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Low Stress? SP500 Levels, Refreshed...

We took this market into the dunk tank again on the open, tested my support range of 730-734, and bounced pretty convincingly. I covered my short position in the US Financials (XLF) this morning – no, they aren’t all going to zero…

In the chart below, I have painted the lines of this market’s support/resistance. I have SP500 resistance lines at both 767 and 816. For certain, this remains a bear market. But with each lower low, it’s becoming a less stressful one to trade. People are getting used to this slow motion government sponsored train wreck – this is the behavioral side of finance.

While this may very well change into the close, the VIX is actually only +2% here on the day at 45.50. On the margin, that’s actually one of today’s surprisingly bullish signals. I have stiff intermediate term “Trend” resistance up at VIX 51.38, and even with Citigroup collapsing we didn’t come close to testing that VIX level. As volatility continues to break down, we should be able to form another trading bottom.

I have SP500 support down at the 733 line. That’s not a lot of downside reward left for me as a short seller, so I’ll be buying/covering on the way down, from here…

Keith R. McCullough
CEO & Chief Investment Officer

Eye On US Housing...

Looking past the bad news is very hard to do…..

Over the past two days we have been dealt a body blow on the housing front. Sales of existing homes nosedived in January to the lowest level since July 1997 - the NAR said Wednesday that sales of existing homes fell 5.3% to an annual rate of 4.49 million in January, from 4.74 million in December. Importantly, supply of existing homes was 9.6 months at the end of January, up from 9.4 months at the end of December. Single-family home sales fell 4.7%, while sales of condos and co-ops were down 10. In addition, sales of new homes in the U.S. plunged to a record low in January. While inventories of unsold homes fell by 3.1% to 342,000 (the 13th consecutive decline), sales are falling even faster. As a result, the inventory of new homes at the end of January represented a record-high 13.3 month supply at the January sales pace.

The January trends are less encouraging, as opposed to December when sales surged providing some hope that the long-awaited housing market bottom was in sight. This sequential slowdown in home sales is, on the margin, not a positive. The glut of supply combined with the lack of buyers is currently driving prices down, but looking forward, we continue to think that housing prices will bottom by 2Q09 (prices will decline at a lesser rate).

There are a lot of reasons to be sanguine about the real estate market; there are also plenty of reasons to be optimistic. Sure, if more Americans are worried about job security, they are not likely to buy a new home. That being said, it is actually a great time to be buying a home today as prices have declined significantly. Additionally, the combination of low interest rates and the $8,000 first-time homebuyer tax credit in the economic stimulus plan signed by Obama this month should motivate some buyers.

Significant issues still rest with home builders and home building stocks. Today, homebuilders are faced with intense competition from foreclosures, distressed sales of older homes and the supply of new homes on the market. Buyers are facing two opposite forces when thinking about buying a home, with the force against buying currently having the upper hand. Buyers are faced with declining wealth (in both their stock portfolios and their home values) and an uncertain labor market, offset somewhat by lower mortgage rates that are improving affordability. If housing prices do bottom in 2Q09, buyers’ wealth will begin to decline at lesser rate, thereby mitigating one of the opposing forces.

Howard W. Penney
Managing Director


"As long as I can see the puck, I don't think you can beat me."
-Alec Richards (Yale Hockey's Senior starting goaltender)

In 2006, when Alec Richards broke my classmate, Alex Westlund's, single season saves record for a Yale goalie, I started paying attention. While people and their politics might lie, the numbers never do. President Obama had better figure this out - and soon.

At 6'4, 200 and something pounds, this young man takes up a lot of net, and he's extremely difficult to beat. If you'd like to take him to task on his comment above, he'd be the first in line to let you try. He knows how good he is. He has a repeatable process. He's 14-2 this year for the nationally ranked Bulldogs.

Alec spent this past summer working for us as an intern at Research Edge. He'd sit in our morning research meetings very quietly, taking it all in. As anyone on our team would assure you, I suck the oxygen out of that meeting room talking ... and I always anchor on someone's eyes to see if they really get it or not. Alec had that look in his eyes - that look of someone who gets it.

Why do I call this out this morning? Simply because the only thing left in this market is hope - and while hope is not an investment process, sometimes that is all that's left. Betting on America's financial future is much more tolerable when I can trust that we have a world class goalie behind us. Metaphorically, America's last line of defense needs to have a legitimate and proactive risk management process. What the financial savants on Obama's team have right here and now is basically a joke.

A joke? Yes, when it comes to risk management, as sad as that is to say, that's exactly what we have at the US Treasury. Timmy Geithner can't even manage the accounting of his own personal taxes, never mind the tail risk associated with an increasingly interconnected global market place of interacting factors. Does the man even know what global macro is? Timmy, other than looking like a deer in headlights on CNBC, what is it that you do?

After one summer in this Wall Street league, Alec Richards knows more about what a real "stress test" is than Geithner or whoever that 2-year Goldman man in investment banking that Coach Hank Paulson appointed to oversee the TARP net. America needs to get serious about finding a world class goalie - and soon.

While its all good and fine for Jaime Dimon at JP Morgan to proclaim his mystery of faith suggesting that he doesn't need a stress test, what does that really mean? What did you expect him to say? What is a stress test worth if it doesn't actually test the thresholds of maximum pain? What does a stress test mean if it is based on the economic forecasts of a government who is perpetually reacting to economic news on a revisionist basis? Is this some kind of a joke? Does our new government think we are stupid? Or, when it comes to understanding how markets really trade, are they?

I would love to wake Vikram Pandit up each morning and take him through the paces of what I would consider a global risk management stress test. Mr. Pandit, I must warn you in advance, not proactively preparing yourself for this might make it a real ugly exercise. And by the way, as long as I can see you, I don't think you can beat me.

When you consider the US government owning 36% of Citigroup, America becomes a much scarier place, and in a hurry (we are short Citigroup in our virtual portfolio). The only thing worse than Pandit and his crony from the hedge fund he blew up running risk management at Citigroup is Timmy Geithner checking their math, and Jimmy Cramer signing off on it!

Don't remind Larry Summers of this, but markets are much smarter than people. This is probably one more reason why the US Treasury market has gone from shaking to breaking. Why should the Chinese trust American-backed bonds if this is who we have standing in front of our net?

Unlike the current said leaders of Big Broker, Big Auto, and Bit Stress, Alec, like American Idol's Kris Allen (who got America's vote last night), knows who "The Man In the Mirror" is. He's responsible for his own actions. He's accountable to his teammates. He doesn't point fingers, and he has definitely never begged for a bailout.

Tonight Alec will lead the Top 10 Nationally Ranked Yalies into the final weekend of the regular season. His teammates expect him to win, because that's what they wakeup expecting of themselves. That's what winners do.

It's been well over a year of my going off on this lack of competence in our leadership, and I'm rather tired of focusing on the losers who have brought this great country's financial system to its knees. So... as of this Early Look note... please be advised that as this market makes new lows, I'm shifting gears. I am going to go back to focusing on and dealing with winners. America has a lot of them, and I am going to do my small part in making sure they are at the table of this country's leadership debate by the time my son grows up.

My downside target for the SP500 is now 730 (-3% downside in the immediate term). Like the confidence that Americans have in our financial system's leadership, that would be a lower low. That will be bearish.

I have sold down my long position in America to 9% of my Asset Allocation, and while that's higher than in any other country where we have an invested position, that pales in comparison to the 76% position that I have re-built in Cash this week. My Cash is American. For my family and firm, my Cash is king. I don't want the government's moneys. I just want the economic freedom to wake up every morning and take my shot at winning. Thank God for that.

Have a great weekend - go Bulldogs!



  • GLD - SPDR Gold-We bought gold yesterday with the S&P500 in the red and gold down. We believe the market is favored to the risk side, allowing gold to re-find it's bullish trend.

  • TIP - iShares TIPS-Bought more inflation protected TIPS on Wednesday into the close as oil and copper had an up day. The U.S. government will have to continue to sell Treasuries at record levels to fund domestic stimulus programs. The Chinese will continue to be the largest buyer of U.S. Treasuries, albeit at a price.  The implication being that terms will have to be more compelling for foreign funders of U.S. debt, which is why long term rates are trending upwards. This is negative for both Treasuries and corporate bonds.

  • EWZ - iShares Brazil-The Bovespa is up 1.68% YTD and the country is slated to have annual growth of 1.7% in 2009. We're bullish on President Lula da Silva's leadership and believe that policy makers are determined to keep inflation in check, despite a recent rise in food costs. Likely, Brazil will cut its benchmark interest rate 75bps to 12% when the Central Bank next meets on March 10-11, which will help to spur growth. Brazil is a major producer of commodities. We believe the country's profile matches up well with our reflation theme: as the USD breaks down (especially as we move further into the US's stimulus package) a deflated USD will lift global equities and commodity prices.

  • DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.

  • VYM - Vanguard High Dividend Yield -VYM yields a healthy 4.31%, and tracks the FTSE/High Dividend Yield Index which is a benchmark of stocks issued by US companies that pay dividends that are higher than average.


  • USO -Oil Fund- After a nice squeeze back up to resistance yesterday we shorted oil into the close.

  • XLF -SPDR Financials- Shorted the financials yesterday on their bounce.

  • DIA -Diamonds Trust-We re-shorted the DJIA on Wednesday on an up move.

  • EWY -iShares South Korea- We bought EWY on Monday on an up day. Despite efforts by the Bank of Korea to weaken the Won to spur exports, we see no catalyst in sight to drive external demand to the levels necessary  to stimulate recovery. January export data was down -32.79%, the lowest Y/Y level recorded.

  • IFN -The India Fund- We have had a consistently negative bias on Indian equities since we launched the firm early last year. We believe the growth story of "Chindia" is dead. We contest that the Indian population, grappling with rampant poverty, a class divide, and poor health and education services, will not be able to sustain internal consumption levels sufficient to meet the growth levels targeted by the Singh administration. Other negative trends we've followed include: the reversal of foreign investment, the decrease in equity issuance, and a massive national deficit. Industrial production fell 2% in December Y/Y and exports decreased 22% in January Y/Y.

  • EWH -iShares Hong Kong- Hong Kong is not China. The ETF is broken on both a trade and trend perspective.

  • UUP - U.S. Dollar Index - We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. The Euro is down versus the USD at $1.2672. The USD is down versus the Yen at 97.5650 and up versus the Pound at $1.4186 as of 6am today.

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RL Nugget: iRalph

Anyone who has an iPhone is probably addicted to the app store where you can download from thousands of low-priced, but often outstanding, applications. As I prepared to shut my laptop down this evening, I synched my iPod and was surprised to see the new ‘Ralph Lauren Collection’ app staring at me on iTunes. I’m both amazed and impressed to see how far this company has run with its multi-media initiative since buying back the license from GE two years ago.

For so many other reasons, RL is one of my top investable names today.


RCL and CCL are down 83% and 54%, respectively, from their 52 week highs. Both stocks trade well into single digit P/Es. While both estimates need to come down in our opinion, the stocks appear cheap and in need of some good news. We think evidence of stability may be good enough.

Business really fell off a cliff for these guys beginning in September. However, there has been no deterioration since the tough Q4. Pricing is probably down 10-15% but consumers are responding, which is serving to stabilize the market. On the margin, the wave season and pace of forward bookings are probably a bit better than what the market is expecting. Here are some observations about current trends:

• Near term yield, revenue, and earnings guidance still looks reasonable
• Looks like industry has restored booking volume and price equilibrium (granted at lower pricing) post last quarter. That has gotten the ball rolling again for a more normalized pace of business
• Wave season, seems to not have tapered off yet and bookings are going at a healthy pace (again at lower prices with greater incentives being offered).
• Europe has been surprisingly robust, especially the UK, despite the large capacity additions.
• There will be a big mix shift towards cheaper cruise options (shorter, inner cabin booking vs balcony, closer ports).
• Alaska is faring poorly because of this mix shift and due to the short booking window. People are just not booking for Q3 yet.
• Agent commissions are being pressured higher, but not by much. RCL is providing an extra 1% incentive to travel agents in January and a bit towards February, which has benefitted volumes but this extra incentive isn’t material enough to matter. Two very small brands have gotten aggressive including Regent.

None of this changes our intermediate and longer term concerns surrounding capacity increases, demographics, and the sustainability of the decent European trends. However, the stocks are ripe for a potentially big move given stabilizing business levels. The high leverage and short interest probably makes RCL the more interesting near term trade.

DECK: 2.5x EBIT?

I was never a massive fan of the DECK story, but it’s rare that I see any brand have this kind of momentum and get so beat up by the market. DECK printed a solid quarter, but inventories were up and sales guidance was light for 2009. That’s all this market needs to punish a stock that was already getting painted with the CROX brush – the ‘ol ‘earnings are not real because the fashion trend will not sustain itself’ call. While you call your 18-year old daughter/niece/neighbor/wife (hopefully not 18) to gauge the sustainability of the Ugg brand, consider this…
1. Let’s believe company guidance for a minute…
a. We’re looking at about $7 per share in earnings, but this includes $10.5mm in stock comp expense and $10mm of added marketing expenses for its Simple and TSUBO brands. We can’t ignore these P&L events, but they each account for $0.50 in EPS that management could have averted if it so chose. In my mind, $8 in EPS is closer to the core earnings number here.

b. The market cap is down to $620mm, but DECK has an astonishing $175mm in cash ($15/shr). Yes, $175mm in cash and $175mm in EBIT next year if you believe mgmt can actually forecast its business and hold core EBIT flat. Net it all out and this thing is at 2.5x EBIT. If you trust this management team, you can’t ignore this name here. I don’t think that management is anything to write home about in the grand scheme of retail, but I’d go as far as to say that it is a better team than a company the size of DECK probably deserves…

2. Let’s say that the US business rolls over, proves to have already hit its point of saturation, but remains a well-run, tightly distributed relevant brand in key consumer segments (a realistic bear case, I think). Then we’re likely looking at earnings closer to $6. No – not the direction of revisions I want to see. But that suggests that this name is trading at 8x earnings today.

I know you can’t make valuation calls in this market, but once real capitalists creep back onto the scene some of these small – but relevant – brands will be plucked away.

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