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Mr. Macro Market

“Everything comes to him who hustles while he waits.”
-Thomas Edison
 
While it makes perfect sense for market operators to take some time off in the summer, Mr. Macro Market waits for no one. Yesterday, I wrote that I was going to wait and watch for the US Dollar’s reaction to this US unemployment report – that doesn’t mean I stop hustling.
 
For me at least, this is not unlike preparing for a hockey game. The discipline and repeatability of my preparation process is critical. If I sleep in or let someone in my inbox distract me, I will undoubtedly miss something. You have to eliminate all the noise – stay focused.
 
What’s most interesting to me this morning is the Russian stock market getting hammered (down over -3%) after their central bank CUT interest rates. Not only is it interesting from a causal perspective, but it correlates with the reaction we saw in Indonesia on Wednesday (they cut rates to 6.25%, and stocks on the Jakarta Composite Index suffered a -1.8% down day). This is new.
 
What’s new? The marked-to-market reaction to central bankers pandering to the political pressures to cut interest rates is much different than what we saw 9 months ago. At that time, I called it “going Greenspan” – which simply meant that Asian and European central bankers simply followed the strategy that the US Financial System’s “maestro” taught them. Everyone cut rates.
 
Since then (in a testimony to Congress in October 2008), Greenspan himself has gone on the record saying that there “was a flaw in the model that I perceived as the critical functioning structure that defines how the world works.” Doh! Now what?
 
Now what we have are a lot of politically compromised (and very inexperienced) international equity market policy makers being directed by a failed strategy of perceived wisdom. That’s not good – and Mr. Macro Market is going to fix it.
 
As opposed to some of those Blackstone “marks” on their private equity book that Steve Schwarzman marked-to-model (UP!) in his Q2 earnings report, Mr. Macro Market operates on a real-time, marked-to-market, basis. No, this isn’t new. This has been happening for hundreds of years. The only thing that is new is that the American Financial system has allowed the “how much money do you make” mantra to eclipse the laws of bid-asked gravity.
 
Gravity is what you are seeing Mr. Macro Market show you in these countries that continue to cut interest rates ahead of a significant acceleration in reported inflation here in the USA in Q4. This is one of our three core investment Macro Themes for Q3 – we have labeled it “Reflation’s Rotation.”
 
Cramer is too busy getting bulled up on Citigroup to poach that one liner from me this morning, so let me explain what it means before his hounds make a US currency style debauchery out of it. Reflation Rotation means that instead of reflating prices (Q2-Q3 of 2009) from year-over-year DEFLATION price levels, REFLATION will morph into reported INFLATION in Q4. That’s it. It’s that simple.
 
Does Mr. Macro Market see this coming? You tell me – here are his marked-to-market signals this morning:
 
1.      Chinese demand is running in the high single digits now year-over-year now to the point where their government admits the need to tighten “appropriately”

2.      Inclusive of the corrections they’ve seen in the last 3-days, stocks on the Shanghai and Hang Seng are still up a by a moon-shot in 2009

3.      The US Dollar continues to make a series of lower-highs and lower-lows (imports inflation to America by Q4)

4.      The CRB Commodities Index continues to make a series of higher-lows and higher-highs (that’s why the American commoner is bitter)

5.      Dr. Copper, one of inflation’s best prognosticators, is trading at $2.71/lb this morning – that’s will be +94% over Q4 of 2008 prices (no more deflation in Q4)

6.      Oil prices continues to test YTD highs, and will be trading 2x where they were in Q4 of 2008 (no more deflation in Q4)

7.      The US Treasury yield curve is trading within 15 basis points of its all-time steepest this morning at +255bps wide (10’s to 2’s)

8.      3-month LIBOR (as in the rate that $375 Trillion of the world’s debt is based off of) is hitting new YTD lows this morning at 0.46%

9.      The US Financials sector ETF (XLF) is up over +125% since March 5th of this year (classic reflation rotating into inflation)

 
The Bank of England opted for the political compromise yesterday, keeping Quantitative Easing in place. The pound immediately got pounded on that news, and this morning you are seeing the FTSE in London trade down a full -1%. If there is one country that has been willing to sacrifice her currency’s credibility for political job security other than the USA, it’s the UK. The Dow and the FTSE are two of the worst performing markets in global equities YTD for good reason.
 
The New Reality is this: if you maintain an un-objective monetary policy into Q4, Mr. Macro Market is going to sniff you and your lack of domestic rates of return right out of your hole.  As for the right here and now, well… I’ll deal with how the US unemployment report affects the US Dollar in 2 hours. In the meantime, I’ll hustle while I wait.
 
My immediate term upside TRADE target for the SP500 is now 1,012, and I have downside support at 991. A breakdown through 991 puts 969 in play.
 
Have a great weekend with your families,
KM
 


LONG ETFS
 

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.

 

SHORT ETFS
 
XLI – SPDR Industrials
We don’t want to be long financial leverage, which is baked into Industrials.

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.

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.


KSWS: Warming to a Dog

Core biz hit bottom, new biz ramping while R&D rolling and product costs out of Asia are down. New CEO at FL is big call option. Until then, $11 stock with $5 is cash. Not bad when I’m modeling a 40% 2-yr growth acceleration and 25 point boost in mgns.

 

It’s pretty darn rare for me to warm up to a story when sales are down 35% and inventories are flat. That kind of trajectory and its implication for margins is just outright scary. But K Swiss is proving to be the exception. I think we’re at an inflection point here. It will initially be a ‘results are trending less bad’ story, but I have many reasons to believe that fundamentals will turn positive within 12 months.

Here’s the ‘Then vs. Now.’

Then… (2007-Today)

1)      K Swiss has had a fashion trend going against it for the past 2-3 years (weakness in ‘classics’), which hit revenue by 50%.  Some companies would retrench and pull back in every spending area imaginable when under such top line pressure. But KSWS invested in two new technologies – Tubes and miSoul in order to grow around the core fashion category.

 

2)      At the same time, we were looking at the tightest capacity strain out of Asia that we’ve seen in over 10 years. Not a pleasant margin event for anyone in this industry – especially a small player like KSWS.

 

3)      Foot Locker was a massive drain on KSWS’ top line. I’d characterize FL as one of the worst managed companies in retail over the past ten years – up there with Sears. As FL struggled with its US business, it cut KSWS orders meaningfully. FL went from a peak of 29% to less than 10% today. Being held hostage to a bad retailer is, well…bad.

 

4)      At the same time, the company was also dealing with its failed Royal Elastics division, which was losing money and distracting management.

 

 

Going Forward

1)      The new running line is ramping up at the same time the R&D related to the technology is rolling over. In addition, a new line is always lowest margin when it starts – i.e. now. Each incremental pair that sells gets more profitable due to amortization of tooling and molds.

 

2)      I feel pretty comfortable in banking on KSWS’ ‘classics’ business being close to the bottom. It’s now sub-$200mm globally. The math there on both door penetration and pair per door is pathetic.

 

3)      We don’t need to assume any growth in the core, and with the addition of running, Palladium (its new boot business) and skate, we’re looking at over 40% growth in revenue over 2-years.

 

4)      With costs out of China coming down near double digits for footwear as capacity reopens from 6,000 factories up to a number closer to 10,000 in the Pearl River Delta, there is a meaningful COGS tailwind.

 

5)      Let’s not forget the Foot Locker factor. Next week, the new CEO starts his job – Ken Hicks, formerly President and head merchant at JC Penney. Think about it…If you come from a company where you flat-out own every vendor that tries to sell to you, and you end up at a retailer where one brand is half of your sales (Nike), what will your first move be? Probably to sit down with smaller, but profitable, brands that can be better partners to Foot Locker under its new leadership. Keep in mind that a K Swiss classic shoe is one of the most profitable sales for FL. I don’t have anything in my model for a major change in this relationship.

 

6)      Did I mention that KSWS has over $5 in cash on its balance sheet? With the stock at $11, and near a buck in EPS power, this is tough to ignore.

 

What concerns me…

1)      Time… You could have made the ‘great balance sheet’ call in each of the past 3 years. You’d have gotten smoked. There’s nice support here, but it might take time to get paid.

 

2)      I can’t shake the possibility that this management team goes out and does a stupid deal to ‘get more connected with the youth consumer.’  C’mon guys… Fix your current business, pull the levers you can, and get on with it. You’ve proven that your deal prowess isn’t anything to write home about. In fact, you have yet to make one work.

 

3)      I want to make sure that these guys are allocating enough capital to growing these new businesses. If it turns out that I need to take up SG&A in my model north of 10% to get the product to resonate w consumers, then it’s tough to find any earnings.

 

KSWS: Warming to a Dog - KSWS miSOUL

 

KSWS: Warming to a Dog - KSWS Palladium 2

 

KSWS: Warming to a Dog - KSWS Tubes


Shanghai's SHIBOR Experiment...

Over 700,000 new trading accounts were opened by Chinese brokerage firms last week as more first time investors flock to the Shanghai market. Even after last night’s downturn as the market digested a slew of newly announced IPOs the Shanghai composite is still up 84% YTD.  

 

The “it’s a bubble” crowd are pointing out, correctly, that short term rates have been spiking as more hot money flows into the equity and futures markets (see the 7 day and 14 day SHIBOR chart below). Despite an 18 basis point pullback last night the one week swap rate is still up 32% from this time last month. Clearly the bearish thesis is based on a common sense perspective that often: unbridled optimism + easy credit + inexperienced investors = an overextended rally.

 

Shanghai's SHIBOR Experiment...  - barber123

 

The “it’s not a bubble (just yet)” crowd – which includes the strategists at most big banks,  are arguing that multiples, while expensive, are justified by ramping internal demand dynamics that presents the best long term growth prospects on earth. In other words, on a longer duration the exuberance is justified. Where these cats were 9 months ago on China (100% lower) is beyond us…

 

The PBOC quarterly monetary report released yesterday stated with usual opaqueness that policy tools would be used to achieve “appropriate” liquidity levels. Although I am not privy to any inside track at the PBOC, if I was going to speculate about exactly what “appropriate” means in this instance –I’d guess that it means that the desire to continue bring new issues to market will be offset by an equally stronger desire to avoid any market volatility that could cause consternation among the masses in advance of the celebration of the anniversary of the People’s Republic on October 1st. As such any tightening of credit will likely be executed in stages designed to provide a soft landing. 

 

China is a managed economy, not a free market, and order is prized above all else in Chinese society. Therefore it is only natural that the powers that be in Beijing will attempt to manage the equity market towards an orderly outcome in advance of the biggest public event since the Olympics.

 

How appropriate.

 

Andrew Barber
Director 


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EAT – WHAT IS MANAGEMENT GOING TO DO?

I could spend the next 500 words expanding on all of the details of the past quarter and rehashing the guidance, which was obviously a big disappointment, but I don’t see the point.  Right now, the only thing that matters is what senior management is going to do to stem the decline in same-store sales and take the Chili’s brand to a level that will put it significantly above the competition.

While the current promotion “3 courses, 2 people for $20” may have helped have helped stem the decline in same-store sales in July, it’s not a game changer for Chili’s.  The current Chili’s promotion is only slightly different from the current Applebee’s promotion of “2 entrée’s for $20.”  Management acknowledged that this current promotion is only a short-term fix to drive traffic in this extremely competitive environment.  To that end, management said it will be implementing a new initiative in late fiscal 1Q2010 that it said will drive long-term menu innovation.  The company did not provide any further details about this initiative.

So what is management thinking?  The Brinker management team needs to be thinking that it must elevate the Chili’s brand, so that the food it serves is substantially better than the competition.  In the Bar & Grill “sea of sameness,” it’s imperative that it makes substantial changes and does not just launch some run of the mill value promotion.  Chili’s needs to start taking significant market share from its competition while its competitors are on the ropes.  Many of Chili’s competitors in the Bar & Ggrill segment are either marginally profitable or are so significantly leveraged, they have limited ability to navigate the challenging environment. 

Chili’s needs to go for the jugular while it can! 

Earlier this year, I had the opportunity to work in a Chili’s, put on a Chef’s coat and “fire up” a Fajita.  Without going into details, what struck me was how complicated it was to execute the current menu.  If my memory serves me correctly, there are three different sizes of chicken breasts with six different marinades.  It is very easy to put the wrong size breast with a meal at the wrong price point, costing the store incremental profitability.      

So why do I bring this up?  The menu has begun to complicate Chili’s ability to execute effectively.  Chili’s needs to simplify its back of the house operations by reducing the menu to include only the core items that represent the bulk of the chain’s sales.  At the same time, it can increase the quality of the items left on the menu.  A menu that is simpler to execute will translate into better food delivered to the guest with fewer complaints, thereby allowing the concept to build increased customer loyalty.  Importantly, it will provide a better work environment for restaurant employees.

A strategy like this is not without risks, but it’s also not unprecedented in the restaurant industry and for consumer companies.  In the restaurant industry, McDonald’s did it a few years back and the old “Philip Morris” did it in 1994 when it was under attack from “discount” brands.  Also, if I’m not mistaken, Grand Metropolitan (the UK based beverage company) reduced its SKUs in the mid 1990’s before it was taken over.


Monkey Time: SP500 Levels, Refreshed...

Can our monkey hold onto the high-wire of price momentum into and out of tomorrow? Here’s the SP500’s setup into the unemployment report:

 

1.       Immediate term TRADE resistance = 1,011

2.       Immediate term TRADE support = 990

3.       Watch out below line of support = 967

 

I say watch out below because I think a close below 990 takes the monkeys down to the floors of their cages. We’ve had 14 straight days of positive TRADE and TREND across all 9 sectors of our SP500 views – the only other clanging momentum rally of that duration in 2009 was the one that ended, abruptly, at the beginning of June.

 

If you really want to throw a monkey wrench at this, think about the implications of a fantastic unemployment report tomorrow… Yes, it may very well drive the US Dollar higher (like the jobless claims # did today). Dollar up, and momentum monkeys fall down – you’re seeing a sneak preview of that today.

 

A worse than expected unemployment report tomorrow would throw everyone for a loop if it equated to Dollar down and everything straight up. That’s when you’ll see that 1,011 print. That’s the line I’ll sell. I’m a better buyer here.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Monkey Time: SP500 Levels, Refreshed...  - spref

 

 


QSR - Big 3 Market Share Shifts

We learned today that Wendy’s company-operated July same-store sales improved sequentially to up 2.0% (up 3.4%, excluding the impact of 300 fewer restaurants serving breakfast compared to a year ago) from -1.2% in 2Q09 (up 0.6%, excluding the breakfast impact).  From the chart below, you can see that Wendy’s had been underperforming both MCD and BKC in the U.S. since about 2Q07.

 In the most recent quarters , Wendy’s has started to gain share from BKC as Wendy’s increased its value messaging at the same time BKC focused more heavily on its premium priced menu items.  MCD is scheduled to report its July comparable sales growth on Monday, but has said that it expects its U.S. segment to post a number that is similar to or better than June’s 1.8% result (see my post titled MCD – July Sales Preview for more details).  Assuming MCD reports about 2% same-store sales in the U.S., July will mark the first month since 1Q07 that Wendy’s matched MCD’s comparable sales growth level.  And, excluding the YOY breakfast impact, Wendy’s may have actually stolen market share from MCD in July.  

BKC does not report fiscal 4Q09 (calendar 2Q09) until August 25, but the chart below reflects my belief that BCK’s same-store sales growth continued to decline on a sequential basis in the quarter and in July.  BKC acknowledged that its focus on premium products has failed to drive traffic and has more recently increased its advertising around more value items, such as the $1 Whopper Junior.  TAST reported 2Q09 results earlier this week and its Burger King same-store sales growth (TAST is a franchisee of 314 U.S. Burger King restaurants) fell off a cliff during the quarter on a sequential basis, -4.7% versus +5.1% in 1Q09.  These less than favorable trends continued in July with comparable sales down about 5%.  Directionally, these TAST results do not bode well for BKC. 

 

QSR - Big 3 Market Share Shifts - big3


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