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Asia Isn’t Buying Into Santa Claus

Conclusion: In this three-part note, we update our outlook for Chinese economic growth and monetary policy, hit on recent economic growth trends and outlooks across Asia and the associated implications for U.S./E.U. growth, as well as offer some sobering analysis on Asia’s role in funding the Eurocrat Bazooka.


With the bulk of U.S. investor attention oscillating between a sequentially worse domestic equity earnings season and Europe’s Sovereign Debt Dichotomy, we thought it be a helpful to quickly focus your attention on a few data points out of Asia over the last 72hrs that we think are instrumental to constructing a more clear intermediate-term outlook for both the U.S. and global economy:


While Chinese Growth Is a Real Problem, Broad Easing of Monetary Policy Is Unlikely to Occur Soon Enough

On the heels of Chinese Vice Premier Wang Qishan’s urging that the nation adopt more “forward looking and flexible” monetary policy (i.e. ease), the People’s Bank of China cut reserve requirement ratios in the province of Zhejiang, where Wenzhou is located (home to the sensationalist media reports of a dramatic credit crunch). While the single-province, -50bps reduction is hardly something to get excited about, it does support our view that China is unlikely to broadly ease monetary policy for 1-2 quarters, instead electing to “fine-tune” economic policy, per the PBOC. Chinese equities, as measured by the Shanghai Composite Index, are in support of our view (broken on our TRADE and TREND-duration quantitative factoring):


Asia Isn’t Buying Into Santa Claus - 1


Also consistent with our contrarian view that rate cuts aren’t always bullish when initially implemented because of the effect fear-mongering has on private sector confidence, Vice Premier Qishan’s call for monetary easing was accompanied by the following statement:


“The global economic recession triggered by the international financial crisis will be long-term.”


We remain convinced that this type of negative sentiment coming from high-ranking officials is not conducive for small business owners investing in additional capacity or consumers opening up their purses for big(er)-ticket items. Moreover, they aren’t conducive for international confidence in the world’s third-largest economy; it’s not a coincidence that the first decline in yuan holdings at Chinese banks (a gauge of “hot money” in/out flows) since December ’07 occurred in October.  As such, we’re now seeing 12mo non-deliverable forwards for the Chinese yuan trade at a slight discount to spot prices – the first break into negative territory since September ’08.


Asia Isn’t Buying Into Santa Claus - 2


Asia’s Woeful Export Growth and Downward Growth Revisions

Japan joined Hong Kong, Singapore, and Thailand as another large, export-dependent Asian economy to post flat-to-down YoY export growth in the latest reporting period. This is consistent with the general trend of softening industrial production statistics and weaker manufacturing PMI surveys throughout the region. This has obvious negative implications for the intermediate-term inventory build and consumption trends in the U.S. and E.U., given that Asia generally rests atop the developed-world’s supply chains. We say this time and time again, but it’s worth repeating:


“If the velocity of Asia’s production and shipment of goods and services is slowing or in decline, then the velocity of U.S./E.U. orders and consumption is sure to follow. Suppliers can’t sell what isn’t on the shelves and consumers can’t consume what hasn’t been produced.”


Asia Isn’t Buying Into Santa Claus - 3


Elsewhere in Asia, Singapore updated its 2012 GDP estimate to a baseline forecast of +1-3% and revised down its 2011 forecast for export growth to +2-3% from +6-7% prior. Per the Trade Ministry, neither forecast is inclusive of "downside risks to growth", such as a Eurozone recession. This follows up the Monetary Authority of Singapore’s stern warning issued on Friday:


"The world economy and financial system are at their most fragile state since the 2008-09 global financial crisis."


Just a thought, but if Singapore – a place home to the world’s 1st, 5th, and 6thstrongest banks and consistent a ~2% unemployment rate – is growing at only +1-3%, where does that put French and Italian growth in 2012?...


Additionally, Singapore joins Japan, Hong Kong, India, Indonesia, Thailand, and Australia as key Asian economies to either reduce official GDP estimates or talk them down publically in recent weeks.


Are China and Japan Setting Consensus Up for an Asymmetric Downmove?

With global equity prices still elevated relative to their early October lows, we think it’s fair to say that there is a decent-sized faction of buyside consensus that is betting on an orderly resolution to the Eurozone’s Sovereign Debt Dichotomy. That, of course, requires a leveraging of the existing Eurocrat Bazooka, per the latest official commentary out of Germany. Unfortunately for this viewpoint, we continue to come across glaring data points that are supportive of our belief that the EFSF will struggle to attract capital – especially on the order of our estimate of $2-3 trillion needed for the upcoming fiscal year:


In China, Gao Xiqing, president of China Investment Corp (the country’s sovereign wealth fund) had this to say regarding the potential of them reallocating assets to aid in the Euozone bailout:


“When we talk about international investments, we must consider whether they serve our interests… We can’t say that we’re a generous nation and we can help you at whatever economic costs to us.”


Additionally, Jin Liqun, chairman of the board at China Investment Corp, had this to say as well:


“China cannot be expected to buy the highly risky bonds of euro-zone members without a clear picture of debt workout programs.” 


Clearly, the powers that be over at CIC share our view that China is no lemming. They won’t be foolishly convinced to step in and bail out Europe at these prices! Refer to our 9/14 research note titled, “China to the Rescue?” for more details on what conditions China needs to see before stepping in to bid for European assets with size. Moreover, we are perhaps even farther from meeting those conditions than we were just over two months ago.


Turning to Japan, in recent weeks we’ve had conversations internally and also with various members of the buyside centering on the possibility that Japan can “save the day” with major purchases of EFSF issuance and/or PIIGS+French sovereign debt via central bank money printing. Japan appears to have a vested interest in weakening the yen from near-record levels, having carried out three largely-unsuccessful interventions in the YTD with record size. Such a bold move could prove a great deal more successful than their previous interventions (the yen is trading +5.4% YTD vs. the USD vs. a median decline of -2.0% for all other Asian currencies), in addition to perhaps giving them a boost to their public image and international influence.


Unfortunately, today Finance Minister Jan Azumi rejected the possibility of the Bank of Japan establishing a ¥50 trillion yen (~$650 billion) fund to purchase foreign debt (a plan proposed to him last month by BOJ Deputy Governor Kazumasa Iwata) by saying:


“We think that would be similar to intervention… Such an idea isn’t in-line with our thinking.”


This is a major blow to this creative line of Keynesian thinking, as the BOJ takes orders for currency intervention from Japan’s Finance Ministry – whose sole purpose for intervention has been to stem “speculative trading and excessive movements”. An outright currency devaluation isn’t on their agenda and certain members of the BOJ remain publically concerned of the ill-effects of Keynesian money-printing:


“We should minimize the chance of distorting markets [when the BOJ buys assets] and I’m very cautious about that.’’

-Sayuri Shirai, Monetary Policy Board Member, November 2011


“If a central bank starts to underwrite government bonds, there may be no problems at first, but it would lead to a limitless expansion of currency issuance, spur sharp inflation and yield a big blow to people’s lives and the economy, as has happened in the past.”

 -“Masaaki Shirakawa, BOJ Governor, May 2011


To his point, in the last round of outright JGB monetization which occurred during the Great Depression era, Japan’s CPI and PPI eventually peaked at YoY growth rates north of +40% and Real GDP growth slowed sequentially for nearly 15 years. While buying EFSF or PIIGS+French paper isn’t the same thing as buying domestic securities, it is created from the same source – an expansion of Japan’s monetary base. Should such expansion eventually seep into Japan’s domestic money supply in the coming years, Shirakawa’s worst fears are at risk of being realized.


Asia Isn’t Buying Into Santa Claus - 4


All told, we think Japan is doing the prudent thing by standing pat here. Moreover, our analysis would suggest it’s also prudent to remain cautious about the EFSF – at least in the short-to-intermediate term.


Darius Dale


AN: Shorting


"McGough and Flavin do not like the go forward outlook for this stock. Shorting the Goldman upgrade on green.

TRADE and TREND converging above last price in the 36.56-36.98 range; immediate-term downside to $32.11." - KM


AN: Shorting - AN trade trend



Selling Gold, But Just Like The Terminator : We’ll Be Back

Position: We sold our position in the Gold ETF (GLD) earlier today.


Earlier today, we sold our position in the Gold ETF (GLD) for a small loss of -3.6% in the Virtual Portfolio.  Obviously, it is never enjoyable to take a loss, but, as it relates to our decision making process, it is actually pretty simple: we change our views as our factors change. 


In the instance of gold, the inverse correlation with the U.S. dollar index has recently heightened (going from +0.08 on the 30-day duration to -0.45 on the 15-day duration) and our King Dollar thesis (bullish on the U.S. dollar) has not changed.  Thus, in the shorter term it seems dollar up is likely to mean gold down, which is obviously not good for the long gold position.


The key catalyst for us with this sale was the price of gold.  As outlined in the chart below, gold broke its TREND line of support at $1,724, which, according to our quantitative models, establishes the TAIL line of $1,559 as the next key line of support.


Longer term, the key reasons to own gold are in tact.  First, inflation from fiat currencies is still, and will likely remain, a key support for the price of gold, especially as the size and scale of European sovereign debt bailout increases.  Second, and as outlined in the chart below, when real interest rates are at, or below, zero, it provides a favorable backdrop for gold as investors search for return.  (Incidentally, we don’t see a meaningfully increase in U.S. rates at least while Bernanke is at the helm.)  Finally, gold continues to be a hedge for geopolitical risk, which is only accelerating in the Middle East due to concerns over the Iranian nuclear program and uncertainty over upcoming elections in Egypt.


Selling Gold, But Just Like The Terminator : We’ll Be Back - DJ 1


Unlike other asset classes, specifically bonds, real estate and equities, the challenge with gold is that it is difficult to value.  As outlined above, it is typically used as a hedge against certain macroeconomic environments. That said, in the charts below, we took a look at gold versus WTI oil and the U.S. housing market. 


On the first metric, gold can currently purchase ~17.3 barrels of oil.  This is just above the long run average going back to 1983 of 15.7 and well off the highs of early 2009 when one ounce of gold could buy 25.7 barrels of oil.  So, on this metric, gold is basically fairly priced, at least versus the last thirty years of data.


Selling Gold, But Just Like The Terminator : We’ll Be Back - DJ 2


On the second metric relating gold and U.S. home prices, the data suggests gold may be more extended on valuation.  Currently, a hundred ounces of gold will buy 1.06 houses in the U.S. based on the current median home prices.  Almost ten years ago, a hundred ounces of gold would buys less than 0.19 of a U.S. house.  This analysis, at least over the last decade, suggests that gold is at an elevated valuation.  Longer term, going back to 1963 as highlighted in the second chart below, gold has traded higher versus U.S. home prices, so it actually remains well off its highs. 


Selling Gold, But Just Like The Terminator : We’ll Be Back - DJ 3


Selling Gold, But Just Like The Terminator : We’ll Be Back - DJ 4


The key negative fundamental data point relating to gold is on the demand side of the equation.  According to the most recent data from World Gold Council, global demand for gold was 919.8 tonnes in Q2 2011.  This was down -17% on a volume basis from Q2 2010 and down -5% sequentially from Q1 2011. While the actual volumes were down, the dollar value actually increased year-over-year by 5% and sequentially by 2.8%.  The implication for the recent demand figure is that there is some elasticity in demand and price increases.


Even if demand is more tepid at higher prices of gold, as long as interest rates in the U.S. remain near all time lows and Keynesian policies remain intact globally, the bullish TAIL position in gold should hold.


Daryl G. Jones

Director of Research




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Notes below from CEO Keith McCullough


Intraday yesterday I made the 4th“Short Covering Opportunity” call I’ve made since August 4th:

  1. OVERSOLD – is as oversold does. Yesterday’s SP500 immediate-term TRADE oversold line = 1187 and this morning’s math gets me 1186, so that’s the zone. Problem with that so far is that a 10-14 point bounce can’t get us back above 1203 (TREND line resistance)
  2. ASIA – better than bad is the best way to describe how Asian stocks traded after the European and US selloff. Again, immediate-term TRADE ranges are what they are – they always get overbought/oversold. India finally arrested its recent decline, +0.75%.
  3. GOLD – I’m long and wrong Gold here and do not like it having broke its intermediate-term TREND line of $1722/oz. Gold selling off like this has a lot more to do with liquidations in the hedge fund business than anything else. Performance is not good out there.

Growth Slowing in Asia and the US combined w/ European Stagflation remains our fundamental Global Macro view on the topline.





THE HBM: JACK, YUM, CBRL, MSSR - subsector fbr





JACK: Jack In The Box reported 4Q EPS of $0.49 versus consensus $0.41.  Company same-store sales at Jack in the Box restaurants gained 5.8% in the quarter versus consensus of 2.0%.  Qdoba system same-store sales came in at 3.7% versus consensus 4.1%.  Margins continue to improve.  Guidance for 1QFY12 same store sales indicates a high level of confidence in the top line.  Same-store sales are expected to increase approximately 4 to 5% at Jack in the Box (consensus +1.5%) and 2 to 3% at Qdoba system restaurants versus consensus of 2.7%.  Below is a chart of Jack in the Box company same-store sales including management’s guidance for 1Q12.  Commodity costs for the full year FY12 are expected to be up 5% on FY11.


THE HBM: JACK, YUM, CBRL, MSSR - jack pod1



YUM: Yum! Brands’ Taco Bell has cut 105 jobs across the nation and at its Irvine headquarters, according to media reports.  30 of those jobs were open and unfilled and 75 were layoffs. Taco Bell Chief Executive Greg Creed said that the structural changes being made were necessary to compete in an increasingly competitive marketplace.





CBRL: 1QFY12 EPS was reported at $1.03 versus Bloomberg consensus $1.05.  Comparable store restaurant and retail sales were down -1.6% and -1.3%, respectively.  The press release said that there was a sequential improvement in both metrics during the quarter. Food costs are expected to be up 5.5% to 6.5% versus FY11.


THE HBM: JACK, YUM, CBRL, MSSR - cbrl pod1



MSSR: McCormick and Schmick’s and Landry’s have announced that Landry’s tender offer to acquire all of the issued and outstanding shares of common stock of MSSR at $8.75 per share has commenced.


THE HBM: JACK, YUM, CBRL, MSSR - stocks 1122



Howard Penney

Managing Director


Rory Green



PSS: Cheap w/o a Catalyst


Uninspiring fundamental results the quarter after a significant shift in strategy (i.e. aggressive store closures) is enacted is to be largely expected, but the reality is that PSS’ stock remains a waiting game for investors. We still think the break-up value is ~20%+ higher, but with the company under strategic review we need to have better confidence in a sale either in part or whole, or that a new CEO will raise the bar to take our estimates meaningfully higher. Until then, break-up value math is a simple smokescreen.


But the biggest question that we increasingly think needs to be answered is whether or not the Core Payless business deserves to exist at all. To determine a real margin of safety here, we have to evaluate the NPV assuming that it does not. 


But we all know that we can’t simply make pretend that the business goes away with a special charge or two. It would be a painful exercise of absorbing losses in the Payless in order to get to the optimal store count. The question is whether that store count is 3,500, 2,500, 1,000, 500, or zero.  We don’t think it’s zero. There are some Payless stores running at a margin well above 20%. But it’s probably not a number starting with a 3 – and perhaps not even a 2.


We don’t have the answer to this yet, and there’s no doubt that anyone that would step in as a buyer for the company would need to have done the work, or if there have been offers for PLG, then PSS will need that level of comfort for the Payless business that remains.


In looking at Q3 results, sales were mixed with domestic Payless coming in lighter than expected with comps down -4.5% along with a deceleration in International Payless offset in part by PLG wholesale coming in strong. A major point is that PLG accounted for 78% of aggregate operating profits in the quarter.


The biggest delta in the quarter is on the gross margin line coming in down -524bps reflecting the company’s new pricing strategy – offering more moderate price points. The issue here is that the strategy was implemented on legacy product purchased prior to the new strategy and intended to have a higher initial price (i.e. a great exercise in finger-pointing). We are reducing our gross margin estimates to down -325bps in Q4 as this disconnect will weigh on margins near-term and through Q1 in addition to reflecting like product cost increases of +10%.


While near-term fundamentals are mediocre at best, there is early (and we stress early) evidence to suggest the company’s new strategies are starting to show signs of progress. After a weak start in August, domestic Payless sales improved through the quarter from down high single-digits to flatish in response to the sharper pricing. While hardly a trend, it’s a trajectory worth noting. In addition, the company ramped the number of store closures by year-end to 350 from 315 of 475 over next 3-years as well as cut the associated costs (lease terminations, severance, etc.) to $25mm-$30mm reducing the high end of the range by $5mm. Taking the pain now is a positive and should accelerate the timing of a turn in profitability.


Assuming PSS continues to operate as it exists today (including store closures), we’re shaking out at $0.70 for F11 EPS and $1.14 for F12 EPS. This stock typically trades at 10-12x EPS and 5-7x EBITDA, which suggests a modest premium to where it is now. We get to a valuation of $12-$17 based on our bear case breakup analysis and can justify a valuation of the PLG business in the mid-teens to low 20s alone suggesting decent support at current levels, but we need better confidence in a sale either in part or whole, or that a new CEO will raise the bar to take our estimates meaningfully higher before we get more constructive on the name.


Below is the detailed analysis of the three potential outcomes noted above from our August 25thpost “PSS: The Decision Tree”


PSS: Cheap w/o a Catalyst - Family FW Comp Table


PSS: Cheap w/o a Catalyst - Family FW Comp Charts


PSS: Cheap w/o a Catalyst - PSS SIGMA


Our Take on Strategic Review Outcomes (from 8/25):


1) An all out sale of the company:

  • This is the least likely of the three scenarios given the disparate characteristics of two business that would ultimately attract different buyers.
  • The high fixed cost and real estate intensive nature of the domestic Payless business is best suited for a financial buyer. One with a Ron Johnson-like 7-year duration that can take control, absorb losses, and slowly but surely take the store count meaningfully.
  • Another possibility is a large property owner like a strip-mall REIT that is better equipped to utilize the company’s store base and either take out/take down the leases, or flip them to a more profitable concept. But these companies are hardly cash-rich right now.
  • Based on our breakup analysis, we get to a valuation of $3-$6 per share for the ‘core’ payless business (both domestic and international) taking debt into account and $9-$11 per share for the PLG business on our bear case assumptions. $3-6 + $9-11 = $12-$17. Using less than heroic assumptions, we can get a valuation for the PLG business in the mid-teens to low-20s alone.

2) A sale of some part of the company:

  • This is a distinct possibility, but the company is less likely to sell off PLG in its entirety as the company’s key growth engine.
  • Saucony and Sperry are the most likely candidates and both could see interest from both financial and strategic buyers.
  • Re Saucony:
    • VFC could buy it in a heartbeat. It’s small enough that they can do this side by side Timberland.
    • Adidas makes sense. They’ll do anything to get into the technical running market. They’d rather buy Asics, but if the price is right it can happen.
    • Why not Li&Fung? Li Ning? Yue Yuen? Li&Fung has stated flat out that it wants to buy brands to leverage its scale. Yue Yuen has diversified into retail. Moving into the content side of the equation would definitely leverage its manufacturing base.
    • New Balance, Asics, and Under Armour are all out.
    • Nike wouldn’t touch it with a twenty foot pole. The irony is that Nike does not do well at all in the technical running category – despite the fact that it views its birthright to be rooted in running (watch the movie ‘Without Limits’ or ‘Pre’). An interesting angle on Nike’s running share… it has about 35% share in the running space. But count the number of swooshes on the feet of the first 20 finishers of the Chicago marathon. You’ll see far fewer than 35%. Nonetheless, the factoid here is that as long as Nike THINKS it can dominate this category (which it does) it won’t buy anyone else. It’s a strategy that has paid off for shareholders, by the way.
  • Re Sperry:
    • A financial buyer is more likely. This brand is strong enough to be a stand-alone company – and even a public one.
    • On the strategic side, there’s everyone from VFC, to JNY, to the same Asian acquirers that we think are going to make their way into this market.
  • We’ve already hit on the valuations above, however in breaking out PLG further, Stride Rite and Keds are worth $1-$2 per share with Saucony and Sperry valued at $9-11 with slightly more than half of the value attributed to Saucony at $5-$6.
  • There are no structural impediments that would prohibit a carve out of PLG from happening. However, carving out a single brand within PLG would be a bit more difficult in terms of integrated back office functions. Consider the following…
    • It took the company a very very long time to integrate some of the back-end infrastructure (consolidated 2DCs and a manufacturing facility) and pulled roughly $25mm of SG&A out, but the PLG brands still operate independently to a large extent.
    • The entire PLG team still operates out of their own HQs in Lexington, MA.  
    • It wasn’t until Q2 that only some of the PLG stores were hooked into the same PeopleSoft financial systems that the core domestic Payless business uses and in a similar fashion, the retail systems that count traffic/store metrics are also still largely independent from one another.

3) No sale at all. Instead, the company names a new CEO and gets to work on closing stores:

  • Business as usual is probably the most likely outcome as the company completes its strategic review process.
  • Assuming an asset sale does not occur, who PSS hires as the new CEO will be the most important near-term catalyst. (positive or negative)
  • The board wasted no time in getting a plan in place to aggressively reduce underperforming stores, which is the most significant positive development to come out of Q2 results.
    • In total, the company expects to close approximately 475 stores (~400 Payless & ~75 Stride Rite) over the next 3-years with 300 closings by year-end with most coming after the holidays.
    • We are modeling approximately 60 store closures in Q3 and another 255 at the end of Q4.
    • With roughly $110mm in revenues associated with these stores, we expect closures to impact revenues by $5mm in Q3 and ~$15mm in Q4. The greatest hit to revenues will come in F12 (~$75mm) given the timing of closures in F11.
    • Additionally, there are $25-$35mm in costs (lease terminations, severance, etc.) associated with these closings, the bulk of which are expected to be realized in the 2H F11. Of course, the Street will strip these costs out as being non-recurring – even though they represent real cash going out the door, and PSS making up for poor decisions made in years past. Nonetheless, on an ‘adjusted’ basis, we’re likely to see far better comparision starting in 1Q12.
    • Lastly, the net benefit of these actions are expected to improve EBIT by $18-$22mm once all closures are completed. We’re modeling in an incremental $0.15 in F12 EPS as a result of these actions.



The Macau Metro Monitor, November 22, 2011




The Macau government is expecting to rake in MOP85 billion (US$10.6 billion) in 2012 as revenue from direct taxes on gaming. Local officials say they are expecting the city’s casinos to post an average monthly gross gaming revenue of MOP20 billion for the year.  For 2012, the industry consensus is that the local casinos will post a year-on-year growth of 15 to 20%.  Estimated government expenditure for 2012 stands at MOP77.4 billion while revenue is projected to go up to a record MOP115.2 billion.



Angela Leong, Executive Director of SJM Holdings, stressed that the company had not abandoned the plan to construct the Ponte 16 theme park in the O Porto Interior area, which was announced in 2002.  She said the company could not get things done without support from the government and the public.



Total labor force was 344,000 in 3Q 2011, comprising 335,000 employed and 8,900 unemployed.  Analyzed by industry, 24.7% of the employed were engaging in Recreational, Cultural, Gaming & Other Services.

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