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SP500 Levels, Refreshed: Trade The Range...

Provided that the SP500 cannot close above what I see as THE line that matters – the intermediate TREND line at 829 – I think we’re going to trade within a proactively predictable range. The shock and awe crashes to the upside/downside of this market’s expectations look to have subsided, for now…

Any time Timmy Geithner is You Tubed (like he was today), the sober investor who has gains to realize is going to start making sales. This is not a political comment – this is simply one of my personal judgment. However “smart” the Washington/Wall Street brain-trust claims him to be, Timmy is a squirrel hunter - and I don’t trust him.

The trading range that I’d like to start covering/buying stocks again continues to shift to higher lows (753-780 in the chart below). As the market’s trading range narrows and volatility continues to rally to lower highs, the market’s March 9th bottom looks more convincing as an established intermediate term low.

Buy low, sell high.

Keith R. McCullough
CEO & Chief Investment Officer

Taiwan: Economic Bottoms Are Processes, Not Points

Export orders are significantly better than they were last month. No matter how bad on an absolute basis, better than toxic matters.

Taiwan has felt the pressure of contracting global demand for consumer technology products acutely, with declining orders driving unemployment levels to 5.75% (an all time high for the island republic), and February export orders data was released today by the Ministry for Economic Affairs, showing the 5th consecutive year-over-year decline.

At -22.7% Y/Y, Export orders came in over 5% better than the median market forecast and showed a 13.81% improvement over January’s numbers. Meanwhile, Industrial Output also showed signs of relative improvement, arriving at -27.14% Y/Y, up 8.32% from January on a monthly basis. Significantly, the impact of Lunar New year, which fell in January this year, accounts for a large portion – though not all, of the relative improvement.

Although a bottoming in the Taiwanese economy will be a process, the evidence that Panda Diplomacy is starting to thaw trade relations with the mainland continues to be a secular positive. Meanwhile, signs that the bullish TREND in semiconductor demand (that our Tech group identified six weeks ago) is helping to slow the rate of export contraction in that critical Tech sector. These are steps in the right direction. Don’t forget, everything that matters in our macro models happens on the margin.

Central Bank Governor Perng Fai-nan will lead a board meeting on Thursday to discuss cutting rates below the present 1.25%, but it’s doubtful that any resulting uptick in domestic consumption arising from lower interest rates could move the needle significantly. We will remain focused on Taiwan and its etf, the EWT, looking for any signs that external demand may be starting to find its feet.

Andrew Barber


It was only 9 months ago when SONC reported its 3Q08 results that management was blaming overly aggressive pricing for the underperformance at its partner drive-ins…now, the company’s declining average check is the main concern.

SONC implemented its Everyday Value Menu on December 29th and has since experienced sequentially better traffic trends across multiple day parts. On a system-wide basis, traffic improved to only down 0.2% in 2Q09 (actually increased slightly excluding the extra day in February 2008 due to the Leap Year) from -1.7% in 1Q09. Despite this sequential pick up in traffic, system same-store sales declined 3.6%, even with the prior quarter. Again, last year’s Leap Year negatively impacted comparable sales growth by about 1% in 2Q09, but regardless, the new value menu put increased pressure on average check. On a reported basis, average check declined 3.4% relative to -1.9% and -0.6% in 1Q09 and 4Q08, respectively. So the company is giving away food to get people in the door…not a new concept within QSR.

Surprisingly, despite the damage the value menu has done to SONC’s average check, the company’s food costs as a percent of sales were flat with 1Q09. The value menu already accounts for about 10% of SONC’s sales so management has done a good job managing its costs to prevent margin erosion. Going forward, management expects the value menu to contribute 12%-15% of sales, a level that is comparable to that of its competitors. As the value menu becomes a bigger part of the company’s mix, I would not expect margins to remain immune from the pressure that is already hurting SONC’s average check. Management stated that the value menu is attracting incremental customers and has not yet materially cannibalized sales of other menu items. This translates to the company has been successful in attracting the bottom feeder customers, which if it continues, will eventually impact margins. MCD’s dollar menu has helped the company to post consistently strong comparable sales number, but its U.S. restaurant margins have declined for the last eight quarters. Increasing value menu contribution and growing margins just do not go hand in hand.

In an attempt to boost average check, management said it will split its advertising dollars between promoting both the Everyday Value Menu (almost all of the company’s ad spending has been allocated to the value menu since its introduction) and its more premium menu offerings. From both an average check and margin perspective, this is the right strategy for the long-term. In the near-term, however, I would suspect that any pullback on advertising of the new value menu could result in a slowdown in the traffic growth that we saw in the second quarter.

We have always been impressed with the SONC business model and management team. I suspect that we have 3-6 months before the concept can adjust and work through the new operating business model. As we begin to see some stabilization in the trends, the stock will work higher. I’m just not ready yet to pull the trigger.


Last weekend Malcolm Knapp released his monthly insights into casual dining sales trends. He reported that the same-store sales change for February 2009 was -3.6% and -5% for guest counts.

It’s interesting to note the same-store sales trend since October 2008:
October -6%
November -2.6% (positively impacted by calendar shifts)
December -9.5% (negatively impacted by calendar shifts)
January -4.1%
February -3.6%

December was clearly an aberration for every retailer, either way the trends are clear; the pressure on the consumer is easing and/or the value promotions at casual dining is stemming the defection of consumers to supermarkets and QSR.

As we look into 2Q09, it’s unlikely we will see significant improvement in sales trends from the -3% to -5% levels. The issue facing all operators will be the impact on the P&L from discounting in an effort to drive customer counts. Year-to-date, the Full Service Restaurant (FSR) stocks on average have increased 20% versus 10% for the QSR stocks. I suspect the lack of a top line catalyst will mean the FSR stocks will take a breather. I would expect sales trends, however, to reaccelerate into the third and fourth quarter.

That being said, we are buyers of large cap, early cycle casual dining names (EAT, DRI, CAKE and PFCB) on down days. Right now I’m working on some of the names that have lagged so far this year like MSSR, MRT and LNY. Another thought would be to look at the QSR names that have underperformed so far this year like SONC, PEET, JACK and CMG.

I’m still not buying MCD, despite it being down 11% this year.

Eye on Re-Regulation: Where There’s Smoke… Notes for the Week Ending Friday, March 20, 2009


Whenever blue teardrops are falling
And my emotional stability is leaving me,
There is something I can do,
I can get on the telephone and call you up, Baby.
And, Honey, I know you’ll be there to relieve me.
- Marvin Gaye, “Sexual Healing”

One quadrillion dollars.

You heard it here first.

Chinese Premier Wen Jiabao said he was “a little bit worried” about the safety of US Treasurys. Although the world is now referring to the China-US nexus as the “G2”, Premier Wen was not expressing altruistic concern over his partner’s well-being. This was part of a bout of Mandarin muscle-flexing that has emerged in various forms in recent days.

Also in the news this week, China has a law stipulating that an entity deemed to be a “lifeline of the national economy” is to be protected as a matter of national security. This law was trotted out to put a highly public Kibosh on Coke’s proposed over-priced acquisition of Huiyuan, China’s leading juice maker. We do not disagree with China’s decision – our colleagues Howard Penney and Andrew Barber make a strong case for the Coke acquisition being anti-competitive and a Bad Idea for the Chinese. We see it as another step on China’s Long March to capitalism.

The US has gotten the message. On the heels of White House spokesman Robert Gibbs assuring China that “there’s no safer investment in the world” than Treasury Bonds, Chairman Bernanke stunned the world by offering the Chinese a trillion dollars’ worth of Sexual Healing.

America’s latent racism and xenophobia aside, the Chinese really are giving us something to worry about. They have accurately assessed their dilemma and found no way out. Meanwhile, they are pressing forward deliberately with what appears to be both the determination to become – and the recognition that they are – what America was to the world in the twentieth century.

We hear from one major US bank that the Chinese are setting up customer service call centers chock full of telephones, all manned by Indian immigrant workers – they speak English, the Chinese don’t. The Chinese may be poised to take over this market and dominate it entirely.

The Wall Street Journal’s “Overheard” (16 March) reports China’s Alibaba Group is looking to hire an additional 5,000 employees this year. Specifically sought are Westerners with software and information technology backgrounds. Will the Chinese retaliate by draining Silicon Valley’s brains, or will they slap us by restricting visas for American geeks? The good news: a number of America’s most talented information technology experts already speak Chinese because they were born there.

In the aftermath of the Bird Flu cover-up, and the recent baby formula disaster, are we the only ones struck by the irony of this item from the Wall Street Journal (18 March, “China Investigates J&J Products”)? “Chinese health authorities are investigating products made by Johnson & Johnson in response to a U.S. consumer group’s charges, disputed by the company, that some chemicals contained in the products could cause cancer.”

J&J, according to the WSJ story, has a 69% market share of baby-care products in China. We wonder whether the domestic baby-care products industry also represents a “lifeline of the national economy.”
Chairman Bernanke is offering “Quantitative Easing”, a surreal mechanism whereby interest rates will be functionally brought well below zero. We hope this dicey bet pays off. It appears that it can only work under one of two assumptions. Either we continue to have the financial credibility to borrow money in large enough quantities, and at low enough interest rates, to service these trillions in debt forever. Or our goods and services will sell at such a clip and price level that we have the revenues to buy out our obligations. Economist Hyman Minsky calls this Ponzi Financing. The US now risks becoming the Bernard Madoff of Last Resort.

A Quadrillion Dollars. You saw it here. Send us your guess on when that figure first gets mentioned in the mainstream media. The winner will have the satisfaction of knowing that they pegged it right. By the time we get to that number, there will be little else in this world to be satisfied about.

Squeeze This
Prominently featured on the front page of the Wall Street Journal Weekend Edition is a picture of the Ben Bernanke squeeze doll, handed out at a recent bankers’ convention.

Inside the same paper is what, in these dreary times, must pass for a Human Interest story, “Lehman Can Now Have Its 2,055 Stress Balls Back”. A New York bankruptcy judge has ordered Barclays to return thousands of Lehman corporate premiums – T-shirts, logo pens and pads, messenger bags, and 2,055 Lehman logo stress balls.

There is something else Barclays may have got its hands on that doesn’t belong to it. In fact, it never belonged to Lehman either.

As major brokerages went out of business, hedge funds were forced to find new homes for their prime broker relationships. While very little that is happening in today’s markets can be described as “orderly”, a number of firms were able to transfer their assets. What they are having trouble with is an asset which, while it is in their name, doesn’t belong to them.

Hedge funds and other money managers pay a significant percentage of their commissions out in soft dollars. These are commission dollars generated by trades done at the prime broker, then directed to firms that provide research to the funds. In the last few years the SEC has sanctioned the Commission Sharing Account – or CSA. This enables hedge funds to set aside money for future payment to research providers. This is in keeping with the buy-side practices of the larger funds, which pay their providers semi-annually, on the basis of an internal vote of the portfolio managers. This has replaced the practice of giving individual trades to brokers each time they come up with an idea.

The transfer of assets between prime brokers has been complicated by the status of the CSA balances. These are commission dollars, and no longer belong to the funds. They are for third parties to be designated later, and are therefore not assets of the prime broker.

We hear that prime brokers are not transferring these balances when their clients leave for new relationships. There appears to be confusion on all sides. Neither the old nor the new broker appears to be able to state clearly whether they can transfer these monies between them – it belongs to neither. The hedge funds do not want to take a check, which has been offered in some cases, for fear of it being deemed a commission rebate to an unregistered customer.

Soft Dollar Commissions, the financial equivalent of rollover minutes. We hear that, when the hedge funds fled Lehman, they were glad to get out with their assets intact. We do not know how many millions in CSA or other soft-dollar balances were left behind, and to our knowledge, no former Lehman prime brokerage client has gone after this cash.

We have no way of estimating how much money is involved, but Lehman declared bankruptcy in mid-September, halfway through the second half of the year, which is to say, smack in the middle of a soft dollar allocation period. We don’t know how much money three months’ worth of soft dollars represents, but given that damned near everyone had a Lehman prime brokerage account, we have to assume it’s worth more than the squeeze-balls.

Eye On iShares
Speaking of Barclay’s we note the talk about Barclays selling its iShares business. The media are reporting this as Barclays being forced into selling something of a crown jewel, but we think it may be one of the most fiendishly clever asset disposals in recent years. We are always willing to be proven wrong, but we have written before about what we believe may be significant legislative changes to the ETF market.
The Wall Street Journal (Weekend Edition, 21-22 March, “Barclays To Aid iShares Sale”) mentions private equity firms TPG and Apax Partners as possible buyers for the ETF business. We have commented on the ETF business before. See especially our item “The Gold-Bug” (27 February) which discusses moves by the government which we believe may curtail ETF issuance. It would be the ultimate irony if the TALF gave money to TPG and Apax to buy Barclays’ ETF business, which then ran afoul of Senator Levin’s newly-introduced bill to restrain speculation.
We have seen numerous instances in recent months of side-by-side departments of the US Government not knowing what each other are doing. We suggest that, if TALF does not know what the Senate intends for the ETF market, at least the potential buyers of Barclay’s business should.

Death Spiral
When the facts change, I change my mind. What do you do, Sir?
- You Know Who…
The above much-abused quote from John Maynard Keynes has become the watchword for every wannabe entrepreneur, capitalist, Ayn Rand-ian and business leader. We have also had occasion to note that it is often the media who are changing the facts.
One recent example of rewriting reality comes from Friday’s Wall Street Journal (20 February, “Citi Defends Redesign, Plans A Reverse Split”).
The reverse stock split was long a staple of the over-the-counter world. Stocks that had sunk to levels that could trigger a delisting often sought to survive by doing a reverse split, thereby repackaging their securities into an artificially higher price. One for five. One for ten. We have seen one for one hundred stock splits. Anyone who has worked in the low-priced end of the equities markets knows that these reverses are almost always merely temporary measures that often unleash a death spiral, as the stock quickly sinks back towards its delisting price. If a stock was bad enough to go from over ten dollars, down to below a dollar, it will get there again. We are not aware of academic studies on the topic, but our observation is that stocks decline by a measurable percentage in the days – or even hours – immediately following a reverse, and most companies eventually sink back to the price that stimulated the first reverse split.
This is generally helped by the short sellers. Nothing equates to blood in shark-infested waters like a public admission that you are finished, and the shorts have been only too happy to oblige by chomping on these stocks the moment reverses are done. By the way, if Citi is foolish enough to believe that this will not happen to them, we refer Pandit & Co to recent reports that, of over 5,000 complaints of illegal shorting filed with the SEC in recent years, not a single one has resulted in an Enforcement referral. If you were wondering whose side the regulators are on, wonder no more.

The WSJ has different take on reality. They write that Citi’s planned reverse split “would shrink the number of shares outstanding while keeping the company’s income and shareholder equity unchanged. As a result, each remaining share would have a call on more earnings and shareholder’s equity and the price should rise in relation.”
This information is just plain wrong. The level of earnings and equity in a company do not change, and while the raw numbers go up – by the ratio of the reverse split – the ratio of share price to earnings, equity, cash flow and every other measure, remains in the same ratio to the resulting share price.
A company with a one-dollar share price, and five cents in earnings is trading at a 20 P/E. Reverse the stock 1 for 5 and the result is a 5 dollar share price, with 25 cents in earnings, for a 20 P/E ratio.
The Journal article appears to be confusing a Reverse Split with a company retiring its stock. By shrinking the shares outstanding, the earnings, cash flow, and assets per share do actually increase. We wonder how many of today’s holders of Citi shares have this figured out.
If you are confused by all this, we suggest you ask the Chinese who, one year ago, abandoned a multibillion-dollar investment in Citi. Maybe they were drawing on their own Goldman Sachs brain trust – John Thornton, retired President and Chief Operating Officer of Goldman, retired to become Director of the Global Leadership program at Beijing’s Tsinghua University. We haven’t heard anything about him since, but it is difficult to imagine he is not playing an advisory role.
Or maybe the Chinese, watching the inability of the US financial marketplace to keep its balance, remembered Confucius’ warning: never give a sword to a man who can not dance.

Congress Shrugged
Congress may be on the verge of rescuing capitalism and setting America back on a path of dynamic creativity and explosive growth.

Ably abetted by President Obama, who resolutely refuses to take a stand on anything, Congress has mobilized to punish 73 AIG employees who accepted bonuses of one million dollars or more.
Our associate, Andrew Barber, has written before of his personal relationships with AIG executives, and we will admit that our version of the facts may be slanted, given their source. Yet, this whole story has the ring of truth to it. We have been on Wall Street long enough to know a debacle when we see it.
In a classic scenario of “Sell – to who?” AIG apparently opened its books to Secretary Geithner. Things, they told him, were not going well. The holders of their CDS contracts were unwilling to unwind them at a loss. First, AIG’s counterparty would have to take a substantial loss on their investment. And second, it would create a Last Trade, and force repricing of other CDS contracts, which would mean a tremendous hit to the value of their portfolios.

We are told that no more than ten people within AIG structured and sold $1.6 trillion worth of CDS contracts, representing a substantial piece of the problem. AIG is making a legitimate case for “stay” bonuses for the only people who, in AIG’s estimation, might be able to work out of at least some portion of this paper.

For what it’s worth, we believe it is all Fool’s Gold, and the hundreds of billions thrown at AIG will, in the end, go up in smoke.

Here are some other facts. In 2003, Congressman Charles Rangel pushed through a bill offering exemption from Federal taxes to financial firms that set up in the US Virgin Islands. Congressman Rangel’s friends included financier Jeff Epstein – the billionaire whose conviction for having improper relations with underage girls gave new meaning to the phrase “the US Virgins”.

Epstein and others like him – US Virgin Island-based financiers, not sex offenders – funneled large donations to Rangel’s political machine. In 2006, Congressman Rangel again rushed to protect his favorite islanders from the prying eyes of the IRS.

The NY Times reported (20 march, “For Rangel, A Complicated Relationship With AIG”) “As recently as last year, he was trying to woo the company to donate $10 million to a school to be named in his honor. And while A.I.G. officials mulled the request, Mr. Rangel supported a provision in a tax bill that saved the company millions of dollars.”

As someone once said, Follow The Money.

So why has Congressman Rangel now introduced the bill, now passed by a pitchfork-wielding Congress, to eviscerate the annual compensation of The AIG 73?

If this were “Mr. Smith Goes To Washington”, we would guess it had something to do with the investigation of Rangel’s personal tax issues coming to a head. In the current environment, even Charlie Rangel would not take money from AIG. Asked recently on CNBC why he was going after AIG, Rangel said “When you violate the public trust, different rules apply.”

Remember that statement, Congressman.

Congress has become a raging crowd lusting for blood. It is media distraction, lest We The People step back and contemplate the disaster wrought upon our lives by the incompetent and venal dealings of our elected officials. The mismanagement of our financial markets would be comedy on a Shakespearian scale, were it not a tragedy of Biblical proportion.

The creeps of Wall Street are no innocents, but the wickedness of our legislators at every turn has aided, abetted, and sucked voraciously at the teat of the very industry they were supposed to regulate. The incestuous relationship between The Street and The Hill is not going away any time soon. In a panic that they are on the verge of being found out, Congress has reacted with the Capitalist version of a Stalinist purge, urging the roaring crowd on in their lust for vengeance.

Where is President Obama in all this? The same President Obama who refused to rein in the outright nastiness of Speaker Pelosi over the Bailout Bill is now leaving Secretary Geithner twisting in the hurricane. Secretary Geithner has both Senators and the media clamoring for his blood, while President Obama makes his debut on Jay Leno and gets to say a prime time Shout Out to Timmy.

By revealing their own incompetence and wickedness for what it is – for possibly abrogating the Constitution, and for thrusting a stake through the heart of the relationship which, for all its flaws, was supposed to keep the US the bastion of global capitalism – Congress may have finally hit on The Solution.
The AIG 73 are now looking out the windows of their offices and realizing that there is a world out there. Those who worked in good faith are contemplating leaving, not because they will have to give back their bonuses, but because they do not want their families to have to hear a constant rant of “Blood! Blood! Blood!” They feel like Dr. Frankenstein holed up in his castle as the mob approaches.

Now, all over Wall Street, teams of highly skilled, experienced professionals are realizing that it is Game Over for the major firms. The stories trumpeting the Death Of Wall Street may have gotten it the wrong way round. If you run a trading desk at AIG – a thirty-year veteran, surrounded by ten- and twenty-year veterans, all skilled at making decisions on billion-dollar transactions, and with global connections at all levels of the financial markets – the temptation to walk away is peaking just about now.

When the head of a mortgage-backed desk calls his team of thirty professionals into a room and announces “We are all leaving to start our own firm,” is there anyone who will not say “I’m in”? At this point, it does not matter that there may never again be a mortgage-backed market. Teams of smart, creative people, used to working together to devise financial strategies, will always find ways to make money. The difficult thing is not finding the market, it is crafting the team. This is something that takes years – decades. The heavy lifting has been done, and Congress has now opened the door, freeing all these employees of the TARP firms of the burden of having to work out of distressed portfolios.
We see a brave new day of Capitalism dawning. Instead of holding AIG’s hand while its employees struggle to keep the titanic CDS portfolio afloat, Congress may have forced AIG to go bust. The professionals who know that portfolio intimately will be standing around, reconstituted into independent boutique firms. They will take the TARP financing and pick up the pieces – those worth saving. They will make a fortune in the process. Members of Congress, from Rangel, to Dodd, to… oh, forget it – will continue to get away with fiscal murder. The Chinese will continue rolling forward, while the US taxpayer is left holding a very smelly bag.

At one point in his testimony last Wednesday, AIG CEO Liddy stated “I think the AIG name is so thoroughly wounded and disgraced that we're probably going to have to change it.” We strongly suggest that Congress follow his example.

Congress has taken a significant step towards undermining American society. Passage of the AIG 73 Bill is a body blow to our nation’s credibility, and very possibly to the Constitution. President Obama, by refusing to stride into the middle of the fray and shout the participants back to neutral corners, has created a leadership vacuum when we can least afford it.

Politics abhors a vacuum – because politicians are terrified of uncertainty. But Capitalism loves a vacuum – it gives the smart, the quick and the deft an opportunity to take advantage of whatever comes next.
Congress can not destroy the creativity of Wall Street. By pushing the industry’s top professionals out of the plane without a parachute, Charlie Rangel may have rescued Capitalism.

The final truth remains that, what Atlas has shrugged off, only Atlas can pick up again.


The US Dollar is in the same position as a home owner in default: in the absence of liquidity the debtor has the power not the creditors...

Bank Governor Zhou Xiaochuan’s proclamation that the US Dollar should be replaced as the primary reserve currency in favor of an international currency issued by the IMF echoes similar calls made by Russian leaders in recent weeks.

In advance of the upcoming G20 meetings, the esoteric daydream of a global benchmark currency has gained more political traction with the larger emerging nations –Nations that both resent the US Dollar hegemony and hold the bulk of their nation’s wealth in government controlled pools while their citizens live in relative deprivation. For these leaders the political attraction of knocking the US down a peg is intense.

This rhetoric is powerful and incendiary and, ultimately, meaningless. Even the most reactionary of these governments, if given the actual chance to replace the USD with an international basket, have only to look at the historical failure of international organizations to achieve long-term goals –whether the UN or IMF, or the squabbling between the strong and weak economies that comprise the EU to see the downside in holding reserves in a currency run by international committee.

When the rhetoric passes the US Dollar will remain the benchmark for the time being, and Chinese leaders will recognize that the best way to attack the Dollar’s dominance is to allow the Yuan to float freely and challenge the its leadership status – something that will be a political impossibility in the present environment.

Forward contracts for Yuan rose almost 1% overnight to the highest level in three months as a weaker US Dollar is increasingly priced in while spot rates increased 0.05% to 6.8296 USD. As the Chinese stimulus program picks up steam and the effects of reduced export taxes are felt by producers, the weakening Dollar will be paramount politically.

Andrew Barber

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