Eye On Financials: XLF, Immediate Term View

I am getting a lot of great questions on this topic today. The US Financials are flashing a positive divergence relative to the SP500, with the XLF (financials etf) trading +1% in a down -2% tape.

The “shark line”, as we like to call it, for the XLF lies overhead at $12.77. All of the panic covering underneath that line is not particularly relevant data in my macro model. If the XLF fails to overcome and close above the shark line, there is an immediate downside strike of $10.55 in play – that’s -12% lower.

In terms of US Financial stocks, we covered our short position in Morgan Stanley (MS) on Monday 12/1/08 at $12.36/share. Away from my long standing core thesis that the legacy full service brokerage/investment banking/research model is broken, currently we are short Bank of America (BAC), for three reasons: 1. The BAC Bailout Merrill deal getting approved (bad) 2. This week’s flattening of the US yield curve (bad for returns long term; think Japanese banks), and 3. Complacency (short interest is shockingly low at less than 2%).



I’m a pure fundamental guy so I sometimes need help when it comes to entry points. Luckily, I’m partnered with Keith McCullough who is the best trader I know. Here are some of his comments:

• PENN: the best looking gaming stock, strong support built up at $17.86, closing above $23.26 and this one is off to the races

• BYD: doesn’t look great but support at $3.64

• ASCA: doesn’t look so good

• MGM: right on the line. bias to the short side

• WMS: massive resistance line developing at $26.59, breaking down and closing below 22.87, and $19 is in play

• WYNN: anywhere under $32 and I would buy the whole company

• HMIN: flashes another positive divergence today, stock shaping up – needs to hold $9.18

• CCL: breaking down and closing below $20.52 is a big problem for this one, particularly if I am right on an oil squeeze coming

Here is my fundamental retort:

• PENN: the safest play in gaming right now. Great management team on the right side of the liquidity trade. Near term numbers are not good but PENN is poised to leverage its liquidity with a value creating acquisition (PNK? See my post LIKE PEANUT BUTTER AND CHOCOLATE – 11/11/08).

• BYD: the cheapest stock on a free cash flow basis I’ve ever seen with a 40% yield. The numbers will ugly for awhile but the company’s liquidity will allow it to steal market share, particularly in the Las Vegas locals market.

• ASCA: Q2 covenant bust is a mathematical certainty unless they raise sub debt. For this reason company is over-earning and estimates will fall 20% when they raise sub debt with a rate in the mid to high teens.

• MGM: LV is a disaster and getting worse. MGM is the poster child of the egregious exploitation of the easy money crowd. CityCenter is the wrong project at the wrong time in the wrong market. Overleveraged with little liquidity could pave the road to bankruptcy.

• WMS: Industry slot sales will fall off a cliff in 1H CY2009 due to cash strapped casinos delaying replacement sales and a dearth of new casinos and expansions. Yet, analysts continue to project 10% revenue growth over that time period. Pricing could be the next shoe to drop.

• WYNN: Great balance sheet, tons of liquidity, best operator, and exposure to the best long-term market in the world (Macau). Where do I sign up? Short term guys should wait for Keith’s levels on this one. Near term is choppy.

• HMIN: We like China. Citizens are traveling more. Solid long-term fundamental story.

• CCL: Industry Capex going up, cost of capital going up, ROI declining. On board spend ready to drop off a cliff.
I personally owns shares of PENN and PNK

Skaters Turned Capitalists

Adidas North America canceled its holiday parties – saving the US unit $6.3mm in expenses (or $0.03 per share). In one of the most aggressive competitive tactics I’ve seen in a while, skate brand Etnies is taking its crew from Southern California up to Portland, Oregon (Adidas’ US HQ) and throwing a holiday party for Adidas employees only. Open bar with all the Pabst Blue Ribbon and Chardonnay their rivals to the North can consume. So Etnies spends a couple grand on booze, and gets the best PR it will ever get.

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US Unemployment, In Context...

This morning’s US Employment report for November was as we expected it to be 3, 6, and 9 months ago - nasty. We proactively prepared for this by shorting SPY at 874 yesterday in the Hedgeye Portfolio. Now that the alarmists are running around sounding the sirens that this morning’s “news” is a surprise, it’s time to take a breath and consider gravity.

If you took this chart (see below), and struck gravity upon it (turning it upside down), you’ll see how Goldman shakes out with their newfound bearishness of a 9% unemployment rate. The math here isn’t trivial. The Street’s freak-out estimates of 9-11% unemployment rates are conveniently in line with the highs of the mid 1970’s and early 1980’s. You do not need a PhD in math to figure this out. It’s called mean reversion.

My Dad is a firefighter – trust me, he and I know what a real fire is. Before you start chasing fire engines out there today, consider this -533,000 in job losses in context. Inclusive of the upward revisions to October (320,000), the average of the last 3 months has been 419,000. This is in the top 3 of the worst employment prints we have seen since WWII. Are things horrible out there? You bet. But the SP500 is down 49% in the last year for a reason!

US stock market expectations have been burning closer and closer to reality for the last 3 months. This fire has been ablaze for a while here. Don’t get burned by the narrative fallacy of alarmist rhetoric. It’s a year late, and plenty a dollar short.

I’ll be looking to take my exposure to US Equities up (from zero) in the coming sessions.

It's Time For Change

"Not everything that is faced can be changed. But nothing can be changed until it is faced."
 ~ James Baldwin
It is year end. Performance results are on the scoreboard, and it’s finally time for the said leaders of the American Financial System to face the facts. This interconnected global marketplace of risk factors has a new proactive boss in town – she doesn’t look like Sheila Bair, but her principles rhyme with Bair’s approach – transparency, accountability, and trust are the new rules of “The New Reality.”
Chrysler’s Bob Nardelli and the US Treasury’s Hank Paulson were ‘You Tubed’ by The New Reality yesterday, begging for bailout moneys from sea to sea. There isn’t much difference in their respective (and reactive) left brained, “task oriented”, management approach. When you see these billionaires of yesteryear perform live, you can’t help but wonder what you are missing.
For me, the wonder of it all ended last year. I had already sat in a “small group meeting” with Nardelli and shorted his stock while he was blowing up Home Depot. I had already been to the vaunted “invite only” buy side Paulson lunches of 2006, where he was speaking a language that was even more confusing than that which you hear coming out of his mouth today. Been there, done that.
My conclusion to leave the Street in November of 07’ was not that complicated. I was overpaid to over-analyze companies and the people who ran them. I was underpaid to consider global macro risks. My conclusion was simply that groupthink had become unbearable, and that the leadership in this business needed to change. “Not everything that is faced can be changed”, of course… “but nothing can be changed until it is faced.”
Let’s face it for what it is. The river cards have been turned face up on the table for all to see. This is no longer a trivial exercise in analytics. The old boy network has rendered itself conflicted, compromised, and constrained. It’s time to move forward. It’s time for new leadership. It’s time for change.
The Chinese are providing an ample amount of leadership. While I doubt Paulson dropped to his knees like he did for Madame Speaker, Nancy Pelosi, he didn’t have to. His bowing to the smiling men in suits in Asia is what a great banker does when he knows who has the cash. Paulson didn’t ask them to stop letting their currency appreciate. He begged them for bailout moneys. Thank God December ends in a few weeks. Hank will be gone. It’s time for change.
This $20B “China Pledges to the US” headline has predictably warmed the hearts and minds of the hopeful CNBC futures entertainers. I have never seen one of the “money honeys” or Dillan Radigan use a calculator, so I am not upset with them for not having done the math. Their investment process is what it is – an embarrassment to the profession. The math here is simple. China’s $20B pledge = 3% of what they have committed to their own domestic stimulus spending plan ($586B). They have the cash. They will do with it as they please. It’s time for change.
Despite the USA closing down another -2.9% yesterday, taking the SP500’s December to date deflation to -5.7%, China’s stock market closed higher for the 3rd consecutive day, taking the Shanghai Stock Exchange Index inflation from the first week of November to +18%. For those of us with calculators, we know that the US market is down -16% over that same period of time, and is now sitting on the edge of a precipice ahead of this morning’s US Employment report. This is not a time to panic. We have proactively prepared for this. It’s time for change.
Japan was down again last night. Their economy is stagflating, and their stock market is running head to head with Hank “The Market Tank’s” US market performance – since the beginning of November, the Nikkei is down -17%. The Japanese bailout resolve isn’t new. They have taught economic historians that a negative real interest rate and a flat yield curve doesn’t work.
Unfortunately, Hank and “Heli-Ben” didn’t get that history memo. Bernanke clearly spent too much time studying the Great Depression, and not enough time studying the last 20 years in Japan. Paulson’s Goldman cronies are depressed, and they should be. So at least “Heli-Ben” is qualified to moonlight as their depression shrink.
The most depressing development in the US market is that the slope in the US Treasury’s yield curve is beginning to flatten again. Since 3-month Treasuries are yielding 0.01% this morning (ZERO), the only place for short rates to go from here is UP. That should continue to pressure the only American Capitalists that we have left standing – those who are liquid long cash, who might be willing to borrow short and lend long in search of a risk adjusted return. It’s not a time to disenfranchise those Americans who have managed through this cyclical downturn responsibly. It’s time for change.
We shorted SPY yesterday into the hope associated with the intraday print we picked up at SP500 874. Could this morning’s employment report be better than bad? Sure. But that’s not going to get me to be a raging bull on US Equities folks. When it comes to buying US stocks, I simply want to buy low and sell high. Let whoever told you that managing money is all about buying high and selling higher deal with their own year end accountability check. We have a tremendous opportunity to get back to doing what prudent American investors have done since the days of Marcus Goldman. That’s change I can be long of in the United States of America. It’s time for change.
Have a great weekend,
Long ETFs
GLD -SPDR Gold Shares – Spot gold prices gained 0.5% reaching 770.55 this morning g in London.
OIL iPath ETN Crude Oil – Front month NYMEX Light Sweet Crude futures fell as low as 43.39 in early trading this morning. So far this week oil contracts have lost nearly 20% of market value –the largest one week drop since 2003.
EWG – iShares Germany  --The DAX declined 2.62% this morning to 4444.26. Bundesbank’s semiannual macro report projects an economic contraction of 0.8% for 2009. Auto parts supplier Rheinmetall AG (EWG: 0.17) will eliminate 750 jobs due to slowing automotive demand.
EWH –iShares Hong Kong  --Hong Kong home prices are down almost a quarter from their five-year high in March. HSBC raised mortgage rates as much as 75 basis points to 5.75% this week, the most in a decade.
 FXI –iShares China – US officials, led by Secretary Paulson, pledged to cooperate with China on a $20 billion package to stimulate trade in talks in Beijing.
Short ETFs
SPY-S&P 500 Depository Receipts--Futures traded as low as 843.6 this morning in advance of Payroll data due at 8:30 Am.
IFN -iShares India –Infosys (IFN: 11.09%) dropped 4.9% on news it will freeze hiring in the next fiscal year. The Rupee has rebounded slightly to 49.725 per USD since its slide following the terrorist attacks.
EWU – iShares United Kingdom –The FTSE is trading down 1.14% this morning to 4116.43. Royal Dutch Shell Plc (EWU: 5.68%) lost 4% as crude oil traded below $44 a barrel.
UUP – PowerShares U.S. Dollar Index – The dollar declined to 1.277 EUR, putting it on course for the second weekly decline in a row.
EWJ – iShares Japan –The Nikkei closed down 6.73 or 0.08% at 7,917.51 in trading today on news of a dimmer earnings outlook for lenders. Mitsubishi UFJ Financial Group (EWJ: 3.36%) dropped more than 5%.


KEITH - DIN, massive resistance at the 12.64-14.99 range... short with impunity.
Howard – DIN - Last week I posted a note that said casual dining could perform better in early 2009... In that environment DIN will participate in any rally. That being said, I think the fundamentals of this company are very questionable and the balance sheet is choking the life out of the company.

KEITH - DRI flashing a + divergence here... needs to hold 18.27, I'm holding my breath
Howard – Fundamentals suck but I like DRI here for a trade. I highlighted DRI and EAT in my casual dining note.

Keith - CMG, I am going to short at 53.10
HOWARD - CMG - $8.00 in cash on the balance sheet will provides some stability in this market, but a 6% menu price increase will hurt traffic trends. Margin comparisons in 1H09 are very difficult.

KEITH - STZ - you like wine? STZ shaping up very bullish
HOWARD – No real opinion other than I’m a consumer. Going to do some work on this one!

KEITH - your ole friend Ruby, RT, looking ripe to be shorted again... anything new there?
Howard – RT is still on the bankruptcy watch list.

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