Research Edge Position: Short Indian Equities via IFN


Weekly Wholesale Price Inflation data issues by the Indian Ministry of Commerce today rose for the third consecutive week on a year-over-year basis.  While still well below 1%, inflation has clearly signaled a bottom inside positive growth territory.  For the politicians jockeying for position in the final stages of the National Election, the critical question is how much impact the wholesale decline in the past 8 months has had on the cost of living for the lower economic classes. 




CPI data is released by the Labour Bureau on such a time lag that we do not have a clear view of how significantly prices have contracted in urban or rural areas, but fertilizer prices released today as a component of WPI registered at over 4% Y/Y providing some clues. As a critical component of the cost overhead for the massive portion of India's population laboring as subsistence farmers, we have been watching fertilizer prices carefully. Despite the increase in farm subsidies (including those on fertilizer) as part of the stimulus packages, the price of some basic agricultural products is still higher than many Congress Coalition incumbents from rural states would like. While there has been no indication of any major upsets yet, the opportunity for leftist hardliners to pander to the anger of the rural poor -the 700 million people that have seen the quality of their life improve little (or even erode) during the miraculous economic growth of the past decade, are real and could force a coalition realignment.


We have maintained a negative bias on the Indian economy since launching our firm early last year. Our short bias on Indian equities yielded spectacular results throughout last year, but we were bloodied a bit by a nasty little hit last month after we battled the India Bulls unsuccessfully. Now as the election draws to a close and the markets shake off the impossible promises of the campaign to focus on core issues, we expect the equity market to contract.


With global commodity reflation, slim prospects for increasing internal demand for high tech goods and services sufficient to offset US market share loss and the looming spectacle of the Satyam trials (which may well underscore basic concerns about accounting standards and regulatory controls) there are lots of near term drivers that could prove us right.  As always we will take our cues from price action and change our positions as the data dictates but, for now, we are comfortable being contrarians and shorting the Indian market.


Andrew Barber


Restaurants - SAFETY TRADE - NOT

I wrote the Early Look on Thursday titled "Beta Shift - Down" The note was to think about the next 3-month move for the market and not reacting to what is being said today. The next 3-month move favors the SAFETY TRADE. On Tuesday and Thursday this week, there was a BIG positive divergence in the "safety trade" just as the Research Edge quantitative models flashed that every sector in the S&P 500 was positive from a TRADE and TREND perspective.

The two early-cycle sectors that led the way from the March 9th lows, Technology and Consumer Discretionary, have been lagging as of late. Restaurants are likely to underperform, as the market shifts to the ‘SAFETY TRADE."

In this environment the FULL SERVICE could suffer more than QUICK SERVICE.

CAKE, EAT, DIN and DRI look vulnerable.


Restaurants - SAFETY TRADE - NOT - fsr


There is no denying that these are some very strong monthly sales numbers from MCD, especially in light of the trends we're seeing at Burger King, Wendy's, and the rest of the consumer names.

So where do we go from here?

The summer will be critical for MCD as the discounted drink promotion was an enormous success for the company last year. If you are a believer that MCD's Latte promotion will be a successful follow up to the drink promotion, there is nothing to worry about. Personally, it's hard to see how an expensive hot beverage is going to do as well as a cheap cold beverage in the summer.

For the balance of 2009 McDonald's global comps get much more difficult; the US comparisons get more difficult peaking at 6.7%; Europe peaks at 11.6% in August and AMPEA in November at 13.3% (10% August comparison).

The current sales trends we are seeing from McDonald's can challenge my cautious stance on the stock. I still stand with my thesis that MCD's coffee strategy moves the store execution away from the core competency of the company and the price tag will limit the success. The average check at breakfast for McDonald's is $3 (+/- $0.50 depending on how you order). Adding a $3+ latte will double the average check at breakfast! Once we get past the trial phase, sticker shock will limit repeat business.















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It's Not Just Manny Who Should Be Sad

"Faced with what is right, to leave it undone shows a lack of courage."
Los Angeles Dodgers skipper, Joe Torre, said he was "saddened and disappointed" with Manny Ramirez being revealed as one more of Major League Baseball's superstars who needed to cheat in order to succeed.
Whether its cheating or changing the rules as you go, do the leaders of the US Financial System strike you as anyone who has any shame at this point? Is there any irony, shame, or accountability in how close these Stress Test numbers ended up being versus the inside information leaks that the market was getting for the 3-days prior to the results? Is Timmy Geithner kidding me saying that this has been a process that the public can finally "trust"?
This entire political exercise has rendered itself plain sad. There is no other word for it. The world's You Tubes are on - the leadership from the US Treasury to American Investment Banking Inc. has once again been revealed. There is nothing right about any of this. Anyone who is allowed to take one deep breath and a step back, can look at this for what it is - nothing but a lack of courage.
Amidst all of the manic media's hyperactivity as to where the futures and Banker of America's stock is trading pre-open this morning, don't miss that ex-Goldman Chairman (actually, he still has Goldman stock and is a Director for De Club), Stephen Friedman, resigned last night from his post as Chairman of the New York Fed. This was Geithner's old seat, but it was no less a compromised and conflicted one then as it is now. Being in De Wall Street Club has always been what it is, and everyone knows it.
I'll be on Fox later on this morning, and I am certain that the first question will be 'what do you think about the Stress Tests'? My answer, on a lot of levels has been answered in prior missives but, again, I think Joe Torre's last night is a metaphor for America broadly - "The worst thing I think a person can be is a disappointment to somebody else"...
I am saddened and disappointed that my son Jack may have to live in a country where principles have been short sold in the immediate term for the sake of the compensation structures and political careers of compromised individuals. Shakespeare said that the "expectations are the root of all heartache", and I guess I expected more of President Obama, given what he has given lip service to.
Upward and onward we go then right? Ah, don't we all feel fantastic about the US Futures being indicated up one percent for the sake of this sad rhetoric...
The New Reality remains. The world isn't as stupid as our said leaders are. As the Wizard of American Oz's Financial System is revealed, everyone who has US Dollars is less interested in owning more of them. A country's currency is her credibility, and there is very little of that left.
In a perverse way, the US Dollar being down is bullish for a continued REFLATION trade in the intermediate term. This is why I have been bullish, on balance, on commodities, stocks, etc... for the better part of the last few months. In the long run however (which you hear the levered long community talking about again now that stocks aren't down), the US Financial system's integrity will be dead.
With the SP500 failing right at my line of resistance yesterday, you saw the SAFETY Trade that Howard Penney wrote about play out in textbook fashion. In the face of the US market flashing a massive outside reversal (attempting to breakout above the prior closing high, but reversing only to close at a lower level), we saw a stampede of volume come to life on the offer. NYSE volume was +57% on a day over day basis! No, this isn't what a bull wanted to see...
In the face of Geithner and Friedman maneuvering behind the scenes of the magical Land of Oz, the saddened market operators of the US stock market sold into the lemmings who legitimately believe that the Stress Test results provided a fundamental solution to all American trust betrayed.
Healthcare and Utility stocks charged higher as what we have been calling the "Three Horseman" (Tech, Consumer Discretionary, and Basic Materials stocks) of riding a generational short squeeze got creamed.
Do I think that this market will continue to make higher lows on selloffs? Sure, for now... I have SP500 support at 886.
All the while, as we make our clients money navigating this circus, am I going to ignore The New Reality? C'mon. Let's keep it real here folks. When it comes to genuinely addressing all that is wrong about the US Financial System, when "faced with what is right"...  we have, sadly, left this one undone.
Have a great Mother's Day Weekend with your loved ones,


VXX - iPath VIX- The VIX is inversely correlated to the performance of US stock markets. For a TRADE we bought some of the Street's emotion on 5/4, getting long their fear of being squeezed.

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.

GLD - SPDR Gold-We bought more gold on 5/5. The inflation protection is what we're long here looking ahead 6-9 months. In the intermediate term, we like the safety trade too.  DVY -


Dow Jones Select Dividend-We like DVY's high dividend yield of 5.85%.  


EWJ - iShares Japan -We re-shorted the Japanese equity market via EWJ on 5/6. 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". 
EWW - iShares Mexico- We're short Mexico due in part to the media's manic Swine flu fear. The etf was up 7% on 5/4, giving us a great entry point.  The country's dependence on export revenues is decidedly bearish due to volatility of crude prices and when considering that the country's main oil producer, PEMEX, has substantial debt to pay down and its production capacity has declined since 2004. Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.
DIA  - Diamonds Trust- We shorted the Dow on 5/4 for a TRADE. Everything has a time and price. 
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%.  


EWL - iShares Switzerland - We 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.

A Tale of Two Energy Tapes

Crude oil has rallied smartly over the last five days.  As a proxy, the iPath Crude etf, OIL, is up ~11% in that period.  There is a view that oil could have meaningful upside as the re-flation trade continues to play out, especially with a weakening dollar.  We manifest our global macro calls in our etf portfolio, but for those who cannot play etfs, or the commodities directly, we want to highlight an important data point as it relates to the energy sector.  Specifically, in a rising oil and natural gas environment the largest capitalization companies may be laggards.


We saw this in spades over the last five days.  As outlined in the chart below, the etf OIL was up 10.9% and the Energy SP500 etf, XLE, was up 8.8% in this time period.  Within the XLE, there was a major bifurcation between the two largest companies and the eight next largest companies.


The two largest companies in the XLE are Exxon Mobil (XOM) and Chevron (COP).  Together these two companies comprise 37% of the XLE.  Over the past five days, these two stocks were up 2.6% and 2.8% respectively, dramatically underperforming both oil and the XLE.  The next eight largest companies comprise 28.3% and over that same period were up 11.2% on average and outperformed both the XLE and the commodities.


While the next eight largest companies are a mix of oil, natural gas, and services (Schlumberger), this is a dynamic that will likely continue.  The largest oil companies, such XOM and COP, while cheap with healthy cash flows, have a very difficult time adding reserves that will enable them to grow their production at a high rate.  Thus, in a rising oil environment, when scarcity of oil begins to get priced into the equities, the super capitalization companies could dramatically underperform, as they have in the last five days.


Daryl G. Jones

Managing Director


A Tale of Two Energy Tapes - crude

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