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US Financials (XLF) - Stressed?


Chart Of The Week: Bear Bubble

I must say, after reading Alan Abelson's latest weekend rendition of Goldilocks and The Perpetually Un-objective Three Bears, I was amused. If you know the man, personally, please send him my regards... from calling China to the USA short the whole way up, the last 6 weeks have really been embarrassing for him. Hopefully he's enjoying being right here for a few hours of trading.

 

The New Reality is this: Bear Bubbles are equally as relevant as those that we called out as liabilities for the Bulls 18 months ago. Bubbles are measurable and so are the walls of worry that are associated with them.

 

Abelson called out a comment this weekend from ex-Merrill, ex-Banker of America, about to be ex-Bear Bubble boy, David Rosenberg that challenged we men and women of the objectivity gridiron to "call us when claims fall below 400,000"...

 

Understanding that Rosenberg is both a fellow Canadian and a former fellow Bearish friend of ours, understand this - Rosenberg is one of the many Bears who remain un-objectively bearish as he cashes in his new chips with a new firm and a new contract...

 

David, I'll definitely call you when we/if we ever hit 400,000 in claims, but will you call me if the SP500 hits 1051 on the way down to your target?

 

Bubbles work both ways. So does managing risk. If you think that being short a 28.6% six-week move in the SP500 didn't require a risk manager to show you charts like this, I can tell you that whomever's money you are managing may think otherwise. Perpetual is not a real risk manager's stance.

 

This past week's falloff in jobless claims fell sharply to 610,000 (see chart). Most importantly, this print snapped the immediate term duration (4 week moving average) by a considerable margin (that's the yellow line in the chart at the 651,0000 marker). And it reminded all of those who continue to say that this market is "overbought" that that Bear Bubbles remain misunderstood.

 

Keith R. McCullough
Chief Executive Officer

 

Chart Of The Week: Bear Bubble - ffffffffffffffffffffff


LVS - JP Morgan making our call


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Irresponsibility In Recommendation

"In addition to trying to determine how to make money one must also try to keep from losing money. It is almost as important to know what not to do as to know what should be done."
-Jesse Livermore
 
Shorting this market because the Bears keep saying it's "overbought" does not fit within the parameters of what I would consider understanding Livermore's "WHAT NOT TO DO"... Selling your long positions into a proactively prepared plan, however, will continue to keep you from losing money. That's what risk managers do.
 
Plenty of Portfolio Managers in this game proclaim that they do not "trade"... but do they manage risk? I think a lot of people are starting to... but are they doing it within the construct of what's already happened, or what has the highest probability of happening next?
 
I am no longer a money manager. Unlike Goldman, I like the idea of my clients making money doing what it is that they do, while I do what I do. There is responsibility in recommendation.
 
Like the sun rising in the East, one can proactively predict that the perma-bears of this stock market are going to say that we're "overbought", and... at a price... we are. That's why I issue risk/reward ranges for our clients to manage risk around. On Friday, I issued an immediate term TRADE target for the SP500 at the 874 line. When we hit that line midday, I sold into it. Unlike "Level 3 Asset" accounting, my process isn't that complicated to follow.
 
My risk management plan in today's globally interconnected marketplace of colliding macro factors is quite simply that the plans are going to change. It's both un-objective and reckless to take a dogmatic view that one is either perpetually bullish or bearish.  
 
For certain, a broken clock will be right at least 2 times in a day. Alan Abelson at Barron's has made a career understanding that math. In an investment community where 97% of the ratings from the sell side's investment bankers are NOT sell, it's not that hard to sound like a contrarian when one has a weekly pamphlet to capture people's attention with on Saturday mornings.
 
Last month Abelson was all beared up on China. This morning, the facts on the tape are flashing China closing up another +2.1% overnight to a new year-to-date high of +40.4%. Sure, the Bear Bubble boys will be quick to remind us all that they "don't trust China's numbers"... and that's all good and fine, because the Chinese don't trust our American irresponsibility in investment recommendation either.
 
Alan Abelson is a fantastic writer, and I have learned a great deal from him over the years, including what not to do. The folks over at Barron's are seemingly training Mike Santoli to take over the conch once Alan retires. Santoli is just another man who has never managed an amount of money of consequence who is going to tell the world what to do with theirs - just what we need. This weekend, Santoli's take on the +28.6% REFLATION of the SP500 from the March 9th lows has been "Too Far, Too Fast" - gee, thanks for the memo, man.
 
The New Reality is this: Bear Bubbles are equally as relevant as those that we called out as liabilities for the Bulls 18 months ago. Bubbles are measurable and so are the walls of worry that are associated with them. Managing risk works both ways.
 
The manic media's latest meme is to preface all sell side analyst questions with "in your view..." (implying that the rest of the conflicted firm one works for doesn't have the same view). For the immediate term TRADE, what's my view? My view is that what it was Friday morning - as we scale towards 874 on the SP500 it was time to scale out of longs and lay out some shorts. On Friday I shorted McDonald's (MCD), Starwood (HOT), and Coke (KO); and I sold out of long positions I'd been carrying in Whole Foods (WFMI), Sherwin Williams (SHW), Dick's Sporting Goods (DKS), and the Basic Materials and Canadian ETFs (XLB and EWC).
 
Does that make me a bear? Or was being long these 5 positions as the SP500 was locking down its 6th consecutive week of gains make me a bull? I really have no idea, so maybe I'll let the savants who don't have responsibility in their recommendations label me what they may.
 
Could the US market pullback? I sure hope so because, like my beautiful wife Laura, I love buying stuff on sale. In my Asset Allocation Model (just ETFs), I've sold down my invested position in equities to a point where I have ample ammo to be buying red.
 
Squeezy The Shark is awaiting the short seller of everything Depressionista down at the SP500 depths of 846 and 819. Respectively, those chum lines are -2.6% and -5.7% below Friday's closing price. All the while, on any down day, the Bear Bubble boys can say what they're always going to say... and we men and women who take responsibility in recommendation will be thanking them for teaching us what not to do.
 
Best of luck out there this week,
KM
 

LONG ETFS

EWZ - iShares Brazil- The Bovespa is up 21.9% 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.

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.  

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%.


SHORT ETFS

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. GDP declined 1.5% in Q1, unemployment  is on the rise, and housing prices continue to fall.

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 $1.2957. The USD is down versus the Yen at 98.7370 and up versus the Pound at $1.4571 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 broke out of the TREND line resistance. 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.


GAMING REGIONALS: THE FALLACY OF EV/EBITDA

I recently read a BYD valuation downgrade by a sell side analyst based on a high relative valuation.  The valuation analysis was performed using EV/EBITDA, the industry standard, and concluded that BYD's multiple of 7.6x was too high relative to the competitors at around 6.5X.  This superficial analysis fails to take into account that BYD's free cash flow yield is more than twice that of its nearest competitor, when normalized for true ongoing interest cost.

 

EV/EBITDA fails to capture the big disparity in true borrowing costs.  ASCA and PNK face refinancing risk due to maturities of credit facilities and/or bonds over the next 1-2 years.  BYD, on the other hand, has no maturities until 2013.  BYD's average interest rate should stay at 2% above LIBOR (assuming no covenant breaches) while the other companies will experience rates 2-3 times that rate.  This is a phenomenal asset that EV/EBITDA cannot capture.  ISLE is in a very similar position to BYD with no large maturities until 2013.

 

In the table below, we've calculated the implied EV/EBITDA multiple assuming a constant 15% free cash flow yield across the sector.  Additionally, we've included implied target prices at those multiples.  Our analysis considers true interest cost assuming credit facility amendments and extensions based on reasonable comps. 

 

GAMING REGIONALS: THE FALLACY OF EV/EBITDA - FCF COMPS

 

Other factors to consider:

  • BYD - This FCF yield is too attractive to pass up unless you believe the company will trip its leverage covenant this year. In that scenario, BYD's interest cost would rise and its $2bn in borrowing capacity would be sharply reduced. If BYD can get through 2009, as we think it will, the likelihood of a covenant breach diminishes greatly due to the quarterly step up (a quarter turn per quarter through the end of 2010) in the maximum leverage ratio beginning in Q1 2010. BYD has a lot of levers to pull, however, including maintenance capex cuts and deleveraging bond buybacks. Based on valuation, BYD looks like the most attractive long-term play in gaming.

 

  • ASCA - The stock looks fairly valued on FCF yield when considering the likely higher interest cost associated with refinancing its credit facility due in November 2010. ASCA is likely to hit the high yield market sometime this year and we estimate a 15% coupon. However, Q1 is likely to be a blow-out quarter and estimates should go higher. We continue to like ASCA into the Q1 earnings announcement on 4/29.

 

  • ISLE - ISLE looks very attractive on a FCF yield basis. While the company maintains the highest leverage (7.5x) among the regionals and its competitive positioning is the weakest, ISLE does not have any material maturities until 2013. Next to BYD, ISLE may be the most attractive long-term gaming stock.

 

  • PNK - PNK looks very similar to ASCA. Reasonable leverage but fairly valued on a FCF basis. PNK will likely be in the market to amend its credit facility which means interest cost will rise. This is reflected in our projection. The positive catalyst for PNK is also the Q1 earnings announcement. In addition to very strong earnings, PNK may scale back or delay development due to the rising cost of capital. This should be taken positively by investors.

 

  • PENN - PENN looks fairly valued based on FCF yield. To be fair, we are assuming PENN makes an acquisition to utilize its borrowing capacity at its current bank rate. PENN is underleveraged which penalizes its current free cash flow yield. We assume almost 20% accretion to free cash flow on a $1.25bn acquisition at 6.5x EBITDA. Under this assumption, PENN's yield rises to 13%, still below our industry target of 15%. PENN is a terrific company with a great management team. However, it is the Wall Street darling of gaming right now and the valuation looks full.

 

GAMING REGIONALS: THE FALLACY OF EV/EBITDA - STOCK APPRECIATION TO 15  YIELD


A New Secular Trend You Can’t Ignore

I think that the General Growth bankruptcy filing is only the tip of the iceberg as it relates to what is to come for retail and content distribution. With landlords under duress and acting irrationally leading up to the bankruptcy filing, and with cost of capital on the rise for those retailers and brands who would otherwise buy store locations themselves, the smart CEOs are sitting in their war rooms planning how to reach the consumer regardless of what happens in the world of real-estate. Of course, they're playing catch-up to the best management teams who proactively prepared for this years ago.


The one and only answer? Invest in content to boost relevance with the core consumer while simultaneously investing in direct/virtual distribution. Create a ‘pull model' where the consumer comes to you, and have a dot.com platform that enables conversion into dollars.


Keep in mind that this is easier said than done. Most legacy wholesale models are streamlined and efficient, but are good at processing one shipment of a thousand units, but are structurally not set-up for a thousand shipments of one unit.


Companies that have invested in this regard over the past 1-3 years include Nike though (still too early to get involved for other reasons), Ralph Lauren (check out the Ralph Lauren iPhone app), and Lululemon (launching dot.com right now).


We'd also highlight less obvious companies that have a particularly strong fulfillment platform, such as Williams-Sonoma, and Zappos. Amazon.com, of course, remains the gold standard from a fulfillment standpoint. Offerings from FedEx and UPS are increasingly helping the brands without bricks and mortar step up fulfillment operations, we prefer those that have organically built and perfected their own proprietary systems.


We think that this theme will play a massive role in the upcoming wave of industry consolidation - both in bankruptcies and M&A. We'll be going deeper and deeper into this theme in the coming weeks to ferret out t he winners vs. losers.


Here's an analysis of a collection of retailers as ranked (by us) in terms of both shopability and brand consistency.


A New Secular Trend You Can’t Ignore - .com Matrix

 

 


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