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SUCKERS SQUEEZE

"No one can possibly achieve any real and lasting success by being a conformist."
-J. Paul Getty
 
Remember all that Swining, Stressing, and Whining from early last week? I do - it was just one more of 2009's great opportunities to capitalize on what we have labeled as Glaring Groupthink.
 
As most of you know, I really like to make up names for things. I start writing this note at an un-Godly hour of the morning, and I guess part of it is finding a way to entertain myself. Now that my morning missive is beginning to find its way into broader distribution, it is fascinating to see things like The New Reality or The Great Recession pop into Wall Street's bloodlines. At the end of the day, Wall Street is proving to be just what it is - one giant meme machine.
 
Jean Paul Getty was one of Main Street's real-life oil men and his aforementioned quote, when considered here in 2009, needs an asterisk - and that's that anyone can achieve lasting success as a politician by being a conformist. Did anyone watch Arlen Specter backpedal on Meet The Press yesterday? Wow - solid session of You Tubing there.
 
Now that Paul Volcker has a Transparency/Accountability date on the calendar to actually walk Americans through what he sees on these compromised Streets of the US Financial System (May 20th), he is going to get some overdue airtime. The men and women of Research Edge thank Mr. Volcker for supporting our program - he is calling this, "The Great Recession."
 
As a result, the manic media can now officially shift their focus away from Roubini and the Depressionista theorists, and see the light.  That is, the light that's been on. As in any Recession, however Great it may be... early cycle leading indicators begin to signal a recovery. The signals that I focus on most are grounded in marked-to-market prices. Since late February, these prices have been as crystal clear as the sun rising in the east.
 
To review the fundamentals:
 
1.       Chinese growth accelerated from the Q408' cyclical lows (all of Asia and the manic media covering it is going gaga over China printing an expansionary PMI number for April last night - Chinese stocks closed up another +3.3% at 40.6% YTD).  

2.       ASEAN countries (Southeast Asia) have adopted a $120B currency reserve fund (the Chinese replacement rhetoric for Yuan vs. the compromised US Dollar continues, and what's bad for the Buck, is great for REFLATION).   

3.       Breaking the Buck works, in the intermediate term (the US Dollar closed down again on a week over week basis last week, breaking down through TREND line support of 85.64 = REFLATION).  

4.       The Russians get paid when oil goes up (as the USD breaks down, oil is starting to breakout... oil was up for the 2nd week in a row last week and this morning Russian equities are tacking on another +2.2% to their YTD stock market gain of +34.7%)  

5.       The Saudis, The Canadians, The Australians, The Brazilians, etc... all get paid by either China or Petrodollars too (re-read points 1 and 4; The Client is China).  

6.       Credit markets look as good as they have looked in a year (as the credit mechanism is reinstated, capital starts to flow, and being long short interest becomes one of the best ideas an investor can have).
 
I'll stop at six relatively large factors that are A) Fundamental and B) Historical Facts, because if I broaden the note out to US Consumption being +2.2% in Q1 of 2009 or explain the fundamentals of the MEGA Squeeze in Consumer Discretionary stocks (Mortgage Rates, Employment, Gas Prices, Asset Prices), some people really get upset.
 
The New Reality remains that in a country that has lost the integrity of its Financial System and the validity of the handshakes by those leading it, that being a conformist of Wall Street consensus is starting to trade at a significant discount to even perceived wisdom.
 
With all of these fundamental realities in the rear view, expect consensus to morph into a liability again... at some point... but not yet. For now, we are still very early in Q2 and the hedge fund redemption cycle has the power of kicking in Part Deux of what I am now going to label the Sucker's Squeeze.
 
Hedge fund redemptions work both ways folks. I can assure you that those who missed the both crashes (on the way down and on the way up versus consensus expectations), will be forced to cover their illiquid short positions in the very near future.
 
There will be no "side pocket" or government bailout for unrealized losses on the short side. Unlike the crash on the way down, this recent one on the way up is going to highlight who the real Sucker's of Stress and Swine Tests really are.
 
In the immediate term, I have the SP500 overbought above the 883 line. I'll be back in the game buying short interest on the down moves using 860 in the S&P as my support.
 
Best of luck out there today,
KM

 

LONG ETFS  

SPY - SPDR S&P 500-The SP500 is positive from both a TREND and TRADE perspective.  Additionally, the market continues to make higher lows, which is a bullish indicator.  

EWD - iShares Sweden-We bought Sweden on 4/30 with the etf down on the day and as a hedge against our Swiss short position. Sweden is up a healthy 15.3% YTD and has bullish fundamentals. The country issued a large stimulus package to combat its economic downturn and the central bank has effectively used interest rate cuts to manage its economy. Sweden's sovereign debt holds a strong AAA rating despite Swedish banks being primary lenders to the Baltic states. We expect Sweden to benefit from export demand as global economies.  

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 resourcerich Vancouver should provide a positive catalyst for investors to get long the country.  

XLE - SPDR Energy- Energy decidedly outperformed the market on 5/1, closing up 3.2%. We're long this sector and think it works higher if the Buck breaks down.

EWA - iShares Australia-EWA has a nice dividend yieldof 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.

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%.

 

SHORT ETFS
 
IFN -The India Fund-We have had a consistently negative bias on Indian equities since we launched the firm early last year. We believe the growth story of "Chindia" is dead. We contest that the Indian population, grappling with rampant poverty, a class divide, and poor health and education services, will not be able to sustain internal consumption levels sufficient to meet targeted growth level. Other negative trends we've followed include: the reversal of foreign investment, the decrease in equity issuance, and a massive national deficit.

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 down versus the USD at $1.3268. The USD is up versus the Yen at 99.4750 and up versus the Pound at $1.4876 as of 6am today.


Keeping European Retail On Life Support

JJB Sports announced this morning that it averted Administration (bankruptcy) by pushing through a Company Voluntary Arrangement (CVA).  While they have been around since the 1970s, CVAs are growing in popularity, which is very notable for landlord/tenant relations in Europe. The punchline is that they can keep alive a business that otherwise would/should go bust in this bankruptcy cycle - prolonging the inevitable. If we see many more of these in European retail, we could see the business cycle take meaningfully longer to recover when compared to the US. 

 

What is a CVA?

 

A CVA is a contract between the insolvent business and creditors to repay some or all of their debts with future profits. It's an answer for those companies who don't want to go completely bankrupt and a solution for creditors to at least receive some of the money they are owed.

 

A CVA does not just consist of two sides coming up with an agreement to pay back money. It goes much deeper than that. To start with the CVA process, one must believe that their business can come back and be profitable, and come up with a convincing enough argument such that the creditors believe it. The managers and owners still remain in control of the company, but open up the strategic plan and allow the creditors in to make suggestions. A 75% approval rate is needed at the creditor level, and it must be fully vetted and endorsed by the country court.

 

Anyone who has been following our teams' collective work at Research Edge has heard us refer to this bankruptcy cycle as a game of Survivor. The last one to get voted off the island is going to come out on top as it relates to market share, and likely get the highest multiple along the way.  The irony with these 'CVAs' is that they could prolong the inevitable (and prolong the pain) for European retailers.

 


JNY: A 5-Year Downward Spiral Ends?

JNY is closing 225 of its 1000+ store base over the next 18 months.  Did anyone even realize that JNY is one of the largest specialty retailers by door count?  Even if you were aware that JNY is a retailer is disguise, it's very positive to see that they are no longer growing for the sake of growth.  It's also positive to see management cutting its losses and moving on.  We applaud the move to close over 20% of the store base for a few reasons:

 

1) Closing unproductive, loss producing stores has an immediate and positive impact on the P&L.  In aggregate, JNY will save $37mm in losses and costs from closing these stores from '09-'11.  This equates to $0.29 per share.  Off of our new estimate of $0.65, this is substantial opportunity to help rebuild the earnings base

 

2) The cash cost to execute the store closing plan is only $5mm!  That seems incredibly low and should make any rational person wonder why they didn't close store more aggressively in the recent past.  Think about it, JNY gets to over half of the 20% number almost entirely by letting existing leases run off without renewing.  Seems simple - but prior management has never made anything simple.  Regardless of prior decisions or lack thereof, the net benefit of this effort is a no brainer.

 

3) Approximately 60% of the stores are mall-based, which leaves the base with a higher concentration of outlet stores.  The outlet stores have recently been comping down only a few points while the mall based stores have been tracking down 20%.  Outlets are a good compliment to a better distribution and inventory clearance strategy.  Leave the mall-based selling to the department stores.

 

4) Inventories will come down further as the chain shrinks, freeing up additional working capital.  This should be about a $30-$35mm reduction in working capital annually.

 

In JNY's case, addition by subtraction is not a cure-all for general market share loss and declining brand relevancy.  However, we believe there is still upside in the nearer term as the business shrinks and expenses are once again leveraged.  Of course, must of this is already in the shares which have now tripled from the March lows.  Gains from here will have to come from measurable EPS improvement. But check out the estimate revision chart below. This company has faced 5-years of downward revisions (for good reason). The downside has stabilized, and my strong sense is that any recovery will last more than just a quarter or two. Don't get me wrong, I would not touch this name here. I'd much rather play LIZ for so many reasons. But if you're looking at jumping on the shorty bandwagon now on this perennially hated name - beware.

 

JNY: A 5-Year Downward Spiral Ends?   - jnyeps

Eric Levine

Research Edge


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.33%
  • SHORT SIGNALS 78.49%

Revisions Rule The Day

 

Another week passes where revisions are trending better, and the group is following suit. The major call-out, however, is that we're now sitting at peak valuations based on NTM consensus EPS estimates (17x).

 

The major question here for me is whether or not estimates are real. Has the sell-side finally overshot on the downside and what appears to be 17x earnings is actually something in the low teens?

 

In aggregate, I think that estimates are largely too low for the next 12-months, as our team has outlined since March 5th (We're Getting Fundamentally Bullish). But back then, it did not matter which names you played, as pretty much the whole group went up in unison.

 

The sector call still matters (check out Howard Penney's sector strategy work), but now, company-specific revisions matter a lot more than they did a month ago. If you're involved in a name and think that 'a miss is already in the stock,' then I feel for you come earnings day.  There are lesser quality names that have set themselves up to smoke estimates in the upcoming quarters - such as CRI, JNY and SKX. Expectations are now lofty and I'm not convinced the upside is coming in a healthy way (setting up for shorts as '10 nears). Then there are others like UA, RL, HIBB, and HBI where I think the upside is meaningful AND warranted. PSS is another, with my lingering concern being the upcoming quarter. It won't be squeaky clean - which probably matters after double in the share price. I think that 2H estimates need to go up by almost half, so I'd keep that name front and center.

 

Revisions Rule The Day - 90 day revisions chart

 

Revisions Rule The Day - NTM and Consensus Chart


UA: Bottom Up Shoe Math

 

Having doubled off its lows and trading at 11x EBITDA, UA is admittedly not cheap. But the top line growth is there - esp in shoes as outlined herein. Margin oppty is being realized, and capital intensity is coming down. Don't underestimate this one.

 

I'm still amazed by Wall Street's myopic nature associated with Under Armour's presence and opportunity with its new footwear initiative. People hear management's comments on the conference calls and conferences and get so hyper-focused around a few hundred thousand pair here or there. Let's put some numbers into perspective.

 

If we take the running category alone, and assume a rate of daily sell through averages at less than one pair of shoes per day at a conservative list of major retailers, then it gets us to $65mm in annual sales along at a $40 wholesale price point.  This suggests about 8-9% market share for UA in the running category at these retailers. Could I argue 2 pair per day on overage over the course of a 12-month time period? Yes, not unreasonable by any means.

 

This does not include basketball, outdoor, or any form of casual footwear whatsoever. You could take that $65mm number, and multiply it several times over into new categories. Therein lies my assertion that it is not tough at all to get to $300mm in footwear revenue in 2-3 years (40% growth over today's sales base).  Furthermore, this would put UA at half the market share run-rate of the likes of Adidas, New Balance, and Asics. Ironically, it puts it right in line with Reebok (which is a mess).

 

If I'm going to place my bet on which brand will pierce the 10% share barrier next, it's going to be UA.

 

UA: Bottom Up Shoe Math - ua


US Market Performance: Week Ended 5/1/09

 

Index Performance:

 

Week Ended 5/1/09: DJ +1.7%, SP500 +1.3%, Nasdaq +1.5%, Russell2000 +1.7%

Q209 To-Date: DJ +7.9%, SP500 +10.0%, Nasdaq +12.5%, Russell2000 +15.2%

2009 Year-To-Date: DJ (6.4%), SP500 (2.9%), Nasdaq +9.0%, Russell2000 (2.5%)

 

Keith R. McCullough

Chief Executive Officer


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