China: Raw Power

Research Edge Portfolio Position: Long Chinese equities via CAF


July Trade and Industrial Output data released last evening by national Bureau of Statistics disappointed some observers looking for continued sequential year-over-year improvement spurred by the massive stimulus injection earlier this year. On the news, the Chinese equity market closed higher on the day for the 1st day in the last 5.


On a year-over-year basis, July trade data is mildly disappointing, but should be taken in context. For starters, viewing last month’s figures this way creates obvious distortion since it is a comparison against the final frantic month of activity last summer before the massive disruption of the Olympic Games in Beijing.  Viewed on an absolute basis however, the actual trajectory and power of the rebound since the beginning of the year remains arresting (see chart below). 


(discussion continued after chart)

China: Raw Power - a1


Although Industrial Output data for July registered at a respectable 10.8% Y/Y, the third consecutive month of acceleration, the glass half empty crowd looking for signs of fatigue in the recovery cycle may attempt to find one in this number since the rate of sequential improvement appears to be moderating. We do not subscribe to this view. The data shows continues strength, with heavy industry and domestic demand driven components like automotive continuing to expand at double digit Y/Y rates.


We continue to be positive on China’s economic recovery cycle, with focused stimulus programs driving internal demand in the near term while developing broader consumer demand patterns for the long term. This will not completely offset lost external demand, nor will it happen fast or smooth: China is a poor nation in many ways and has a consumer base still in an early developmental stage and, as such, it would be absurd to think that the emergency measures enacted in late 2008 by the government there will return the patient to full health with no side effects or recuperation time.


What we do believe however is that all data continues to suggest that the operation has been a major success and the patient is well on the way to recovery. We remain focused on the negative impact of monetary loosening on asset valuation and other risk factors, but for now the data continues to provide us with confidence on our thesis on the recovery and development of the real economy.


We bought more CAF on a red tape today as some investors flee because the news is merely great and not perfect.


Andrew Barber



11 AUGUST 2009




It’s harder than ever for ‘jobbers’ to find product to feed into off-price retailers. There’s another 2 quarters where favorable buys that were subsequently ‘packed-away’ will boost results. But then what’s there to maintain peak margins?


One area in apparel where we think we have a particular edge is in the off-price channel and getting a sense of the incremental change in buyers’ ability to find deals on certain brands. In that regard, there is no question in our minds that the flow of excess inventory is tightening in the domestic market. After retailers and suppliers cut inventories way back, the amount of goods sitting in warehouses and in limbo is diminishing. This should not be a shocker to those listing the standard retail tag line over the past year ‘we’re managing inventories closely, blah blah bah…’.  As such, what we’re seeing is meaningful momentum at TJX and ROST – not to mention peak margins and inventory over the 2 quarters baked due to elevated levels of ‘pack-aways’ purchased over the past year. But let’s not ignore the chart below, which shows how such favorable inventory/sales for the apparel industry has driven gross profit growth over the past decade. This WILL matter as we head into 2010…

2010 IS NOT THAT FAR AWAY - Avg ROST TJ and Sales Inv Spread



Some Notable Call Outs


  • One did not have to work too hard to determine the age of some of the merchandise at DSW’s “secret” Gucci sale. A quick glance through the leather planners clearly included vintage 2007 calendars. While DSW probably got a deal on the goods, at least some of the inventory has been sitting in a warehouse for quite some time.


  • BKS agreed to purchase Barnes & Noble College Booksellers for $596 million from the company’s founder and owner, Len Riggio. As many people know, Len is also the founder, Chairman, and largest shareholder of BKS. While the board engaged a special committee to explore and evaluate the transaction, it was interesting to learn that the College business was not shopped to any third parties. Even more interesting, is the parallelism to a previous transaction in which BKS purchased Babbage’s (from Riggio) and combined it with Funco (both are predecessors to GameStop). At that time the transaction was viewed with some skepticism, but ultimately shareholders won out. A quick check shows that the original investment by BKS in Babbages/Funco was about $400 million in ‘99/’00. Today GameStop’s enterprise value is $4.4 billion.




-UK retail sales values across all retail sectors rose 1.8% on a like-for-like basis and 3.6% on a total basis during July - July showed an improvement on June – when like-for-likes were up 1.4 per cent - but the growth was versus a weak July 2008. Sales in department stores were mixed during last month, but the category benefitted from the wetter weather in the latter part of the month. Clothing sales fell back to just below the July 2008 level last month. During the good weather in the early part of the month, summer ranges sold well during the Sales. However, stronger discounting was needed towards the end of the month. The cooler, wetter second half of the month meant that new autumn ranges had a good start, with rainwear, jeans, leggings, tights and light knitwear proving popular. Casual ranges outperformed formal ranges and childrenswear outperformed adult ranges. Footwear sales were strong during the month. Sandals and casual footwear sold well on sunny days, especially when Sales were extended or increased. Footwear retailers implemented deeper discounting than last year and shoes drove sales in the wetter second half of July. Children’s footwear showed the strongest gains helped by back-to-school. Non-food, non-store sales, which include the internet, mail-order and phone sales, in July were 20% higher than a year ago, bolstered by clearance Sales. The mixed weather hit women’s and men’s clothing but not footwear or children’s clothing which all had another good month. <>


-The supermarket buy-one, get-one free (bogof) offers could be banned under a Government plan to reduce Britain’s food waste - The Department for Environment, Food and Rural Affairs is demanding that grocers agree to a tough target on reducing food waste or face legislation that forces them to make savings. They could be told to ditch bogofs in favour of half-price deals and package food in a greater range of sizes to suit the single person’s fridge as well as that of a family. The series of reports – called Food 2030 – has been welcomed by food specialists. Defra and the Food Standards Agency are preparing new guidance to reduce confusion about date labels on food. However, the BRC said it would resist attempts to restrict bogofs.  <>


-Privacy clearly has its attractions for online retail - While online discounters such as Bluefly and Overstock have been around for years without impressive results, the online sample sale format known as a “private sale” has caught on worldwide like Champagne at a wedding, showing impressive growth and attracting venture funding. The hype and froth over firms such as Vente-Privee, Gilt Groupe, Rue La La and Ideeli are reminiscent of the dot-com bubble. On the one hand, it seems too good — or too gimmicky — to be true. On the other hand, the off-price market has been estimated at $29 billion a year and it stands to reason at least some percentage of that could move online. (In the apparel world, online retail accounts for about 10 percent of sales.) The magic words seem to be “private” and “sale.” The bargains are hidden behind a firewall where only members can see them — although becoming a member is usually not difficult. (Some sites are invitation only, and others will accept anyone who registers.) The sales are up for a limited time, usually 36 hours, and generally focus on only one brand. Returns and exchanges tend to be limited. Discounts can run as high as 70 percent off. Because nonmembers (and search engines) can’t see what labels are for sale, even luxury and designer brands such as Gucci, Zac Posen and Carolina Herrera don’t mind clearing their excess inventory this way. The deep discounts, the aura of exclusivity and the convenience of shopping online appeal to consumers — who are signing up in the millions to join the sites. The results? Many items sell out within minutes.  <>


-It’s the 11th hour for Escada AG - The German fashion house said Monday it would file for insolvency later this week if its bond exchange offer fails to reach an 80% acceptance rate. The tender period for the bond exchange of 200 million euros, or $287 million at current exchange, expires today at 3 p.m. European Standard Time. The offer has already been improved and extended, but Escada said given the company’s imminent illiquidity, it is not possible to do so again. Results of the offer aren’t expected to be known until Wednesday, however. Escada’s supervisory and management boards will meet Wednesday to determine what further steps to take if the financial restructuring fails. Under the improved exchange offer, bondholders are being given 400 euros, or $572, and 10 Escada shares per 1,000 euros, or $1,430, of debt. The exchange is a crucial part of Escada’s financial restructuring program, and is required to set up future credit lines as well as permitting the planned capital increase to go through. <>


-Best Buy puts an e-commerce industry veteran in charge of global marketing - Barry Judge, who helped launch, has been promoted to executive vice president and chief marketing officer. Judge has held the chief marketing officer title since February 2008. <>


-Knitwear firm Hampshire Group cuts more jobs - Hampshire Group Ltd. on Monday reported a wider second-quarter loss and job cuts that will bring its global head count to half of what it was at the start of fiscal 2009. The Anderson, S.C.-based knitwear firm is in the final phase of a restructuring that began in April and will shed 93 further jobs, or 29% of its current staff. The majority of the latest cuts will come as a result of consolidation of its Asian operations, but will also include some in its executive level, the company said. Hampshire expects to save $9.3 million in selling, general and administrative expenses through the restructuring. Since the start of the fiscal year, the company has shed about 160 positions, or 50%of the workforce. <>


-The United Football League said its online retail store,, will launch Monday, August 10th - The UFL's e-commerce launch is in advance of the League's press conferences next week in Las Vegas, San Francisco, Orlando and New York to announce team names, unveil "Premiere" season uniforms and commence ticket sales. Team merchandise will be available next week after each team name is revealed.  <>


-New York Knicks' Harrington promotes affordable footwear - A new challenger has entered the sneaker arena and with the endorsement of several high-profile athletes and one rapper, Protege hopes to provide an affordable alternative to the big-name shoe brands. On Saturday at the Kmart on Wabash Avenue in Northwest Baltimore, about 500 people were on hand to meet New York Knicks forward Al Harrington and his guest, rapper Fat Joe, at the Protege Basketball Block Party. Harrington, who helped develop the shoe line, is one of the first athletes to sign with Protege. The brand is sold exclusively at Kmart and Sears, with most pairs retailing at $34.99. The brand is also worn by Golden State Warriors guard Stephen Jackson and several WNBA players. "It's all about giving back," said founder and chairman Rodney Henry. "They have great hearts. It's not about the money. It's a chance to give back to the kids - inspire and uplift them." Said Harrington: "It's a give-back brand. We did it for our community. Made it affordable so people can look good and feel good wearing it. ... Kids see me and Stephen wearing them every night so they know they're battle-tested." <>


RESEARCH EDGE PORTFOLIO: (Comments by Keith McCullough): KSWS


08/10/2009 10:41 AM


See McGough's note titled "Warming To A Dog." This dog is down today. Buying red. Everything has a price. KM



UA: Gene McCarthy, SVP of Footwear, was either awarded or purchased 35,000shs ($840k) the 8K filing does not disclose if these shares were awarded, but we assume it may be part of Mr. McCarthy’s employment plan.




2010 IS NOT THAT FAR AWAY - SV 8 11 09



Macau casino billionaire Stanley Ho’s condition became unstable two days ago, according to the Apple Daily.   The Chinese-language newspaper did not cite anyone but stated that Ho, 87, is in a semi comatose condition following brain surgery to remove a blood clot. On August 7, Chan Un Chan, Ho’s third wife, told reporters that her husband was recovering.   




Commission caps were officially approved by the Macau government yesterday.  Casinos will, from September 9th, be limited in the amount of commission they can pay VIP junket operators.  Amendments to Macau’s 2002 administrative regulations on junket licensing outline fines of up to MOP500,000 and other penalties for casinos or junkets found to be disregarding the rule. The regulator will have the power to suspend or revoke junket licenses.


The secretary for economy and finance will announce the official cap through a separate announcement.  Observers expect the announcement to be in line with casino operators’ recommendation that the cap be set to 1.25% of VIP revenue. 

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The Maintenance Man

“People in Hollywood are not showmen, they’re maintenance men, pandering to what they think their audiences want.”
-Terry Gilliam
The mania of this US market’s every trading moment has revealed a generational level of groupthink. The movie-star status that the US Financial system has assigned to US central bankers and economic policy makers isn’t something to get upset about anymore. This is showbiz. It’s one giant gong show – capitalize on it.
The key question for the US stock market yesterday, today, and tomorrow is simple – will Ben Bernanke pander to the politicians?
That’s it. While it’s incredible and saddening all at the same time, we have created a world financial “reserve” system that largely depends on the output of one man - one man with a job security plan. One man acting as the Global Maintenance Man of conflicted political intentions.
In the immediate term, my task is to manage risk. In the intermediate term, it is too – in the long term, I need to be aware that this will render the current US Financial System of perceived wisdom dead.
This game of trying to debunk different investment durations isn’t for everyone, but I’m all in. So let’s stop the whining, strap it on, and get at it. There is a lot going on this morning as global market operators position their bets ahead of a yes or no on the aforementioned Bernanke question. I posted an intraday to our Macro subscribers yesterdays titled “Buying Red” – my chips are on the buy reflation line.
Tomorrow’s latest edition of the gong show will feature two potential scenarios:
1.      Bernanke Panders to his role as The Maintenance Man. Then the Buck will start to Burn again, and everything priced in Dollars will continue to reflate.

2.      Bernanke stops acting out the lines of the “Depression” narrative fallacy, and signals a proactive series of rate hikes. Then, I have no idea what happens.

A “proactive” fiscal stance is what Chinese Premier, Wen Jiabao, signaled to the world’s economy this weekend. As opposed to the reactive “emergency rates” of zero percent that The Maintenance Man is currently holding the bag with, the Chinese policy of remaining “moderately loose” with “appropriate tightening” continues to seem sober.
Remember, all governments are actors in this gong show called Greenspan Goes Global – so it’s important to “seem” sober, objective, and under control – if you want to be the fiduciary of the world’s financial system that is…
After the US stock market has rallied +49% off of her lows, I have had a lot of people question how I could stand here buying/covering anything right now. While that’s a fair question, it seems to be the equivalent of asking me why I would dare step on the ice given prior performances? Exactly – that makes no sense for someone who wakes up every morning expecting to win. Learn from yesterday, and focus on playing the game that’s in front of you today. Stop whining.
Today’s setup in global macro is as follows:
1.      China posted another sequential improvement in monthly industrial production to +10.8% y/y growth (imagine what the Nasdaq would be doing on those #’s!)

2.      China posted another sequential low in Consumer Prices at -1.8% y/y (it is getting cheaper for a billion people to consume)

3.      China posted its 1st stock market up day in the last 5 (positive double digit economic growth and negative low single digit deflation = stock market +79% YTD)

4.      Hong Kong’s Hang Seng Index, closed up another +0.69%, making a fresh new YTD high at 21,074 = +46.5% YTD

5.      Australian business sentiment posted a 2-year high, and the Aussi stock market closed up another +0.58% at a fresh new YTD high of 4334 = +18.4% YTD

6.      Germany’s CPI reading for July came in at -0.5% y/y = strong currencies (Euro 1.42) import deflation in consumer prices for the common man

7.      Japan keeps moneys for free, pandering for the umpteenth time in the last decade, keeping rates at ZERO

8.      Russia’s rear-view of disaster Q2 GDP gets posted at -10.9% y/y, and the stock market goes UP. At +69% YTD, Russian stocks are discounting Q4 inflation (oil)

9.      America’s Ackmanism (sub for 2007 mania called “activism”) shows the efficacy of buying high and selling low (he files cutting his levered long position in Target this morning) = US Financial System and currency credibility?

I know, I know… that last one was a shot at a levered long investment strategy that I have been shooting at since he started selling his wares on CNBC to plenty a poor fund of fund lemming and American citizen alike. The point is that this CNBC’s interpretation of American finance is the metaphor for the gong show. As the show goes on, the aforementioned thing called global macro will continue to move forward – with or without America’s perception of holding the world’s currency…
Until he changes as the facts do, bet on The Maintenance Man doing what they hired him to do. Don’t fight it. Capitalize on it. I have immediate term TRADE upside in the SP500 at 1,018 and downside at 996. Depending on how overtly Bernanke panders to his compromised role of The Maintenance Man tomorrow, I see an intermediate term TREND scenario whereby the US Dollar Index trades down to $76.97 and the SP500 up to 1,041.
Best of luck out there today,


USO – Oil FundWe bought USO on 8/10. With Bernanke as the catalyst for the USD breaking down we want to be long oil.

QQQQ – PowerShares NASDAQ 100 We bought Qs on 8/10 to be long the US market. The index includes companies with better balance sheets that don’t need as much financial leverage.

COW – iPath Livestock This ETN tracks an index comprised of two thirds Live Cattle futures, one third Lean Hogs futures. We initially began looking at these commodities because of recession inspired capacity reductions combined with seasonal inflections. A series of macro factors including the swine flu scare, a major dairy cattle cull in response to collapsing milk prices and the collapse of the Argentine agricultural complex due to misguided policy provided us with additional supporting fundamental data points for the quantitative set up in price action.  

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.

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.

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.

UUP – U.S. Dollar IndexShorting the USD on a strong 3-day rally to another lower high. Your catalyst is Bernanke pandering to political consensus on Wednesday. We believe that the US Dollar is a leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. Longer term, the burgeoning U.S. government debt balance will be negative for the US dollar.

DIA  – Diamonds Trust- We shorted the financial geared Dow on 7/10 and 8/3.

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.

RL: Water Polo

RL: Water Polo

This story is on-track to prove that $6 in EPS power on a disproportionately lower operating asset base is a reality. Mar10 numbers are still low, but for the first time in a year and a half, I can’t model a 40% blow-out in the upcoming Q.


Now that RL has printed yet another bullet-proof quarter, let’s step back and reassess the thesis as well as expectations going forward. I still think that the ultimate call here is that within 12 months, people will begin to eye $6 in earnings power on a disproportionately lower operating asset base. Translation = higher earnings without dumping capital into the model in order to get there. I can’t find many of these stories out there in retail.


But I need to keep myself intellectually honest about duration on this one. Yes, I am still getting to a number for the year that is well ahead of the Street ($4.17 for the Mar10 year vs. Street at $3.70), but for the first time in a year and a half, I’m not modeling meaningful upside to this quarter. I don’t think that RL will miss, but let’s not ignore that this company beat each of the past seven quarters by over 40% on average. I’ve got them beating this one by less than 2%.


Given all the moving parts in this business and the changes in distribution, product, geography (and the overlap therein), it is increasingly important to model the puts and takes. Here’s an overview as to how we’re coming out with our numbers. Our 2Q10 (Sept) assumptions are outlined in Exhibit 2 below.


RL: Water Polo - 8 11 2009 6 56 18 AM


RL: Water Polo - 8 11 2009 6 54 44 AM


RL: Water Polo - 8 11 2009 6 55 25 AM



Raw-sugar prices have surged 86% this year to a 28- year high on concern that a global production shortfall will widen amid a drought in India and rain in Brazil, the two biggest sugar cane producers.  In addition, the global sugar trade is also impacted by European protectionism and subsidized ethanol in Brazil.


While is only a matter of time before Farmers shift back to sugar cane due to higher prices, the damage is done this year. 



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