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WHEN BAD IS NOT BAD ENOUGH

ISLE’s FQ2 was a disaster. Company EBITDA missed projections by a whopping 24%. EBITDA fell 21% from last year, and last year was certainly no prize. So the stock should be down big, right? Wrong. ISLE’s stock is ripping, up 10%.

I’m not necessarily making a call on ISLE although I am biased to the long side. The $95 million in insurance proceeds from Hurricane Katrina will help the balance sheet, and the company’s liquidity position was already in decent shape thanks to Dale Black, CFO. The suspension of Capex, as announced today, is another good liquidity move.

However, the stock is essentially an option, and there are probably better risk/reward opportunities on the short and long side elsewhere. I do think the investor reaction to these horrendous operating numbers is quite positive for other regional gaming stocks. This may signal a bottom for stocks such as BYD, PNK, and PENN. All of these companies have ample liquidity and are not going away.

This fits the definition of a bad quarter yet the stock is up!

Commodity Exposure Exposed – Casual Dining

Last week, the USDA lowered its food inflation forecast for 2009 by 0.5% to reflect the decline in prices for meat, eggs, dairy, cereal and baking products. Despite these declines, food prices are still expected to increase by at least 4% in 2009 (marking the third consecutive year that food prices have increased by 4%). The USDA left unchanged its forecast for 2008 food prices, which are expected to rise 5.5%, the largest increase in two decades.

Specifically, 2009 beef, pork and poultry estimates were lowered and are now forecasted to grow 3% and the forecast for dairy prices were reduced to up 2.5%. That being said, commodity inflation pressures should begin to moderate on a YOY basis in calendar 2009, but will still remain at historically high levels. Gas prices, which are down 40% YOY, should help from both a cost standpoint as added fuel surcharges begin to decline and from a customer demand perspective.

The tables below highlight specific casual dining companies’ commodity exposure and their most recent cost outlook for fiscal 2008 and fiscal 2009.

SP500 Levels Into The Close...

Using 3PM EST prices to refresh our models, here's where we wash out on the SP500:

Negative "Trend" Line resistance = 886

SELL "Trade" = 833
BUY "Trade" = 747

Provided that the VIX closes above 64.58, the US$ closes weaker, US Treasury yield curve continues to flatten, and the SP500 closes under that 833 line, watch out below. You have -10% downside from here.
KM

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The Flattening Global Yield Curve...

On this morning's call, we highlighted that the US yield curve is starting to flatten again. This, on balance, is one of the primary reasons why I have a zero position allocated to US equities.

Primarily, this flattening is a function of the long end of the curve coming in hot in the last week. Today 10yr yields in the US are making new lows, trading all the down to 2.69%. Financial models work when the yield curve is steepening (borrow short, lend long), not flattening. Financial liquidity builds from a base of real savings. Real savings do not appreciate when the return on that capital is cut to zero (Japan).

Take a look at the nominal interest rates at Europe below: 1. they are higher than the US rate, and 2. monetary policy has not been neutered yet (they can still actually cut rates and have it matter on the margin).

The balance of global economic power is shifting. The world is gaining what the compromised American central bankers are giving up. The US stock market got clocked yesterday for a lot of reasons. This is one of the big ones.
KM

Trading Gold?

See the playbook below. We are long gold via the GLD etf, and trading it with an upward bias. Our immediate term upside target is $854/oz. We think you make money buying it when the yellow rocks are on sale down around the $754/oz level.

This iteration of the Federal Reserve is going to cut rates to zero. One of our most recent Investment Themes is "Re-Flation". This is, at its most basic level, the best way to be long that Theme.

Keith R. McCullough
CEO & Chief Investment Officer

Eye On European Prices - Down, But Not Out...

Crashing commodity prices are driving down PPI, this is marginally positive –but only marginally…

Eurozone PPI data released today showed the largest single month decline since 1987. This is good, though hardly unexpected, news for the EU business community -with collapsing commodity prices, the cost of materials was bound to swan dive. The room that the drop gives the ECB to cut rates further was enough to help spark a rebound in European Stock indices with the STOXX 600 rising 0.6% from earlier lows of over -2%. European rate cuts are on the tap for Thursday.

We remain negative on the EU markets in aggregate. Lower inflation will not do much to help the EU in itself, consider the full picture:

• Eurozone Unemployment for October increased by 0.1% to reach 7.6% (inclusive of Germany, where unemployment remained flat)
• Economic Confidence for October dropped to 74.9 from 80, with both consumer and industrial confidence reaching -25 for November.
• PMI data from NTC dropped to 43.61 for October, the lowest level in over a decade
• Industrial production in September declined by 2.4% year-over-year, the largest drop since 2002.
Taken in the aggregate, the glass-half-full crowd’s bullish reaction to PPI seems premature. With the Euro currency collapsing, imported inflation remains a very relevant factor to model – this is one of the reasons why nominal European inflation remains elevated. With no catalyst for resumed growth on the horizon for many of the region’s major economies, the impact of further rate cuts can only help to stabilize the trajectory of the decline.

Although we are long Germany’s Stock Market via the ETF EWG, and will opportunistically buy into the markets of other EU nations that have well managed economies, we won’t be a buyer of the Union as a whole unless some truly positive data emerges. We remain very bearish on the UK, and we remain short that market via the EWU etf.

Keith McCullough
CIO

Andrew Barber
Director

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