Beware Of Congress...

Pelosi is on the tape here effectively pushing out expectations on the Obamerica jobs package to mid-February. She doesn't understand markets and how they move, never mind the impact of expected duration surprises on those of us proactively managing this market’s risk.

Look for any Congressional changes in rhetoric that push out expected Obama inauguration announcements (positive catalysts) to have a dampening effect on the stock market. Everything has a time and a price. We must respect that this market’s “re-flation” has moved too far, too fast.

Looking for The LOW Beta Shift...

After global equity markets put on the kind of “re-flation” move that they have, the masses tend to crowd the call, coming into the game late, chasing beta.

This is when I think you should be shifting to low beta because 1. low beta outperforms on down days and 2. it's what a risk adjusted return demands.

We bought WMT yesterday using our "low beta shift" call. Other low beta positions that we like on the long side are BMY and TIP.

Keith R. McCullough
CEO & Chief Investment Officer

Crisis In Credibility

Crisis In Credibility - asset allocation010709

“Success is how high you bounce when you hit bottom”
-George Smith Patton

In yesterday’s note we talked about Chinese Generals leading Asian stock market’s out of “hitting their bottom”, so it’s only fitting that we go back to the history books and cite one of America’s finest Generals in order to give our morning call some geopolitical balance.

Despite the massive performance “bounces” that we have seen in both commodities and global equities since that November “bottom”, a global crisis in credibility continues to manifest. In the end, calling all of the cockroaches onto the mat will be a good thing… but in between now and then there will be plenty of daily trading issues investors have to face in making these people accountable.

This morning, the “Made-up” Madoff crisis in credibility has gone global. The Romanian stock market is getting tatoo’d this morning, trading down -12%, after Banca Transylvania was cut in half. Meanwhile India’s stock market got smoked for a -7.3% down day after Satyam Computer’s CEO confessed that he has been “falsifying accounts” – Satyam, which ironically means “truth” in Sanskrit, was down -69% on the news of this fraud.

Whether they be Romanian bankers, the said “Warren Buffett’s” of India, or your local American ponzi schemer, these are all outputs of the same governing secular trend in the world of finance. The said savants of “making money” are being ‘You Tubed’, one by one. In the end, there is nowhere to hide anymore. The game of global finance’s rules are changing. Be transparent and accountable to your investment process, or get out of the way.

In the USA we are seeing the “wanna be” short sellers move themselves out of the way, just as expeditiously as those who levered their brains out on the long side did for us over the course of 2008. This “Trend” of amplifying the performance issues associated with investing alongside consensus is as an important one as ridding ourselves of CEO’s, bankers, and money managers who have no credibility. After all, investing in The New Reality is going to be Darwinian – as it should be.

At yesterday’s close of 934, the SP500 has “re-flated” the shorts’ books for a +24% move off of the lows. You can be harder on those US equity short sellers than those who sold short CRB Commodities Index at the bottom a few weeks back – those guys have only had to deal with a +16% “re-flation”… as for the short sellers of our “buy oil” call, well, that percentage move would be too “mean” for me to print.

The reality is that the bears continued to signal the apocalypse cometh while the bulls were too bearish.  That sentiment shift is finally changing however, and we need to call that out this morning for what it is – a fact. This week’s II Bullish to Bearish survey has flashed a positive delta of +3 for the Bulls over the Bears. After a +24% move in US equities and greater than +40% moves in Brazil and Hong Kong, is that a surprise? Absolutely not – this is what the consensus crew does – they chase the performance leaders. To put this +3 delta in perspective, less than 2 months ago, we were signaling a “bottom” in sentiment when the Bears in this survey outpaced the Bulls by a -27 point delta!

I am not a Keynesian, but I do like some of his one liners – “as the facts change”, I do. As sentiment continues to shift to our side of the bullish immediate term “Trade” call on global equities and commodities, I’ll start to walk away. Will I start to sell too early? Of course – that’s what I am really good at – making calls and never seeing the last tick of upside!

So now that I have sold all of the commodity exposure in our Asset Allocation model, and have pared back my exposure to US and International Equities, what are the important levels of support where I come back and buy stocks and commodities on weakness?

In terms of US Equities, there is considerable support that has built itself at the following levels in the following indices: SP500 885, Nasdaq 1538, and Russell 472; on the International Equities front, meaningful support for Hong Kong and Brazil resides at 14,569 and 39,875 on the Hang Seng and Bovespa, respectively; and in commodities land I like buying back the CRB Index, Oil, Gold, and Copper at these prices: $224, $44.73/barrel, $828/oz, and $1.44/lb.

These quant levels in my models used to be resistance – now they are support. If support lines break, it’s bearish, and I will change my immediate term “Trade” point of view alongside those prices.

My name is Keith McCullough and I support this message of transparency and accountability. George Patton’s “bottoms” are processes, not points. Don’t buy into immediate term tops. Don’t sell panic lows. Be patient, and be your own process.

Best of luck out there moving this world forward,

Crisis In Credibility - etfs010709

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%


Trading opportunities aside, the trend for hotel stocks won’t be positive until occupancy turns. The good news is that occupancy will move into positive territory before average daily rate. The bad news is that we are probably still a long way from a sustained up move in occupancy rates.

We are not breaking any new ground by revealing that lodging is a highly cyclical business. The demand cycle is generally driven by economic growth. Fortunately, supply growth looks tame for years to come which should limit this lodging downturn to the duration of the economic downturn.

The stock market is a discounting mechanism and the same applies to lodging stocks. While ADR is the more important metric for profitability, occupancy is the optimal leading indicator of sustained moves in lodging stocks. Since the flow through on room rates is so high, hotels hold rate as long as possible. Typically, occupancies drop long before rates and so while revenues and profitability will continue to accelerate, this is a signal that the industry is on the back side of the cycle.

Similarly, and more germane to the current environment, a positive turn in occupancies signals the beginning of the cycle and usually rates will follow. The following chart clearly shows the relationship between the stocks and occupancy. In the supply led downturn in the mid-90s, occupancy declined well before rate and the stocks soon followed. After the supply situation worked its way out, occupancy and the stocks began a short-lived ascent, cut short by the 00/01 recession and 9/11 attacks. Occupancy recovered in mid-2002 and the stocks commenced a four year bull market in early 2003. Finally, occupancy again began its current descent in mid-2006 and the stocks peaked in May of 2007, no doubt kept afloat by the hope of private equity involvement.

So what are the takeaways for the current environment? We are currently at an occupancy rate around 60% which leaves about 2-3% downside to the post 9/11 low. It could take 9-12 months to get there which probably means we are still a long way from a sustained recovery in lodging stocks. We had gotten more positive on lodging into the New Year, particularly MAR, due to the winding down of timeshare (more cash flow) and unprecedented bearishness. There will be other trading opportunities but for those investors looking for a sustained rally, watch occupancy levels. We don’t appear to be there yet.


Ok, I admit it. I am a lease junkie. I don’t mean to beat a dead horse on issues like differences in rent escalators and contract terms, but the reality is that they matter – a lot. The difference between a 10 year duration and 5 year duration equates to a multi-point swing in margins for most retailers. That can’t be looked over when some of these guys are operating in the mid-single digit margin range.

A client asked me to deliver a comparative analysis of lease structures for different retailers. Note that such projects are a regular part of our business, and upon completion are ‘embargoed’ for a period of time specified by the client – after which I can share if I so choose. This is one where the results were clearly worth sharing. It brought several questions to the forefront for me that I previously did not appreciate.

The analysis looks at the total duration of lease portfolios for different retailers, which we calculate using disclosure of minimum obligations by year on off balance sheet assets (Y Axis). Then on the X axis, we plot the 2-year change in portfolio’s duration. It other words, what is the duration, and are recent actions by management extending or shortening that duration.

There’s no right or wrong place to exist on this chart, but it definitely opens up a few questions regarding management’s growth philosophy where such investments are being accounted for, and how they are funded.

Making sweeping statements based on the analysis would be intellectually dishonest, as there’s no right or wrong place to exist on this chart. This is really more of a tool to ask management teams the right questions regarding growth philosophy, where such investments are being accounted for, and how they are funded. Some observations…

1) Generally, I like shorter durations, as it suggests that the companies have the most optionality lengthen it if they’d like and boost margins vis/vis deferring payments. Not a strategy that I recommend, but it is a lever available nonetheless. Some companies (DKS, DSW) will argue that they are confident enough about their business plan such that they can model sales far enough out to warrant at 10-15 year lease. I find that tough to stomach. The only time I prefer longer-tailed agreements like this is when companies that have ample liquidity take advantage of suffering landlords and lock in longer agreements on the cheap (i.e. we just leased our new San Diego office for a buck a foot. How? It is a new space originally built for Lehman. Enough said…).

2) CAB: How scary is Cabela’s? 20-year duration in its portfolio, with a whopping 4-year growth rate in that over 2 years. Yes, this suggests that new stores are being added to the tune of about 25 years in duration. Good luck with that.

3) LULU: I’m a very big fan of LULU. But this is a negative datapoint for me. A 10.5 year duration is not horrible, but the fact that this grew by 2.25 years at the same exact time the company meaningfully broadened its exposure to the US suggests to me that US stores are being added at a rate far higher than 10 years. It makes me wonder what margins would look like with terms on these new stores closer to a high single digit rate. Definitely something to look in to.

4) UA: Under Armour originally concerned me with a doubling of its rate over the past 3 years to 6.25 years. But this is largely because a) UA is building a retail store network that previously did not exist (which takes up off balance sheet liabs), and b) athlete endorsements are growing at a rate disproportionate to sales as UA invests in businesses like basketball and training. I’m ok with this.

5) HIBB: How could I do this analysis and not mention Hibbett? 4.2 years and has not budged in years. These guys have the ultimate flexibility with their ‘Wal-Mart remora’ real estate strategy. I particularly like HIBB in ’09 bc it should see a reversal in almost every pressure point of the P&L and balance sheet. Consider this…Aside from weak urban business, sales have slowed because of HIBB’s inability to close on new deals over the past 2 years at a rate to facilitate its’ stated growth goal. At the same time HIBB built a DC and installed JDA (ERP system) which are well-needed operational investments. On top of that, the product cycle has been lousy. Now UA is sparking a healthier product cycle, JDA and DC investments are done, and the weakness in credit markets and business trends is making better real estate available at a greater number of mom and pop locations. Not only should growth accelerate in ’09, but margins should go up and take incremental ROIC with it.

6) COLM: I like Columbia, and with a 7-year duration I am not worried. But a 2year boost in duration over 2 years (as it opens more retail) bugs me.

7) DKS: DKS much look good with a 2 point improvement, but that optic is driven by Golf Galaxy. Strategy remains risky.

8) Nordstrom, Kohl’s and JC Penney all hovering around 9 years. But JWN duration improved by a year, KSS was relatively flat, and JCP eroded by a year. I like KSS, have been warming to JWN, and despite a strong near-term incentive structure at JCP, am so grossly uncomfortable with the story that I need to hold out and be greedy on that one.

So many more questions to ask and answer here. Let me know if you’d like to discuss.

The analysis looks at the total duration of lease portfolios for different retailers, which vs. the 2-year change in the portfolio’s duration.

Hunting American Bear...

Much like yesterday’s Chinese PMI chart, today’s ISM non-manufacturing chart found itself a little hook higher (see chart). What happens on the margin matters most to our macro models, and this, on the margin, was another better than toxic economic report.

The bears traps are still land locked in a thesis that bottomed in November, not only locally here in the USA, but globally. In December/January, things started to get “unstuck”, and that’s why equity markets, globally, continue along this path that we have been calling for – “Re-flation”…

Keith R. McCullough
CEO & Chief Investment Officer

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