SP500 Levels Into The Close...

Volatility (VIX) and the US Dollar Index are both finally seeing an overdue bounce here today. Dollar Up = Stocks Down. There’s nothing new here in terms of the playbook inverse correlation that matters.

What is new is that volume is decelerating on the down moves and accelerating on the up moves. Yesterday’s volume on the NYSE for example was down 34% from Wednesday’s (when the US market was up). On balance, this is bullish for the market – but only at a price. I think the lows for 2009 are locked in, at least for the intermediate term (next 3 months). I think we continue to make higher lows on selloffs, and higher immediate term highs on up days.

Bullish support resides in the range that I have outlined in green below (754-758 in the SP500). There’s TRADE line resistance up at 809 (dotted red line) and TREND line resistance (solid red line) up at 829.

The big meltup and meltdown moves for 2009 are behind us, for now. Trade this very trade-able range. Buy low, sell high.

Keith R. McCullough
CEO & Chief Investment Officer

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

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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.

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