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Eye On Japan: The Ghost Of Stagnation Past

CPI is down but Shirakawa opposes more rate cuts. Will he hold the line?

October Japanese consumer inflation came in lower for the second month in a row yesterday, reaching 1.9% year-over-year as lower commodity prices eased pricing pressure. Other circumstances could have provided an opportunity for a rate cut but, with the overnight call rate already at 0.3%, BOJ governor Shirakawa has publicly pledged to abstain from further cuts, favoring other strategies to increase liquidity. He can’t cut from zero – how strong a stance these Japanese economic ones are!

This policy course may become more politically difficult for the BOJ with mounting evidence that the recession is deepening rapidly. Data released this week registered a month-over-month decline of 3.1% in industrial production in October and rapidly slowing export data in recent months suggest still further production cuts ahead. Meanwhile domestic demand is slowing rapidly with household spending down 3.8% in October –the eighth consecutive monthly decline, and retail sales for October that were lower by 3.3% year-over-year.

Unemployment dropped to 3.7%, the lowest level since July 2007 and the second lowest since 1998. While at face value this data looks surprisingly positive, all is not as it seems. Japanese employment data does not acknowledge the division between permanent employees and temporary workers, the so called “haken”, who work outside the pension and benefits social-safety-net (see our September 7th post). Toyota’s recent factory layoffs, for instance, were confined to temporary workers, who will not be fully factored into official unemployment data. The figure also excludes those who have ceased looking for a job –a rising group among less educated young adults in large cities.

With the memory of the “lost decade” fresh in the minds of policy makers, the reluctance to take rates to zero again makes simple sense. One alternative measure to spur growth was a corporate tax break on repatriating offshore income proposed by the tax commission. Ideas like this seem to be superior to cutting rates further but, with rates already at a mere 30 basis points, the damage may already be baked in Japanese Stagnation cake.

We are short the Japanese equity market via the EWJ ETF and the yen via the FXY ETN. We sincerely hope that Japan does not suffer the same prolonged stagnation that it experienced in the 90’s, but if you read our work you know that we do not consider hope a valid investment thesis. We will remain short as long as the data tells us to.

Andrew Barber
Director

Eye On The Euro Zone: That Shrinking Feeling

EU Inflation plunges, so does confidence…

While we were celebrating the holiday several key economic data points emerged from Europe.

Consumer inflation in the Eurozone declined by the largest margin since 1991 as November CPI declined to 2.1% year-over-year from 3.2% in October and unemployment increased. This decline will provide more ammo to the ECB in its rate cut decision next Tuesday. The market has largely factored in a 75 basis point cut.

New Eurozone sentiment survey data released yesterday plunged lower than anticipated by surveyed economists with many of the major EC confidence indicators coming in the lowest levels for the past decade:

• Economic Confidence: Oct. 74.9 vs. 80 in Sept. (Revised)
• Consumer Confidence: Nov. -25 vs. -24 in Oct.
• Industrial Confidence: Nov. -25 vs. -18 in Oct.
• Service Confidence: Nov. -12 vs. -6 in Oct.
• Retail Confidence: Nov. -13 vs. -13 in Oct.

Euro Zone unemployment for October picked up by 0.1% since September to reach 7.6%. An outlier to the positive side was Germany. November unemployment in Germany arrived at 7.5% (seasonally adjusted), unchanged since October while ILO definition figures from the Federal Labor Office actually showed a decrease of 0.1% to 7% in October.

This job data fits with our thesis on the German economy which we remain long via the EWG ETF. We continue to believe that Germany is the best competitively positioned major economy in the EU. Stability and liquidity is what Germany is long – we like both.

Andrew Barber
Director

Keith McCullough
CIO

India: Don't Ignore The New Reality

Violent attacks in Mumbai overshadow key economic data points…

The terror in Mumbai appears to be finally abating. Indian Commandos freed a reported 200 hostages from the Oberoi-Trident Hotel today and only a handful of remaining terrorists are believed to be still holding out in the Taj Mahal and Tower hotels. The official death count now stands at 124, with over 350 wounded. During the crisis two key data points emerged which were overshadowed by the violence:

• Indian GDP data for Q3 released today arrived at 7.6%. That’s the slowest growth rate registered in 4 years. Finance Minister Chidambaram continues to stick to his guns that the global downturn will be offset in full by increased domestic demand bringing growth back to 9% next year.

• Weekly Indian wholesale Price levels released yesterday showed a slight decline to 8.84%, the fourth consecutive weekly decline (spurred by lower commodity prices). With WPI now having declined over 9 of the past 10 weeks, this data should clear the way for further rate loosening by the central bank.

Clearly Security threats are nothing new to India which has witnessed violent terrorism, both domestic and foreign, in every decade since independence. The nature of these attacks however, planned with military precision, suggests the work of a sophisticated terrorist organization. The fact that Pakistani based Lashkar-e-Toiba’s has denied involvement or endorsement combined with the choice of targets - aimed at hotels catering to foreigners and a Jewish center, raise the unwelcome possibility that is this is the work of a new element in India –possibly one allied with extremists from outside the subcontinent.

Regardless of security issues and the inflation reprieve provided by falling oil prices, we continue to view the Indian economy as structurally flawed and strongly question the rosy economic forecasts that Prime Minister Singh’s administration clings to with looming elections. In a nation heavily dependent on imports for many basic commodities where more than 25% of the population lives below the poverty line ($0.40 per day by Indian government metrics) we discount the ability of consumption to increase to government target levels.

We have been short India for the better balance of 2008. After covering our prior position profitably, we re-shorted India today (via IFN). We’re not sure what the world sees, but we are very sure as to what we see. This is a socialist bureaucracy that will be coming under increasing economic pressure.

Keith McCullough
CIO

Andrew Barber
Director

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Eye On Rates: Who Has Room To Maneuver?

Some Central bankers have more to work with than others … proactively preparing for crisis rather than reacting to it has its merits.

This morning, Russian Central bankers raised the benchmark refinancing rate by 100 basis points to 13% after blowing out $148 billion in currency reserves failed to stem the Rubles fall.

This move contrasts with Wednesday’s action by leaders at the People’s Bank of China who lowered the benchmark one-year lending rate by 108 basis points to 5.58% - the lowest level in more than a decade. On the same day the OECD released a bullish report on Australia’s prospects citing the effectiveness of rate cuts there as one of the reasons they predict that the land down under will emerge from recession within a few quarters and realize GDP growth of 1.7% in 09.

As policy makers scramble to avert disaster a clear pattern is emerging. Those who have managed their economies wisely and have interest rates that are sufficiently high can get results from rate cut stimulation. Those countries that kept rates artificially low and encouraged an easy credit environment for too long have little room to cut and get little reaction when they do. Those who have exhausted all their other options and failed to stem devaluation will be forced to raise rates.

We continue to be long China via the FXI exchange traded fund. We believe that a strong interest rate policy is one of the reasons that they will emerge from the global quagmire before the rest of the pack.

Andrew Barber
Director

How Much Do You Know?



“What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know.”-Warren Buffett

There’s nothing like getting lulled to sleep by her turkey, then getting smoked by my wife, Laura, in Scrabble. No matter how many glasses of wine, I am never realistic about my chances at beating her at that game! The morning after is always when reality bites. I get up to do my research, think about the score, and I feel shame. This must be how the “Depressionistas” are feeling about having sold the US market short -18% lower only one week ago.

No, that’s not a typo – that’s an eighteen percent short squeeze. Despite this move, the US market is still on track to post its worst November since 1987. Most people were not realistic that year either. This is why markets crash folks – when perception eludes reality, markets can bite.

This, of course, is an applicable thought to both the long and the short side of trading. Most levered long investors don’t get this on one side, never mind both. Ask one of the private equity firms who are staring down “portfolio company” bankruptcies or the illiquidity illusionists of “activism” what reality is today versus the perceptions of yesteryear. When access to capital tightens, and cost of long term capital begins to heighten, these “business models” fall apart.

Bill Ackman is one of the more entertaining investors in today’s proverbial game of mass media Scrabble. When I ‘You Tube’d’ him on CNBC earlier in the year, I received plenty of crackberry mail from those who were levered up long “Targ-eh” alongside him. Maybe they can all go “channel checking”, do some shopping, and enjoy “Black Friday” with Bill today. This man is the guru of all things real estate and retail, isn’t he?

Ackman said that when he looks at Target, he thinks about it on a “50-year basis”… he better, because that might be how long it takes for this stock to hit his initial cost basis. He also owns a massive percentage of the shares outstanding of another US retailer that we have often shunned, Borders Group. This company is imploding again this week, trading down to $1/share. That’s one dollar – everything starts on one guys! Now where can I get me some of that “50-year” money?

“Ackmanism” and levered long investing is not complicated. All you need is enough people to not be able to “realistically define what they don’t know.” Then you get those people to give you more and more money so that you can average down into positions. This isn’t Buffett style value investing. Nor is it value investing legend Marty Whitman’s definition. Marty puts the gravity of averaging down into losing positions into context best, “a bargain… that remains a bargain… is no bargain.”

As obvious a bargain as the S&P500 was last week (when we bought it), is as much as it isn’t this morning. We sold the SPY (S&P500) short into Wednesday’s close, primarily as a hedge against what people thought they knew, forgot, and then made up a new narrative to explain. The meme machine of CNBC has gone from depression in their portfolios, to euphoria, back to being chalk full of turkey and no idea what to do next because the futures are down.

The S&P500 has moved into an ominous position in terms of risk versus reward. It wasn’t very long ago that I gave you a “down 1%, up 10%” risk management outlook for the US market. After warning “Beware Of The Squeeze” (www.researchedgellc.com, 11/12/08) in mid November, I am now warning you of an up +1%, down -15% setup in the same index. As prices and facts change, I do. The Thanksgiving turkey is done, and the chickens have come home to roost. Volatility (VIX) has dropped -31% in less than a week, and Wednesday’s +3.5% stock market move was on one of the lightest volume days of the month. This is a bad brew.

How much did Bill know about Borders? How much does the Street know about Mumbai, India? Has Bill been to India? Have Indians been to Borders? In closing, maybe that’s the best Thanksgiving idea we have this morning. That everyone from India to Wall Street strap on the accountability pants, travel the globe’s bookstores, and start reading about what it is out there that “they realistically don’t know.”

I, for one, have a lot of reading to do. My new downside target for the S&P500 is 757.

Have a great weekend,
KM

Long ETFs

GLD -SPDR Gold Shares –LME Gold is on path for the largest one month gain in 2.5 years.

TIP –iShares Lehman TIPS Bond --Treasuries are on track for the largest monthly gain in almost twenty years as 10-year yields reached an all-time low this week. The 10-year bid yield this morning was 2.94% with Fed Funds futures indicating a 64% chance of a 50 basis point cut on or before the Fed meeting on 12/16.

OIL - iPath ETN Crude Oil –Crude declined in advance of this weekend’s OPEC meeting in Cairo to discuss further tightening measures after last month’s 1.5 million barrel per day reduction failed to overcome market concerns over decreasing demand.  NYMEX Light Sweet front month contracts traded as low as $53.00, down from above $54.90 in late trading on Wed. before 6 AM this morning

EWA –iShares Australia – The Australian dollar rose to $0.65 USD as of late Wed.

EWG – iShares Germany  -- ThyssenKrupp AG (EWG: 1.01%) announced cost cutting of more than  1 billion EUR on significantly lower sales. Commerzbank AG (EWG:1.09%) announced planes to accelerate the 5.1 billion EUR Dresdner Bank acquisition to complete a 60% stake by January.

FXI –iShares China – The CSI 300 Index 2.2% to close at 1,829.92. Aluminum Corp. of China (FXI:1.34%) traded down as  aluminum futures declined 4% hitting the  Shanghai exchange limit.

VYM – Vanguard High Dividend Yield ETF –Korean manufacturer LG Electronics announced that it is not in discussions to acquire General Electric’s (VYM: 5.2%) home appliance unit. EC antitrust regulators issued a preliminary report today accusing Pfizer (VYM: 2.6%) and other major pharmaceutical companies of using legal actions to deliberately stall the sale of generic medications after the expiration of patent protection, with EU Commissioner Kroes commenting that antitrust actions are likely.

Short ETFs

SPY –S&P 500 DR –S&P 500 futures traded as low as 881.2 before 6:30AM this morning, threatening to cut into the largest weekly gain since 1974. Oil prices and retail promotions for “black Friday” dominate domestic stock headlines.

EWU – iShares United Kingdom – Existing Royal Bank of Scotland Group (EWU: 1.05%)shareholders took only 0.2% of the current offering leaving the remaining 20billion GBP placement in the hands of the government –bringing the total government stake to 58%.

UUP – U.S. Dollar Index – The USD 1.2871 per EUR from $1.2904 yesterday, while the Pound declined to  1.5416 USD.

EWJ – iShares Japan –Data shows factory output declined 3.1% from September while household spending declined 3.8% for the same period.

FXY – CurrencyShares Japanese Yen Trust – Earlier today the USD reached 95.26 yen, from 95.19 yesterday and 95.96 a week ago.


TRIBAL GAMING IS SUFFERING TOO

Don’t look to the tribes to offset the precipitous drop in slot sales everywhere else. Their casinos are struggling too. Layoffs and expansion delays are indicative of the slowdown. Tribal casinos also tend to be more one-off in terms of location. In these less competitive markets, the pressure to offer the latest and greatest slots is diminished. Tribes do not have to buy slots either.

As we’ve written about extensively over the past few weeks, slot sales are likely to be down considerably in 1H 2009 after a likely strong December quarter. Slot sales to new casinos and casino expansions could be down around 50%. Replacement demand should fall as well despite an easy comparison, as corporate CFO’s reign in Capex to stave off liquidity issues.

Throw a tribal casino downturn into the mix and the picture isn’t pretty. The following are just some examples of tribes cutting back:

• Pechanga laid off 368 workers, or 8 percent of its workforce
• Morongo Casino, also in southern CA laid off 95 casino workers
• Thunder Valley Casino, managed by Station Casinos, stopped construction on a hotel and will likely downsize the project.
• Foxwoods laid off 700 workers.
• Mohegan Sun cut 600 jobs through attrition and there are rumors of layoffs for early 2009
• Odawa Casino in northern MI laid off 100 employees

Foxwoods laid off 700 employees

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