The Client is back and the cash register is ringing...
A core theme of our work on the Chinese Stimulus program is that as the Ox starts waking up he will be craving the basic materials that countries like Australia and Brazil provide. In the case of Brazil, data has arrived demonstrating that in the form of increasing shipments of iron ore. Total Chinese ore imports totaled over 52 million metric tons for March, with more than 22 million tons worth coming from Brazil.
Without a doubt this data is a huge shot in the arm for Brazilian exports which are concentrated so heavily on commodities and certainly explains why the Bovespa is trading up again today. Although anecdotal reports put Chinese ore stockpiles at about 1.5 months worth of imports and growing -an uptick that could signify speculative purchasing, all signs point to continued strength so far this month with expectations that it will continue.
We are long the Brazilian equity market via EWZ and remain bullish on prospects there as Chinese demand works through the global chain. In the coming days will be delving into the other half of the export equation for that nation -Agricultural commodities, as well as drivers for domestic demand, but for now the Client is the most important part of the story.
PS: Anyone out there short shipping stocks?
Fiscal 2010 top line won't grow by 10% - without providing details, management indicated that revenue growth would be similar to fiscal 2009. WMS has executed - no question. We just question their forward guidance. The bar looks like it might be set too high, and investors are trading the stock as if the guidance was conservative.
Here are our concerns:
- North American new and expansion units will fall 47% in the 4Qs ended June 30th, 2010 - Management touted that only a 1/3rd of their business is North American box sales. That's still a lot of exposure to a business that will experience a huge decline in 2010.
- Financing may have pulled sales forward - WMS ramped up its financing efforts to secure sales. We fear that this aggressive approach may have pulled sales forward and artificially inflated market share at higher prices. The company added $37 million in receivables in the quarter. We are not against using the balance sheet to fund sales. IGT and BYI do it. We are just point out that market share gains in the quarter may not be sustainable.
- No free cash flow - Despite a strong quarter, the company's free cash flow was negative in the quarter. Obviously, the aggressive financing will push out free cash flow generation. We project only $0.80 to $0.85 in free cash flow per share in fiscal 2010.
- No visibility on fiscal 2010 - WMS is no longer providing backlog for "competitive reasons" and because they believe the lead time has shortened so much that comparisons are not useful. They also indicated that the current backlog is within the normal range of the last 16 quarters - that's a big range.
- Hit driven business - More than the other slot companies, WMS's business is more reliant on generating "hit" games. Their strategy is narrowly focused on fewer game launches. Their superb execution has generated by far the highest success rate. The problem is that with their guidance, WMS is projecting success at an even higher level going forward.
- WMS doesn't have the breadth of product to permanently increase market share - Since WMS is more targeted, they don't offer the breadth of product of an IGT or BYI which makes them more reliant on hits but also could cap their market share in the mid 20s%.
- Valuation - We believe 2010 will be flat in terms of EPS growth putting the forward multiple at about 21x our $1.50. Even on the Street's aggressive $1.75 estimate, the multiple still looks full at 18x.
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Every time you see a data point on housing the first thing to remember is that affordability is at all time highs. Over time, affordability and population growth will solve the US housing crisis. The only thing left to solve for here is duration.
Today the NAR reported a 3.0% decline in March sales, which was weaker than the 1.5% consensus estimate. The volatility in all housing data today suggest it's very difficult to get a read on trends looking at one month numbers. On the margin the more relevant point is that home sales, like other consumer centric companies, showed improvement from early this year, but nothing happens in a straight line. Inventory of existing homes remains elevated at 9.8 months, but is down from the worst levels seen last November at 11.0 months.
All of this remains consistent with our Macro Housing call that a housing bottom will happen in 2Q09. We continue to believe that there is stabilization in housing price declines. As seen in the chart below, we did not go below the January lows and we are now seeing a notable uptick in median sale price. A clear bottoming process!
One nagging concern is the end of the foreclosure moratorium. I continue to see anecdotal evidence to suggest that speculative cash bids for bank-owned homes have been a significant portion of existing home liquidity -particularly in harder hit markets like Florida and southern California.
As more forced sales come to market, it will place pressure on buyers seeking to capture the relative value spread between bank sellers and non-distressed owners, who have held on to higher asking prices.
Today, the WSJ ran a story on bidding wars between buyers vying for bank owned properties at these levels. Clearly, any expansion of the spread between these two types of sellers could dampen liquidity as more foreclosed homes come on the market.
Other than the MACRO implications of our housing call there are other ways to play the rebound in housing. Our Healthcare team has a very compelling way to play a housing recovery - Senior Housing.
For the Senior Housing companies, home sales are the key underlying factor. The majority of seniors own their homes free of any mortgage and have the bulk of their net worth tied up in their home. As the housing market tightened beginning in 2007, occupancy and pricing has stalled.
With a severe decline in the revenue drivers and leveraged balance sheets the equities collapsed and pose significant upside from current levels. If housing is indeed bottoming, Brookdale Senior Living (BKD) and Assisted Living Concepts (ALC) could benefit from the reversal of the same drivers to the upside.
Howard W. Penney
I don't wake up every morning to wash the laundry. I wake up to make calls. I'll be right, and I'll be wrong. This is my job as a risk manager.
This call I have been making on US Employment Turning (see 4/3/09 note - "This Is BIG: US Employment Is Turning")... has been one of the top 3 calls that I have been getting pushback on (albeit now at a lesser rate). Given that the facts have forced the Bears to agree with me on this, that is probably no surprise. Facts are stubborn little critters to deal with. This we all know.
While the Depressionistas will quickly point out that this week's jobless # was higher than last week's, I will be the first to agree with that fact. But will they, in turn, agree with that this morning's claims report was:
1. A lower high versus the peak we saw 5 weeks ago (see chart)
2. Below the 4-week moving average
3. Better than what you'd expect to see in a Great Depression
I have claimed the conch on this debate and would like to know where the squeezed Bears wash out on this. What's the bear case from here?
I'm not trying to be bullish - I'm just trying to be right.
Keith R. McCullough
Chief Executive Officer
"Learn to fail with pride - and do so fast and cleanly. Maximize trial and error - by mastering the error part."
The only thing worse than NOT doing global macro, is then doing it, and coming to the wrong conclusions! When Taleb refers to "mastering the error part", he doesn't mean compounding one colossal mistake with making another one. Masters of Herd Island read on...
The New Reality is that there are a lot of leaders in the financial services industry who didn't "do macro", who are now, rightfully, looking to incorporate macro into their process. While I'd like to say that they are embedding macro into their risk management process, I can't - some of these said financial savants didn't have one of those either.
As the financial facts change, we are big supporters of risk managers changing - but we are also very aware that there is compounding risk associated with rookies making what they think are "prudent risk management decisions" that are really based on erroneous premises.
Let's take Morgan Stanley's fearless leader, John Mack, as a case and point. Sometimes being fearless equates to being recklessly wrong. Morgan Stanley's brass, not unlike a lot of Portfolio Managers who got sucked into the Depressionista camp, took the point of view that markets were not going to recover. Now, understanding that this what we refer to as "making a macro call", realize that the reason a lot of guys like Mack never did macro to begin with was simply because they never HAD to get it right.
So what happens when a whole bunch of ex-levered long PMs and horse and buggy whip CEOs think they are "managing risk" AFTER they didn't see the crash coming? Well, you get the mother of all short squeezes in everything from Chinese to US Equities in a very compressed period of time.
Having had my clock cleaned plenty of times in this business, I have to side with Taleb's conclusion that managing risk requires trial and error. However, managing risk needs to be embedded, objectively, into one's portfolio management process on BOTH the upside and downside of markets. Is there risk in getting chomped on by one great white we affectionately refer to at Research Edge as Squeezy The Shark? You bet your Madoff there is!
So let's throw on the junior stock market operator's risk management pants and take a walk down that path. What's changed most obviously in the last 6 months?
1. The Volatility Index (VIX) has been hammered for a -53% peak-to-trough drop over the course of the last 6 months
2. The TED Spread (counterparty risk measure), has narrowed by 400 basis points (or 80%!) since the Oct/Nov crashes
3. The Yield Curve (US Treasuries) steepens almost on a weekly basis and is now 200 basis points wide (10yr rates vs. 2yr)
Junior stock market operator? Why Junior? Aren't the likes of Mack to Madoff very rich and Senior? Aren't "Senior Partners and Managing Directors" on Wall Street supposed to know what they are doing? Who needs this Junior Hockey head, McCullough's, point of view? You tell me...
On this score, The New Reality isn't a new one at all. We're finally just being privy to the proverbial Wizard's of Wall Street Oz being undressed here. As the tide rolls out, you see that plenty of these guys were not only swimming naked on the way down, but remain in the nude now on the way up.
Bernstein's stand up financials analyst Brad Hintz said he was "humiliated" by his earnings estimates for Morgan Stanley, whereas Fast Money's Pete Najarian said that "conservative trading held Mack's numbers back." We're getting down to the nitty gritty here in America Idol season folks - who are you going to vote for between these two gentlemen in terms of how they addressed being wrong on MS yesterday?
Mr. Hintz, you need not be humiliated. There are plenty of men and women in this business who are posing as the renewed faithful of risk management who have plenty of that to accept for you. Your being transparent and accountable is to be commended. The Research Edge team salutes you.
As you're thinking through how you incorporate global macro into your proactive risk management processes, always remember this: "Learn to fail with pride"... "do so fast and cleanly" ... and never manage risk using a consensus macro call that's in your rear view.
This market's range remains as proactively manageable as any I have seen in at least 6 years. I have an immediate term upside/downside range in the SP500 that is only 44 points wide this morning. Buy 830 and sell 874 on that index, and smile every time someone tries to tell you that they now do macro and that "we're overbought"...
Best of luck out there today,
EWG - iShares Germany-The DAX is up 12.4% month-to-date. We bullish German fundamentals, especially as a hedge against financially levered and poorly managed Switzerland. While the automotive industry is ailing, the strength of Germany's labor unions will preserve jobs and maintain a slower rate of sequential acceleration in unemployment. Compared to most of Western Europe, Germany has a positive trade balance and will benefit from Chinese demand, especially if the Euro can stay below $1.32. The ZEW index of investor and analyst expectations for economic activity within six months rose to +13 in April from -3.5 in March, the highest reading since June 2007. We're bullish on Chancellor Merkel's proposed Bad bank plan to clear toxic bank assets and believe the country will benefit from a likely ECB rate cut next month.
EWZ - iShares Brazil- Brazil 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.
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%.
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.
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 up versus the USD at $1.3065. The USD is up versus the Yen at 98.3200 and down versus the Pound at $1.4564 as of 6am today.
EWJ - iShares Japan -We re-shorted the Japanese equity market via EWJ on 4/22. 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-the government cut its forecast for the fiscal year to decline 3.3%, and we see no catalyst for growth to return this year. We believe the BOJ's 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 is breaking down through the TREND line again. 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.
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