A Whole Lot of Nothing

I'm not sure if it's because WMT is no longer reporting monthly same store sales are there are fewer companies reporting across the board, but May results feel like a very small part of the bigger picture at this moment (because they actually are!).  Yes, the majority of companies missed estimates but at the same time the actual results were also generally in line with company guidance. Expectations were a little higher as the trend last month got baked in and the trajectory of recovery appeared to be gaining momentum.  At the very least, May results remind us that volatility can and still exists with consumer on a weekly and monthly basis. 


Check out the two charts below showing sales trends in mall-based vs. specialty apparel and in department stores. The 1 and 2-year comps have been all over the place, but the 3-year (which mitigates issues like weather, stimulus checks, tax rebate timing, etc...) has hardly budged at (-3%) to (-5%).

A Whole Lot of Nothing - Apparel Mall Specialty May Chart


A Whole Lot of Nothing - Department Stores May 2009 


Perhaps the term "stabilization" was used a few too many times over 1Q earnings season.  The trend does remain stable but shorter term upticks and downticks will continue.  The facts is, May is the smallest month of the quarter, inventories remain clean across the sector, and everyone knows comparisons are getting increasingly difficult as we lap stimulus checks. 


In looking at the standouts, of which there are few, there is nothing overly surprising.  Those companies with momentum still have it.  TJX, ROST (the only company to cite weather as a positive), ARO, and KSS are the outliers to the upside.  Not so surprising again in that all of these companies are price-driven, value retailers.


In trying to discern product or regional trends, anecdotes were mixed across the board.  Consumable categories appeared to outperform while home related goods were mixed.  On the apparel side, dresses are still the hot category and footwear remains a positive call out.  The Southwest region was most often cited as being an outperformer while the Southwest was the weakest.  Overall, it sounds like the pricing environment remains unchanged (i.e. no uptick in promotional activity or heavy discounting) and traffic was a just a bit weaker than anticipated.


So the question is, what has changed now that May sales have been released?  Nothing.


Eric Levine


Understanding Why

"Because things are the way they are, things will not stay the way they are."
  -Bertolt Brecht
Arbitrarily we titled two posts yesterday "In search of...."  I know I'm in search of why the S&P is levitating at 931.  Don't get me wrong I'm happy the S&P is at 931, I just want to understand why.
Yesterday, there was some bearish manufacturing numbers and a warning from Federal Reserve Chairman Ben Bernanke that U.S. deficit spending is contributing to higher long-term interest rates.
On top of that the there are also similar indications from senior officials in Germany and Australia that interest rates are going higher!  Guess what, interest rates can only go one way - UP!  
And the reality is they are! Interest rates on 30-year fixed-rate mortgages averaged 5.25% this week, up from 4.81% last week.  The biggest sequential jump since October!  As mortgage rates rise, this leads to a decline in mortgage applications, which suggests the good news on housing has peaked too.
On top of that you can only conclude that there are a number of factors that are likely to continue to weigh on consumer spending; a weak labor market, a decline in consumer assets, increased savings rates and tight credit.  All of this should cast a bearish cloud over stocks, yet it has not.  
On this news, the S&P 500 was ONLY down 1.3% yesterday.   Amazing resilience to unsettling trends!
I can't find a company that is going to tell me that they are going to provide guidance to the investment community that will include positive trends for the balance of 2009; and when I ask them about 2010 they just laugh.  How many times have you heard there is no visibility into our current trends!   
As I sit here this morning the futures are looking higher, despite the fact that most retailers will communicate a mixed bag of May sales trends.  As we look at the numbers today we will be "in search of" signs of a second-half economic recovery.  Clearly things are less volatile and bottoming, but it's still not "good."  I guess I'm jaded because I spend every waking moment talking to consumer centric companies that continue to express to me the reality that things are not really getting better for the consumer.    
Coming into Friday's jobs report, we have zero exposure to US equities.  As we said yesterday, Friday's employment report should be less constructive than the last two - which were bullish catalysts for us as we looked for signals that the rate of job losses was compressing.  Now our thesis has become consensus- as is optimism.
Anything less than a relatively strong payroll number can give the bulls something to think about, but who is bullish?  

The Early Look is brief today, because I'm in "search of" good news and I can't find it. If I do find any you'll be the first to know!
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.

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. Utilities underperformed the market yesterday, closing down 1.7%.

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.



If you have read our work for a while you probably know that we have a pronounced bullish bias towards Australia. With significant geographical hurdles and commodity export dependence to deal with, the land down under has consistently shown resilience through the level headed policy of central bankers there through the good times and swift government stimulus actions during the bad.


Today's GDP release for Q1, 0.4%, looks positively robust in the current global environment as order flow from "the client" and government spending have kept unemployment relatively stable, combined with stimulus checks, which have encouraged consumer spending to stabilize.


The numbers also reveals some real pain however, with private investment declining by 1.6% and imports off by over 10% the expectation that the positive overall trend can continue hinges in large part on recovery in the sectors not directly linked to energy, agricultural and industrial commodities to provide confirmation.  While plenty of worrying factors remain (the financial sector continues to be a concern for us with the recent increase in bad loan provisions by major financials, and commercial real estate remains a minefield) the improving housing market and a comparatively robust equity syndicate calendar seem to bode well for the broad equity market.


We continue to like Australia and will be looking to go long the equity market there via the EWA ETF if presented with a favorable entry point. As always our trading will be informed by price action as well as fundamentals.


All props to Mr. Seamus Quick, our man in Sydney.


Andrew Barber




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Lately everyone has been sharing their thoughts on the yield curve with me.  Unsolicited.  PMs, academics, floor traders  -even some of my nefarious journalist contacts.


The general breakdown of these opinions seems to suggest that the more sophisticated your understanding of finance or impressive your credentials, the more likely you are to arrive at a thesis (with complex academic underpinnings naturally) that could support a sustained period at a range close to present levels. Mere mortals tend to expect the curve to moderate sooner and faster, and tend to expect absolute yield to rise more significantly. 


As Keith noted in his morning note today, the Treasury Department sponsored limbo contest on the short end of the curve has literally left depositors bending over backwards to help  fatten margins for lending institutions with the spread between the 2 year and the 10 year above 270 basis points the curve is at its steepest point in living memory.  I drew the chart below to illustrate the current spread in context. The outlying points since 1976 focused on are the spikes in 1992 and 2003 as the flow of cheap money that Chairman Greenspan let loose to combat recession drove spreads north of 250 basis points; while the monster backwardation in early 1980 marks the height of Paul Volcker's assault on double digit inflation.


The obvious initial conclusion that anyone would draw from this picture visually is that mean reversion should have a moderating impact on the slope of the curve. Additionally, any casual observer could reasonably surmise that with nowhere for short term yields to go but up and with the debt to GDP ratio of the US balance sheet continuing to balloon, the fundamental catalyst for this reversion is both clear and present.  The spread between short term treasuries and the target rate has diverged for sustained periods in the past (as well as jumping wildly in the volatile 1982-83 market) so indications from the Fed that rate policy will not change in the near term do not negate these presumptions.


As always, the moment of confirmation for the peak will arrive well after it has passed.  Until then you can continue to feel free to share your view with me.


Andrew Barber



IN SEARCH OF A TOP - spreads


Is the hotel fee business the greatest thing since sliced bread?  It may appear to be in the middle of a strong cycle.  However, when times are tough (now) or even in a recovery period, the fee business doesn't look as invincible. 


Let's take a look at Starwood since Marriott generates significantly more franchise fees as a percent of total.  As shown in the following chart, 51% of Starwood's fee revenue came from base management and some franchisee fees, 20% from incentive fees, 18% from Bliss & "Miscellaneous", and 11% came from amortization of deferred gains on asset sales and termination fees in 2008.  The base management and franchisee fee are high quality revenues that deserve a high multiple, but what about the rest?  Incentive fees will be lower in 2009 and again in 2010 and will take a very long time to recover.  The Spa business is highly cyclical could be permanently impaired in the economic reality.  We're not sure how to value "miscellaneous" but "amortization of gains" deserves close to a zero multiple since it is non-cash and proceeds have already been received.




In the next chart we attempt to break down fee revenue between same store (organic) and non-organic growth.  Same store growth includes contribution from new management contracts except those obtained through asset sales encumbered with management contracts.  We estimate it took 6 years for HOT to regain the prior peak level of core fee revenue generated in 2000.  Obviously, new management contracts this time around could expedite the recovery but beyond 2010 there are some serious hurdles to growth.




While limited new supply is good for hotel owners, the challenging financing environment will make it difficult to grow the hotel fee business.  Non-recourse financing, which the vast majority of hotel owners have used, is a thing of the past.  Most investors will think twice about constructing a hotel if their personal assets are on the hook.  For existing assets, banks are simply looking to reduce exposure. When loans come due or if any technical breach occurs, banks are using it as an opportunity to call part of the loan, regardless of the rate opportunity.  We have seen this on the institutional side, with almost every amendment coming with a mandatory reduction in credit facility size.



Friday's Jobs number looms as delinquency data shows that the pain continues


As it stands today, we have zero exposure to US equities in our asset allocation model.  In particular we have aggressively sold off our exposure to consumer discretionary in the vortex of the recent MEGA squeeze. 


After a good, solid start to June and with the S&P at 930, we have been harping on the theme that "less bad" is different from "good."  We are data driven and, as such, need to see the "good" in the dominant story to cement a bullish conviction. We are not seeing "good" yet.   


Today's, payroll report estimates that another 532,000 workers lost jobs in May.  More than consensus thinking!  This continues to cause trouble for the consumer lending markets, from mortgages to credit cards and everything in between.


About 12% of mortgage loans were delinquent or in the foreclosure process during 1Q09, according to data released by MBA last week, while Federal Reserve estimates put the number at almost 9% on a broader measure of residential real estate loans.   These levels represent the highest recorded, exceeding the levels reached in the early 1970's and follow broad trends in consumer credit, with rising delinquencies in categories like credit cards and car loans showing no clear signs of abating.


 The majority of the foreclosure problems remain concentrated in four states: California, Nevada, Arizona and Florida, where home prices spiked the highest and are now in freefall. According to MBA, these four states alone accounted for 56% of the increase in foreclosure starts.  Anecdotal reports from brokers in those markets report that sales trends appear to have bottomed but are not getting measurably better.


Clearly the housing picture is better than it was in January, but with seasonal inflections, the Obama taxpayer credit for first time home buyers and historically low interest rates any resilience here should be no surprise.


Our zero exposure to US equities is a big statement!  Friday's employment report should be less constructive than the last two - which were bullish catalysts for us as we looked for signals that the rate of job losses was compressing. Now that our 1H thesis has become consensus and the seeds of optimism have begun to nurture loftier expectations, a signal of anything less than a strong signal of leveling in payroll declines seems poised to strike fear into the hearts of hopeful bulls.


Howard Penney

Managing Director


Andrew Barber






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