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Swissy Bulls?

As the latest data rolls into our macro models, Switzerland looks more and more attractive on a relative basis to other European economies…

This week’s economic data was bullish, on the margin. Unemployment increased by a paltry 1,200 job seekers in October according to SECO data released today, leaving the total national rate barely changed at 2.6%. On an absolute basis, that’s amongst the best unemployment levels in the world. On a more significantly negative note, state data indicates manufacturing contracted in October for the second consecutive month while exports declined for the first time in 4 years. On the GDP front, this is not a surprise. This is just one more piece of the new reality – a global slowdown.

Following the lead of central bankers around the globe, SNB yesterday made a surprise rate cut, lower their target by 50 basis points to 2%. Easy money will prove to be stimulative, in the end.

Although Swiss GDP is heavily dependent on financial services (the % driven by banks, brokers and insures at north of 25%), this concentration factor provides risk as well as potential reward. The preeminent institutions like UBS and CS face the prospect of continued write-downs as toxic assets work their way through the system, but the steepening yield curve should offset that as the gnomes of Zurich start to deploy the massive deposits at their disposal. Within the framework of our “New Reality” Investment Theme for 2009, the players best poised to win are those who have access to capital.

We are long Swiss equities via the EWL ETF and will continue to be until the relative math changes.

Keith McCullough & Andrew Barber

SBUX – Lowering Guidance

Yesterday, SBUX announced that Troy Alstead, senior vice president, Global Finance will succeed current CFO Pete Bocian at the end of the month. Mr. Bocian is leaving the company to join Hewlett-Packard, as chief administrative officer.

The trend for management turnover at SBUX is not good. Over the past year, as you can see from the details provided to me by First Rain, there have been a significant number of high levels of departures from SBUX. Importantly, the First Rain Data does not include the fact that SBUX’s own advertising agency fired the company! Do you think Howard Schultz is difficult to work for?

Two thoughts; First, it was nice of Mr. Bocian to postpone his announcement until after the big internal conference in New Orleans last week. Second, I can completely understand that he does not want to face the music of telling the street that his projection for positive 2-3% same-store sales growth in 2009 is a tad aggressive!
Management Turnover over the past 12-months (provided by First Rain)


Whoever is careless with the truth in small matters cannot be trusted with the important matters.
~ Albert Einstein

Today is a great day for my family - it’s my son Jack’s birthday. For me personally, it will be a special day to reflect, as this culminates the anniversary of the week in 2007 when I left the hallowed halls of titles and resume builders, put on my new shoes, and left Wall Street.

Clearly this was not a financially inspired decision (I haven’t been paid in a year!). It was one based on principle – and I thank God every day for allowing me to see that money means a whole heck of a lot less in life when you can “Trade” up for the “Trend” of spending time with the people you love. If that’s too “soft” for an investment note, that’s cool with me – I am the Editor here.

We have built a firm on the principles of transparency, accountability, and trust. This moral compass is not unlike that which Marcus Goldman must have used when he relocated his wife and 5 kids to New York City in 1869. If you have not read “Goldman Sachs -The Culture Of Success” by Lisa Endlich, I highly recommend it. One of the most inspiring chapters I have ever read, in any book, is chapter 11 (my hockey jersey number!), titled “The Family Firm.” Mr. Goldman built his firm and reputation on a “promissory note” business model – nothing was more golden in the eyes of this American Goldman than the integrity of his handshake.

Einstein’s aforementioned quote speaks to the simple structural fix that Wall Street needs most. Like my son Jack, the Captains of ‘Investment Banking Inc.’ love storytelling. The problem, of course, is that there is a small matter that is being revealed to the American public this year – the truth. Fiction is not just a sell side phenomena - storytellers are everywhere in this business. After a -39% down move in the US Consumer Discretionary stocks from early September’s high (when we were suggesting you be in 96% cash), the charlatans of certain “buy side” firms were firing off emails and IMs to the Street yesterday that the US Consumer is in trouble. Gee, thanks for the “Early Look”…

As these markets gyrate, the story telling finds what Nasim Taleb appropriately alludes to as “narrative fallacies”. It’s good for “The New Reality” as those new American capitalists who are liquid long cash can take advantage of it. It’s bad for the levered long investors obviously, because the manifestation of fibbing equates to higher volatility. When you slap volatility on top of leverage, things blow up.

The Volatility Index (VIX) busted out through our immediate term momentum indicator again yesterday, closing up almost +17% on the day. This made sense in our macro models as it coincided with the S&P 500 failing to close above it’s “shark line” resistance level. The result, after a +18.5% six day meltup rally, was an expedited two day -10.3% swan dive. Since the most fanciful story telling on Wall Street finds itself after the fact, you are waking up again this morning to a down -8% pre-market move in stocks like Disney because oooh, ahhh, consumer spending demand is slowing! Mickey must find this investor insight the stuff of genius.

As our Research Edge Macro clients witnessed, rather than giving lip service to “our best ideas” at some “idea” dinner, we made sales in the ‘Hedgeye Portfolio’ from opening bell to close. We weren’t saying one thing and doing another – we we’re hedging ourselves after getting too long into a bear market trap. This morning, ahead of the employment report, where the 2008 conflicted version of Goldman Sachs is warning of the apocalypse all of a sudden, my ‘Hedgeye Portfolio Allocation’ is much more prudent. We want to start buying weakness at the S&P500 line of 857, and be very respectful of making appropriate sales up at the 967 line. Yes, this is called trading. My name is Keith McCullough, I put my money where my mouth is, and I support this message.

As clearly as my macro models were flashing “getting hedged” yesterday, they are reminding me that there is every reason, in the immediate term, for the US and global stock markets to bottom this time at a higher low. That, on the margin, is bullish. If this US employment report is Armageddon, could the VIX retest 80, and the S&P500 take a gander at 848 (the prior closing low)? Definitely. But it’s where prices close in my models that matters most, not where the intraday storytelling is told. Over time, closing prices don’t lie, people do.

Asia traded very positively overnight (ex-Japan, which we re-shorted yesterday via the EWJ, that closed down -3.6%). China led gainers, and that’s what I like to see. The Chinese are the most liquid long investor in the world today. With $2 trillion in cash reserves, they have the opportunity to take advantage of “The New Reality”. Asia was really only down for a day this week, and European stock markets didn’t confirm the bearish storytelling you are currently hearing of humans abandoning their pets in back alley garbage cans in order to save their discretionary spending euros. My models like 3s – if the US and Europe can put in positive sessions today, neither are confirming the pervasive bearishness in global market rhetoric.

From a performance perspective, this week hasn’t been a good one for me. While we were down less than 100 basis points in the ‘Hedgeye Allocation Portfolio’ yesterday, my objective is not to outperform on a relative basis. My 3 objectives are: 1) to not lose my or your family’s hard earned capital, 2) tell you the truth, and 3) rinse and repeat objectives 1 and 2. A year after leaving Carlyle and my seat on the trading desk in New York City, I am thankful to report that I have accomplished all three.

Have a great weekend,

Long ETFs

JO – iPath Coffee –Coffee shipments from Brazil increased 6.7 % y-o-y in October with Arabica exports up 12%.

EWL –iShares Switzerland- October unemployment increased slightly, but not enough to increase the national unemployment rate which remained unchanged at 2.6%.

EWA –iShares Australia- The Australian dollar is on its way to the second consecutive w-o-w increase against the USD.

EWG – iShares Germany –Industrial production in Germany declined the most in almost 14 years in September, declining 3.6% for the month and 2.1% y-o-y.

FXI – iShares China – -- Rizhao Steel Holding Group, the Chinese steelmaker set to be taken over by Shandong Iron & Steel Group Co., may layoff as many as a third of its 10,000 line workers because of slowing demand. Lenovo Group, announced quarterly earnings that were lower by 78% y-o-y, said slowing demand from corporate customers poses an “unprecedented challenge”.

VYM – Vanguard High Dividend Yield ETF – Detroit auto makers reportedly seek a $50 billion federal loan package. Media reports indicate that individual investor exposure to GMAC bonds has been estimated at $15 billion.

Short ETFs

UUP – U.S. Dollar Index – Former Treasury official Eisuke Sakakibara gave an interview where he predicted that in the current environment the Yen may reach 80 USD.

EWU – iShares United Kingdom –UK Individual bankruptcies rose 8.8 % from the second quarter to 27,087, according to the government Insolvency Service , while Corporate filings increased 105%.

IFN – The India Fund – The rupee completed its largest one week rise versus the dollar.

Keith R. McCullough
CEO / Chief Investment Officer

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RUTH – Madison Dearborn to the rescue, but still on the Bankruptcy watch list

RUTH was already in a tough position relative to its debt covenants as evidenced by both its sale-leaseback transactions and its recently announced cost reduction initiatives, but October’s same-store sales decline of 15% has further complicated the situation. RUTH ended the quarter with long-term debt of $167M (reduced by $17M from the proceeds from the sale-leaseback transactions) and a total debt/adjusted LTM EBITDA ratio of 3.23x relative to its maximum debt covenant level of 3.5x.
RUTH announced last week that it has entered into a purchase agreement to sell its support center in Heathrow, Florida, which the company hopes to close by year end. The sale is expected to generate $12M in proceeds and could provide a 20bp cushion to the company’s debt/EBITDA ratio at the end of the year.

Management stated, however, that if the sale of the support center does not happen in Q4 and same-store sales remain down 15% for the balance of the quarter that remaining below the 3.5x covenant “will be tight.” Management even reiterated this point later in the call in response to a question regarding its debt covenant, “Well, David, first, in terms of Q4, I didn't say safe. I said tight and we think we can get over the top but I don't want to suggest that it's a layup, if you will.”

The company’s only flicker of hope, outside of completing the sale, relies on strong gift card sales in Q4, which added $12-$13M of revenues to 4Q07. Management is expecting about the same level of gift card sales in this year’s fourth quarter as a result of RUTH’s increased units and the addition of Mitchell’s (so a decline in gift card sales/unit).

When asked about bank relations, management stated they have a good relationship with their bank lenders and although premature to speculate, that if a default did occur, the strong relationship they have (combined with the strong relationship their largest shareholder, Madison Dearborn, has with the bank lenders) would help to provide a favorable outcome…if it came to that.

So as I highlighted last week, these are clearly desperate times for RUTH.

Strong Side: Australian Jobs

The job market down under has been remarkably resilient so far … this morning’s unemployment report hammered home another win for Glenn Stevens and co., who continue to manage monetary policy the way that the objective economists out there admire.

The Australian markets received a bullish surprise in October’s employment numbers which saw a 34,000 increase while official Unemployment registered unchanged at 4.3%.

With a cooling global market for metals and energy commodities, no one seriously expects that unemployment levels won’t rise in the coming months. In a statement today Deputy Prime Minister Julia Gillard acknowledged the positive job data but cautioned that "while we are better placed than most other countries, Australia is not immune from the global financial crisis. The global crisis will impact on growth and employment here, and the government does expect to see unemployment rise."

We are long Australia via the EWA ETF. Despite the reality of slowing demand for commodities and a volatile currency environment we continue to think that the market there is among the strongest in the developed world.

If you have been reading our work since we started, you know that we have been fans of central bank chief, Glenn Stevens, for a long time now. Under Steven’s management the Reserve Bank held rates high while the Australian economy experienced the biggest market boom in decades. Now, with metal and energy prices slashed back to 2007 price levels, Stevens has room to maneuver that poorly prepared market students like Ben Bernanke do not. So far, his recent rate cuts appear to be providing a soft landing down under.

Keith McCullough & Andrew Barber
Research Edge LLC

Eye On the UK: Shock Therapy!

British housing numbers that were released today didn’t surprise anyone with a pulse, but the BOE’s reaction did!

The BOE’s 150 basis point cut today, took the benchmark rate to its lowest level since Winston Churchill’s second term as Prime Minister. We attached a long-term chart of Rates and GDP growth below to put the present situation in context.

Mervyn King is not the only central banker pumping liquidity into the system today – both Switzerland (which we are long via EWL) and the EU cut rates today by 50 basis points each, but he does appear to be the most desperate. The British economy has been reeling under the weight of worsening data: HBOS housing numbers declined by almost -15% year over year, the worst performance since 1983, while yesterday’s industrial production numbers confirmed that manufacturing contracted in August, adding to the longest losing streak since 1992.

In a theme which is echoed in other markets where lawmakers have rushed to bail out failing banks, Gordon Brown’s administration is exerting increasing pressure on banks who participated in the government recapitalization program to begin actively lending again and pass lower rates through to borrowers rather than hoarding capital.

We continue to be short the UK via the EWU ETF. As one of the more levered and poorly managed economies in Europe we anticipate relative weakness there for the seeable future.

Andrew Barber