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Jimmy and Timmy

“Never do anything against conscience even if the state demands it.”
-Albert Einstein

Consensus “stock pickers” didn’t do macro during the 25-year bull market, and now that’s all they talk about. At least we, as an investment community, are evolving – Darwin and Einstein would be proud.

Jim Cramer is one of those people who is now proclaiming his macro mystery of faith. Last night while I was driving home I heard him going off on how everyone “is throwing Tim Geithner under the bus...” and that he isn’t going to – he likes Geithner. For the Street.com’s accountability record, please let Cramerica’s “call” on Geithner be known.

Jimmy, hate to break it to you big man, but I’ll take the other side of the Timmy trade. For the transparency purposes that the likes of Cramer and others are all of a sudden giving lip service to, I issued a note to our macro clients shorting Geithner and the Dow Jones Industrial Index at 10:19AM yesterday morning (see www.researchedgellc.com  for the Hedgeye Portfolio). Having had Timmy’s prepared 11AM speech notes in hand, this actually wasn’t a very difficult call to make, provided that you had a proactively prepared macro investment process to have put the Timmy plan in context.

Context is much different than contacts. Some of the said hedge fund masters of yesteryear, who don’t have a macro process (like Jimmy), rely heavily on their “contacts” in the business telling them what to do and when. In this brave new world of globally interconnected markets, that doesn’t always work. It’s the equivalent of having to have someone turn on your high beams and wipers for you rather than flipping the switch yourself.

Following the leader isn’t actually all that bad – that’s if you’re following the right one. Cramer himself actually finds a way to get my intraday investment notes (without paying for them) – but heh, that’s the way some people in this business do business. While it’s sad, it is efficient. Eventually, the right call makes the rounds.

“Making the call” in this business is what differentiates the winners and the losers. That’s why this game is such a great one. Provided that you don’t play by the rules of the Blackstone “marked to model”  ideology, every day you can measure yourself, on a marked to market basis, versus the Jimmy’s of the world.

Jimmy has, of course, had his own issues with transparency, accountability, and trust. He and General Electric are in the midst of a cat fight with Rupert Murdoch’s Barron’s these days, and the poor guy is taking it on the chin. He’s an entertainer, not a portfolio manager – give the man a break! When it comes to his “call” on Timmy, however, what qualifies his opinion? I actually have no idea – maybe he is right. But I can tell you this – where I come from at least, being able to tell whether someone is trustworthy or not is not a life lesson learned on Wall Street. In the real world, we call this leadership quality sound judgment.

My judgment call on Timmy is not unlike that I have always had on Jimmy – I just don’t trust him. Yes, that’s a personal call… and sometimes my readers think I am being too hard on people… but guess what, calling someone out on the mat is actually ok in the real world, especially if you are going to be right. Whether its Jimmy, Timmy, or Billy (Ackman), it’s all one and the same – it’s called risk management.

Clearly, President Obama had someone proactively prep Timmy with media training (he spoke slow-ly… and arti-cu-la-ted his ev-e-ry con-so-nant), but forgot the content part. While the three parts to Timmy’s speech were spoken to cl-ear-ly… they lacked cl-a-ri-ty…

When it comes to delivering on Wall Street’s expectations, one needs to be crystal clear. Now that I have put myself in the fishbowl taking Jimmy and Timmy to task, here is what I read into the three point plan:

1.      Stress Tests – this was a way for Timmy to dance around what he should have said explicitly to the bankers who receive TARP moneys. If you receive bailout moneys, there will be a string attached – it is called re-regulation. There will be less bailout moneys to go to public banking companies, and as a result, you either comply, or you fail.

2.      Expanding the TALF (Term Auction Lending Facility) – this has been signaled by Larry Summers and the Rubinites for weeks. The number of recipients of government support is going to expand alongside the size of the free lunch. Instead of $200B, this number is closer to a tr-ee-lion do-llar-z… and the duration by which the government is going to get it into the hands of the people who are shameless enough to take it is being pushed out.

3.      Establishing a PPIF (Public Private Investment Fund) – this was new, but again, rather than say it explicitly, Timmy was as coy as he looks. I read this as team Obama leaning more to the side of marking to market (which Blankfein and Wasserstein support) versus marking to model (Schwarzman and Fuld).  Everything has a clearing price, indeed.


When it’s all said and done, I think the conclusions here are much more straightforward than the plan that Jimmy officially now supports: public companies will fail, survivors will be regulated, and the socialization of the United States of America will expand.

I didn’t need to have one of Jimmy’s “contacts” tell me what to do as I was listening to all of this. I have a process that’s my own, and I made the call. No, I am not always right… but I am accountable to the time stamp on every call that I make. As our markets revisit the darkness of trust in our financial system lost, all I have left is hope. Hope is what I kiss my son and wife’s forehead goodnight with in this great country, but unfortunately it’s not an investment process.

Jimmy and Timmy, I have been blessed to live in a country where I don’t have to “do anything against conscience even if the state demands it.” The days of old boy network “contacts” trumping repeatable investment processes are over. It’s time for The New Reality to take hold. President Obama, our expectation is that you uphold these principles of Transparency, Accountability, and Trust by which you now speak.

I, like many Canadians and Americans, am protecting my family’s cash. I have a 76% position in cash. I am short the Dow, and I have an immediate term downside target for the SP500 of 809.

God Speed out there today. This is going to be a rocky ride,
KM

Jimmy and Timmy - etfs021109


SHOULD GAMING BE RECLASSIFIED UNDER FINANCIALS?

News flash: ASCA, BYD, ISLE, LVS, MGM, and PNK have been added to the XLF. Just kidding of course, but the stocks sure seem to be trading that way. Of course, this is a fairly reasonable outcome. Gaming operators are one of the most financially leveraged sectors out there.

The difference, however, between the gaming operators and some of these financial companies is the gaming operators have hard assets that generate cash flow and are easy to value, and their business models are sustainable with high barriers to entry. The surviving gamers, whose debt doesn’t kill them, will be worth significantly more than where they trade, in my opinion. Pick the survivors and there is a lot of money to be made.

If you believe the financials remain toxic as our Chief Investment Officer Keith McCullough believes, gaming stocks could be a nice hedge to a financials short position when the inevitable short squeeze hits. As can be seen in the following table, the correlation between gaming operators and the XLF was higher than that between the gamers and the S&P over the past two years.


Nike: I Like What I’m Seeing

There are some powerful takeaways from Nike’s decision to reduce up to 4% of its workforce – especially for students of Nike history. There are puts and takes, but in the end I like what I see.

1. The timing is rather odd by industry standards. The quarter ends in 3 weeks and there’s no major company event happening imminently. I guess this is what happens when a company is managed proactively instead of waiting until the last minute to react to what the market environment throws its way. But what perplexes me is that the reduction will be done by the end of May. So why announce it now? If there is one thing that drives Nike above all else is the fact that people that work there genuinely love to show up every day. Leaving a dark cloud above the campus in Beaverton for several months can’t help productivity.

2. Speaking of which, Nike has the second-highest employee productivity out of any company in, or near, this industry. It generates $630,000 per employee in revenue, right behind K-Swiss at $633k. With this announced layoff, Nike will need to take its employee productivity just past $700,000 in order to get to a ‘high single digit’ revenue growth goal next year (or up to $656,000 to stand still at current rev run-rate). Productivity is up from about $525k three years ago – so Nike is no stranger to growing in efficiency. But let’s keep this hurdle in mind given the cloud of uncertainty for employees.

3. History plays an important role here as well. Nike almost never cuts jobs. Here’s Nike’s layoff history.

a. 1987: 269 cut

b. 1993: 459 cut

c. 1998: 450 cut. In this cut, there were many rumors that Nike was going to cut roughly 1,500 jobs but within a month of the job cut announcement, Nike only cut 450 (4% of US work force, half of which was in Beaverton, OR).

d. 2000: Warehouse closure that cost 150 jobs and relocated 25.

4. Violating the sanctity of Nike employment is one of the things that led to Bill Perez’ ouster as CEO after just one year at the helm back in 2006. His statements about ‘Nike has too many employees for company that doesn’t even make anything’ did not fly at the company. He wanted to let go of employees and cut costs (among other things) without first really understanding the business.

5. This is a massive move for Mark Parker (CEO). Having spent nearly every moment of his adult working life at Nike – and for so many on Wall Street labeling him as ‘a product design guy’ – for this to come to fruition there could be little doubt as to his allegiance to shareholders. I like that. Make no mistake – Parker is no Perez. Cuts under his regime will actually be carefully planned and will not take away from brand heat. Bill would have hurt the brand.

6. A 4% cut comes out to about $0.21 per share, or 6% EPS accretion – all else equal. Not bad.

7. Does this get me excited about owning NKE?

a. Near-term, no. There has to have been a meaningful slowdown in business that prompted this move. For the first time in my history analyzing Nike, I could not get to the Street’s numbers even before this announcement. Now that’s even more pronounced. Sales slowing, GM getting tougher, with any earnings growth coming from SG&A and better FX hedges. Not pretty.

b. Over a longer duration, however, the answer is yes. Stellar balance sheet, great brand momentum, investing to take share, making the right business decisions, and trading at trough cash flow and earnings multiples. Tough to find something better in this market for a long-term investor.

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Looking for a Level? SP500 Levels, Refreshed...

Suffice to say, Obama and Geithner dropped the American confidence ball over the course of the last 24 hours, and now the US market is paying the price. What is good for the buck is bad for Obama’s scorecard. He’ll figure this out, I hope, soon…

Markets are built and blown up on confidence. Without the confidence to invest, people save. Hoarding cash and gold are what you are seeing today (both the GLD and UUP etfs are up). What else is a man/woman without confidence in his/her government to do?

Below are both the Trend and Trade lines of SP500 resistance. Intermediate term Trend resistance (sold red line) is now 881, while immediate term Trade resistance, which we flashed this morning as support, becomes resistance (dotted red line) at 862.

I don’t see any lines of credible support until 811. This is a line that we have been paid handsomely to buy/cover for the better part of 2009. This market is to be traded, not owned until the US Government either lets the free market reign, or establishes some credibility/confidence in their process.

Keith R. McCullough
CEO & Chief Investment Officer

Eye on Shipping - Baltic Dry Rates Moving Higher...

Eye on Shipping – Baltic Dry Rates Moving Higher

Winston Churchill once famously said:

“If you have an important point to make, don't try to be subtle or clever. Use a pile driver. Hit the point once. Then come back and hit it again. Then hit it a third time - a tremendous whack.”

In that vein, we want to hammer home the price performance of the Baltic Dry Index over the last three weeks, which is outlined in the chart below.

The rates for shipping dried goods globally, as measured by the Baltic Dry Index and its derivatives, have close to doubled over the last three weeks. This is an important leading indicator for the sequential reacceleration of global economic activity, even if off of low levels. Based on our research, a large part of this recent surge in Baltic Dry Rates is a function of increased iron ore and wheat demand from China. While we were early, and non-consensus in our bullish thesis on China heading into 2009, that thesis is obviously less contrarian with the Shanghai Composite up 24.5%+ year-to-date.

Our view on the Baltic Dry Index as a leading indicator for the sequential acceleration in economic activity in H1 2009 versus Q4 2008, on the other hand, still appears to be contrarian, as the following two headlines appear to suggest:

• “Is the Rise in the Baltic Dry Index a Fakeout”, U.S. News and World Report, February 10th, 2009
• “Is the Rally in Baltic Index a Storm Surge”, Wall Street Journal, February 10th, 2009

The consensus financial media appears to be solidly in the camp that the stability in copper pricing, the increase in shipping rates, and the dramatic outperformance of the Chinese stock market year-to-date are a head fake. These facts tell a different story to us.

Auto-correlation amongst global equity markets is dead. China can power forward, leaving plenty of levered long investors both in the US and abroad behind.

Daryl G. Jones
Managing Director

EYE ON CHINA: INFLATION

January CPI & PPI data released by the National Bureau of Statistics in China last night showed a continued decline in price inflation with Consumer Prices declining to a year-over-year growth rate of 1% while Producer Prices registered at -3.3%, the largest contraction in more than five years. The Chinese bond and equity markets rallied on speculation that the central bank will cut rates again in the wake of the data.

CPI:
Declining CPI brings a mixed blessing to leaders in Beijing. On one hand, just 6 months after grave concerns about skyrocketing food costs were dominating headlines, the most recent data shows that collapsing commodity prices have removed much of the pain for consumers at the register (see below).

{SEE TABLE 1 BELOW}

The dilemma facing the central bank now is how to coax consumers to loosen their purse strings. Governor Zhou Xiaochuan was quoted yesterday saying that the Central bank will balance interest rate and FX policy to get people shopping. Although a rate cut in the near term now seems likely, the overlapping cultural and economic incentives for Chinese consumers to save rather than spend –particularly members of the fragile emerging middle class who have been watching job losses among the lower wage earning classes warily, will not be overcome simply through rate cuts.

PPI:
The falloff in prices for energy commodities and base metals drove PPI to its lowest Y/Y levels since March 2002. The breakout in component costs below clearly reflects this decline in commodity prices (with the notable exception of coal which continued to show relative price pressure into year-end, though recent production cutbacks of as much at 20% by generators on the state electricity grid should soon provide some temporary demand respite).

{SEE TABLE 2 BELOW}

The recent increase in iron ore inventories reported by trade publications suggest that mills are taking advantage of lower prices as they gear up in anticipation of the massive stimulus programs which will begin to break ground in Q2.

Unlike the US and Europe, China has liquidity and the potential for massive growth in domestic demand; the question now is whether they can capitalize on this position of strength. We will have our Eyes trained on the Chinese Ox in the coming weeks as we look for more signs that Beijing’s leadership is working on solutions, both near and long term, to both drive growth and sustain it.

Andrew Barber
Director

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