The Pain in Spain: Europe Isn't All The Same...

Research Edge Position: Long Germany via EWG

Unemployed in Spain in Q1 topped the charts at 17.4%, up from 13.9% in Q4. Spain now has twice the amount of people unemployed (4.01 M) as Germany, a country with twice its population. 


The "Spanish Nightmare" in unemployment is more of the same. Spain is transitioning from a decade-long boom to bust as a result of the leverage cycle finding her dark side. In particular, Spain's housing industry, which fueled much of the country's prosperity, is now being turned on its head as prices have depreciate precipitously. As it relates to unemployment, many of the unskilled construction workers that fed the boom are now out on the street, with companies across all industries cutting jobs. The chart below demonstrates just how hard unemployment is hitting young adults. 


Real Estate and building companies as well as the banks that funded their borrowing remain on our watch-list; we're likely to see default on debt rise. It's important to note that one play on Spain, iShares eft EWP, has 35.72% of its weight in Financials and 10.35% in Industrials.


As Spain continues to socialize its recovery its budget deficit will balloon. Any country with this high of an unemployment number we're going to stand clear of on the long side. It's worth noting that in going through Spain's methodology for unemployment data, tabulation metrics are on balance "conservative" (actually counting immigrant and adolescence between 16-18 years of age to a greater degree than in other European countries), helping no doubt to contribute to this double digit figure. We believe Spain will underperform its Western European peers - Germany, in particular.


Matthew Hedrick


The Pain in Spain: Europe Isn't All The Same... - spain1

HBI: Some Thoughts Into The Qtr

 There's a lot of both positives and negatives for me on HBI right now.  Given that the stock has nearly doubled since management loaded up in Feb/March, it's tough for me to chase it here. Every quarterly release is an event for HBI, so here's a few things I'd look out for...


1) At face value, I don't love the revenue compares right now, but when I stack it up against retail sell-through (as reported by Sportscan) it suggests that we've gone through 1+ years of severe inventory destocking.


2) When I put that into context with the fact that 1) inventories that have been way out of whack for HBI for the past 3-quarters, and 2) the spread between revenue and retail sales appears to be narrowing, I can't help but get intrigued that the supply/demand balance is finding itself.


3) While revenues decelerate on both a 1yr & 2yr basis, Q2 will benefit from a BTS shift in 2008 that resulted in ~$50mm in revs to being pushed into Q3.


4) A 4% price increase was implemented at the end of January that effects Innerwear will not be enough to offset the Fx impact in Q1, but will more than offset Fx related losses for the balance of the year.


5) Cotton, oil and other sourcing/input costs should start to be a tailwind in 2H - at the same time we see easier balance sheet compares.

This name may be a rocky ride for a quarter or two, but worth looking at into 2H.


HBI: Some Thoughts Into The Qtr - 4 27 2009 1 28 08 PM

HBI: Some Thoughts Into The Qtr - 4 27 2009 1 17 43 PM


It is widely known that "the Chief Executive is selected by election or through consultations held locally and be appointed by the Central People's Government."  But what are these local consultations?  Well, they are taking place right now in assembling what is called the Election Committee.


The process is not altogether different from what happens in Hong Kong. While Hong Kong's Election Committee is comprised of 800 representatives chosen from 28 functional constituencies, religious organizations and ex officio members taken from the government, Macau's Election Committee is an even more private affair.


The 300 Election Committee members in Macau are made up of 100 members representing the industrial, commercial and financial sectors, 80 from the labor, social services and religious sectors and 80 from the cultural, educational, professional and sports sectors. Deputies to the National People's Congress and the Chinese People's Political Consultative Conference have 12 seats each. The remaining 16 seats are allocated to the Legislative Assembly, with the members choosing their representatives via a poll.


The current CE Edmund Ho hasn't announced an "election" date but it is looking like it will be in August.  The two leading contenders are Ho Chio-meng, the Macau Chief Prosecutor, and the Cultural Minister Fernando Chui Sai-on.  Not surprisingly, Beijing holds both in high regards.  We continue to view the election as a positive for the visa situation in Macau which should provide a tailwind for the new CE.  2009 is also the 60th anniversary of the People's Republic of China and the 10th anniversary of Macau returning to China rule.  All of these are potential growth catalysts.

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Chinese Demand: Bubblicious?

Shanghai Copper futures are building in massive expectations for the Doctor's summer...


 Industrial & Commercial Bank of China reported a Q1 profit increase of 6.2% on rapidly expanding credit today, with comments suggesting that that the torrent of loans will not abate anytime soon. If you read our comments on the increasing liquidity in the Chinese credit market ("Gushing" 4/13) you know that we harbor two serious reservations about the surge there:


1. inflationary pockets
2. bad loans


At 1.97%, the ICBC NPL ratio looks good (for now) but potential evidence of bubble formation is being provided by the good Dr. Copper.


YTD, Shanghai futures contracts have led COMEX and LME contracts on a return basis as trading volume has exploded.
*more comments before and after charts


Chinese Demand: Bubblicious? - cop1


Chinese Demand: Bubblicious? - cop2


While Shanghai contracts have shown greater strength, they have also exhibited a more pronounced backwardation on a percentage basis.  Meanwhile total open interest going into the summer exceeds total imports for the same months last year significantly.


Chinese Demand: Bubblicious? - cop3


While the copper bulls in the rest of the world have been driven by the anticipation of the stimulus program in China, local traders appear to be driven by more than just raw demand from the hungry Ox. With credit flowing through the system the Shanghai copper futures market appears to have become a preferred domestic venue for speculation on the recovery.


We remain bullish on Chinese demand for basic materials tactically because we think the brute force of the stimulus measures, particularly the infrastructure build out, will create sustained demand for the remainder of the year.  As always however, price action is king in our world: if we judge Copper's momentum to be driving it to levels well in excess of real demand we will short without hesitation.


Andrew Barber

Where There’s Smoke… Notes for the Week Ending Friday, April 24, 2009

Investigate This


It's the oldest established, permanent floating crap game...
  - Frank Loesser, "Guys and Dolls"


Bloomberg (April 21) reports that House Speaker Pelosi has proposed a bipartisan (there's that word again!) panel along the model of the 1933 Senate Banking Committee hearings led by Ferdinand Pecora.  These were key to the creation of the Securities Act and the Glass Steagall Act - both in 1933 - and of the Securities Exchange act of 1934, which created the Securities and Exchange Commission.


Speaking in half-hearted support of his compatriot's proposal, Barney Frank said "I think it's useful to have it, but that should not be a reason to hold off on legislating."


Why wait until we figure out what actually happened?  In a development worthy of Kurt Vonnegut, Barney "Roll the Dice" Frank is getting ready to remake the markets in his own image yet again.


The Obama Administration has made rewriting the rules governing Wall Street a top priority.  We hope the Democrats recognize that this will take considerable finesse, otherwise we will gain not merely a Super-regulator, but a Super-Duper Regulator.  Legislators need to recognize that, until we change the approach to actually confront the existing mechanisms and structures that have contributed to the demise of the markets, each new layer of regulation will merely serve to set back the cause of capitalism, free markets and global fiscal well-being.


Connecticut Democrat John Larson of Connecticut, the No. 4 House Democratic leader, said "We need to provide a narrative."


That does get to the issue.  We Americans are willing to be beaten within an inch of our lives.  Just tell us why.


Writing on the Wall Street Journal's OpEd page (24 April) Nobel Prize winner George Akerlof and Yale University Economics Professor Robert Shiller point to the late 1980's as a time when "our economic system was remarkably well-adapted to weather any storm."  They take the S&L crisis as their case in point, saying that "government protections isolated this collapse into a microeconomic event that, while it cost taxpayers quite a bit of money, only rarely cost them their jobs."


We are a nation driven not by cash, but by cash flows.  Americans grumbled and chafed, but as long as we had jobs and paychecks to cash - and access to credit - we have not balked at this nation's Bizzarro version of capitalism, where losses are socialized and profits are privatized. 


But the American Way is changing.  The true "credit crisis" is not the refusal of banks to lend to one another.  It is the refusal of Americans to borrow.  While economists and senior government officials are taking the Average American to task for saving money instead of spending, those same Average Americans are in a state of shock, wondering how their government could have let things get this far out of control.  The days of "You Auto Buy!" are over.  Average Joe and Jane have put away the credit card in favor of the passbook, signaling that the old narrative is dead.  Congressman Larson had hit the nail on the head: they had better get the new narrative right, or Speaker Pelosi will have no one left to speak to.


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None of them along the line know what any of it is worth.
- Bob Dylan, "All Along the Watchtower"


Wall Street has its own unique form of Stockholm Syndrome - the psychological phenomenon where hostages come to identify with their captors.  Those who work around incredibly wealthy, successful people come to take on the characteristics of those they serve, sometimes with devastating results.  Permit us to coin the term "Stockbroker Syndrome."
We have seen compliance officers become swaggering mouthpieces for their firms, bragging that the regulators can't touch them.   Perhaps the most egregious was Stuart E. Winkler, compliance officer and CFO of the now-defunct brokerage firm A.S. Goldmen.


Winkler, who spent seven years as an NASD examiner, was caught on tape offering $35,000 to a hit man to kill the judge trying him for stock fraud.  Winkler is currently serving 8 1/3 to 25 years for conspiracy to commit murder, plus three to nine years for stock fraud.


This is an extreme case.  But we can not emphasize strongly enough: risk management is about preparing for extreme cases.


Speaking of extreme cases, a devastating case of Stockbroker Syndrome seems to have affected the ratings agencies, who were paid fortunes to assess the creditworthiness of public companies.  Now, under Chairman Schapiro, the SEC has announced it will look closely at the raters' work.  (WSJ 16 April, "SEC Puts Ratings Firms on Notice").


Where conflict is inherent, conflict will surely arise.  Let this lesson be lost on no one.  Take the following excerpt from USA Today, for instance.  "The nation's largest credit-rating agencies failed to protect investors during the real estate boom because of sloppy business practices and inadequate staffing, federal regulators said in a report issued Tuesday.


"An investigation by the Securities and Exchange Commission, launched 10 months ago because of the subprime mortgage meltdown, says the big three ratings firms - Moody's, Standard & Poor's and Fitch - struggled to keep up with the workload of rating an ever-increasing number of mortgage-backed securities from 2002 to 2007.


As a result, all three lowered their standards in rating complex investments known as residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs).
Because many institutional investors can put money into only investment-grade bonds (i.e., bonds with a rating of "AAA"), investment banks scrambled to win the highest ratings for the mortgage-backed securities they developed during the real estate bubble.


When the subprime mortgage crisis erupted last year, bondholders demanded to know why so many of these securities, constructed with toxic subprime mortgages, had been awarded "AAA" ratings."


For those of you about to congratulate Chairman Schapiro, we admit that we tricked you.  This story ran in USA Today in July of 2008, and recounted an initiative by then SEC Chairman Christopher ("Can't We All Just Get Along") Cox to reform the ratings agencies.


The story just keeps getting better and better.


The Wall Street Journal reports (21 April - yes, of this year) that the ratings agencies have taken the position that their published ratings are Protected Speech, under the First Amendment.  McGraw-Hill says that their ratings are "of public concern and entitled to all the protections of the First Amendment."


We make no claim to expertise in matters of Constitutional Law, but we know a howler when we see one.  The ratings agencies are paid not by those who rely on the ratings - the investors - but by those who want to flog their securities to the public - the issuers.  Clearly, an inherently conflicted model.


We agree with Connecticut Attorney General Richard Blumenthal, who has filed an action against S&P.  Blumenthal maintains that securities ratings are "very different from the classic First Amendment-protected expression.  It's much more akin to an advertisement that misstates the price of an item on sale than a political candidate on a soapbox."  Far from providing risk assessment, ratings became a marketing tool. 


 The inability of the raters to keep up with the volume of work was blatantly obvious (it was even noted by Chris "Get Along" Cox).  And nothing was done about it (because it was uncovered by Chris "Get Along" Cox?)  This inefficiency was voraciously exploited.


Then, when the markets got nervous, investment-grade ratings became ever more important to propping up price and creating liquidity.  The CDS issuers received AAA ratings based on the rating agencies' internal formulas of the market's opinion of the issuer's creditworthiness, which is to say, it's a proprietary process.  Which is to say, we're not going to tell you what standards we apply.  All Wall Street was effectively in collusion.  Face it, would Lehman question the AAA rating of an AIG CDS sold to a hedge fund by Bear Stearns?  


At the beginning of 2008, as has been widely cited, there were 12 AAA-rated public companies in the world - and some 64,000 AAA-rated structured finance instruments.  No practical distinction existed in the minds of most buyers between ratings of operating businesses - with assets and a vested interest in profitable operations - and synthetic securities issued by financial firms, which are ultimately only moral obligations of the issuers.


Reporting on the SEC's current initiative, Time writes (15 April) that "in the wake of the Enron collapse, the Senate held hearings about the role of the ratings agencies - which considered the company's debt investment-grade until just days before it went bankrupt. The Senate investigation found that the ratings agencies hadn't asked particularly probing questions of Enron and had glossed over warning signs like accounting irregularities. In other words, the ratings agencies didn't objectively and accurately rate."


Clearly, the failure of a ratings agency to publish negative rankings is the equivalent of not shouting "Fire!" in a crowded theater when the theater is ablaze.  We are not sure whether neglecting to save someone's life qualifies as protected speech under the first Amendment.
The Financial Times reports (13 April, "Moody's Reveals Level of Credit Quality Has Hit 25-Year Low") that "the ratio of companies having their credit ratings cut versus the number of companies being upgraded - an indicator of declining credit quality - had reached its highest level since 1983."  We would welcome a study that would assess how much of this sudden decline in credit quality is the direct result of inflated ratings awarded to companies and instruments that did not deserve them.


New York Times chief financial correspondent Floyd Norris (23 April, "Subprime, Corporate Style") uncovers a parallel mess in the market in Collateralized Loan Obligations, or CLO, which are repackaged corporate debt.  Norris quotes Moody's Investor Services as saying "as of the beginning of April, a record 27 percent of speculative-grade debt issuers had a rating on their senior debt ranging from Caa down to C. These are the lowest rungs of credit quality - rungs that once rendered a borrower ineligible for a loan."  He goes on to note "The default rate on leveraged loans and speculative grade bonds is rising rapidly."


According the Norris, defaults in this sector could range to as high as 24%, double the peak level of past recessions.  Norris foresees a possible wave of corporate bankruptcies attributable to lax credit practices by lenders - fostered by irresponsible practices by the rating agencies.  


With few exceptions, the financial press has dramatically under-emphasized the agencies' lax analysis and pandering to their paymasters in the irresponsible awarding of "investment grade" designations.  The fabled AAA rating, referred to as "coveted" in hushed and reverent tones, appears to have been reserved for companies that the rating agencies themselves ran in fear of.  GE, for example, had gotten to a point where it could have "gone naked" - dispensed with ratings altogether.  It was a global empire, more powerful and better capitalized than most sovereign nations.  Imagine the consternation at Moody's and S&P if GE's internal audit staff sent their own CEO a report delineating the weaknesses and gaps in the rating agencies' practices.  GE would have rattled the financial markets by announcing that it would no longer pay for a credit rating.  As a model corporate citizen, and in the interest of market transparency, GE could have gone public with an analysis of the glaring failures in the rating agencies' practices.  For the raters, it would be Game Over.


We wonder what enterprising law firm will make its fortune on class action lawsuits, claiming that public companies had an obligation to their own shareholders to reveal the inadequacies of their own ratings, as set by the agencies.  Because clearly, GE - and everyone else - knew exactly how lax the raters' standards and procedures were.  Just a random thought. 
Brokerage firms that relied on ratings in making suitability determinations for their customers will likely find themselves in the crosshairs, as will hedge funds that relied on ratings in their portfolio valuation process.


The sudden collapse of ratings can surely be traceable to nothing so much as to the excesses and negligence of the raters themselves.  Particularly egregious is not even the fundamentally dishonest structure of this business model - nor even the obvious fact that this practice was so pervasive as to saturate both corporate America and Wall Street - but that, having come to light, the SEC under Chairman Cox did not eviscerate this model.  The collusion of Big Government, Big Business, Big Money, and an acquiescent press was promoted by a regulator who was willing to put all important matters through a slow and deliberate review process, more enamored of administration and unanimity than results.


This brings us back to our proposal to revamp the regulatory system.  The SEC should bring in a team of high-level Wall Street compliance professionals on a limited contract - we recommend a three-year term.  Fifty of the smartest, most competent compliance officers in the industry can easily be brought in at Street compensation levels for only a small increase in the Commission's budget.  Give each of them a team of lawyers and examiners, and turn them loose on the industry.  Trust us, you will see results.


The few truly outstanding Street-side professionals the SEC has managed to lure come into the Commission with high hopes for really making a difference, only to find their efforts stymied by the bureaucratic morass.  In order to make these folks effective, they should be set up as a Chairman's Special Task Force, attached directly to the office of the Chairman of the SEC, and responsible only to the marketplace.  It just might work.


Meanwhile, for all of you still sitting in the theater...




A New York Minute


These criminals have so much political power they can shut down the normal legislative process of the highest law-making body in this land.
 - Rep. Marcy Kaptur (D. Ohio)


What do,,,,, and have in common?


Besides being widely derided by the mainstream media as crackpot websites, they all reported on the interview granted to Tulsa, Oklahoma radio station KFAQ, where Senator James Imhofe described the conference call held by Secretary Paulson on 19 September, pushing Congress for passage of the original TARP bill.  Paulson allegedly told his listeners that, if they failed to pass this emergency measure - for which he frankly stated there would be no transparency, no oversight, and no accountability - there would be an immediate crash in the stock market, followed by civil unrest and martial law.


With visions of National Guardsmen and Army tanks dancing in their heads - and with next to no debate - Congress handed Paulson the TARP in short order.  Not since the Patriot Act have so few moved with such alacrity to deprive so many of so much.


The absence of any mention of Paulson's phone call in the mainstream press is highly instructive.  A search of brings up nothing on this story, while typing the words "Paulson martial law" into brings the message "No articles match your search criteria. Please try again."


Now we have found someone to try on our behalf.  New York State Attorney General Cuomo is yanking back the tarp from the TARP, and it isn't pretty.  Agreeing with Justice Holmes that sunlight is the best disinfectant, we believe this rot will require mega-doses.


Reading between the lines, we take as our point of departure this week's Wall Street Journal banner headline (23 April), "Lewis Says U.S. Ordered Silence on Deal - Bank of America Chief Testified Bernanke, Paulson Barred Disclosure of Merrill Woes Because of Fears for Financial Systems".


The implication is that the government forced the Bank to follow this course of action.  Mr. Cuomo's version of this story, based on testimony obtained in his investigation, is more nuanced.  The website (24 April, "Storm Erupts Over BofA's Merrill Takeover") reports "In a letter to congressional leaders and the Securities and Exchange Commission, Mr Cuomo quoted the BofA chief as testifying under oath that Mr Paulson told him 'we feel so strongly that we would remove the board and management' of BofA if it tried to renege on the deal."


In other words, Mr. Lewis was given a Procrustean choice.  Knowing full well Merrill Lynch's financial position - and of course knowing the magnitude of the bonuses already paid to Merrill executives - Mr. Lewis and his board chose to keep mum and allow the deal to go through, after which they would deal with the outcome.  This is Wall Street's traditional approach.  Get paid now, worry about the details later.  (The same mentality that found it acceptable to lend to unqualified borrowers, on the presumption that real estate would always to go up in value.)


Lewis and the BofA board could have gone public with the reality of the Merrill deal.  Indeed, we argue they had an obligation to do so.  The CEO is an employee of the shareholders, and the Directors have a fiduciary duty to protect their interests.  This is the rock-bottom definition of Speak Truth to Power.


Meanwhile, "Mr Paulson clarified his comments, saying his 'prediction of what could happen to Lewis and the board was his language, but based on what he knew to be the Fed's strong opposition to Bank of America attempting to renounce the deal'. Meanwhile, both Mr Bernanke and Mr Paulson insisted that they had not advised Mr Lewis to conceal Merrill's mounting losses from his shareholders."


Any compliance officer will recognize this gambit.   "I didn't tell him to say that!"  What clearly did happen was that Paulson "predicted" to Lewis what would happen, leaving Lewis to figure out how to pitch it to his shareholders.  In the event, the pitch turned out to be a balk.


We imagine Ken Lewis, fresh from a shower, luxurious white Turkish towel wound around his waist, shaving at his sink.  With the steam rising to his face, he is practicing his speech to the BofA shareholders.  "We are going to acquire Merril Lynch.  Now, you should know that they have hidden tens billions of dollars of losses - all of which will come right out of our net worth.  They have also hidden the fact that they already paid out billions of dollars in bonuses to their executives, and none of those executives will stay on and work for us once the merger is completed.  It gets worse.  Because in order to do the deal we will have to borrow tens of billions of dollars from the government, who will hound us and interfere with us running our business.  We realize this looks bad, but the alternative is worse. We have the assurance of the Secretary of the Treasury that, if we don't acquire Merrill Lynch, there will be a general collapse of the global financial system, leading to armed insurrection worldwide, martial law, and blood in the streets of America."


On second thought, he muses...


By the way, in his letter AG Cuomo tells Congress and the SEC that Chairman Bernanke refused to testify, citing "bank examiner privilege".  We have bad news for you: there really is such a thing.


As to why these stories are not fleshed out in the mainstream media - or sometimes not even reported - it's all in the way you read it.  When someone says "all the news that's fit to print", you need to ask: who is making the determination?


As with torture in time of threat, some people at high places in government truly believe that extreme measures are required.  We have to cling to the comfort that Secretary Paulson truly believed it when he told members of Congress there would be blood in the streets.  And we have to cling to the belief that Chairman Bernanke truly believed the BofA-Merrill merger was the only way to avoid another disaster of the scope of the collapse of Lehman.


We have to believe that Secretary Geithner thinks the only way to rescue the financial system is to blindly continue throwing trillions of dollars into the hands of the banks, without requiring accountability or transparency.  We must believe all this.  Or we must believe that the banks run the world, and President Obama finds himself in the same position as Ken Lewis: just keep your mouth shut and no one will get hurt.


 We like to believe that even we are not so cynical as to think otherwise.


Are you?


Moshe Silver
Chief Compliance Officer

Chart Of The Week: The Green Monster

That's what this chart is - it's GREEN, and for a someone short selling US Equities into it, it's a MONSTER...


Most economists and strategists will have a very hard time convincing me or, more importantly, Mr. Market, that a steepening yield curve isn't a very bullish signal for Equities. Below (see chart) we express this steepening by showing the spread between 10 and 2-year US Treasuries.


One of the main reasons why I was running 70-96% cash levels in my Asset Allocation Model in September/October of 2008 was that this spread was compressing. In both December and March/April, you have seen me drop my average position in US Cash down to the 45-65% range, primarily because, on the margin, I have seen this relationship for what it is - a bullish leading indicator.


The best question you can ask me from here is why can't this curve begin to flatten again? It definitely could, and I'd argue that a compression of this spread + the strengthening of the US Dollar, were the two governing factors behind the US stock market selloff that we saw in February. The problem with that pattern (for the Depressionistas at least) is that it has not repeated itself here in April.


So the point is, beware of the Green Monster - because it can inflict pain on both bulls and bears, depending on its directional move. This morning, despite the manic media's Swine Stress, the yield curve was steepening further. It is now +203 basis points wide, and US Equities have moved to green on the day.


Keith R. McCullough
Chief Executive Officer


Chart Of The Week: The Green Monster - GM

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