Eye On The New Reality

A New Home On Wall Street, in…New Haven

Gregory J. Fleming, the former president and chief operating officer of Merrill Lynch & Co., was appointed Senior Research Scholar at Yale Law School, which just happens to be located on the corner of Wall St. and York St. Coincidentally, it is also about two blocks from our offices on 111 Whitney Avenue in New Haven.

Fleming joins the list of ML employees jumping ship after its merger with Bank of America. A culture clash has erupted between Bank of American and Merrill over what many former ML brokers describe as an under-appreciation by their new boss of the broker-client relationships they bring to the firm. This comes in the wake of Bank of America’s CEO Kenneth Lewis proclaiming that ML’s 16,000-strong brokerage group as the “crown jewel” on the day he unveiled the acquisition.

The departure of Fleming, who was slated to run the corporate and investment banking unit, demonstrates Wall Street’s inability to retain talent as Investment Banking Inc. rolls over in the “The New Reality”. On Jan. 5, Robert McCann, head of Merrill’s brokerage and a 26-year veteran of the firm, resigned.

Matthew Hedrick


SONC recently announced the addition of several value items to its menu. Earlier this week, on its fiscal 1Q09 earnings call the company stated that its change in strategy is in response to the fact that in the past several months, QSR growth has come primarily from value offerings. This statement is supported by the charts below, based on NPD data, which show that QSR deal traffic growth has really picked up since early 2008 and has been steadily increasing as a percent of total traffic since mid 2007. Based on this data, it suggests that SONC’s new value focus is necessary if it wants to be successful in gaining market share in today’s environment. It will, however, drive traffic at the expense of margins (please refer to my post from yesterday titled “SONC – Management Seems Disconnected from Reality” for more details). That being said, I think it is the right move in the near-term from a competitive standpoint.

As I have said many times before, the restaurant industry is a zero sum game so if SONC’s new value offerings enable the company to increase its traffic growth, this growth will be coming from somewhere…its competitors. And, SONC said that in the 10 days since it implemented its new value menu that its comparable sales growth and traffic have turned positive. WEN has also experienced success recently with its aggressive push into the value arena with the introduction of its Double Stack Cheeseburger, Jr. Bacon Cheeseburger and Crispy Chicken Sandwich, all for $0.99. Although Wendy’s 3Q company-owned same-store sales declined 0.2%, they improved sequentially throughout the quarter and were up 2.1% and 5% in September and October, respectively, following the September introduction of these three value items. Again, with this incremental growth, WEN is stealing market share from someone. I would guess that MCD, which has posted consistently strong U.S. same-store sales growth, has the most to lose should WEN and SONC continue to experience improved traffic growth.

BKC might be another potential market share loser as the company is currently pursuing a strategy that focuses more on its premium products. BKC is not abandoning its value menu, but it is increasing its focus on innovation that will give the company more pricing power. Pricing power is by no means a bad thing and if the company is able to achieve both increased pricing power and traffic growth, then BKC will come out a winner. Based on the fact that value is the current driver of industry traffic growth, however, I don’t think this will be the case. Specifically, BKC management said on its most recent earnings call, “You have to look at value in terms of price point accessibility, which is what our value menu provides but then value for the money also comes with premium products that are on par with casual dining that are available for a fraction of the price. We work the value for the money equation on both ends of our menu. We have no plans to abate our advertising levels around the value menu but we’re going to continue to drive against higher quality and innovation which are better values for the money then one can find in casual dining as well.” I think it will be difficult for BKC to gain share from the casual dining segment right now with all of the attractive price points casual dining restaurants are currently offering. Personally, I see more value in the $5.99 burger with endless fries that is now being promoted at Ruby Tuesday’s.

Like BKC, CKR could also experience some near-term market share losses as it maintains its premium offering strategy. CKR management has said numerous times that it refuses to participate in the discounting tactics of its competitors by offering what it calls “low priced margin impairing products.” CKR is probably making the right decision for the long-term because these discounting initiatives will inevitably hurt margins. MCD has maintained its same-store sales growth with the help of its Dollar Menu, but it has also seen its U.S. restaurant margins decline for the last seven quarters. So the traffic growth versus market share tradeoff debate continues…


I think I’ve expressed my concern surrounding WYNN’s Q4 pretty clearly over the past several weeks so I’d like to turn my attention to 2009. Unfortunately, the picture looks even worse. In 1H 2008, the Rolling Chip (RC) environment was flooded with credit and Wynn Macau was a major beneficiary. Moreover, Wynn’s Mass Market (MM) business benefited from loose visa restrictions in mainland China and an upswing in credit directly from the casino. Wynn Macau knocked the cover off the ball, generating 70% and 27% growth in RC and MM revenue, respectively, in 1H 2008.

What a difference a year makes. Junket credit has dried up and direct credit has been tightened. Strict visa restrictions will likely impede Mass Market growth. Q4 2008 was the worst quarter of the year in both segments. The first chart provides quarterly revenue and year over year growth by segment for Wynn Macau for 2008-2009. Assuming a Q4 run rate for all of 2009, Wynn Macau’s 1H 2009 RC and MM revenue could fall 28% and 18%, respectively. While there is some seasonality, particularly in Q1 with Chinese New Year, the offset is the continued deterioration in the credit situation.

The second chart details how overly optimistic analysts appear to be with their Wynn Macau and WYNN corporate EBITDA estimates. We estimate Street EBITDA projections for 1H2009 may need to be reduced by 24% and 18%, respectively, for Wynn Macau and WYNN corporate.

Difficult comps and deteriorating trends
Analysts not bearish enough

US Employment: It's always Darkest Before Dawn

One important component to my call this morning to be buying/covering stocks in the SP500 range of 885-900 (right where we are now), is to consider the chart below within the construct of expectations.

Before we look forward, let’s take a deep breath, and a step back… and look at where this chart has come from on this very January day of 2008 – when all smelled like a rose to those who couldn’t afford to foresee smelling anything else.

Today the fear associated with unemployment trends in this country are backward looking – the amount of emails I get about “Depressions” is one sure fire proxy of what that level of doubt investors have in their mind right now that this unemployment trend could reverse.

Looking forward, all I need to see is a probability that the delta in this chart turns to the negative (i.e. unemployment accelerates at a lesser rate). As you can see, there has been a steep ramp in expectations catching up with reality in this country. The trailing economic data is telling you why we just printed the 2nd worse year for the US stock market since 1871. The New Reality is that was 2008’s “news” and that the USA has a 7.2% unemployment rate.

While the pundit patrol talks about “Great Depressions”, after the big moves have been made (unemployment during that Depression was 23%, and if we were going there, I would be scared of my own shadow too), consider this question: could I be emailing you an unemployment chart on this same day, next year, reviewing that this was both a peak in terms of quarterly sequential acceleration and the US manic media’s pessimism embedded therein?

Keith R. McCullough
CEO & Chief Investment Officer

Buying Adversity, At A Price

Buying Adversity, At A Price - asset allocation010908

“Nearly all men can stand adversity, but if you want to test a man's character, give him power.”
~ Abraham Lincoln

When reflecting, Barack Obama often cites Lincoln… and for that… we should all be thankful. Having a President who actually pauses before something comes out of his mouth, who is both proactive and patient with his words, is a welcomed leadership change that we can invest in.

Whether you are a Democrat, Republican, or neither, I don’t think your political affiliation will do a darn thing for you in trying to earn a return in The New Reality. What you will need is the ability to stand tall in the face of the market’s adversity and ask yourself the tough questions when it’s the toughest time to ask them.

From the very beginning, Obama has been doubted. So don’t doubt for one second that expectations for him to over-deliver versus the levity of his rhetoric will continue to face adversity into his Presidential Inauguration. Being long Obama’s principles has been THE winning “Trade” that has trumped consensus politics for the last nine weeks. Since November, every time this man’s character has been tested by the US stock market’s Crisis In Credibility, the fact of the matter is that the SP500 has made higher lows. Credibility starts with this man’s word potentially meaning something.

Yesterday’s market action was no different. The SP500’s early morning lows were laced with the fear and adversity associated with a consensus that Obama can’t fix this country’s problems today. Now that everyone who didn’t have it in themselves to ask THE question as to where unemployment and savings rates in this country could go at this time last year considers themselves professional “Great Depression” analysts, once again that groupthink is facing the tremendous adversity associated with the madness of crowds. They are myopically anchored on yesterday. They are structurally blind in seeing the potential of the opportunities associated with tomorrow.

This is mainly why I have been hammering home the patience point – be patient on price. Yes, after the SP500 ran up to 941 at 3PM on Tuesday it was overbought. Yes, when the SP500 was on its intraday lows of 897 at 10AM yesterday it was oversold. Buying into adversity is all about expectations, prices, and timing. If you don’t have a process to monitor these critical factors surgically, use ours.

The math here is what it is. At 941 SP500, we had already run a truck through the short selling “ideas” of the US Consumer “Depressionistas.” Since the November 20th panic lows of 752, we had ourselves +25.1% price “re-flation” to sell into. At yesterday’s intraday low, you had a 48 hour sale of -4.7% to buy into. Everything has a time and price.

While the manic media is painting the apocalypse ahead of this morning’s widely anticipated unemployment number, please consider timing. On Monday, that unemployment print will be a historical event, and the short sellers of higher lows will be forced to consider Tuesday January 20th, 2009. Will the SP500 breakout to 1000? No, that’s not my call. My call is that it could very well make higher highs than 941 and test 954. The math implied at the 954 line is +5% from yesterday’s close and +27% from the November lows – that’s math that investors chasing relative or absolute performance cannot afford to miss.

Does managing this US market like a doctor would her patient in the operating room require precision “Trading”? You bet your Madoff it does – the “long term” investor calls it whatever they call it – I call it risk management.

The best risk managers in this business, and in life for that matter, always consider “improbable” events, and manage their decision making in consideration of what no one thinks can happen. This morning, everyone and their brother thinks they’ll see the 7% unemployment rate that we called for 6, 9, and 12 months ago – what if it’s 8%? – I don’t think it will be, but what if it is? What if its 6%?

The point here is that you better have a plan for both 8% and 6%, because the crowd expects 7%. My plan is simply this: No matter what that number is, if the SP500 holds my buying range of 885-900, and the VIX (Volatility Index) keeps its head under $50.21, I COVER, and I BUY.

Yesterday I saw those prices, and went shopping, taking my asset allocation model in US Equities back up to 18% versus the 9% position I had sold that exposure down to by the time my Wednesday morning Early Note went to print at the Transparency/Accountability press.

I have started to buy my position in Commodities back. As usual, I started with a conservative 3% position in Gold – call me boring; I’m cool with that. After markets get squeezed like this one has, at the top of intermediate market moves I am an incremental buyer of low beta and a short seller of high beta.

The highest beta “Trade” you can make into any US market weakness this morning is short-selling weakness ahead of Obama’s January 20th date. In the face of that adversity, provided that my prices hold, I’ll be buying everything that my old friends in the bear camp have on the offer.

Have a great weekend,

Buying Adversity, At A Price - etfs010909

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