"How much can you know about yourself if you've never been in a fight?"
-Brad Pitt, Fight Club
One of our rising young analysts here at Research Edge who is also a martial artist, Christian Drake, reminded me of an important lesson that I had to learn the hard way in life. That lesson came while I was playing junior hockey 15 hours away from home at the age of 16 against men 3-4 years older than I in an ice cold barn - when he dropped the gloves, I had nowhere to hide. Now my front teeth are fake.
Losing a fight in the wake of a disciplined and repeatable process is largely forgivable. Pitiful performance stemming from fiduciary malfeasance and laziness is not. The last year has certainly been a financial fight. What have you learned about yourself? Perhaps more importantly, what have you done about it? Initiative and innovation are born of self-reflection... self-awareness... accountability...
At this stage of the fight, I am hardly going to hide from the fact that I am just starting to "make the call" to be Long America. One down day in the market doesn't a loser make. Those seats are reserved for those who were bullish 50% higher in the SP500 from yesterday's close.
Fifty percent - yes, for you history fans out there, you know that's a huge number! And yes, markets are both leading indicators and discounting mechanisms of everything that you see the manic media flashing you today. The US market has been signaling the malfeasance of Madoff to the Texan who was knighted in Antigua for almost 16 months now. And Guess what? There are plenty more cockroaches where those ones came from. The good news is that, finally, we're going to smoke them out of their holes. Boys, it's time to drop the gloves.
As of yesterday's close, the SP500 is down -13.8% for 2009 to-date. That's also a big number! So don't wake up to this note feeling like now is the time to get bearish. I hope we have been proactively preparing you for this for well over 12 months now. Success in the arena of life is most obviously won when proactive preparation meets obvious opportunity.
I won't hammer on the 6 reasons that I issued in yesterday's missive as to why this morning is different than those mornings in and around November 20th. Overnight, the herd's emotions may have changed, but those 6 macro factors haven't.
Some "economists" and spectators of this full contact sport still think that markets move on "rational expectations" - I don't. I'm more of a meat and potatoes Darwin kind of a guy. When a 230lb Albertan defensemen loses a few screws out there on the ice, you take one look into his eyes and realize what the real world practitioner better figure out about the definition of "rational."
Darwin's theories support what I think the horse and buggy whip US Financials, and anyone who needs leverage to run their business are going through right now - "the struggle for existence." At the end of the day, seeing the XLF (S&P Financials ETF) down another -5% yesterday, and down -40% for 2009 to-date, is a clean cut reminder that the New Reality is here. This isn't new this morning folks - this is an ole school brawl and the rules of mark to market are reigning supreme on these stock prices and their shareholders alike. Being willfully blind doesn't work when you are in a fight.
If you want to straight line this newfound consensus that companies and their market caps can lose their teeth across the entire globe of trade, you can go and do that... but at these prices in the US market I dare say making short sales on that being a unique investment idea is borderline reckless. Some people call this "meme theory" (humans innately want to mimic the behavior of the crowd), and others call this the "herd mentality", which is pretty much aligned with the same inspiration that people in this business generally have to cling to consensus rather than drop the gloves and fight the crowd when the timing is right.
On yesterday's gap up open for the US stock market I made some sales. You can call that "over-trading" - I call it fighting for survival. There is a very relevant mathematical difference between yesterday's intraday test of 800 in the SP500 versus it's smack down 778 close. If you have a proactive process that allows you to play both defense and offense in this market, use it.
From here, I see 2% downside in the SP500 and +6% up. That's BUY/COVER the 761 line and SELL/SHORT the 823 line. As one of my old junior coaches used to tell me "Backcheck, Forecheck - Paycheck." The next bull market does not cometh - this is a market that needs to be traded.
In terms of Asset Allocation, some of those profitable sales resulted in taking my position in Cash back up to 64%. I sold out of our long position in China for a gain, and that leaves our exposure to International Equities at 6% (all in Brazil). I have an 18% position in US Equities, and I will double that exposure, at a price. Why? Well, primarily because I can. Not using leverage has it's perks. So does having the liquidity associated with a large cash position and owning my own duration.
Who owns your duration? I hope it's not some fly by night Swissy Fund of Fund... or God forbid an investment banking CEO who is about to be shot out back behind that barn of the horse and buggy whip...
After a fifty percent throttling by that big burly defensemen called Mr. Market, what have you learned about yourself? Perhaps more importantly, what have you done about it?
Darwin said you better evolve, or you will go away. It's time to drop the gloves - I'm not letting my small part of this country turn into Japan. You can bet your Madoff on that.
Have a great weekend.
"How much can you know about yourself if you've never been in a fight?"
This data points help confirm that European economies - which we are tracking individually, have yet to reach anything approaching a bottom.
This week the SP500 has been hammered, approaching and briefly touching its Nov. 20th low today. We’re getting bullish on US equities and moving out of cash, yet as always managing our portfolio at a price and level. As we move further out on Obama’s socialist stimulus package we believe were going to see the USD break, which will be bullish for US equities. Additionally today we saw a bullish inflection point in the consumer price index, turning from -0.8% in December to +0.3% in January.
We’ve not seen similar confirmation from European indices. The math still signals that more pain may be ahead: production levels continue to tank, unemployment continues to rise sequentially, and politically there is rising tension between EU leadership over the possibility that weaker nations of the Union may seek a bailout from their larger neighbors.
We’ll be watching ECB President Trichet’s next move when policy makers meet next month. With the benchmark rate at 2%, Trichet is running out of room to cut, and due to European Union rules, the ECB is not allowed to purchase bonds from member countries in a “soft” bailout . We’ll be monitoring the impact of the €200 Billion stimulus package and continue to look for signs of political and economic divergence among the European economies.
This morning’s Consumer Price Inflation report in the USA (see updated CPI chart below) reminds us that the inflation fears of yesteryear are no longer an immediate term concern. In the immediate term, inflation has been brow beaten to the mat. In the long term, we are all dead…
While I do think that, in the intermediate term, all of these free moneys will create another reflationary bubble … for now, we are a long ways away from that reality. Additionally, the notion of inflation re-emerging is no longer a unique investment thesis. Inflation always comes back.
On the margin, this is one more fundamentally positive stimulus to year over year consumer spending which, after all, represents over 70% of this ailing US economy. This is one reason why the consumer stocks are outperforming today.
Keith R. McCullough
CEO & Chief Investment Officer
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1. SP500 intraday test of the 752 line
2. VIX intraday test of the 50.82-52.93 range
3. US Dollar Index test of the 88 level
4. Gold taking a good hard look at $1000/oz
5. XLF (Financials ETF) test the $6.83 line
6. One more sell side analyst say Citigroup is going to zero
Keith R. McCullough
CEO & Chief Investment Officer
Although these higher priced items have the potential to boost QSR margins at a time when most QSR players are focused on discounting and promoting value, the fact that these new menu offerings are being pushed aggressively at the same time casual dining restaurants are providing “buy one get one free” coupons among its other value items leads me to believe that this might be the exact wrong time for QSR companies to focus on premium offerings. The CNNMoney.com article states that the lines between a QSR and casual dining product are starting to blur as QSR companies offer higher priced, higher quality products. This may be true, but the lines are starting to blur from a pricing standpoint as well, however, as casual dining companies desperately try to lure customers back into their restaurants. So then the question remains, where is the better value?
The article cites BKC’s CEO John Chidsey as saying “For someone who was having a premium burger at an Applebee's or a Chili's that's paying $9 to $11 dollars and can come to Burger King for a Steakhouse Extra Thick burger and pay $5 to $6 dollars, that's value to them.” Looking at both Applebee’s and Chili’s menus, I found that you can buy a hamburger for $7.49 and $6.79, respectively. You can buy Ruby Tuesday’s classic burger for only $5.99. Based on these prices, BKC’s Steakhouse burger does not seem to offer the same type of value because although people have less money to spend today, there is still value in going out to dinner, sitting down and having your food brought to you.
This QSR premium offering strategy will be made more difficult by both Wendy’s and Sonic’s recent aggressive push to drive sales with more value-priced menu items. Additionally, NPD data shows that QSR deal traffic growth has really picked up since early 2008 and has been steadily increasing as a percent of total traffic since mid 2007.
CKR is another QSR player that is trying to drive sales at higher price points. For CKR, however, this is not a new strategy. Instead, the company continues to sell premium priced items and has said it refuses to discount despite the moves by its competitors. CKR is in a different position than BKC or JACK because it is not choosing now to more aggressively push into the premium segment but is attempting to maintain and grow its share within the premium segment. For reference, Carl’s Jr.’s average check has been north of $6 since FY06 and has exceeded $7 in each of the last two quarters. Just this week, CKR said at an investor conference that its same-store sales have not held up as well as some of its competitors who have discounted more, primarily MCD, BKC and YUM, but management is working to protect both its margins and brand for the long-term.
If you have zero tolerance for miniscule-cap, highly volatile stocks with high risk/reward, then don’t bother looking at the chart below. But the reality is that so many consumer names – especially in retail – are trading at or near a bone. In other words, bordering on unworthy of any equity value whatsoever. The question with these names is quite simple. Is it going bust? If not then it is probably not going to stay near a buck for too long. Remember that we’re coming off a year where the average analyst/PM on the buy side was not allowed to like these poor-quality, highly-levered and risky names. They’re the kind of names where you get a golf clap from your PM if you’re right, but get fired if you’re wrong. I’m not condoning that by any means (it’s the opposite of the process we have at Research Edge between Keith and the Analysts), but it exists nonetheless.
My favorite name in this group of Bones is LIZ. Ok, at $2.50 it’s not really a bone. But in my mind anything under $3 is fair game. I’m increasingly confident that LIZ will not breach a covenant, will cut capex to a greater extent than most people give it credit for, and will start to show meaningful margin improvement after a multi-year slide starting in 2Q as it cuts away the fattest cost structure in all of apparel. Quiksilver is a close second. Cost cuts on an inefficient platform will help, with a call option of monetizing its core brands with a break-up of the company. It was driven down initially due to horrible performance associated with its ski/hardgoods business. But that’s gone, seasonality is back to normal, and balance sheet risk is slowly but surely being mitigated.
If you want any more details on our thought process here, or factors behind timing and sizing, please contact Jen Kane at .
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