Chart Of The Day: Breaking The Buck, and Shorty's Bank...

I'm more of a quantified process guy than a technician - but throw this chart onto the desk of one of those Depressionista Chartists, and ask them if they'd be long it... it looks just like Gold started to in March...


The governing factor in the REFLATION trade remains the US Dollar. As the Buck breaks down through my TREND line support level of 85.54 (thick red line), you're seeing US Equities charge to new intermediate term highs.


As much as lower highs (USD chart) are bearish, higher highs (SP500) are bullish. We all know this. We also know that volume has not been behind this rally (it hasn't been behind the market down days either), but Volatility (VIX) has been breaking down all the while - do those two factors offset one another? Good question... and one I will be delving into in the coming weeks. For now, my job as a risk manager is to manage the game that's in front of me.


For now, dollar DOWN = stocks UP, and I see risk in making this any more complicated that it really is.


Keith R. McCullough
Chief Executive Officer


Chart Of The Day: Breaking The Buck, and Shorty's Bank...  - usd1

Who Is Allowed To Take The Shot?

"I've missed more than 9000 shots in my career. I've lost almost 300 games. 26 times, I've been trusted to take the game winning shot and missed. I've failed over and over and over again in my life. And that is why I succeed. "
-Michael Jordan
Swine, Stress, Whine - that's what losers do. We're focused on winning here over at Research Edge. Let's stay with the proactive process, and keep taking the shots that consensus still isn't ALLOWED to take.
Allowed? I can assure you that people at some of our compromised and conflicted financial institutions were not allowed to be bullish on a squeeze in the US Consumer Discretionary stocks. Quantified, this governing sector of the US economy has higher short interest than the Financials! Now, with the group (XLY is the Discretionary ETF) up +4% YTD, I am left to wonder how many of the Depressionista short sellers are still allowed to be pressing these things into strength...
I've had to learn this lesson the hard way (many times over, with live ammo), but not changing your positioning as the facts change will most certainly shorten the duration of your career in this business.
So, on the margin, have the facts changed? Let's go through them, and you tell me:
1.      US Consumer confidence has bottomed (both this week's ABC/Washington Post reading and the April Conference Board reading are on the tape)

2.      US Housing is bottoming (Case/Shiller confirmed that the rate of decline in terms of what matters - the price of your home - is going down at a lesser rate)

3.      US Unemployment losses are finally decelerating in terms of their rate of growth (weekly jobless claims, monthly unemployment, CFO firings, etc...)

4.      The US Yield Curve continues to steepen (at 207bps this morning's spread between 10 and 2-yr Treasury rates is at its widest YTD)

5.      The nominal yield on 10-yr Treasuries is crossing the 3% line this morning (yes, all those savings people whine about can eventually earn a return)

6.      The TED Spread (counterparty risk measure) is as narrow as it has been all year (3-month LIBOR hitting a post Lehman low at 1.04% this morning)

7.      Chinese stocks locked in their best session in two weeks (last night the Shanghai Composite was +2.8% taking YTD gains to +35.6%)

8.      German stocks are starting to breakout from a TREND perspective (the DAX is providing leadership in Western Europe, making a run at flat for the YTD)

9.      Commodity prices are bouncing this morning after seeing their Swine Test (Oil and Copper continue to trade above their TREND lines)

I have another 18 real-time data points in my notebook that are more bullish than bearish this morning, and I really need to shave so I don't have time to go through them all. If you'd like to dial into our 830AM fact finding session, that's when I give clients the full rundown of the 27 factors in my global macro model.
It's not a "quant" model, but everything in the model is fundamental and quantified. My model operates on one basic premise - that market prices are leading indicators. I have a deep rooted respect for what's always been a reality in this business - prices don't lie, people do.
Did Kenny Lewis and Vikram "The Pandit Bandit" pass the "Stress Test"? How about the Swine Test? Whine test? C'mon - let's seriously wake-up and smell the Robusta beans this morning folks - these guys are part of a horse and buggy whip banking model that will not change until it creatively destructs. Waking up every morning trying to find reasons as to why your shorts are going to work isn't an investment process, it's a prayer...
Swine, Stress, Whine...
The New Reality is that what the malfeasant at Citigroup or the Bankers of America did, said, or will continue to do, matters less and less to the US stock market every day. In a perverse way, these people revealing who they are and what it is that they actually do is fantastic for the stock market in the immediate term.
Fantastic? Yes, I love that word as much as I do someone getting in my face about being longer than I am short right here (in our virtual portfolio I have 30 long ideas and 8 shorts, see The more Wall Street and Washington get YouTubed by the global investment community, the lower the US Dollar goes. As the Buck's Integrity Breaks, stocks breakout. It's called REFLATION.
In the long run, we're all dead. While it may not be one that people want to talk about, that too, remains a fact. Regardless, if what you don't want to admit is ignored, that certainly doesn't mean that it ceases to exist. Make no mistake, in the long run, America compromising her currency's integrity won't end well...
Back to the immediate term, what's next? The manic media's news cycle will turn away from the Swine and there are two big catalysts for Squeezy The Shark to sink his teeth into the shorts with:
1. Obama's 8PM Prime Time "First 100 Days" Speech tonight (Fox not running it is bullish contrarian indicator in and of itself)

2. April's month end is tomorrow
So after another fantastic month for those who weren't short everything Roubini, what is a player in this game to do?
In the face of a staggeringly low weekly Institutional Investor "are you bullish?" reading of 36% this morning, I'm going to take the shot that most still aren't allowed to take - LONG SIDE!
My upside target for the next leg of this short squeeze is 877 on the SP500. That would be a higher intermediate term high...
Best of luck out there today,


EWC - iShares Canada- We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's large government recent history, and believe next year's Olympics in resource rich Vancouver should provide a positive catalyst for investors to get long the country.   

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-In the face of manic media hysteria, we have once again held onto higher lows.

XLE - SPDR Energy- As of 4/27 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're long this sector and think it works higher if the Buck breaks.   

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. The Euro is up versus the USD at $1.3240. The USD is up versus the Yen at 97.1240 and down versus the Pound at $1.4787 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 outperformed for the second consecutive day; 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.


Starwood amended its credit facility to raise the maximum leverage covenant from 4.5x to 5.5x.  In return HOT agreed to the following:

  • The applicable margin (AM) on the revolver increased from a range of 37-80bps (at 4Q08 they were borrowing at an AM of 50bps) to 175-300bps above LIBOR
  • The term loan AM increased to 200-350 bps from 45-100 bps
  • Limits on HOT's ability to pay dividends and repurchase stock subject to the Company's FCF and Leverage ratio
  • Decreased Permitted Lien basket to 5% of Tangible Net Assets from 10%
  • An amendment fee of 50bps or $13.75MM


The positives to HOT are clear.  Based on our projections, we had Starwood exceeding its 4.5x maximum leverage covenant in Q3 2009 and maxing out at 5.2x in 2010.  This amendment should provide them enough cushion under the new 5.5x maximum leverage covenant.  To the extent HOT can sell some assets or complete a securitization deal, this will provide them with incremental liquidity. 


On the negative side, the amendment will cost the company about $35MM in pre-tax income or $0.12 in EPS.  Moreover, HOT management should be able to give more reasonable (lower) guidance.  Their 2009 guidance (from the last earnings release) was way too high and did not indicate a covenant breach.  An amendment would not have been necessary if their initial 2009 EBITDA projections were achievable. 


Look for another "beat and lower" quarter out of HOT.  We are at $0.08 and $170MM in EPS and Adjusted EBITDA, respectively, for Q1 versus the Street at $0.03 and $155MM.  However, our 2009 projections of $0.55 and $775MM, respectively, fall well below the Street at $0.92 and $850MM.  2010 should look even uglier.



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The Specter of Arlen: Is Cloture on Employees Free Choice in Play?

"If a politician found he had cannibals among his constituents, he would promise them missionaries for dinner."
- Henry Louis Mencken


"I'm a Republican and I'm going to run in the Republican primary and on the Republican ticket."
- Senator Arlen Specter, Newsweek, April 4th, 2009


In a major about face from his stance less than one month ago, Senator Arlen Specter, Republican from Pennsylvania, announced that he is switching parties earlier today.  The literal implications of this are that, assuming Al Franken from Minnesota gets confirmed, the Democrats will have 60 seats in the Senate, which is a filibuster-proof majority.


In the statement announcing his decision, Specter said the following:


"Since then, I have traveled the state, talked to Republican leaders and office-holders and my supporters and I have carefully examined public opinion. It has become clear to me that the stimulus vote caused a schism which makes our differences irreconcilable."


After voting in favor of Obama's stimulus package, one of three Republicans that did so, and then travelling his state and talking to members of his own party, it became clear to Specter that his nomination for the Republican party in Pennsylvania  2010 would be at risk.  Coincident to this, Pat Toomey, head of the anti-tax Club for Growth, stepped down from that post in mid-April with the intention of running in the 2010 primary.  In 2004, Specter barely beat Toomey in the primary by 17,000 votes out of a million cast.  Undeniably, that margin would have shrunk or gone away with Specter's support of the Obama stimulus package and polls showed Toomey ahead by double digits versus Specter, which made Specter's decision that much easier.


Specter now has to appeal to a different constituency in the Pennsylvania primary.  He can do this in both promises, as to Mencken's quote above, or in actions.  Quite frankly, if I were a Democrat in Pennsylvania I would want to see some actions from Specter in the next 18 months to prove his party allegiance before I would cast my vote for him in the primary.  Even in the most recent congress, he voted over 61% of the time with his Republican colleagues.  That number will shrink, likely below 50%.


That said, in his statement today, Specter did hedge himself in order to assert his independence when he stated:


"My change in party affiliation does not mean that I will be a party-line voter any more for the Democrats that I have been for the Republicans. Unlike Senator Jeffords' switch, which changed party control, I will not be an automatic 60th vote for cloture. For example, my position on Employees Free Choice (card check) will not change."


Given that Specter had previously voted for cloture in 2007 on Employee Free Choice, before he spoke out against it (if you will), I would consider this issue very much in play, among many issues, despite his referencing it in the quote above.


Now my Dad was a former labor leader in Canada, so I do not have a bias either for or against unionization, but it is reasonable to assume that the passage of this act will increase unionization as union representatives will no longer be selected solely by a secret ballot based NLRB election.  Under the Employee Free Choice Act, the NLRB would be required to certify a bargaining representative if the majority of employees sign cards, which obviously introduces the factor of peer pressure in determining representation as union members collect these signatures from their colleagues.  As was stated in Supreme Court decision NLRB versus Gissel Packing: "A secret ballot election is the most satisfactory - indeed the preferred - method of ascertaining whether a union has majority support." Indeed.


Unionization obviously has differing impacts on different segments of the economy, but for those businesses that are dependent on labor, the rise in labor cost could be dramatic.  According to estimates by the Economic Policy Institute, if 5 million service workers join unions they would "get an average raise of 22%", which would add up to "$34 billion in total new wages". While this is obviously a positive outcome for the service worker, assuming they're able to keep their jobs, the impact on the margins of their employers can only be negative.


Make no mistake about it, the balance of power in the United States has officially swung to the left and as a result we should analyze both risk and reward accordingly with this new geo-political input.


Daryl G. Jones
Managing Director

EYE on Confidence – Armageddon no more!

In today's, Early Look I proactively prepared for what was beginning to look like another day of "fear" in the markets.   The data we collected seemed to point to a better than average possibility that consumer confidence would come in very strong relative to "Armageddon" expectations. 


To summarize - April was a good month; the Obama's had a successful 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, and it's the spring time!


The cutoff date for April's preliminary results was April 21st, so the fear consumers may be feeling now from the Swine flu will impact May's sentiment reading.   Clearly, if the swine flu remains an "above the fold" story it will slow the rate of change in confidence we may see in May. 


Helping to boost Keith McCullough's "big call" on jobs was the employment outlook, which improved on a  4-week moving average basis so far every week in April. According to the Conference Board, the percentage of consumers anticipating fewer jobs in the months ahead decreased to 33.6% from  41.6%, while those expecting more jobs increased to 13.9% from 7.3%.


Howard Penney
Managing Director


EYE on Confidence – Armageddon no more! - cc

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