Chart Of The Week: 2009 Year To Date SP500 vs. Gold...

On a week over week basis, gold was +7% and the SP500 was -2.1%. For 2009 Year To Date, this puts Gold +2% vs. the SP500 at -7.9%.

In reviewing this past week of price changes across global macro, the most interesting callout here is that the US Dollar has been going up at the same time gold has. A strengthening dollar has effectively hammered equity prices everywhere but in China. Meanwhile, last week at least, the early signals of “re-flation” have manifested themselves in both 10 year yields, gold, and oil (oil had a +27% move this week, and 10 yr Treasuries sold off taking 10 yr yields 30 basis points higher week over week to 2.62%).

What does all of this mean? In the face of an improving American credit and liquidity picture (narrowing TED spread, steepening yield curve, etc…), there remains a Crisis of Credibility in Foreign Currencies, large cap US Financial Stocks, and US Treasury Bonds alike.

Keith R. McCullough
CEO / Chief Investment Officer

Eye on RL Promos

You don’t need to be a rocket scientist to know that Ralph Lauren’s business is suffering – i.e. Coach, Tiffany, Burberry, Guess!, Nordstrom, Sacks, etc… But I was pretty shocked to see that the online discount activity has changed very little versus this time last year. Better inventory management? Better control over .com business after year 1 of repo from GE? Or simply lack of read through in velocity of sales through discounted price points represented in this advertised sample?? Maybe all of the above.

We’re not making a bull call on RL’s business, but when I stress test the model in the worst way imaginable, I can’t get below $3.50ps. Realistically, I still think that a $4.00 number or better is in the cards. This is something to consider with the stock under 5x EBITDA.

Eye on Earnings Revisions

Lack of erosion in revision factor sent this group higher. Now we’ve got the lowest earnings expectations in at least 10 years on trough multiples. Be VERY selective.

These charts speak volumes. Yes, earnings revisions are bad, but the rate of change has stalled. The SECOND that this happened, the stocks ripped.

Even though we need to see revisions ease from here for another move in the group, now we’re looking at 12x earnings when the Street is looking for 12 month forward earnings to be down 4%. That’s the first time in over 10 years I can find a period where the Street is actually looking for down earnings. Pretty tempting at face value.

It’s near impossible to call the bottom here – as there are so many companies where that -4% decline will prove to be a pipe dream. But there are plenty of names that have been tossed aside, and I think will grow meaningfully better than expectations next year. RL, HIBB, UA, and PSS, to name a few.

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US Market Performance: Week Ended 1/23/09...

Index Performance:

Week Ended 1/23/09:
DJ (2.5%), SP500 (-2.1%), Nasdaq (3.4%), Russell2000 (4.7%)

2009 Year To Date:
DJ (8.0%), SP500 (7.9%), Nasdaq (6.3%), Russell2000 (11.0%)

Keith R. McCullough
CEO / Chief Investment Officer


We have ASCA pulling on every lever in their arsenal and, short of raising subordinated debt or amending its credit facility, we don’t see how the company avoids a covenant breach. The maximum senior leverage ratio allowed by the credit facility steps down from 5.25x in Q1 2009 to 5.00x in Q2. It is almost a mathematical certainty that ASCA will bust this covenant in Q2. Despite the incremental cash flow from LIBOR dropping to 1.12% this past week, and factoring in almost zero in maintenance capex in Q4 2008 and Q1 2009, we estimate the senior leverage ratio will reach 5.40x at the end of Q2.

It could get worse. ASCA will only barely escape the 5.25x in Q4 and will likely breach the covenant at the end of Q1, even before the step down. ASCA needs to act and act fast. The most likely course of action is a junk bond offering. Unfortunately, in today’s environment the interest rate will likely approach 20% versus ASCA’s current average borrowing rate of around 4.5%. Thus, on a $200 million subordinated debt offering, ASCA could incur an incremental $30 million in interest expense and a $0.30 hit to EPS.

ASCA could breach covenant in Q1 and most certainly in Q2

Not the Supply Chain Margin Flow I’d Expect

Despite anecdotes from athletic footwear/apparel brands and retailers about pricing pressures, we’ve not seen broad-based flow through of inflationary pressures disproportionately hit the US -- yet.

With so much capacity closing in Asia over the past 12 months (upwards of 1/3 of factories in China’s Pearl River Delta alone), my rather strong view was (and still is) that larger Asian manufacturers would begin to gain pricing power and push costs through the US supply chain (brands and retailers). Oddly enough, this has not proven to be the case as outlined by the chart below.

My sense is that the initial hit is enough to get lost in the smaller companies that do not show up in the sample of publicly traded companies. But it is a near-mathematical certainty that these pressures will work their way up the quality curve.

We can’t make any broad-based statements about who to own and not own in this context – other than to say that the key is to flag those companies that are managing through this proactively vs. reactively. On the proactive side, I like UA, NKE and HIBB. On the reactive side, it pretty much includes everyone else…

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