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EYE ON JAPAN: STALLING OUT

The final cabinet Office tally for Q3 GDP came in at a decline of -1.8% more than 4 times the initial estimate of -0.4% released last month as the full impact of the global slowdown reverberates through Japan’s export industries –illustrated by the 16,000 employee headcount reduction announced by Sony (50% comprised of hapless haken) this morning.

If you read our work regularly you know that we think Japan bulls looking for a glass-half-full scenario in which US and EU government stimulus packages shore up demand are going to be sorely tested as they wait for income derived from public works projects to be converted into flat screen TV purchases. Furthermore, we don’t see domestic demand helping to close the gap in Japan: BOJ has only 30 BP of wiggle room left and, if consumers there were content to build of $15 trillion in the zero rate environment that ended less than 3 years ago presumably they won’t be rushing out to spend now.

We closed on EWJ short out last Friday, but we will be looking for opportunities to go short again in the near term if we can sell into strength.


Andrew Barber
Director

EYE ON CONSUMER SPENDING: GASOLINE

Average retail gasoline in the U.S. reached $1.70 per gallon last week, which is its lowest level in more than 4-years on the back of demand destruction for oil which has driven the price of front-month NYMEX RBOB futures below 92 cents a gallon. According to estimates by General Motors, each $0.01 change in the retail price of gas has a $1.5 billion impact on annual consumer spending. Based on the current U.S. average retail price of regular gas of $1.70 per gallon and the 2007 average price of $2.81 per gallon, this equates to a $1.11 change or an additional $166.5 billion of annualized consumer spending injected into the economy (or about 1% of consumer spending in 2009), not an insignificant amount. And this could be just the beginning.

Not surprisingly a clear divergence has emerged between the Consumer Discretionary (XLY) and the broader S&P 500. Over the last month the XLY increase 3.6% versus the SPX at -2.3%. See today’s Early Look for more thoughts on some changes at the margin that may be influencing consumer trends down the road.


SAY IT ISN’T SO(CAL)

Unemployment and housing matters when it comes to gaming. Southern California provides 25% of the visitors to Las Vegas.
  • As can be seen in the first chart, both metrics are correlated to Strip gaming revenues. It’s no secret that the economy in SoCal is horrendous. The problem is that the unemployment rate is getting worse, and at a worse rate.

  • National unemployment and housing prices also matter. While not as bad as SoCal, the US unemployment picture is worsening as well. The second chart provides the most recent YoY and sequential changes in employment for the large feeder markets to Las Vegas. Los Angeles and San Diego look the worst on a YoY basis but Houston and Dallas are deteriorating the fastest.

  • We’ve addressed the global situation in previous posts and the picture there is not pretty either. Global economies are slowing and entering recessions. Las Vegas is no longer on sale to prospering overseas visitors.

  • Investors should adjust the timing of a recovery scenario until at least 2010. MGM, WYNN, and LVS are all levered to the Las Vegas Strip in that order.

SoCal housing prices and unemployment rates are highly correlated with LV Strip revs
The recent unemployment trends in the LV feeder markets are getting worse

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EYE ON CONSUMER SPENDING: GASOLINE

Average retail gasoline in the U.S. reached $1.70 per gallon last week, which is its lowest level in more than 4-years on the back of demand destruction for oil which has driven the price of front-month NYMEX RBOB futures below 92 cents a gallon. According to estimates by General Motors, each $0.01 change in the retail price of gas has a $1.5 billion impact on annual consumer spending. Based on the current U.S. average retail price of regular gas of $1.70 per gallon and the 2007 average price of $2.81 per gallon, this equates to a $1.11 change or an additional $166.5 billion of annualized consumer spending injected into the economy (or about 1% of consumer spending in 2009), not an insignificant amount. And this could be just the beginning.

Not surprisingly a clear divergence has emerged between the Consumer Discretionary (XLY) and the broader S&P 500. Over the last month the XLY increase 3.6% versus the SPX at -2.3%. See today’s Early Look for more thoughts on some changes at the margin that may be influencing consumer trends down the road.


Howard Penney
Managing Director, Chief Sector Strategist

MCD – Loss in Translation

I fully appreciate that MCD’s currency issues have no implication on the company’s ability to generate free cash flow, but it will impact perception. And the current perception is that MCD can grow EPS at a double digit rate for the next five years. Those expectations need to come down.

MCD posted another month of strong comparable sales growth across the board yesterday with total company same-store sales up 7.7% in November. In today’s environment, it is hard to find weakness in a U.S. number up 4.5% and APMEA up 13.2%. MCD’s systemwide sales number of up 1.9%, however, was negatively impacted by foreign currency rates which reduced the reported number by 7.7%. MCD’s sales and operating income growth has benefited from currency translation every quarter since 3Q06 on both a total company basis and in Europe. The magnitude of this positive currency impact has grown rather steadily since that period until 3Q08. And in 3Q08, even with the slight contraction, currency still boosted consolidated and Europe’s reported EBIT growth by 5% and 9%, respectively.

Fourth-quarter 2008 will mark the first quarter since 3Q06 where that favorable currency trend reverses and actually hurts MCD’s reported results. From the chart below, it is easy to see that the currency impact has turned sharply negative in October and November, thereby reducing reported systemwide sales by 4.5% and 7.7%, respectively. According to the company’s guidance, “earnings are affected by changes in foreign currency exchange rates, particularly the Euro and the British Pound. If the Euro and the British Pound both move 10% in the same direction compared with 2007, the Company’s annual net income per share would change by about 8 cents to 9 cents.” MCD stated as a point of reference that the weighted average exchange rate used to translate the company’s income statement in 4Q07 (U.S. Dollar rate for one unit of foreign currency) was $1.45 for the Euro and $2.04 for the British Pound. Based on those numbers, both currencies have moved in the same direction in excess of 10% quarter-to-date on a YOY basis and should cost MCD about $0.10 in EPS. Although MCD’s same-store sales remain healthy, this currency headwind in 4Q and going forward could remove some of the company’s past quarters built-in earnings cushion.

EYE ON THE UK: STILL FALLING

UK Industrial production contracted sharply in October according to data released today by the ONS with total production declining by 5.21% Y/Y and manufacturing specifically down by 4.86% Y/Y. Trade data released today showed the aggregate deficit expanded to £7.75 billion for the month while the EU specific trade gap narrowed slightly. Although industry accounts for less than an estimated 20% of the UK’s GDP the rapid slowdown still comes as a shock to the system and will inevitably add to employment pressure. Housing data released today painted an equally bleak picture as October prices measured by the DCLG declined 7.4% Y/Y.

Clearly, rate cuts will not be sufficient panacea for the present situation regardless of whether the banking sector actually starts to pass liquidity through to consumers (see our post yesterday which detailed liquidity issues there). Unfortunately, further rate cuts appear to be the only arrow left in the quiver at this point for Brown, Darling, King & Company Ltd.
We remain short the UK equity market via the EWU ETF and continue to see few prospects for revived growth that might stem the tide of the crisis there.

Andrew Barber
Director

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