Switzerland: What A Mess!

Swiss National Bank intervenes to prevent appreciation of the Franc yet the negative economic fundamentals and weighting of the ETF will outstrip the positives of currency devaluation…


Position: Short Switzerland via the etf EWL


SNB started buying foreign currencies on March 12th to encourage devaluation of the Franc versus the Euro and Pound and reduced its benchmark interest rate to 0.25% to improve liquidity by lowering borrowing costs.  The SNB is now continuing to devalue the Franc by buying foreign currencies and corporate bonds.


On the margin, Swiss monetary policy is positive. A weaker Swiss Franc will benefit exports to its largest trading partner, the Euro zone, and better match deflating prices and waning demand that are pushing down GDP. Since 3/09 the Franc has depreciated 3.7% versus the Euro and Pound.


The Swiss Market Index is down -9.7% YTD, but up +6.9% in the last four weeks.  We shorted the Swiss etf EWL on 3/25 at an intermediate top.


Yet our negative outlook on the country is confirmed by Switzerland’s fundamentals. Despite the positive “spirit” coming from G20 along with the $1Tillion increase to the IMF’s balance sheet, Western Europe has a ways to go before it recovers from its recession, especially Switzerland, which is levered to European financials.


From a monetary standpoint the SNB has run out of room to cut interest rates, and deflationary pressure is a real concern. Swiss CPI declined 0.4% in March Y/Y, the biggest decline since 1959. Economists predicted a drop of 0.1% after a 0.2% gain in February.


While deflated prices (led by a y/y drop in oil costs) will benefit consumers in the short term, unemployment is rising and a weaker Franc will put downward pressure on wages and increase the price of imports. Cooling prices may have the opposite intended effect and prolong the recession, especially if consumers pull back spending and increase personal savings or wait for lower prices, a trend we’re seeing throughout Europe. The economy is forecast to contract as much as 3.5% this year and the SNB expects inflation to remain close to zero in 2010 and 2011. This is a bearish forecast for recovery in the intermediate term.


See the chart below - the Swiss eft EWL is heavily concentrated in healthcare (36.33%), consumer staples (22.47%), and financials (17.18%), sectors we’re bearish on. Our Healthcare analyst Tom Tobin is decidedly bearish on Swiss healthcare companies (Roche and Novartis each make up 13.5% of the etf) because they sell primary to the Europe, where profit margins are heavily reduced due to fixed pricing. Nestle makes up 20.2% of consumer staples. We’re bearish US Financials and believe European Financials will lag the US’s recovery by at least 3 Months. Again, Switzerland is heavily levered to financials and EWL’s financial composition includes: Credit Suisse 4.9%; UBS 4.4%; and Zurich Financial 4.2%. 


The country’s negative fundamentals coupled with the weighting of the etf in underperforming sectors leaves us confident in our bearish thesis despite the intermediate gains that might result from the central bank’s devaluation of the Franc.


Matthew Hedrick

Switzerland: What A Mess! - swis1

Switzerland: What A Mess! - swis2


I recently commented on EAT’s CFO Chuck Sonsteby’s bullish view on margins following his presentation at an investor meeting in mid March.  Specifically, he said he was optimistic about margins because EAT is benefiting from slower unit growth, improved labor productivity, lower employee turnover and better food cost control.  At the same time, commodity costs are coming down.  EAT’s controlling what it can combined with the fact that it consistently outperforms the industry on a same-store sales growth basis as measured by Malcolm Knapp, particularly at Chili’s, causes me to maintain that the company is one of the better positioned casual dining companies.  That being said, despite Mr. Sonsteby’s more bullish sentiment, I continued to question how much fat could still be cut out of the system.  The company reported better than expected 2Q09 earnings as a result of better cost control and better margins, but I remained concerned about the company’s ability to maintain its margins without a lift in top-line results.


After taking a more in depth look at EAT’s recently announced organizational changes, which it says will “create additional synergies across its portfolio of brands,” I am only more convinced that the company’s margins will not only withstand the current sales environment but also improve significantly once sales growth returns.  The most important organizational change, in my view, was the announcement that the current president of the Chili’s concept, Todd Diener, will now also serve as president of On the Border, overseeing operations for both concepts.  CEO Doug Brooks said, “These changes will help us to streamline organizational efficiencies and elevate the guest experience across all brands.”  Although I agree with the first part of that statement in that by increasing Mr. Diener’s span of control, the company will be able to streamline its costs, this type of organizational change or cutting of brand-specific management  does not typically bode well for a concept’s operations and/or guest experience.   The company’s franchisees have had success with this dual brand management approach, but I think increasing management’s span of control could possible hurt the company’s ability to operate efficiently at both Chili’s and On the Border.  Time will tell!

The next obvious move would be for the company to reduce its number of area directors across the two concepts, particularly where there is some overlap of brands on a geographic basis.  Again, although I don’t necessarily agree with this change to the company’s business model, this could be where the real bulk of fat remains in the system.  The company could easily cut people and costs out of the system across these two concepts.  These reduced costs along with the company’s continued focus on labor and food costs, which are already rolling over, will provide a big cushion to margins despite sales performance.  Of course, growing same-store sales would help! 


It is this margin cushion that leads me to the paradigm shift…I have been talking a lot recently about the market share shifts between QSR and casual dining.  Here is what we all know:  The QSR players upped their quality, which helped them to become more competitive with casual dining restaurants.  The restaurant industry is a zero sum game so the QSR companies grew their market share at the expense of the casual dining industry as a whole.  The challenging economic environment then perpetuated this market share shift to QSR as more people sought lower priced, value menu offerings.  The casual dining operators began playing the discounting game in order to try to drive traffic regardless of the impact to margins.  

Now, selective QSR players are continuing to drive value (at times giving away food) but also offering more premium-priced menu items to try to compete with casual dining.  So the question is, will casual dining restaurants have to maintain its current low prices in order to compete with QSR?    Are lower priced casual dining offerings just a sign of the times or are they here to stay?  Brinker is making structural, lasting changes to its business model.  The company cannot easily or quickly reverse these recently announced organizational changes once sales improve, which leads me to believe that Brinker is permanently resetting its cost and margin structure to adjust to these lower prices and maintain the current, reduced price gap with QSR. 

In the past casual dining companies operated on the basis that more is better.  To drive incremental revenues restaurant companies would add more food to the plate and take prices up.  This strategy works in good times but does not work when nearly every consumer is looking for ways to save money.  This strategy also works when you don’t care what you are eating.  As the industry is faced with the need to tell consumers how many calories they are eating, adjustments to the menu are required. 

The result is a further evolution of the new paradigm in casual dining - less is more.  New menu items are being introduced, with less food on the plate (fewer calories), at lower price points that are designed to maintain margins and improve traffic.  Given the decline in commodity costs, it’s a great time to be reinvesting in driving new occasions.  


We continue to see more price points on the menus at casual dining restaurants in the $7-$8 range.   I see these price points as a big challenge for QSR operators, especially for those concepts with average checks near $6 and for those with new products geared toward trying to capture the casual dining customer.   In our March 26 post titled “Is Market Share Shifting?”, we highlighted new menu items from EAT that are being introduced at $7 (• Chili's.  On April 6, the chain will offer a "10 meals for under $7" deal).  Regardless of the potential industry paradigm shift, EAT’s changes to its business model will definitely boost margins in the near-term.






This Is BIG: US Employment Is Turning...

There are a lot of ways that the pundits are going to try to skin the cat on this morning’s US employment report for March – but I have yet to see anyone on the tape with the call that I am about to make. Like US Housing, US Employment is now turning to the positive.

Positive? Yes – very much so. On a nominal basis, this morning’s report was obviously better from a claims perspective than both January and February, but the more important point is the sequential deceleration in the acceleration of the monthly US unemployment rate.

Everything that matters to my macro model occurs on the margin. This month’s sequential acceleration in US unemployment was only +.40% (from 8.1% FEB to 8.5% MAR). That’s a significant deceleration of the acceleration, and one that should start to TREND in Q2 – Why? Obama has 4 plus million jobs to bring into the base, and that ball is finally in motion.

For the math on this (and for Transparency/Accountability purposes), below is the call I made on March 6th, 2009 on employment titled “The Great Recession: Why I'm Not Depressed”:

Why I’m Not Depressed: It’s all about the delta. The revisionists are straight-lining the record setting acceleration in unemployment into becoming a repeatable rate of growth – mathematically speaking at least, that’s silly. Whether you want to look at this relative to the mid 1970’s when year-over-year trough to peak unemployment last ramped this quickly (up 300-400 basis points year over year), or in terms of percentage accelerations across different durations, my conclusions are the same – the rate of growth in the US unemployment rate is setting up to SLOW… right as the manic media worries people about it most.

This Is How a Depressionista Can Get To His/Her Numbers: the February 2008 to February 2009 acceleration in the unemployment rate was 330 basis points (from 4.8% to 8.1%, see charts below) – that’s a 69% acceleration of the nominal level of unemployment in this country. If we were to straight line that steep curve (chart) and project the same rate of growth in unemployment to February 2010, you’re looking at a 13.7% US unemployment rate. That would err on the side of a Great Depression type number. Using a shorter duration model, maintaining the current pace of growth in monthly unemployment gets you a 8.6% unemployment rate by the end of March – that too would be depressing, but I don’t think we see that number – if we don’t, the growth rate of unemployment will have SLOWED sequentially.

Back to today, April 3rd, 2009 and updated for this March report, the steepness in the chart below incorporates the peaking slope of this curve.

Was this steep? You bet your Madoff it was – but at +340 basis points year over year, the expansion of the US unemployment rate is not as bad as we saw in the 1973-75 recession, and it also coincides within earshot of both US stock market bottom and a bottoming in the y/y price declines in US housing.

The February employment report marked the peak of the acceleration in US unemployment. March just gave us one more critical economic data point that supports the recent +23% squeeze in the US stock market. While the Bears of 2008 are still writing books, I feel that I am one of the few bears who has made the bullish turn here with hard cold mathematical facts behind my reasoning.

Stock prices remain leading indicators. The fundamentals of the US economy have turned positive, on the margin, and materially so. Trailing economic data just reminds most economists why they are revisionist historians.


Keith R. McCullough
CEO & Chief Investment Officer

This Is BIG: US Employment Is Turning...  - kmch

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CVD continues to break down...


"The memories of men are too frail a thread to hang history from."  
~John Still, The Jungle Tide

Ah the memories ... after a +23.3% four-week meltup in the SP500, the days of the Great Depressionista flying around in his Dark Lord helicopter now seem so far far away... get them crackberries fired up, and let's get this American mania right back to where it's always been!

This morning, it's only fitting that AFTER the US stock market has handsomely paid those who invested when they should have (I know, the "long term" guys called those who bought low "traders") that the relic of the $145/share RIMMer is back! Never mind that it's now a $50 or $60, or heck - a $70 dollar stock - who has memories of such silly things like math, when we can socialize this country to smithereens, Break The Buck, and REFLATE just about everything you can buy with that US Dollar!

America's global leadership currency certainly isn't what it used to be. Away from it being implied at the G-20 meetings in London, at home we ensured that yesterday by Marking-America-to-Madoff. As much as reading that might taste like chewing on a cat's tail, basically that's what we're doing here in the USA - and oh, boy isn't it fun for an immediate term TRADE! Or is it an intermediate term TREND? Or is it fun?

Why yes, Dear Main Street Client, that is indeed what all of this is - a TREND of breaking the integrity of this fine nation's financial system, and TRADING our handshakes for the ability to change the rules of everything from American accounting standards to who knows what's next - all for the benefit of those who really "can't handle the truth" of marking their performance to market. Never say you never thought you'd see the day - you're seeing them right here and now, live!

What would America's finest intellects of everything financial engineering do if, say, the Chinese changed their accounting rules in the middle of the game to benefit those who cozy up to government? Ah the memories of those people in China who "make up their numbers" that we'd have...

The most dominant driver of 2009 US stock market performance continues to be the US Dollar. Yesterday, the inverse correlation we have been barking about between US Equities and USD was as clear as Jack Nicholson's response on Tom Cruise's trial in 'A Few Good Men' - "crystal". And now, AFTER the REFLATION leading indicators from Dr. Copper to a steepening of the American Yield Curve are in the rear view mirror, we can all wrap up this week and get ready for Barron's to proclaim that the bottom for the US stock market in 2009 is in...

Three weeks or so ago, I was on CNN and said two things that garnered the attention of plenty an angry Bear anonymous emailer who is hurrying to publish his Great Depression book: 1. "The stock market bottomed on March 9th" and 2. "US Housing will bottom in Q2"... call me a hockey knucklehead, or call me brave - plenty of my boys back home in Thunder Bay call me the former anyway. This is what we men of the ice do - take the shots that no one wants to take...

The squirrely thing about all this "market bottoms are processes, not points" stuff that I riff about, is that it was fairly predictable. Much like calling the topping process of global markets in 2007, most people with an objectively proactive investment process called this. It wasn't that complicated.

What is complicated is understanding how some of these artists of having money to manage will be explaining to their investors how it is that they missed the crash here on the way UP. Market's crash on the way UP - pardon? Ask someone who has been running net short for the last 4-weeks what's happened to their client's moneys...

Crashes, I think, are simply what happens versus consensus expectations. If the move is equal to or greater than 18% in one direction, at an expedited pace, my Macro team here in New Haven calls it a crash.

You can call it getting run over, crashing, or whatever - it's happening all over the world right now, particularly in places that REFLATE when the US Dollar DEFLATES. Check out that lonely ole West Texas soul of an asset class for instance - crude oil is up another +2% this week, taking its REFLATION rally to 7 consecutive weeks and adding up to a +45% move.

How about them American "Tech Wrecks" that our Tech guru, Rebecca Runkle, and I have now re-labeled as "Tech Specs" - the S&P Technology Sector etf (XLK) is +25% in the last 4 weeks, and now trading +7% for 2009 to-date! Depression? Not so much... and you gotta love anything American that we can make up the accounting on, and sell it to the Chinese for cheaper US Dollars! Pardon??

Yes, no matter how much money you're making on this REFLATION trade, it's actually all quite sad when you really take a step back and think about what's happening in this country. One of our more astute clients emailed us yesterday looking for my immediate term upside target in the SP500... so I sent him the number with the following note: "today is the most profitably sad that I can remember - does anyone not chase?"...

Understanding where this market is going next is one thing - that's how we feed our families and pay the bills. Marking-America-to-Madoff is an entirely different thing - and for now at least, all I can do is hope and pray that the crackberries don't take hold of our long term vision of what makes America great, forever.

My immediate term risk/reward outlook for the SP500 is balanced now at +1/- 1% (SPX 825 and 844).

Thanking God that it's Friday,


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 via a quicker decline in asset prices. 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.  

USO - Oil Fund- We bought oil on Wednesday (3/25) for a TRADE and are positive on the commodity from a TREND perspective. With the uptick of volatility in the contango, we're buying the curve with USO rather than the front month contract.  

EWC - iShares Canada-We bought Canada on Friday (3/20) into the selloff. We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's large government recent history, and believe next year's Olympics in resource rich Vancouver should provide a positive catalyst for investors to get long the country.   

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. 

GLD - SPDR Gold- We bought more gold yesterday (4/02). We believe gold will re-assert its bullish TREND as the yellow metal continues to be a hedge against future inflation expectations.

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


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 $1.3448. The USD is up versus the Yen at 99.8870 and down versus the Pound at $1.4776 as of 6am today.

EWL - iShares Switzerland - We shorted Switzerland for a TRADE on an up move Wednesday (3/25) and believe the country offers a good opportunity to get in on the short side of Western Europe, and in particular European financials. Switzerland has nearly run out of room to cut its interest rate and due to the country's reliance on the financial sector is in a favorable trading range. Increasingly Swiss banks are being forced by governments to reveal their customers, thereby reducing the incentive of Switzerland as a tax-free haven.

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".

DIA -Diamonds Trust-We shorted the DJIA on Friday (3/13) and Tuesday (3/24).

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 re-shorted India yesterday (4/02). 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- Consumer staples was the third worst performing sector yesterday. This group is low beta and won't perform like Tech and Basic Materials do on market up days. There is a lot of currency and demand risk embedded in the P&L's of some of the large consumer staple multi-nationals; particularly in Latin America, Europe, and Japan.

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.


As we pointed out in our 2/26/09 post, “CRUISING TOWARD STABILITY”, the cruise liners recently found their pulse.  The good news is that the customer is elastic.  Sure, prices are down a lot but at least the boats are full and the numbers are more predictable, at least for 2009.  For the first time in a while we believe the Street estimates for 2009 are reasonable.  That’s the bull case.

How long the bull case dominates the trading in the stocks is debatable.  Indeed, RCL and CCL are up 68% and 45%, respectively, off of their March lows.  It seems the 2009 stability thesis has played out.  Now for the bad news.


Capacity Kills

I have no idea what the consumer will spend in 2010.  However, if investors are looking for yield growth the economy needs to improve dramatically.  Capacity growth is huge, as depicted in the following chart.  If industry-wide capacity grows 10% in 2010, how can analysts project flat yield growth?  Maybe my calculator isn’t as smart as their slide rules but negative yield growth in 2010 is pretty close to a mathematical certainty. 



THE TRIPLE THREAT TO CRUISERS - cruiseline capacity


For investors hoping for capacity exiting the market, we’ve got bad news.  Even the older boats are still cash flow positive.  None of the operators, not even the small ones, have plans to reduce capacity, at least not through 2010.  Unfortunately, the new supply is pretty locked as well due to very putative termination costs of breaking a shipyard contract.


Demographic Headwind

As can be seen in the following chart, the number of Americans in the core cruising age group of 47-52 will grow only 0.8% in 2009.  This represents the first year in decades that growth in this segment falls below 1%.  More importantly, growth will slow every subsequent year until 2015.  The segment population turns negative in 2012 and remains so until at least 2020.  In 2020, the core cruising population will have dropped 9% from the peak of 2011.



THE TRIPLE THREAT TO CRUISERS - cruise demographics


The Wealth Effect

Given the business already booked and the price elasticity, 2009 revenue estimates are pretty reasonable and predictable.  However, 2010 estimates look way too aggressive due in part to the capacity issue discussed above.  Moreover, the significantly reduced wealth of the core cruising customer puts future demand at risk.  This age segment could be the most impacted by The Wealth Effect reversal.  A 50 year old is precisely the person that probably has much of his wealth in stocks and real estate, two of the hardest hit asset classes.  Those looking to retire early have likely pushed back retirement expectations, and are not happy about it.  Saving is more important now than almost any other time in their working lifetimes.  You think a cruise vacation might be “backburnered”?  I do.


The question now is when do investors turn their attention to 2010?  They are certainly feeling better about the 2009 outlook as indicated in the big stock moves.  However, when sentiment turns, as it inevitably will, 2010 will be the focus and it won’t be pretty.


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