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Bearish TAIL: SP500 Levels, Refreshed



Last week was the best Thanksgiving week to be short stocks since 1932. This week has been one of the best weeks to be long stocks in 3 years. It’s what La Bernank calls the “price stability”, baby!


No matter where you go into the close, here we are – setting up for next week.


Across durations in my model, here are the lines that matter most: 

  1.        Long-term TAIL resistance = 1270
  2.        Immediate-term TRADE resistance = 1259
  3.        Intermediate-term TREND support = 1204 

In the attached chart, I also show a very immediate-term TRADE support line at 1234. Breaking that line on a sharp down move puts 1204 in play – and in a hurry. Holding 1234 will provide the 2011 bulls an opportunity to suspend disbelief until Santa arrives at lower-highs on the 25th.


What could go wrong next week? I think the Euro’s intraday move today is already previewing that. We think the European Summit could very well disappoint whatever market expectations remain for an immediate-term solution to a long-term leverage problem.


Enjoy your weekend,



Keith R. McCullough
Chief Executive Officer


Bearish TAIL: SP500 Levels, Refreshed - SPX


Today’s employment data were positive for the restaurant industry. 


With the exception of the 55-64 YOA cohort, which is seeing healthy employment growth despite the sequential deceleration in trends, all age cohorts we monitor saw a sequential improvement in employment trends.  The chart below illustrates the national employment trends by age.  For QSR, in particular, the pickup in the numbers from the summer through the fall has been encouraging for sales trends in the fourth quarter.  Food and beverage spending trends, relative to overall PCE, have been strong throughout this housing downturn as spending on housing-related sectors has lagged.  We anticipate that any continuation of employment growth will be beneficial for the restaurant industry going forward.





The restaurant industry is still hiring.  Despite the upward trend having stalled over the last few months, the data indicates that – at least through October – restaurant operators have been hiring more versus a year ago and that is a positive sign.  We were concerned about the downtick in Full Service employment growth in September, thinking that the trend could have been rolling over, but October’s growth in full service employment was sequentially higher than the month prior.  In the event of a serious downturn or recession taking place we would be more positive on QSR names than Casual Dining.


At this juncture, we like YUM, MCD and EAT on the long side. DNKN and BWLD remain our top two picks on the short side.





Howard Penney

Managing Director


Rory Green











The unemployment rate fell to 8.6% in November versus 9.0% consensus.  The Labor Force Participation Rate fell to 64% from 64.2% in October.  The unemployment rate for teenagers aged 16-19 years dropped to 23.7% from 24.1%. Nonfarm payrolls came in at 120k versus 125k consensus and average hourly earnings declined -0.1% MoM versus +0.2% consensus.



Beef Costs


According to an article on cattlenetwork.com, now is one of the best times to be in the cattle business.  According to Randy Black of Cattle-Fax, “this is the first year in history the U.S. has been a net beef exporter.” For restaurant companies with exposure to spot market beef, this is not good news for margins.



Notes from CEO Keith McCullough


Fed sponsored Dollar Debauchery this week has its reflation perks – don’t mistake it for growth:

  1. CHINA – unfortunately, the Chinese economy doesn’t like the commodity inflation – this only compounds the already accelerating deceleration in sequential (Q4 vs Q3) Asian and European growth. China closed down another -1.1% overnight, right back to where it was pre the rate cut.
  2. BRAZIL – fortunately, the Bovespa is linked to inflation (Petrobras, etc) and is one of the ways to get long of Bernanke getting pushed around by the Germans and the French on bank blow up fear. We’re not long the EWZ yet, but likely will be on a pullback – the Bovespa is down -16% YTD but trading above its TREND line of 55,378 as Brazil cuts rates and taxes.
  3. COPPER – the Doctor looks exactly like European Stoxx because they have the same correlation to the USD. Copper climbs back above its immediate-term TRADE line of resistance this week of 3.47/lb and remains under TREND line resistance of 3.72/lb. Pick your European stock market and the TRADE/TREND setup is the same. Trade the new ranges.

US Futures spikey as short sellers are now in Pain Trade mode while the long-onlys chase beta. Always a powerful combo in the immediate-term – also the biggest downside risk after the immediate-term squeeze makes a lower-high. My refreshed SP500 range = 1.







THE HBM: DPZ, WEN, GMCR, SBUX, KKD, DIN, CBRL, EAT - subsector fbr





DPZ: Domino’s Pizza was initiated “Hold” at KeyBanc.


WEN: Wendy’s announced plans to consolidate its World HQ in Dublin, Ohio.  Wendy’s said that it has 200-210 employees in the Atlanta office right now and that most Atlanta-based employees will be offered relocation.  30-40 jobs, according to the company, are redundant and may be eliminated.


GMCR: Green Mountain Coffee Roasters was raised to “Outperform” at William Blair.


SBUX: Starbucks is set to create 5,000 jobs in the UK as it opens 200 more drive-through stores across the country.


KKD: Krispy Kreme same-store sales gained 4% in the third quarter.  EPS came in at $0.35 versus $0.41.





DIN: Dine Equity was initiated “Neutral” at Janney Montgomery.  The twelve-month price target is $45.


CBRL: Cracker Barrel reported November sales metrics yesterday.  Comparable restaurant traffic was down -1.0% while average check gained 2.2% to leave the overall comp at +1.2% for the month. Comparable retail sales were up +2.7%.


EAT: Chili’s features in an article on NRN.com today describing the “kitchen of the future”.  We have been bullish on this name for some time and remain so following store visits this week. 





Howard Penney

Managing Director


Rory Green



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The Macau Metro Monitor, December 2, 2011




November GGR Share: SJM (27%), GALAXY (20%), LVS (16%), MPEL & WYNN (13%, with WYNN slightly ahead), MGM (11%).



Secretary Tam said the Macau government has still not received any application from MPEL to include gaming elements in the Macau Studio City project.  Tam said that if an application is filed, the DICJ would consider it according to the relevant legislation.  He also stressed again that the 5,500 table limit on live gaming tables will not be lifted before 2013.  He added the remaining number of table licenses should be enough for Sands Cotai Central to operate successfully.


The first phase of Sands Cotai Central is set to open in March and will include a 9,850 square-metre casino and VIP gaming areas.  The company expects to open a second casino there by 3Q 2012.



Singapore visitation hit 1,033,013 in September 2011, up 9.1% YoY, the lowest growth rate since November 2009.  Mainland China visitors accounted for 10% of total visitation.




Just when the sell side warms up to the idea of a recovery, Q4 replacement sales are likely to disappoint.



The sell side finally seems to be on the replacement recovery bandwagon, even though the bandwagon has been moving forward for a number of consecutive quarters and years.  BYI and IGT put up solid September quarters and the stocks took off.  The sell side followed up with enthusiasm about replacement demand returning and all is well.  Or not. 


We hate to rain on the parade but calendar Q4 replacements are likely to fall sequentially and, yikes, YoY.  IGT could see the biggest drop since they appeared to pull sales forward into the September quarter.  A significant market share decline in CYQ4 may be disappointing, considering IGT's long thesis of “continued share gains”. 


BYI should still gain share in CYQ4 and we continue to believe they are the best positioned supplier over the intermediate and long-term (trend and tail).  However, this stock has been a rocket ship since our positive call during G2E.  A disappointing industry wide replacement quarter will likely not be a positive for the stock with maybe the most bullish sentiment. 


At this juncture, we think both IGT and BYI can make consensus estimates but the quality would be low and transparent.  IGT does a better job of managing earnings – lower than expected revenues, higher margins and vice versa – so it may be a little safer from an earnings perspective but the market share drop would hurt.  WMS is likely to miss in our opinion but we can’t believe there are still people out there who think WMS is going to have a decent quarter any time soon. 


So why do we think replacements will fall in CYQ4?

  • IGT which had a 40% share of replacements last quarter at 5,100 is likely to see about a 1,500 sequential drop in replacements – partly due to seasonality and partly due to what we believe was pulling forward of demand.  September is IGT’s fiscal year end, so that quarter tends to be their best.
  • WMS should be up sequentially but definitely still down YoY so they won’t be making up the difference.  WMS also appeared to pull forward some units into the September quarter.
  • We believe that with all the uncertainty in 2010, there was some flushing of capital budgets in the December quarter
  • Bottom line, we think that there will be a modest YoY decline between 1-5% in replacement demand – the first YoY decline since 3Q of calendar 2010.

We still think 2012 will be a good year for the slot suppliers: resumption of replacement demand growth, huge growth in slot sales to new and expanded casinos, and a more visible and growing systems business (mostly BYI).  But we may have to take a step back this quarter to move forward.  However, we’re not sure the Street is ready for the step back just yet.

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“The state is the great fictitious entity by which everyone seeks to live at the expense of everyone else.”

-Frédéric Bastiat


In Frédéric Bastiat’s 1950 essay, “That Which Is Seen and That Which Is Unseen”, he describes the impact of opportunity costs on economic activity.   In his essay, a small boy breaks a window in a store.  The glazier comes to repair the window and is paid six francs for the job.  Some observers would suggest this is a positive economic event as it increases the money circulating in the community.


There is, of course, no free lunch.  In the case of Bastiat’s essay, the unintended consequence is that the store owner with the broken window must pay for the repair of the window.  In using six francs to pay for the repair of the window, the shopkeeper no longer has six francs to expand his inventory, advertise for the shop, or purchase personal goods.  In effect, the transaction has two sides and it is not even certain to be a zero sum transaction, especially if the glazier does not spend his incremental six francs within the local community.


In modern economic theory, the key current debate relates to the role of the government in transactions.  The Allowance Rebate System (more commonly known as Cash for Clunkers) program is a prime example of this dilemma.   Under this program, car buyers were incentivized to purchase new cars by being given a $4,500 rebate for their old cars, which then had to be scrapped.  Practically, this was a transfer of money from tax payers to car buyers.  In the short term, new car sales skyrocketed. Meanwhile, older vehicles, which admittedly produced more pollution, were taken out of the national car population.


Akin to Bastiat’s essay, the question in the case of Cash for Clunkers Car is whether destroying an otherwise productive asset, such as a working car, actually benefits the economy.   In looking at some key results of Cash for Clunkers, the implication is at best inconclusive.  Specifically,

  • The program led to market share gains for Japanese and Korean car manufacturers at the expense of U.S. manufacturers. (Incidentally, the equivalent Japanese program did not include U.S. produced cars.);
  • A study by the University of Delaware concluded that for each vehicle trade, the net cost was $2,000, with total costs exceeding benefits by $1.4 billion; and
  • A study by economists Atif Mian and Amir Sufi indicated that the 360,000 additional purchases in July and August 2009 were pull forwards that were completely reversed by March 2010.

So, once again, no free lunch.


On the back of rumors of an IMF bailout of Italy, global equity markets rallied in a big way yesterday.  Not surprisingly, the Italian equity market was one of the global leaders yesterday up an impressive +4.6%.  While we would suggest this was more of a short squeeze than anything, there is perhaps a fundamental case to be made if the IMF rumors finally come to fruition . . . or is there?


Our trusty research intern Josefine Allain pulled together some detail around the rumored IMF plan.  According to the rumors, the IMF would provide €400-€600B to Italy at a rate of 4-5%, which would allow Italy up to 18-months to implement reforms without having to refinance. 


Setting aside the fact that the IMF denied it is in discussions with Italy, the plan has two main issues.  First, the IMF only has $285 billion currently available.  Second, an expansion of the IMF, or an explicit Italian bailout fund, would require a substantial contribution from the United States (likely more than $100 billion).  Clearly, given the current political environment in D.C. and on the back of another tacit U.S. debt downgrade this morning from Fitch, the likelihood of the United States stepping up to bailout out Italy is slim to none, absent a global financial crisis.


Indeed, European credit markets continue to signal that no free lunch from either the ECB or IMF is imminent.  Specifically, the Italians “successfully” sold €7.5 billion of bonds this morning versus a maximum target of €8.0 billion.  The 3-year yield was 7.89% versus 4.93% on October 28thand the 10-year average yield was 7.56% versus 6.06% on October 28th.  Success is a relative term.


In the Chart of the Day today, we’ve highlighted the Euribor-OIS 3-month spread, which measures the spread between what banks charge each other for an overnight loan of their excess reserves versus what they could earn by lending it risk free to the central bank.  The key take away is simply that risk, not surprisingly, has accelerated dramatically in the last three months in the European banking system.   In early July this spread was less than 0.20 and it is now at 0.94.  No free lunch there, to be sure.


This afternoon Keith and I are going to take a much needed break from the grind and go across the street to play a quick game of hockey at Yale’s Ingalls Rink.   Ironically, it will cost us $10 each, so there isn’t even free lunch time hockey.

Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


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