"Not by the hair on our chinny-chin-chin. You can't fool us with that old sheepskin."
-Three Little Pigs
As we trekked to higher-highs on low volume in the US stock market yesterday, I for one was having a hard time discerning the sheep from the wolves. That said, the piggies were right where they have always been - hanging out in plain daylight, chowing down at America's trough.
After a +39.6% trough-to-peak move in the SP500 from the March 9th lows, all you have to do at this stage of the game is follow the feedbag. Who gets paid with the free monies in play and the US Dollar looking more and more like a straw house? Follow the monies...
In America, there are three very important constituencies that have been getting paid in Q2:
1. The Politicians
2. The Debtors
3. The Bankers
Bankers? Getting paid? Uh yeah... big time. The combination of A) a free money short end of the Treasury curve (3-month Treasuries hit 0.13% this morning!) and B) a socialized Heli-Ben flight pattern of limitless credit creation that has imposed the steepest yield curve that we have seen in modern history. The spread between 10 and 2-year Treasury yields hit a new high yesterday at +270 basis points wide!
In simpleton terms, all that means is that Timmy Geithner and De Boys in De Banking Club get to borrow from a socialized US banking system at effectively less than 1%, and lend it whenever they so choose to the American commoner at, well, whatever rate they so choose. Borrowing short and lending long is what bankers build those big houses with folks - this compensation structure isn't new.
What is new is that we have a highly politicized US Financial System that pays Piggy Banker first. The reason why it's hard to discern the wolves from the pigs is because they're all in the same house together! Yeah, you might knock off another third of the hedge fund community who shorted this compromised and conflicted system the whole way up, but who cares? Timmy? C'mon - these guys want hedgies to fail - it amplifies their populist political capital.
The Politicians get paid as the US stock market and home prices stabilize. This is THE REFLATION trade that everyone and their pet piggy bank finally understands. Don't forget that The Debtors also get paid when you collapse the world's reserve currency. Roughly 53% of the world's debt is denominated in US Dollars. Reckless borrowers of levered long days past, worry no more - that big bad wolf ain't in the business of blowing your underwater houses down!
So if the Politicians, Debtors, and Bankers are all getting paid in some form of actual or political capital, who loses? Ah... yes, Mr Darwin, there are losers here aren't there? There two very important ones actually:
1. The Creditors
2. The Americans
Of course some Americans, like money managers who can only make money in an up tape don't lose - the last 3-months have been fantastic, if you were long that is. That said, some of them... like say, Bill Ackman, will go as far to cry in public if they can't muster a way to lever up their clients' monies one last time to make some hay. If you can't make money during one of the most expedited short squeezes in US stock market history, and you're a "fundamentally oriented" lever it up to the wazoo type guy, your asset management house of cards is probably coming down.
Most Americans who have had the sobriety of a savings account get screwed here. Jaime Dimon will prance around CNBC's stage while his government funded bank pays effectively zero on this US citizen's savings. But he's going to have a great quarter - and he's "really smart."
Never mind the yield curve chow down at the trough of American savings. Now Piggy Bankers and the corporates they pander to are issuing more shares than even the math guys can count. Last check we had Timmy's survivors of his made-up test with made-up rules plugging the Street with almost $70B in common stock issuance. Jaime was good for $5B of that himself!
The US stock market may have made a higher-high yesterday, but the US Financials (XLF) didn't. The XLF (Financials ETF) closed down -1.6% on the day, after the Piggy Bankers, well... they pigged out.
The Creditor of this Piggy Banker story is China. President Obama isn't highlighting this obviously (he's more into the storytelling needed to support The Politicians as of late), but when Timmy told the audience in Beijing this week that "Chinese financial assets are very safe," the audience laughed!
They laughed at the Piggy Banker and sent him back into the stratosphere of American Credibility Lost. The US Dollar and US Treasuries have been marked-to-market folks. This children's story, unfortunately, doesn't end with the American dream I aspire to tell my son Jack that I have had the blessing to live.
I've sold all of my exposure to US Equities as of yesterday's close. No, that doesn't mean I am shorting this Piggy Banker system en masses, yet... I remain long China, Gold and Inflation Protection (TIP). My downside target for the SP500 is 910, and my upside target remains 955. Trade the range. If you have to be invested in the US, that's all you can do for now.
Best of luck out there today,
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.
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.
XLU - SPDR Utilities - As long term bond yields breakout to the upside, Utility investments are the relative yield loser. XLU was the second worst performing sector behind financials yesterday.
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.
"Not by the hair on our chinny-chin-chin. You can't fool us with that old sheepskin."
OEH announced after the close that it sold the 109 room Lapa Palace in Lisbon for $41.8 million. OEH deemed it important to identify the huge 22x EBITDA multiple of the transaction. The property generated under $2 million in EBITDA. Who cares what the multiple is? On a per key basis, this palace sold for $383k per key, hardly a trophy value. We had the property valued higher.
Apparently George Maloof (The Palms) has a solution to a weak condo market-self financing. Speculation is that if The Palms is successful MGM may follow suit. Well that sounds like a great idea - I wonder why no one has done that? Oh wait, someone has thought of that - it's called Timeshare. The difference is, in this version, the financing spread would likely be hugely negative and there would be a horrible duration mismatch with no securitization market.
Maybe we're missing something, but last we checked the average Vegas operator's cost of borrowing is still around 10%, which is at least a few hundred basis north of the 30 year mortgage rate (even for Vegas condos). Assuming $1000/month of maintenance charges on a $1MM purchase, any rate less than 8.3% would result in a negative carry on a 70% loan to value. Then there's the whole issue of duration mismatch since the duration on the borrowings of most companies is less than 10 years while most mortgages have over a 20-year duration.
Aside from perhaps an incremental 10% of equity from the buyers, we're not sure why financing condo sales makes any sense versus just putting them into the hotel rental pool. Assuming $200 ADR, 75% occupancy and a 30% EBITDA margin, it seems like it would make a lot more sense to just rent out the rooms despite the probable cannibalization of existing room demand.
The other risk of providing 70%-80% financing is that operators will be left holding the bag on any pricing declines in excess of 20-30%, which is a reality given that many of these deals were struck at the peak of the market.
Looks like a pretty stiff wind to spit into.
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Positive data point from a very small, very strong economy ...
May PMI data released by the Singapore Institute of Purchasing & Materials Management showed a positive reading for the first time since August of last year, registering at 51.2 as orders flowing in from "The Client" showed no signs of abating. Demand from China for consumer electronics were particularly pronounced, driving the electronic sub index to its second consecutive positive monthly reading of 52.9.
As an entrepot economy with the highest per capita GDP in Asia, Singapore has always served as a barometer of regional trade. These latest figures are yet more support for our long China thesis and a reminder that Korea and Taiwan do not have a monopoly on Chinese demand for high margin consumer goods.
We're getting a lot of questions today as to why we won't ride this perceived to be Bull into the land of perpetuity. The answer is basically because we don't think it's a Bull. We don't think it's a Bear yet either. We think it's a Bull Shark that we don't want to mess with, and we are very price sensitive.
For the past three months we have ostensibly picked up a few of the professional Bull riding fan base, but that wasn't our intention. To be clear, we were making the REFLATION call that Squeezy The Shark was going to expedite a short squeeze of generational proportions.
After a +40% trough-to-peak move, I'm establishing an intermediate term target that's only 5% higher than yesterday's close (at the 989 in the chart below), this is hardly the time to be pleading for me to be as bulled up about Squeezy as I was... been there, done that.
As the US Dollar broke down through the $80 line into the end of December, I got sucked into overstaying my welcome long US equities into mid-January. I have no need to replay that mistake all over again. January was a month where I was wrong, and I don't want to repeat the mistake of buying an overbought tape like that again here in June for the sake of pandering to a stale thesis.
Everything has a time and a price. I have an immediate term TRADE line of SP500 resistance that's formidable at the 955 line (dotted red) and if I see that print, I'll only see another 3.5% upside left from there. With the only support line of resistance all the way down at 910 (dotted) green, for now the best decision I can make is to do nothing and wait. Both the US currency and US Treasury market are in crisis - that will have unintended consequences.
Being in a YTD position to sit on performance and wait is reserved for those who didn't miss the last 3 months of performance. Chasing bulls is not what I do.
Keith R. McCullough
Chief Executive Officer
Given the environment, there was nothing earth shattering from any of these companies. It was notable that the tone was still one of caution.
Burt Vivian started the day off at 8am with his typical dour tone that we have become so accustomed to. He noted that there continues to be small steps of progress being made at the Pei Wei brand. Although the tone at the bistro is the same; weekdays suck (down double digit) with the weekend showing better trends, allowing the overall trend to be down mid single digits. Favorable cost trends remain a big tail wind for the company. Right now PFCB has a 36% short interest; I'm having a hard time seeing what the short story is on PFCB.
JACK presented next with very typical commentary on current business plans. The focus continues to be on the new platforms and refranchising. I'm actually becoming more favorably disposed to JACK as we head toward the back half of its fiscal year. JACK has the potential to end the year with a blockbuster FY4Q09. With Carl's Jr. lost in its premium product strategy, there is some market share for JACK to take in the California market, so sales trends should continue to show better trends as we finish the fiscal year. At the same time, commodity trends will continue to improve for the balance of this fiscal year, with commodity costs down 2% in FY4Q. With JACK trading at 5.5x EV/EBITDA and the group trading at 7.5x there appears to be at least $6-$12 of upside on accelerating business momentum.
CAKE was next with a very solid presentation. I really think Doug Benn adds a lot of credibility to the CAKE cost cutting story. With CAKE generating $90 million in FCF, which will go to reduce the debt on the balance sheet by $100 million, the focus is on cost cutting and the company ability to offset the MACRO environment. The real opportunity for CAKE is to get the average unit volumes back to $11 million from the current run rate of $9.8 million. Barring a big change in sales trends, the CAKE story is solid and with a 14% short interest there is risk to the upside.
SONC was more depressing. Over the past 12-months, the company raised the prices of its combo meals to the point where consumers are now buying more à la carte putting pressure on the average check. According to the company, the fix is to raise prices on the à la carte products to make the overpriced combo meals look better! How does that work? How did such a well run company get so screwed up? SONC has seemed to have lost its way in a very competitive QSR segment, and the short interest only stands at 10%.
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