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Deflation Day

"Only the wisest and stupidest of men never change."
-Confucius
 
Having played plenty a Canadian Junior Hockey Night cage match in the Bear's Den of Smith Falls, Ontario (instead of glass behind the end boards, they had chicken wire), I can assure you that I am definitely not the stupidest of men. Most guys who I chirp at with these morning investment missives will assure you that I am neither the wisest!
 
Ah, if you can't have fun playing this game, what's the point in waking up at this un-Godly hour and playing it at all! That said, even after taking my US Cash position back up to 62% on Friday, yesterday wasn't much fun for me. My Asset Allocation Model lost -1.05% on the day, largely because I got smoked out of my hole with a 12% allocation to Commodities. The Buck broke out, and it broke my bank.
 
When we did our Q2 Macro Trend call a few weeks back, I gave explicit levels on the US Dollar. I outlined a critical resistance line of 86.33 on the US Dollar Index as being my line in the sand. With that crystal clear in my rear view mirror now, yesterday's meltdown in everything other than yellow rocks (Gold was +2.4% on the day) was proactively predictable. Yes, we're long TIPs and sold out of our long positions in China, Canada, and Russia, but we still lost money, and that's unacceptable.
 
In conjunction with the 19 component CRB Commodities Index closing down -3.6% on the session, the SP500 got tagged for an even larger loss of -4.3%. Thankfully, I have shunned everything US Financials (XLF was -11% on the day), and have opted to stay away from being long any index with Financials in it (XLF, SPY, DIA, etc...). Regardless, on DEFLATION Day, I still took it on the chin with the 13% exposure I have to US Equities via the XLK and XLY (Tech and Consumer Discretionary ETFs).
 
So what to do from here? Well, as usual, the plan is that the plan is going to change. As market prices and the risk/reward embedded within them changes, I will. Only the bravest of men and women stepped up and bought additional US or International Equity market based exposure yesterday, and for that, if they get paid on this morning's US market open, I salute you. I think we have at least one more round of selling left in this thing.
 
Although I'm not sure what he'll have to say about this, I have never thought of my Dad's primary job as being brave - neither is mine. Notwithstanding that my cushy job up here in New Haven is nearly as dangerous, Dad's job as a firefighter, and mine as a stock market operator, is to proactively manage risk/reward.
 
I put up an intraday note to our Macro clients yesterday telling them that I was going to wait. With the SP500 breaking down through an important immediate term momentum line at 846, the 815-819 intermediate TREND base of support is now in play. Waiting may not seem brave, but neither is losing a toe for the sake of being in a hurry. If anything has held true for the last 18 months, it is that patience pays a big performance premium.
 
The entire way up to that 874 line in the SP500 I was rightly pressed by our clients and prospective ones as to why I wasn't choke full of US Equity exposure. On the way up to the top of a proactively predictable trading range, those questions get harder to answer. On the way down however, I rarely hear a peep...
 
Peeping is what people do who are trying to get a look-see on something that they probably shouldn't. When it comes to the inverse correlation of the US Dollar versus virtually everything else that's asset based on your screens, there is hardly any peeping required. Dollar UP = DEFLATION. If you need a chart to show you this more succinctly, we can send you one. For the guys and gals up in Boston last week, we called it The Green Monster.
 
In 1999 I worked on the "sell side" at CSFB, then I moved to the "buy side" for the next 8 or so years... and now I like to think that I am on the right side. I am in the business of being right, or being fired - and I like that. It keeps me awake.
 
Being long is one thing. Being wrong is completely another - and I don't need to stick around to see the reruns of how this movie went post mid-January when the US Dollar caught a bid again. If the Dollar goes up, I think everything else is simply going down.
 
The good news now (if you're long anything other than cash and gold that is) is that at 86.59, the US Dollar Index is overbought from an immediate term TRADE perspective. If the US Dollar fades here, it will put in another lower high, and that, on the margin, will be bullish for anything that you'd like to see REFLATE.
 
Just remember, what you'd like to see, and what the malfeasant of our Financial system still hope to see... may not be what you end up seeing. Peeping isn't cool, and neither is a risk management model that doesn't have the ability to change as the macro factors embedded within it do.
 
Best of luck out there today,
KM
 

LONG ETFS

EWZ - iShares Brazil- The Bovespa is up 18.3% 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 more oil on 4/20 after a 9% intraday downward move. We 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
 
VXX  - iPath VIX- The VIX is inversely correlated to the performance of US stock markets. On 4/20 the VIX shot up 15.5% intraday, an overcorrection we want to be short as we believe US indices will make higher highs and the volatility is currently overbought.

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 see recovery. GDP declined 1.5% in Q1 and unemployment  is on the rise.

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 up versus the USD at $1.2970. The USD is up versus the Yen at 98.2010 and down versus the Pound at $1.4582 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 down through TREND line support, closing under the TREND line by a dime. 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.


SBUX – GRASS ROOTS SURVEY - MARCH SAME-STORE SALES TRENDS

Over the past five days, three firms have cut their ratings on Starbucks; two have gone from buy to hold and one from hold to sell.  All of the downgrades cited basically the same reasons; the company is going to report a lousy quarter and the McDonald's marketing machine is going to make it nearly impossible for Starbucks to survive.  This is now consensus!

 

What if things are not that bad? - We know from the trends in most of the consumer discretionary universe that things are "less bad" in 1Q08.  

 

What if the hundreds of store closures have had a positive impact on sales trends?  - 75% of the stores closed are within three miles of an existing company-operated store.

 

What if lower commodity prices and reduced labor expenses help to stabilize margins? - Milk prices are down about 35% year-over-year.

 

What if our grass roots survey is right and sales trends improved during the quarter?

 

What if McDonald's gourmet coffee strategy does not work?

 

Don't get me wrong, the issues Starbucks faces are far from trivial and McDonald's is a great competitor, but to think that Starbucks is not fixable is crazy.  There are a lot of high-end retailers that are not doing well today.  The Starbucks basic drip coffee is anything but expensive at around $1.65 for a 12oz cup.   

 

It has been well over a year since Starbucks first announced its initial restructuring, including slowed U.S. unit growth, store closures and a renewed focus on store-level unit economics.  Although these transformational changes all signaled a move in the right direction for the company, Starbucks' stock is still down nearly 40% in the last year as sales trends deteriorated further.  The company has since announced $500 million in costs savings in FY09 alone, which should help to offset sales weakness.  SBUX's fiscal 1Q09 results reflected these cost saving initiatives as EBIT margins improved sequentially from 4Q08 even with U.S. same-store sales declining 10% (worse than the 8% decline in 4Q08).  And, the savings are expected to accelerate throughout the year.  The stock's 21% move year-to-date reflects these improved results. 

 

In order to sustain continued stock price appreciation, SBUX cannot rely on cost saving initiatives alone.  Investors will expect to see a turnaround in sales to keep bidding up SBUX's stock price.  That being said, I set out to come up with a way to gauge SBUX's progress toward improving monthly sales trends, which resulted in the inception of the SBUX monthly "grass roots survey."  With Starbucks introducing its combo meals in March (the company's first attempt at a nationally promoted price point and a significant change in management strategy), I thought March would be a telling month to get started.  To that end, of the stores surveyed (representing a geographic mix across the U.S.), they are selling an average of 20 of these breakfast combo meals per day.

   

STARBUCKS MARCH "GRASS ROOTS SURVEY" SALES TRENDS:

 

The survey indicates that March same-store sales on average were flat to -3%.  These numbers 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 at down 5-7%.  This would be a significant improvement from the trends in fiscal 1Q09 when same-store sales declined 10%.  As this is the first month of the survey, I think it is more important to focus on the numbers on a directional basis rather than looking at the absolute numbers, and directionally, these March numbers look better than what we have been seeing out of Starbucks' U.S. business.

 

Also of significance was that 100% of the partners surveyed commented that they thought management was taking the company in the right direction, with its new focus on combo meals and value offerings being the most consistent supporting answer, particularly in light of today's challenging economic environment and its subsequent toll on consumers.  A handful of Starbucks partners pointed out that advertising would help even more, which according to CEO Howard Schultz should be coming soon as he stated at the company's March annual meeting that the company is ready to take its gloves off and will no longer be silent regarding the false claims its competitors have made about the Starbucks brand in the past.  As I said earlier today in my post titled "BKC - What's up with Burger King...?", advertising is critical to driving incremental traffic within the mature QSR segment.  Time will tell!

 

SBUX – GRASS ROOTS SURVEY - MARCH SAME-STORE SALES TRENDS - SBUX US SSS 1Q09


Dispatches from the General: Thoughts on Obama's Foreign Policy As a Tail Risk

While we sometimes get accused of partisanship here at Research Edge, that accusation is often coming from people that are themselves, partisan.  We have a strong belief in free markets, which sometimes manifests itself in a view, but the reality is we follow politics as a means of inferring investment trends and thinking about managing risk. 

 

Obviously, the last few weeks have provided data points for us to contemplate the next four years under the foreign policy of an Obama administration.  While there are some similarities to Bush, and some continuations of Bush administration policies, there are also some marked differences that indicate that the future may be dramatically different than the post 9/11 era, in which the Bush Doctrine, that of pre-emption, stood paramount.

 

This weekend we noted with interest the front page picture on the New York Times of President Obama shaking hands with Hugo Chavez and also both Obama and Secretary Clinton's limited response to Nicaraguan President Daniel Ortega's rant against United States foreign policy.  Interestingly, oil is down almost 8% today on the back of Obama's engagement with Chavez this past weekend, which may be signaling that the implications for this action, at least in the short term, are positive from a geopolitical risk perspective.  Although clearly with all equity and commodity markets down broadly today, it is difficult to extrapolate too much into this move in oil.  Nonetheless, it is important to consider the longer term implications of Obama's foreign policy. 

 

We asked a father of one of Research Edge's Analysts, a retired Brigadier General, his thoughts on this weekend's events and the emergence of President Obama's foreign policy in general.   We don't necessarily endorse his thoughts, nor consider ourselves competent enough in foreign policy to adequately gauge them, but we take the former General's thoughts seriously. He is a serious man who has seen the consequences of foreign policy acted out first hand through the course of his career, sometimes at great cost. We have pasted his email response below:

 

"I have been enjoying the nice weather and also was traveling (as you know) this weekend - so I did not see the speech (and this news junkie has not seen any since Friday morning).  But I gather that our 'friends' have been helping our current Commander in Chief point out our deficiencies as a county.  So I just scanned the NYT online and did a search on Ortega's speech.  And we have our share of mistakes in the past.  BUT - always remember that Ortega is a Marxist, and will always be one.  And trash talk is cheap.  What really scares me is the message that total passiveness and cozying up to bullies (like Chavez and Castro) sends to the other snakes that lurk under rocks out there.  Lots of people can interpret no reaction from us as being weak.  Like it or not, I agree with the adage that other countries do not have to agree with us, but they should respect us and have a healthy fear that we will not be weak if anyone attacks us.  The old school yard bully routine.  Just take a look at Jimmy Carter's performance as Commander in Chief - Iran considered him weak and treated this country as if they had nothing to fear (as was true).  Iran only freed the hostages on inauguration day in 1981 because they assumed (correctly) that Reagan would take action; the window to maximize their position was closing.  Obama could well be walking down the same path - and not really realizing it, given his blind spots.  The unintended consequence of that is what could lead to problems.  Some group somewhere will push us; it is just a matter of where and when.  And I don't mean pirates - that is a totally local (Somalia) issue due to a failed nation state.  The key will be what the response of this administration is when someone bloodies us.  That is what you need to watch for, and what will tell everyone what to expect until 2012 at least. And then, depending upon the miscalculations on either side, we could be in one heck of a mess.  I just hope the first problem is not a spill over of drug violence from Mexico (on a larger scale than the current violence constrained to drug operatives) on a large scale - I don't think this administration has the guts to deal with that issue if it is the first one out of the chute."

 

Clearly, the General see's tail risk that could be that a passive foreign policy could leave the United States vulnerable.  President Obama has certainly not indicated that he will in any way act passively when the country's interests are at direct risk, and in fact acted very decisively with the Somalian pirates, but clearly his willingness to not either dress down or respond to Daniel Ortega does provide some evidence of the direction of Obama's future foreign policy positions.  As does his willingness to engage with Iran, Cuba, and Hugo Chavez in Venezuela when his predecessor was much less willing.

 

Daryl G. Jones
Managing Director


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Stressed? SP500 Levels, Refreshed...

I am getting an inordinate amount of feedback in my system today, which leads me to assume that people are somewhat stressed by today's down move. Don't be.

 

Breaking down through my 1st line of support at SPX 846 (dotted red line) puts the downside support range of 815-819 in play. That range (shaded green) is a powerfully bullish intermediate TREND line of support and it should be respected.

 

After continuing to make lower lows last week, the Volatility Index (VIX) is finally spiking +16% here today. The VIX  could easily run to 40.67 (up another +5%) and remain broken from both a TREND and a TRADE perspective. All that considered, combined with a US Dollar that's strong on the day (which is DEFLATIONARY), leads me to believe that I can be patient here and wait on buying/covering anything that I sold last week.

 

No stress. From the 840 line in the SPX, you're looking at another -2.5% of downside to manage risk through. If the SPX breaks down and closes below 815, and you're really levered up long, my best advice would be to pray.

 

Keith R. McCullough
Chief Executive Officer

 

Stressed? SP500 Levels, Refreshed...  - chsp


Where There's Smoke...Compliance Update for the Week Ending 4/17/09

Thinking About The Government


Look out, Kid.  It's something you did.  God knows when, but you're doin' it again.
 - Bob Dylan, "Subterranean Homesick Blues"


Our colleague Todd Enders shared with us a recent Politico poll, accessible at
 http://www.politico.com/news/stories/0409/21213.html


Todd spells out the survey's highlights as follows:


1) Obama is trusted by half-again as many Americans as any other public figure or entity.


2) American belief that the government is headed in the right direction has jumped from 34% to 54% in 3 months.


3) 61% of Americans believe regulation should be increased.


All we can say is - we told you so.   Killer double-whammy one-two punch.  The public overwhelmingly favors President Obama.  And the public overwhelmingly favors increased regulation in the financial markets.

 

The President is not out of the woods - indeed, we fear he may be dragged back into the woods.  But for the moment he is riding high, and those in favor of increased market regulation have been handed the Talking Stick.

 

For all the breathtaking irresponsibility and wanton partisanship of Pelosi & Co, the Republicans themselves are doing everything in their power to maintain President Obama's Teflon coating.  Let's face it, even at their worst, Pelosi, Frank, Dodd and Schumer - call them The Four Horsepersons of the Fiscal Apocalypse - are no match for the new face of the Republican Party: Rush Limbaugh.  Did we mention that political debate in this country has sunk to a sorry state? 

 

Oh, and what's the deal with accusing the President of "taking on too much"?  Those who believe President Obama should be limiting his scope have only to look at then-candidate McCain's gambit, putting the campaign on hold and heading back to Washington to deal with the fiscal emergency.  It did not do McCain credit as a candidate, and it would do Obama far less credit as President.  No, we urge President Obama - for whom we voted largely on the strength of his ability to handle complexity, as demonstrated in the management of his campaign - to keep moving forward on all fronts.  The job of a Chief Executive is to be in charge of everything at once.  

 

President Obama has so far pulled off the Regeanesque act of making the Geithner-Paulson-Goldman link not stick to him.  And all is well and good, as long as he still has that new-President smell.  We wonder what sequence of events will cause a significant portion of the public, in their new-found thirst for regulatory oversight and avoidance of conflict, to turn against him.

 

Clearly, we are in for some serious muscling-about on the regulatory front.  We told you so.

 

Item: The Wall Street Journal ran a story in its weekend Money and Investing section (11-12 April, "Investors Face Tough Duel When Fighting Brokers") describing the tribulations of retail customers trying to sue brokers over portfolio losses.  The article makes a couple of worthwhile points.  Private investors who deal with brokers are generally clueless about FINRA's arbitration process.  This often works against them, particularly by setting unrealistic expectations and overestimating their leverage to force a lucrative settlement.  Even when they win, investors often suffer through months - if not years - trying to collect their awards, only to see one-third of their proceeds taken off the top by their lawyers.  It is all around a nasty business.

 

Drawing on our years of experience, we believe that there are observable patterns in investor lawsuits.  The WSJ article says "With the market still off more than 40% from its peak in 2007, investors are examining how their portfolios ended up so filthy - and blaming brokers.  Through March 31, investors filed 1,264 arbitration cases with the Financial Industry Regulatory Authority, or Finra, up 114% from the year-earlier period."

 

As with many other social phenomena, the call to arms - here in the form of angry investors filing arbitrations and lawsuits - comes after the fact.  The financial services industry runs purely on emotion.  But whereas in dealing with the death of a loved one, there is a finality, investors continue to be tormented by the notion that their losses may reverse, if only they hold onto their positions. Dr. Kubler-Ross would have a field day applying the Five Stages of Grief to the psychology of the investor.  There is a psychological lag between Destruction and Revenge.  The recognition that lost money will not be recouped is also spurred by tax season, but we believe that a large blip in customer arbitration filings likely signals that we have passed the peak in market destruction.

 

Item: Other phenomena include President Obama's latest attempts to talk up the markets (Financial Times, 15 April, "Obama Hints at Hopes for Recovery"), perhaps an attempt to capitalize on his own great call on the market. 

 

Item: We hear from recruiters specializing in the compliance sector that things are turning up.  Folks we have not heard from in months are resurfacing.  Indeed, folks we have never heard from at all.  Something is in the air.  Alongside media reports and hopeful Presidential prognoses, there is the reality that Wall Street and the banks are going to be put under very real pressure, and that new programs launch best in hopeful times.  There will be far less traction if the nation feels we are staring down into the abyss, than if we feel we are at last clambering out.

 

But Obama & Co will have to work to find the handle in all this.  It will be no easy matter to balance the financial connections between the banks and the Democrats, with a popular - if not yet "populist" - push to force draconian regulation. 

 

Bush brought us Paulson.  But Obama gave us Geithner who, as President of the New York Fed, both supported and learned from Paulson.  It is something of a vanishing act for Obama and the Democrats to distance themselves from the excesses and lack of judgment of the Bush administration, when the Democrats voted for Paulson's TARP, and when Obama replaces Bush appointees with their own acolytes.

 

Obama is playing for very high stakes with Secretary Geithner.  One might take the position that walking Lloyd Blankfein into a room full of government officials, and letting him walk out with Goldman's AIG exposure paid off at one hundred cents on the dollar, is nothing more than the end of the process started under the Bush Administration, but that is a complicated argument and likely to be a tough sale.  As reported last September and October by the NY Times' Gretchen Morgenson, Blankfein was part of the group that met with Secretary Paulson in early September.  One of the results of that meeting was the decision to deliver the coup de grace to Goldman's ailing competitor, Lehman Brothers.  Another result was the decision to move heaven and earth to rescue AIG - which owed Goldman $12.6 billion.

 

Are we free of conflicts of interest yet?

 

Now Goldman is pandering to the public's lust for blood, with CEO Blankfein writing a resounding OpEd piece in the Financial Times (6 February, "Do Not Destroy the Essential Catalyst of Risk") in which he made all the right noises.  "Much of the past year has been deeply humbling for our industry. People are understandably angry and our industry has to account for its role in what has transpired... Financial institutions have an obligation to the broader financial system. We depend on a healthy, well-functioning system but we failed to raise enough questions about whether some of the trends and practices that had become commonplace really served the public's long-term interests."  The man sounds positively socially responsible.

 

Add to this his YouTube appearance, in which he did all but don sackcloth in his promise of future good citizenship.  What appears to be stacking up is the Obama Administration and Goldman Sachs on one side, and everybody else on the other.  We hope President Obama can walk this tightrope with his reputation intact.  John Gapper, commenting in the Financial Times (16 April, "Don't Set Goldman Free, Mr. Geithner") observes that, on the heels of Blankfein's criticism over Wall Street pay practices, "Goldman is still putting aside 50 percent of revenues - $4.7bn in the first quarter - for the bonus pool."

 

We have not examined Goldman's recent earnings release - of which more below - but we wonder whether this is characterized as a contingent liability, on the chance that the Government actually caps Goldman executives' compensation in 2009.  We would not take the other side of a bet against Goldman, regardless of who sits in the White House.

 

The wave of investor arbitrations is the signal: the public has come to terms with these losses and does not believe the markets will rebound.  The fact that this sentiment may, itself, prove to be a market bottom is not lost on us, but we do not make market calls.  We leave that to the President, and to our own CEO.  What we do foresee is a pending clash.

 

Driven to desperation by their losses, the public are starting to read newspapers, to analyze the business practices of the companies and sectors that have harmed them, and to demand full accountability and the undoing of conflicts of interest.  There will be a change in thinking.

 

We believe Goldman will get to pay back its TARP loans.  It is still a private enterprise, and it is financially sound.  (Indeed, as an advertisement for America, we wonder how many banks will actually come off looking all right when Secretary Geithner announces the results of the Stress Tests.  Would you buy a used financial sector from this man?)  Secretary Geithner has stated for the record that he does not want the government running financial institutions.  More to the point, among the very biggest beneficiaries of Wall Street financial contributions are Senator Schumer -  who, through his positions on the Senate Finance and Banking committees, is one of the nation's most important influences on Wall Street - and President Obama himself.

 

The upshot is likely to be a strengthened Goldman Sachs, and a damaged approval rating for the President.  Goldman, already romping on the carcasses of its one-time competitors, will remain untouchable.  Thus, in order to be seen to be doing their job, the regulators will have to beat up on other firms.  Which may explain the recent uptick in compliance hiring.

 

You don't need a weatherman to know which way the wind blows. 

 

Theories of Relativity


O brave new world, that hath such creatures in it!
 - Shakespeare, "The Tempest"


As we all remember from high school physics, Time is relative.  This has now been brought home forcefully by Goldman Sachs, which has recast Time in service of its own new place in the cosmos and in so doing appears to have rewritten reality.

 

NY Times chief business correspondent Floyd Norris, writing in his blog last week, took Goldman to task over their differentiating between the $10 billion advanced to them under TARP - which they are chomping at the bit to unload - and "the $19.5 billion it borrowed in the credit markets with a guarantee from the federal government... A spokesman tells me it has no plans to pay that back early," writes Norris.

 

Note that, unlike the TARP cash, federal backstopping came with no conditions.

 

In discussing Goldman's earnings, Norris digs into Goldman's reporting their first quarter on a January-March calendar basis - a change from their traditional November fiscal year end.  The Goldman spokesman told Norris "that the change in fiscal year was required when it converted to a bank holding company. The bank regulators did not, however, force Goldman to avoid any mention of the December orphan month in the text of its earnings release, instead relegating it to a table deep in the announcement."

 

Writing in the WSJ blog Deal Journal (14 April), Heidi Moore gets up close and personal with Goldman's latest earnings report.

 

According to Moore, one had to be alert and "checking the news last night after the market closed, when Goldman made a surprise announcement of its first-quarter earnings and cancelled its previously scheduled 11 a.m. analyst call..."

 

Instead, Goldman's CFO David Viniar hosted the quarterly earnings call at 7 AM the following morning, prompting the following exchange with star banking analyst Meredith Whitney:

 

Meredith Whitney: Good morning. Too early this morning.
David Viniar: Sorry, Meredith.
Meredith Whitney: I'm back on caffeine.

 

The medical condition known as caffeinism probably strikes more Wall Streeters than goes recorded.  We urge Meredith to look into whether her insurance carrier has a provision for the condition.  Of course, now that she is running her own shop, she will likely not qualify for workmen's comp.

 

Quoting further from Ms. Moore's piece - and grateful that she was both alert to the news and awake for the dialogue - we see the following examples of Goldman's own Theory of Relativity.

 

Optimism ahoy: CFO David Viniar noted, "Our economists are, I would say, more optimistic or less pessimistic than they've been about the outlook for the economies going into the second half of the year, so that gives us some cause for optimism, but we're still in a difficult economic environment and that's what makes us cautious."

 

We note that "more optimistic" and "less pessimistic" occupy the same location on the continuum, the only difference being one's angle of approach.

 

Quoting from Moore's blog again:
"Later, Viniar commented on the deal pipeline for Goldman:
So I think over the last several weeks, you've already started to see a pretty big pick up in capital markets activities... if the equity markets hold, given the need many companies have for equity, I think you'll see a pretty big pick up in capital markets activity."

 

This translates as: If things get better, they ought to get better.

 

Finally, one would think that an entity of the size, scope, and influence of Goldman Sachs (clearly Too Big To Fail) would, as part of the TARP terms, be required to report two sets of earnings figures - one, according to its old fiscal year, and one corresponding to its new accounting.  One would also expect them to state clearly any and all changes to their accounting practices, as a result of their converting to a bank holding company.  Instead, writes Moore, "It's like December never happened: In its 10-K in January, Goldman Sachs told investors that it would move its fiscal year-end from November to December, which erased the entire month between Nov. 29 and Dec. 26 from the firm's financial record. CFO David Viniar did, however, lay out the carnage that took place in December, when Goldman would have booked a $1.3 billion pre-tax loss."


CFO Viniar did give an explanation of December's numbers ("December net revenues were $183 million. Net earnings were negative $780 million..."), but we are not aware of anyone having gotten a clear statement from Goldman as to what year end (November) and first quarter (February) would have looked like under their old structure, and where the palpable differences lie.

 

Goldman's surge in profitability should come as no surprise, and the latest positive results from Goldman's compadres such as Citi, were telegraphed in a case of what our CEO Keith McCullough calls publicly available inside information.  The financial press ran a series of front page articles predicting big earnings lifts as a result of trading for customers.  See, for example, the Financial Times (5 April, "Trading for Clients Lifts Bank Revenues") telling us "A number of US banks said last month they had enjoyed a good start to the year in comments that have helped lift sentiment towards the sector."

 

Trading spreads, which had narrowed to the barest limits of profitability during the boom years, have now loosened dramatically.  "Now, according to a report from Morgan Stanley-Oliver Wyman, bid-offer spreads and margins in some markets are up 50-300 per cent from last year."

 

This means that the Goldmans, Citis and Morgans of the world have been raking it in by matching their customer orders in-house and pocketing the spreads.  This was the business model created and exploited so successfully by Bernie Madoff - when he actually had a business.  He had to pay folks for their order flow.  Goldman does not.

 

Sharp pencil types out there take note: Morgan Stanley also converted from a November year to a calendar year, in keeping with its new reporting responsibilities as a bank holding company.  Stay tuned as they prepare to report earnings this week. 

 

Quoting from the FT story, "Simplicity is in," says Fred Brettschneider, head of global markets for the Americas at Deutsche Bank. "It's a most favourable trading environment for liquid products."

 

Indeed, paying yourself out of your customers' own money is, as Bernie might have said, simplicity itself.

 


The Lehmanator

 

Finally, the ultimate in toxic assets.


Lehman Brothers is holding some 500,000 pounds of yellowcake, enough unprocessed uranium-oxide concentrate to make a nuclear bomb. 


According to Bloomberg (14 April, "Lehman Sits on Bomb of Uranium Cake as Prices Slump") uranium prices have declined steadily since last year, partly over concerns that Lehman might be forced to sell its holdings.


But Lehman says they are holding and will sell "when the market improves."  How long can they hold out?  There is always the possibility that Goldman may bid for it - say, if Geithner balks at letting them off the hook for the TARP terms.  Otherwise, uranium has a half-life of almost 4.5 billion years.  Presumably the markets will be in better shape before then.

 

Moshe Silver
Chief Compliance Officer


BKC – WHAT’S UP WITH BURGER KING…?

Last week Burger King said its EPS results were negatively impacted by significant traffic declines in the month of March, resulting in lower than expected margins.  Importantly, Germany (BKC's second largest company-owned market) and Mexico (the only company-owned market in Latin America) experienced the largest declines in traffic.  The same trends hold true in the US and Canada, where same-store sales were 1.6%.  With 3%+ pricing, the decline in traffic is significant. 

 

In the mature QSR market, a successful advertising strategy is critical to driving incremental customers into the stores.  Rarely, will a QSR company or stock do well without a successful advertising campaign.  Over the past few years the resurgence of the "King" as a marketing icon was critical to Burger King's success. 

 

From an advertising standpoint, Burger King has recently made two critical missteps with its edgy advertising tactics.  First, critics are up in arms about the suggestive new SpongeBob "square butt'' commercial that juxtaposes a beloved children's character with sexy women dancing suggestively.  Why would the company take a children's cartoon character, SpongeBob, and combine it with the backs of well-toned female dancers, wearing SpongeBob's brown pants with phone books in them to make them "square butts"; all set to the tune of Sir Mix-a-Lot's 90's hit, "Baby Got Back"?

 

Today, I learned that Burger King had to apologize to Mexico after Mexico's ambassador to Spain alleged that the company's new Texican Whopper advertisement released in Europe demeans his country's national flag. 

 

Burger King's advertising issues are nothing compared to poor Domino's.  I think it will be very difficult for anybody to order a sandwich or a pizza from Domino's without imagining a curl of cheese being stuck first in the cook's nose, or worse thinking about an employee hawking a loogie into your Cheesy Bread!  At Burger King, the judgment of some of those in the marketing department needs to be questioned.

 


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