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Daschle Withdrawl: What's The Macro Call?

From our Healthcare Sector Head, Tom Tobin:

"This is positive for healthcare. Delay to name a successor when timing is everything in getting major Heathcare Reform done. Also negative for the dollar as entitlement spending remains a long term budget risk."

KM Macro Read Across:

1. Healthcare (XLV) is now +1.7% on the day - we are long that ETF.
2. US Dollar (UUP) remains weak today - we are short that ETF.
3. US Dollar weakness augurs positively for US stocks in the immediate term.

Ruble Rubble

Russia’s currency shows signs today of stabilization after a week of consecutive drops and a pledge by Bank Rossii Chairman Sergey Ignatiev on January 22 to insure that the Ruble stays within its 41 target level versus a Dollar/Euro basket.

We’ve been following the Ruble’s slide in our playbooks as the slump in oil prices over the past six months has weakened Russia’s energy economy. In trading yesterday the Ruble touched its lowest level against the Dollar at $36.3550, just short of the critical 36.45 per Dollar level to break through its band versus the Dollar/Euro basket.

Russian foreign-currency reserves, the world’s third largest, currently stand at $386.5 Billion from a July high of $462.7Billion, a decline of -16.8%, as the central bank attempts to offset the Ruble’s slide. The question remains: will these measures be enough to right the Russian ship, and equally, what degree of tail risk could be associated with Putin’s attempt at a “gradual and careful” devaluation over the last weeks?

Already the numbers look atrocious: the Russian stock market is down -79.4% from its high on 5/21 last year and down -15.3% YTD. The Ruble has lost -56.2% versus the USD since its low on 7/15/08. Just last week the IMF forecasted Russian GDP at -0.7% for 2009, which we think is too aggressive an estimate.

In this recessed environment a weaker Ruble will encourage exports yet will increase the cost of imports and aggravate domestic inflation. Further, a weaker currency and an unstable market encourages investors to flee to safer investment havens, which has already begun, with withdrawals equaling ~$290 Billion leaving the country already.

Should oil hold around the $40 range, we expect Russia to run a much larger deficit than the IMF prediction. The Ruble’s low against the Dollar and Euro begs the question if Russia will be able to maintain the trading band as the governments hopes for an oil reflation trade. If you’ve read our work hope is not a valid investment process.

Matthew Hedrick
Analyst

Eye On US Housing: Better Than Toxic is Good

EYE ON U.S. HOUSING – PENDING HOME SALES

The Pending Home Sales Index is a leading indicator for the housing sector, based on pending sales of existing homes. The Pending Home Sales Index, rose 6.3% to 87.7 in December from an upwardly revised reading of 82.5 in November, and is 2.1% higher than December 2007 when it was 85.9.

The improvement in the index is spurred by buyers responding to lower home prices and lower mortgage interest rates. According to the NAR, “The biggest gains were in areas with the biggest improvements in affordability.” While the housing market is still facing significant issues, on the margin, this is good news for our “MEGA” investment thesis on the US Consumer. The US Consumer Discretionary sector etf (XLY) is leading the market higher today, trading +1.5%, partly as a function of this data point.

At the center of the housing crisis is the decline in home values and the consumer’s ability to stay in his or her home. In the coming weeks, we will hear from President Obama that he is seeking to stem the record surge of foreclosures (the biggest contributor to the decline in home prices) by using government guarantees for modified home loans.

The US housing market is still extremely challenging, but significantly lower prices, lower interest rates and government guarantees will help put a bottom in the US housing crisis. Remember, everything that matters in our macro models occurs on the margin – going from toxic to bad, in this case, is good.

Howard W. Penney
Managing Director

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Eye On Re-Regulation: Hedge Fund Update...

For whatever reason, I missed posting on this last week, but this data point has not hit the mainstream media, yet...

At the end of last week, Senators Grassley (R-IA) and Levin (D-MI) introduced “The Hedge Fund Transparency Act”...

This is what it is - it's all part of an investment theme that we have long held which is simply that all that is not well in American finance will end in regulation and litigation.

Congress has already summoned the bankers who have TARP moneys to appear in Washington next week. Asset managers will definitely have their turn on the hill. This cleansing of our economic system will take time. Look for the principles of Transparency and Accountability to become ring tones at America’s kitchen table.
KM

Keith R. McCullough
CEO / Chief Investment Officer

Eye on Private Equity: Embarrassing

David “Ruby” Rubenstein gave a keynote speech at the 15th annual venture capital and private equity conference at Harvard Business School earlier this week. His comments were at best embarrassing.

According to news reports, Ruby blamed both the private equity industry for doing deals that didn’t make sense and the investment banking industry for offering cheap debt with loose terms to finance the deals.

Specifically Rubenstein stated:

“I analogize it to sex. You realize there were certain things you shouldn’t do, but the urge is there and you can’t resists”

While the analogy may be funny to some and interesting on some level to others, this is an American leader of one of the largest private equity firms in the world speaking to one of our top business schools. As such, it would be a great place for Ruby to show some accountability for an industry that has gone wildly awry and lost untold billions for shareholders.

Comparing the private equity industry to the sexual urges of a teenage boy, for we assume most adults can control their urges, is not the type of accountability we would hope for from said leadership. Hope, of course, much like levering up to buy assets into cyclical tops, is not an investment process.

Into the weakness associated with the Barron’s cover article this past weekend, we covered our short position in Blackstone (BX) in our Hedgeye Portfolio, but suffice it to say we remain negative on the fundamental and ethical trends in the private industry and will likely be looking to re-short any strength.

With Obama’s forced expansion of US consumer lending, a steepening of the US Yield Curve, and the global TED Spread having narrowed to less than 100 basis points, the “Liquidity Crisis” of October/November 2008 is behind us. What we have now is an “Illiquidity Crisis” combined with a “Crisis in Credibility” – those two crises will be the crosses to bear for some, and create forced sale prices for the next generation of American capitalists who own liquidity.

Daryl G. Jones
Managing Director

LIZ: Bill Throws Us A Bone

Finally! LIZ announced an 8% headcount cut, which I think is huge. With margins going up and capex coming down, I think this is the near-term bottom for EPS revisions. More strategic call-options remain.
To put this into perspective, assuming $125k/yr per employee on average (including benefits, and the suspension of bonuses for remaining employees), this equates to $90mm in EBIT, 2.2 operating margin points (off a base of 4.0%), and about $0.60 per share in earnings. In addition, this can fund LIZ’s entire maintenance capex budget for each of the next 3 years.

My view on this name has been, and continues to be, that it is not going bankrupt – which a $2 stock suggests is quite possible. The company has secured new lines of financing to mitigate default risk, is cutting capex net year in half, and is now FINALLY cutting into what has consistently been one of the fattest SG&A structures in apparel (43% SG&A ratio???).

We’ve seen the near-term bottom of estimate revisions for LIZ, and with what I believe is minimal balance sheet risk, and a call option on monetizing Juicy, Lucky, and Kate Spade while selling the legacy Liz Claiborne brand to a major retailer (like Wal*Mart?), it is not tough for me to build to a net value 2-3x where the stock is trading today.


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