Where There’s Smoke… Notes for the Week Ending Friday, May 8, 2009


The Big Easy

Ex nihilo, nihil fit.

- Parmenides


The ancient Greeks posited that "nothing comes from nothing" - a passable translation of the above (Yes, we know it's Latin, not Greek.  We are conspiracy theorists, not classics scholars).  Parmenides authored the ontological argument against nothingness, saying there can not be a state of existence in which nothing exists.  Aristotle took up the argument for a beginningless cosmos.  He was countered by Maimonides, who identifies a definite moment of origin of the cosmos: the Biblical Creation.  Before this moment, argues Maimonides, there was no "before", as Time itself did not yet exist. This identical statement about Time was made by physicist Steven Hawking, in describing the Big Bang.


Thus, whether one is a Judaeo-Christian-Moslem theist, a secular Platonist-Aristotelian, or an atheist scientist, we all agree there can be no moment in Time when Nothing exists.


Unless, that is, you are short it.


With the SEC now mobilizing its resources and its PR facilities to press for re-introduction of the Uptick Rule, we thought this an apt moment to touch on the topic of short selling.


Both securities law and common sense dictate that you can not sell something that does not exist.  Yet every day, under the watchful eye of the regulators, financial firms sell millions of phantom shares of stock, on which they pocket very real money. 


The rules governing short sales do not require that all shares sold short actually be physically delivered, but that the seller, prior to entering the order, identify a source where such shares can be borrowed, should they come due for delivery.  Once the trader has recorded a "Locate", the short sale can be entered.


Here's how it works:


Trader Joe, a hedge fund portfolio manager, gets a tip from a salesman at a major Wall Street firm, indicating that a well-considered company is about to issue a dismal earnings report.  This, despite management having given positively glowing guidance as recently as a month before.


With minutes to go before the market open, Trader Joe calls his securities lending department.  There, the manager scrolls down his computer screen looking at the spreadsheet emailed to him at 5:00 that same morning from their prime broker's Stock Loan desk.  The spreadsheet is the prime broker's Easy To Borrow list and has entries for several thousand stocks.


Today, Trader Joe's stock in question - we shall call it XYZ Corp, prosaic though it may seem - is showing as Easy To Borrow for up to 500,000 shares.  The prime broker - a major Wall Street firm that operates its own brokerage business, as well as acting as clearing broker for several hundred broker dealers, and as prime broker for over 100 hedge funds - holds over 500,000 shares of XYZ Corp stock, all covered by hypothecation agreements permitting the firm to loan the shares for correspondents and customers to make short sales.  From the hedge fund point of view, half a million shares is much more than Trader Joe will ever do in a single day, so the securities lending desk simply tells Joe "You're good."


When, in the opening minutes of trading, Joe sells short 140,000 shares of XYZ, his trading desk marks their orders "Locate at Prime Broker - 500,000 shares."


Joe's prime broker also acts as prime broker for over one hundred of the largest hedge funds in the business, all of which hold their assets with the broker.  And the same email that went to Trader Joe's firm also went out to all 112 hedge fund prime brokerage clients of this broker, and to all 848 of their correspondent broker dealers.


Joe, it turns out, is one of more than three hundred traders who will short XYZ Corp today, all using the same brokerage firm's Easy To Borrow list.  And, while the broker's list has 500,000 shares available, total short sales off that same list will be far more.  Some of the hedge funds will short the full 500,000, while others will run much smaller orders.  In our example, the average short sale off this Easy to Borrow list will be for 125,000 shares of XYZ.  The resulting number of shares sold short in the first hour of trading will be


          314 traders X average 125,000 shares = 39,250,000 shares


Note that this applies only to the prime broker or correspondent relationships at this brokerage firm.  Many hedge funds have multiple prime brokers and will ask for additional locate from their other relationships.  It is a multiple multiplier effect.


All but a handful of traders will cover their shorts in the early stages of the stock's decline.  Since most of the short sales are covered on the same day, the prime broker's stock loan desk will calculate offsets on all the closed trades, meaning that very few XYZ shares will actually have to be delivered on settlement date, three days hence.


Thus hath Wall Street wrought Something out of Nothing.  In our example, 500,000 shares of stock have given birth to over thirty-nine million shares, each of which resulted in a profit for a trading desk, and none of which will ever be delivered.  For, with the exception of the original 500,000 XYZ shares, none of them ever existed.


With this type of trading being the Order of the Day on Wall Street, should the SEC be pulling out all the stops to re-introduce the Uptick Rule, and nothing more?


On one side stand corporate executives such as Overstock.Com CEO Patrick Byrne, who has been waging an articulate campaign against short selling abuses.  Or former Lehman Chief Dick Fuld, whose personal fortune was inflated by his firm's participation in the Street's short selling party, only to turn on his own customers when he complained that short sellers were driving down the price of Lehman's stock. 


On the other side, we have reality, which is that short sellers are among the foremost drivers of market transparency and enablers of liquidity.  They are the better informed and more alert traders.  Inside information aside, the shorts' legitimate market information is more thorough, better researched, and more timely than their counterparts on the long side.  This is partly the effect of the widespread prohibition of shorting by mutual funds, which has created slow-moving behemoths who are vulnerable to swift commando-style attacks from the short side.  It's hard not to describe these activities in military terms.


The turnover in volume in our example is fundamental to the functioning of our markets.  We would suggest that, if there were fears the banks might fail the stress test (which is the equivalent of a Big Ten quarterback on track to win the Heisman Trophy being allowed to flunk freshman English...) one area critically affected would be the ability to sustain current levels of short selling.  The thirty-nine million-odd "phantom" shares traded in our example generate considerable wealth.  The lending broker charges for the lending, the traders and brokers are all paid for the transactions, the firms on either side of the trades charge to process, clear and settle the trades - and taxes, as well as substantial political contributions, flow from all these activities. "Stressing-out" the banks that facilitate these trades would eliminate a huge chunk of the equities markets.  Meanwhile, taking the extreme view - hard physical borrow and delivery on every short sale - is not realistic, and would eviscerate both the markets, and the politicians' war chests.


But taking the view -as the SEC appears to be doing - that "nothing" needs to be done is blatantly irresponsible.  The highly political nature of the debate - the SEC is being pushed along its current course by such market luminaries as Barney Frank and Hillary Clinton - perpetuates the damage done by the real abuses that continue.


The legitimate activity of short selling is based in large part on creating Something out of Nothing, a phenomenon that also prevails in the long side of the market, relying as it does on margin, which multiplies customers' assets, miraculously enabling them to purchase securities they can not afford.  Is this so different?


Until the SEC sets aside politics and addresses the Big Easy from top to bottom, we will not truly understand where legitimate market action ends and the scamming begins.



Brave New World

If what you have done yesterday still looks big to you, you haven't done much today.

- Mikhail Gorbachev


No less a light of Capitalism than David Rubenstein, co-founder of the storied Carlyle Group, appeared on Bloomberg Television this week mapping out a New World Order of Capitalism.  He stated - as our CEO, Keith McCullough has been patiently explaining for most of the past year - that America has lost its single most important quality as the leader of world capitalism: its moral credibility.  Rubenstein did not use those words, but the sense was unmistakable: The American Handshake is not worth what it once was.  And because we have so blatantly lied to our global customers, American ingenuity is no longer seen as the touchstone for the world's financial markets.


Now that the whole world has grasped this reality - and in the wake of the worldwide market meltdown that America was powerless to prevent - Rubenstein observed that the world will move inexorably towards a multi-central capitalism, in which market centers will spring up in China, the Middle East, Latin America, Europe and beyond.  Wall Street will never be the same again.  In our view of the Brave New World, capitalism will be fully democratized.  From Silicone Valley to Singapore, and from Karachi to Machu Picchu, anyone with a laptop, a Blackberry - even a cell phone - will manage their own personal Fund of Funds.


The democratization of information is unstoppable, and those who can not lead will be tossed aside.


In this environment the new administration is pressing forward resolutely on all fronts.  We hope the resoluteness will not give way to wantonness. 


The latest chapter in the undoing of American credibility centers around the newly-released CIA torture memos.


Contrasting views abound, notably from sources who have firsthand knowledge of interrogation methods.  We are not legal scholars and can not judge the Bush Administration's memos; we don't know how many times a person has to undergo waterboarding for it to qualify as torture.  But we note that recent polls indicate a large percentage of the American public - in many polls, over half - are willing to accept outright torture if it serves a specific and identifiable end of preventing disaster.  Torture ends up being a societal construct, like Theft and Murder.  In a stable society the use of force is the sole prerogative of the state, as constrained and defined by the society which either approves or condemns actions by their designated agents.


The debate about interrogation methods rests on notions of transparency, and of the affirmation - or denial - that there is one set of Rules on which America rests.  It entails discussion of sticking to the rules, bending the rules, making it up as we go along, or outright breaking of the very rules by which we believe we identify ourselves as Americans.  Current attempts from both sides of this argument have tried calling it different names in an effort to divert open discourse.  In business this is known as fudging the books. 


Government officials were certainly advised of certain procedures and programs.  Attempts to recast this as "But I didn't mean that!" undermine America's credibility.  Meanwhile, putting a name like Extraordinary Rendition on a practice merely converts it to off-balance-sheet torture.  Like Enron's SPE's - from which the company drew revenues and profits, but whose debt and leverage were kept off the corporate books until they exploded - the offshoring of our dirty work always comes back to haunt us.  This was true of Iran-Contra, it is true of the Mujahedeen-turned-Taliban in Afghanistan, and it is now true of the dark warrens into which inconvenient individuals - among them citizens of friendly nations - disappeared with hands bound and sacks over their heads.


The judgment of history will show that these phenomena were all of a piece.  The ill-conceived notion that, if we ignore bad things long enough, they will go away.  Wall Street, Main Street, Pennsylvania Avenue and Capitol Hill have all been under the sway of Out Of sight, Out Of Mind.  We have created a Bad News Bubble, just as surely as our ignoring the issues created a dot-com bubble and a housing bubble.


Now the chickens are coming home to roost, ably shepherded (or whatever it is one does with chickens) by President Obama.  Lost in the non-debate is the fact that governments all over the world, and throughout history, have relied on people - often highly-principled ones - doing extremely naughty things to their enemies in secret.  The broad uncovering of the CIA memos may be President Obama's cleverest gambit: there is much political capital to be gained - and little efficacy lost - in noisily outlawing the interrogation techniques in question.  They are well known by now, and the argument that terrorists will train to resist them is a red herring.  These techniques have been reported in detail by everyone from the New York Times to "60 Minutes", and the terrorists already know more about these techniques than will emerge in six months of Congressional hearings. 


At home, this highly visible action enables us to believe we have retained the moral high ground that was always the bailiwick of the True America.  Internationally, it sets the underpinnings of a new global dialogue where America can re-emerge as an honest broker, a role we long enjoyed before squandering it.  Finally, it is better to appear weaker than one is, than to show all one's strength up front.


We suspect this is Obama's deep, dark secret.  That, if we make enough noise about what the whole world already knows, we will score a political win.  Meanwhile, we will be able to keep quiet the newest truly frightening stuff we now rely on to keep our country secure.


What?  The President playing at politics?!




You're only as good as your last envelope.

          - Silvio, "The Sopranos"

So, let's say we knew this guy Mikey (not his real name).  And let's say Mikey knew the Buongiornos (not a real Family) who used to hang out down on Mulberry Street in New York's Little Italy (not their real address).  Only now, Tony Buongiorno is doing 15 to 22 years (not his real sentence) for Man One in the killing of New York police officer (not his real crime).

So, when we would read about goings-on in the tabloids, Mikey would say "let's go out for a walk", and he would tell us what he had heard about how things really went down.

According to Mikey, the key slip-up that led to the FBI raid on the Ravenite Social Club in December, 1990 - where John Gotti and Sammy "The Bull" Gravano were arrested - was that the mobsters got lazy and forgot Rule Number One: don't talk indoors.  Gotti and his cronies got cocky and fell out of the habit of taking walks.  Instead, they held business conversations wherever they found themselves, be it in a taxicab, in a restaurant, or standing in line at the ballpark.  More than anything else, Mikey said, this is what led to their being caught.


If even "Dapper Don" John Gotti lost his bearings, we suppose a mere hedge fund manager can be forgiven the occasional lapse.  Though as reported in the Financial Times (6 May, "SEC investigates first CDS insider trading case") we may be the only ones in a forgiving mood.


The SEC has charged Renato Negrin (as far as we know, his real name), a former portfolio manager at Millennium Partners, with trading on the basis of inside information passed to him by Jon-Paul Rorech (ditto on the name) a bond salesman at Deutsche Bank.  The information in question related to repricing of a junk-bond offering for which Deutsche was the banker, and the trade in question was the purchase by Negrin of credit default swaps. The CDS were priced based on the then-anticipated issue price of the forthcoming bonds.  When the actual pricing was revealed, according to the SEC compliant, Millennium took a quick profit of $1.2 million.

The SEC is making much of this story, because it is the first time they have launched a case on CDS.  The SEC does not regulate the CDS market - neither does anyone else - but they do regulate hedge funds.  We wonder what took them so long?


Embedded in this cautionary tale is a moral that is definitely not just for compliance officers.  We reprint here the last paragraph of the FT story:

"The SEC complaint repeats fragments of recorded conversations between the two men. After Mr Negrin asked Mr Rorech for some way to 'handicap' the probability that VNU would issue new bonds at the holding company level, Mr Rorech paused and allegedly said: 'You're listening to my silence, right?' Mr Negrin then said: 'Okay, I'll call you back.' The men then had a three-minute, unrecorded conversation on their mobile phones."

As our alleged friend Mikey might say, This needs no f***ing explanation.




An Offer We Can't Refuse

"You don't s**t where you eat.  And you really don't s**t where I eat!"

- Tony Soprano


While we're on the topic, a friend of ours reports that his firm has had a TAMMS (Trading and Market Making Surveillance) exam, plus nine additional FINRA examinations and reviews in the last six weeks alone, culminating in a sweep where the examiners handed him a year's worth of the firm's own trades and said "tell us which ones were crooked."  One would think these guys were desperate to raise money, looking to generate fines and settlements By Any Means Necessary.


Is FINRA broke?


As avowed Conspiracy Theorists, it's comforting to know there are folks out there whose imaginations run even wilder than ours.  Blogging in the website of the Securities Industry Professional Association ( former professional trader Rogan LaBier (author of The Professional Trader's Toolkit, published by Wiley & Sons) speculates on the possibility that the 45% of the FINRA endowment allocated to "alternative investments" were invested with Bernard Madoff.


The FINRA Endowment is estimated to be (or to have been?) on the order of $1.5 billion.  The Alternative investments portion of it is invested in unidentified hedge funds.  Bernard Madoff, former Chairman of Nasdaq - in the years before the market oversight function was separated from the marketplace - had his hands on plenty of OPM ("other people's money").  Why not FINRA's own?


The neat thing about Conspiracy Theories is that they explain everything. It fits perfectly, if Madoff was in fact managing the NASD's endowment, that they would never audit him.  Still, we recognize it may not be financial panic spurring FINRA's efforts, but desperation to be seen as efficacious.  ("Hah!" we say.  "Hah!")  And we will not even mention some of the more outlandish suspicions raised - that FINRA's own investigation of the auction rate securities markets led it to dump more than $800 million of these very securities from its Endowment portfolio, well in advance of the widespread meltdown in that market, and before they had raised this issue to a level of public awareness, thus making this a case of insider trading by a regulatory agency. Oops - we said we weren't going to mention that.  Sorry, FINRA. 


How much credence do we give to all this?  Just because you're paranoid, doesn't mean they aren't really out to get you.


Moshe Silver

Chief Compliance Officer


Chart Of The Week: Breaking The Buck

Suffice to say, the masses are beginning to figure out this inverse relationship. AFTER things really move, that's what revisionist historians do.


Over the course of the last 3 weeks, this REFLATION trade has really been amplified (see chart). While last week's down -2.5% week-over-week move in the Dollar probably created capitulation short covering in everything high short interest, that certainly doesn't mean that this inverse USD/SPX correlation will cease to exist.


If you're looking for lines in the USD Index that matter, here's what I'm using:


•1.       USD immediate term oversold = $82.69 (bounces from that line will create short term selling pressure in stocks)

•2.       USD immediate term TRADE resistance = $84.15 (all market selloffs should be bought/covered, provided that USD can't close above that line)

•3.       USD intermediate TREND resistance = $85.71 (that's the big line that matters; trading below it with the SPX holding above 861 will remain bullish)


Immediate term TRADEs and intermediate term TRENDs are what I am addressing here. No matter where you go in this market, these durations will dominate daily price action in everything on your screens.


In the long run, if the USD breaks down and closes below $81.11, this REFLATION party won't be so much fun anymore. Instead of smiling when I see a consensus short seller getting squeezed, I will be getting very weary of the US Financial System's long term viability. For now, whatever credibility this conflicted American system has left needs to be respected, above all else.


Rather than buying the SP500 (SPY) this morning, I re-purchased the Technology (XLK) and Healthcare (XLV) ETFs. On a relative basis, these 2 sectors need less financial engineering than others to survive any legitimate economic stress test. No, Timmy Geithner didn't have a US Dollar crash in one of his multiple choice test boxes.



Keith R. McCullough
Chief Executive Officer


Chart Of The Week: Breaking The Buck - chart12

Bah, Bah

"In order to form an immaculate member of a flock of sheep one must, above all, be a sheep."
-Albert Einstein
With all of the early cycle economic recovery facts largely in the rear view, it's actually getting harder to NOT chase the flock these days. On Friday, I started selling at 2:21PM, but the reality is that I had been selling too early throughout the week, so what do I know anymore?
Other than not translating my risk management decision of selling longs into shorting everything that ticks, I guess the only good news associated with my not waiting to sell everything at the highs on Friday was that I proactively predicted my own behavior. After all, my Early Look from Tuesday May 5th was titled "Selling Early"!
After a great March/April run, I've been taking down exposure to long positions that have worked. That exposure move and the recommendation to downshift the beta in your portfolio (buy healthcare, gold, etc...), was not an explicit signal to start short selling everything you see that's up. With the US Dollar getting hammered like it is right now, being short anything in size that could be the recipient of a more amplified REFLATION trade is borderline reckless.
In our virtual stock picking portfolio (see I have recently cut the number of long positions in the portfolio in half. At the beginning of May, I wrote about running with a 30-8 ratio of longs to shorts - now I'm at 17-9. Unless the SP500 breaks down and closes below the 894 line, I'll keep a long bias.
With the SP500 up 37.4% from the March 9th Depressionista freak-out low, am I interested in shorting stocks? Of course! I'm always interested. I love shorting stocks. I am as interested today as I have been every day in 2009 - but that doesn't mean I need to giveaway performance for the sake of feeling "smart" - smart is as smart does.
Having read more than a few of the "smart" money quarterly letters from Q1's end when the flock of sheep was telling you to lock hoofs with them and jump off the cliff, it will be fascinating to You Tube some of their mid-quarter updates. For Q2 to-date, the SP500 is up +16.5% to the strong side and the Russell 2000 is up a mind numbing +21.1%.
So, with the Stress and the Swine tests out of the way, what is a stock market operator to do this fine Monday morning? Now that earnings season has squeezed the brains out of the "oh, you just wait for earnings season" sheep, should we already be looking forward to next quarter? Should we stay long, or should we go short whatever and be wrong?
Being on the sidelines is a reasonably safe job, if you can get it. I don't especially enjoy riding the pine here as I watch other market participants collide head on, but I needed a break. With volatility (measured by the VIX) as oversold as the US Dollar is all of a sudden, I'm cool with watching, for now... the SP500 could easily drop 4% in a day, or over the course of 1-3 days for that matter, and I don't think a whole heck of a lot about this game will have changed. We'll keep making higher lows on selloffs.
For now, the most dominant macro factor playing out on the field of the US market remains Dollar DOWN and everything priced in Dollars UP. The US Dollar is broken across immediate and intermediate term durations. If the US Dollar Index breaks my long term duration line of 81.11, that's when I will stop talking about Breaking the Buck, and focus more explicitly on Breaking America's Back.
A country's currency is the confidence interval that the world has in her. Around the world, as either the commodity prices that they anchor on or The Client (China) they service goes, so do foreign currencies. Right now, as the US Dollar's Credibility Crisis moves into prime time, you're seeing breakouts in foreign currency markets from Brazil to Australia. These countries don't have the compromised and conflicted banking system that we have - or at least if they do, it isn't being You Tubed, daily....
As the world's sheep flock to perceived higher integrity pastures, what is a US stock market operator to do? Pray? Maybe - but what side of your book would you be issuing your most passionate cries for help - long or short? Are you an investor for the "long run" or a Depressionista who gets smoked in the short run?
I certainly don't purport to know the answer to any of these questions, but I do know that I won't be rubbing elbows with the likes of Bill Ackman as they find their way back onto CNBC to talk about being invested on a levered long basis. BEFORE the markets crashed to the downside, the sheep were blind. AFTER the markets had the most fantastic short squeeze in modern history, they remain, "above all, sheep."
Failing to close above the US market's January high of 934 will be bearish in the immediate term. Closing above it will be bullish. I have an immediate term upside target for the SP500 of 941, and a downside support level of 894.
Best of luck out there this week,


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.

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.  

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.

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WRC: Getting Easy To Not Like It Again

I struggle with this one. My model has the company missing the quarter by a nickel due to weaker top line and gross margins (see below), and visibility on any stability is six months away at best. I still don't think that the margin structure is sustainable without any temporary help from the Obama administration breaking the buck. In fact, the consensus is looking for flattish EBIT margins at 10% during the upcoming year as well as in 2010. Maybe that's doable, but I can't get to upside - even with sourcing savings on the docket.


But would I be shocked to see them beat the quarter? No. WRC has posted an average 40% variance each quarter over the past 5-years. In fact, this company beat for the last 11 quarters until dropping the bomb in 4Q (just after management sold the most stock since emerging from bankruptcy). Since then the company has not given explicit guidance to the public, but set low general hurdles, and has subsequently worked the conference and 1-on1 circuit meaningfully. Would it have done so in advance of a big miss? Probably not. If another big miss happens, this name will be in 'sentiment purgatory' for a long long time.


But it's certainly not there now. 80% of sell-side ratings are 'Buy' and only 4% of the share are held short. As noted, management timed mass sales magically before the last big miss in 4Q.  But with the stock dropping to $12.60, you would think that management would have jumped back on board, huh? Not quite. Not a single purchase from $13 up to its current $28. Maybe the senior management team is as weary of the current multiple as I am.


Our Model

Our WRC model is coming out at $0.68 for the quarter, $0.05 below the Street consensus of $0.73.  The key difference in our model vs. others lies on the top-line coupled with a slightly more negative forecast on gross margins. 



Revs are decelerating as square footage growth in CK cannot fully offset declines in all other divisions, comparisons extremely tough, and unfavorable FX(-9)%.


Revenues decelerating on a 2 yr basis throughout the year and will decelerate in 1H on a 1yr basis.  Compares ease a bit in 4Q, as this was the first quarter that WRC reported a substantial slowing in sales momentum at any point over the past 9 quarters.


Square footage growth of 20% (up 25% in F08) for CKI will continue to help drive sales in the sportswear and intimate (CK retail) segments.  The most recent data point given at a March B of A conference was that comps were running 10% for retail. While still robust, this was down from a 12% run rate in 4Q.


Timing of swim shipments may have an impact on 1Q as retailers continue to shift receipts closer to need.  Also given the short selling season for swim, it is possibly that wholesale accounts remain extremely conservative on inventory commitments given the inherent margin risk associated with the category.



Decelerating along with sales after huge gains over the past 2 years.  1H especially tough with GM's up 600+ bps total over prior 2 years.


SG&A expected to be down but at a slightly lesser rate than sales. 


$70mm in cost cuts announced for 2009 and more recent headcount reductions are expected to the keep SG&A dollars down for the year by 8%.


Capex/Working Capital

CapEx should be down slightly in 09, $40mm vs. $42mm in 08.  Square footage growth down slightly to 20% from 25%.  Keep in mind that this rate of growth is in the top 5% of retailers in this climate. Why not ease back with capital commitment and hold out for better terms on properties (i.e. LULU, URBN, HIBB, COH).


Inventory position will be the first metric I check when numbers are released. WRC has done a solid job over the past three years with consistently growing inventories ahead of sales. This was when FX was a benefit, growth came disproportionately from International ops, and they sold off low-turning intimate and swim businesses. The extent to which WRC can hold this will be the key to Gross Margin volatility in 2H.



WRC: Getting Easy To Not Like It Again - 5 10 2009 8 38 34 PM


WRC: Getting Easy To Not Like It Again - 5 10 2009 8 29 43 PM


Macau table revenue fell 10% y-o-y, very similar to March's 9% decline.  The breakdown was also similar with the decline driven by a 14% decline in Rolling Chip revenue, partially offset by a 1% increase in Mass Market.  Once again, Rolling Chip continues to face tough comparisons with the liquidity driven, massive growth last year.  Those tough comparisons will end in September.  Despite the tighter visa restrictions, Mass Market revenue is holding in.


The following are some observations about the property level numbers:


  • Wynn: Down to 12.3% from an 12 month average of 16.3%
    • Some of the drop on Wynn's share is due to lower hold % in month, but Rolling Chip was also down materially, as was Wynn's Mass Market share
  • LVS: Flat from March at 26%
    • Rolling Chip was up 5% y-o-y for LVS's properties on a combined basis (Sands was down but Venetian was up)
  • MPEL: Crown's market share increased to 9% from 8% last month
    • Hold was weak in both March & April, so the share gain was based on better rolling chip volumes
  • MGM: Down to 8.4% vs 9.8% last month
    • Bad hold was responsible as Rolling Chip was up y-o-y
  • Galaxy: Up 2% sequentially from March levels to 12.6%
    • Some of the lift is due to better hold
  • SJM: Up to 31.7% from 30% in March


Y-o-Y Win comments:

  • LVS:
    • Sands up 30% driven by an 85% increase in RC with Mass down 11%
    • Venetian & FS up 14%
    • Total table revenue from Macau + 20% at $253MM
  • Wynn:
    • Down 36%, with VIP down 38% and Mass down 27%, total table revenue: $120MM
  • Crown:
    • Down 54%, total table revenue $89MM
  • Galaxy:
    • Up 17%, with VIP up 30% and Mass down 29%, total table revenue: $123MM
    • Growth driven by Starworld which had table revenues grow 49% to $84MM

APRIL SIMILAR (NOT) TO MARCH - macau april total bac rev shr

APRIL SIMILAR (NOT) TO MARCH - Macau April mm rev shr

APRIL SIMILAR (NOT) TO MARCH - April Macau RC turnover shr

Exports: What Germans Do Best (…or Second Best)


Marginal fundamental improvement leaves us cautiously optimistic


Exports rose 0.7% in March on a monthly basis from February, the first positive month-over-month change since last September, according to data released by the Federal Statistics Office today. The delta here is critical to note. We could only focus on the annual percentage change in exports (see chart below), yet we're of the camp that the incremental improvement of fundamental data points on a sequential basis is confirming that Germany's recession is waning.  Is Germany out of the dark? Certainly it is NOT, however we're bullish that the country's recovery will come sooner and outperform many of its Western European peers, especially if it can get its strong side, exports, moving.


 Additional data points that have come in this week show a mixed fundamental picture:


  • Industrial Production held steady from February's contraction of 3.4% on a monthly basis or fell 20.4% on an annual basis
  • Manufacturing Orders increased 3.3% in March on a M/M basis
  • Retail Sales (excluding autos) fell 1.0% in March M/M
  • Trade Surplus increased to 11.3B EUR in March from 8.6B EUR in the previous month

Not included in retail sales is the success of Germany's auto rebate program. According to the VDIK Association of International Motor Vehicle Manufacturers new car registration in Germany was up over 30% in April year-over-year, and anecdotally the program has been a huge success. The program incentivizes individuals to trade in their old cars (9 years+) and receive 2,500 Euros towards a new car that meets certain emission standards. As we discussed in a post on 4/24, "Germany's Lifeblood Das Auto", the automobile industry has remained relatively resilient despite severe global demand destruction. But the numbers don't lie.  BMW beat Q1 expectations, yet still recorded a net loss of 55M EUR before taxes and depreciation and Daimler reported that revenue fell by 25%, adjusted for exchange-rate effects. GM's German Opel division still hangs in the balance as it looks for a buyer. Increasingly Italy's Fiat looks like a strong candidate.


While the ECB trimmed the interest rate 25bps to 1% yesterday, the cut was largely baked in. We've been harping on the ECB's lethargic call to action to cut for the better part of this year. Yesterday helped to confirm that ECB monetary policy can only go so far, especially as it runs out of room to cut. We've highlighted the positive fiscal stimulus measures issued by countries like Sweden. Additionally we believe that Norway will roar higher due to its leverage to the price of oil. We're oil bulls on a TREND (3 month or more) duration. 


The ECB decision yesterday to pump some 60B EUR in the Eurozone economy through its purchase of euro-denominated covered bonds will help put wind in Europe's sails. Importantly for Germany and Chancellor Angela Merkel, who is fighting for reelection in September, there will be a focus on offsetting the negative sentiment associated with a burgeoning unemployment rate, which currently stands at 8.3%, and getting domestic deals done, like an owner for Opel. Importantly, German confidence indices (ZEW and IFO) have improved in April. Confidence, according to a distinguished Yale professor of European Union Studies that we recently had the pleasure to meet with in our office, is a measure not to be overlooked.


As always, price rules. With the appropriate entry point we'll be considering the etf EWG on the long side.


Matthew Hedrick



Exports: What Germans Do Best (…or Second Best) - germany1

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 80.46%
  • SHORT SIGNALS 78.35%