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The Dance Of The Veils

"Thou art not listening to me. Be calm. As for me, am I not calm? I am altogether calm."
- Oscar Wilde, "Salome"
The ink is not yet dry on President Obama's proposals for overhauling the financial regulatory system, and already it looks like it is being sidelined.  In order to succeed, this behemoth of a proposal must satisfy two key requirements.  It must materially increase transparency across all markets, and it must address the special interests, so as to hold water politically.  
The largest and most complex financial institutions are those that benefit most from the cloaking provided by regulatory inefficiencies.  This is no secret, and it lies at the heart of President Obama's credibility.  What everyone from the highest levels of government, to the popular media are calling the "interconnected" financial firms are, in fact, the most conflicted ones, and those most likely to balk at lifting the veils.
But lift them we must.  Systemic Risk Czars and resolution authority over large institutions are all to the good.  These mechanistic repairs will plug gaping holes in the system - assuming they are unambiguous as to authority and staffed with the right people - two big "ifs".  But fundamental and lasting benefit will result from Mr. Obama's proposals only to the extent they result in greater disclosure of information, and greater uniformity of that information, for the future of the marketplace rests in transparency.
While the world is still enamored of Mr. Obama, the world is very decidedly not in love with the US model of market capitalism.  This leaves us at a precarious tipping point: on the one hand, we have the moral momentum of a new President with the world's backing to force dramatic change.  At the same moment, we are the inheritors of what the world considers a failed and discredited model.  The press today is referring to the reigning "Anglo-American" market model that the entire world has definitively rejected.  
This explosive convergence - damning failure of our market model, coupled with the resounding success of our political choice - has created a window of opportunity that is at once quite large, but that will not remain open for long.
We fear that President Obama's power is already on the wane domestically, and the lack of muscularity in his White Paper proposals will not be seen by the world as hope they can cling to.
While the markets are being roiled by fits of economic uncertainty, we fear that regulatory uncertainty will prove to be most devastating of all.  If the United States does not lead a massive charge to restructure the oversight of financial markets, the certainty is that fragmentation will rule for some time to come.  Then markets will not be able to coalesce into a global engine for recovery for transnational capitalism.  Rather, countries with closed-off markets and tightly controlled economies will assert themselves, both regionally, and in those markets where they have clout.
Think China, which has replaced the Dictatorship of the Proletariat with dictatorship of the Bourgeoisie, and which controls enough US dollars to dictate the direction of our hedge funds industry.  Think Russia which, now that oil has struck a speed bump, may need geopolitical unrest to restock its coffers.  Think Europe, whose low-octane capitalism has not managed to drag itself even to the level of indecision of the US, and that will hobble the engines of growth with a Vonnegutian web of regulation.
Think how quickly political unrest can rock the cradle - or how quickly it can be snuffed before it even draws breath.  We have another hour to show real leadership.  Bland as much of Mr. Obama's proposals are, they will be seen as meaningful if he attacks Congress, Wall Street and industry with a muscular and even-handed ruthlessness to make the plan a reality.
Alas, it looks as though President Obama intends to throw the overhaul of the financial markets to the political process.  Already we hear talk of the all-important health care and global warming bills before congress.  Already, our expectations are being managed to a certainty that the debate on financial markets reform will not even begin before next year.
While there are indisputable social and economic issues to be addressed in the areas of health care and the environment, every day we put off definitive changes in our financial markets, we lose credibility and stoke anger worldwide.
Obama's promised reform - the one with immediate global implications - will be eviscerated before the debate even starts.  By placing what will be perceived as domestic initiatives ahead of market reform, Obama is paradoxically signaling to the world that the Business of America is Business as Usual.
Be afraid.  Be very afraid.

Moshe Silver
Chief Compliance Officer


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 of 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.


BBBY: P&L/Balance Sheet Synch

It's rare to see a sales/margin/balance triangulation set up as well as with Bed, Bath & Beyond. The graph tells all...

BBBY: P&L/Balance Sheet Synch - BBBY Sigma


Yes, It's confusing, I know.

If you need interpretation, shoot me an email.

Greek Goddess of Duration


Greek Goddess of Duration


You might think I am nuts, but I'd call this an in-line quarter. Puts and takes ignore the real call - but that's a full year out. If the market shoots first and thinks second, a sell-off might = opportunity.


I'm sitting here staring at my keyboard wondering what to say about Nike's quarter. The sell-side will talk about how 'management is executing in a tough retail environment' (while Analysts take down numbers and justify ratings), or that we are in a 'swoosh-shaped recovery'.  But I'm coming up dry. You're gonna think I'm nuts, but despite management's cautious tone and guidance, I really think that this Q was right in line. Yes, NKE beat by a couple pennies, and yes, the numbers Nike is printing in light of 1) its reorg and 2) the economy are commendable. But on the flip side, orders are down both sequentially and yy nearly across the board. Inventories have stopped rising, which is great, but receivables and payables went the wrong way. The balance sheet still looks stellar, but not buying any stock in the quarter is a negative.  Put, take, put, take...blah blah... I could go on, but these items add up to one big push in light of what the REAL call should be.


I'm going to tie this all back into my thesis that with Nike, we're in a period where you simply can't look at a few points either way in inventories, futures or EPS. It's pretty irrelevant in the grand scheme of this story. Nike is setting itself up today for one of those massive bursts where futures take off, inventories contract, and we're looking at 20-30% EPS growth. The bad news is we won't see this until fall 2010. Even if the market starts to discount this 2 quarters out, we've still got to wait a year.  Check out my note from 2 days ago titled 'Duration, Duration, Duration.' If you can be a year early on a stock, then knock yourself out here. But my sense is that we're looking at a range bound name for the better part of a year. I walk through why in my 'Duration' note.


What could change near-term?  The Street may or may not know. But Nike's CFO just sandbagged them big time. If we're looking at $0.20-$0.30ps reduction in consensus estimates heading into lowered 1H10 (May) guidance, then I'd be prepared to be nimble on this sucker if it sells off into the mid $40s.

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CKR - Is Management Changing its Tune?


In today’s FY1Q10 press release the company made a very significant announcement about a potential value initiative.  Please see today’s post on SONC as a case study on the P&L impact when a company goes after a value initiative.

CKR’s period 5 same-store sales declined 7.1% at Carl’s Jr., accelerating the 2-year average declines at the concept to -2.3% from period 4’s -1% and fiscal 1Q10’s -0.6%.  The company blamed the weak California economy and the lapping of last year’s stimulus check spending for softness in sales.  Although these factors most definitely impacted numbers, Carl’s Jr.’s same-stores sales continued to underperform its QSR peers that are facing the same issues.  Carl’s Jr.’s underperformance stems from the company’s adherence to its premium menu strategy.  CKR’s recent press releases are loaded with comments like “not resorting to deep discounting practices designed to boost same-store sales in the short-term” and being “prepared to ‘tough-it-out’ to protect brand image.”  This premium brand focus, however, has not worked and sales have suffered as a result.  Like SONC said yesterday, value is the number one driver of traffic in this environment.

CKR announced last quarter that it would add some lower priced products to its menu but that it would not use media support for these lower priced items.  In today’s quarterly earnings release, the company said it “intend[s] to launch initiatives that increase the awareness of the value of our premium products relative to casual dining as well as our existing value items that we have previously only promoted in the restaurants.”  The key word in that sentence is "previously" as it signals that the company will begin to promote these value items outside the four walls of its restaurants.  Although I am sure the company will downplay the significance of such a change in strategy as management seems proud of its having not succumb to the deep discounting tactics of its competitors, this is a definite change in strategy, and a welcomed change as Carl’s Jr. significant same-store sales declines are evidence of recent share losses.  Too much focus on value could hurt margins, but not getting enough customers in the door will have the same impact.  The question is will management change its strategy enough to really drive traffic?

CKR - Is Management Changing its Tune? - CKR Carl s Jr Period 5 sales


BBBY: One Word...'Solid'

One word: Solid


Ok, a few more words...


BBBY reported 1Q EPS of $0.34, substantially ahead of the Street which was looking for $0.25.  Our model was looking for $0.27.  The beat came on all three key line items.  First, same store sales came in at only down 1.6%, about 80 bps ahead of the Street.  We were looking for down 2%.  Gross margins were much better than expected, down only 44bps vs. our model which had them down 80bps.  Sequentially the performance was better than 4Q. This further indicates the real opportunity in the near term from the Linen's liquidation still lies with a more benign promotional environment and fewer coupons.  SG&A was much better as well, with the expense ratio down 163 bps.  We were modeling a slight decline.  Finally, the balance sheet was solid with inventories down just over 1%, against total sales that grew by 2.8%.  Still no debt and a growing cash balance now standing at $855 million.  With almost $900 million remaining in share repurchase authorization, perhaps we'll see some activity there as the cash generation accelerates.


Bottom line here is solid outperformance with all of the key metrics coming in better than expected.  I still believe there is more upside to come as the year progresses and the couponing subsides.  To report a down 1.6% comp in what most would consider a very tough environment for home-related products is a standout on its own.  EPS growth of 14% is also a rare commodity these days.


 Our thesis here remains unchanged.

  • Over the next 12-24 months BBBY is a "mean revision" story, driven by an improving economic backdrop, the elimination of the company's most direct competitor, and the bottoming of the worst period in modern history for home furnishings consumption.
  • Gross margin recovery is the most overlooked item by the Street and the source of upside over the near and intermediate term. A more rational promotional environment driven by Linen's absence is key to the story.
  • Modest square footage growth of 5% coupled with operating margin recovery should drive FCF growth in excess of 15% over the next 2 years. Cash flow yield remains attractive at 6.1% ('09) and 9.0% ('10) respectively.
  • Multiples are full, so this needs to be an earnings-driven story. The good news is that the Street's numbers are 1-year behind. $0.25-$0.30 beat per Yr1 and Yr2  x current multiple = $5-$6 in share price/yr.


Eric Levine



Export data released by the Japanese customs office today showed a decline of 40.9% year-over-year, lower than consensus estimates and a sequential decline from last month's figures.


Critically, May exports bound for China registered under 5% of Total exports -the lowest percentage in over 20 years. Although the Japanese auto manufacturers and other durable goods producers are participating in "the client's" recovery financially through joint ventures, the reliance on higher margin North American and European markets continues to keep domestic assembly lines stalled.

With job security still weighing heavily on domestic consumers and nowhere for rates to go but up, we continue to see Yen weakness as the sole near term positive catalyst for Japanese manufacturers as they grapple with stagnant customer markets.

Andrew Barber


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