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Eye On Early Cycle Stocks: The Good News...

EYE ON EARLY CYCLE STOCKS

As we have said many times, economic bottoms are processes, not points. We continue to receive incremental data points in number of different industries that suggest sequentially things are getting less bad…

Early Cycle Technology

Today, Research Edge technology analyst Rebecca Runkle noted some news out of Xilinx that supports our thesis that we are beginning to see a bottom process take hold, setting the stage for a market recovery. Xilinx guided Q4 revenues (Mar09) to a 13-18% sequential decline vs prior guidance of a 15-25% decline. They also commented that gross margin guidance of 61% to 63% and operating expense guidance of flat to slightly down sequentially remain unchanged. From a timing standpoint demand metrics fell off a cliff in late 2008. While the spigots were turned off in Q4 the global inventory build was not as big as when the dot.com bubble burst. Xilinx is a component company selling into the supply chain, where the data points (while still ugly) are beginning to be less bad.

Also, Dell CFO Brian Gladden said today that the company’s performance in January was not down as dramatically during January vs. December period as it was during October from September. He commented that the government business is relatively strong, while the large
e enterprise business is the weakest.

Early Cycle Consumer

Restaurant industry resource Malcolm Knapp’s reported January same-store sales numbers showed once again that the lights went out in December but came back on in January. Same-store sales growth came in down 4.1% with traffic down 6.0%. Although these are not strong results, on the margin, they show a definite improvement from December’s 9.5% comparable sales decline and 10.5% traffic decline.

We’re bullish on Brinker (EAT), and talked about that stock on our morning client call…

DELL, XLNX, and EAT are up +8%, +4%, and 2%, respectively, today for fundamental reasons that shouldn’t be ignored.

Howard W. Penney
Managing Director

EYE ON INDIA: RATS FLEE THE SINKING SHIP

Headlines for Indian news services today were a litany of woes as the terrorist attack on the Sri Lankan Cricket squad helped drive treasuries and equities lower while the rupee registered an all time low against the Dollar. Meanwhile, the decision by regulators to allow a sale of scandal battered Satyam BEFORE the criminal fraud probe is complete and BEFORE a public restatement of company financials in order to “restore confidence” appears to be having the opposite effect.

Bloomberg news reported today that a number of foreign hedge funds are shopping large stakes in public companies to private equity investors due to the lack of liquidity in the private markets. This decision to cut bait and run no matter what the cost by the fast money crowd does NOT represent a contrarian bullish inflection point: when those investors leave there is no new money waiting in the wings to sweep in. These outflows of foreign capital represent capital that is leaving for good.

Import and Exports

Trade data released yesterday paints a grim picture with exports declining by 15.87% Y/Y and Imports sliding by 18.22%. Declining global demand makes the outflow data unsurprising, but the import data was more significant. This sharp decline in imports cannot be simply chalked up to lower commodity prices: total Oil imports by volume, for instance, have declined by 13.5% over December and 6.62% Y/Y. Real domestic demand appears to be weakening at a faster pace than external demand for Indian goods.

The argument that India should be relatively resilient since it is less dependent on exports than other South Asian economies is absurd. Essentially the tortured logic behind that thesis leaves the remaining India Bulls arguing that the fact that major segments of the population are illiterate subsistence farmers is really a positive. Real math indicates that the recently released 5.3% Q4 GDP print is not anomalous and the first two quarters of this year could easily register at significantly lower levels: a far cry from the double digits that the Singh administration has been counting on to deliver on its promises in an election year.

We continue to expect the situation in India to deteriorate economically and politically. We covered our short position in India (IFN) yesterday. We are not short the Rupee currently, but will seek opportunities to re-short into strength.

Andrew Barber
Director

US Bond Bulls Beware: Chinese headlines like this aren't a coincidence...

From Nikkei: "China considering purchase of crude oil as a way to diversify holdings away from US Treasuries"

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EYE ON AUSTRALIA: HATS OFF TO GLENN

The RBA governor leaves rates unchanged…

Glenn Stevens is unique among central bankers worldwide: he is enjoying the results of both disciplined fiscal policies through the credit boom and prudently measured responses to the bust.

The decision to keep rates flat at 3.25% today represents an acknowledgement that the Australian economy is as strong as it can be given the external factors beyond the government’s control. That is not to say that the situation for the land down under is rosy, but simply that any further rate cuts right now would be superfluous at best (Australian mortgage rates are at historic lows and consumer credit is not frozen like in the US) and at worst could spur inflationary pressure. For now, Stevens has decided to keep his powder dry and wait.

We finally went long the Australian equity market via the etf EWA yesterday, and expect that the relative strength of the economy there, combined with increasing commodity demand from an emerging China, will provide significant upside potential. It is at times of extreme stress such as the one we find ourselves in that the incremental advantage of good leadership is felt in the fullest. Stevens has proven himself to be a solid leader.

Good on Ya’ Mate!

Andrew Barber
Director

EYE ON OPERATING EPS – S&P 500

We calculated expected 2009 operating EPS numbers for each of the nine sectors of the S&P 500 based on market capital weighted averages of the earnings expectations of the companies included in each sector. In doing so, we compared the expected “normalized” 2009 operating EPS numbers with the “normalized” 2008 operating EPS results. We are using the term normalized, but it should be taken with a grain a salt, given the unique circumstances we face today. I would note that only 451 companies are included in the analysis. Of the nine sectors in the S&P 500, four are projected to post positive EPS growth in 2009 – Consumer Staples (+12.1%), Healthcare (+4.5%), Utilities (+2.2%) and Financials (+15.9%).

Two of the four sectors showing positive growth don’t seem too out of line, but the XLP (Consumer Staples) seems to be aggressive at 12% growth. And, the expected 18.2% operating EPS growth for the XLF (Financials) seems completely out of line.

A closer look at the number shows that it is being driven by three companies – Wells Fargo (projected 73% 2009 EPS growth translates into a market weighted 6.5% contribution to the XLF’s overall growth), Goldman Sachs (6.1% growth contribution based on 91% expected EPS growth) and JP Morgan Chase (12.7% growth contribution based on 97% expected EPS growth). It is important to note that these sector EPS growth rates are based on street estimates, and therefore, are only as good as the estimates. That being said, with the S&P 500 -55% below the all time high set in October 2007, an earnings recovery story in three of the nation’s leading financial institutions does not seem plausible.

Howard Penney

PEOPLE’S REPUBLIC OF CALIFORNIA

It’s no secret that the Las Vegas Strip derives approximately 30% of its visitation from California. Given the sorry state of the California economy, this exposure will be yet another drag on the Strip. That’s the obvious call. The less obvious and more interesting call is what happens to population growth in Nevada when the big state next store craps the bed?

Let me pose that question a different way. Would you choose to live in a state with a higher unemployment rate, a 25% higher cost of living, a higher sales tax, and a state income tax rate of 9.3%? Or would you rather live in a bordering state with no state income tax? That is the alternative facing California residents who are likely to face even higher taxes as soon as April to balance the state budget in the coming years.

If you run a small business, or any business for that matter, it may make sense to forgo that 8.84% state corporate income tax and pay zero by relocating to Nevada. I’m sure many of your employees would appreciate the higher take home pay. The economic differentials between the two states are highlighted in the table below.

While Nevada has its own budget issues, it remains in a good spot to capitalize on California’s demise. I would never put it past government to ruin a good thing, but Nevada has a history of pro-growth, somewhat libertarian government and hopefully that will last. A continued low tax environment and a favorable climate should keep them coming. Unless the Nevada state government pulls a California (i.e. shoots itself in the foot), the Las Vegas locals market will retain a pretty unique characteristic among gaming markets: population growth. BYD looks to be the primary beneficiary.

When times get tough where would you choose to live?

Early Look

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