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GDP was uninspiring, but much of the March data suggests that things are back on track

At 6.1% Y/Y, Q1 GDP was disappointing to many - but also inside the expectations of every rational observer.  With exports down by 20% Y/Y, this contraction is unsurprising if unwelcome.




Industrial production data for March showed a Y/Y increase of 8.3% with western industrials registering growth of 11.8% Y/Y vs. 5.2% for central regions and 3.7% for the export dependent eastern coastal regions.   While production has remained resilient, profits contracted sharply with NBS reporting a 37.3% Y/Y decline for large enterprises despite the respite provided to refiners by falling oil prices.




Critically, the sequential improvement in retail sales for March suggests real consumer resilience as the increasing credit and liquidity we discussed on Monday ( “Gushing “), combined with a 11.2% Y/Y real increase in urban disposable income for the quarter (the rural population realized 8.6% cash income growth in the same period) and  CPI which declined by 1.2% Y/Y for March –the second sequential negative growth month, Chinese shoppers appear to be willing to spend.




For our macro view, perhaps the most important data point release last night was fixed investments which clearly demonstrated that increasing  stimulus juice is hitting the OX’s  bloodstream at 28.5% Y/Y up from 26.5% in Feb.  This continuing growth (particularly felt in the central and western regions) continues to support our thematic conviction in reflation driven by proximity to the “customer” as the stimulus measure adopted by Beijing continues to improve prospects for pragmatic commodity centric economies.


With Q1 headline data Inside the low of the anticipated range, but signs of life in March data the market’s reaction is divided as both the glass half-full and half-empty camps see support for their thesis. From our perspective, although the numbers are far from pretty, there is a clear indication that the Chinese economy has begun to find its legs.


Andrew Barber

Seeing The Light

"Education is the movement from darkness to light."
-Allan Bloom
Early on in the Obama administration's first 100 days we were clear that the administration needed to "shake hands" with The Client - the Chinese.  Shortly after we said that, on January 22 in a statement to a Senate panel U.S. Treasury Secretary Timothy Geithner said that Obama "believes that China is manipulating its currency."  Yesterday, Mr. Geithner said "while the yuan remains undervalued, no country has met the standards for illegal currency manipulation. "  On the job education is a beautiful thing - moving from darkness to seeing the light on China.
The New Reality is that the Chinese need us, and we need them.  
We also learned recently that despite their rhetoric, the US Treasuries are still a critical element of China's investment strategy for its foreign-currency reserves and that is not going to change.  The Chinese also need the US to help dive their export driven economy.    Overnight China reported its slowest GDP growth in 10 years; GDP expanded 6.1% in Q1 after 6.8% last quarter.  This was below the 6.2% median estimate...
Yes, China is The Client, but we are all in this together!
Yesterday, the S&P 500 rallied another +1.2%, and now has rallied +26% from the March 9th low.  There are two sectors with a positive return on a year-to-date basis, Materials (XLB) and Technology (XLK).  Prior to yesterday's move, Consumer Discretionary (XLY) was positive, but is now only down 0.3% on the year. Great Depression?
What's driving the move in Technology? Earnings.  As it turns out, relative to every other sector, operating EPS estimates for the XLK have only declined by an incremental 2% to a 24% decline since March 9th- the best performance in the S&P 500. Surprisingly, Consumer discretionary operating EPS estimates have only declined by an incremental 4% to a 14% decline since March 9th - the 4th best performance of the S&P sectors.
The Materials (XLB) turned in the second biggest decline at an incremental 10% to a 28% decline in operating EPS estimates.  Helping to REFLATE the XLB is the decline in the US Dollar and Basic Materials is what China needs.   Things are bad, operating earnings are lower this year, but things do not appear to be falling off a cliff.
What we are seeing for most consumer centric companies is that there is tremendous flexibility in the middle of the P&L, thanks to slower growth and lower commodity prices.  Yes, demand is lower across the board, but there is flexibility to manage the P&L in a lower demand environment; a theme that should continue to play out this earnings season.     
Yesterday, the market was also influenced by the Federal Reserve comments that there are some "faint signs the steep plunge in economic activity that began last fall is starting to level off." Yes, that is true, but we are constantly reminded that it will not be a straight line to economic bliss from here.    
The captains of industry that are currently speaking out on Q1 performance are telling us "There's still a lot of stress" or "We're now seeing for the first time the real impact of the economic downturn on healthcare."
Also, the last two data points we received on housing are marginally negative, but that has not stopped the home builders from rallying.  The Mortgage Bankers Association reported that its application index fell last week for the first time in over a month.  More importantly, the nation's largest mortgage companies are stepping up foreclosures on delinquent homeowners.  The resulting increase in the supply of foreclosed homes could further depress home prices.  This poses the biggest risk to our housing call that prices will bottom in 2Q.
Despite all the potentially bad news, the market does not seem to want to go lower.  As we sit here today, on down days we won't see a major break down unless the S&P 500 closes below 821 and the US Dollar starts to appreciate - a sign the S&P 500 will DEFLATE again.
The story that caught my eye on Bloomberg this morning is one on Billy Ackman.  I'll be the first to admit when I make a make mistake and will try to learn from it and be a better person.  Bloomberg reported that Ackman sent a letter to clients telling them he lost 90% of the $2 billion fund set up to invest solely in Target - he remained confident that his bet on the retailer would pay off and asked investors to double down and there was no apology for the colossal miss??
The amazing part is the math - Ackman's Target fund needs to produce a 900% return from here just for the original investors to break even!  Billy is still in the dark and can't see the light on this one.
Function in disaster; finish in style,
Howard Penney
Managing Director


EWZ - iShares Brazil- The Bovespa is up 20.1% YTD and continues to look positive on a TREND basis. 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 has managed its interest rate to promote stimulus. The Central Bank cut 150bps to 11.25% on 3/11 and likely will cut another 100bps when it next meets on April 29th. 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.

XLY - SPDR Consumer Discretionary-TRADE and  TREND remain bullish for XLY.  The US economy is showing faint signs the steep plunge in economic activity that began last fall is starting to level off and things are better that toxic.  We've been saying since early January that housing will bottom in 2Q09 and that "free money" for the financial system will marginally improve the US economy in 2H09, allowing early cycle stocks to outperform.  The XLY is a great way to play the early cycle thesis.

EWA - iShares Australia-EWA has a nice dividend yield of 7.54% on the trailing 12-months.  With interest rates at 3.00% (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.

XLK - SPDR Technology - Technology looks positive on a TRADE and TREND basis. Fundamentally, the sector has shown signs of stabilization over the last six+ weeks.   As the world demand environment becomes more predictable, M&A should pick up given cash rich balance sheets in this sector (despite recent doubts about an IBM/JAVA deal being done).  The other big near-term factors to watch will be 1Q09 earnings - which is typically the toughest for tech, along with 2Q09 guide.  There are also preliminary signs that technology spending could be an early beneficiary of the stimulus plan.

TIP - iShares TIPS- The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%.  We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

XLB - SPDR Materials -It's a bull on both a TREND and TRADE duration. The Materials sector is, obviously, a key beneficiary of our re-flation thesis.  Domestically, materials equities should also benefit as the stimulus plan begins to move into action.

USO - Oil Fund-We bought oil on 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 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 on 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%.


LQD  - iShares Corporate Bonds- Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back. Moody's estimates US corporate bond default rates to climb to 15.1% in 2009, up from a previous 2009 estimate of 10.4%.

SHY - iShares 1-3 Year Treasury Bonds
- 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.

EWU - iShares UK - We shorted the UK on 4/08. 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 to attain its 2% inflation target as inflation has slowed considerably. GDP declined 1.5% in Q1, unemployment  is on the rise, housing prices continue to fall, and the trade deficit continues to steepen month-over-month.

EWL - iShares Switzerland - We shorted Switzerland on 4/07 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.

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 $1.3157. The USD is down versus the Yen at 98.6610 and up versus the Pound at $1.4894 as of 6am today.

EWJ - iShares Japan -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".

XLP - SPDR Consumer Staples- Consumer Staples continues to look negative as a TREND and bullish as a TRADE. 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.


CCL’s valuation looks reasonable based on Street 2009 estimates of $2.15, in line with management guidance of $2.10-2.30.  Moreover, the Street estimates look doable, although they should probably be reduced with the recent spike in fuel costs and FX moves.  At current spot rates, fuel costs will be about 5% higher in Q2 than management’s guidance and 9% higher in 2H 2009.  Nonetheless, EPS estimates are probably in the ball park.

It is 2010 where we differ materially.  Our $1.33 estimate is 40% below the Street.  Analysts are currently projecting flat to slightly down yields for 2010.  I’d like to speak to their economists that are projecting such growth in consumer spending to offset the 9% industry capacity growth slated for 2010.  Even in a big 2010 rebound scenario, demand probably won’t grow more than 3-5% which still implies down 4-6% yields.  That seems to be a best case scenario.  We are projecting net yields to decline over 7% in 2010.  There is no good news on the capacity front.  New ships are being built and old ships are not being scrapped.


CCL does not look any better on a free cash flow basis.  The significant capacity additions and negative working capital will drive FCF down to a negative $700 million and $1 billion in 2009 and 2010, respectively.  In prior years, as CCL grew capacity and had positive yields, they had a working capital benefit from growing customer deposits.  This trend reversed itself in 2008 as the booking window narrowed, and yield growth came to a halt.  Free cash flow turns positive in 2011, but even on these numbers the FCF yield is not compelling at only 3%.

CCL: NOT CHEAP ON REALISTIC 2010 - ccl free cash flow


Turning to the balance sheet, it is in pretty good shape at only 3x leveraged.  However, if we are correct, leverage will increase in 2010 to 4x.  Liquidity is fine for now although CCL will likely need additional financing in 2010 as we project a $600 million cash shortfall.  We don’t anticipate this being a problem, especially since CCL had two export credits totaling $500 million awaiting insurance policies at the end of the March.

So what’s the appeal?  Visibility has improved since CCL lowered prices and its guidance so 2009 bookings look fairly solid.  At some point, investors need to focus on 2010 earnings, the ugly 2010/2011 capacity picture, and the long-term demographical challenge (see our 04/03/2009 note “THE TRIPLE THREAT TO CRUISERS”).  As the focus moves forward we believe the market will be unwilling to pay 19x for this earnings stream.


Chinese GDP Prints this evening. Traders with an appetite for risk might look at the options market


The Chinese Bureau of Statistics releases Q1 GDP tonight, and NBS spokesman Li Xiaochao will be hosting a press conference at 10am Beijing time to announce the data. In the wake of the comments made by the Premier over the weekend while he was attending the aborted ASEAN summit in Bangkok, expectations are running high despite all of the obvious negative data points for exports and production which have arrived in recent months. 


Our preferred ETF vehicle for China, CAF, does not have option available. FXI, which has significant Hong Kong exposure, does have options and as such I am looking at it as a (somewhat flawed) volatility surrogate. Despite structural flaws, the volatility levels implied FXI options may be appealing to speculators.


Chinese indices have had significantly higher realized volatility Than US equivalents recently:



Specifically looking at options expiring this Friday, with FXI at 32.95 traders may find the Apr. 33 strike Calls and Apr. 32 Strike Puts an attractive (if risky way) to capture any major move above 34 or below 31 driven by tonight’s data.


The VIX, at 32.7, is only 7.3 % higher than 30 day realized on the SPY, while at-the-money SPY calls expiring this Friday are trading at implied volatility levels more than 10 % higher. Meanwhile at 54.8 for the April 33 Strike calls and 56.05 April 32 strike Puts –the implied volatility for FXI options is actually below  both the 30 & 90 day realized vol level (obviously skewed by liquidity etc) and also below the realized 90 day vol level of the underlying index. For those looking to capture a really big surprise, this is probably the place that you want to play.


Critically the term structure of implied volatility is nearly flat, meaning that the May contracts although more expensive on an absolute dollar basis, are equally attractive for more conservative traders.


So far trader expectations appear to be split evenly with the ratio of Calls to Puts at 45459 vs. 43809 so far today. We do NOT have an inside track on what the numbers released tonight will look like, nor do we have a firm forecast based on our work –although we remain very bullish on the Chinese ox. 


For those brave souls who want to take a swing,  we salute you.


Andrew Barber


PNK should post a very strong Q1 that we believe will exceed expectations and last year’s performance.  In fact, the size of the beat could be significant as indicated in the first chart.  We project EPS of $0.02 and EBITDA of $47.5 million versus the Street at ($0.02) and $45 million, respectively.  Our estimates may even prove too conservative.  Look for strong revenue and margins at Lumiere Place and in Louisiana to drive the upside. 


Management usually puts forward a theme with every conference call.  This quarter the theme could be particularly interesting, and positive.  We’ve talked a lot about the rising cost of capital, particularly for gaming companies that face covenant, liquidity, and/or refinancing issues.  PNK faces little probability of a covenant breach this year but could be at risk next year.  The safety play is to try and extend, amend, or refinance its current facility which matures 12/2010.  That will mean a significantly higher cost of borrowing.  Depending on the agreement, PNK could pay 300-400bps more on the credit facility.  If the company opts for a high yield offering, the interest rate on this type of debt could approach 15-18%.  Of course, there would be no need to tap the high yield market if PNK cancels development.

I recognize this doesn’t sound positive.  However, the takeaway is that the higher cost of capital may force PNK to delay or suspend development on the Sugarcane Bay and Baton Rouge projects.  I think this would be taken very positively by Street.  It would signal to the investment community that PNK is, indeed, return focused (a frequent criticism of management).  With the cost of capital so high, it’s hard to justify investing in the space.

Thus, the theme will not be “our borrowing costs are going up”.  Rather, the relevant theme may be the transformation of PNK into an IRR-focused, free cash flow machine; a pretty powerful theme indeed.


Today, there are bullish calls on a number of QSR names, including Chipotle (CMG), YUM Brands (YUM) and a bullish initiation on the Wendy’s’/Arby’s Group (WEN).  CMG was also downgraded today, which seems a bit more justified after the stock’s 30% move in the last month and 42% move in the last three months.

There is also a negative call on SBUX this morning and according to Street Account the analyst cites “competitive pressures.”  I’m not sure if there are new pressures that we did not know about yesterday, or if this is a continuation of the street’s bullish call on MCD, my guess is the latter.  The consensus call on McDonalds is that the company can do no wrong and that the new beverage initiative will be a blow out success.  Specialty beverages are not a core competency for McDonald’s; they are expensive to install and complicate the back-of-the-house operations.  This is very different than improving the quality of the chicken nuggets or adding a salad and snack wraps.  I will concede that the success of the improved core drip coffee business gives McDonald’s some “coffee credibility.”  I believe that selling an upgraded drip coffee that people were buying anyway is different than trying to sell a premium product in a challenging economy. 


We have nearly completed a grass roots survey of SBUX March sales trends (not including California and Florida), and they are so good I don’t believe what I’m seeing.  Naturally, I provided a haircut to the numbers, but that would still put SBUX same-store sales (not including Florida and California) at down 2-4%.  Including the other two key states, March comparable sales for SBUX could be down 5-7%.  This would be a significant improvement from the trends in fiscal 1Q09 when same-store sales declined 10%.


An influential McDonald’s sales survey was released last night, which confirms our belief that McDonald’s sales trends are slowing.  The McDonald’s same-store sales chart is using reported numbers, but the timing adjusted numbers for January, February and March would be +3.4%, +6.8% and 4.6%, respectively.  This brings the underlying same-store sales average to 4.9% for 1Q09 vs. 5.0% in 4Q08.  It’s important to note that March and April are the last two easy comps for MCD this year!  Put that into context that the 2 and 3-year average same-store sales trends are already slowing.  This is clear evidence that McDonald’s senior management team is praying that the beverage strategy is a silver bullet for the US business.

As an aside, it looks like Easter hurt the U.S. by 0.5%-1% last year and helped Europe by 2%, so this year March numbers would be helped by about 0.5%-1% in the U.S. and hurt by 2% in Europe, which is why we adjusted the survey’s reported March 5.1% number down by 0.5%.  Even with the Easter timing benefit, however, US 2-year trends slowed in March.



Burger King today reported fiscal 3Q09 worldwide same-store sales of 1.0%, with the US and Canada up 1.6%.  The company stated that earnings were negatively impacted by significant traffic declines in the month of March, across most company-owned restaurant markets, resulting in lower than expected company restaurant margins for the quarter.  I recently highlighted same-store sales trends for the big three and BKC looked to be the loser.  The resurgence in WEN was always going to be bad news for BKC and other weaker competitors in the QSR segment.


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