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Political Brouhaha in Canada

Although we haven’t bought the Canadian stock market yet, from a purely capitalistic perspective, we have had a more positive view on Canada recently based on the political shift to the right of center driven by current Prime Minister Stephen Harper. As we have previously noted, Harper solidified his minority government just seven weeks ago. We took this as a sign that Canadians, on the margin, were more predisposed to the conservative economic policies espoused by Harper and his Conservative Party.

Unfortunately, in the last couple of days, the political outlook in Canada has clouded over dramatically. Late yesterday, Reuters called recent events “one of the worst political crises in the country’s (Canada) 141-year history.” As a Canadian, it is an assessment I have a hard time denying.

A coalition has formed between the Liberal Party, the National Democratic Party (the NDPs), and the Parti Quebecois. In combination, the coalition has 163 seats (Liberals 77, NDP 37, and Bloc Quebecois 49) versus 143 seats for the Conservatives. On December 1st, the three opposition leaders signed an accord in which they agreed to form a coalition to pursue a non-confidence vote in Parliament. Under the accord, the Liberal leader will become Prime Minister and the cabinet will be split between the Liberals (75%) and the NDP (25%). Collectively, the three parties have agreed to vote together for the next 18 months on all matters of confidence.

As a result, Prime Minister Harper faces a non-confidence vote on December 8th. Given that the coalition has 163 seats, he will almost certainly lose the confidence vote and have to resign and/or call a new election. In order for the new election to proceed, the Governor General has to approve the plan for a new election. Harper’s only option to circumvent the non-confidence vote, and either a new election or handing the government over to this Liberal led coalition, is to get the Governor General Michaelle Jean, a Liberal appointee, to end the current session of parliament, which would then reconvene in January.

The coalition is taking advantage of the current economic turmoil to gain power under the guise that the Conservatives do not have an economic plan. Ironically, the coalition has not put together a new economic plan of substance, nor do they have a history of working effectively together. In fact, in the most recent election the Liberals and NDP were much at odds over economic policy. The largest disagreement was over $50 billion in corporate tax reductions that the Liberals supported and that the NDP wanted to invest into social programs.

As David Frum wrote on December 1st in the National Post, Canada’s major newspaper:
“Imagine Canada 6 months on. There’s a Liberal prime minister. He will head an unstable coalition of Liberals and socialists aligned with separatists. To appease the socialists, he will have to raise taxes. To appease the separatists, he will have to direct disproportionate money and attention to the province of Quebec.”

Frum’s point is adroit. A Canada in six months from now, under this leadership team, could well be an unmitigated economic disaster. We can debate whether Prime Minister Harper has the qualifications and wherewithal to develop an economic plan that will soften the current economic crisis, but undoubtedly a coalition led by the Liberals and backed by a self proclaimed socialist and a leader of a party whose primary goal is the separation of Quebec, leaves much to be desired.

Keith and I, reluctantly, may have to short the homeland in the coming weeks.

Daryl Jones
Managing Director

Dear Speaker Pelosi,

Tuesday, December 2nd, 2008
Somewhere in America

Dear Speaker Pelosi:

We saw you this afternoon announcing that the auto makers have come and gone, and at least two of them left behind large missives explaining why they are entitled to $25 billion of our money. We might underscore that this is our “hard-earned” money, as opposed to the money with which the automotive industry appears to have been awash over the years. Granted, on Wall Street we get astronomically overpaid for even mediocre performance (kind of like the senior management of our nation’s automotive industry, come to think of it…) but even this Vatican of capitalist greed has not come up with an idea to rival the two-headed labor/management monster that is the Jobs Bank.

We have heard the tenor of what the Motown crowd’s arguments are likely to be. As our dear departed Dad used to say: “You can’t kid a kidder.”

Once upon a time, we started our own company. People liked us. They not only liked us, they also trusted us, and they thought we were smart. This is what we call a win-win-win combination. Yet, every potential investor we approached asked the same question – and they asked it right at the beginning of the conversation: How much of your own money are you putting up? The argument we made – having learned it in our days as stockbrokers – was: you are only risking capital. We are risking our reputation! Surprisingly, it failed to gain traction.

The offer of the Motown Mousketeers to forego compensation for the forward year is laughable. After taking home tens of millions of dollars apiece in all the previous years – years during which both management and labor were doggedly not addressing the death rattles of the American automotive industry – the CEOs now offer to take “only” $1 in compensation.

Since the twenty-five billion dollars at stake is our money, we believe we should be heard in the negotiations. Here is our counter-proposal:

We have no illusions that we will personally benefit from any future profit the Government may win out of buying warrants on the US automotive industry. We pay our taxes every year and, though we think we have better uses for the cash, we smile as we write out the checks on April 14th and we thank God that we live in America today, and that we make so much money that we have to pay this much in taxes. It is a great feeling, even though we know that your colleagues, Madam Speaker, will waste ninety cents on the dollar on evil, pernicious programs like Fannie and Freddie.

Now to Detroit: These faltering giants have come to us like a stockbroker trying to talk his way out of a losing streak. “We’ll sell something! And we’ll buy something else! We’ll average down! We’ll take our losses! And we’ll…” As Shakespeare has it in Cymbeline; “I’ll… do something!” Never mind.

Here’s the deal, Motown: The CEOs and senior management of the auto makers, and of the UAW, sign full-recourse notes for their entire net worth. And no sneaky hiding assets in your spouses’ names, because they have to sign too. In addition, each executive – and all members of the boards of directors – must put their entire compensation, in cash, for all the prior three years into the Government bailout fund, to establish an equity pool as a guaranty against the $25 billion. They may have to sell stock at depressed prices, or mortgage their homes to do so, but that is not our problem. You want our money, here are our terms.

This program will extend to the UAW. The Jobs Bank gets cancelled today, and all Jobs Bank-related monies paid out over the last three years gets, likewise, turned into cash and deposited in the guaranty pool. As an added incentive – since you believe the industry will turn the corner – any industry executive or employee, any union member, can buy into this equity pool. The pool will be open for ninety days, while the Government starts feeding the cash into the coffers of the auto makers. For those of you who have trouble imagining the unimaginable, by the way, the amount of money we are being asked for looks like this:


We think that’s a lot of zeroes. We believe that everything to the right of that first comma represents our ultimate return on investment. But we admit to knowing nothing about the automotive industry, except that there are 2.2 cars for every household in America. Still, perhaps there is hidden demand. To us, it looks very well hidden indeed.

Here’s an idea we like – now that we are your partners, to the tune of 25 large: the automotive industry gets paid to retrofit all the cars now on the road to improve mileage and reduce emissions. If we got a tax break, for example, we would be motivated to spend two thousand dollars on fixing up the old jalopy – especially if the alternative was being required o buy a new $35,000 electric car in 2012 to meet the Obama Administration’s new Personal Carbon Footprint standards.

We should be willing to help out an industry that lies at the heart of what makes us America. And we should do so in a manner that incentivizes them to re-invent themselves in a way that contributes to society. If they succeed, we will be better off as a country, and as consumers, and they will be rewarded financially when they repay the $25 billion loan, plus interest, and divvy up the remaining profits.

If they fail, Mulally and Wagoner and Nardelli and Gettlefinger – and their families – lose their shirts, homes, cars, private school, limos, Detroit Lions season tickets, 401(K)s, IRAs, jewelry, golf club memberships, Detroit Tigers season tickets, golf clubs, summer homes, executive suites, corporate expense accounts, and those suddenly-notorious corporate jets. This is not harsh, vindictive or unreasonable. It’s called Capitalism, and it’s extremely fair all around.

Madame Speaker, we believe fervently in the creative power of Capitalism. You have our permission to use our money to promote Capitalism in the country that values it most. But, Madame Speaker, please spend our cash wisely. We beg of you, do not sell the patrimony of American Capitalism for a mess of pottage.

Very truly yours,

A. Taxpayer

Moshe Silver
Director Of Compliance

111 Whitney Avenue
New Haven, CT 06

XLF vs. SPX: When Financials close the gap, Short them...

This chart speaks for itself. During the 5 day +19% US market squeeze, US Financials had a +35% move. Selling the XLF when this relative performance gap closes is the money making move.

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Goldman Sachs: Charting Global Credibility Risk

This is a fascinating chart that finally captures what I have been stressing for the last few weeks – the US no longer has a liquidity crisis. It has a US Financial System credibility crisis. The Chinese called America out onto the mat on this score today. They were right to do so.

Since the beginning of November, GS has lost over a 1/3 of its already drepressed value. When people talk about the Great Depression, I think they are talking about having their compensation tied to this Titanic’s sinking chart.

More interestingly, since CEO Lloyd Blankfein was ‘You Tubed’ (November 11, 2008), look at what the stock has done on a relative basis to 3mth LIBOR.

Question: Since LIBOR is a reference rate for “counterparty risk”, and it’s been relatively stable since November 11th, after coming in meanginfully from it’s October highs, what does the GS chart’s volatility really tell us?

Answer: stating that leverage has no correlation with returns lack credibility.


PSS: Timing is Everything

I’ve been concerned that margin expectations are too high headed in to the upcoming quarter for PSS, which is the ONLY factor that has prevented me from getting loud on an otherwise high-conviction long-term name. Combine that with a big debt burden, such risk has driven this name down to 3.3x EBITDA (the new trough multiple level for retailers – so far – in this cycle). It’s also driven up short interest to 30% of the float. I think we’re going to need more than a big miss to send this lower. We’ll also need a commensurate guide down, and I don’t think we see it.

Why do I like PSS? I hate to regurgitate a term that the company coined – because I am anything but a mouthpiece for anybody. But the fact is that there remains a massive ‘white space’ in footwear between $13 and $20. The basic private label brands are under $13, and any ‘brand’ that the consumer has actually heard of is usually over $20.

Make no mistake, if it were easy to gain share in this white space, someone would have done it already. What I think was brilliant at PSS is they took what was arguably the Radio Shack of footwear retail (lots of tired stores in decent locations), refurbished them, and most importantly bought (and at the time overpaid for) Stride Rite (which included Saucony, Sperry, Keds, etc…). What does that mean? That PSS owns content AND distribution. In a space with increasing cost pressures as capacity closes in Asia and props up price, it’s the companies that own the consumer relationship (ie content and distribution) that will win. Will PSS sell Sperry in Payless stores? Saucony? No way. But an exceptional brand manager can tier these brands and subsegment them in a way to touch numerous consumers in different channels. Note Ralph Lauren with $500 denim in its stores, and $75 denim Kohl’s. Nike with $325 Jordan’s in its own stores, and $35 walking shoes in JC Penney. It can, in fact, be done. I very rarely tout a CEO, but I’m extremely confident that Matt Rubell at PSS is the man for the task.

This is one of those names where the upside outweighs the downside but at least 3 to 1.

Note: Here’s a couple of tools you’ll see from me more and more often in advance of key earnings events for companies that I think are particularly important to watch.

The first exhibit below is a P&L margin walk. The second is our SIGMA analysis. It’s a bit intimidating visually but tells me everything I need to know on a retrospective basis about how sales triangulate with inventories, margins, and capital spending. How to read it…

1) Vertical axis is the spread between sales growth and inventory growth. The higher up, the better.
2) Horizontal axis is yy chg in EBIT margin.
3) The yellow line synchs points 1 and 2, and shows you the path over the past 1.5-2 yrs.
4) Columns are change in GM% and SG&A%
5) Grey line is capex as a percent of sales.

Putting it all together, PSS, is about to lap a qtr last year where they had high GM, but inventory was building rel to sales. Starting in 4Q, GM compares get very easy, and the company goes up against very favorable inventory and capex compares. If it is off on the quarter bc of a miss, it will be a layup from a timing perspective heading into 4Q.

(Click on picture to view full screen image)

Russia: The Worst Looking Major Country Chart In Macro

While European stock markets rallied broadly into today's close, Russia flashed another major negative divergence, closing down another -2.4%.

The Russian Trading System Index (RTSI, see chart) has been crushed in the last week, trading all the way back down to 603. The capitulation low of October 24th was 549, and there is no technical support for this index until we revisit that line. The geo-macro concerns in this region of the world are real. Pay attention to them.

We've drawn the important resistance lines in the chart below. There is massive resistance up at 1,116. That line will need to be overcome before the negative intermediate "Trend" reverses to the positive. A cold Russian winter cometh...

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