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Getting Nervous?

My math says SP500 close at/above 875 is bullish.
KM

Bear Mace: Volatility (VIX)

Every time this market has sold off this week, the VIX has not confirmed the newfound ideas of “risk management” that some of the market’s players are implementing. Some people were not cut out to be short sellers – that’s part of The New Reality.

Let’s analyze today’s intraday SP500 selloff versus the fear you should see in the VIX – there was none – nada – zero. The VIX is still down -3% here on the day, and worrying the dizzied bears like fresh fluorescent spray of bear mace.

The chart below outlines both the double top and the recent momentum breakdown in the VIX. At 62.22, I’ll change alongside those facts. The good news, if you’re long, is that those aren’t facts yet – the VIX is at 54, the bears are worried, and they should be. If the VIX breaks and closes below 48.86, I think you’ll be staring a SP500 bull of 1,036 right in the eyes.

Buy low.
KM

King Kong Chart: Hong Kong

The Hang Sang Index close up another 23 basis points last night. While that may not impress on an absolute basis, the ability for this index to hold its recent gains must.

Since it's October 27, 2008 low, the Hang Seng has shot the moon, tacking on a +42% move! No giveback in this market is getting a lot of people to ask us questions now. Ordinarily, I would be selling into these questions, but we do have more upside left here.

Looking at the EWH exchange traded fund, next stop is $11.40/share. If the EWH can close above $12.09, the shorts might be asking me a better question - does King Kong really live?!

Macro matters, and so does China's recent "Re-flation."
KM

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20 Proprietary Risk Ranges

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Capitalism's Most Bullish Chart Bottoming Again?

Albeit at a “no drama” Obama pace, for 5 consecutive days, the slope of this curve has steepened. See the chart measuring the spread between 10s and 2s below. We like to see a positive and expanding slope to the curve because it allows for liquid long capitalists to make money off of the levered.

Borrow short; Lend long – that’s not a new investment model, but it is one that I need to see in order for The New Reality to prosper.

Flat yield curves beget banks taking on undue amounts of leverage in order to earn a return. I don’t do that. Call me conservative, or call me right. I think this is the kind of American Capitalism that people can buy into and trust.
KM

LULU: Early Cycle Company Acting Mid Cycle-ish

The store growth slash overwhelmed the fact that the company managed its business like a retailer who has been in business for 30 years. As growth investors cycle out, this name is a gift.

What a flat-out weird quarter from LULU. Truly. Expectations were for a miss due to weaker comps, eroding gross margins, higher SG&A due to ERP investments, and inventory build. In actuality, the P&L looked better, the balance sheet looked exceptional, but store growth expectations were decimated. Bears definitely right on this puppy – though most probably for the wrong reasons.

Why do I say that LULU is acting like a mid-cycle company? Two main reasons…

1. The degree to which the company managed its inventories this quarter almost knocked me off my chair. Check out the SIGMA below. For 2 quarters straight, inventories built (and the multiple contracted), but then LULU took a massive V-shaped move to clean its balance sheet at the expense of margins (upper left quadrant). The key point here is that 80% of retailers revert to the lower left quadrant first – i.e. inventories building AND margins down – before taking any action. LULU is a step ahead. That’s unusual for a company like this where people so frequently question managements’ ability to execute.

2. The fact that LULU has secured only 5 real estate locations for next year on a base of 107 at year-end 2008 should scare even the most conservative growth investor at face value. Yes, it scared me as well. For most retailers, this behavior suggests management’s lack of confidence in its own growth platform. I don’t think this is the case with LULU. But it does show that the store growth strategy is part offense, and part defense.

a. The defensive angle is that company realizes that it does not live in a vacuum, and investing in a declining spending environment is risky business.

b. The offensive angle is that LULU fully realizes the leverage it holds with prospective landlords. LULU is taking a ‘come to Daddy’ approach to secure lower rents, which I like given that it will balance store-level economics as business shifts incrementally from 4-wall to .com.

c. The part of the growth equation that does not sit well with me is that a major theme next year, in my opinion, will be that the power brands that consumers want to succeed that also have the balance sheets to dominate the share-grab game and put weak competitors away will emerge the clear winners. LULU should be one of those. I’d rather see a more aggressive posturing here. They can afford it.

I still like the fundamental story here. Check out my 11/9 Post for the full thesis (I’m Finally On-Board with LULU”).

EYE ON REGIONALISM: The Swiss Vote in Another Right-Winger

In case you haven’t noticed, the Swiss do things differently. The country stays out of most military conflicts, is not part of the European Union, remains a “neutral intermediary” on the international stage, and the people speak any number of the country’s four official languages. So it should come as no surprise that their system of government looks different from the rest of Europe as well.

The governmental structure of Switzerland is important in the context of understanding yesterday’s election of conservative Ueli Maurer to the Swiss Federal Council, a seven-member (or four party coalition) executive council that operates as both a cabinet and collective presidency.

Switzerland’s Federal Council once represented all four major parties in the same ratio: two representatives each from the Free Democratic Party, Social Democratic Party, Christian Democratic Party, and one from the Swiss People's Party. This ratio changed in 2003 when Maurer’s People’s Party took an extra seat away from the Christian Democrats, having gradually amassed increased voting share to 29%, from 11% in 1987 to 22.5% in 1999.

Yesterday’s vote for Maurer was surrounded by considerable clout for his running mate for the People’s Party seat was Christoph Blocher, a sixty-eight-year-old billionaire industrialist who dominated political life for over a decade, transforming the Swiss People's Party from a small, rural party into a political machine firmly anchored to the far-right.

Blocher’s party emerged as the largest party in the coalition in 2003 and with it he was elected to a seat on the Federal Council. During his term he sparked much controversy in Switzerland and abroad with his anti-immigrant policies and musings. An example of the racism the party espoused is demonstrated in the below advertisement that shows three white sheep kicking a black sheep off the backdrop of the Swiss flag, with the bold black works “Create Safety”.

The racist suggestions in the message are clear; and this was a party poster that would have been displayed on any bus stop throughout the country.
Switzerland, a country known for its multicultural heritage nestled between France, Italy, Liechtenstein, Austria, and Germany has had its own cultural problems with immigrants. Much like the guest workers in Germany post WWII (see: ) Swiss society has integration problems with immigrant groups from the Balkans and Turkey in particular, with total foreigners living in Switzerland to be estimated at 20% of the population. Switzerland has some of the toughest naturalization rules in Europe. To apply you must live in the country legally for at least 12 years, pay taxes, and have no criminal record, making “integration” difficult. Although crime statistics are not definitive, many Swiss blame crime on the immigrants. In particular, the Swiss People's Party holds this to be true, and is their justification for deporting them and their families.

Returning to Maurer’s election to the Federal Council yesterday, it is important to understand that Maurer has been referred to as Blocher’s lackey over his political career. In 1996, at Blocher’s behest, Maurer was elected president of the Swiss People’s Party. His presidency saw the party double its voter base, establish itself in the French-speaking part of Switzerland, and in 2003 rise to the country’s strongest party. Maurer, who shares Blocher’s xenophobia, once said: “As long as I talk of negroes, the camera stays on me.” His conservative values have shown through with his comment, “"the downfall of our society."

Yesterday’s election of Maurer grabbed our attention for it confirms a current European thread of right-wing support. This was demonstrated in last week’s regionalism article on the legacy of Jörg Haider and the previous week’s look at multicultural tensions in Germany. The Swiss case further shows the integration problems of foreigners in continental Europe. The integration strain can be financial and cultural.

We’ll be following Maurer and Swiss politics in context of the Eurozone. We have recently sold our position in Switzerland on account of the country’s highly levered economy to the banking industry.

Matthew Hedrick
Analyst


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