"Monkeys are superior to men in this: when a monkey looks into a mirror, he sees a monkey."
-Malcolm de Chazal
Irrespective of the 200-day Moving Monkeys clanging for cover, you may have noticed that some actors in this circus continue to take themselves very seriously. And maybe they should. This is a serious game of storytelling. Particularly for those without a mirror.
I might write a children's story about them. Maybe a Curious George tale. Or better yet, how about a "best of" You Tube video? Are all Moving Monkeys the same? Or do they rotate cages on those 6 panel CNBC shouting matches when shown the green banana of an up market day? Who eats green bananas anyway?
At yesterday's bright green 940 close, the SP500 is 0.6% off her YTD high. No, these returns are not Chinese (+75.2% YTD). No, these are not the returns of a Great Depression either. These super special 2009 YTD returns for the SP500 (+4.1%) are especially for the monkeys.
They are for Merideth Whitney, who launched her firm as bearish as you could be before the most expedited short squeeze in modern history. They are for Nouriel and Garty. Never mind if one was hyper bearish at the March lows and the other last week - who cares about some silly accountability metric like a +39% rally from March 9th or a +7% one from July 9th? This is the CNBC zoo where professional monkeys rarely have to be called out on the instant replay.
Our Q3 Investment Theme call of Range Rover remains. Buy the SP500 at 871. Sell at 954. As the monkeys clang for crashes and bubbles just sit back, take your time, and manage risk around their noise.
Research Edge is an accountability mechanism. Every position, its timing and price - it all has a time stamp. Have I been early shorting things this week? Sure, but I was also early buying things too. On July 9th, with the SP500 closing at 982, I had my highest invested position of 2009. That's not me trying to get a helicopter ride to my next media event - that's just shot that I decided to take.
On May 27th, 2009 I agitated the consensus bears when I wrote an Early Look titled "Roubini The Revisionist" - suggesting that the former professor turned manic media rockstar was going to fly his helicopter of pessimism into a wall. This morning, his revisionist tales are next to impossible to comprehend. Are you bullish? Are you bearish? If the recession ends in 5 months, do you stay short that lagging economic indicator until that day? Martini or caviar?
The New Reality remains: as everyone is trying to call for crashes and bubbles AFTER they occurred, we're just going to trade in a proactively predictable range.
As we squeeze the temples of consensus to the high end of my range, I will be selling. When and if we revisit the low end of my range I will be buying. Monkey hockey player, yes I am. Monkey say as monkey do.
The Volatility Index is broken across all 3 of my durations (TAIL, TREND, TRADE), the yield curve (10 year US Treasury yields minus 2's) is 260 basis points steep, and the TED Spread (my best measure of counterparty risk) is as narrow as it gets - only 34 basis points wide.
These cross asset class risk management facts were not a whole heck of a lot different on July 9th. The only thing that's changed is Wall Street's narrative. We are seeing an unprecedented level of groupthink impact what used to be the world's finest financial system. While not as concerning as piling leverage on top of leverage, it's getting close. Larry Kudlow is not a fiscal fiduciary. He is a partisan perma bull with a TV contract.
The only way out of this is to take away the bananas and put the monkeys on mute. That will be most effectively achieved by raising the Fed funds rate. Don't forget that the steepest the US Treasury yield curve has EVER been is 270 basis points wide. All that means is that the short end of the curve is politically compromised and conflicted. When that happens, three constituencies get paid: Debtors, Bankers, and Politicians.
Every payout to Washington/Wall Street has a payer. As the Buck Burns, so do our Creditor's anxieties. Them Men and Women with the Yellow Hats be Chinese and American. If you want to earn a rate of return for being fiscally responsible (saving), this Fast Money trade aint for you.
Whether its weak demand for Chinese government bond sales last night or the government of Hungary issuing 5-year debt this morning at 6.8%, the long term cost of capital in this world is going higher, not lower. Capital in an interconnected global financial system has no religion. It's not political. Over time, savers seek rates of return on their moneys. Japan and the USA don't get that yet. Over time, I hope they do...
Hope, of course, is not an investment process. As cost of capital heightens... and the access to it tightens... the 200-Moving Monkeys at GE's financial entertainment division will go away. That's when I'll call this a bull market. For now, this is just a circus of clanging monkeys, and I am happy to trade the range of their predictable behavior.
Have a great weekend,
USO - Oil Fund-We bought USO on 7/6 and 7/8 on a pullback in oil. With the USD breaking down, oil should get a bid.
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.
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.
CYB - WisdomTree Dreyfus Chinese Yuan - The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.
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.
XLI - SPDR Industrials - We don't want to be long financial leverage, which is baked into Industrials.
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.
DIA - Diamonds Trust- We shorted the financial geared Dow on 7/10, which is breaking down across durations.
EWJ - iShares Japan -We're short the Japanese equity market via EWJ on 5/20. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.
XLY - SPDR Consumer Discretionary - We shorted XLY on 7/9 on a rip as our team has turned negative on consumer.
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
"Monkeys are superior to men in this: when a monkey looks into a mirror, he sees a monkey."
We won't see the words NO and VACANCY anywhere on the Strip in 2010. Hotel supply growth has been on a tear since late 2007 while demand has cracked. And we're not done yet.
The chart below shows that Las Vegas Strip visitation levels are back to 2004 levels, on a TTM basis. Over the same period, room inventory increased 10%. The supply/demand situation is about to get much worse. With visitation still potentially falling, room inventory will jump another 9% by the end of 2010. Is the CityCenter/Fontainebleau/Cosmopolitan triumvirate enough of a draw to drive a 9% increase in visitation?
While visitation to Las Vegas may have gotten "less bad", it will need to improve materially to offset the new supply that is on the way. CityCenter is opening in December 2009 with 5,900 rooms, followed by Fontainebleau and Cosmopolitan, both likely to open sometime in 2010, adding another 6,800 combined. CityCenter is billed as being "destined to be one of the great urban places of the world", according to its website. It will need to live up to that billing and more to attract the 1.1 million incremental visitors necessary (assuming two guests per room) to offset the new supply. Unlike The Mirage and Bellagio before it, CityCenter is more of a residential product that may lack the "wow" factor to drive significant incremental visitation to Las Vegas.
High-end properties will be hit hardest by the new supply. The cumulative supply additions represent a 57% increase in the current number of high-end rooms on the Strip. It is difficult to imagine that the market will be able to absorb this increase in the current economy with, at best, a "tepid" recovery on the way in 2010. We believe that the incremental rooms will generate little new demand and will end up diluting the market for the existing Strip players particularly impacting WYNN, LVS, and MGM.
As a reminder, RevPAR is already on a big time decline. YTD RevPAR is down around 30%. The only question now is whether 2010 or 2011 will be the RevPAR trough, because it doesn't look like it will be 2009.
It seems that once a month someone spreads the rumor that Beijing is loosening the strings. We've said it before but Beijing is always tinkering but never fully opening or closing the spigot.
As can be seen in the following chart, it didn't take long for Beijing to stabilize the Mass Market. Beijing began controlling the border in June of 2008 and by September Mass Market revenue growth was reduced to 5%. From September to the present, growth was consistently in the range of +9% to -5%. We don't have the data but our guess is the volume was even more stable. I'd say the Beijing powers are quick learners.
It has been my belief that Beijing is interested in keeping Macau growth consistent with the growth in China GDP; that is, mid to high single digits. The evidence certainly bears that out. This is good and bad for the operators. Certainly, over the long-term, this kind of stability warrants a high valuation in terms of cash flow multiples. Unlike most gaming markets there is excess demand for Macau and Beijing is the stabilizer. The downside is more near-term. As Macau approaches a 6 month period of 25%+ Mass table supply growth beginning in December, same store revenue will plummet. It is unlikely that Beijing is targeting mid to high single digit same store growth for Macau.
So don't believe the rumors that Beijing is somehow going to completely pull its big finger off the big hole in the dike to Macau. Moderation is the likely goal here and to date, Beijing has succeeded.
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Research Edge Portfolio Position: Long CAF
The NBSC Q2 GDP release registered at 7.9% year-over-year growth for a total of CNY 7.4 trillion (based on current price, production approach).
This headline growth data was accompanied by slew of other positive data points: Industrial Output increased by 10.7% Y/Y in June, Fixed Investment rose to 33.6% (cumulative) and Retail Sales register a 15% increase for the month. On the heels of this data, the Shanghai composite rose by 1.4%, lifting the total capitalization of Chinese public equities above Japanese stocks to retake the status of second largest global equity marketplace.
On the heels of yesterday's blockbuster M2 and Reserve figures the rearview mirror for Q2 supports the bullish thesis we were espousing at the time: that the enormous amount of money being put to work by the central government would shock the system back into motion through sheer force while tax incentives and subsidies would encourage increased internal consumer demand. Now that the stimulus is baked into the equation and our Q1/Q2 thesis has played out, we face a diverging path ahead.
As I commented yesterday, the massive infusion of credit has created real systemic risk and consumer demand -though resilient, will not be able to broaden to the extent necessary to offset the decline in external demand in the near future. As we move forward, our focus will be on identifying specific sectors and industries in the Chinese market and we will be proactively managing risk as the likelihood of a short term correction has increased significantly in our opinion.
SBUX is scheduled to report fiscal 3Q09 numbers after the close next Tuesday, July 21 and I would expect the company to continue the trend of beating EPS expectations ($0.22E vs. consensus of $0.19) despite continued weakness in top-line numbers. Fiscal 3Q09 should mark a return to double digit operating margins, the first quarter of YOY operating margin improvement for SBUX since 4Q07 and the company's U.S. segment should post its first quarter of margin expansion following 12 quarters of declines. And, this is based on my expectation of a 5%-6% decline in U.S. same-store sales, which would signal a sequential improvement from the 8% decline in 2Q09.
The real benefit to margins in the quarter and going forward will stem from the company's goal to eliminate $500 million of costs in FY09, $345 million of which should be implemented by the end of 3Q09. Although SBUX will continue to feel some pressure on the cost of sales line as a result of the fixed cost nature of occupancy costs, lower dairy and coffee prices should minimize the deleveraging effect of continued same-store sale declines.
With the company having launched its first national advertising campaign in May (mid Q3), I am most interested in hearing about how the campaign is being received and the impact it is having on driving customer traffic. Specifically, was the company successful in continuing its trend from 2Q of reducing traffic losses on a sequential basis? My 5%-6% U.S. same-store sales decline estimate relies on a quarterly sequential improvement in traffic. Easier YOY comparisons, new advertising, the company's first limited time promotion of iced coffee for $1.95 (initiated in May through the end of the quarter) and the results from my May "Grass Roots Survey" all make me comfortable with this assumption.
SBUX management commented on last quarter's earnings call that the marketing campaign "will build over time" so I am not expecting that the marketing will have made a big impact on Q3 results, but increased communication to consumers can only help. The company did state that it is not significantly increasing its advertising spend and instead, it is making a long-term investment. As I have said before, I think SBUX needs to spend $300-$400 million in the U.S. to have a share of voice that will make it competitive with its peers. Although Starbucks will not get to this level of spending right away, I would like to hear more about the direction and magnitude of the new advertising campaign, which I think is essential to the long-term success of the brand.
From a cash flow perspective, SBUX should continue to demonstrate its ability to generate significant cash even in a tough environment. With an estimated 25% YOY decline in capital spending, SBUX should be able to pay down more debt in the quarter and further strengthen its balance sheet.
- Cost cutting has run its course
- Margin pressure will accelerate as rate declines continue
- International RevPAR declines are intensifying
- Transient rates below group rates are a very bad thing - group rates are usually lower. Points to further downside in 2010
- Rate driven RevPAR declines will hurt a lot more than occupancy driven RevPAR declines
- On a positive note, defaults by owners will have no effect on MAR and other franchisee companies since the last thing to go is the flag
MAR Q2 EARNINGS CALL
In NA they saw stabilization in occupancy
Mix of business remains skewed to leisure transient travel
- Corporate rate travelers decline 18% while leisure increase 12%
- Personal group up 7%
- Weekend occupancy was actually better than weekday occupancy
Expect pricing power to return only as occupancy recovers
Leisure the strongest, expect business travel to follow as the needs presents itself
Swine Flu is negatively affecting their 17 hotels in Mexico
Properties are aggressively controlling costs
Timeshare promotion offering 15% discounts to new owners and 25% off to existing owners
- May consider becoming more aggressive on residential and fractional projects going forward which may result in further write-downs
Expect to continue to reduce debt levels throughout the years
Have eased brand standards where it makes sense, and deferred capital expenditures
Opened 8,000 rooms in the quarter and have 110,000 hotels in the pipeline (50% under construction)
- Expect that US growth will be driven by conversions
Second Quarter Results:
Timeshare - some sales were likely pulled forward from future periods
Tax rate higher as revenues from lower tax jurisdictions lower
Transient room nights only declined 4% in the quarter as they replaced that business with lower rates business (government / etc). Rate decreased 19% here.
Room nights from group declined 19%. While cancellations have subsided in recent months, however, attrition continues to deteriorate. RevPAR declined 25% from this segment
- Room night bookings are down 18% for the rest of the year
House profit margins only declined ~530 bps, despite the steep drop in RevPAR
- management wages down 16%
Mexico and Asia where badly affected from the swine flu
Ritz had the worst RevPAR performance, but had a large increase in leisure travel (59%)
Delinquency rate on timeshare loans was 10% in June down from 10.2% in May. Triggered change in payments, which reduced cash flow by $20MM.
- FASB 166 & 167 will make them consolidate off-balance sheet loans
- However, the covenant calculations won't be affected and don't expect any change from rating agencies in the way they look at the debt
- Won't change the fact that its non-recourse
3rd Quarter Guidance:
International lodging markets have significantly weakened
- Impact from swine flu doesn't help
Much of the NA RevPAR decline will come from rate and lower rated mix
While unit expansions will help their fees, tough comps will also hurt them
Seasonality more pronounced as well in the 3rd quarter
Believe that they pulled forward some sales with the promotional activity in the 2nd quarter, therefore impacting their 3rd quarter results
Full year 2009 Guidance:
Confident that timeshare business will be cash flow positive in 2009
Reduced total fee income by 5 cents per share (weaker international and incentive fees)
Higher tax rate reduces outlook by 4 cents
Higher diluted share count due to stock dividend reduces EPS by 2 cents
Think that the impact of political rhetoric is gone, but clearly the economic pressures haven't lessened. Don't see any rebound from the economic pressures anytime soon
How much room is left to cut costs (non-occupancy related?)
- Going forward the pricing pressures will make it more difficult to maintain margins, especially as cost cutting comps become more difficult
- On the corporate front they continue to look at overhead - doesn't sound like it
How are they positioning themselves for future growth opportunities?
- Maintaining a strong balance sheet to take advantage of any opportunities that arise
- Paying attention to asset trades that drive conversions and reflagging fees
- Expect more defaults or the number of delinquent loans to increase... still not a lot out there yet
Seeing transient rates fall below group rate - how will this effect group rates?
- Pace of decline in rate is still accelerating while occupancy has stabilized... could be a big issue for group business
Impact of more cuts from airlines?
- Corporates just aren't traveling
Timeshare - top-line is the same but profitability is worse
- As default rates accelerate they don't get interest on their residual, they also had the write down this quarter
- Services revenues related to unused rooms that are sold have also dropped as rate has dropped
- Plus the tax item (8-9MM)
- Rating agencies - each one looks at the timeshare business a little differently (left it vague)
- China - high supply growth and travel restrictions have outweighed stronger economy
- India - very small market, also has very weak RevPAR
- US: DC is still one of the best markets
- Middle East is a relatively strong performer (Saudi & Egypt stronger)
- Europe is average
If RevPAR stays negative will they get little to no incentive fees going forward?
- When they report incentive fees they do it on a run-rate basis and then have to make adjustments if it results deteriorate on a TTM basis. (basically we think that they are paying back fees that were previously accrued)
- Don't need to have positive RevPAR to get incentive fees because some contracts pay them off the top (like in some international markets). But generally negative RevPAR will have negative impact on incentive fees.
How does a recovery look like?
- It is not unusual for leisure customers to be pursued more aggressively and respond more quickly to discounting and therefore fill in lower demand periods
- Will not be able to drive pricing through leisure though - group/business will really need to drive pricing
Incentive fees lower, why?
- International much worse
- Rate is worse so margins (even if occupancy is better) will be worse (that's why we're negative on 2010 for owners)
Occupancy (mid-60's) is starting to level off, but rate continues to weaken. But until occupancy improves they don't have any pricing power.
Courtyard is all transient business travel - hence it's performing worse than many limited service brands
Business on the books for next year is down significantly (about 20%).
- Not a meaningful number because a lot of the business booked in 2008 for 2009 was cancelled
- Right now they have a very short booking window. Meeting planners are all sitting on the sidelines looking for better deals
Composition of development pipeline
- 50% under construction
- 6-7% conversions
- 30% is international
- 60% is limited service in North America, predominantly franchise
- Balance is international and mostly management
- Think that they will continue to add rooms in 2010 - don't know how many
- Conversions vs new builds - only had 2 conversions in the 2nd Quarter, expect 8-10% for the balance of the year to be conversions
What percentage of management or franchised hotels is in some state of default?
- Cash defaults on debt payments - very few
- Hotels financed in 2005-2007, and if they were financed aggressively may be in trouble, but most of that was floating rate debt - so those owners have also benefitted from very low rates
- Defaults will depend on how long this malaise will continue... if the recovery is fast there will be less defaults because owners will fund the shortfall... we take the other side of that though.. we don't think it'll be a fast recovery
- We would note that even if a hotel defaults on its bank financing this DOES NOT mean that the property will be de-flagged. Normally banks will keep the flag and pay the fees.