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Eye On India: This Isn't China!

MACRO: ASIA -Indian Industrial Production

Although the November numbers look bullish on the margin, we think it is a head fake…

India’s industrial production numbers came in at 2.4% for November, unexpectedly stronger, sequentially, after October’s -0.34% decline. This positive data point was not enough to stem the tide of post -Satyam selling as Sensex sold off by another -3.2% on the heels of a -1.88% decline in Friday’s session. The cumulative decline in India’s stock market has been approximately -12% in less than a week.

This production data looks positive on the margin. From an industrial manufacturing standpoint, India should have a few things going for it now… in Theory:

• Cheap Labor and good engineering schools
• Lower basic material prices globally
• Strategic geographic location
• Sharply decreased maritime shipping costs
Whereas the Services sector is being held hostage by declining demand in the US and Europe, and the problems facing the agricultural sector are too involved to touch on here, the Industrial portion of the subcontinent’s economy should be able to retain a relatively competitive stance in pursuit of what demand remains. It probably won’t.

India’s union biased employment laws and socialist governmental policies will make it difficult for producers to capitalize on the vast sea of cheap skilled and unskilled labor around them effectively. Additionally, the obese overlapping state, local and national governmental bureaucracies have made it virtually impossible to create new industrial facilities –with years’ worth of legal wrangling required to build new factories and badly needed new ports.

We have been negatively biased regarding India since I started at Research edge, which was the day we opened our door. We continue to believe that the deep structural flaws in the Indian economy outweigh the massive potential that lies there.

Andrew Barber

Golden Eye: Buying More Gold Today

The last time/price we sold out of our long position in GLD (Gold’s etf) was 12/29 at $86.66. The only fundamental facts that have changed since that date play in gold’s bullish favor.

As the entire free world devalues their respective currencies (at $31.12 per USD, the Russian ruble dropped to a 6yr low this morning, putting it down -25% since the price of oil peaked in July/August of last year) in order to stoke export growth and re-flation, gold continues to look attractive. Today I am taking Gold to 6% of my Asset Allocation model, up from 3% prior.

See the chart below for my buying range in the GLD etf (in green): in terms of physical gold, this green range is the equivalent of $812-$838/oz. I’d sell some up at $891/oz (dotted red line).

Keith R. McCullough
CEO & Chief Investment Officer

MCD – Adding complexity to the system

The NY Times ran an article over the weekend that highlights MCD’s recent success against the backdrop of both a struggling economy and restaurant industry. Specifically, the article points out that the company has delivered 55 consecutive months of global same-store sales growth and that MCD shares increased nearly 6% in 2008 when the stock market lost a third of its value. The article attributes much of MCD’s outperformance to the company’s turnaround efforts which began in 2003 and focused around the then CEO James Cantalupo’s “Plan To Win.” This plan shifted the company’s strategy and focused largely on improving in-store operations and growing same-store sales performance rather than relying on aggressive, new unit growth to drive sales. It was a back-to-basics strategy that worked to improve the customer’s experience by refreshing MCD’s existing store base and by upgrading the quality of the food being offered.

Prior to this turnaround period, the article reported that “McDonald’s was struggling to find its identity amid a flurry of new competitors and changing consumer tastes. The company careened from one failed idea to another. It tried to keep pace by offering pizza, toasted deli sandwiches and the Arch Deluxe, a heavily advertised new burger that flopped. It bought into non-burger franchises like Chipotle and Boston Market. It also tinkered with its menu, no longer toasting the buns, switching pickles and changing the special sauce on Big Macs. None of it worked.”

The WSJ ran an article in mid December about the best CEOs of 2008 and included MCD’s CEO Jim Skinner among its list. This article also pointed out that the company’s success stems from the fact that it “has done a terrific job of improving what it does at its existing locations, improving the food, improving service, expanding the menu, expanding hours. They've stuck to their knitting and made their existing stuff better and it's paid off."

I would agree with the conclusions of both of these articles that MCD has improved its performance by focusing on initiatives within its four walls, which resulted in higher returns. The company had lost its focus on what made it great by failing to execute on a store-level basis as it tried to expand its menu and store base in every direction. This misdirected growth and subsequent return to basics strategy which has enabled MCD to outperform formed the basis of what I like to call sustainability or “Shrink to Grow.” SBUX is undergoing a similar turnaround now as it closes underperforming stores and refocuses on the customer’s in-store experience.

I would argue that MCD’s current specialty coffee launch is a shift away from the basics and will prove to be a distraction for the company. The specialty coffee program is the most expensive new product initiative in the history of the company, costing the company about $100,000 per restaurant to implement in the U.S., as MCD has to revamp its current drive-thru configuration to accommodate the beverage equipment. I don’t think the beverage strategy will drive the top-line numbers that most are expecting. At the same time, it will increase the complexity of the system.

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Bush's Bottom?

George W. Bush just finished giving his final Q&A to Washington's finest revisionist historians. It was as colorful an interchange as we have seen in quite some time.

While it's hard to find a case whereby Bush's approval rating as President of the United States drops further (there's only 1 week left!), I never say never...

While watching the man's confidence in the manic media's myopia drop at the same expedited pace that crude oil is today, I can't help but wonder what a Bush bottom will look like, in hindsight, weeks and months from this day...

Some bottoms start with the end, after all...

I am long SPY, looking forward to the Thursday/Friday US PPI and CPI deflation reports.

Keith R. McCullough
CEO & Chief Investment Officer

The Risk Manager

The Risk Manager - asset allocation011209

“The magic lies in orchestrating the extremes…”
-Mick Malisic, 2008
Mick is our Chief of everything Creative Design here at Research Edge, and when he said that to me last year... I paused… and looked at him and said, “Mick, you would be a great risk trader.”
Make no mistake folks, this is a global market of interconnected macro factors that needs to be risk managed with both precision and a process. The “extremes” of October- November 2008 have burned imprints into most trader’s heads. Those days are behind us, and the volatility (VIX) associated with them has been cut in half as a result. There is a huge difference between a global risk manager and a securities trader. Don’t mistake one for the other.
SP500 futures traders who got bulled up at the 941 peak of last week and freaked out 72 hours later on Friday’s closing low of 890 (-5.4% lower) are not risk managers – they are the people we to wake up and manage tail risk for. Not unlike most of the “prop desk traders” that are no longer part of the core “Investment Banking Inc.” business model of the 25 year bull market past, most of them come and they go.
Most of the received wisdom in this business would have told you 18 months ago that the likes of Dick Fuld and John Mack were “great traders” – I have no quibble with that. Bull market traders they were, indeed. No one in this business who ever worked with Vikram the Pandit “Bandit” will ever tell you he could trade anything. Some of the guys on the floor at Morgan Stanley used to make fun of him calling him “Trader Vic” (you don’t want to be that guy).
Pandit is good at trading his credibility however. After telling his team he wouldn’t sell Smith Barney, it looks like he is going to hope the You Tubers don’t call him on the mat again, after he turns around and sells it to Morgan Stanley. The US Financials (XLF) etf is the worst looking sector exchange traded fund in our 9 Sector S&P Model for a reason – there remains a “Crisis in Credibility” in the leadership at these horse and buggy whip investment banks. Our models had the critical breakdown line of $12.23 broken in the XLF on Friday. The math doesn’t lie, people do.
In stark contrast to the legacy US Financials that everyone and their brother wants to “buy because they’re cheap”, 7 out of the 9 SP500 sectors look relatively healthy. This is also part of “The New Reality” associated with markets and sectors that continue to close at higher highs and higher lows. The SP500’s test of 941 was a new 3-month cycle high, and at 890 it is still a healthy +18.4% higher than its cycle low of 752.
So what is the risk trader to do? I started buying US Equities again more aggressively on Friday, taking our Asset Allocation Model’s position in US stocks up to 21% from 9% on Wednesday. I actually bought the SP500’s etf (SPY) outright, and that’s something I have done very infrequently over the course of the last 12 months – does that mean anything to most of the said masters of the hedge fund universe? I don’t know – I’m just a newsletter writer with a better than bad batting average.
All 3 of the following levels in the major US stock market indices would have to be overcome (we need to close below them, not trade below them) for me to move back to the dark side of trading my shorts more aggressively: SP500 887, Nasdaq 1550, and Russell 476. Yes, those are very close to where we closed trading on Friday. No, managing risk in a bear market is not for the faint of heart.
After the 2nd worse year for the US market since 1871, plenty of money managers and the manic media alike basically aren’t allowed to be bullish anymore – with the SP500 already down -1.4% for 2009 to date, the trigger fingers associated with chasing short term performance are already shaking. This is good - crisis in confidence creates opportunity.
What has people shaking is a view that I don’t share – that unemployment trends in this country will sequentially accelerate (on a 6-month basis) from here. This 7.2% unemployment rate, of course, is last year’s number. Markets move on expectations of tomorrow, and this past week’s -4.5% drop in the SP500 implies that the masses genuinely expect US unemployment to worsen – and I agree that it will – but NOT at an accelerating 6 month rate…
That’s why I am getting bullish for another “Trade” higher in both commodities and US stocks. Everything that matters in my macro model occurs on the margin. If the unemployment rate starts to go up at a decelerating rate, the US stock market is going to continue to make higher lows.
US jobless claims have improved materially in the last 2 weeks, and we are eight days away from Obama waking people up to the simpleton math that he has 3M jobs on his accountability card to get on the tape in short order (the USA lost 2.6M jobs last year).  Do we have a lot of economic problems in this country? You bet your Madoff we do! They are much larger than the spreads he stole. This, however, presents the Capitalist with one of the greatest opportunities that has ever presented itself – to rebuild the US Financials sector on our handshakes.
Yes, that will take time. No that wont equate to the current US Financial stocks that have inflated market caps to outperform – but together, stylistically at least, this rhymes with where the US stock market is flashing Sector Level divergences. The American consumer of financial services is taking back this country from the bankers. Be patient on price, and always pay attention to Mick’s “extremes” – that’s where we should continue to find the magic of risk management.
Have a great week.

The Risk Manager - etfs011209


With the ICR conference this week, it’s important to look at the ‘serial preannouncers’ of years past. Many have already fallen. GES, WRC and VFC have yet to comment. My bet is on VFC.

Warnaco’s expectations look fair to me. Ditto for Guess!. But VF Corp is a different story. We need to assume that VFC’s 4Q business meaningfully outperformed in order to a) hit the quarter and b) mitigate the chance of a tepid outlook. That’s tough to assume. The North Face is weakening on the margin, the denim business is feeling price pressure from Levis in Wal*Mart, FX is not helping anymore, and the department store business – including contemporary brands – are not where they need to be.

In the meantime, VFC is trading at 6.5x EBITDA (30% premium to the group), 80% of sell-side ratings are ‘Buy’ (with no Sells), short interest remains low at 3.5% of the float, and management buying has been nil.

VFC’s communication strategy is quite good, which is why the company so frequently preannounces before a public appearance. Such announcements are usually positive for VFC. The math is tough for me to get all bulled-up this time. In fact, I’d argue that even a lack of an announcement is a negative.

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