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SBUX – Advertising: Offense or Defense?

First we had the “cola wars” as Coca-Cola and Pepsi sparred for market share in the 1980s, with many casualties on both sides of the corporate battle-front. By the 1990’s we moved from colas to the “burger wars.” Although I would note that the “burger war” is still being waged, as McDonald’s success and a sluggish economy has caused erosion in traffic trends. As a result, the dollar menu has legs. For the second half of this decade, get ready for the “coffee wars!”
Last October, I said, “Starbucks will be forming a new advertising strategy – they have no choice.” Starbucks is a great brand and is too big of a company not to be using the media to communicate with customers and to defend the brand against bold attack by its competitors.

Both McDonald’s and Dunkin Donuts are strong brands competing for their share of the breakfast day-part. Not long ago, Dunkin’ Donuts fired a shot at Starbucks by saying that it beat SBUX in a recent national blind taste test, and SBUX had no way of responding. Not good brand management!

Also, in May/June 2009, MCD will be on TV talking about its coffee initiative. Taken together, McDonald’s and Dunkin’ Donuts will be spending a significant amount of money promoting their respective brands.

At the recent Starbucks annual meeting, CEO Howard Schultz spent some time talking about advertising and how in the past the company did not feel the need to advertise outside its 4-walls. Mr. Schultz addressed head on the false claims competitors are making about SBUX and the myth of $4 coffee. Although Mr. Schultz did not comment specifically on McDonald’s billboard advertisement that stated “Four bucks is dumb”, he definitely was including McDonald’s among the competitors that he says have made false claims about SBUX when he talked about the myth of $4 coffee. As of today, SBUX has had no real way to respond to these types of claims so the company has been silent on the subject, but according to Mr. Schultz, that will not be the case going forward.

The CEO said that SBUX is ready to take its gloves off… There is something exciting about a good corporate battle! The Starbucks strategy has been primarily focused on the quality of coffee, while the competition has focused on price alone. Starbucks does not plan to compete on price alone as selling quality coffee will always be at the forefront of its strategy, but the company hopes to change consumer perception around the value of the brand. As Starbucks noted, half of its beverages cost under $3, 1/3 cost less than $2 and its brewed coffee represents strong relative value. Mr. Schultz stated, “We have allowed others to define us…stay tuned.” He also said the majority of the people not going to SBUX as often are not going to fast food restaurants for their coffee – but instead making it at home.

If Starbucks goes full throttle with a U.S. advertising strategy, and spends 4% of U.S. system-wide sales on advertising and promotion, based on FY08 numbers that would equal nearly $450 million. This compares to U.S. advertising spend of $1.1 billion for MCD, $364 million for Burger King, $404 million for Wendy’s and $1 billion for YUM (includes spending on KFC, Pizza Hut and Taco Bell), according to Advertising Age.

That being said, to be competitive, Starbucks needs to spend $300-$400 million. Although Starbucks will not get to this level of spending right away, the company will have to eventually allocate this amount of money to advertising in order to be offensive rather than defensive in its attempt to increase its share of voice. What I mean is that Starbucks will have to spend more in order for its advertising dollars to generate real returns for the company rather than just helping to stop further erosion of the brand. For reference, $300-$400 million would represent 60%-80% of the total cost savings the company has articulated it can achieve in FY09. This level of spending would eliminate the bulk of the company’s newfound earnings potential but is, nonetheless, necessary to the long-term strength of the brand and the company. It is encouraging to see that SBUX has finally admitted the need for advertising!

JPM Likey The Slump Dog?

What now?

JP Morgan analyst Bharat Iyer made the news this morning with his scintillating call on the Indian Equity market. According to Bloomberg, Bharat’s stance is that after there is confirmation that the slump in industrial production has ended, the market should bottom over the successive 2 to 4 months: “The above analysis would suggest that the equity markets could bottom out over June to July. This would also be a decisive phase for the equity markets as there should be clarity by then on the results of the national elections and the progress of the monsoon and its seasonal impact on the economy.”

So Bharat, you are saying that if we get confirmation that industrial output has bottomed, and a new government has been selected, and we know what the impact of the monsoon on the agricultural sector is that then, we may subsequently conclude that the equity market has bottomed? Thanks man. That is truly amazing insight. I bet that you also tell investors that if they take a walk outside and get wet that it probably indicates a strong likelihood of rain.

All joking aside, Bharat Iyer is correct, the Indian equity market will find a bottom at some point after a lot of unknown factors that we grapple with currently become known. Part of our process is managing risk and we will always be on the lookout for signals that the economic cycle is starting to turn. For now however, with the data we have available, we continue to expect more declines for Indian equities.

We are short the Indian equity market via IFN, and continue to see the economy there as the most structurally flawed of the major Asian nations.

Andrew Barber


Wholesale Price levels have hit an all time low and rate cuts are coming, will it accomplish anything?

Wholesale Inflation levels reached the lowest recoded level in data released today. For the week of March 6th, the Ministry of Commerce and Industry estimates that factory gate prices rose by 0.44% year over year. The expectation is now that the Reserve bank will cut the repurchase rate lower despite the fact that, at 5% after being reduced by 400 basis points since October, rate cuts have thus far failed to spark any signs of recovery in the system.

Consumer prices have shown no reflection of wholesale declines yet. Prices paid by industrial workers (India’s measure of urban CPI) rose 10.45% in January, the highest since December 1998, with rural consumer prices even higher at 11.62%. With elections coming up this spring and job losses becoming an increasing worry the consumer data for February will need to begin reflecting declining wholesale levels if Prime Minister Singh is to get any political breathing room.


One important positive call out in today’s data is the rapid decline in fertilizer prices. The price inflation of this critical component declined to 5.24% Y/Y versus 8.38% Y/Y the week prior. Declining fertilizer costs would come as a welcome relief for farmers to be sure despite subsidies but, at over 5%, the issues we outlined in our note on March 5th (interpreting inflation) continue to fester, and we are not alone in our thinking.

In an interview on Tuesday Arvind Virmani, Chief Economic Advisor to the Ministry of Finance, expressed concerns that lower growth in the agricultural sectors would likely make the government’s 7.1% growth forecast for 2009 unattainable. With the critical Punjab wheat crop already impacted by unseasonably warm weather combined with yellow rust outbreaks, underuse of fertilizers and pesticides could have a serious negative impact on crop yields.

Why do we write so much about the price of fertilizer? More than half of the Indian population is dependent on small farm operations for livelihood, and antiquated practices and bad government policies have not been addressed during the past 10 years while the “economic miracle” occurred in the IT outsourcing centers in Calcutta and other urban areas.

Now that external demand for high tech services has receded, the fate of farmers is crucial in our analysis for two reasons:

1) This is an election year and the unhappy rural population will be a critical factor in the coming reshuffling of power and, by extension, policy.
2) The India bull thesis which is so regularly flogged in the press is based on the assumption that the subcontinent will be resilient in the face of the global meltdown since “it is less dependent on exports than other major Asian Economies”. Far be it from us to question this logic of finding virtue in the fact that a major segment of the population is comprised of illiterate subsistence farmers living in abject misery -but clearly the thesis will be undermined if growth in the neglected agricultural sector slows or disappears.

We are short the Indian equity market via IFN, and continue to see the economy there as the most structurally flawed of the major Asian nations.

Andrew Barber

NKE: The Second Of Many Headcount Announcements

Today's announcement was an addendum to what we already know. The mgmt change was a good one. Unfortunately, we're still in year 2 of a period of flat earnings over 4 years.
Nike added color today to its restructuring plans announced last month. Eunan McLaughlin, former VP/GM of EMEA, will now run the Subsidiaries and he’ll be replacing Lee Bird, who only joined three years ago.

Three years might not sound like an incredibly short tenure, but at Nike it is. That organization has a unique way of expunging objects that do not belong, like Bill Perez (and for those witty clients of mine who are about to fire me an email – I’ll pre-empt you in reminding you that my departure from Nike was not one of those!). Lee Bird did not make the cut. Is it a shocker that this happens days after Nike announces that they are writing off over 60% of Umbro – a sub that they acquired halfway through his tenure? No, probably not. The subs as a whole (except Converse) did not exactly crush it over the past two years either.

The good news is that I like Eunan – a lot. He did a lot for EMEA – making a lot of tough decisions, and taking the company into the CEMEA region which now accounts for 25% of EMEA’s rev base.

This is a good move. We’ll see more of them. The bad news is that now you have to go back and read the post I put up yesterday that walks through the “flat earnings over four years” theme.

Nugget: CRONS = Branding Equivalent of Powerball

A tiny upstart apparel company called CRONS (Come Ready Or Never Start) hit paydirt when the only team it endorses – Robert Morris University – made it to the NCAA tourney. This would be the branding equivalent of winning powerball if RMU takes the title. I’m always one to vote for the little guy, but I wouldn’t hold my breath on this one.

Importantly, I’m not concerned that ‘this is a new Under Armour’ coming onto the scene. The product pales in comparison to UA and NKE, and without a few hundred million in startup capital (which is not flowing too freely these days) it lacks the infrastructure to compete.

It's Galt, Not Geithner!

"The evil of the world is made possible by nothing but the sanction you give it. "
Ayn Rand, Atlas Shrugged, 1957

Isn't that quote the truth! Maybe all of these BIG Government people should remind themselves of what they sanctioned...

Ayn Rand's 'Atlas Shrugged' paperback edition is currently in 1st place in the "Classics" section on Amazon.com's best-seller list for book sales in the USA. How can this be? This was a novel published in 1957. It is over 1,000 pages long - who in this crackberry culture has the time to read that? Be forewarned, this is my longest note yet!

Apparently anyone who is sick and tired of being told that Big Keynesian Government socializer's of AIG and Goldman losses do! The book is based on the philosophy of Objectivity - show me one American with a moral compass who doesn't objectively understand that Big Government isn't the answer any more.

The protagonist in Atlas Shrugged is a man by the name of John Galt - he's a hardcore free market capitalist who leads a general strike by leading businessmen against the world, refusing to contribute anything (inventions, leadership, art, science, ideas, etc...) to anyone, anymore. If you don't have time to read the first 300 pages, let me give you the Cliff Notes version - Galt is the modern day antithesis of yes-man Timmy Geithner.

You see, Geithner, like his new best buds supporter Jimmy Cramer is a Goldman guy (see my Early Look note on 2/11 "Jimmy and Timmy"). No, Timmy didn't work for Goldman... but he worked for the Goldman brain-trust of levering up long with cheap Greenspan moneys.

Robert Rubin was also Goldman guy (joined Goldman in 1966 in risk arb of all places; nice job managing that Citigroup risk man). Larry Summers is Rubin's guy (Deputy Treasury Secretary under Greenspan and Rubin)... and Geithner is Summer's guy. So who's this guy John Galt?
Rand starts Atlas Shrugged with that very question - "who is John Galt?" Rather than me go on and on about this, I'll let you do the required reading that apparently plenty of Americans are in the midst of doing right now. It's called American Capitalism - as in the non-socialization of corporate losses kind - as in the old fashioned economic freedom to win or lose kind...

The Russians, The Chinese, The Australians, The Brazilians (and even The Canadians!) are moving forward as Americans let the manic media anchor on what Hank Paulson sanctioned with AIG (whose business was highly profitable to Goldman Sachs) while Barons is running cover stories of Goldman "being back!" We need to seriously get a grip here on The New Reality or the 21st century will not remember America well.

Bailing out billionaire compensation structures that implode at the sniff of an economic cycle is not the answer. There is a big difference between a compensation structure and a repeatable American business model.

Even American Idol's Simon Cowell has issued a bailout! He calls it a "save", whereby he and his intimidated crew can effectively stop someone from losing via America's vote. Folks, wake up and smell the Starbucks here - this is embarrassing power mongering... and Americans are tired of it. America has voted!

Let's look at the world's 2009 global equity market scorecard:

1.      China up again last night (sorry Alan Abelson), taking the Shanghai Composite to +25.3% YTD (we are long China)

2.      Russia is up again this morning (re-flating alongside commodities). Russia is +35% in the last month and +12% for the YTD (we are long Russia)

3.      Brazil was up another +0.78% yesterday despite the US being down, taking YTD gains to +8% (we're long Brazil)

4.      Australia was down small overnight, but has paired her YTD losses back to -7% (their proximity to the Client (China) matters) - (we're long Australia)

5.      Canada was up again yesterday, like Brazil and Russia, outperforming the USA, and has paired her YTD losses to -3%

6.      India is -7% YTD; Japan is down -10% YTD; USA -13% YTD; and the UK is down -14% YTD

What are the takeaways? A) Auto-correlation in global stock market returns is dead B) heavy handed government intervention countries are getting creamed and C) investment capital in the halls of what used to be capitalism (London, New York, Tokyo) is leaving those countries en masse to service the client - China.

Client? Yes, most of you out there are managing other people's money, remember? The client with the most cash and growth is no longer the USA, its China. Buy what China NEEDS, not what Wall Street wants them to need is what is working. This is how a globally interconnected market of capital that flows freely works.

Let's look at how a few things that China needs (no, not US Financial Services) are doing:

1.      The confidence associated with a strong domestic stock market = +25% YTD

2.      Copper (which closed limit up in Shanghai overnight) = +25% YTD

That correlated YTD return must be some kind of irony right? Yeah, capitalists call it math.

How about Russia? They have some of that energy stuff The Client needs... think about this:

1.      After tacking on another +11% week to date to its re-flation, oil is up +35% in the last month (we are long oil)

2.      Russia's stock market is +36% in the last month...

More irony in the math? Or does Russia understand that shaking hands with The Client rather than Nancy Pelosi is how you move forward in this world. On February 12th, 2009 the Russians signed $25B in pacts (Transeft and Rosneft) with the Chinese. What was BIG American Government doing on 2/12/09? Making excuses and pointing fingers?

The point here is that America is not unlike Britain was as the United States entered the 20th century - vulnerable. There is no reason why the 21st century of global economics can't belong as much to China as it did to the USA in the 20th or Britain in the 19th.

No matter what your politics, my advice is that the American mindset needs to continuously evolve. Learn, un-learn, and re-learn. We need to challenge the received wisdom of our Government, particularly when it comes to economics. I'm probably not old enough to be given the benefit of the doubt on this, so my suggestion would be to pick up Atlas Shrugged and read the chapter "This is John Galt Speaking"... next to the Holy Bible, this is the most influential book in American history and it has a track record that dates back to 1957.

It's Galt, not Geithner...

This has been a solid week of performance. Enjoy some time away from your screens this weekend with your families.

Best of luck out there today,


RSX - Market Vectors Russia-The Russian macro fundamentals line up with our quantitative view on a TREND duration. Oil has benefited from the breakdown of the USD, which has buoyed the commodity levered economy. We're seeing the Ruble stabilize and are bullish Russia's decision to mark prices to market, which has allowed it to purge its ills earlier in the financial crisis cycle. Russia recognizes the important of THE client, China, and its oil agreement in February with China in return for a loan of $25 Billion will help recapitalize two of the country's important energy producers and suppliers.  

DJP - iPath Dow Jones-AIG Commodity -With the USD breaking down we want to be long commodity re-flation. DJP broadens our asset class allocation beyond oil and gold.  

XLK - SPDR Technology-Technology looks positive on a TRADE and TREND basis. Fundamentally, the sector has shown signs of stabilization over the last several weeks.  Semiconductor stocks, which are early cycle, have provided numerous positive data points on the back of destocking in the channel and overall end demand appears to be stabilizing.  Software earnings from ADBE and ORCL were less than toxic this week and point to a "less bad" environment.  As the world stabilizes, M&A should pick up given cash rich balance sheets in this sector and an IBM/JAVA transaction may well prove the catalyst to get things going.

EWZ - iShares Brazil- The Bovespa is up 7.7% YTD. President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt -leading to an investment grade credit rating. Brazil cut its benchmark interest rate 150bps to 11.25% on 3/11 and will likely cut again next month to spur growth. Brazil is a major producer of commodities. We believe the country's profile matches up well with our re-flation theme: as the USD breaks down global equities and commodity prices will inflate.  

EWA - iShares Australia-EWA has a nice dividend yield of 7.54% on the trailing 12-months.  With interest rates at 3.25% (further room to stimulate) and a $26.5BN stimulus package in place, plus a commodity based economy with proximity to China's H1 reacceleration, there are a lot of ways to win being long Australia.

USO - Oil Fund- We bought oil on Friday (3/6) with the US dollar breaking down and the S&P500 rallying to the upside. With declining contango in the futures curve and evidence that OPEC cuts are beginning to work, we believe the oil trade may have fundamental legs from this level.

CAF - Morgan Stanley China fund - The Shanghai Stock Exchange is up +25.2% for 2009 to-date. We're long China as a growth story, especially relative to other large economies. We believe the country's domestic appetite for raw materials will continue throughout 2009 as the country re-flates. From the initial stimulus package to cutting taxes, the Chinese have shown leadership and a proactive response to the credit crisis.

GLD - SPDR Gold- We bought gold on a down day. We believe gold will re-find its bullish TREND.

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

EWJ - iShares Japan - Into the strength associated with the recent market squeeze, we re-shorted the Japanese equity market rally via EWJ. This is a tactical short; we expect the market there to pull back when reality sinks in over the coming weeks. Japan has experienced major GDP contraction-it dropped 3.2% in Q4 '08 on a quarterly basis, and we see no catalyst for growth to return this year. We believe the BOJ's recent program to provide $10 Billion in loans to repair banks' capital ratios and a plan to combat rising yields by buying treasuries are at best a "band aid".
EWU - iShares UK -The UK economy is in its deepest recession since WWII. We're bearish on the country because of a number of macro factors. From a monetary standpoint we believe the Central Bank has done "too little too late" to manage the interest rate and now it is running out of room to cut. The benchmark currently stands at 0.50% after a 50bps reduction on 3/5. While the Central Bank is printing money and buying government Treasuries to help capitalize its increasingly nationalized banks, the country has a considerable ways to go in the face of severe deflation. Unemployment  is on the rise, housing prices continue to fall, and the trade deficit continues to steepen month-over-month, which will hurt the export-dependent economy.

 DIA -Diamonds Trust-We re-shorted the DJIA on Friday (3/13) on an up move as we believe on a TRADE basis, the risk / reward for the market favors the downside.

EWW - iShares Mexico- We're short Mexico due in part to the country's dependence on export revenues from one monopolistic oil company, PEMEX. Mexican oil exports contribute significantly to the country's total export revenue and PEMEX pays a sizable percentage of taxes and royalties to the federal government's budget. This relationship is unstable due to the volatility of oil prices, the inability of PEMEX to pay down its debt, and the fact that PEMEX's crude oil production has been in decline since 2004 and is down 10% YTD.  Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.

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 targeted growth level. Other negative trends we've followed include: the reversal of foreign investment, the decrease in equity issuance, and a massive national deficit. Trade data for February paints a grim picture with exports declining by 15.87% Y/Y and imports sliding by 18.22%.

XLP -SPDR Consumer Staples- It performed in line with the market yesterday. 20.71 is a critical line. Should it break-watch out below.

SHY -iShares 1-3 Year Treasury Bonds- On 2/26 we witnessed 2-Year Treasuries climb 10 bps to 1.09%. Anywhere north of +0.97% moves the bonds that trade on those yields into a negative intermediate "Trend." If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yield is inversely correlated to bond price, so the rising yield is bearish for Treasuries.

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