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Eye On European Presidency: Vaclav Klaus-More Theoretical Than Practical

EYE ON EUROPEAN UNION PRESIDENCY:
Vaclav Klaus—More Theoretical Than Practical

Vaclav Klaus’s son recalled in an interview that when he was 13 his father told him to read Aleksandr Solzhenitzyn to better understand Communism’s oppressiveness. Those not familiar with Solzhenitzyn should note that the Russian novelist, dramatist, and historian exposed the Gulag, the Soviet Union’s forced labor camp system, which he himself served in and became the basis for his book One Day in the Life of Ivan Denisovich.

Suffice it to say that 67-year-old president of the Czech Republic Vaclav Klaus, who recently assumed the rotating presidency of the European Union, is a man shaped by his communist upbringing. In an interview Klaus said, “if you lived under communism, then you are very sensitive to forces that try to control or limit human liberty.”

It is this point about communism’s “repressive” nature that has become the crux of Klaus’s outlook, as a politician and economist. He is an economic liberalist that demands personal and state individualism. Without question, Klaus has provoked strong reactions from the international community.

For one, he is a fervent critic of the environmental movement, calling global warming a dangerous “myth,” arguing that the fight against climate change threatens economic growth. He went so far as to call out Al Gore as an “apostle of arrogance” for his role in the fight against global warming. Additionally, Klaus is a zealous eurosceptic. He claimed that the Czech Republic’s accession to the EU would reduce Czech sovereignty, and said in 2005 to a group of visiting US politicians that the EU was a “failed and bankrupt entity” that should be “scrapped”. He has most recently blamed the banking crisis on too much regulation, rather than too little, which some say display his dogmatic devotion to the free market economist Milton Friedman, who deeply influenced him when he was obtaining his economics degree.

So it should have come as no big surprise—although it played out as a big PR disturbance—that Klaus refused to fly the EU’s flag over Prague Castle on the 1st of January, the day French president Nicolas Sarkozy handed the presidency of the 27-member union to Klaus and the Czech Republic.

Yet while much of the European community is outraged the Klaus represents the “face” of the EU, Klaus garners appeal by Czechs. His credentials certainly speak for themselves: he became finance minister after the Velvet Revolution in 1989, founded the center-right Democratic Party to become prime minister between 1, and has been President since 2003 (reelected in 2008). He is credited with presiding over the peaceful 1993 split of Czechoslovakia into two states and helping to transform the Czech Republic into one of the former Soviet bloc’s most successful economies.

Yet Klaus has also been credited with what Vaclav Havel has called “gangster capitalism”, referring to his radical privatization strategy in 1992—including a voucher scheme that was later emulated in Russia—that led to the amassing of wealth by a few oligarchs. Klaus was also forced to resign as prime minister in November 1997 after a government crisis caused by a party financing scandal. Finally, he espouses friendly ties with Russia and criticized Georgia for causing war with Russia in August.

Klaus’s position as leader of the 6-month European Union presidency begs the question of his possible influence (and to what degree) on Europe and the Czech Republic. Critics say given the largely symbolic function of president in the Czech Republic he will wield little power. Yet Bohumil Dolezal, a leading commentator who once advised Klaus, said Klaus’s greatest talent—and therefore appeal—is his ability to appeal to average Czechs.

While Klaus’s role as President could be written off as strictly ceremonial, Klaus’s popularity and stature could sway the Czech “majority”. While we cannot substantiate this point, fact is that Klaus has an affinity for Russia (at least to the extent that he sided with the Russians in their attack on Georgia), and with the Czech Republic’s geographic location closer to Russia it is worth considering that the former “East” could have more influence Europe now that the “capital” has move to Eastern Europe.

Conversely this geographic shift from Paris to Prague will encourage Central and Eastern European countries not in the EU, or not using the Euro, to join. If Russia hasn’t put a bad taste in their mouths already, its recent stranglehold on natural gas may just tip the balance.

We’ll be looking more closely at the Czech Republic’s balance sheet as we considered our investment strategy in Europe.

Matthew Hedrick
Analyst
Howard W. Penney
Managing Director

Germany's Disinflation...

EYE ON GERMANY: PPI
Declining inflation is a solitary bright point on a gloomy horizon…

The December German PPI number was announced today, registering at -1.20% month-over-month or +4.31 year-over-year, the lowest Y/Y rate since March of last year. This is positive, on the margin, as input costs for manufacturers’ contract - with the heavy industrial and chemical segments particularly helped by collapsing commodity costs. On balance, any benefits from this will do little to offset the contraction of global demand for pricey German exports.

Chancellor Merkel is attempting to push a €50 Billion stimulus package (counting tax cuts and other incentives –including a tax benefit for new car buyers) through the lower and upper houses of parliament this week in the face of increasingly negative employment and production data with the shadow of upcoming elections looming large over all decisions.

Projected 2009 numbers don’t appear to provide relief for incumbents. Today the Economy Ministry said Germany may contract by as much as 2.25% in 2009 - the biggest contraction since 1975, with the jobless rate projected to rise to 8.4% on average this year from 7.8% in 2008.

We’re neutral on Germany respecting that, on a relative basis, it has the strongest of any of the large EU economies. As we see it, being the strongest member of the EU is looking more and more like being the tallest man on a sinking ship.

Matthew Hedrick
Analyst

LVS: MAKING A CALL TO NOT MAKE A CALL

LVS will miss the current Q4 and 2009 estimates but for the first time in a while the Street is not that far off. Our numbers are only 5-10% below the Street’s, and we think that if LVS survives its credit crisis in 2009, 2010 numbers and beyond are probably reasonable. However, we are also aware that given the somewhat binary set of outcomes that LVS faces, and hence “balanced risk-reward” at current stock prices, investors probably aren’t losing a whole lot of sleep about 2010 and beyond.

The incredible volatility in LVS’s stock should provide levels for long and short traders. We’re on the sidelines at this level waiting for the volatility coach to give us an opportunity to jump in the game. In the meantime we’d like to throw out some plays for both bulls and bears.


NEGATIVES:

 LVS is likely to breach the leverage covenant of its Macau credit facility in Q2 2009 unless drastic steps are taken

 The Macau Rolling Chip environment may be decimated by the credit crunch over there.

 In 2007, Venetian Las Vegas promotional spend was 18% of casino revenues, YTD promotional expenses are running at 33% of casino revenues. LVS has just recently started using promotional dollars to lure in slot players, so we believe that promotional spend will probably be around 40% in 2009. Same goes for Palazzo - In absolute dollars, promotional spend at Venetian & Palazzo was $76MM in 2007 and $146MM YTD 2008

 ADR at the Venetian was $259 in 2007 vs. approximately $242 YTD in 2008. Given the weekly STR #s and the offer’s we’ve been getting from Vegas casinos, we believe that ADR will be down about 15% in 4Q08 and deteriorate further in 1Q09. The opening of City Center in 4Q09 isn’t going to help ADR’s recover. We estimate that the cost of cleaning a room is about $70-75, so you can guess where our hotel EBITDA margins are heading

 While the Venetian Macau has been ramping up well during the last 3 quarters, we believe that they will experience significant cannibalization with the opening & ramp up of the Four Seasons


POSITIVES:

 In 3Q08, Venetian Las Vegas held about 10% and Palazzo held about 16% on table games, costing these two properties about $33MM of lost revenues & EBITDA. Assuming normal hold next year, this easy comparison should soften the blow of lower drop

 LVS has implemented a cost savings program that should save them an incremental $50MM or so in 2009

 We believe that in 2Q-4Q08, LVS had one of the higher commission rates in Macau set at 45% (all-in for F&B credits). With the commission potentially capped at 1.25% or 40% currently, this could provide some margin relief for their properties in 2009

 Sands 1H08 results experienced massive cannibalization as Venetian Macau ramped up and have seen some decent recovery in 2H08 which provides an easy comparison

 With most of LVS’s debt linked to LIBOR and other floating rates, LVS will benefit from the massive drop off in rates -3 month LIBOR rates were 1.09% on 1/16/2009, down from average of 2.9% in 2008

 LVS should have positive working capital in both 4Q08 and 2009, generating an estimated $175MM of cash over the next 5 quarters
o Construction Payables should begin to ramp down
o Accounts receivable should also ramp down as LVS has tightened credit extension to players

 LVS’s credit troubles are with the banks, which are more incentivized to provide the company covenant relief at a “price” than would bondholders.
o Banks have $9.5BN of credit exposure to LVS
o Gaming licensing requirement provide a huge deterrence to banks taking the keys in an event of default
o Lack of a transaction market means that even if Banks took the keys, they probably couldn’t sell the properties


Anna Massion
Director

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Eye On Asian Greenspans: Rate Cutting ...

EYE ON MALAYSIA: RATE CUTS
More Easing from Bank Negara Malaysia didn’t won’t accomplish much…

December consumer inflation data released by the Malaysian Department of Statistics today came in at +4.39% year-over-year, well below last summer’s high when CPI seemed poised to enter double digit rates. The central bank took this cue as justification for further rate cuts, lowering the overnight rate by 75 basis points to 2.5% and slashing the statutory reserve rate from 3.5% to 2% effective Feb 1.

But… the benchmark KLSE traded down almost -1% for the day as the investors weighed the prospects of a second government stimulus package.

The big picture for Malaysia is negative, if not awful. As a net exporter of oil and other commodities, the receding inflation figures are a double edged sword –lower prices at the pump come hand in hand with lower prices at the docks. Cooling demand for electronics from developed world economies is weighing heavily on the manufacturing sector.

A second stimulus package or further easing at this stage will likely not do much offset external demand retraction, although further declines by the Ringgit spurred by the rate cut may help shore up some sectors.

See the chart below, which largely reflects the dynamics of stock markets as stealth leading indicators. The “re-flation” rallies we saw in December were largely pricing in the expectation of aggressive rate cutting that we are now seeing here in January. By the time this aggressive rates cutting news is hitting the tape, the marginal buyer has already turned to selling on the news.

Andrew Barber
Director

SP500 Levels, Refreshed

I refresh the math in my models after every 90 minutes of trading. As prices change, I do.

Today’s math reveals a downside support level in the SP500 of 788, and a magnified bearish intermediate term “Trend” – we show immediate term “Trade” rally resistance at 855, and intermediate term “Trend” line resistance overhead (thick red line) up at 879 in the chart below.

Keith R. McCullough
CEO & Chief Investment Officer

Grilling Geithner, As They Should...

Tim Geithner being either careless or unaware on his personal taxes is not an acceptable excuse. We are seeing an overdue expectation of transparency and accountability put forth in this US Government hearing today.

At the end of the day, however, the gun is at the US Government's head. The political winds associated with the US Financials crashing (XLF) this week will force Geithner into this critical seat to head up the Treasury - the reactive media is demanding a bailout, and so are the banks. Paul Volcker himself just called this “the mother of all” financial disasters. They won’t take the time to find someone else for the job.

In terms of policy, today's Geithner grilling reveals a critical point for the US stock market - and that’s simply one of duration. He is clearly pushing out the expectations for the "fix" - and, importantly, Paul Volcker has his back on that. Understanding that The New Reality team of the Obama administration may very well be trying to set up expectations that they can over deliver on... that doesn't mean the immediate term "Trade" in the US stock market owes them any benefit of the doubt.

Next support on the SP500 is 788. I have been selling strength since the opening bell.
KM

Keith R. McCullough
CEO & Chief Investment Officer

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