Waking Up

“I hear and I forget. I see and I remember. I do and I understand.”
Managing risk up here on the high-wire of a global US Dollar Devaluation move is what it is – a daily and athletic exercise of doing. I hear the American commoner’s disgust. I see the bankers getting paid. I trade around everything I see and hear, as I try to understand.
Trying to make sense of an interconnected global macro system of colliding dynamic factors isn’t for everyone. Neither is trading. Or at least doing macro and managing risk weren’t given parts of the investment process in years prior to 2008. That’s when a long/short stock picking hedge fund monkey like me could make money in a market that went straight up alongside access to capital. That’s changed.
Every day we wake up to slug it out with a global macro consensus. Sometimes consensus isn’t bullish enough. Sometimes it’s so nauseating that you can only fade it. Sometimes it isn’t bearish enough. Consensus is the backbone of the market’s being. Embrace it, daily, and you begin to understand.
My daily risk management process includes the measurement of ranges, deltas, and spreads. If there is something we can attempt to quantify on those 3 scores, we do.
One of the weekly sentiment indicators that was shining bright red on my screens yesterday was the Institutional Investor sentiment survey. The spread in that survey was one of the most bullish we have measured in well over a year. The spread between Bulls to Bears widened to +21 points (for the Bulls).
The most interesting part of the math was how bombed out the Bears were. Less than 4 months ago almost 50% of the respondents in that II survey were outright bearish (at the bottom). In this week’s report, only 26% of investors admitted they are bearish anymore (at the top).
My understanding here is quite simple – and it’s no longer that investors aren’t bullish enough – investors aren’t allowed to be bearish! When your director of research or master of the hedge fund universe PM rains down on you every morning for missing the latest daily market move, you end up in a box. You end up with embedded rules that govern your analytical output – it’s called career risk management. Sometimes you just aren’t allowed to be bullish or bearish. That’s obviously a problem.
So with the Chinese and US stock markets pinned up here at YTD highs and people not being allowed to be bearish anymore, what do you do? I think the best option is to wait and watch. All the while, keep measuring your ranges, deltas, and spreads. Patience provides opportunity.
I know, for Mr. Qualitative Research Superstar… this part of the investment process probably makes you laugh. Trust me, there are a lot of people out there just like you. I used to be one of them. Evolving your investment process should be a perpetual exercise in doing.
So let me take you through some of my basic training global macro calisthenics this morning and flash you some US market factors:
1.      I have the SP500’s daily range of price probability at 43 points = tight and trade-able (bullish)

2.      I have immediate term TRADE support/resistance for the SP500 at 989-1,010 = risk barely outrunning the reward (bearish)

3.      I have the daily spread for the VIX at 3.15 points = volatility remains broken across durations (bullish)

4.      I have the daily delta for NYSE volume expanding = 1st day in the last 14 where that came on a market down day (bearish)

5.      I have the daily spread of the US market’s breadth deteriorating = one day does not a TREND make (bearish)

6.      I have 9 out of 9 SP500 sectors in my quantitative model signaling positive TRADE and TREND = (bullish)

Now let’s flip over to a cross section of asset class and geographical considerations:
1.      China closed down another -2.1% overnight, taking its 2-day decline from the YTD high (+92%) to -3.3%

2.      Australia shot up another +1.4%, 2-days AFTER signaling that their next move in interest rates is UP

3.      Germany is up +0.4% again this morning and continues to lead mature western European economies despite a 1.44 Euro

4.      Turkey, a beacon for emerging market growth, is flashing a big daily negative divergence this morning, trading down -2.5%

5.      The US Dollar made a new low yesterday trading below 77.50 on the US Index

6.      The CRB Commodities Index made a new YTD high yesterday, trading up to 268

So where does this all wash out? You tell me. We all have different investment styles. We all have different durations. I don’t wake up in the morning trying to be everyone’s banker or politician. I don’t wake-up trying to be bullish or bearish. I wake-up trying my best to do, and to understand.
Best of luck out there today,


EWG – iShares Germany Chancellor Merkel has shown leadership in the economic downturn, from a measured stimulus package and budget balance to timely incentives such as the auto rebate program. We believe that Germany’s powerful manufacturing capacity remains a primary structural advantage; factory orders and production as well as business and consumer confidence have seen a steady rise over the last months, while internal demand appears to be improving with the low CPI/interest rate environment bolstering consumer spending. We expect slow but steady economic improvement for Europe’s largest economy.

XLV– SPDR Healthcare Healthcare has lagged the market as investors chase beta.  With consumer confidence down and the reform dialogue turning negative we like the re-entry point here. Buying red.

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.

QQQQ – PowerShares NASDAQ 100 With a pullback in the best looking US stock market index (Nasdaq) on 7/24, we bought Qs. The index includes companies with better balance sheets that don’t need as much financial leverage.

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.

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.


XLF – SPDR Financials
Gotta love the backward looking guys at AXP. Freakout and fire people at bottoms, then talk up the market at bottoms. Shorting hope.  

XLI – SPDR IndustrialsWe 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 and 8/3, which is finally overbought.

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 DiscretionaryAs Reflation morphs into inflation, the US Consumer Discretionary rally will run out of its short squeeze steam. We shorted XLY on 7/9, 7/22, and 8/3.

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.

Early Read on July Same Store Sales

With a handful of companies reporting July sales so far, the results are generally in line with expectations.  On the upside, Urban Outfitters reported better results for its second quarter with overall same store sales decreasing by 6%.  Still an absolute negative but on track with their sequentially improving trends.  On the downside, cult rocket-ship (stock) retailer The Buckle reported what appears to be a huge disappointment.  Results were up 2.8% with expectations for a 10% increase.  Given the large calendar shift which impacts teen retailers disproportionately, this may explain some of the deceleration from prior months. 

Our main call out comes from Costco, which had interesting comments on its category performance.  Management mentioned that the overall trends were very similar to last month, with the exception of non-food categories which showed a slight uptick in trend.  Office, sporting goods, small appliances, domestics, and mens/womens apparel produced a same store sales increase of 10% excluding currency effects.  With overall traffic up 3.5%, it appears market share gains and perhaps a bottoming in the more discretionary categories is beginning to occur.  This trend warrants more data points before we can make a definitive call, but the positive tone is certainly noteworthy.

MCD - July Sales Preview

MCD is scheduled to report July comparable sales on Monday.  MCD said on July 23 in its 2Q09 earnings release that it expected to report July consolidated comparable sales similar to or better than June.  Specifically, management stated on its 2Q earnings call that July sales trends in Europe and APMEA were running better than June.  For reference, MCD’s June same-store sales growth was 1.8% in the U.S., 4.7% in Europe, 0.3% in APMEA and 2.6% on a consolidated basis, which represented a slowdown in 2-year trends in each geographic segment. 


Given that MCD had visibility on nearly 3/4 of the month when it gave its outlook on July sales trends, there is little chance that July results will vary too greatly from its guidance.  That being said, I wanted to provide comparable sales ranges for each geographic segment as a benchmark of what I think would be good, neutral, or bad results based on 2-year average trends. 


U.S. (company increased coffee giveaways, facing a tough 6.7% comparison from last year)

Good: +2.5% or better would signal a re-acceleration in 2-year average trends.


Neutral: +1.8% to +2.5% would signal an improvement in 2-year average trends, but is somewhat expected given the company’s guidance.


Bad: < +1.8% would come in below management guidance.  Anything below -1.3% would signal a continued sequential slowdown in 2-year average trends.


Europe (Germany was weaker in June due to less couponing YOY, rest of Europe continues to be strong)

Good: +6.0% or better would signal a return to the strong level of 2-year average trends that was present earlier in 2009.  Europe really only faced one month (June) of softness in 2–year trends.


Neutral: +5.0% to +6.0% would signal an improvement in 2-year average trends from June levels, but again is somewhat expected given the company’s guidance.  Although MCD’s guidance said similar or better than the 4.7% number in June, management said it was trending better than that so I think a better than 4.7% number is already built into expectations.


Bad: < +5.0% would come in below management guidance and built in expectation.  Anything below +3.0% would signal a continued sequential slowdown in 2-year average trends.


APMEA (Japan and China were responsible for June slowdown, Japan had improved off of June levels, China continued to be negative but was more negative in June than it had been for prior 5 months)

Good: +4.0% or better would signal a marked improvement on a sequential basis from June’s 0.3% number.  +7.0% or better would signal a return to the strong level of 2-year average trends that was present earlier in 2009.  Like Europe, APMEA really only faced one month (June) of softness in 2–year trends.


Neutral: +1.7% to +4.0% would signal that APMEA trends have stabilized with 2-year average trends flat with to slightly better than June levels. 


Bad: < +1.7% would be better than management guidance and would show a sequential improvement from June on a 1-year basis, but would signal a continued sequential slowdown in 2-year average trends.  Again, management had already stated that APMEA July trends were running better than June’s 0.3% number so some level of sequential improvement is built into expectations.


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Yesterday Macau’s government approved an amendment that caps junket fees.  A maximum fine of MOP 500,000 ($62,000) was established for anyone who breaks the law.  The measure comes after the authorities received strong evidence of anti-competitive practice by VIP junket operators, according to the Executive Council spokesman, Tong Chi Kin.  The secretary for economy and finance will have the power to determine the maximum commissions and other remunerations casinos can pay the junkets.


The six gaming concessionaires and Sub-concessionaires, who recently formed the Macau Casino Gaming Concessionaires and Sub-concessionaires, hope to cap the commission paid to junket operators at 1.25, something Melco Crown and LVS have already implemented. 

JACK - Capex is Coming Down

Sales Update: Jack in the Box same-store sales declined 1% in fiscal 3Q09 (ended July 5).  Sales deteriorated rather significantly in mid-June and were actually down 4.4% for the entire month of June.  The company said a big portion of the decline stemmed from decreased sales of breakfast, side items, carbonated beverages and shakes, which it said is “indicative of consumers continuing to cut back on discretionary spending.”  JACK saw somewhat of a lift in numbers beginning in July with comparable sales running at about the midpoint of its Q4 guidance of -2.5% to -4.5%.  It is important to note that the company is lapping an easier comparison in Q4 of -0.8% versus -0.4% in Q3. 


Competitive landscape:  Management commented on its earnings call that its QSR competitors continue to get increasingly more aggressive with their couponing.  Although we already know that the 4-week period ending July 13 was particularly weak for CKR with reported same-store sales down 5% on a blended basis, and -6.1% at Carl’s Jr., a higher level of competitive discounting will only put further pressure on Carl’s Jr.’s premium-focused menu strategy. 


Management also said that when it initially experienced such a dramatic slowdown in June that it suspected sales were being hurt by the significant discounting by casual dining operators.  CEO Linda Lang said that with casual dining offering such compelling price points (meals for under $7 and 2 for $20), she would not have been surprised by some share shifts to casual dining but that relative to what she has been hearing from QSR and casual dining competitors, alike, she does not think this is the primary cause of the fall off in sales.  Rather, she thinks it is a sign of the difficult macro environment.  I always say that the restaurant is a zero sum game so when one company loses share, another wins.  And, although some restaurant operators are faring better than others, it would seem based on what we are hearing across the board that the overall pie got smaller in June…less people are dining out.


Following the Cash:  I pointed out in June (see my June 24 post titled “Following the Cash”) that the biggest negative for JACK has been the rapid growth in capital spending over the past two years, which has contributed to the decline in JACK’s return on incremental invested capital (ROIIC).  Importantly, I said the real turnaround in returns could come in 2010 depending on the company’s growth plans going forward.  Management had said that it would ramp up the growth of its Qdoba company units to 30-40 units per year, which I think is aggressive in this challenging environment.  To that end, I was encouraged to hear the company say that it will slow Qdoba growth a bit in fiscal 2010 because “the downturn in the development cycles and the ability of developers of shopping centers and the like to get credit is still difficult.”   Management did not quantify by how much it will slow Qdoba new company unit growth in 2010 following its targeted 19% new unit growth in 2009, but it did say that it expects capital expenditures to be down about $25 million from its planned $175 million in capital spending in 2009 (down 14% YOY).  I would like to see this growth cut rather significantly but it appears that JACK is at least headed in the right direction from a capex standpoint.


While top-line demand will typically take center stage for any restaurant company, JACK was not penalized today for missing same-store sales.  If you are taking the longer term perspective, following what JACK does with its cash will generate the most incremental return for shareholders over the next 12 months.

Athletic Footwear Takes a Leg Down

After getting a relatively positive read on athletic apparel earlier today, it appears that footwear did not follow suit.  For the latest week, athletic footwear in the sporting goods channel decelerated significantly.  Units and ASP’s both showed a sharp deceleration in trend vs. prior weeks.  The move in ASP’s is a trend we’re watching closely.  Anecdotally, the promotional environment as well as the major shifts in product mix remain stable.  However, this data point certainly challenges these observations.  It is still too early in the back to school season to suggest that promos will ramp up aggressively or beyond plans, but a prolonged negative trend in units and ASP’s would warrant some changes at retail.   With inventories still tight on and off the mall, a promotional ramp up would be a large departure from the relatively “stable” environment we have enjoyed for the past two quarters.


Athletic Footwear Takes a Leg Down - Sporting Goods Channel Table

Athletic Footwear Takes a Leg Down - Footwear and Apparel Dollar

Athletic Footwear Takes a Leg Down - Footwear and Apparel ASP chart


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