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HOT: REFLATION TRADE BUT WHAT ABOUT THE FUNDIES?

There have been a few upgrades in the sector recently based, in part, on optimism about business getting less bad.  This thesis has certainly played out in the gaming and cruise line sectors.  While the same thesis will eventually play out in lodging - even a broken clock is right twice a day - we are not seeing any evidence of sequential improvement.  Our 2010 estimates for HOT EBITDA and EPS remain 10% and 30%, respectively, below the Street.

 

YoY occupancy remains way down from last year.  As we opined in our 01/07/09 post, "FILL 'EM AND THEY (INVESTORS) WILL COME", improvement in occupancy is a strong signal that there is indeed light at the end of the tunnel, even if lower rates are still driving overall RevPAR down.  Lodging stocks typically do not sustain rallies until occupancy bottoms.  Unfortunately, there is no visibility on that pivot.

 

As can be seen from the chart below, lodging fundamentals are not improving.  We're not sure what data other sell-side analysts are looking at, but the STR data doesn't show any recovery or stabilization and our network of private hotel franchisees certainly doesn't see things getting any better.  Just because the YoY decrease in RevPAR isn't accelerating doesn't mean that we've reached the bottom or that there is any improvement in sight.   Occupancy fell 11% in April, and is tracking down 12.5% for the first 3 weeks of May.  Given the lack of demand for rooms, the only way to fill rooms is by stealing share from your neighbor by dropping price.  In order to change this you need real demand growth stimulated by job growth and income growth - things stabilizing at bad levels isn't enough.

 

HOT: REFLATION TRADE BUT WHAT ABOUT THE FUNDIES? - hotel metrics

 

We will give credit when credit is due. Starwood has done a great job cutting costs, but we do not believe that all of these cost cuts are sustainable, especially the ones at the capex level.  We wrote about this in our 5/2/09 note "YOU TUBING HOT".   Like the gamers, many hotel companies are simply deferring capital expenditures.  The deferred maintenance capex issue is why many of the recent asset sales have come with mandatory investment requirements.  We heard that the W New York - The Court & Tuscany is on the market for $100MM but the required capital improvements are almost as high as the ask price.  Cuts on timeshare are only sustainable until the inventory on hand is sold, and then companies need to start investing again - otherwise we need to look at these businesses on a liquidation basis, not a multiple basis.

 

We understand the reflation trade.  In fact, Research Edge was a big proponent of this thesis beginning in early March (thanks Keith), especially with the gaming and cruise lines sectors.  That trade has worked.  With cost of capital rising and valuations rising there needs to be more to keep this rally going.  How about the fundamentals?  Not quite yet.   



JAPANESE PRODUCTION

  

"Better than bad" is not "good"

 

METI Industrial Production data released today registered at 5.24% on a month-over-month basis, the largest increase on a M/M basis in 56 years and the second consecutive increase.  The news bolstered hopes that the worst in now over for Japan as marginally increasing exports and inventory depletion helped get the wheels turning again in several production categories.

 

 JAPANESE PRODUCTION  - japan2

 

Unfortunately the glass half full argument appears to us to be undermined by the data.  On a year-over-year basis total production for April still declined by a measure of over 31% with durable goods production declining over 41% -effectively taking absolute production back to levels last seen a generation ago.  Although on a sequential basis output of basic industrial products like fabricated and non-fabricated metals and plastics improved for the month, the continued decrease of output of transportation equipment, heavy machinery and other highly engineered products suggests that Korean factories -helped by a weakened Won, continue to place competitive pressure on Japanese rivals in the higher margin segments of heavy industry.

 

One of the bright spots to note for April was electronic products, which saw very significant improvement in output levels, with the rippling impact of increasing Chinese demand helping to drive production to a Y/Y decline of 37%, a 10% improvement over March levels and the smallest decline since November of last year. Passenger automotive also saw slight sequential improvement on marginal export recovery.  None of this was sufficient to stem rising job loss as official unemployment registered at 5%, the highest level since 2003 and within half a percent of the highest levels the nation has experienced since 1953.

 

We view today's data as mixed at best, with some marginal improvement but certainly no indication that a bottom has been found for the land of the rising sun. We fortuitously covered our EWJ short position yesterday, locking in a modest gain ahead of this news, but we continue to maintain a negative bias on the Japanese economy. Unlike the emerging Asian economies, which appear to be showing early signs of real recovery, and South Korea and Taiwan, who are being impacted more directly by "the Client"  and currency inflections, Japan still appears firmly stuck in a rut to us. The only positive catalyst that could sway our near term opinion on Japanese equities would be a weakening Yen.

 

Andrew Barber

Director


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Chart Of The Year Update: Pending US Dollar Crisis?

 

After seeing today's smack-down selling and follow through (the US Dollar Index is getting hammered, trading down a full -1.5% to $79.36!), I am comfortable stating as plain fact that the US Dollar has moved into pending crisis mode.

 

Pending Crisis? What's that? It's something that you need to address, acutely, before it becomes an outright disaster. Don't start managing risk after things crash - start addressing the probability of a crisis when it starts to threaten to move into the heart of the bell curve.

 

Three weeks ago, before the USD broke my long term TREND line of $81.54, I was comfortable being long the REFLATION trade ("Breaking The Buck" is a call I have been making for 6 months). Three weeks ago I considered a US currency crisis "tail risk" (i.e. a 3% or less chance of happening). Today, I think there is at least a 33% chance. That's way too high for me.

 

If you take a long term view of the US Dollar's history and go back to the date that matters most (1971, when Nixon abandoned the gold standard and started what would be limitless global credit creation using a US Dollar peg), there has only been 1 other time when the US Dollar Index sustainably broke the $80 level - that other time was Q407' to Q208'. What happened to the US stock market after that breakdown is now history.

 

I don't get paid to pander to the US government's position on this. Politicians and bankers get paid as debt obligations deflate. At this stage of the game, everyone is getting paid here via the REFLATION trade other than the real creditors of the US Financial System that matter: the Chinese government and American savers.

 

Breaking The Buck pays people like it should via REFLATION. Crashing it will have many unintended consequences. It will be global this time, indeed.

 

Be careful out there,

KM

 

Keith R. McCullough

Chief Executive Officer

 

Chart Of The Year Update: Pending US Dollar Crisis? - crisis


WHAT COMES AFTER THE AFTERGLOW?

 

 

Post election optimism and some better-than-bad data in India masks serious potential pain on the horizon

 

Today's data release from the ministry of statistics  showed that Indian GDP grew at a better than hoped for rate in Q1: 5.8% Y/Y. Although the rate of growth has now contracted on a y/y basis for 5 consecutive quarters the figure still represents much better than anticipated recovery in response to government stimulus programs and rate cuts. This is good news indeed for The victorious Singh Administration as it attempts to shore up confidence, but it still greatly lags government target growth rates needed to drive higher employment and consumer demand.   

 

WHAT COMES AFTER THE AFTERGLOW? - ind1

 

Prime Minister Singh's initial moves in his new term are critical. India needs to borrow a significant amount to implement new stimulus and social programs, bringing the total borrowing for the year to 3.62 trillion Rupees - yet with total public debt above 75% of GDP there is a real chance that the country's credit ratings will slip below investment grade exacerbating already expanding long term yields.   Any move that could undermine confidence in the nation's credit carries risk since a stronger Rupee will be critical, with over 80% of current external debt already denominated in foreign currencies and new capital raises likely to be issued in USD, not to mention an import dependence for key commodities.

 

 

Inflation and Debt  

 

Wholesale price Inflation levels released yesterday by the Ministry of Commerce registered below 1% for the 11th consecutive week. With inflation seemingly tamed, market expectations are squarely pegged on continued easing from the central bank as the government gets down to the business of kick-starting growth. One cloud on the horizon however has been the continuing resilience of consumer inflation, with the measure for rural workers still hovering above 9% and urban measure over 8%. With government subsidies currently insulating consumers from direct energy commodity pressure (more below) the discrepancy is driven by pressure in consumer staples  -making further rate cuts less tenable.

 

WHAT COMES AFTER THE AFTERGLOW? - ind2

 

 

Note that earlier this week the Food Ministry responded to rising sugar prices by banning new contracts and new positions in existing contracts on the National Commodity Exchange in Mumbai. Prices of Sugar have been up sharply on anticipation of major shortfalls in domestic production for the current cycle, with an expectation that India will be a net importer this year for the first time since 2006.

 

Another new development is a move by the newly empowered INC administration to lift fuel price caps and allow refiners to maintain natural margins in response to lower oil prices. This lifts a major burden from state controlled energy companies and has driven equities sharply higher but it also adds an element of inflationary risk in the near term if oil reflation (or rupee deflation) resumes.

 

Still, this week's news is decidedly net positive for India Equity Bulls and, more importantly, for the Indian economy and people. Singh -a massively respected leader before this new victory, has been handed a very large check in the form of the optimism sweeping the nation post election, and he will need every ounce of that goodwill to buoy sentiment as his administration makes some very tough calls. As investors we continue to remain skeptical on the long term prospects for the Indian Economy and have a short term bias on the equity market there.

 

Andrew Barber

Director


Steinhardt: Leder Tracking the Legend

In April Research Edge announced that Footnoted.org has joined the Research Edge platform, creating additional competitive advantage for Research Edge subscribers.  We found this to be a post worth of passing on given the asymmetric views people have of where the hedge fund industry goes from here...

 

Michelle's thoughts follow:


We take a break from our usual troll through the filings because last night, I had a chance to hear legendary hedge fund investor Michael Steinhardt speak at a Brandeis event at the Harmonie Club. Though Steinhardt has been retired from the industry for nearly 15 years now, and said he spends most of his time on philanthropic issues, including trying to set up a charter school that focuses on teaching Hebrew in (of all places as the Brooklyn native joked last night) Gerritsen Beach, he had lots to say about the current economic situation, including how impossible it is to really predict anything.


During the hour-long talk, I attempted live tweeting, focusing on the market-related issues (as opposed to the other questions that came up about philanthropy and Jewish education) though I don't think Twitter was able to give the full flavor of the talk, which was really incredibly interesting and more than a bit inspiring.


Of particular interest to footnoted readers were Steinhardt's comments on the SEC losing its way (he also said the Department of Justice had too). He also said that the current period has "made me less of a capitalist" because so far at least, it has been a "punishment-free period." That's particularly interesting given Steinhardt's personal history with regulators. Some might remember that back in the early 1990s, Steinhardt settled with the SEC and DOJ over an investigation over T-bills, personally paying over $50 million in fines. He said the money management industry had "failed miserably" and that hedge funds were "no longer a place for the best and the brightest".


During the talk, he kept returning to the theme that everyone is a product of the last tick. So with markets going up since early March, there's an expectation that they will continue to go up. Ditto for back in September, when things started imploding. But the contrarian - and it would be hard to describe Steinhardt as anything but - doesn't follow the crowd. Steinhardt also kept returning to the theme of creative destruction and said that while some companies had been allowed to fail, there was "no appetite for short-term pain" like allowing GM to fail.


Afterward, as I stood in line to introduce myself, I heard the guy behind me - a fellow alum - say, "It must be nice to make a billion bucks and tell everyone else that they have it all f-ing wrong." Needless to say, he didn't say that to Steinhardt directly.

 

Steinhardt: Leder Tracking the Legend - footnoted.org


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