“If it's a good idea, go ahead and do it. It is much easier to apologize than it is to get permission”
~ Admiral Grace Hopper
At the end of the day, this business isn’t about having “ideas”… it’s about asking the right questions first, acting ahead of the crowd, and being right on those ideas.
We’ve been saying this for the last 12 months, and we’ll hammer it home one more time this morning – those who do no respect the history of how manias and markets move are doomed to repeat its mistakes. While we can get the “knucks” for having called the market crash, I am much more proud of our recent wins in being able to be long China, Hong Kong, Brazil, and the USA before these massive one day rallies. It’s one thing to be a perpetual bull or bear. It’s entirely another thing to have a business model that’s driven by one cause – to be right. That’s why I started this firm. That’s what gets my feet on the floor to write this every morning.
Prior to yesterday’s open we had been beating our “Re-Flation” Investment Theme to a pulp. As history buffs will recall Churchill saying, “if you have an important point to make, don’t try to be subtle or clever. Use a pile driver.” And like wrestling fans of yesteryear, there was nothing quite like growing up in the 80’s when we could all watch Hulk Hogan on the “Main Event” teeing Rowdy Roddy Piper up for one of them babies like we did to the shorts yesterday. Americans love one thing, above all else, a winner.
Upon reviewing the replay of yesterday’s Bull vs. Bear title match, the facts are beginning to emerge for all revisionist historians and CNBC entertainers to see. Yesterday’s +5.1% gap up in the SP500 to close at 913 (we were in print with our “Are You Ready For Some Rate Cuts” call looking for 914; close enough) was the biggest “Fed day” rally since 1994. If you want to be paid 2 and 20, you can’t miss those. Post “Weekend at Bernie’s”, Re-Regulation cometh, and the performance You Tubes are on. There is nowhere to hide. You will be accountable to uphold a transparent investment process from this day forward.
Proactively predicting that a bunch of wanna be short sellers were going to get squeezed was about as complicated as understanding how Madoff made-up the numbers – not very. What is jumping out of my notebook this morning however is how far away from the land of nod the bulls were… where did all the bulls go?
This morning’s II Bullish to Bearish survey still has a negative delta of -20 points, playing to the Bear camp. This iteration of the market’s rally may not be as much about the bad news bears being late as it is the “buy the top” bulls missing the boat. Now that the US Dollar has collapsed -11% in less than a month, stocks on the Hang Seng have rallied 40%, and gold has ripped higher for a +21% one month move, CNBC “Reports” (they don’t call Kudlow’s show by his own name anymore; I wonder why) is catching onto the idea that there has been a little “Re-Flation” being passed around at the Greenspan Goes Global rate cutting party!
“Economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time” – thanking God that that statement by the US Federal Reserve yesterday is not my religion, that certainly doesn’t mean that the fact of the matter ceases to exist. Reality can bite bulls and bears alike, and the reality is that we are in the midst of seeing a FREE money global devaluation of everything called currency. The output is that asset classes from Chinese stocks to Brazilian ones “Re-Flate”, so I’d personally like to thank our financial media sponsors for reiterating this message across the loudspeaker today. I realize it’s the holiday season, but this is very kind of you all. Special thanks to Larry.
Since the thralls of a nuclear October, this is what the perpetual “it’s global this time” bulls of yesteryear have missed: Hong Kong +40%, Brazil +36%, Russia +28%. If you’re more into the liquid local thing, since the November capitulation “everyone is going to cash” low, the SP500 is +21.4%. The facts don’t lie folks, people do. I think that one of the main reasons why the bulls don’t want to believe this global market rally is that they can’t afford to. What kind of storytelling would Portfolio Managers be able to make up if the best asset allocation, globally, for December of 2008 turns out to be what they have been preaching for the last 25 years of the bull market – “being fully invested for the long run?”
I’ll end with that. The SP500 futures are pretending to be worried, but that looks like some form of emotion than anything else. Since the Japanese Prime Minister is quote, un-quote, “hailing” the US rate cut decision this morning, your next macro calendar catalyst is the Bank of Japan cutting to zero on Friday. Hong Kong cut rates by 100 basis points overnight to 0.50%. That’s the lowest rate that the Honk Kong Monetary Authority has EVER had. China told us that they’ll be cutting again in t-minus whenever they decide to. Brazil is going to start cutting aggressively next.
It’s a global rate cutting holiday party, and the best parties are the ones where all the booze is FREE!
Good luck out there today,
SPY-S&P 500 Depository Receipts – CME front month futures were down this morning, trading as low as 887 in morning trading before 7AM.
DIA –DIAMONDS Trust Series – CBOT front month futures were down were down this morning, trading as low as 8,738 before 7AM.
XLV Health Care Select Sector SPDR – Bristol-Myers Squibb (XLV: 4.08%) announced a 10% reduction in employee headcount, the second round of layoffs for the year.
EWZ – iShares Brazil—Brazil’s Bovespa Index was up 4.4% yesterday in trading. Petroleo Brasilerio SA, Brazil’s state-controlled oil company, found more evidence of oil in an onshore block in the Sergipe Basin, the country’s petroleum regulator said.
EWG – iShares Germany – The DAX is trading down slightly this morning to 4,697.88 or 0.68%, with financials leading the decline.
EWH –iShares Hong Kong –The Hang Seng closed up this morning 2.18% at 15,544.97. Hong Kong’s central bank lowered its base rate 100 bps from 1.5% to 0.5% and asked lenders to follow suit to help grow the city’s economy.
FXI –iShares China – The CSI300 closed up today 6.97 points, or 0.35%, at 2001.42. China announced it will reduce a tax on home sales to improve the property market. Sales profits, rather than prices, will now be taxed.
FXY – CurrencyShares Japanese Yen Trust – The USD fell to 88.54 Yen, a 13-year low, in the wake of the FED’s rate cut.
IFN The India Fund—The Sensex fell 47.55, or 0.5%, to 9929.43.
Keith R. McCullough
CEO & Chief Investment Officer
The bottom line is that this brings me to a dilemma. The company will beat the quarter. But guidance on core business drivers should be light (I think that sales slow from 17% in 1Q to 5% by 4Q). Despite a weaker core, Nike can lever SG&A in 2H, and should benefit from higher non-operating income as FX hedges are marked-to-market. Yes, the stock is cheap at 7x EBITDA. But should it be any higher in light of how downright cheap other businesses are out there? No. I love the 3-year strat plan and massive call option on deploying its cash hoard, but fundamentally, this is a ‘do nothing’ story right now.
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Casual Dining operators on average are facing a much easier EBIT comparison in the current quarter as 4Q07 marked the first quarter of significant YOY declines, with margins on average down over 200 bps. Although same-store sales growth started to taper off in 2006, the casual dining companies saw a dramatic fall off in growth in 4Q07 when comparable sales growth fell 2.4% and traffic declined 4.2%. Trends have obviously deteriorated further since then but that sequentially more substantial decline in top-line growth in 4Q07 coincided with a sequential and YOY spike in both food and labor costs, which put increased pressure on EBIT margins.
This easier margin comparison in 4Q08 will not be enough to offset the significant same-store sales declines. We already know that October casual dining same-store sales declined 6.1% with traffic down 8.2% and we are expecting November to not get any worse. However, should top-line growth start to stabilize in December and early 2009 as a result of Obama’s expected fiscal stimulus program, the YOY comparisons could finally start to play in these companies’ favor. Casual dining operators are lapping both higher food and labor costs in 4Q08 and 1Q09 so the YOY pressure on margins should start to moderate, particularly with the recent declines in commodity costs. Most of the companies are forecasting that their cost of sales will be up in FY09 but at a much more manageable pace relative to the increases experienced in FY08 with the biggest YOY benefit expected in the back half of the year. Lower gas prices (down nearly 45% YOY) should help margins both from a cost and demand perspective.
Although the timing around when top-line results start to stabilize remains the number one question, I would not be surprised to see this group rally in early 2009. Any incremental lift to same-store sales growth in 2009 will coincide with moderating food costs on a YOY basis and should improve margins from their current depressed levels.
We believe MGM may be interested in selling other assets. It would seem to make sense for MGM to sell its 50% interest in Borgata back to BYD. BYD already manages the facility and has liquidity. MGM, needs to de-lever and find liquidity. Strategically, it makes sense for BYD to fully control the asset for future cross-marketing benefits combined with an eventual Las Vegas development. Most importantly, the deal would be accretive from both a free cash flow and earnings per share perspective.
BYD is effectively borrowing at an incremental rate under 4%. At 7.5x our projected Borgata 2009 EBITDA, BYD would be paying $800 million, including $350 million in assumed debt, for the remaining 50% of Borgata it does not own. We calculate EPS accretion of $0.07-0.13 at that price, or 11-17% accretive to the current consensus estimate. On a free cash flow per share basis a Borgata deal could generate accretion in the 20% range.
This is a deal BYD probably should pursue.