Mother Russia’s Allure

We’ve had a watchful eye on Russia all year as it plays into one of our main macro themes, owning countries that will benefit from commodity reflation and can supply THE client (China) with the resources it needs for domestic growth.
As we’ve noted in previous posts, despite the risk premium associated with owning the Kremlin’s leadership and negative fundamentals, you can’t argue with the Russian stock market’s (RTS) +27% YTD performance, despite today’s pullback.
Below are negative and positive fundamentals and data points to consider when owning Russia:
1.      Increased corporate debt default risk. By some estimates Russia has $780 Billion of corporate debt, $135B-$220B of which is short term debt due this year.  The deterioration of internal credit markets has pushed rates up to 15% and 20%, prohibiting refinancing of many loans.
2.      Uncertainly and lack of transparency with respect to Russia’s banking crisis.
3.      IMF forecasts the economy to contract 6% this year, versus government’s forecast of 2.2% contraction.
4.      Unemployment currently stands at 9.5% and should continue to climb this year and next, according to anecdotal evidence.
1.      Russia will likely remain a strong horse as long as commodities reflate. Our underlying thesis here is that if the USD can break down equity and commodity asset classes will get a bid to reflate.  Oil is up 16% YTD.
2.      Monetary Policy. On 4/24 the central bank lowered its main (refinancing) interest rate 50bps to 12.5%, the first cut in nearly two years. (See charts). Additionally the central bank raised its minimum reserve requirements on all retail deposits to 1% as of May, and will increase the rate at an interval of 0.5% until August.  The take-away here is that Russia has plenty of room to cut, unlike the US, UK, Switzerland, Canada, and Sweden to name a few. The ability of Russia to influence the direction of its economy through monetary policy is bullish, and raising reserve requirements shows central bank leadership to demand higher standards for lending.
3.      Currency. The Ruble has shown relative stability versus the USD and EUR in Q1.
4.      Russia’s international currency and gold reserves, the world’s third largest, increased to $900 Billion. Russia’s strong reserves (at the very least) bode well should the government need to address corporate or sovereign default issues. 
Look for us to buy Russia via the etf RSX if we can get our price from a technical level. We last bought Russia on 3/27 and sold it on 4/09 for a 15.79% gain.
Matthew Hedrick

Mother Russia’s Allure - image001

Pop, Pop, Bang...

Whether it's McGough with that UA call or Penney on this Consumer Confidence report coming in better - the shorts in Consumer Discretionary remain on the ropes...

Pop, Pop, Bang...  - 11


Whatever you fear most has no power - it is your fear that has the power.
Oprah Winfrey
What do you fear? 

The birth of the new millennium has ushered in an "age of fear" in our culture. First, there was the Y2K; then the tragedy of September 11th followed by the anthrax scare which lead to continued government warnings that we are no longer safe.   Add to all this, corporate malfeance by major U.S. corporations such as Enron, WorldCom, AIG and Bernie Madoff.  Not to forget, the failure of Bear Sterns and Lehman Brothers and the near collapse of the US financial system, this was a precursor for the worst decline in the stock market in generations and the "Great Recession."  Worst of all, we are also faced with the real possibility of bioterrorism, and growing, multigenerational hatred of the United States and of Americans.

At Research Edge we try to be disciplined and wrestle with fear.  Personally, I don't live in live in fear; if I did I would never drive a car! As a Research Edge analyst if we let fear rule our investment process, it would prevent progress, lead to stagnation and, thus limit the ability to make our clients money.

So that bring me to swine flu - it's"flu" - we have a vaccines for flu's.  I don't mean to be cold hearted to those that have died or are hospitalized, that is not my point.  As it stands now, the fact that only one of the 40 U.S. victims required hospitalization is not something to be fear full of.   
I fear, what some crazy person can do with some bio-weapon that we don't have a vaccine for, which could kill tens of thousands of people!  That is something to be fearful of!  As long as swine flu is an "above the fold" story it will prevent consumers from making certain decisions for a finite period of time.  Chances are it will create a great buying opportunity in some consumer related names!

Living in a fear-based culture will inevitably affect your state of mind and thus the decisions you make.  As a steward of capital, if you become less demanding and less willing to take risks because of fear you are doomed.  You can't let fear distort what is real and focus only on the on the negative, it prevents you from generating ALPHA!

Learning to work skillfully and proactively preparing for "fear" is essential to know how to react and be opportunistic. 

What are some things that could go wrong and spark real fear and panic, that may take the S&P 500 to new lows...? 

(1)    Every major central bank around the world is doing nothing but throwing up a "Hail Mary!"
(2)    The China's stimulus package is not working and they throw good money after bad
(3)    Copper is a bubble - perceived to part of the Chinese China recovery story
(4)    The Ratings agencies still don't have it right and defaults surge
(5)    Fear of stagnation - running in place on a treadmill sucks...
(6)    More fraud in the system
(7)    Geithner pulls a Spitzer (more entertainment than fear)
(8)    A dollar rally

In early trading we are learning that Citigroup (C) and Bank of America (BAC) are declining on concern the companies may be forced by regulators to raise more capital.  So what!  The government effectively owns C and we now know that the CEO of BAC is a government employee.   This is nothing to be fear full of - the government will not let them fail.

At 10:00am today we will learn that consumer confidence improved for the month of April alleviating some fear in the market.  How do I know this?  April was a good month; the Obama's had a success full trip to Europe, the Dow Jones has moved closer to 8K, and there has been a clear sign of stabilization in the housing market in February and March, or just plain spring fever! 

Yesterday, the fear trade was in full swing; Healthcare (XLV), Utilities (XLU) and Consumer Staples (XLP) all improved on the day, while Materials (XLB), Industrials (XLI) and Energy (XLE) were the worst performing sectors.  The dollar index rallied and the VIX shot higher, but only by 5%.  The fear trade may last another day or two, but I'm not scared!

There are so many good quotes about fear, I liked Oprah's the best - "it's your fear that has the power."

Function in disaster; finish in style!  
Howard Penney

Managing Director


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.

SPY - SPDR S&P 500-The S&P500 closed down 1% yesterday to 857.51. In the face of manic media hysteria, we have once again held onto higher lows, a bullish indicator, prompting us to buy SPY.

XLE - SPDR Energy- As of yesterday crude oil is down the most in a week on U.S. economic concerns and the potential of the swine- flu outbreak to curtail air travel. We bought energy (on sale) for the first time this year as the US Dollar's early morning strength fades.

CAF - Morgan Stanley China Fund- A close end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the wave of returning confidence among domestic Chinese investors fed by the stimulus package.  To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth.

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.  

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%.


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.

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 outperformed yesterday; we're still short.  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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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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