Charting China...

Having been bulls on China since December of 2008, and having published a “China Black Book” recently, you know we have an opinion on the monkeys calling China a “bear market” today. Stock market drops of -19.8% since August 4th matter, but so do year-to-date gains of +53% that include a -19.8% drop!


As a point of accountability, in Andrew Barber’s “China Black Book” there was a tactical overview section called “The Path Ahead.” It was there that Barber put some responsibility behind our recommendation, reminding our clients that the big YTD move in China was behind us.


Barber wrote on July 21, 2009:


“We believe that after this extended rally in Chinese equities, the “easy money” is now behind us and that at present the Shanghai composite has the potential to correct to its immediate term TRADE line of support of 3020 (a 7.5% correction from its peak) without any significant fundamental change in the underlying data. Price momentum carries risk. If there is a sustained breakdown of the 3020 level, the intermediate term TREND line of support for the SSEC is 2713 (a 17% correction from the peak) and that would be a critical risk management level in our model. Furthermore, the likelihood of a pullback of this magnitude occurring has increased exponentially as more “hot money” has surged into the market.” 


Today, of course is August 19th, and one month later we are looking at the manic media freaking out about China being “over” at a closing price of 2,785 on the Shanghai Composite Exchange. Again, Barber’s TREND line of support is 2,713.


Could we, should we, will we, see a breakdown of 2,713? We will have to see about that wont we. For now, all we saw in China that was “over” was a bull market that was OVERBOUGHT.


In the chart below, my man AB and his crystal ball shows the long term TAIL line of support for the SSEC at 2,364. We suggest you use the manic media as your backboard to generate alpha in global macro. We remain “bullish of” Chinese equities, at a price.


Our long term China piece can be found at the link below.




Keith R. McCullough
Chief Executive Officer


Charting China...  - a1


Dick’s: Same Store Sales Trend Correlation with Sports Apparel and Footwear Data

As many of you know, we pay careful attention to the weekly footwear and sports apparel trends from two data service providers (Sportscan and NPD).  We recognize that weekly data can be both a blessing and a curse.  On one hand, we see trends develop and change with a great degree of frequency, while on the other hand we see the volatility that exists in the “real world” of retailing.  Nonetheless, we are often asked the question about the relevancy of the data and if there is any conclusion to be drawn for the publicly traded athletic footwear retailers and manufacturers.


As shown in the chart below, the footwear and apparel data suggests that the industry backdrop was less favorable in Q2 for DKS and sales results may not substantially exceed expectations (as we saw last quarter).   At the end of 2008, DKS’ management guided Q109 comps to a range of -9% to -12% and ultimately reported a -6% result.  This prompted a change in quarterly and annual guidance from a range of -8% to -12%  to a new range of -6% to -9% (the Street is currently expecting a -6.7% comp).  Yes the backdrop is getting better on the margin in recent weeks, but the to-be-reported quarter was marked by a sequential deceleration following a post-holiday rebound.


A little more detail on our analysis.  It is important to note that Dick’s does not report their weekly sales to the two data providers that we use.  However, given geographic, product, and pricing trends represented in the sample set, there is value in the comparison.  The bottom line is, quarterly sports apparel and athletic footwear trends have a strong historical correlation with DKS’ reported same store sales.  Based on our analysis, the correlation between a weighted average of apparel/footwear trends and DKS’ historical same store sales is 80%.  To arrive at this conclusion, we aggregated our weekly data sets in order to properly align DKS’ fiscal quarters with the corresponding Sportscan/NPD information. 


Ultimately, we can’t claim 100% accuracy in the predictability of using the weekly trends to forecast DKS same store sales for any given quarter.  However, marrying the data with historical sales results shows directional changes and inflection points with a high degree of accuracy.  Based on Sportscan and NPD alone, we see that Q209 trended down measurably from Q109.  Again, this suggests 2Q results could be weaker than the slight deceleration expected by the Street.  On the other hand since June, it appears that sporting apparel sales are holding even, while athletic footwear is showing a slight uptick.  Consistent with many other retailers and recent weekly data, we expect commentary on back to school to be incrementally positive.


Dick’s: Same Store Sales Trend Correlation with Sports Apparel and Footwear Data - 1


Note:  DKS quarterly comp trends correlate most with a blended footwear-apparel data set.  The blend is comprised of a two-thirds weighting in sports apparel from Sportscan and one-third footwear data from NPD.  The blended data set is designed to best represent Dick’s product mix in these categories, with the obvious limitation of not representing any hard goods in the analysis (hard goods represent 54% of DKS total sales).


Weekly Sports Apparel Update


Sports Apparel posted a positive week in the thick of the back to school season, with strength in the Full Line Sporting Goods (increased 12.1%) and Family Footwear channels (up 29.2%).  All channels experienced a sequential improvement in total sales growth.  Average selling prices remained relatively stable while there were some signs of sequential deceleration in  ASP growth.  In general, the environment does not appear to be overly promotional or aggressive.  Sport Retailers have been easing into the 2009 BTS season with incrementally slower ASP growth for the last 5 weeks, culminating with essentially flat ASP’s this week.  Geographically, the South Central and South Atlantic showed the biggest change in sales trends, helping to drive the total sports apparel category back into positive territory.  New England and the Mid-Atlantic (both later back to school markets) showed the weakest trends for the period.


Dick’s: Same Store Sales Trend Correlation with Sports Apparel and Footwear Data - 2


Dick’s: Same Store Sales Trend Correlation with Sports Apparel and Footwear Data - 3


Dick’s: Same Store Sales Trend Correlation with Sports Apparel and Footwear Data - 4




PFCB - Diversification

Earlier this week, PFCB announced that it has entered into an exclusive licensing agreement with Unilever to develop a line of frozen Asian entrées for the U.S. under the P.F. Chang’s brand.  The terms of the agreement were not disclosed and the launch date of the new products has not yet been set. 


This new agreement sounds familiar to the trademark licensing agreement California Pizza Kitchen has with Kraft.  CPKI partnered with Kraft in 1997 to distribute a line of CPK premium frozen pizzas in the U.S. and Canada.  Kraft distributes CPKI’s frozen products, which now include flatbread melts, in about 20,000 select grocers in the U.S.   CPKI collects royalties from Kraft, based on a percentage of Kraft’s net sales of the frozen products.  This licensing agreement has provided CPKI with a high growth and highly profitable royalty stream, contributing $6.6 million to the company’s 2008 sales, up nearly 40% from 2007.  Most importantly, Kraft is required to spend a percentage of net sales on advertising and promotion of California Pizza Kitchen’s licensed products, which acts an extremely effective marketing platform for CPKI.


We don’t know yet how PFCB's agreement is set up.  We don’t know what percentage of sales PFCB will earn, the price point of the new frozen entrees or whether Unilever will provide the marketing dollars for the new products.  I would suspect that PFCB has watched CPKI’s success with Kraft and is working to create its own high-return royalty stream.


PFCB - Diversification - CPKI Kraft royalties

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US Housing: Reflation's Rotation

Tightening supply and ZERO rates help stoke the inflation fire for Q4…


July housing starts fell to an annualized rate of 581,000 units, from an upwardly revised 587,000 units in June and below the median expectation of 600,000 units; the July decline was due to a 13.3% drop in multi-family homes. 

(continued discussion post charts)


US Housing: Reflation's Rotation - a1


THE GOOD NEWS - The all important single family housing starts rose 1.7% in July to 490,000 units. The 14.0% gain in the Northeast was the driving force behind the growth in single family starts. 


THE BAD NEWS – There is a housing supply imbalance building.  The chart below provides a clear picture of the true supply of housing in the United States – the number of houses started minus the number of houses completed.


US Housing: Reflation's Rotation - a2


Since 1979 there are three pronounced periods where we see a real reduction in the true supply of new homes being built; 1, 1 and the current housing crisis.  While there are numerous nuances to each time period, each one was followed by a significant increase in inflation.  Intuitively it makes sense that during recessionary periods supply tightening will occur when producers overestimate demand declines, and that the resulting imbalance can create inflationary pressure (particularly if combined with low rates). In the chart below, we have mapped out this ratio against PPI. Note that historically; cycles of declining Starts to Completions have troughed at the same time that inflation has peaked prior to the current cycle.


US Housing: Reflation's Rotation - a3


The reality is that the decline in home values, low interest rates, government incentives and the increase in household formations WILL create real demand for housing units.  As a result, there is a disconnect between the perceived demand that people are not buying houses right now and the real demand, creating a “real” decline in housing supply.  At some point this will lead to future issues – INFLATION.


This is not the sole impact of housing on reflation: after all it is the substantial decline in home prices that created a tidal wave of problems for the economy and our financial system.  This has allowed the FED to keep interest rates artificially low for an extended period and helped the Government to go on a debt fueled  spending spree, killing the value of our currency.  The currency crisis will ultimately lead to imported inflation. We’ve labeled this transition period, Reflation’s Rotation (Q3 prices moving from y/y deflation to Q4 y/y inflation).


THE CONSEQUENCES – We are not just looking for another data point that will help justify our Q4 “reflation rotation” theme, but things are looking more ominous for inflation to return in Q4. 


Howard Penney

Managing Director


Andrew barber






The real estate sector in Macau has rebounded in the second quarter; real-estate transactions rose 123% quarter-over-quarter to 3,713, according to the Statistics and Census Service.  The 3,713 building units involved had an officially declared value of MOP4.57 billion, up 115% quarter-over-quarter. 


An annual comparison is less positive; the number of property transactions in the second quarter was down 53.2% when compared to the same period in 2008, with the total value of the properties down 60.8%. 

Monkey See, Monkey Do

“By continuing a process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”
-John Maynard Keynes
I tend to surprise some investors whenever we are talking “macro” and I remind them that John Maynard Keynes wasn’t (initially) a government Yes Man. Today’s manic financial media tends to think of him as a beacon for big government spending. Don’t forget that Keynes made a name for himself by chastising and mocking the British government’s economic policies.
Most economic strategists and forecasters get respect after they are dead. I get that. That’s just the way life goes. Keep in mind that Keynes was only 36 years old when he penned some of his most influential writings.
Warren Buffett wrote an Op-Ed this morning that will get a lot of people’s attention. In that piece he cited Keynes’ aforementioned quote. Since this sounds a lot like what I have been pounding the monkey cage on for the last 3 months, I smiled and took a big bite of my banana.
I could care less if your run of the mill revisionist Wall Street economist disagrees with me on the US Government Burning The Buck. 1. It’s a mathematical reality, and 2. If Buffett (and now PIMCO this morning as well) supports the “view”, there will be more than one dog barking from here on in. Monkeys get excited when dogs bark.
One of the key differentiators between the time that Keynes made this critical point on currency led inflation and today is this thing called You Tube. In all economic crises past, governments have been able to maneuver “secretly and unobserved.” That’s changed. We’re watching every move that the old boys in De Club are making. They will be held accountable.
PIMCO calls it the “New Normal”, and I get how that ring tone nestles nicely into the Street’s narrative. Nine months ago, I labeled it “The New Reality”, and despite getting overridden by PIMCO, I’ll humbly re-submit one of our core Q4 2008 Macro Themes. The New Reality of financial forecasting is to uphold these 3 basic principles: Transparency, Accountability, and Trust.
That’s it – very simple. Show us, Mr. Geithner, what it is that you do. Be accountable to your global macro investment process and what you are doing to this country’s currency. We’ll decide whether or not we trust you. That’s The New Reality.
Whether it’s Buffett finally You Tubing the US Government’s debt issuance as a “gusher of federal money” or PIMCO’s Curtis Mewbourne posting on his company’s website that he effectively sees the US Dollar as losing its status as the world’s reserve currency, it’s all the same point – it’s the point we continue to hammer on. It’s the point that those who are surveying the world as an interconnected marketplace of colliding economic factors understand. There is no “I” in USA.
Some people use monkey charts - I use mathematical inputs born out of complexity theory to come up with my risk management levels. Complexity theory allows me to find deep simplicity in investment conclusions. That’s all my Q3 Macro investment Theme of Burning The Buck boils down to. One simple and dominating investment point that’s been born out of a very dynamic ecosystem of interacting global macro factors.
So, Dear Mr. Buffett – before we run into the long term TAIL of inflation output (Q409), here’s the intermediate term TREND call. US Dollar down = everything priced in US Dollars up. US Dollar up = everything priced in US Dollars down. That’s it. That’s still the call.
Inverse correlations in global macro aren’t perpetual. As they morph into consensus, returns get crowded out. With respect to our Q3 Burning The Buck theme, we haven’t seen daily, weekly, or monthly returns crowded out yet.
On Monday, with the US Dollar up, I made purchases. Yesterday, with the US Dollar down, I made sales. Buy low; sell high – rinse and repeat.
In sharp contrast to the zero-accountability model that most “economists” and sell side “strategists” abide by, The New Reality model of responsibility in recommendation here at Research Edge empowers me to be fully transparent with every market move I make. All of the long and short sales I made in our virtual portfolio have a time stamp on our portal at No, I don’t have a “conviction buy” list versus a “buy” list. Whatever that means…
With the US Dollar down yesterday, I made long sales in COW (cattle/pork ETF), XLB (Basic Materials ETF), and Cardinal Health (CAH). On the short side, I shorted CKE Restaurants (CKR), Darden Restaurants (DRI), Eli Lilly (LLY), Research In Motion (RIMM), and AutoZone (AZO).
All of these tickers were green when I sold/shorted them. I like selling green bananas to the monkeys who will eat them. With the US Dollar trading up this morning, I’ll be looking to buy/cover on red. I learned these rules as a child watching street lights. I know, a monkey could do the same.
My immediate term TRADE support for the SP500 is now 979 and I have immediate term upside resistance at 1,000.
Best of luck out there today,


XLK – SPDR Technology Tech and Healthcare remain the two sectors most primed for accelerating M&A activity in Q4. Both look great from an intermediate term TREND perspective, but at a price.

EWC – iShares Canada We bought Canada on 8/11. Canada has what THE client (China) needs, namely commodities, which we believe will reflate as the buck burns.   

USO – Oil FundWe bought USO on 8/10 and 8/17. As the Buck breaks we want to be long oil.

QQQQ – PowerShares NASDAQ 100 We bought Qs on 8/10 and 8/17 to be long the US market. The index includes companies with better balance sheets that don’t need as much financial leverage.

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, which posted a positive Q2 GDP number.

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. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient 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.


VXX – iPath VIXAs the market rolled over and volatility spiked, we shorted the VXX on 8/13.

UUP – U.S. Dollar Index 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.

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