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Eye on China: The Yuan

Although it is very early in the policy implementation stages for the new administration, Obamanomics appears to include a two pronged strategy emerging with respect to China: 1) To Assume a more dominant role for the US in international financial policy while acting to protect domestic industry –in part by demanding that China cease its currency manipulation and, 2) continue to borrow heavily from China to finance the stimulus programs designed to get the US economy moving again.

Put plainly, the people that owe China money and are hoping to borrow much more are also demanding that they place themselves at a competitive disadvantage going forward in the name of fair play.

We believe that internal demand will be the primary engine of growth in China as the short term impact of the massive stimulus programs there are supplemented by steadily increasing personal consumption at home. In the near term, however, Beijing must be pragmatic in defense of its export industries. In the spirit of “soft power” that the administration of Hu Jintao has promoted, it is unlikely that the reaction of officials will be anything more than the polite brush off that they have largely provided until now in response to calls to allow the Yuan rise.

As we noted this yesterday, Luo Ping’s comment to reporters last week that a depreciation of the US Dollar is inevitable signals a certain resignation by Chinese leaders as they continue to float their best customer’s bar tab. We think it is a mistake to read this as a signal that Beijing will also acquiesce to US currency policy demands.

Andrew Barber
Director

Eye on Sentiment: Rasmussen Total Approval Index

As we mentioned in The Early Look today, President Obama’s total approval rating, based on the Rasmussen Daily Tracking poll, is at 60%, which is near the lowest levels of his Presidency. At the peak, Obama’s total approval rating, which is a combination of approve and strongly approve, was at 69%. While the current approval rating is well off the peak, it is still a very high approval rating and eight points above his approval rating on November 6th.

More noteworthy from the poll is the Presidential Approval Index, which stands at +10 today and is charted below. The Presidential Approval Index measures the delta between Strongly Approve and Strongly Disapprove. At its peak, on January 22nd, just two days after the inauguration, this measure stood at +30. In less than a month, President Obama’s Presidential Approval Index rating has declined by an amazing 20 points. This is partially attributable to his very high rating post inauguration, which was obviously unsustainable, but also due to a number of missteps that the administration has made in the first few weeks in office.

The decline in the Presidential Approval Index is about the best leading indicator we can find for President Obama’s approval rating. It shows the broad shift of approval for President Obama as voters downshift from Strongly Approve to Approve and from Disapprove to Strongly Disapprove. To the extent that it matters, it is very likely that President Obama’s broad approval rating heads into the mid-50s in the coming months, if not lower, as these internals are showing a very negative trend. As his approval rating declines further, his mandate is likely to diminish as will his ability to accomplish legislative actions quickly.

Daryl G. Jones
Managing Director

Boozin'

“Well done is better than well said.”
-Benjamin Franklin

Japan’s Finance Minister, Shoichi Nakagawa, didn’t do either. What he said over the weekend at the G-7 meetings, drunk or not, never had a chance. There is nothing about Japan’s economic resolve in the last 20 years that has been “well done” – when considering the disaster of it all, one can understand why the man was bombed.

Nakagawa’s alleged sippin’ of the Sapporo ultimately called for his resignation overnight. This didn’t help Japanese or Asian trading overall – confusion in markets doesn’t breed confidence. Japan closed down another -1.4%, taking the Nikkei to 7,645 and down -14% for 2009 to date. Given the lack of leadership in the world’s largest socialized bureaucracy, one can hardly blame the poor man for boozin’. The reality is that Japan’s yield curve has been flat for the last decade – bankers there have zero interest rates and, alongside that, zero inspiration to attract foreign capital.

The New Reality (sorry Vikram Pandit, that’s our line you are using now – don’t be the raccoon), is that politicians, globally, will be YouTubed and held accountable, real time. Politicians stand on no lower moral ground obviously than some of the bankers or bandits who got us into this mess. Now that the Obama love fest is over, Americans are coming to their senses and reminding themselves of as much.

At -8.5% for the year to-date, the USA isn’t down as much as Japan, but it’s still rather embarrassing. While Timmy Geithner wasn’t loaded last week, maybe if he pounded back a few Bud heavies prior to his being YouTubed he wouldn’t have looked like he was such a stiff. From the Pandit Bandit to the tricky Dick Fuld wanna be’s who performed marvelously in front of Congress last week, I bet they wouldn’t have minded if Timmy chugged back a few and endowed them all with another trillion of bailout moneys. “Booo-yah” Timmy Boy! Boozin’!

Unfortunately, for the bankers at least, there were no wheel barrows of moneys marched down the Congressional aisle. While “Heli-Ben” (Pandit, don’t go using that line of ours now) was doing his best to drop massive amounts of US Debt on our former Chinese friends, Timmy was told to save some of the moneys for teachers, firefighters and tree huggers instead. My Mom is a teacher, my Dad is a fireman, and my brother hugs trees – too bad they are Canadian!

Today, “no drama” Obama will be signing the almighty stimulus bill from Colorado rather than from ole Bushy’s desk. Maybe he is looking for some karma of his own – maybe he just needed to get away from that evil doer Washington DC rhetoric. Obama’s approval ratings have fallen rather dramatically in the last 6 weeks. Since the first week of January his approval rating (Rasmussen poll) has tanked from 69% to 60%.

Obama saw a 60% approval rating in the week of November 20th. Ironically enough, that was the week where the SP500 bottomed at 752. Given that the SP500 is now trading almost +10% higher than that global Liquidity Crisis capitulation low, Obama and his strategy man, David Axelrod, should be rather thankful that it hasn’t been worse.

With the world’s 2nd largest economy sending their Finance Minister to the microphone drunk, the Chinese signing their largest oil deal ever with the Russians last night ($25B, Vladdy – we lend you that cash that we used to lend Americans, you give us the black stuff), and America’s Batman being soured on by Gotham… could things for Obamerica be worse? Of course they can… so pay attention to the deltas out there in your geopolitical analysis. Everything that matters to markets from here will most definitely occur on the margin.

We all know, in hindsight, what Obama’s confidence did for the US stock market in December. However, most people still don’t fully realize what that did to the US Dollar. As the buck broke down in December, stocks broke out to higher highs, almost weekly, and never looked back at making lower lows. The only week that we saw a material rally in American stocks in 2009 was the one week where the US Dollar Index was down on the week. Last week, was not that week, of course. Last week, the US$ Index closed up a tidy +1.5% and the SP500 lost -4.8% as a result. This morning, the US$ is bid 1% higher, and S&P Futures another -2% lower…

Hold on here Keith, this doesn’t make sense. If Biden wants the world to “buy American”, and the Chinese are selling into that… shouldn’t the dollar break down? In theory, every economic case can be made – that’s why John Maynard Keynes and Irving Fisher never got along. But The New Reality is that the inverse correlation between the US Dollar and US Equities is as formidably relevant as any major one I see right now in macro.

For 2009 to-date, the US Dollar Index is +7% and US stocks are -8.5%. Interestingly, the CRB Commodities Index is down exactly the same percentage as the US Dollar is up – seven percent. While seven is a lucky number in China, and there is a seven in the Chinese stock market’s YTD return of +27%, there may be no other correlation to be made here other than that being the minimum amount of cocktails a Japanese man who has to talk transparently about his country’s economic situation needs to pound back prior to speaking.

Markets, globally, are going to try to put in another higher low this week, and I think they should. I have our Hedgeye Asset Allocation Model holding a 76% position in Cash (US Dollar denominated!), and I am looking forward to getting invested again at lower prices.

If one thing has held true for the last 12 months of investing, it is quite simply that patience pays. In The New Reality, this proactive risk management approach will allow you to buy low and sell high. Buying from forced sellers and drunken sailors of the free money leverage cycle will continue to remind us that, “well done is better than well said.”

My downside target for the SP500 to cover/buy stocks remains 810.

Boozin' - etfs021709


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Impact of a 1% Sales Tax Hike in CA

A 1% boost in sales tax in CA is a double-edged –sword. Here’s an overview of those most heavily exposed. ROST is a name I keep coming back to where risk increasingly outweighs reward.

For those not watching the financial disaster unravel in California with Schwarzenegger’s budget impasse, keep in mind that the current proposal includes a 1% increase in sales tax, which is not particularly welcomed by the retailers. Sadly, 1% is probably better than the state going bankrupt, government payrolls shutting down, and the regional economy contracting further.

The chart below outlines retailers with the greatest percent of their respective store base located in California. The one that stands out for me is Ross Stores. It is overexposed to CA, is in a space that I increasingly do not like (off price channel), is near peak margins, has two more quarters until inventory, GM and SG&A compares become very difficult, sentiment is generally positive, and is trading at a 30%+ premium to the group. I still think it is too early to get super negative on this name – but the fundamental cards are starting to line up.

Year of the SG&A Cut

The multi-year cycle is clear. ’03-’06 = organic revs and ‘free money’ gross margins. 1Q07-3Q08 = inventory draw down and capex reduction. 2009 = cut SG&A, and where no fat remains kill the muscle.

We all know that margins drive stock prices in this space. But visualizing the derivation of the change in margin over the past five years for the apparel and footwear retail space puts the current situation into a much clearer perspective. The punchline is that there will be some questionable head fakes by companies that should not cut costs, but will anyway. Others can genuinely afford it -- like LIZ, ZQK, and HBI.

Cycle considerations:

’03-’06: Revenue consistently ran ahead of inventory growth, the rate of gross margin improvement trumped SG&A margin changes, money increasingly flowed through the acquisition landscape, and capex was coming off a cyclical low and slowly building. This was a multiple-enhancing environment that allowed less severe competition allowed average brands and management teams to exist.

1Q07-3Q08: Revenue growth slowed by about 1,000bp nearly spot on with the inventory growth slowdown. But weaker pricing dynamics took gross margins down steadily while SG&A margin went the complete opposite direction as the retailers were (as usual) 9-12 months behind in aligning costs.

Interestingly, capex growth came down before SG&A – which is a departure from past cycles. We’re already benefitting from slower capex growth in 2009, but the big theme for the year will be SG&A. Think about it – more than half of companies in this industry have announced layoffs. With slower capex growth and even the slightest (even if temporary) reprieve in top line pressure, SG&A cuts could spur some meaningful EBIT growth pops this year.

I’ll never pay up for SG&A cuts as opposed to real organic growth. But for companies that have been left for dead like Liz Claiborne, Quiksilver, Hanesbrands and even Macy’s – a directional change in EBIT growth at current valuations can’t be ignored.

Quote and Chart of the Week: Choking On US Treasuries...

“We hate you guys. Once you start issuing $1 trillion-$2 trillion [$1,000bn-$2,000bn] . . .we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.” –Luo Ping

While some America’s self perceived “financial savants” (Larry Summers) think that going Greenspan is the only way to bail ourselves out of this colossal mess, some of the objectively sober think about this a little differently. While the quote above, not surprisingly, is being back-pedaled on now by Beijing… the reality is that Ping said it, and it certainly sounded like he meant it.

Over the course of the last few week’s we have started to see what we have been calling “The Queen Mary” turn (10 year yields on US Treasuries turning higher). The 25 year chart of American long term debt yields has made many a leverage hound look like a financial genius… until most recently, of course.

The Chinese and Japanese are finally choking on the Greenspan/Bernanke legacy of rate cutting and debt issuance. At this point, it’s only a matter of math and time before America’s top debt customers say enough is enough. In the meantime, never mind what they say - watch what they do from here.

The government sold a record $67 billion in notes and bonds last week:

• FEB 10: a record $32 billion of three-year debt at a yield of 1.42%
• FEB 11: a record $21 billion of 10-year notes at yield of 2.82%
• FEB 12: $14 billion of 30-year bonds (the most since the auction when it reintroduced the security in 2006 -also $14 billion), at a yield of 3.54%

According to Bloomberg “The Fed’s custodial holdings of Treasuries for foreign institutions including central banks rose 0.5 percent to a record $1.743 trillion, central bank data showed. The holdings slipped last week to $1.735 trillion, the first decrease in 24 weeks.”

Keith R. McCullough
CEO / Chief Investment Officer

Andrew Barber
Director

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