GS: Would Marcus Be Proud?

Below we have attached what we think is a very noteworthy "Trade" developing in the US market. What is bad for GS and MS stock prices has not been a leading indicator for downturns in the broad indices (see the 3 week overlay chart below of GS vs. SPY). The US market was strong on Friday, while Goldman’s stock miserably underperformed. This performance divergence matters. The “New Reality” is finding clearing prices.

Goldman has already lost another -9% today, and the talking heads like David Faber at CNBC are saying whatever it is that they say. Marcus Goldman can't be smiling down on how this story is starting to unwind. Taleb’s “narrative fallacy” is alive and well in terms of the media seeking explanations as to what is going on here. How about this: GS and MS are now bank holding companies who cannot earn 2007’s returns, ever again.

When Chris Cox and his cronies banned short selling, they were only postponing this inevitable fundamental realization. Shame on them.

Barclays Is Getting In The Game With Us Here!

It's dressed up like Barclays but it's really Lehman, and their analyst is downgrading Abercrombie (ANF) today. We bought ANF in the Hedgeye Portfolio on Friday and are happy to butt heads for this ball. Be sure to 'You Tube' Lehman's prior positive rating on ANF - note the price. I won’t be mean and attach a chart here.

Incidentally, the stock is trading up on this downgrade…

This is a great game, and another great day for it.

Power Shifting

“Nearly all men can stand adversity, but if you want to test a man’s character, give him power.”
-Abraham Lincoln

This market is having a heck of a time evaluating Obama’s power. We posted a note this weekend discussing Obama’s expectations. This week’s ‘Economist’ actually has “Great Expectations” on its cover. Call it consensus or call it “The New Reality” – those are two very different things, with varying debates, definitions, and deductions.

Obama’s rhetoric gives his core constituency hope and, at the same time, makes his doubters cringe. Obama’s congressional and senatorial power, on the other hand, will be something that his supporters and detractors alike are just going to have to deal with. The market traded violently on this last week, trekking almost +19% higher from the October 27th S&P500 low of 848, then swan diving for its worst 2 day-move since 1987 (Wednesday-Thursday post election), and finally rallying on Friday, closing +2.9%.

Political power can be both scary and exciting, all at once. Ask the Chinese how that works… yesterday they reminded the world who is wearing the global economic power pants. They plugged in a domestic stimulus plan that could very well end up being the same size (in US dollars) as Paulson’s bailout plan. In response, China’s stock market (which we continue to be long via the FXI etf), gapped up +7.3% overnight, leading Asian and European markets higher. This is all part and parcel of our 2009 Investment Theme, “The New Reality.” If you are liquid long cash, to the tune of say $2 Trillion in reserves, you wear the pants in this game. If you are levered long and in dire need to borrow… well, you can follow your new leaders, and/or just get out of the way.

In “The New Reality”, leaders will continue to emerge in many more places than the said “make money” capital of consensus. This weekend on page 33, Barron’s was kind enough to spend the money on a nice full page color shot of the New Haven skyline. There is a Wall Street here at Yale – it’s at the corner of Church Street right next to the New Haven Green. There are some weird people down there reading books and stuff…

Barron’s also highlighted one of my favorite global market strategists, Don Coxe, this weekend. Mr. Coxe is stationed in Canada, so his suit was doctored up a little with the simply Canadian mauve tie that would make him look a little quirky in a meeting of the minds at Goldman Sachs, but he cares about what “they” think about as far as he can throw them. Today, Goldman’s stock price is testing its IPO price of many moons past. Some “dude” threw out to the crackberry community on Friday that GS could be “LBOd”… that was a lot funnier than Coxe’s cravat.

Goldman isn’t alone in this fight for futility. They are just part of the losing team that is being ‘You Tubed’ by America. Although Merrill Lynch was force fed to Bank of America, they are still lighting up Barron’s with their full page advertisements of purporting to “be there” for the client. This weekend they colored a full page with a headline that says “Volatility, the Markets and You”… seriously, I can’t make this stuff up. Volatility, measured by the VIX, lost another -6% week over week, closing last week at 56.10, down -30% from the nosebleed high of 80 that the market locked in at the S&P500’s October lows. Thanks for reactively preparing us to read yesterday’s news guys.

After seeing his stock tank from $31 on his IPO payday last year to $7 something today, Blackstone’s Steve Schwarzmann is going to be speaking with Merrill’s “clients” tonight on one of these revisionist “” events. I suspect that he is going to be discussing part of his Wall Street Journal Op-Ed call to action from last week where he was pleading for “full transparency in financial statements”… Again, I couldn’t make this stuff up if I tried.

Power is money. Money is power. Right? What about political power or the power of your word? These are simple questions with complex answers. I won’t spend any more airtime on them this morning, as there is plenty to do here with the Chinese ringing the game time buzzers. European markets are up for the second consecutive day, trading +3-4% across the board. Russia has shot up another +9.3% this morning after Medvedev reached out to Obama, and the Russian Foreign Minister extended the US an olive branch for the first time in, well… a long time. Russia has rallied +51% since the October 24th low. That’s a powerful move!

Andrew Barber posted a great note to our Research Edge Macro clients this weekend titled “Eye On Alliances: The Obama Factor” (, 11/9), diving into some scenario analysis from Iran to Russia to Venezuela, from the perspective of the price of oil. In this increasingly interconnected global marketplace of risk factors, I consider it borderline reckless not to be doing “the Macro” work. Power is shifting, quickly, across asset classes and geopolitical spectrums. Power is not only about money. Power can be leveraged as much as it can be abused. Power is best allocated to the men and women of character.

There will be a power struggle at the S&P500 line of 958 today. A close above that line makes us incrementally more bullish.

Best of luck out there today,

Long ETFs

JO – iPath Coffee – All India Coffee Association announced estimates that total output for this harvest may drop 8% to 270,000 tons from 293,000 tons forecast by the state controlled Coffee Board on unusually rainy weather.

EWL –iShares Switzerland- Credit Suisse announced the acquisition of a Saudi Arabian brokerage that it already held a stake in to increase its wealth management activities in the Kingdom.

EWA –iShares Australia- Reserve Bank of Australia cut its 2008 economic expansion forecast to 1.5% from 2 %. Australian home loan approvals fell in September by 2.7%, for the eighth consecutive monthly decline.

EWG – iShares Germany –Volkswagen AG Audi division, reiterated its target of 1 million vehicles sold for the year after sales rose 7.2 % last month. CPI and GDP data are reported later this week for Germany.

FXI – iShares China – China’s government announced a $586 billion stimulus plan to sustain growth pledging “fast and heavy-handed investment” and a “relatively loose” monetary policy through 2010. PPI data for October showed a 6.6% y-o-y level, a second consecutive monthly decline.

VYM – Vanguard High Dividend Yield ETF – CDS markets for the most part responded positively to the Chinese stimulus plan with the exception of the US where credit concerns for the auto industry helped prices hold firm.

Short ETFs

UUP – U.S. Dollar Index – The dollar weakened against the EURO and GBP on the G20 Sao Paulo meeting statements and Chinese stimulus plan.

EWW – iShares Mexico - Fitch Ratings cut Mexico’s debt outlook to ``negative'' on concerns over the recession in the US, reduced foreign investment and declining oil prices.

EWJ – iShares Japan - Machinery orders declined 10.4% for Q3 matching the biggest drop on record. Heavy machinery manufacturer IHI Corp. reduced its full-year profit forecast and announced a reduction or elimination of dividends on concerns over rising yen, the latest in a string of similar guidance from major Japanese industrials.

EWU – iShares United Kingdom – HSBC announced that it has set aside $4.3 billion for bad loans in the US. Nationwide Building Society reported that mortgage lending declined by 72% y-o-y in the fiscal first half.

IFN – The India Fund – India will release industrial production growth data for September on Nov. 12th , one week earlier than scheduled. Society of Indian Automobile Manufacturers released data showing that passenger-car sales declined 6.6 % last month, while total vehicle sales declined by 14% - the largest drop in 8 years.

Keith R. McCullough
CEO & Chief Investment Officer

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I’m Finally On-Board With LULU

This name is officially in my zone. Expect to hear much more from me on it going forward.

It’s tough for me to find a brand that is as dominant with its core consumer as Lululemon is with the Yoga community. I’ve always admired the brand, but could never quite get over the hump as it relates to valuation. Well, now we’re sitting here with LULU at an Enterprise Value of $707mm. Do I care that 1 year ago it had an EV topping $4bn? No. This is a different world we live in. But I can promise you that there are several other brands out there lacking a key growth driver that are keenly aware that this is being valued for under $1bn.

Some considerations…
The holy grail for any company in the athletic space has always been Women. NO ONE, and I mean NO ONE, has even come close to success. The traditional athletic brands have failed outright. The upscale fashion brands and their ‘Sport’ sub-brands did not catch on. LULU is perhaps the first that resonates with the most important consumer in the apparel market. Women age 20-50 (wide band, I know, but LULU spans multiple age groups). Do you think Nike would want this (not at $4bn, but sub $1bn is a different story)? VF? Adidas? LVMH? Yes, yes, and yes. The list goes on.

I am not saying that a sale is in the works. In fact, I like this name for the simple 2-3 year market share opportunity… But when everyone is sweating it out about near term comps, the Canadian dollar, and store opening costs, I love the fact that regardless of any hiccups, there is huge intrinsic value, and a call option on a strategic buyer realizing it.

It’s fair to say that one of the key concerns at this point is that this has been a hyper-growth retailer that has been comping 30%+, but that is decelerating due to not only the law of large numbers, but also the turn in the Canadian dollar (which represents 75% of sales). The next 2 quarters will be particularly tough in that regard, leading up to the launch of LULU’s e-commerce strategy. This means that the consumer no longer has to drive an hour to get to the store, but can simply go on line, click a few buttons and buy the merchandise.

To be clear, I could care less where the sales come from. As long as they are profitable, and brand-enhancing. Will the store-level economics look less attractive? Will store comps slow? Yep. Absolutely. Maybe I cared about this when LULU was a $4bn market cap name and had massive expectations to live up to. But this name is being valued at $707mm, or 7.5x EBITDA. It is one of the most powerful brands in athletic apparel, has a pristine balance sheet, and can realistically grow both top line and bottom line at 20%+ for 5-years.

I’ll take that all day. This name is officially in my zone. Expect to hear much more from me on it going forward.


Talk of sustained $200 dollar oil has receded as fast as it arrived and its wake has battered the implausible alliance of Russian nationalists, Shiite theocrats and Latin American Marxists that sprang up in the face of the Bush administration’s foreign Policy.

Response to the Obama victory drew very different responses from the Russian, Iranian and Venezuelan governments –prompting not only the test of the president elect predicted by Joe Biden, but also the commitment of nations whose only common cause was anti-American sentiment to cooperation.

The State of the Nation delivered by Dmitry Medvedev this week was the most nakedly aggressive statement made by his government since the cessation of hostilities in Georgia. In direct statements Medvedev threatened to challenge NATO and US plans to put a protective barrier of missiles in Poland with new Russian missile deployments on the borders of former soviet satellites, vowed that the Russian policy in the Caucuses would not be altered by pressure from the west and placed the blame for the economic turmoil threatening the Russian markets squarely on the failure of US banks and regulators. In the days since the speech, developments have suggested that the face Medvedev wears before his countrymen differs from that he shows to the outside world. The Russian president had a phone conversation with president elect Obama yesterday while official statements surrounding the call were couched in less confrontational terms. No doubt the tragic fire on a nuclear submarine over the weekend has underscored the fragile state of their soviet-era military infrastructure in the minds of Kremlin leaders.

By contrast the tone of Mahmoud Ahmadinejad’s response to the Obama victory seemed remarkably reconciliatory. In a statement posted online the Iranian president wrote that “the great nation of Iran welcomes basic and fair changes in US policies and conducts, especially in the region", among other pleasantries sprinkled amid the saber rattling bluster that the world has grown to expects from this clown prince. As the president of a debtor nation dependant on alliances of convenience to achieve military and energy security, Ahmadinejad has seen his popularity at home plummet with successive diplomatic blunders over Iran’s nuclear program and a series of scandals –most recently the discovery that a trusted cabinet member had forged his academic credentials. As such, securing any audience with the new US administration would provide him more political breathing room. His popularity with voters is not his only concern: Supreme leader Ali Khamenei has been publicly supported Ahmadinejad’s policies to date, but there has long been speculation that the nation’s religious authorities grow tired of his constant posturing. For Obama the cost of any dialogue with Iran in the early stages of his administration would be steep –the alienation of Israel and handy fodder for partisan criticism at home.

Hugo Chavez raised prospects of new dialogue with the US even before the election took place. In a statement on November 2nd he expressed willingness to meet with the anticipated president-elect saying: “Hopefully with Obama, we will enter a new phase”. For Chavez, the prospect of declining oil may bring fewer concerns than many opponents at home and abroad might hope. Although his political base was built on expansive social programs fueled by petro dollars (as was his foreign policy), Mr. Chavez has long singled out Fidel Castro as a role model. Presumably, like El Camandante, Chavez will not be overly concerned about the misery of his people so long as he is able to maintain power for himself and his Bolivarist comrades. Despite this, it is doubtful that Venezuela’s leaders are anxious to see any of its’ regional allies swing towards greater US economic cooperation as the global recession deepens, nor will they be happy about prospects for completing the announced military contracts with Russia now that state coffers cannot count on endless revenues from oil. Like Ahmadinejad, Chavez cannot afford to let the opportunity provided by the changing administration in the US slip through his fingers –Obama’s international popularity provides the chance for US critics to soften their stance without appearing weak at home.

It’s true that politics makes for strange bedfellows, but by any standards the cooperation between Chavez, Ahmadinejad and Putin’s Russia has been particularly bizarre. A convergence of the opportunity for new beginnings with the US and the end of sky-high energy prices (at least for now) seem to spell the end for this alliance of convenience. Whether this will make the world a more secure place, is still far from clear.

Andrew barber

Eye on Behavioral Finance: "Narrative Fallacy"...

“For every problem, there is a solution that is simple, elegant, and wrong.”
-H.L. Mencken

The quote above from the man known as “The Sage of Balitmore” is an apt description for what we now call the narrative fallacy. This term as been most widely popularized by Nassim Taleb in his bestselling book, “The Black Swan : The Impact of the Highly Improbable.”

In conventional terms, a narrative fallacy is the need to put information into a story, or narrative, to explain the unknown. In effect, by creating an explanation, we delude ourselves into believing we understand what we are explaining.

We all like to simplify and summarize complex events, it makes them understandable. In fact, it is ingrained in our natural processes to look at a series of facts, events, or words and to, via mental short cuts, simplify them. Take the series of words below as an example:

A bird in the
The hand is worth
Two in the bush

Is there anything noteworthy about the sequence of words? Take another look. There is actually a typo in the way of “A bird in THE THE hand . . .” This is an example that Taleb uses in his book, so credit is due where credit is due, but it is a very simple manifestation of a discovery made by Australian brain scientist Alan Snyder.

Snyder is famous for his study of “savant syndrome”. This is a situation in which people with severe mental disorders can exhibit incredible talents in various esoteric fields, such as music, art, and mathematics. Snyder theorizes that “savant” type abilities reside in all of us, but because of how our brain processes information most people, with a normally functioning brain, are unable to tap into it.

In terms of the series of words above, Snyder discovered that “if you inhibit the left hemisphere of a right-handed person (more technically, by directing low-frequency magnetic pulses into the left frontotemporal lobes), you lower the rate of error in reading [the series above].” The brain naturally looks at the series above and imposes a theme or understanding and, in fact, glazes over the details. We call this interpretation. It is a mental short cut that all humans use in varying degrees. Ironically, by limiting part of our brain, we are more effective in seeing things as they actually are without prejudice.

In highly complex systems, such as investing in the global markets, the creation of narrative fallacies becomes even more likely. The most poignant examples of narrative fallacy are often articulated by the 24/7 business news media, the CNBCs of the world. They are by their very nature constantly reacting to global market events and are required to come up with interpretations of events on the fly. Rarely are these interpretations founded on anything other than mental short cuts, but they share one attribute of all narrative fallacies, plausibility. These “plausible” explanations are then adopted by investors who watch CNBC as part of their process. (Incidentally, if anyone can find me a trading floor in America that does not tune into CNBC I would be shocked. This point seems to verify the broad spread and unknowing acceptance of narrative fallacy).

This tendency to impose a narrative, or causality, leads to what Taleb calls, “dimension reduction”. As we impose an interpretation on a series of facts or events, we unconsciously rule out, or dramatically underweight other explanations. In terms of risk management, which requires a healthy dose of scenario analysis, this can be a fatal flaw. Undoubtedly many of the private equity and long only levered investors of 2006 and 2007 modeled their investments based on future projections that incorporated scenarios that arbitrarily included, or perhaps not so arbitrarily in the narrative fallacies that were their investment memos, limited weightings to more extreme scenarios. Any scenario is, of course, possible if we ignore the facts or probabilities.

Information is costly to obtain, process, and manage. As information expands, these costs increase almost exponentially and the likelihood of false interpretations also expands. An increase of variables in any scenario can actually be mathematically quantified by Kolmogorov Complexity. In very, very basic terms, the complexity of a string of data is related to the length of the string of data.

As investors, we operate in a world that is highly random, complex, and has an almost infinite amount of facts (or at least more facts than we can adequately fit into our brains), so how do we avoid falling into that narrative fallacy trap? The answer, quite simply, is to ignore the initial explanation that our brain, or the talking heads on CNBC offer, and call it for what it is, a mental shortcut that is likely erroneous.

The solution, rather, is to think. Step back, test the facts, find more facts, use scenario analysis, and then make a decision. Write down your process and thesis in journal, as if you were a scientist conducting an experiment, and use those notes to verify whether your decision making is based on a valid process.

Daryl G. Jones
Managing Director

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