BKC – In panic mode

The discounting at Full Service chains is having an impact on QSR!

BKC failure to be irreverent in its advertising strategy has put the company in panic mode. In a business where you are in competition with a company like McDonald's, that out spends you by a multiple of three and can currently do no wrong, any misstep is painful.

Apparently, Burger King plans to focus more of its advertising message on value items. The value message has been working for a year at MCD and more than six months at Wendy's and now the marketing department at BKC have determined that "The current marketplace is demanding value and the company is being responsive to that consumer-driven demand." This is embarrassing!

Burger King focused on premium products; trying to capture market share from casual dining chains was a mistake from the beginning. In a difficult economy, a concept highlighting premium products in a segment of the restaurant industry that has a perceived value bent has proven very difficult to achieve.


The aggressive value message being put forth by the casual dining chains cannot be ignored, and courtesy of Burger King we now have proof of the fact.

While the increased discounting can negatively impact margins if not handled properly, declining food can mitigate some of the margin pressure. On the margin, the increased discounting definitely takes away any potential upside there may have been and increases the risk to the downside.

The news on Burger King only confirms my negative thesis on CKE Restaurant (CKR) as it continues to try holding the line on discounting. The continued decline in traffic at the core Carl's Jr. will ultimately force the company to give up some margin to get more people in the door!

Was anyone really going to buy an "Angry Whopper" with an Ad like this.....?


BKC – In panic mode - bkcads


Game On

"I went to a fight the other night, and a hockey game broke out."
 - Rodney Dangerfield
That quote is for my boss who loves a good quote, but is preparing for a Bloomberg TV interview right now so he has less control over what I'm doing! I digress!
As it stands going into today's market action we will likely end on a positive note for the month.  Currently, for the month the Dow is +2.89%, S&P +3.90%, Nasdaq +2.01%, and Russell 2000 +0.95%.  We are getting to the end of the line here as people try to protect their month end.  Next week starts a new month - Game On!
After a good, solid month like this and with the S&P at 906, it is important to remember that "less bad" is different from "good."  We now need "good" to be the dominant story and I don't think we are there yet.  Coming into the last day of the month, the risk reward for the S&P 500 has 888 on the down side and 919 on the upside.    
Yesterday's market action saw the USD down again intraday, which means REFLATION up!  The reality is that the only parts of the market that were working were things that America isn't the only incremental buyer (Energy (XLE), Materials (XLB), OIL (USO), etc...).  The glaring negative divergence in performance was in Consumer Discretionary (XLY).  
The negative divergence in consumer discretionary is occurring at a time when two of the four key aspects of our MEGA consumer call are starting to turn slightly negative.  (G)as - nationwide gas prices at the pump stand at $2.45 a gallon, up $0.40 in a month and (M)oney - right now the average rate for 30-year fixed-rate loans is 5.44%, the highest level since early February.  
When consumers worry more about their potential gasoline bills, consumer spending slows.  With oil trading at $65 and looking to go higher, it's only a matter of time.  Also, the implication of higher mortgage rates supports our call that the "less bad" news on housing (part of the A(ssets) in MEGA) is behind us.  We are also seeing increased consumer credit and deleveraging concerns gaining momentum.
Yesterday, we Re-shorted the US dollar as a vote of no confidence.  A number of polls have suggested that Treasury Secretary Geithner will not be in his job by year end and now he is headed to China.  Supposedly he will urge China to boost domestic demand and loosen controls on the Yuan! It's a nice thought, but the reality is he can't "urge" them to do anything. He is going to China and they will end up telling him what to do.  We need them more than they need us.  
This is a trip President Obama did not want to make because he could potentially be seen as weak, knowing the Chinese will tell him what to do.  So what does he decide to do, send his treasury secretary who is perceived as weak and who most Americans don't believe should be in the position he is in.  So what is the right thing for us to do - short the dollar!    
The biggest loser on the day yesterday was Bill Ackman.  If you were unsure if activist investing went the way of the buggy whip, you are sure of it now.  Target Corp. said yesterday a preliminary count shows shareholders "by a comfortable margin" appear to have re-elected the company's four incumbent directors and backed a proposal to set the board's size at 12, dealing a sucker punch to activism.
Not only has Bill Ackman lost billions on his investment in Target, he has now spent millions trying to save face by tying to get on Target's board, all for nothing! Courtesy of CNBC, Bill had seemingly endless time on air to make his case and that did not work because he had nothing to offer. His response to all of this: "We can work together going forward, but these guys run the company. We do not want to get involved in any kind of day-to-day involvement."  
Please stop right now!
Function in disaster; finish in style
Howard Penney
Managing Director


CAF - Morgan Stanley China Fund- A closed-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.

EWD - iShares Sweden-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 heat up.

XLV - SPDR Healthcare-Healthcare looks positive from a TRADE and TREND duration. We've been on the sidelines for the last few months, but bought XLV on a down day on 5/11 to get long the safety trade.

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.

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. Longer term, the burgeoning U.S. government debt balance will be negative for the greenback. The Euro is up versus the USD at $1.4082. The USD is down versus the Yen at 95.9510 and down versus the Pound at $1.6128 as of 6am today.

XLU - SPDR Utilities - As long term bond yields breakout to the upside, Utility investments are the relative yield loser. This was not the case yesterday. We remain short.  

EWW - iShares Mexico- We're short Mexico due in part to the repercussions of the media's manic Swine flu fear.  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.


My consultant in Macau had some thoughts about Crown's (MPEL) City of Dreams property following his visit there yesterday.  CoD opens June 1st.  Here is his commentary:



My first stop was dinner at Lung Hin, the Chinese fine dining restaurant at CoD inside the Crown Tower with access from The Boulevard Mall on one side and the VIP Casino on the other.  Personally, I am not a fan of the design of most of the Crown facilities and was really disappointed by the appearance/design of some sections in this corner of the property.  On a more practical note: most of the staff uniforms have yet to arrive, as has all of the linen for the F&B portions of the property.  So the restaurant is operating without napkins... The staff was mostly local, very poorly trained with little to no English skills. A few of the senior managers are Malaysian and Vietnamese with experience and they were very good.


After dinner, we walked through the VIP casino into the Hard Rock Casino - a whole new world.  I would call this the first Las Vegas style casino in Macao.  The moment you walk in, you feel the vibe of party and good times.  However, it is also the smallest of the casinos in the property.  The main Crown casino floor however is huge, unappealing and doesn't display anything I recognized as special to set it apart from other casino floors in Macao.  The dealers and most of the pit managers are completely green.  We were invited to play with fake money in a trial run of the casino and it was a pretty sad experience.  Even with the pit boss standing behind the dealer, a lot of mistakes were made and blatant attempts at cheating were accepted.  I later ran into the VP running the casino and his only hope was that the staff was friendly.  All else, he acknowledged, is beyond expectation right now.


The Boulevard is very interestingly laid out around the exterior of the casino. Pretty much whenever you want to enter or leave the casino, you have to cross through some part of the mall which will likely make retail an interesting component of the experience at CoD.


I am promised that the Bubble Show is a total highlight but it was off limits to us last night.


The pool deck at Hard Rock is fantastic as is the Spa at Crown.

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Gas versus Oil: Flashing an Extreme


My colleague, and Research Edge's Asian Strategist, Andrew Barber told me the other day that he had a dream that we would one day all be driving cars powered by natural gas.  While Barber is a great analyst who has nailed China this year, he is also a man of ideas.  As of now, cars powered by natural gas are just that, an idea.  We neither have the vehicles to do this, nor the infrastructure in place to deliver the natural gas.  With all things, though, there is a price. 


Currently, the oil / gas ratio is suggesting that price may be near as we are at an extreme in the price differential between the two commodities.  In fact, the oil / gas ratio (the price of one barrel of oil divided by the price of one BTU of natural gas) is currently nearing 18x, which is 9-year high.


According to many experts, a barrel of oil contains roughly 6 BTUs of energy equivalence.  On that basis, natural gas should be trading at ~$10.80 per BTU. Based on its current price of $3.93, natural gas is trading at just 36% of energy equivalent price.  In theory, if oil stayed at its current price and natural gas reverted to its energy equivalency value, there would be ~175% upside to natural gas.  As we know, in the real world arbitrage opportunities happen for a reason and the theoretical energy equivalency value is just that, theoretical. 


Our competitor Dennis Gartman uses many ratios to justify his positions.  On most, we would vehemently deny that there is a fundamental underpinning (Gold versus Agriculture as an example).  With oil and natural gas, on the other hand, there is clearly some fundamental basis to consider this ratio since both oil and natural gas have an energy value that can be measured.


Some analysts suggest that on the industrial demand side, there is 5 - 10% overlap in oil and natural gas, which can be switched at different price levels.  While this may be accurate, the most relevant data point relates to transportation.  As the EIA reported last month in their year end natural gas review:


"Natural gas for vehicle fuel has increased over the past several years but remains at less than 1 percent of the total."


Until we see this number move meaningfully, it will be hard to argue that oil and gas are interchangeable from a usage perspective.


Investors who use history as a guide would suggest that either oil is over priced or natural gas is under priced.  In the short term, they could both be correct.  Longer term, the reality is more likely that we have entered an era of cheap natural gas and relatively expensive oil.  Most importantly, oil has quantifiable supply constraints and burgeoning demand from emerging economies, most specifically China, while the natural gas market is flush with supply domestically and abroad.


We can see this change in growth of domestic supply of both commodities. In the simple table below, we have outlined the growth in domestic oil product and gas production in 2008 and 2000 versus 1990, with 1990 as the reference year.  As we can see, on domestic basis, the market for oil has tightened dramatically.  Since 1990 oil production on an annual basis in the U.S. is down -32%, while natural gas production is up 15%.


Gas versus Oil: Flashing an Extreme  - change


While the oil / gas ratio is a relevant input for a fundamental view of the two commodities, until interchangeability becomes more prevalent between the two commodities, the history of the ratio is probably not the best guide to its future.


Daryl G. Jones

Managing Director


Gas versus Oil: Flashing an Extreme  - nymex

German Unemployment Improves on Mixed European Backdrop


German unemployment dropped a seasonally adjusted 10 basis points to 8.2% in May, an important call-out as unemployment is busting out across Europe.  While we're not calling a top on German unemployment, the number should provide a tailwind for German confidence.  For our fundamental view on the country see yesterday's post entitled "Germany Grinding It Out".


Today the European Commission released its May confidence numbers, which improved across nearly all industries.  Overall economic confidence rose to 69.3 from 67.2 in April, a six-month high. Consumer sentiment stayed flat on the previous month, while industrial, services, and retail indices improved. Only construction dipped mildly. (See the chart below).


In conflict with the retail sales results is Bloomberg's purchasing managers index (PMI), which recorded that retail sales for the Eurozone declined to 47.1 from 48.4 in April, based on more than 1,000 executives compiled by Markit Economics.


We continue to follow European data points to monitor health, yet place greater emphasis on country-specific data when considering a position as we believe auto-correlation is dead. Due to the importance of the Union as a trading partner for European countries, improvements in fundamentals and confidence will benefit the whole.


In Europe we're currently long Sweden via the eft EWD. We're bullish Sweden on a fundamental basis and believe that exports will benefit from a weaker Kronor versus the Euro.


Matthew Hedrick



German Unemployment Improves on Mixed European Backdrop - euroconf

Claiming Confucius?


In this morning's Early Look I quoted our old friend of the fabric, Confucius. When market's trade in a proactively predictable range like this, maybe that's the only thing left to do - trade the range and philosophize...


The last few weeks of jobless claims data have given plenty for both perpetual bulls and perma bears to pontificate on. Last week's claims saw us shoot above the 4-week moving average, while this week's print takes us for another dive below it (see chart).


The New Reality is that consensus fears of the American Consumer's death were largely exaggerated. That well known phrase and a Confucius quote might give you the magic fairy dust of a Wall Street narrative fallacy.


Two consecutive weeks of improving jobless claims, is what it is - bullish for a market that tested the bottom end of its new trading range early this morning (886 SPX). Don't make this any more complicated than it is - trade the market and the data points that are in front of you.



Keith R. McCullough
Chief Executive Officer


Claiming Confucius? - initial

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