Long EWG? Germany's Lifeblood "Das Auto"

We recently received a follow-up question from a client who was "surprised by the long Germany call"  when, to his point, so many German jobs are tied to the ailing automotive industry. The client brings up a good point which was not included in our post on 4/21 "EWG: Why We Bought Germany Today." Below you'll find our response to the question, which argues that although the German automotive industry has taken a huge blow in this global recession, the strength of German unions and the subsidy measures granted by the government to prop up the industry have helped to maintain jobs and offset double-digit sales declines as the industry rides off decreased global demand.  


As a point of reference in case you didn't read the original post, part of our reasoning in taking a long Germany position is to hedge against our short exposure to Switzerland via the etf EWL.

---------Thanks for your response. I'm not an automotive analyst, but I have spent a fair amount of time looking at Germany. As you're well aware the automotive industry lies close to the German soul and therefore everything is being done to save it; concurrently GM's Adam Opel in Germany is looking for a buyer. The government has yet to step in, hoping to find a private buyer, yet you can bet that both acting Chancellor Merkel and her incumbent Frank-Walter Steinmeier will be making this a central issue to resolve as election day nears in September.


Firstly, it's important to keep in mind the historical and cultural framework of the German workforce to get at an understanding of the auto industry. German schooling (much like other European countries, but arguably more so)  is very rigid from an early age, tracking children to particular schools (university track, technical, vocational). This leads to the cultural mentality that each individual is suited for one particular industry/profession, which leads both employees and employers to value job security above all else. German business/organizations are very hierarchical and the lack of entrepreneurship compared to the US is strong.


In short, German automotive jobs are relatively resilient (see chart below) for German trade and labor unions play a large part to insure job security.  As an example, the government recently extended subsidies so that companies can keep workers on payrolls for as long as 18 months-it used to be 6-even if layoffs might be easily justified. For cyclical industries like autos, this could mean the difference in riding out the global recession that has destroyed demand.   The government has also created a short work program from more than 670,000 workers and in March the number of applicants was up 55 times.


To use Daimler as an example of labor's pull...although the company threatened a first round of job cuts at its annual meeting last week, management can't carry it out before the end of 2011. In short, it's hard to fire people. 


While EWG, the ETF we purchased, has a sector exposure to industrials of only about 15%, your point about the overall exposure of the German economy to the Automotive Industry is well taken.  (My sources show 1 in 8 Germans are tied to the auto industry).


Yet, Germany is working to help incentivize the auto industry in particular (so much so other industries are crying foul). Germany has issued an auto rebate program (Abfrakpraemie) by which individuals can trade in their old cars (9 years+) and receive 2500 Euros towards a new car that meets certain emission standards. The program has been a huge success and has helped to drive sales.  The government said it expected 2 million purchasers to apply for subsidies, costing it 5 Bill Euros this year.  While German auto sales were down globally on the whole in the first two months/1Q of 2009, both Daimler and BMW announced that the drop in sales in March relative to the same month last year was less than the year-on-year drop measured in previous months. Further, most major German automakers reported that  sales rose considerably in China. 


Additionally, Daimler received a 2 Billion euro investment from Abu Dhabi's sovereign wealth fund in return for 9.1% of its stock.  Perhaps investment from abroad could pick up in the near term at the right price. Therefore I'm of the opinion that despite the country's leverage to Autos, it is relatively stable, despite the global recession's impact on the automobile industry.


Matthew Hedrick


Long EWG? Germany's Lifeblood "Das Auto" - auto1


Long EWG? Germany's Lifeblood "Das Auto" - auto2

CASUAL DINING – Fighting Back

More and more companies in the full service segment (casual dining) of the restaurant industry continue the trend toward smaller and less expensive menu options, as operators attempt to drive traffic at a time when customers are looking for greater value and more healthful options.

I have been beating the drum that, these lower prices have to help casual dining restaurants’ value perception relative to the QSR players. It is these low price casual dining offerings that cause me to believe that now is a difficult time for QSR players to push their more premium menu items to drive incremental traffic trends

We recently learned from McDonald's (MCD) that they are planning to introduce its Angus burger nationally this summer.   The Angus burger is a premium burger; the sandwich alone costs over $4.00 in some markets before you add a fries and a drink.  This implies the Angus combo meal will be $7-$8!  While I’m picking on MCD, the balance of the QSR hamburger chains are just as guilty.   

Here are the latest price points from some important full service restaurants:

Cracker Barrel Old Country Store said it is resurrecting two successful menu items from the past called Campfire Grill.  The Campfire Chicken and Campfire Beef dishes are slow-roasted in aluminum foil and served with carrots, corn on the cob, carrots and red-skin potatoes along with a choice of corn muffins or buttermilk biscuits.

Here is the best part; the chicken is priced at $8.49 and the beef is $8.99.

The Cheesecake Factory is now rolling out a line of smaller-sized dishes at lower prices.  According to the company the new Small Plates & Snacks menu is designed as a “pre-appetizer” or to be combined with other dishes to make a meal.

Cheesecake Factory’s new menu includes 16 dishes priced from $3.95 to $6.50 each.

Not to forget that Chili’s Grill & Bar, recently introduced 10 menu items under $7 earlier this month.

On the surface declining price point for new menu items should be a red flag for margins.  In the current environment operators are benefiting from lower commodity costs, reduced labor and growth related costs and a heightened mandate on efficient operations.  For the time being, all is well on the margin front.  Where future traffic goes is a key issue to watch.

Glaring Groupthink

"It is dangerous to be right in matters on which the established authorities are wrong."
I don't think American economic history has ever seen such a powerful level of groupthink in her financial markets. This, of course, is primarily a supply issue. In terms of participation, The New Reality is that there has never been more people willing to get in this game. Whether it's an oversupply of manic media, money management firms, or the 34 million plus online brokerage accounts in this country, no matter where you go this morning, there they all are...
Being in my seat provides an interesting vantage point. To get here, I drive through the "make money" mecca of Stamford in the wee hours of the morning and see that most of my sell side competition's lights are off. By the time I get to New Haven, my inbox is lit up like a Christmas tree with people who agree/disagree with my firm's points of view. While I don't spend my time with group-thinkers, I am privy to plenty enough of their thoughts. Short Starbucks, long McDonald's anyone?
Do I have baggage in this business? Don't we all?...
After having a great run being overly compensated in the hedge fund business, remember that I was basically fired at the end of October 2007 for being "too bearish"... so, pardon the pun, but I BEAR the cross of my own experience in not trusting the "established authorities" in this business. If it comes across as my having an axe to grind, I apologize for my inability to communicate - I'm grinding alright... grinding to be right.
So away from John Mack and "The Masters of Herd Island" that I went off on in yesterday's note, what are the most glaring groupthinker points of view I have staring at me from my notebooks this morning?
1.      "we're overbought"

2.      "the consumer is never going to be the same... its over..."

3.      "earnings are going to kill the market, watch..."

4.      "Ivy is bearish on housing, haven't' you looked at foreclosures"

5.      "we're overbought"

6.      "Meredith is saying this bank is going to... that will be a disaster"

7.      "China really looks good now... this is how you should play it"

8.      "Tech has moved to far too fast... its over..."

9.      "we're overbought"

Are we overbought? Even Cramer went live with the Doug Kass call on that front last night. But are we really overbought or just getting ready to rip this line of groupthink up and into the right of into its final crescendo?
There is a big difference between stock market operators and stock market commentators. Most pundits, including those regulating US markets, say that market timing is not possible. In fact, on the Series 65 exam, you must check the box that says market timing is BAD, or you get the question wrong...
Understanding that not doing macro or not managing your market exposure around a macro call implies a massive amount of systemic risk in your portfolio is one thing. Understanding that the art of managing money is having a narrative fallacy of an investment process that provides you money to manage is completely another.
So what if you could be more right than you were wrong in calling markets? Would you use it? Is it any different than using the Master of Herd Island "one on one" approach to trading around a stock? Is the perceived edge associated with having sat across from a CEO in one of Wall Street's finest hotel conferences any different than understanding a mathematically relevant market correlation that begins to dominate?
The New Reality is that there is edge in understanding the behavioral side of markets and the glaring groupthink that's embedded therein. Next time someone tells you that we're "overbought", ask them at what price. Like the answers to the aforementioned 9 considerations, I am sure you'll find the specificity of the answer enlightening...
At the beginning of this week, I said China was overbought on the Goldman call - the Shanghai Composite Index closed down again last night, locking in her 1st down week in the last six. I'll say that, in the immediate term, that the SP500 will be overbought at the 874 line, and I'll refresh my risk management model every 90 minutes of trading so that my answer to the question changes as the cold hard facts do.
The "established authorities" aren't allowed to put these kind of a calls in print - making market calls isn't what they tell their clients they do, even though that's what they are doing more and more here every day...
Looks like great weather for a BBQ!
Have a great weekend with your families,


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 (and the game changing ORCL-JAVA deal). 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.

EWG - iShares Germany-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 is up versus the USD at $1.3292. The USD is down versus the Yen at 97.0800 and up versus the Pound at $1.4631 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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We think IGT is sandbagging the numbers.  Nobody can accuse us of being eternal optimists.  This is the first time we've made the claim that guidance was conservative and we did bring our numbers down to 25% below the Street on Monday in our note "IGT: PLENTY OF EARNINGS POWER FOR PATIENT INVESTORS".  IGT guided below even our numbers.  This is exactly what we hoped the company would do, especially with a new CEO taking over.  Smart move, Patti.  Now we'll see if she is the aggressive and unemotional cost cutter that we believe her to be.  Move over TJ, aka Mr. Nice Guy.


We've scrubbed the model after the quarter and our estimates actually went...UP!  Our financing projections changed to now assume a one year extension of the credit agreement combined with a new bond deal.  Previously, we expected a bond deal and a completely new credit facility.  Essentially, this strategy allows IGT to smooth the interest cost mark-up over 2 years versus our previous assumption of a year.  We are now projecting fiscal 2008 and 2009 EPS of $0.87 and $0.89, respectively. 


Now that the earning cat is out of the bag, the real story here is IGT's long-term core earnings power.  The probability of earnings meets and beats are high, in our opinion, so what is the true earnings power?  Our conclusion from our 4/21 note still holds:  $1.40.  However, given the pent up replacement demand, we are likely to see a v-shaped recovery and IGT "over earning" the $1.40 for a few years.


The market reaction to the awful quarter and guidance yesterday was to send the stock slightly higher.  The bottom could be in.  Estimates are likely to be met or exceeded.  As shown below, only 5 out of 19 sell-side ratings are positive.  Upgrades are coming, especially when they beat the next quarter.  Finally, the valuation, even on our Street low 2010 estimate, is reasonable, and downright compelling on core EPS.




This company never ceases to amaze me. If you were to ask me a week ago (as some clients did) I'd have said that I thought that COLM would smoke the quarter by a factor of 2x, but that SG&A and capex would numb the impact of a weak backlog and an FX headwind for the reminder of the year.  Net/net, not a big bull event, but be weary of following the herd onto the short side.  That was in the low $30s. Though the stock has since rallied to $37, I think that my original statement will prove to be flat-out wrong.


The consensus is going to end up shaking out in the $1.50-$1.75 range. There's no way this stock could maintain a 3-handle with that earnings base.  To be clear, I think that they are absolutely sandbagging, and will come in between $2.00 and $2.25.  Let's watch this one real close. If estimates come in closer to that $1.50 line and the stock gets obliterated, it's definitely worth a look-see.


As always, there's a ton of moving parts around the fundamentals here. What's the biggest positive that jumped out at me? The core Outerwear business performed quite well - up 10% yy. Not only is this the highest margin product for COLM, but it is the best authenticator and halo for the brand. On the flip side, just about everything else was flat-out embarrassing. This company simply can't gain traction in any of its non-outerwear businesses.


As noted above, I was in the camp that cutting costs and capex could be a buffer here for '09 and '10. In fact, I was about to beat the company up for taking capex UP in '09 by 10%. But pondering about how little traction these non-core products and brands have, I'm in the camp that COLM needs to invest more rather than cut - or simply close down what's not working (which management will not do).


The other option would be to sell the company, which is plausible if the right partner is willing to buy it and 'leave it alone' (i.e. VFC). That's probably closer to reality now than it was a month ago.


In the end, every story has its price. Let's see where numbers shake out. If this is oversold into sandbagged expectations, it may be a trade. For longer-term investors, there are clearly deep deep issues worth researching. We're on the case.


COLM: CAN'T GET OUT OF ITS OWN WAY. - 4 24 2009 7 37 08 AM


The Nevada Gaming Commission is considering an amendment to allow an institutional investor to own up to 25% of the voting stock of a gaming company without getting licensed, up from the current 15%.  Las Vegas Attorney Frank Schreck proposed the amendment and we doubt he's doing it on his own.  Someone is funding the cause.

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