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Lulling Chinese Bears To Sleep

Chinese consumers are paying less at the cash register, AND they are still shopping …

CPI data from China released today came in at +2.4%. This was a positive surprise for The New Reality where Chinese bulls are getting paid.

Lower commodity costs now provide the Central Bank the much needed room to make further rate cuts. The rate of food cost inflation in particular has come down dramatically from the stratospheric levels at the beginning of the year , declining from 23% in February to under 6% in November –the lowest level since January of 2007, when everyone loved China.

Interestingly, Chinese retail sales were +21% y/y in November, only 1% less than October, indicating that the pace of China’s growing consumer culture is continuing to show resilience in the face of the global meltdown.

We think that domestic consumption will provide continued strength to the Chinese economy on a relative basis (unlike their former “BRIC” cohorts India and Russia). With more money to put to work, more room to cut rates and more new consumers coming into the market they are definitely sitting at the head of the table.

We are long the Chinese equity market via the FXI ETF.

Andrew Barber
Director

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

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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

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”).

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