. Many people don’t realize this, but real consumer spending is actually trending up yy. My model suggests that discretionary spending will finally turn negative in 1Q09. This would be the first time in 66 quarters consumer spending will have gone negative.

I think we’re also looking at discretionary spending down about $170bn next year. The icing on the cake is that the yy delta (prior year’s increase less current year’s decrease) is tracking close to $245bn. As a frame of reference the entire apparel and footwear retail industry is about $300bn. I have a one word answer for this. BANKRUPTCY. I outlined my list of bankruptcy candidates several times over the past few months. But that list is growing. I’ll be back with more meat on the bone there shortly.

I realize that I’m not the only person that has a detailed consumer model. So let’s take a look at some key assumptions, and you can come up with how you’d tweak it one way or another.

1. Gross personal income reflects a 7% unemployment rate, which takes total income growth down by 400-500bp sequentially over 3 quarters.

2. Zero change to the personal tax rate, which averages at 12% across the US.

3. Sub-1% savings rates is unsustainable given negative wealth effect from state of housing and equity markets. (Check out my prior post).

4. Personal interest payments head higher by 0.1% per quarter due to higher debt levels and interest rates.

5. Oil stays at $80, and gas/distillate stay at current levels. YY comps get easier in 4Q.

6. We went through all consumption categories we deem ‘Essential’ such as food, medical, housing, etc… and input growth forecasts based on my fellow analysts’ assumptions.

Tweaks to the many assumptions in our model would alter the $245bn yy delta in spending (2.5% of consumer’s wallets). But even if the geniuses at the Treasury, Fed or in the new political regime find a way to cut it in half, that would still represent 40% of the apparel/footwear retail space.

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State of the Consumer: History 101

One thing I’ve learned at Research Edge is how to be a student of history, and understand how the sins of the past shaped the challenges we face today. The evolution of the wealth effect is classic.

One of the biggest drains on the consumer today is the fact that the personal savings rate is hovering near zero. Yes, we debate academically as to how it is calculated, and how it could technically go below zero (which it has). But let’s look at the big picture here. The chart below says it all.

1. Starting in the Regan/Volcker years and all the way through the end of the Clinton era (when the tech bubble burst), we had a 20-year uber-bull market for equities driven in part by systematic cuts in interest rates to drive consumer spending and keep the economy cranking forward.

2. Once we saw George W. come into office, the equity markets took a pause, but the housing market went parabolic.

3. Put those two together and what do you get?? What I’d consider a 27-year wealth effect. By the way, that’s within 5 years of the average age of a Wall Street analyst. Sad.

4. While this freight train rolled on, the consumer took down the savings rate from the peak of 11.2%, to less than 1% today. As a frame of reference, China’s savings rate is near 40%.

5. Now what? Housing values are deflating, and equity markets do nothing but go down. My sense is that consumers take whatever they can and actually save a bit for once. In fact, it was fascinating to see that the tax rebate checks that hit this summer went almost entirely to beef up savings (the rate temporarily bumped to 2.5%) and repay debt.

As sure as the sun will shine, this savings rate needs to head higher. The order of operation will need to be 1) survive (buy essentials, etc…), 2) pay down debt/save money, 3) buy a $500 cashmere sweater at Saks.

NKE: Ultimate Pricing Power

Nike has taken ‘surgical pricing’ to the tune of 5-10% -- but the 5,000% increase on a new Nike Dunk takes pricing to a new level. $5,405, and dipped in gold. A better return than being levered long.

Eye on Free Market Capitalism...

555 12th Street NW, Suite 620 N, Washington, DC 20004

October 9, 2008

Capitalism Without Guilt: The Moral Case for Freedom

Who: Yaron Brook, executive director of the Ayn Rand Center for Individual Rights

What: A talk defending the profit motive and presenting the moral case for laissez-faire capitalism. A Q&A will follow.

Where: National Press Club, 529 14th Street NW, Washington, D.C.

When: Wednesday, October 22, 2008, at 6:30 PM

The public and media are invited. Admission is FREE.

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