J Crew Needs Macro...And A Referee

Unknown Speaker*
So we're supposed to sit here and believe that you just got the memo in October about inventory?
I mean correct me if I'm wrong. I thought we were down comp in Q2. So when do we finally get some kind of confidence that you guys are ahead of the game and that we don't have a Q1 that looks like this?

What is one thing we can hang our hats on to let --

Unknown Speaker*
I think there is more but Jim will explain the answer to that. Because unless you're in our business I'm not sure you understand how it works. But Jim you want to answer that.

Unknown Speaker*
But weren't you the guy who told us there was a recession back in January?

Unknown Speaker*
Hey listen -- no, no, let's play polite here okay? Seriously there is no reason for that.
We're trying to do the best we can do. I don't ask you to buy our stock and you don't have to. But let's play this game professionally and politely? Okay --

Unknown Speaker*
Fair enough, so give us something that shows us that you have got inventories down for spring.

Unknown Speaker*
All right, you want to listen to the answer now.
Inventories vs sales vs margins vs capex are all just flat-out wrong. This chart is noisy, but it tells a lot. Email or call for more color.

Eyes on the Curve: Still upward sloping, but...

In the morning meeting today, Keith highlighted as a marginal negative the yield curve. On November 10th, 2-year treasuries were trading at a yield of 1.27% and 10-year treasuries were trading at a yield of 3.82% for a spread of 2.55%. As of yesterday, 2-year treasuries were yielding 1.31% and 10-year Treasuries were yielding 3.35% for a spread of 2.04%, so in the space of two weeks the spread between 2s and 10s has narrowed by 51 basis points.

When we highlighted the yield curve on October 30th, 2008 in our note, “Yield Curve: Steep and Steepening”, the spread was 235 basis points and while the curve continued to steepen immediately following that note, yields at the long end of the curve have started to come in once again.

On the margin, this is incrementally negative and foretells, once again, of a slightly tighter credit environment and an economic recovery that could take some time to play itself out. That said, the curve is still upward sloping, which implies that interest rates should rise in the future as growth begins to reaccelerate.

We will continue to have our Eyes on the curve.

Daryl Jones
Managing Director


German GDP for Q3 released today in final form today showed a year-over-year increase of 1.3% suggesting degree of resilience that may make the official forecast of 0.2% GDP growth in 2009 plausible. The “five wise men” government advisory panel’s more pessimistic annual report delivered on the 12th predicted increased unemployment and recommended rate cuts –but even they only foresee flat GDP for next year rather than the negative being factored in other countries.

Two other glass-half-full data points emerged today:

· Q3 data released today by the Federal Statistics office indicated that the balance of trade is contracting; however the numbers suggest that the overall health of the economy remains sound. Exports for the quarter totaled 294 billion EUR, a decline of only 0.37% from Q2 and a year-over-year increase of 3.16%, While Imports totaled 257 billion EUR - an increase of 3.81 over the last period or 5.21% year-over-year.

· The GfK Marktforschung monthly survey of financial services, consumer and savings climate was released today, with the response of German consumers surveyed coming in at 2.2, up from 1.9 last month and much better than the average economist estimates of 1.7. Clearly, the mood of German consumers heading into the holidays will be significantly better than that of many of their neighbors.
We continue to be long Germany via the EWG ETF. As we have stated often, we believe that the German is significantly sounder structurally than other major EU economies and we like it on a relative basis.

Andrew Barber

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PFCB – Clearing the decks

I’m actually a fan of Russell Owens. I believe he did the best he could in a very difficult situation. PFCB’s core concept “The Bistro” is an extremely successful concept generating very strong returns for shareholders. In an effort to maintain growth, PFCB senior management tried to reinvest the Bistro’s cash flow into another growth concept. Unfortunately, we now know how this story ends. With Russell Owens moving on to greener pastures, the decks are cleared for PFCB senior management to make significant changes to the Pei Wei concept. It’s now likely that we will see the company close more stores to focus on a core group of restaurants. So far management has closed 10 of the165 Pei Wei stores. I suspect there are another 15-25 stores that need to be closed. The Pei Wei concept has been struggling under the weight of operational issues, which have hindered the concept’s margins.
  • Unfortunately, PFCB was one of the last casual dining companies to come to grips with the reality of today’s restaurant environment. As a result, it was not until 2Q08 that the company slowed its capital spending on new units for both Pei Wei and the Bistro and closed underperforming stores. Some of the benefit of the 10 closed Pei Wei’s will help the company as we head into 2009. Specifically, management said that they expect pretax income to improve by $2 million annually and for Pei Wei’s operating margins to improve by 70 to 80 basis points.
  • Clearly, there are some critical changes that PFCB can make to better position the company that will allow PFCB to weather the severe issues facing the industry. Unfortunately, the company has a significant number of its stores in parts of the country that have been severely affected by the downturn in the economy. Specifically, Arizona, California, Florida and Nevada accounted for 78% of the company’s total same-store sales decline in 3Q08. See our post “Casual Dining Exposed” for specific details on a number of casual dining concepts’ regional exposure within the U.S.
  • The last time the company provided guidance to the street management guided FY08 EPS to $1.34-$1.40, lowering the range from $1.36-$1.42. Currently the street is at $1.38. Complicating this guidance has been a significant downturn in sales trends since PFCB provided guidance.

OIL : Keeping our eye on the curve

We are long Oil and so far it has been a profitable trade. The primary thesis relates to the likelihood that the dollar will weaken and, therefore, commodities such as Oil should inflate. This weak dollar view is in conjunction with an Oil market that has seen a broad and dramatic decline, so may have already reached a stage of selling capitulation.

Under the guidance of our futures guru, Andrew Barber, we keep our eyes diligently focused on many futures markets to find anomalies. Currently the Oil futures market is showing a widening contango, which is a data point that is actually contrary to our long thesis, for a Trade, on Oil. Obviously, the futures curve is only one data point, but is still worth noting.

As the chart below depicts, contango in the Oil market has widened dramatically in the last month, primarily based on the almost $10 per barrel decline in front month futures. Longer out on the curve, futures have stayed largely stable, which suggests the longer term view of supply and demand has not changed. In the short term, with the decline in front month futures, the Oil futures market, at least, seems to signaling short term over supply as physical producers are being paid to store Oil, which could lead to building inventory.

Daryl Jones
Managing Director

The Prince's Shades

“Success depends upon previous preparation, and without such preparation there is sure to be failure.”

Proactive preparation continues to allow us to profit from some of the best short squeezes in US stock market history. Those attempting to manage other people’s money reactively have their own predictable issues to deal with. The longer we keep them, Goldman, and Citigroup in the game, the better. Without the crisis’s that they perpetuate, we would never be able to “Trade” US Equities from the long side as aggressively. I would never get the terms I just got on a CA office lease. This is the “New Reality.”
Fortuitously, in our Early Look from Friday morning (“Studying History”, 11/21/08) I took the shot and made the call that I saw an immediate term “Trade” opportunity for the S&P500 to test 858 (14% higher). Yesterday’s market traded above that line intraday, and we started to sell into it. Call it my luck, or call it my process – I am cool with either. Most people in this business claim that “you can’t make market calls.” I agree, wholeheartedly…  most of them can’t. However, with the right process, “Yes, We Can.”

Economic history buffs can mark down the last 2 days of US trading as the biggest two-day rally in the S&P500 since 1987. Don’t we all feel great about some of our long positions now? Or are some of you feeling shame having shorted the US Financials 2 days ago, prior to their +19% move? I for one wish I’d covered our Morgan Stanley short position in the ‘Hedgeye Portfolio’ on Friday, but I didn’t… and the ‘You Tube’ replay doesn’t have that “Investment Banking Inc.” editing feature. We stand on our own decisions every day in this business and we should be transparently accountable for all of them.
Prince Alalweed seemed ready and willing to be ‘You Tubed’ yesterday on CNBC’s power hour lunch, or whatever it’s called… that segment where they have the “money honey”, Maria Bartiromo, enlighten us with her very serious sounding “exclusive interviews”. Prior to my securing a buck a foot lease yesterday from a Lehman project that’s distressed (buy low), I was entertained by the Prince who was front center, being interviewed about Citigroup.
The Saudi Prince is a 5% holder in the company – did we need an “exclusive” on proactively predicting that he would step up and push his own book? What did we expect the man to say, other than he loves the idea of US government bailout money? The man was sitting in the middle of the desert in a Four Seasons looking chair, wearing Paris Hilton shades and some sort of scarf with a leather vest. There were camels and horses, and a Western looking campfire burning in the background. Fully loaded with Maria’s line of ingenious analytical drama, I felt like I was watching Young and The Restless.
Unfortunately, the global mania in stock markets has not been fully washed out. The aforementioned live episode from Riyadh, Saudi Arabia is a metaphor for the ridiculous. Do not mistake the last 2 days of a short squeeze for a fundamental change in the US stock market’s negative intermediate “Trend.” The Prince coming to his drowning equity portfolio’s rescue while “Pirates” are stealing his country’s oil ships is what it is. It should be understood, and taken advantage of – not mistaken for research edge.

This morning is the first one in November where the downside risks to the US stock market outweigh the upside reward. My upside target for the S&P500 is 901, and my downside test level is 751. The math here isn’t as trivial as Alalweed’s new look. We’re looking at -12% downside versus 6% upside. With the US Dollar getting hammered yesterday, commodities zoomed higher alongside stocks… so I sold down our US Equity exposure to 12%, and invested in a bond for the 1st time in 2008 (TIP, Treasury Inflation Protected bond fund).
On balance, I don’t like bonds yet because I think long term cost of capital will continue to increase in 2009 as access to capital continues to tighten. Ask the government of Pakistan how these new bailout terms from the IMF feel. They had to raise rates to 15% just so that they could get the money and save their debt from defaulting. Sound familiar? Yes, this sounds like one of our favorite shorts this year, MGM Casinos, who had to pay the same rate for their most recent $750M in financing. Have no fear though… there are surely a lot of newly unemployed dudes wearing those shades that the Prince had on yesterday that are getting all amped up to roll the bones and stoke a resurgence in the table hold at the Bellagio!
The TIP bond fund pays us a 10.5% yield and is a call option on the US government doing everything in their power to re-flate their way out of this deflationary spiral. This has always been in the “Heli-Ben” playbook. This is why the Commodities CRB index had a melt-up +5.1% day yesterday. Every day that we move closer to December is one more closer to free money US interest rates. Free money is as cool as those shades that the “money honey” was digging yesterday on the E! Channel’s new competitor in “The New Reality”. Capitalize on manic behavior. Buy low. Sell high.

Best of luck out there today.

Long ETFs
TIP –iShares Lehman TIPS Bond --10 Year Yields dropped 11 basis points to 3.22 yesterday in advance of today’s Treasury Dept./Federal Reserve announcement.
OIL iPath ETN Crude Oil –Front Month Light Crude futures fell below 52.50 in early morning trading. In an interview yesterday Venezuela’s Oil minister strongly endorsed a further one million barrel a day reduction by OPEC in advance of the producing nations meeting in Cairo this weekend
EWA –iShares Australia – The ASX 200 Index gained 198.30 points, or 5.8%. BHP Billiton (EWA: 13.5%) announced an end to its attempt to acquire Rio Tinto Group (EWA: 3.18%) citing commodity price declines and difficulty in the debt markets. BHP rose by over 20% on the announcement, while Rio Tinto’s shares declined sharply –reaching level 40% lower than yesterday’s close.
EWG – iShares Germany --Q3 GDP  levels release today show a declined 0.5% from Q2 while exports declined by 0.4% from the last quarter. Volkswagen AG (EWG: 13.6%) declined by 14% on news that it would cease production for 3 weeks at its Wolfsburg facility due to cooling demand.
FXI –iShares China –Central Bank inflation forecasts were adjusted down to 6% for this year and as low as 3% for next on declining commodity and energy prices. The World Bank decreased its growth forecast for the Chinese economy in 2009 from 9.2% to 7.5% urging leaders there to focus on developing domestic demand.
VYM – Vanguard High Dividend Yield ETF –Yesterday’s rally in crude oil lifted shares of Chevron (VYM: 4.11%) by 5.4% and ConocoPhillips (VYM: 2.92%) by 5.7%.
Short ETFs

EWU – iShares United Kingdom – BOE Governor King said “We may not have come to the end of recapitalization,” in a speech before parliament yesterday. British Bankers Association data showed a decline of 50% for home loan approvals in October.
UUP – U.S. Dollar Index –An announcement detailing the joint Treasury Department/ Federal Reserve consumer lending package is expected in a press conference today at 10am. GDP figures will be released this morning with surveyed economists predicting a decline of over 0.5% from the prior quarter.

EWJ – iShares Japan --A BOJ report released today reduced growth forecast for the next several quarters. The Nikkei 225 rose 5.2% on the US/Citigroup bailout news to close at 8,323.93.
FXY – CurrencyShares Japanese Yen Trust – The yen rose to 96.81 per USD in trading today.

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