Spanish Nightmare...

Spain’s Unemployment Tops the European Charts…

Spain’s unemployment in Q4 increased to 13.9% from 11.3% in Q3. Put in perspective this level is nearly double the average EU level; for example the UK reported on Wednesday its highest unemployment number since 1997 that came in at 6.1%. Spain’s level now accounts for the lions-share of euro region’s change in joblessness, per Eurostat.

And the trend does not look to be turning around anytime soon—the Spanish government said it expects the jobless rate to rise to 16% this year, which could be a conservative estimate as the ESADE business school predicts 20%.

The numbers are reflecting reality. Spain is transitioning from a decade-long boom to bust as a result of the leverage cycle finding her dark side. In particular, Spain’s housing industry, which fueled much of the country’s prosperity, is now being turned on its head as prices have depreciate precipitously. As it relates to unemployment, many of the unskilled construction workers that fed the boom are now out on the street, with companies across all industries cutting jobs. Nissan Motor Co. announced it would cut 38% of its workforce.

The government predicts that GDP will contract by 1.6% this year, and the budget deficit will soar to 5.8% of GDP, double the EU’s deficit target range of less than 3%. We think that government estimate is optimistic.

Matthew Hedrick

Stymieing Re-flation: The US Dollar...

Notwithstanding this powerful move higher in Gold today, the US Dollar continues to be a meaningful headwind for both global equity and commodity markets alike.

Looking at the chart below I have painted the bullish/bearish lines of support/resistance for the US$ Index. Up At the 86.61 line, the US$ is overbought, and I suspect that it will signal an immediate term trading bottom in the SP500 as it tests that level. Until then, this newfound US$ strength will remain a major headwind for the stock market. Significant support has built itself up to the 83.78 line. With the SP500 down almost -10% for the year to date, this recent strengthening of the greenback makes sense – after all, during a Crisis of Credibility, cash remains king.

Re-flating gold is what FDR did, and that’s what you are seeing happen globally in the face of the Crisis of Credibility that remains in both the global banking system and the foreign currencies that trade within it. Gold may very well be signaling that we are setting up for another big “re-flation” rally in everything from oil to equities, but the questions of timing and price remains. I think we need to stress test that SP500 line of 800 before I start getting invested again.

Keith R. McCullough
CEO & Chief Investment Officer

Gold Diggers

Gold continues to perform, on both and absolute and a relative basis. Today’s +2.8% move to $86.94 in the GLD etf is pushing us closer to where I’d be looking to make sales, not chasing the gold diggers.

Below we have defined the formidable buying range that GLD has formed ($79.64-83.86). Albeit barely, the GLD is up for 2009 to date, and this compares favorably with most of the major asset classes you can own. As the British Pound gets pounded, the Russian Ruble run over, and the Korean Won wackamoled, it’s no surprise that asset allocators are clamoring for the safety valves associated with the shiny yellow rocks. Some still view gold as a currency, after all.

In our Asset Allocation Model, we currently have a 6% position in Gold – look for me to trim that position into strength from here, then buy it back lower. As the SP500 tests people’s nerves under the 800 line and the VIX makes another run for the 55 level, GLD should continue to flash a positive divergence.

Keith R. McCullough
CEO & Chief Investment Officer

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Obama's Push...

This is more of the same because Geithner and Volcker signalled the same in their hearings earlier in the week - but Team Obama is definitely pushing out expectations re the duration of the bailout (see what our friends at Street Account are confiming below). The market rallied a bit on this hitting the tape, but I think you do the opposite - sell any bounce, until we stress test that 800 line in the SP500.

1/23/2009 10:02:57 AM President Obama says on target for goal of approving economic rescue package by mid-February -- wires


Opportunities like this don’t come around too often. I’ve never seen a gaming stock trade so far below what I would consider to be its true value. BYD’s net free cash flow yield (NTM) hovers around 40%. On 2010 numbers, the yield climbs to 50%. Even if I stress test the model and take EBITDA down 20% from my current 2010 projection of $485 million (includes 50% of Borgata EBITDA), the yield is still an astonishingly high 35%. The $485 million is already 21% below the level achieved in 2007.

So what explains this absurdly low valuation? Investors may not believe the numbers. I think I’ve addressed that concern by haircutting EBITDA another 20%, which still yields a very cheap stock. Second, investors believe that BYD will bust a covenant and possibly go bankrupt. We’ve run the numbers. As we pointed out in our 01/17/09 post “BYD: A NOT SO RISKY BUSINESS”, BYD has a number of levers to pull to avoid breaching the leverage covenant should business deteriorate below our projections. Management is not concerned.

Once through 2009, it is smooth sailing on the covenant sea. The maximum leverage restriction actually escalates from 6.5x in 2009 by 0.25x each quarter of 2010. Meanwhile, BYD will be generating positive free cash flow each quarter beyond Q1 2009 and reducing debt, even under dire projections. After taking EBITDA down another 20% in 2010, BYD still doesn’t bust the leverage covenant.

So if you’re willing to bet on BYD as a going concern how do you value the stock? I’m a cash flow guy so I’d rather look at multiples of free cash flow. EV/EBITDA is also appropriate. But there is more. BYD still owns the Echelon parcel, 65 acres right on the Strip. I know I’ll get push back on this but if you believe BYD is a going concern you have to include land in the value. I know of 3 groups/companies that would pay $5-10 million an acre for that parcel in a heartbeat. That’s $325-650 million in asset value that is not currently generating cash flow. By the way, BYD’s market cap is only $415 million. In a pinch, BYD has a huge cash source without changing the ongoing cash flow stream.

The first grid provides a valuation analysis based on per acre land assumptions and varying EV/EBITDA multiples. The second grid values BYD on a multiple of free cash flow, which is more appropriate in my opinion. The last grid assumes that 2010 EBITDA falls 20% below our expectations. Even under this assumption BYD appears grossly undervalued.


RUST - asset allocation012309

“Iron rusts from disuse, stagnate water loses its purity and in cold weather becomes frozen, even so does inaction sap the vigor of the mind”
-Leonardo da Vinci
One thing Research Edge can’t be accused of is inaction or playing it safe.  In the midst of a consumer recession, a financial depression and the worst market in a lifetime, we set out to build a new financial services firm.  Our version of the “New Reality” financial services firm puts our clients first, without them, we have no business. 
Every day of the week we are making calls, and in some cases they are “bold” calls – a client’s description not mine!  We believe the only safe thing to do is to take the shots that need to be taken.  Play it safe and you will stagnate.  I was taught early on that taking calculated risks is the essence of hard work.  In 2009, this is the difference between working for you and working for the government.
While many of the same Wall Street traditions still live on, it’s just not the same.  Surprisingly, I learned last night that there is still way too much research capacity on the street.  Darden Restaurants is a $3.7 billion company with 19 publishing analysts and 9 firms attending the annual analyst meeting that don’t cover the company. My guess is that a majority of the people on “the street” attending this conference are less focused on the business of making clients money, and are more focused on whether their employer is solvent or not. 
As far as I’m concerned, the largest US financial services firms have already been nationalized and now it is just a matter of a formality.  The debate over the status of some of the financial services firms reminds me of last year’s debate over whether GM is bankrupt or not!  Of course it was bankrupt, and yes, the government is running our largest financial institutions.  If we can get past this, we can focus on the “new normal” state of the economy and consumer spending. This implies that the market can focus on the facts and not speculate about what could happen.  Yes, some of the facts about the economy are ugly, but looking beneath the surface there are some real signs of life. 
As I thought about the firms attending the Darden analyst dinner last night, I realized that none of their firms allow their clients listen to their morning meetings, which is the cornerstone of our Tier 1 Macro product.  In addition, every day the market is open the collective analysts at Research Edge can give you two dozen things to think about, and we only have six publishing analysts. 
Shortly, I will be publishing our S&P 500 sector view which comments on the trends in the S&P 500 and the nine major sectors.  As we look at the S&P 500 today, it’s quantitatively broken in terms of both the “Trade” and the “Trend”. The financials are the only sector to have broken the November 2008 lows, as reality has set in.  Healthcare and utilities look the best, with the XLV (Healthcare Sector etf) having a great day yesterday.  The “re-flation” trade and the aspirational consumer are sitting on the sidelines – think wants versus needs.  Excluding Apple, nearly every technology company is a closet “industrial” company, and most are seeing cyclical weakness.  See the RE Macro Sector view PDF for more details. 
Relative to our constructive commentary on the consumer discretionary sector we were hit with a body blow as the economic backdrop remains ugly, which was highlighted by the initial jobless claims rising by 62,000 to 589,000 in the week-ended January 17th, matching a 26-year high!  This makes the “E” in “M E G A” a little harder to swallow.  We will see what next week brings.  As the facts change, so do we.
Function in disaster and finish in style!
Howard Penney

RUST - etfs012309

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