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Retail First Look: 7/2/09


Several analysts are out this morning pumping Aeropostale after seeing the fall assortment. If you want to hinge your investment thesis on the company having the right 'skinny jeans, plaid blazers, and bling' then be my guest. If that's your style then you're probably not reading our stuff anyway.  

But what I'll ask is this... Have you ever heard a CEO or a head of merchandise stand before ANY external constituent and say "boy, our brand new product line really stinks..." In all the years I've covered retail I have not.  

In the meantime, this is a company operating at both peak margins and sales/inventory spread. It's inventory turns defy gravity relative to industry standards (i.e. 3x ANF) and its cash conversion cycle has come down to about 20 days - which is a level that makes it appear as close to a bank as a retailer can conceivably appear to be. I don't want to penalize success, but I scratch my head in wondering how it can get more efficient.  

If you believe in more earnings beats, then you could argue that the current 7.5x consensus EBITDA multiple is actually closer to 5-6x. Still not enough to get me excited, but I won't argue that this is an 'expensive' multiple. But while short interest is not exactly low at 16% of the float, it is down from 37% earlier this year.  

A point I think is most telling is in the sell-side sentiment chart below. Even as the stock lost 65% of its value and then bounced 170% off its bottom, price targets remained within a $5 band of the price at that point in time. There are 30 analysts covering the stock, and not a single 'Sell' rating.  

The bottom line here is that I won't be so close-minded as to say that fashion does not matter. But we need sheer growth in comp and square footage in order to feed this horse. Let's hope that the bling works for Fall.  But neither hope nor bling are part of our investment process. What is part of our process is finding a company where it has something in its DNA that gives it a competitive edge in leading consumer demand as opposed to following it. ARO's inventory turns and speed to market are a plus, but its edge in controlling its destiny is dull.

Retail First Look: 7/2/09 - pt

Retail First Look: 7/2/09 - si



Some Notable Call Outs

- Online-only retailers including Amazon and Overstock have been rapidly dropping their affiliate programs.   According to many state laws, the affiliate programs establish a physical presence in the state in which business is originated and therefore requires the collection of sales tax.  It is widely known that the pure-play ecommerce companies have enjoyed a measurable competitive advantage by not having to collect sales tax.  With budget shortfalls across the nation, it is not surprising that state governments are willing to wage legal battles in an attempt to drive additional revenues.  Net, net this shift in power ultimately hurts the pure play .com companies and levels the playing field for those engaging in a "bricks an clicks" strategy.   The pendulum is gradually shifting back to the traditional retailers and away from value seeking consumers ...

- In a late breaking change of events, CA governor Schwarzenegger vetoed an Advertising Tax bill . This in turn has led Overstock to announce it is not ending its affiliate program in that state. While this is a victory for online retailers, it is also an example of the delicate balance being waged between politics, business, and the best interests of consumers. In this case, the outcome favors not only Overstock, but the small, local affiliates that generate income for themselves and the state.

- Heading into the holiday it's worth taking a look one final time at gas prices as we approach another weekend of heavy driving. After rising for a record 54 days in a row, prices at the pump have subsided each of the past 10 days. The average price of a retail gallon is now $2.63, down from the peak on Father's Day of $2.69. Gasoline was $4.09 on this day last year.

- Add soap and fragrance retailer Crabtree and Evelyn to the list of retailers filing for Chapter 11 bankruptcy protection. The company operates 124 stores in the US and has revenues of $100 million. While we expect M&A to take a breather in the retail space, bankruptcies are expected to continue as cost of capital is on the rise and retailers with thin margin structures have little left to cut on the expense line. 



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

- Overstock ends affiliate agreements in four states over sales tax rules - Following similar moves by two other major e-retailers, Overstock.com is cutting ties with affiliates in California, Hawaii, North Carolina and Rhode Island because of legislation that would require the online retailer to collect sales tax.<internetretailer.com>

 - Ralph Lauren makes more plans with the US Olympic Committee - Polo Ralph Lauren has reached a deal with the U.S. Olympic Committee to dress the American team at the Games in Vancouver this winter and in London in 2012. The agreement, which was signed last month, extends one Polo made with the USOC in April 2008 to supply clothes for the Beijing Games. Polo will pay the USOC a royalty of about 10% from the sale of any items featuring the Olympic seal, according to two people familiar with the matter. For the Vancouver Games, Polo has designed zip-up snowflake sweaters, knit caps and parkas, about half of which will bear its polo-player logo. The athletes will wear the clothes during the opening and closing ceremonies. <online.wsj.com>

- Schuylkill Valley Sports clearing Crocs inventory through donations - Sporting goods retailer Schuylkill Valley Sports, with 18 locations in eastern Pa., recently donated hundreds of pairs of Crocs footwear to four local nonprofit organizations, including Liberty Ministries, the Salvation Army of Boyertown, the Pottstown Cluster of Religious Communities and Cornerstone Church's Give & Take operation. "Crocs worked closely with SVS to enable us to donate close to a thousand pairs of Crocs footwear to local groups," said Phil Baumgardner, marketing director and buyer for Schuylkill Valley Sports. "We are always excited to give back to the local community when we can." <pottsmerc.com>

- Juicy Couture brand has big growth plan - It's been only a year since Edgar Huber joined the Liz Claiborne Inc.-owned Juicy Couture brand as its first president, and he's already made strides in his overall growth plan. Huber has opened several new stores worldwide and has big plans to open more. The ultimate goal, he said, is to develop the Juicy Couture brand, which did $600 million in sales last year, into a multibillion-dollar business. Huber said he's now working with Asian license to open faster - he would like to see somewhere between 45 and 50 stores in China alone. Two Juicy stores in Greece are planned to open in November, five will roll out in Dubai (there are three there already), and he is currently in talks to open stores throughout the rest of the Middle East. In addition, Huber is working on South America, where there is currently no Juicy presence. His plan is to first open in Mexico and then move south into Brazil. In the U.S., Juicy stores are planned for openings this month at the Stanford Shopping Center in Palo Alto, Calif., the Galleria at Roseville in Roseville, Calif., and The Summit in Birmingham in Alabama. In total, Huber plans to open about 25 company-run freestanding stores and 18 outlet stores before the end of the year. <wwd.com/retail-news>

- Wal-Mart shakes up retail with health insurance mandate endorsement - Wal-Mart Stores Inc.'s endorsement of an employer mandate for health insurance shook main street retailers on Wednesday. The move gave momentum to proponents of making the business community help pay for the sweeping, landmark health care reform legislation before Congress, and gave a boost to a centerpiece of President Obama's domestic agenda. The ramifications of Wal-Mart's splash into the political debate over health car:  a battle with other retailers and businesses that have formed a coalition opposing employer mandates and a government-funded insurance option. The National Retail Federation came out swinging against Wal-Mart's endorsement. <wwd.com/business-news>

- China, Brazil, South America, Leather Industry, and plans to eradicate the US Dollar from trade - The financial crisis which hit world trade in 2008 has prompted China and Brazil to search for other ways of consolidating and firming up their bilateral trade. This involves cutting the US dollar out of their two-way trade and accepting reals and yuan for transactions. After Brazil's President Lula da Silva's visit to China in May 2004, bilateral trade between these two countries began to grow significantly. Lula's visit was followed by President Néstor Kirchner of Argentina in June of that year and then President Chávez of Venezuela followed suit in October. South America was making a conscious effort to penetrate China's huge market and also open the door for reciprocal Chinese investments. There are signs of recovery in demand for all Brazilian exports to China. This recovery includes leather exports and the CICB presence in Shanghai. The question is, can this work? Brazil can accept yuan but if it needs to pay the exporters, it is highly likely that the yuan will be converted into US dollars, after the transaction is completed. This means that the demand for US dollars is still present in the market place. Only if other countries join in this trade which excludes the dollar canthis system prosper. Another drawback is how do you calculate the exchange rate between Brazilian reals, Chinese yuan and Venezuelan bolivares? It's all done by referencing each individual currency to the US dollar. (Dollar cross-rates in technical jargon).Thus the dollar's influence is still present even in transactions which exclude it. To exclude the dollar completely, a great number of nations would have to agree to participate using the yuan, the euro or IMFSDR's. <fashionnetasia.com/industryupdate>

Update on China's textile and apparel manufacturers - China's textile and apparel manufacturers are battling tough market conditions, but they are still committed to corporate social responsibility, according to a new report from the China National Textile & Apparel Council. Large-scale textile companies suffered negative growth rates in employment and workers at small and medium-sized companies are particularly vulnerable. In Kaiping, a city in southern China's Guangdong Province, more than 40 textile and garment companies - about 10% of all textile and apparel companies in the city - had ceased operations as of October, according to a municipal survey. The report also noted that Chinese companies faced increased pressure from the appreciation of the yuan against the dollar, the rising costs of labor and compliance with state regulations. China's Labor Contract Law, implemented in January 2008, boosted protection for employees and increased their pay and benefits. But it also contributed to rising labor costs. Over half of the 80 enterprises surveyed in the report gave a "cautious welcome" to the law. Many respondents said the new legislation has helped companies develop a more self-conscious appreciation for employee rights, but pessimistic ones predicted the law would lead to a substantial increase in labor disputes and litigation. To help offset costs, the government has issued several tax rebates over the last year and mandated state loans for the textile industry. Survey responses indicate that such state regulation, which effectively relieves financial pressures, enables companies to remain committed to CSR initiatives. <wwd.com/business-news>

- Vietnam and France's footwear trade relationship - According to the Vietnam Leather and Footwear Association (Lefaso), in the first six months of this year, Vietnam's footwear exports to France increased 1.6%. At present, footwear is one of the country's five main exports to the French market and leads other industries in export turnover. Footwear is one of the few commodities Vietnam exports to France that can take advantage of foreign exchange rates, as it pays for the import of raw materials in USD, but brings home profits from sales in Euros, Lefaso said, adding that this has contributed to this major growth in export. The association also said that Vietnam has many opportunities to increase bilateral trade in the near future, especially after a recent visit by a delegation of French leather businesses to Ho Chi Minh City to study the market and opportunities for joint venture with Vietnamese partners. Two-way trade between Vietnam and France has grown to an annual growth rate of 25% since they set up diplomatic ties 20 years ago and Vietnam has maintained a trade surplus with this market since 1997. <english.vovnews>

- India falls back in business report - India ranked 121 among 181 economies around the world in terms of starting a business in India, according to a recent report published jointly by World Band and International Finance Corporation named 'Doing Business 2009'.  However, compared to its corresponding report published in 2008, India slightly declined from its earlier position, which was at 114 in 'Doing Business 2008'. The study was conducted across 181 economies that include 46 economies in Sub-Saharan Africa, 32 in Latin America and The Caribbean, 25 in Eastern Europe and Central Asia, 24 in East Asia and Pacific, 19 in the Middle East and North Africa and 8 in South Asia, as well as 27 Organisation for Economic Co-operation and Development (OECD) high-income economies as benchmarks. Pasted from <indiaretailing.com>

- Global Retail Development report ranks the top emerging countries growth potentials - A.T. Kearney's latest Global Retail Development Index report  claims  that retailers that operate solely in developed markets are faring far worse than those with a foothold in the developing markets. The 2009 report identifies opportunities for retail in emerging nations where competition is weak, real estate is inexpensive, logistics networks are improving and consumers are beginning to spend on branded products. The retail apparel index, a part of the GRDI, analyzes total clothing sales and imports, population and the presence of international apparel retailers. Here are the results: (1) Brazil, which is a $94 billion apparel market, was top-ranked for the second consecutive year driven by its high apparel spending per capita. (2) Romania: Romania recorded the largest jump in the apparel index this year (from 6th to 2nd) driven by growth in total clothing sales and having Eastern Europe's 2nd largest population. (3) China: $114 billion apparel market with an $85 average spend per capita (500 million people in the nation of more than 1.3 billion live in urban markets).  (4) INDIA, (5) Argentina, (6) Ukraine, (7) Chile, (8) Russia, (9) Saudi Arabia, (10) Turkey. <wwd.com/retail-news>

- Japan's economic situation - There are indications the health of recession-plagued Japan is improving slightly - but market watchers warn a full-fledged recovery for the world's second-largest economy is far from imminent. On Wednesday, The Bank of Japan released its closely monitored business sentiment survey, the tankan, which showed an improvement from a record dip in March but still came in lower than expected and languished in negative territory. The quarterly index gauging large manufacturers' pessimism about the economy rose to minus 48 from minus 58 in March. Separately, household spending rose for the first time in 15 months, gaining 0.3% in May, although some attributed much of the improvement to an isolated event: the government's 12,000 yen ($125) in cash handouts to each resident. <wwd.com/business-news>

- Japan's Uniqlo comps increase but trends are decelerating rapidly - Uniqlo's same-store sales climbed 6.4%, but declines sequentially from 18.3% growth in May and 19.2% in April.  In June, Japanese consumers snapped up summer goods like t-shirts and tank tops with built-in bras.  A Fast Retailing spokesman noted that a series of national holidays in April and May helped lift business during those months. Fast Retailing said the number of consumers visiting its stores in June rose 9.5%, although average spending per consumer dropped by 2.8%. This fall/winter, German designer Jil Sander will debut her first collection for the Japanese chain. Uniqlo's monthly sales figures exclude revenue from the brand's stores outside Japan. <wwd.com/business-news>

- Bath and body soap marketer Crabtree & Evelyn Ltd. filed for Chapter 11 bankruptcy - It will "pursue a plan of reorganization to capitalize on opportunities for future growth and profitability, including evaluation of its real estate portfolio, strengthening brand strategies and restructuring of its financial obligations."Cited operational issues such as changes in management that resulted in strategy shifts and inability to renegotiate lease terms for many of its retail sites as some of the reasons for the filing. As of June 29, Crabtree, which has about 950 employees in the U.S., owed $4.1 million to trade vendors and $790,124 to landlords on leases for its retail stores. <wwd.com/business-news>

- Shareholders lawsuit against Gildan dismissed in court - A federal judge on Wednesday dismissed a lawsuit accusing Gildan Activewear Inc. of misrepresenting earnings' potential and two company executives of insider trading. U.S. District Court Judge Harold Baer Jr. in Manhattan said the suit did not adequately show the defendants' intent to deceive, manipulate or defraud investors. The class-action suit combined complaints from groups of stockholders that filed against the Montreal-based vendor after it reduced fiscal 2008 guidance in April of that year, citing problems at a new factory in the Dominican Republic. Investors alleged the manufacturer spent the months before the revision touting the same facility's promise for increased earnings. The investors also accused chief executive officer Glenn Chamandy and chief financial officer Laurence Sellyn of insider trading for realizing combined gross proceeds of $96 million on stock sales.  <wwd.com/business-news>

- UK company Thom Browne and its new plan with new CEO - Thom Browne has tapped Josh Sparks as president and chief executive officer, succeeding Tom Becker, who exited the company in April. The designer men's wear firm has also completed the first stage of a recapitalization plan, selling a minority share to Japan-based Cross Company, a manufacturer and specialty retailer.To broaden the brand's appeal at retail, Sparks is planning to introduce price points 20 to 30 percent lower than what's now available in Thom Brown collections, where suits start at about $2,800. "We want to be competitive with the European designer brands, which tend to have more elasticity in their pricing, whereas we have been more niche," explained Sparks, who emphasized even the lower-priced suits would be full-canvas and retain the brand's luxury appeal. Sparks would like to expand distribution from its current 45 stores to about 150 to 200 stores over the next three years. Thom Browne is also close to inking a deal for its first license, which Sparks said could be announced by next week. "Thom Browne has built an incredibly respected and aspirational brand and there are many opportunities to leverage that in licensing. But we want to carefully manage those opportunities and not rush into anything," he noted. <wwd.com/business-news>

- Kmart aides unemployed people of Michigan - Kmart has launched a money-off program for the jobless in its original home state of Michigan. The retailer's Smart Assist Savings Scheme entitles the unemployed to discounts of 20% on own-label staples such as baby products, basic groceries and toilet roll. Kmart is issuing discount cards, valid for six months, to customers who are registered as unemployed. It expects to carry on issuing the cards until January, The Financial Times reported. Michigan has an unemployment rate of 14.1% - the highest in the US, where the national average is 9.4%. Other retailers have implemented similar schemes. Spartan Stores, a 99-store grocery chain based in Michigan, issued discount cards to former General Motors employees and Green Hills, a New York family-owned grocer, runs a Recession Assistance scheme, giving the registered unemployed a 10%. <retail-week.com>

- Sears makes it easier to sign in to its new online communities - Consumers can use their credentials from Google, Facebook and other popular web services to sign on to the MySears and MyKmart forums. Sears says it is the first major retailer to employ the OpenID standard for using credentials across web sites. <internetretailer.com>

- J.C. Penny appoints new general merchandiser - J. C. Penney Company, Inc. announced the appointment of Pam Mortensen as senior vice president and general merchandise manager of Fine Jewelry, effective July 27, 2009. Ms. Mortensen comes to JCPenney from Wal-Mart Stores, Inc., where she previously served as vice president and divisional merchandise manager of their Fine Jewelry and Watch division. She will report to Jeff Allison, executive vice president and general merchandise manager of home and custom decorating. <capitaliq.com>

- NexCen's financial results will finally be released after restatements - Due to financial accounting irregularities NexCen has not provided any financial information since the fourth quarter of 2007. Its 2007 results will be restated. Nexcen's franchise brands that includes two retail franchises: TAF (The Athlete's Foot) and Shoebox New York, as well as five quick service restaurant (QSR) franchises: Great American Cookies, MaggieMoo's, Marble Slab Creamery, Pretzelmaker and Pretzel Time. For the first quarter, NexCen expects to report revenues from its franchise business of $12 million against $10 million a year ago, a 15% gain. First quarter 2009 results fully reflect the acquisition of Great American Cookies and the joint venture interest in Shoebox New York, which were completed in January 2008. On a pro-forma basis, assuming these two transactions had been completed on January 1, 2008, revenues from continuing operations were approximately $12 million for the first quarter of 2008. <sportsonesource.com>

- Beyoncé and Tina Knowles launch footwear, apparel, eyewear, and accessories line - Beyoncé and Tina Knowles announced the upcoming launch of the Sasha Fierce for Deréon collection of apparel, footwear, eyewear and accessories, debuting just in time for the back-to-school season. The capsule collection of apparel and accessories for fall will develop into a deeper assortment for spring '10 with sportswear and sneakers as categories for growth. The shoes for b-t-s, which will range from $60 to $80 for shoes and up to $120 for boots, will also feature more fashion-forward elements, including different styles of studding and unique heel treatments. <wwd.com/footwear-news>

- Nike launches Transformers basketball shoe - In honor of the worldwide premiere of the ultra-successful "Transformers" movie sequel, three limited-edition performance kicks pay homage to the Hasbro franchise. Nike is releasing a Nike Zoom Fight Club, Nike Zoom FP and Nike Sharkalaid in colorways that honor Megatron, Bumblebee and Soundwave, respectively. (The Zoom FP and Sharkalaid styles are $100; the Zoom Flight Club will be $120.) All three styles come packaged to resemble boxes from the toys' 1980s heyday, including J-hooks and original Hasbro graphics. The shoes, which can be purchased individually, became available yesterday at select doors in China, Hong Kong, the Philippines and Taiwan. U.S. fans will be able to pick up the styles at House of Hoops, the basketball-focused Nike-Foot Locker retail collaboration. <wwd.com/footwear-news>

Retail First Look: 7/2/09 - Nike Transformer



Retail First Look: 7/2/09 - sector view


Capitalist Survivor

"The human body can take damn near anything. It's the mind that needs training." - Instructor Reno
For those who took Keith's book recommendation on May 26th, you'll know that quote above is from a drill instructor depicted in The Lone Survivor, Marcus Luttrell's first person account of the 2005 SEAL operation in Afghanistan that resulted in the greatest-ever single-day loss of life in the elite unit's history.  
Instructor Reno says this during the infamous SEAL 'Hell Week,' which puts the candidates through unthinkable mental and physical stress with the purpose of eliminating all but the toughest warriors on the planet. The part of this quote that I can't (and don't want to) shake is that towards the end of Hell Week, if someone expressed the desire to quit, the drill instructors would offer them a second chance before they officially 'rang the bell'. A seemingly kind gesture, but one offered with indifference. Why?
No one who takes the offer actually ends up finishing the program - ever.  Once the thought of quitting manifests itself into action, it's pretty much 'game over.' It's like trying to uncrack an egg. Those that complete the program and join the esteemed ranks of the Navy SEALs were truly in control of their own destiny - mentally and physically -- throughout the entire torturous initiation.
I know... you're probably thinking "Thanks McGough, but I'd love to see how you're going to actually tie all that in to an investable theme." That theme is something that you've seen Keith write about time and time again - proactively building and managing a process that allows you to always be on offense, and in control of your destiny.
Trust me; I'd love nothing more than to tie-in the armed forces theme with bullish comments about US markets as Independence Day draws near. But I cannot.
The real survivor in this interconnected Macro web is China. China is in control of its own destiny, and if it ever feels the desire to 'ring the bell,' it certainly does a great job of hiding that from outside observers like me.  China is always on offense - always in control - always a capitalist.
Check out the third most read story on Bloomberg this morning. "China Allows Yuan Trade Settlement, Offers Tax Breaks To Shift From Dollar."  China's official statement includes the following verbiage...
"Companies in China and neighboring countries are facing relatively huge risks of exchange-rate fluctuations because of big swings in the U.S. dollar, the euro and other major settlement currencies during the global financial crisis."
Need I say more? Probably not. But I will anyway...
Let's also take this to the industry level -- Apparel/Footwear Retail for example (86% of our footwear comes from China alone).
There's a lot that controls the margin inputs for any company. For a company tied to this supply chain, one of the majors is the FOB cost of the goods. In plain English, this is Freight On Board, and represents the all-in cost to land a product on US shores. From 2000 through 2007, this cost came down precipitously as capacity in China grew to fulfill a change in WTO regulations that allowed it to scale up production. The timing and magnitude of this change allowed so many US players to garner more margin dollars than they deserved.
But then China changed its offense. In 1Q07, with the Olympics looming, China cracked down on sweat shops, mandated back-pay for factory owners to employees for unused vacation time, and pulled the ultimate lever to reduce capacity - it lowered the VAT rebate. The VAT (value added tax) stands at about 17% in this category, and the government rebates a given portion of it to encourage exports vs. local consumption. In early-'07 this rebate stood at about 13%, and subsequently came down into the single digits.  Think about it...if you are a factory with a profit margin of 3% (about average over the past 10 years) and then not only do your labor costs go up, but your VAT rebate goes down by 500bps, that turns into a pretty catastrophic event. The result? In '07 and '08 the factory count in China's Pearl River Delta went from about 12,000 down to about 6,000. No joke...
The trajectory of exports fell like a stone - bottoming at -23% in 1Q. So how did China react? Yes, the VAT rebate is headed up again - and now is at 15% (above '07 peak). Other countries such as India, Malaysia, Indonesia, Pakistan, and others have followed suit. We've seen around 1,500 factories reopen in China, and there's more to come.

Capitalist Survivor - image001

How's that for proactively managing growth? Most US retailers don't even have a clue as to this dynamic. I'd argue that we're entering a period where they earn what China wants them to earn.
The bottom line is that the companies that really 'get' China are the real survivors. That's the long-term call. There are the ones that have been investing there over the past 10 years. Not those that started last week because the manic media said that they have to.
Have a terrific long weekend with your loved ones, and thanks to all those courageous men and women who are unable to do so as they fight to protect the freedom of this wonderful country.
Brian McGough

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.

XLV- SPDR Healthcare - We re-initiated our long position in healthcare on 6/29. Our healthcare sector head, Tom Tobin, wants to fade the public plan, and he's been right on this one all year.

GLD - SPDR Gold - Buying back the GLD that we sold higher earlier in June on 6/30. In an equity market that is losing its bullish momentum, we expect the masses to rotate back to Gold.  We also think the glittery metal will benefit in the intermediate term as inflation concerns accelerate into Q4.


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.   Added to the position on 7/1, as our stance on the consumer is no longer bullish like it was in Q2, when gas prices and mortgage rates were dramatically lower.

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



According to Lusa, Macau casinos recorded revenues of 8.25 billion patacas in revenue during June, down 17% over the same period last year and 6.3% lower than the month of May.  The first half of 2009 was down 12.4% year-over-year, with 51.4 billion patacas in revenue compared to 58.7 billion patacas in the first half of last year. 

SJM maintained the top spot in terms of marketshare, with 30% of the revenues in June, followed by LVS (26%), Wynn (14%), Galaxy (12%), Crown (9%), and MGM (8%).  


Despite calls for liberalization of the sector, Stanley Ho's Macau Slot remains the sole operator of over-the-counter and internet soccer and basketball betting in Macau.  The administration of outgoing chief executive Edmund Ho Hau-wah has extended the monopoly by one year. 

Rival casino operators and foreign sports-betting firms have expressed interest in launching and managing betting operations in Macau, should the monopoly be broken.  Macau Slot struggles to compete with the larger sports-betting market in Hong Kong.  Whether or not there will be liberalization of the sector will be determined by the incoming chief executive.  Macau Slot is 48% owned by SJM Holdings. 

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Bear Mauling Continued: SP500 Levels, Refreshed...


Here's our updated quantitative views as of 3PM pricing:

The immediate term TRADE breakout line for the SP500 is at 923. A close above that gets me 939. With the prior YTD closing high being the dummy target up at 946, there is no reason why we can't see that 939 print sometime tomorrow morning (remember, I think that employment report is going to be a sequential improvement, so I have a catalyst).

This morning's Bullish to Bearish sentiment survey showed some compression in the spread between bulls and bears. That, on balance, is a bullish indicator. Be rest assured that there are still plenty of Depressionista bears out there getting mauled. Stay long short interest.


Keith R. McCullough
Chief Executive Officer


Bear Mauling Continued: SP500 Levels, Refreshed...  - a1

Dr. Copper Seeing Inventory Declines


Portfolio position: Long Southern Copper, ticker PCU

The LME (London Metal Exchange) reported copper stock levels earlier this week, which highlight declining inventories in London, a trend that has been intact since early March.  As of June 29th, stockpiles monitored by the LME had fallen for 37 straight sessions.  This was on the back of Shanghai Futures Exchange showing copper inventories tumbling by 18% week-over-week, which was its first drop since May.

Interestingly, while inventories on the LME have been consistently falling, inventories in the U.S., as reflected by CME stores have been consistently rising over the same time period.  The CME is smaller in scale than the LME, and this data from the CME, which reflects copper demand in the U.S., likely suggests that the economic recovery is taking a little longer to take hold versus the world, namely China.

There has been speculation that China was amassing copper for speculative purposes and that the copper wasn't being used in actual infrastructure build.  Evidence from China on June 29th appears to suggest that isn't the case.  According to reports, Yu Dongming, who is an official at the metallurgical department of China's top economic planning body, confirmed the State Reserves Bureau had amassed a lower-than-expected, 235,000 tonnes of copper.  The implication is that if the government has a lower than expected store, then copper imports are in fact being used in infrastructure building.

As we wrote on May 21st:

"We have an expression (to be fair, we have many expressions) at Research Edge and we say, "She / He has the Conch", which effectively means that whomever has the conch has the voice or the floor to continue to own the debate.  When it comes to copper, China has the Conch.  In fact, in the year-to-date the correlation between the Chinese stock market and copper is 0.88."

This correlation that we called out six weeks continues to hold and while both the Chinese stock market and price of copper are up meaningfully from May 21st, the fundamental case has only improved with declining inventory data from around the globe.

We are positioned long copper via a position in Southern Copper, PCU, the copper company that is majority owned by Grupo Mexcio SAB.  PCU has copper assets primarily located in Peru, Mexico, and Chile, which are relatively low cost group of assets.  PCU also boasts a pristine balance sheet with ~$600MM in net debt versus a market capitalization of ~$17.8BN, and TTM EBITDA of ~$1.8BN. 

In effect, PCU very directly represents our TAIL theme of being long those companies with meaningful economic leverage, and limited financial leverage.

Daryl G. Jones

Managing Director

 Dr. Copper Seeing Inventory Declines - a1


Chart of The Day: Burning The Buck...


To kick off Q3, the US Dollar was already weak... post the open we've had a few dampeners hit the tape that have exacerbated today's US Dollar weakness:

  1. China asked to discuss a "new global reserve currency" at the G8 (in Italy)
  2. Fed President Evans (Chicago) made a comment about the Fed's discussion about an "exit strategy" not involving a timeline

On the first point, we've been saying this all week and I'll say it again - the Chinese are selling US Treasuries, period. They aren't going to give the USA a real time memo while they are doing it either. Chinese Central Bank Chief Zhou's comments earlier in the week were misinterpreted by the manic media. He said there would be "no sudden change" to policy. No rational investor signals to the world that they are acting "suddenly" with their largest position. To be clear, the Chinese have stopped buying US Treasuries and are selling, gradually - not "suddenly".

On the second point, the Fed's credibility on inflation forecasting is negative. They missed the meltup in 2008 commodity inflation, and now they're hoping they don't see its birth as a result of the most politicized credit creation in the history of America. Hope is not a long term investment process. See my note earlier today titled "Reflation morphing into inflation" for the most current data point we have US Dollar based prices paid.

Finally, and most importantly, there's the marked-to-market price reality of the US Dollar (charted below). The red line with fuses burning is our government Burning The Buck. Long term TAIL resistance is now at $82.26 on the US Dollar Index, and as the USD trades below that line, we're going to be importing real inflation starting in Q4.

If you want a solution to this currency crisis, raise rates from these ridiculously low "emergency" rates that are currently compromising America's credibility.



Keith R. McCullough
Chief Executive Officer

Chart of The Day: Burning The Buck...  - a1

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