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Currency Market Stabilization: "Trade" or "Trend"?

One of the emerging bullish factors in our macro strategy model is the stabilization that we are finally starting to see in the foreign currency market. After a September to remember, followed by an October to forget, the November thaw in daily currency volatility has been a welcomed change.

Below we show this via 3 currency lines: the US, Canadian, and Australian dollars. Last night, Asia currencies continued to stabilize alongside Asian equity markets, which are now all being buoyed by a proactive Chinese government stimulus package.

Bottoms in markets are processes, not points. This is one more macro factor to add to the bullish side of the ledger.
KM

Drip…Drip…Drip…

The Chinese water torture continues... Contrary to what might be a glimmer of hope, China’s answer to ‘Hank the Tank’s’ bailout plan won’t help the apparel/footwear industry in the US.
Adidas, Nike, and Puma all have announced recently that they are relocating manufacturing capacity outside of China. Interesting that Nike and Adidas only source about a third of their footwear in China, versus 90%+ at most other US companies. These companies have been around the block a few dozen times. Most other players have not. There’s massive tail risk for those lacking a proactive strategy here.

While I take any statistical evidence from Chinese authorities with a massive grain of salt, Government stats show that 67,000 factories were shuttered in China in the first half of the year, and more than 100,000 plants will have closed by year-end. My math suggests that about 8-10% of this is footwear and apparel.

An interesting story highlighted in the LA Times noted the closure last week of China’s biggest textile dye operation — with four factories, a campus the size of 31 football fields, 4,000 workers, and 300 local suppliers that also face bankruptcy. Not good at all…

Is China’s stimulus package going to help? My two cents is that we should not hold our breath. Do you REALLY think that a domestic stimulus plan that could very well end up being the same size (in US dollars) as Paulson’s bailout plan is geared toward amping up the firepower for low-end export goods? Quite the opposite… That’s the exact business that China is trying to shift away from in its quest to morph into more of a local consumer-driven economy instead of a sweat-shop economy. That’s great for companies who’s net revenue base in China is greater than its sourcing base (Nike and Adidas are the only ones that come close), but everyone else will suffer the imbalance.

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.
KM

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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.
KM

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 “totalmerrill.com” 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” (www.researchedgellc.com, 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,
KM

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


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.


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