Slouching Towards Wall Street… Notes for the Week Ending Friday, June 19, 2009

To Our Readers

With this week's offering, we announce a change of title - reflecting the challenges in the new regulatory reality.  We launched last year with a weekly oversight of anomalies from the world of regulation, taking our lead from then SEC Enforcement Chief Linda Chatman Thomsen's tip-off to Morgan Stanley, where she commented on an ongoing SEC investigation.  ("Smoke, but no fire...")

We are now staring down the barrel of the loaded gun of new global regulation.  This gun, as we have experienced repeatedly, fires exploding bullets, and the collateral damage is generally far greater than the damage caused to the target itself, even when hit square on the bull's-eye. 

For the record, these bullets are called "dum-dums".  We encourage you to bear that in mind during the coming debate over increasing government regulation...

This week starts what is likely to be a long and messy slog through an extended global process of re-regulation.  We open by asking - with apologies to William Butler Yeats -


                    What rough beast, its hour come 'round at last,

                    Slouches towards Wall Street to be born?


Tim Marches On

 Markets can remain irrational longer than you can print money.

                   - Anonymous

It is a platitude of the money management business that "the art of managing money is the art of having money to manage."  The new-century corollary might be aptly expressed as, "the art of managing an economy is the art of having an economy to manage."

President Obama is trying to rescue America's economy, and the world's.  We must surely all wish him success.  While there is much to discuss in his proposal, we are taken by the political posturing around the enhanced role of the Federal Reserve as overseer of the largest and most interconnected financial firms. 

Members of Congress claim that the Fed was at the core of the disaster and that it should not be rewarded with expanded powers.

The Fed is already one of the most influential institutions on the planet and, while it enjoys a certain continuity from Chairman to Chairman, and from Presidential Administration to Administration, it may not be accurate to portray the Fed as monolithic in the same way as, say, the great sports franchises are.  One might say it is not "the Fed" that wrecked the financial markets.  The failure at that institution can be traced to one person - to one moment.

To Alan Greenspan when, in a speech in March, 1999, he declared "By far the most significant event in finance in the past decade has been the extraordinary development and expansion of financial derivatives," and that the functioning of the OTC derivatives markets without regulation, "provides a strong argument for development of a less burdensome regime."  Shortly thereafter, Chairman Greenspan led the gang-trashing of CFTC Chair Brooklsey Born for suggesting that the dark market of OTC derivatives should be regulated.

This underscores the true nature of what we are facing: that successful regulation of the financial markets depends more than anything on the sound assessments and actions of those charged with oversight.  Had any one of the Gang of Three - Greenspan, Rubin and Summers - voiced a strong demur, it might have brought a different outcome.  Going forward, we urge the Administration to remember that all the regulation in the world is not proof against poor judgment. 

The Fed's hand is now formally on a seemingly inexhaustible spigot of Federal bailout money.  The institutions that the government financed in the past year - from General Motors to Citi - were considered all but independent empires.  Now we are in what may be a generation-long spiral of calculating how many years before we break even on the trillions we have TARP'ed and TALF'ed and PPIP'ed down the drain.

President Obama's plan, by establishing a regulatory category of "Tier I FHC's" (Financial Holding Companies), seeks to enshrine in law the accidental concept of Too Big To Fail.  Were you afraid an Obama Administration would mean rampant socialism?  This is Bushian Corporate Socialism taken to its logical endpoint.

"We should be able to do business with the Federal Reserve -" says one banker (Financial Times, 18 June, "Wall Street Says It Can Do Business With Federal Reserve") "as long as all these new powers do not go to its head."

In what other part of Secretary Geithner's anatomy might they take up residence, then?  Because it is Tim Geithner, and not some amorphous entity called "the Fed", who will call the shots.

Fed Chairman Bernanke's term expires at the end of January.  The choice of a new Chairman, or the decision to reinstate Mr. Bernanke, will doubtless be taken by President Obama in intimate consultation with Secretary Geithner.    As we move forward through the Sargasso of this debate, keep your eye on the degree of power this process will hand to Secretary Geithner.

We applaud President Obama on two counts: first, this is his proposal, meaning he stands to reap the praise for any successes, and he will be targeted for every failure or inefficiency that proceeds from this document.  Second, the President has thrown considerable support behind Secretary Geithner.  Whatever one may think of Mr. Geithner, anything less than full and public support for him at this moment would be tantamount to eviscerating him.  President Obama has voiced the courage of his conviction.  We can only hope that his confidence will turn out to have been well placed.

Speaking on Bloomberg television last week, former SEC Chairman Arthur Levitt voiced the belief that President Obama and his team had thoroughly sounded out opinion - both industry and legislative - before announcing this proposal, and that it would likely pass through the legislative process largely intact.   On the eve of Secretary Geithner's testimony, Senator Shelby piped up and said "Haste is dangerous, especially when you are dealing with comprehensive change in our financial system."  (WSJ 18 June, "Historic Overhaul of Finance Rules").  He has since expressed himself in terms that boil down to "Not so fast!"  It remains to be seen whether President Obama has truly pre-sold this critical and vast program to key players in Congress - or if, like the Bozogate surrounding his cabinet appointments, the President and his entire staff are actually clueless.  Time - and probably very little of it - will tell.

By formally establishing "2B2F" ("Tier I FHC" = "Too Big To Fail") President Obama's proposal guarantees there will be another Citibank, another Bear Stearns, another Bank of America.  But not another Lehman.  Rather, every major, poorly managed and highly interconnected financial firm now stands to be given financing.  Taxpayers, get out your wallets.  Under the proposed new structure, the emergency authority to rescue the 2B2Fs rests with the Fed, but subject to approval by Treasury.  In other words, Secretary Geithner will have legislative authority to take steps that his mentor and predecessor - Secretary Paulson - took only with gritted teeth and by sheer force of his character.

And, like the TARP money - we still don't know where it is - we do not see a black and white guarantee built into the proposed legislation to track down which drains and rabbit holes that new money will disappear.  President Obama has taken the extraordinary and emergency measures forced through by Secretary Paulson, and written them into a proposed new body of law, possibly complete with the barefaced lack of accountability.  The swilling of the next several trillion dollars of taxpayer money down the Johnny-flusher will be at the sole discretion of Timothy Geithner.

President Obama is seeking to write Moral Hazard into law.  In doing so, he has a lot riding on the skill and talents of his Treasury Secretary.  We wish we could be as sanguine.

(This might be the moment to point out that Brooksley Born received this year's John F. Kennedy Profiles In Courage Award, in recognition of her political courage in calling attention to risks in the derivatives markets.  We do not believe she received a congratulatory telegram from Mr. Greenspan.)

Secretary Paulson came to Treasury after one of the most successful careers in the history of finance.  Tough, smart - ruthless of course.  But also a prudent steward of his firm and its legacy, Hank Paulson brought a lifetime of successful deal making to the office of Chief Deal maker - and when crunch time was upon him, he forced a resolution.  To their great and lasting surprise, Congress was hopelessly outclassed.  When Paulson acted - agree with him or not - he got results.

Secretary Geithner, you are no Hank Paulson.


Into The Secret Garden

Whoso breaketh an hedge, a serpent shall bite him.

                   - Ecclesiastes 10:8

The United States is the only country with developed financial markets that does not require money managers to register with a national regulatory authority.  Taken on its face, President Obama's proposition to require hedge fund registration should be seen as, at worst, benign.  It will add a level of transparency designed to give future investors comfort - and transparency is really what has been lacking from the financial system.  The fact remains that, with the exception of outright criminal activity, the disasters in which hedge funds figured prominently were largely the fault of those regulated institutions, the commercial banks and brokers, who lent them money without performing their own due diligence.  In so doing, the brokers in many instances raised their own exposure to far greater levels than the hedge funds.

Hedge funds carry average leverage of under four times their assets.  This is a far cry from the brokers that had gotten up to stratospheric ratios of 30:1 leverage and beyond.  One simple reason is that hedge fund managers almost always have "skin in the game," and if they risk their investors' money, they risk their own alongside it.  Brokers, on the other hand, are tied to Wall Street's traditional compensation model, where executives justify their own paydays because of the "value" they bring to the firm.  When things work out, they take credit.  When things go wrong, they blame everyone else.  Or - this is our favorite howler - "adverse market conditions."  Is it any wonder that, from the rest of the world's perspective, corporate America looks like North Korea?  Average workers are paid small hourly wages, while senior executives make literally hundreds of times the annual compensation of workers on the shop floor.  Bankers are paid gargantuan fees by these CEOs in return for lending the corporations money at exorbitant rates, or are given cash plus stock in return for selling the company to someone else who will fire half the employees.  When firms lose money, CEO's take multi-million dollar bonuses, and hourly workers are laid off.

We are resigned to hedge fund registration.  We urge you to embrace it, too, as it is now as inevitable as tomorrow's sunrise.  The first problem - and it will be significant - is the manner in which this will be implemented.  Regardless of whether ultimate registration authority rests with the SEC, FINRA, or the individual States, the regulatory agencies do not possess the resources to handle the deluge of paperwork this requirement will unleash. 

If Chairman Schapiro reads this column, we offer the following recommendation.  The registration process should be staged, starting with the smallest firms, and leaving the largest for last.  This is because the largest firms are by and large the most transparent and the most widely watched.  In fact, some of them, such as Fortress, Blackstone and Man Group, are publicly traded.  If frauds are being perpetrated at these institutions, a new registration requirement is not likely to uncover it because guess what? - they are smarter than your people. 

Small operators may not provide increased regulatory fodder, as even truly small hedge funds - those managing $25 million or less - are generally careful about their compliance programs.  But from the perspective of gathering information, the SEC - and we believe it will be their bailiwick - should start with those firms not yet on the radar.  This will create a database that does not yet exist, and it will provide valuable training for examiners, as well as streamlining the process, as the Commission moves up to larger and more sophisticated operators.

Oh, and by the way, those really big hedge funds - the threshold is not yet clear - will be under the new Financial Services Oversight Council, to be constituted of the heads of the major financial and bank regulatory bodies.  Did you guess who is going to be chairing this council?  If you guessed Tim Geithner, you were right.

In the Odds 'N' Ends pail, we are told that government will eliminate systemic risks posed by the Tier I FHCs - firms that are now officially Too Big or too interconnected to fail - but we are not told how this is supposed to be accomplished.  The conflicts inherent in the Ratings Agencies business are left largely intact, particularly the issuer-pay model.  There is to be a new Resolution Authority to take over and wind down failed financial institutions.  But juxtaposed with the new 2B2F status - and the political pressure that is sure to be exerted as the 2B2F's start to teeter - we wonder when this resolution authority will ever actually be implemented.

At the end of the day, we generally agree with the assessment of Joe Nocera in the New York Times (17 June, "Only A Hint Of Roosevelt In Financial Overhaul") "Firms will have to put up a little more capital, and deal with a little more oversight, but once the financial crisis is over, it will, in all likelihood, be back to business as usual."

We note that the banks which, this week, paid back the TARP money to great fanfare were institutions Secretary Paulson had forced to take the funding, so that they might be brought under the accompanying restrictions with respect to executive pay and government meddling in general.  It is thus no big news that Goldman and J.P. Morgan, for example, have repaid the money. They never needed it in the first place.  Is this regulatory smoke and mirrors?  You decide.

Our investment thesis for the New Regulatory Reality: go long lobbyists.

As Yoda might say - Good on paper it looks.



ETFs: We Don't Want To Say We Told You So...

Well, actually we do.

The Wall Street Journal (16 June, "A Volatile Mix: Natural Gas, ETF") reports "assets in U.S. Natural Gas Fund recently swelled to almost $3.7 billion from about $670 million in February, even sparking fears it could be disrupting the futures market."

For the first time, price movements in ETF shares appear to be affected by trading in the instruments themselves, and not in the underlying index or futures contracts. 

This calls into question the key underlying concept of the ETF model - that the ETF tracks the underlying instruments and is not affected by other ETF traders.  The other piece of news is not new - that the ETF causes disruptions in the underlying markets.  Indeed, this effect has been observed in the past, but generally pooh-poohed by market participants.  Unless, of course, those participants were senior executives of the stocks underlying the indexes on which the ETFs traded.

The ETF has submitted a request to the SEC for substantial new flexibility, asking for a tenfold increase in shares available for issuance.  In the current regulatory climate, we do not look for quick relief from the Commission.


Chinese Double-Down

Pretend inferiority and encourage the arrogance of your enemy.

                   - Sun Tzu, "The Art of War"

The China Investment Corp - China's sovereign wealth fund - is publicly talking about making significant investments in Western hedge funds, starting with $500 million in a hedge fund unit of Blackstone.  The Wall Street Journal (19 June, "China Ready To Place Bets On hedge Funds") reports "CIC is considering opening its checkbook to a handful of hedge funds, a move that comes as CIC Chairman Lou Jiwei is concerned his fund may miss opportunities near the bottom of the market, according to people who work closely with the Chinese fund."

Miss opportunities?  Is this the same kind of opportunity that, as the popular saying would have it, is written with the same Chinese character as their word for "Crisis"?  The WSJ article goes on to point out that Chairman Lou has refrained from investing in Western financial institutions because "we don't know what trouble they are in."

Why, then, would they be making these investments now?  To us, the answer is obvious: China has too much of our money. 

In the global environment that spawned the Yekaterinburg summit, it should be clear that China has few trade partners with whom it can swap its vast supply of dollars.  Far from a vote of confidence in the American financial system, this looks like a desperate play by those responsible for China's global investment portfolio.  One can almost hear them, as they turn the billions over to us... "you got us into this mess.  Now get us out!"


Worth A Thousand Pictures

From the Wall Street Journal (19 June, "Prison Term for Murder Of Financier").

"A Swiss court sentenced the former lover of French financier Edouard Stern to 8 ½ years in prison for murder after she confessed to shooting him during an argument while the two were having sex and he was tied to a chair in a flesh-colored latex bodysuit."

Almost makes you forget about Iran for a moment...

FINL: Man Alive Deal = No Brainer

It's about time. FINL is finally jettisoning its perennially money-losing 'Man Alive' business for $7mm. I could care less about price at this point. All I care about is that the distraction is gone. This concept worked for only a fleeting moment - unfortunately that was around the time FINL bought and build it. It lost $13mm last year, which nets out to 1 point in operating margin. Does not sound like much until you take into account that the company only had 3.2% operating margins last year. Man Alive hurt EPS by 32% last year. What's funny is that the Street has FINL EPS growing by only a dime over 12 months. But add back the Man Alive loss or $0.15, lower interest expense, and more efficient working capital, and I get to something closer to $0.20. So using the Street's $0.58 next next year as a baseline, this math nudges that closer to $0.78. In that regard, we're still looking at less than 10x EPS for a more focused business with higher incremental ROIC. This name had not been at the top of my list despite my positive stance on the footwear space due to a tougher 2H setup relative to its peers. But even after today's 6% move it's not looking too shabby...


FINL: Man Alive Deal = No Brainer - 6 22 2009 10 33 35 AM

Retail First Look: 6/22/09


Am I the only one who feels like the chamber is locked and loaded, and the Retail gun is waiting to shoot - but it simply does not know in which direction?  The group was down less than 1% last week, tightly tracking the broader market after a blistering 40% (2.5x to 1) run vs. the S&P. Yes, the stocks have finally stopped going up on good news, but even with all the incremental data points about how weak sales have been over the past 3 weeks, the group is largely looking through it. At 15.5x forward earnings? That does not leave me in my comfort zone.

 I think the crux of it all is that 'the E matters.' I know I said this last week, so I hate to be repetitive. But after being on the road for a few days one of the dominant themes that came out was that people are - without a doubt - looking into 2010. But don't seem to delineate between companies that are proactively making decisions right now to drive 2010 growth and earnings (UA, RL, PSS, WSM), versus others that are cutting SG&A and Capex for the wrong reasons and will be left with little to stand on in 2010 when they need it most. Those will set up to be the best shorts. I've got my eye on easily half a dozen (WRC, JNY, GIL, Adidas - to name a few) - but it is early. Anyone can print good numbers if they so choose, but at what cost?



Key calendar events to look out for.

  • Deutsche Bank - German Austrian Conference, Frankfurt June 23, 2009 - Adidas participating



Some Notable Call Outs

  • Embedded in Carmax's first quarter results were some interesting trends.  SUV sales were up 7% year-over-year, rebounding off of weakness last year when gas prices were still very high.  Compacts, mid-size cars, and trucks decreased by 5% for the quarter.  Interestingly, following the Chrysler bankruptcy, residual values and sales volumes on used vehicles remain unchanged.
  • According to the NRF, Americnas spend an average of $130 on Mother's Day gifts compared to $90 for Dad.
  • While Yue Yuen posted solid interim 2009 results owing to stable demand from brand name customers, further consolidation in the footwear manufacturing industry, and strong domestic sales, the company highlighted a 1.6% decline in sales in the first two months of the 3Q. Should top-line results end up down in Q3, it will be the first time in over 5 years, since March '04. 
  • Smith & Wesson management remarked in its updated Q4 results that demand for handguns and rifles remain strong as evidenced in their growing backlog; however, Barron's suggests the FBI's National Instant Criminal Background Check System reveals slowing trends for background checks suggesting fewer gun sales. While there is no doubt that post-election gun demand has fueled earnings growth, the acquisition of Universal Safety Response is critical to diversifying the company's earning streams and should therefore be less effected than it's close competitor Ruger (NYSE: RGR) when demand wanes.  (call at 5pm today)



ZachHammer's overview of items you're unlikely to find in the general press.

  • Changes in the bankruptcy code have complicated the quest for retail reincarnation - and the evaporation of financing in the past nine months has made it even harder. Since the rewriting of the bankruptcy law in 2005, debtors are in a race against time with a 120-day period to file a plan of reorganization (and the possibility of a 180-day extension) where debtors have an initial 120-day period to assume or reject leases. Previously, there were unlimited extensions to both time periods, as well as more lenders ready to work with the debtors. So now retailers have to make business decisions as soon as they file, and often don't get the chance to operate through the crucial Christmas selling period to determine if they've made the right decisions. If one isn't likely, they've usually pushed for a liquidation, Gottlieb said. Just ask Steve & Barry's, Mervyns and Gottschalks. <>
  • The German state of Bavaria has agreed to grant financial aid to the struggling Quelle catalogue business, a subsidiary of the insolvent Arcandor Group. Bavaria agreed to contribute 21 million euros to a planned government guarantee of 50 million euros, or $69.5 million. Quelle currently lacks the funds to print its fall-winter catalogue and to secure orders; Bavaria's 21 million euros would cover the catalogue costs. <>
  • Carrefour to Sell or Close 20 Express Stores in Poland, Parkiet Reports - Carrefour SA, Europe's biggest retailer, plans to sell or shut more than 20 Carrefour Express stores in Poland, Parkiet reported, citing Maria Cieslikowska, spokeswoman at Carrefour's Polish unit.  <>
  • Footwear News, total 2008 pay packages for the highest-paid footwear executives rose 13 percent in 2008, though at a slower pace than the prior year's 14 percent growth. On average, management at the 26 publicly held retailers and vendors tracked earned total pay packages of $3 million last year versus $2.6 million in 2007. The increase was attributable to employment contracts put in place years ago, when business was brighter, guaranteeing their 2008 salary. <>
  • Sperry Top-Sider's famous boat shoe is celebrating its 75th anniversary in 2010, but executives at the brand are hoping a strategic growth plan will drive sales far beyond next year. Sperry has spent the last 18 months expanding into new markets, introducing new performance technology and growing the women's mix. More specifically, the brand has solidified product and marketing in three areas: American Original, Authentic Performance and Enduring Style. <>
  • A growing number of footwear brands are committed to "greening" their products, but with an increasingly fractured supply chain, guaranteeing the sustainability of every component, process, and source is no easy feat. Earlier this month, environmental watchdog group Greenpeace released a report (covering 2005 to date) saying that illegal hides were making their way into the footwear supply chain - and mentioning Adidas, Gucci, Nike, Timberland and Clarks as potential, possibly unwitting end users. The report, "Slaughtering the Amazon," alleged that some leather sourced from Brazil originated on illegal cattle ranches in the Amazon rainforest that contribute to deforestation.  <>
  • Erke, the Chinese tennis apparel company, has reached an agreement to become the designated apparel supplier for Shanghai ATP 1000 matches during 2009-2013. The Shanghai ATP Masters 1000 tournament, which will occur around October each year, is second only to the world's four Grand Slam tennis tournament and regarded as the top tennis tournament in Asian region. <>
  • Spending, Home Sales in U.S. Probably Rose as Consumers Gained Confidence - Consumer spending in the U.S. probably rose in May for the first time in three months and home sales increased as Americans became more confident the recession will end this year, economists said before reports this week. <>
  • Kurt Geiger has inked a licensing and distribution deal with US footwear firm Nine West just one month after the US firm severed ties with its former UK partner Shoe Studio Group. <>
  • Skechers recently ran a variety of display advertisement campaigns. It opts to use the services of ad networks to place ads on thousands of sites aggregated by the ad networks across the Internet. For this select group of campaigns, Skechers achieved a 283% return on ad spend, $2.67 million in revenue and 172 million ad impressions. <>
  • Traffic falls or is flat at top three home and garden retail sites in May -It seems fewer consumers spent time and money cultivating their lawns and gardens in May. As a result, the top three home and garden e-retailers cultivated poor traffic numbers last month. <>
  • Product sales of the 2009 NBA Champion Los Angeles Lakers have surpassed previous championship merchandise sales at New York City's The NBA Store and Lakers' product sales more than doubled last year's sales within the first two days after the team won its 15th title, reported the retailer. Meanwhile, adidas and Wheaties have introduced a special-edition Lakers champions T-shirt, featuring a picture of the commemorative box with the entire Lakers' team. <>
  • Ahmedabad, India (popularly known as the city of textile industries) has become a robust retail destination quite recently with the launch of five malls in quick succession. The city has also been witnessing a series of infrastructural development and has already emerged as one of the most promising cities in the country in terms of economic prosperity. The city formally witnessed organised retail boom with the launch of 3.24 lakh square feet Gallops Mall, followed by Himalaya Mall and the trend is enhanced when 4.5 lakh square feet Iscon Mega Mall on SG Highway opened its door for brands including Tommy Hilfiger, Giordano, Esprit, Westside, Benetton, Wills Lifestyle, ColorPlus and Reliance with Mega Mart as one of its anchor tenants, the shopping behaviour of the local residents are getting transformed.  <>


RESEARCH EDGE PORTFOLIO: (Comments by Keith McCullough):


06/19/2009 10:33 AM


My team has done plenty to signal our turning negative on consumer in the last week. Being patient on price was my responsibility. Selling high today. KM



Retail First Look: 6/22/09 - Calendar

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If MCD goes after the premium segment in August, it will not be good for CKR

According to the Chicago Tribune (they always seem to get internal company documents), the premium Angus burger will be rolled out in August. The document refers to a national launch for the one-third-pound Angus burger between Aug. 3 and Aug. 30.

McDonald's began testing the burger in Southern California in March 2007. It is made from made from a higher grade of beef than other McDonald's burgers and it will become the most expensive U.S. sandwich on the menu, priced at about $4.

Last fall management said they wouldn't roll out the Angus nationally in a weak economy. Lower beef prices are likely the reason for the launch. Don Thompson told the franchise community that the Angus is a "Big Opportunity" because beef costs are down. This could also mean that McDonald's can introduce the product with lots of coupons to stimulate trial. You can see it now, a coupon for a free latte with the purchase of an Angus to boost McCafe sales or vice versa!

I see this as being a big negative for CKE Restaurants (CKR). While the Angus burger has been in Southern California since 2007, a more aggressive approach to the pricing of MCD's premium product will hurt Carl's Jr. As it is, Carl's Jr. is already struggling with its premium pricing strategy and MCD is not going to make it any easier.

Lastly, I have not seen a QSR chain generate incremental traffic by introducing premium products.

As an aside, I'm starting to see a lot of ads for the MAC snack wrap....... Now this looks good to me!

McDonald's - GOING PREMIUM - macsnack



The tourism authorities of Macau and Shenzhen will carry out joint promotions in Taiwan, South Korea and Japan in 2010. In July, the two tourism authorities will meet again to discuss details about the establishment of a mechanism for management of tourism and information exchange. The two sides also agreed to publish a joint brochure to promote Macau-Shenzhen as multi-destination.

In 2008, Macau received 22.9 million tourists and Shenzhen roughly 60 million both foreigners and Chinese.


The financial crisis has brought significant cuts to the number of flights serving Macau, as carriers struggle to respond to the massive drop in cargo volumes and passenger traffic. 

China Eastern Airlines has cancelled all of its scheduled flights to and from the gaming hub in the first three months of the year, compared with an already dismal 67.7% cancellation rate in the second half of last year, figures from the Macau Civil Aviation Authority show.

In the first quarter, Fujian-based Xiamen Airlines slashed 59% of Macau flights, with Malaysia Airlines and debt-laden East Star, a private carrier, cutting 38% and 40% of their Macau flights, respectively.  Troubled carrier Air Macau cancelled 9% of its flights in the first quarter.

Aviation Authority president Simon Chan Wing-hung said, in a written reply to local legislators, that the cancellations were not solely caused by the effects of the financial crisis.  Mr. Chan also points out that the increase in the number of flights between the mainland and Taiwan had an effect on Macau flights.

In the first four months of the year, passenger traffic in Macau fell 21.7 per cent from a year ago, while cargo volumes plummeted 65.7 per cent, according to figures from Macau International Airport. Aircraft movements have declined 22.4 per cent over the same period.


Macau's Department of Health confirmed another two cases of swine flu over the weekend, taking the total of infected people in the territory to three.  One of the new cases was a female flight attendant from Viva Macau that flew to Sydney, Jakarta, and Tokyo between June 16 and 18.  The second case was detected at Kiang Wu Hospital, a private healthcare unit in Macau, and was a 54 year-old man who had recently stayed in Toronto for 17 days.

Despite the third confirmed case, the level of alert remains on "five" as all cases so far have been imported from abroad.


Ng Sek Io and Lei Kin Iun have teamed up to run for the Legislative Assembly's directly elected seats. The two delivered their voters' signatures to the Public Administration and Civil Service Bureau (SAFP) on Friday to confirm their legitimate existence but the list of candidacy has not yet been confirmed, according to the Va Kio Journal.

Ng Sek Io, the director of the United Free Union of Gaming and Construction Workers of Macau, told Macau Daily Times via the telephone that he will probably be the first candidate and Lei the second candidate.

Chasing The Tails

"Dream as if you'll live forever.  Live as if you you'll die today."
                                               -James Dean
We've sent Keith to Scotland for the week to get some rest, smoke a few cigars, and hopefully improve his golf game.  As a result, different members of our research team are going to take turns writing the Early Look this week, and applying our own unique individual lens to the interconnected world of global macro risk management.
Ironically, Keith and I have very different modus operandi when it comes to approaching every research day.  He operates under a strict regimen that incorporates getting into the office at exactly the same time.  My daily process is more based on chaos theory, or is at least chaotic. I get in every day at a different time, take a different route, and read a different collection of articles every morning (my girlfriend calls me the anti-type A).   
Despite these differences, Keith and I have worked together effectively for many years, starting on the hockey rink at Yale, working together at a major hedge fund in New York, and finally building a business that, we believe, is reinventing a broken sell side research model.  We sell our research for a simple fee, produce it real time, and have no conflicts of interests that are ever-present in banking, trading, or a prop desk.  
In terms of how we operate on our Macro Research Team, Keith focuses on the day-to-day grind of the market, while I spend more time thinking and writing about the longer term trends.   As the James Dean quote above implies, Keith manages risk like every day is the last, while I dream about the investment trends of the future.   We call these longer term trends TAILs, and it's my job to chase them.  
A TAIL, to us, is a theme and price that has duration of up to 3 years.  Often ideas with longer duration are less obvious, hence the term tail, which is a statistical term that is used to refer to the extreme area of a distribution.
When we look at the global investment landscape, we see a number of themes that are sitting there out there on the TAIL, these include:
1.       Demographic share taking  - Globally, we are seeing the Middle East and Asia take massive population share and this will only accelerate in the coming years (these regions are growing at 2.0% per annum), as the former Soviet Union and Europe have stagnant population growth patterns (growing at less than 0.5% per annum).  Domestically, we are seeing the emergence of a powerful demographic know as the Millennials (those born between 1), which will be much larger than the cohort before them, Gen X,  given that live births in the U.S. reached 4MM for first time since 1965 in 1985, and have stayed at that level since.  Companies that are positioned for age groups and regions that are taking population share, will inevitably have higher organic growth rates than their peers.
2.       Scarcity of resources - When we think of scarcity of resources, we are referring primarily to oil.  According to the BP Statistical Review of World Energy, from 2004 - 2008 global supply of oil grew at a CAGR of 0.5% and demand for oil grew at CAGR of 0.8%.  Despite massive investment in exploration and production from 2004 - 2008, the supply of oil globally barely budged.  If it were not for the global recession of late 2008 / early 2009, which will lead to an estimated decline of -2.9% in oil demand in 2009, the global oil market would be incredibly tight.  The reality is that the recession has only prolonged the inevitable tightness of world oil supply and demand.  Oil speculators aside, the reality remains that with any economic recovery we will see a tight oil market for years to come with the potential for exponential increases in the price of oil in the foreseeable future.
3.       Potential loss of American dominance - President Obama is approaching foreign policy with a very unique strategy versus his predecessors.  He is reaching out to our perceived enemies such as Iran and militant Islam broadly, and owning up to historical transgressions of the U.S. government.  This policy has the potential to make us look weak and embolden our enemies, or alternatively encourage them to engage in diplomacy, which could hasten the spread of peace.  To date his strategies appear to have mixed results.  On the economic front, China and Russia continue to publicly denigrate the U.S. dollar and questions its dominance.  While on the national security front, North Korea, as of this weekend, is threatening to send missiles towards Hawaii.  Additionally, Iran continues forward with its nuclear program and appears to be suppressing the popular support for Mir Hossein Mousavi despite pleas from President Obama to do otherwise.  The U.S. currently represents roughly 25% of global GDP, therefore any major shift in U.S. economic or foreign policy dominance will have a material impact on the global investment landscape.

Themes on the TAIL are not always actionable, but often accelerate into a closer time frame sooner than we expect.  Chasing the TAILs should be part of any proactive risk management process.
Keep your head up and eyes on the tail,
Daryl G. Jones
Managing Director


EWZ - iShares Brazil-President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt -leading to an investment grade credit rating. Brazil has managed its interest rate to promote stimulus. Brazil is a major producer of commodities. We believe the country's profile matches up well with our re-flation theme.

QQQQ - PowerShares NASDAQ 100 - We bought Qs on 6/10 to be long the US market. The index includes companies with better balance sheets that don't need as much financial leverage.

EWC - iShares Canada - We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's large government recent history, and believe next year's Olympics in resource rich British Columbia should provide a positive catalyst for investors to get long the country.   

XLE - SPDR Energy - We think Energy works higher if the Buck breaks down.  

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.


EWI - iShares Italy - Italian Prime Minister Silvio Berlusconi has made headlines for his private escapades, and not for his leadership in turning around the struggling economy. Like its European peers, Italian unemployment is on the rise and despite improved confidence indices, industrial production is depressed and there are faint signs at best that the consumer is spending. From a quantitative set-up, the Italian ETF holds a substantial amount Financials (43.10%), leverage we don't want to be long of.

XLY - SPDR Consumer Discretionary - We shorted XLY on 6/19 as our team has turned negative on consumer in the last week.  

XLP - SPDR Consumer Staples - We shorted XLP on the bounce on 6/17.   

SHY - iShares 1-3 Year Treasury Bonds - If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.

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.

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.

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