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Part of Hell

“I'm not concerned about all hell breaking loose, but that a PART of hell will break loose... it'll be much harder to detect.”

-George Carlin


George Carlin passed away at the age of 71 last year. Like most of us wanna be market prognosticators, he was an author, an actor, and a comedian. If you can’t wake up and find something funny about this business, you are probably not awake.


We have just witnessed the 2 largest percentage moves in modern US trading history – and as my former (Montreal born) hockey roommate, Frenchie Magnant, would say: “those are two fried egg, side by each, eh.”


  1. SP500 October 10th, 2007 (1562) to March 9th, 2009 (676) = -57%
  2. SP500 March 9th, 2009 (676) to August 25th, 2009 (1028) = +52%


No, these eggs can’t be scrambled. They are already cooked. No matter what your storytelling narrative said, and no matter where you go this morning, there they are – right on your plate.


Not that I am keeping track of the score or anything, but Bloomberg did that for me anyway this morning. On that fine aforementioned morning of March 9th, 2009, one Nouriel Roubini called for the SP500 to hit 600. This business is funny, indeed.


What’s not funny is losing money. Now that we know that markets can crash versus expectations, both ways, we need to learn from it. We as an industry need to continuously evolve. Every day we have to address this market much like a patient. Take its critical signals for what they are, and move forward.


As I look forward, I’m not so much looking for Roubini’s or Rosenberg’s one way advice – I’ll go with Carlin’s. As of this morning, “I’m not concerned about all hell breaking loose, but that part of hell will break loose.”


Trying to call intermediate term tops in markets is for storytellers. Trust me, I try to tell mine every day! What I have learned from the Top, to the Bottom, and Back Again (sounds like a good name for a book), is that tops and bottoms are processes, not points.


In the immediate term, I am very comfortable making what Wall Streeters of responsibility in recommendation years past call “making the call.” I’ve had enough pucks to the head to try to do this every day. I guess the numbness of it all provides me with outputs.


Today will change tomorrow. But today, I see the risk in the US stock market beginning to cleanly outstrip the reward. On the margin, I have been bullish. So this is a change for me, and here are the reasons why:


  1. Daily risk/reward has shifted to the risk side for the 3rd day in a row – this is new
  2. Immediate term risk/reward in the SP500 is -2% risk versus +1% reward (1007-1040 is my new range)
  3. The range of probabilities (again, risk/reward) when I elongate my duration beyond 3-days is now 65 SPX points, that number was 40 points on Friday
  4. Daily volume studies are starting to flash bearish (up days coming on sequentially declining volume – yesterdays new high came on -7% day/day volume)
  5. The market’s breadth is no longer a layup (Advance Decline line was 59% to 38% yesterday – that’s barely bullish AT the YTD high)
  6.  Howard Penney’s S&P Sector Views has flashed only 5 out of 9 Sectors closing up in the last 2-days (that number was 7 or 8 out of 9 last week)
  7. US Healthcare and US Technology are almost flashing beyond 2 standard deviations overbought (my favorite sectors, but overbought is as overbought does)
  8. The US Dollar has been holding the critical line of $78 support for the last 3 days; with the WSJ + Barons parroting my thesis, it’s starting to morph into consensus
  9. If the US Dollar breaks out above $78.63 and the VIX breaks out above 25.04, everything REFLATION is going to go down


So, those are some of the quantitative reasons. However, any well rounded multi-factor model should incorporate Behavioral Psychology into its construction. On that front, I am seeing the most glaring level of groupthink I have seen on one specific factor since, well, the market was topping out in October of 2007.


That factor is the spread between Bulls and Bears in the weekly Institutional Investor Sentiment survey. This morning has finally registered more than 50% of the portfolio managers in the USA as being BULLISH. Yes, they will finally admit it! AFTER the move, of course, but no matter where they go this morning, there they are.


The Bulls have moved up from 48% last week to 52% this week (new highs). The Bears have been bludgeoned, dropping from 23% to 19.7%. The spread between the two is 32 points wide. This combined with 3-month US Treasury rates hitting a new low at 0.15% (yes, that’s ZERO lending rates), is a consensus cocktail for “part of hell to break loose.”


Sometime in the next 3 months, and I have not yet made my call from a timing perspective to the day yet (yes, I am numb enough to do that, and I will), “part of hell will break loose.” It won’t be in Brazil, or Hong Kong either. It will be right here, in the compromised US Financial System that we have barricaded ourselves with.


I have sold down my allocation to US Equities to 3%. That’s the lowest representation I have for any asset class currently. I’m going to go eat my eggs now.


Best of luck out there today,






EWH – iShares Hong KongThe current lower volatility in the Hang Seng (versus the Shanghai composite) creates a more tolerable trading range in the intermediate term and a greater degree of tactical confidence.  


EWZ – iShares BrazilPresident 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 reflation call. 


QQQQ – PowerShares NASDAQ 100We 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.  


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. 





XLP – SPDR Consumer Staples – We shorted XLP on a bounce on 6/21. One way that investors chase a bearish USD is buying international FX leverage in global consumer staples. Shorting green.


DIA  – Diamonds Trust- We shorted the financial geared Dow on 7/10, 8/3, and 8/21. 


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.


Bernanke should depoliticize the Fed, critics say

SAFM – Comments as it relates to the Restaurant industry

The set up for SAFM looks to be very bullish for the next couple of years if all of the pieces of the puzzle fall into place.

(1)    The surge in corn prices in 2008 caused domestic chicken processors to cut back on production, reducing the supply of chickens

(2)    As we sit here today, feed costs look to be headed lower.  A bumper crop of corn could send it to $2.50.

(3)    Retail demand remains robust, but food service demand is challenged.

(4)    If food service demand picks up in 2010 and supplies are tight - chicken prices are headed higher. 

(5)    Higher chicken prices combined with favorable feed costs means better margins. 

(6)    In 2011, SAFM will be bringing on a new production facility, improving operational efficiencies.

Clearly, weather can ruin any good story, but the set up for SAFM looks to be positive for the foreseeable future.

Some comments from SAFM senior management as it relates to Restaurant investors:

FOOD SERVICE DEMAND – “We continue to believe we will not see a meaningful rebound in food service demand until well into calendar 2010 at the earliest, and then only if employment numbers begin to improve. Consumers need to get their jobs and confidence back before they're going to start eating out again.  Fewer chickens than normal will be needed this fall to meet demand, and fewer chickens will be available, but we won't know until we get there whether or not the industry has balanced supply with what we believe will be reduced demand.”

CHICKEN PRICES – “Overall market prices for our fresh chicken improved during the quarter, compared to last year's third quarter. But I continue to believe the improvement has more to do with production cuts than demand improvement.”

FOOD COSTS – ($2.50 Corn?) “We expect feed cost to remain below a year ago for the rest of this year. The USDA August crop report indicated there should be an adequate supply of corn next year, and that the record number of soybean acres should produce a harvest that should help prepare the soybean balance sheet.

However, while all indications are this year's corn and soybean crops will be adequate, and that significant progress should be made replenishing depleted soybean stocks, market volatility will continue as concerns grow for an early frost and yield issues.  This is particularly true for soybeans, as old crop supplies remain tight and the expected large crop is needed.”

CHICKEN SUPPLY – “The chicken markets are no easier to predict than the grain markets. While egg sets have remained below a year ago, and we are heading into the fall with fewer chickens on the market, we are also heading into the fall and the seasonal reduction in chicken demand with weak demand at most food service establishments.”


The S&P/Case-Shiller Home Price Indices are calculated monthly and published with a two month lag.  It was reported today that the Standard & Poor's/Case-Shiller's U.S. National Home Price Index rose nearly 3% in 2Q from 1Q.  In January we predicted that the housing market will improve in 2Q. It has.


Home prices are still down 15% year-over-year in June (better than the expected consensus decline of 16.4) and down 30% from the peak in the second quarter of 2006.  The housing market is bottoming, but there is clearly a long way to go to get back to the peak.


Last week, the NAR reported that existing home sales jumped 7.2% to an annual rate of 5.24 million homes, the highest since August 2007.  With the S&P/Case-Shiller housing numbers now showing sequential improvement for the last two months, we would expect the existing home sales numbers to continue to get better in the short run.  If house prices have stopped going down and the free money policies persist, it makes sense to think that consumers will have an increased propensity to buy new homes, helping to gradually push market prices for homes higher (with “dark pools” of inventory overhang waiting in the wings to keep a ceiling on any substantial rally) . 


As we head into 4Q09, however, we are likely to see the best data points in housing in the rear view mirror as a result of the following three points (reiterated from last week):


(1)    THE PEAK SEASON - For those consumers with “need based” moves, it’s August and the kids will be back in school soon, if they aren’t already.


(2)    INTEREST RATES - Interest rates are headed higher in Q4.  See Keith McCullough’s note on “Bernanke Pandering” and you will get the picture.


(3)    THE GOVERNMENT - The Government home buyer stimulant is going to end.  The deadline to close a home purchase is November 30, 2009. The process of buying a new home is not quick and easy - finding a home, lining up financing and getting inspections and closing, all takes time to accomplish.


Howard W. Penney

Managing Director



Lower High: US Consumer Confidence

While it’s interesting to have confirmation that one of the most relevant Pain Trades that remains in the hedge fund community is “short the US Consumer”, it’s always interesting to consider the context of that interesting point.


In the 2 part chart below, Andrew Barber shines a light on where this morning’s better than expected US Consumer Confidence number fits. The top part of the chart focuses on the our intermediate term TREND line, whereas the bottom part of the chart broadens our perspective to the long term (back to 1979).


Understanding that, in the intermediate term (3 months or more), that some of the Q1 2009 confidence readings are some of the lowest on record is very important. That explains, partly at least, why the US Consumer Discretionary ETF (XLY) is the best performing sector in the SP500 today of the nine we have in our Sector Views. From a contrarian perspective, the Pain Trade on US Consumer shorts remains up as a result. It’s the highest short interest group in our SP500 Sector Studies. Being long of short interest continues to pay off.


In the long term however, this morning’s US Consumer confidence reading of 54.10 is a LOWER-HIGH (albeit barely) than those dead cat bounces we saw in both September of 2008 (61.4) and May of 2009 (54.8).


Interesting is as interesting does and, remember, tops are processes, not points.



Keith R. McCullough
Chief Executive Officer


Lower High: US Consumer Confidence - Consumer Condidence 12



BKC’s 4Q09 EPS of $0.43 (including a $0.07 benefit from a lower tax rate) beat the street’s $0.33 estimate.  I would say the biggest positive in the quarter was the 130 bp YOY improvement in U.S. and Canada company restaurant margins.  The biggest negative, though somewhat expected following TAST’s 2Q numbers, was the 4.5% decline in system same-store sales in the U.S. and Canada. 


Judging by the stock’s significant move higher today, investors seem comforted by the U.S. margin improvement and the fact that traffic trends in the U.S. have improved each month since May (but are still negative).  Traffic has been helped by the company’s shift in focus to include more value offerings, such as the $1 Whopper.  Even with traffic getting sequentially better in July (as stated by management), I would expect the overall comp number to continue to be weaker than MCD’s U.S. 2.6% same-store sales growth and Wendy’s estimated 2.0% growth.




Q4 Earnings Call Commentary

Current macro backdrop continues to adversely impact results:

-higher unemployment (July's unemployment rate in the U.S. 18 to 39-year-olds is now 12% and even more disconcerting is the 20% unemployment rate among ethnic groups in this age group which represents a disproportionate amount of the heavy user and super fan base)

-more consumers eating at home (out of home eating expenditures which are now at a 28 year low in the U.S. according to the NPD group)


Current comp trends (most of Q&A focused on U.S. traffic trends):

- U.S. comps and sales have improved since May although not to levels with which management is satisfied.  New value promotions will continue to put pressure on average check and it is expected to be flat to down.  Importantly, management stated that the dilution to gross profit margin, from these lower price points, has been lower than initially forecasted.

-Germany and Mexico comps and traffic have improved albeit still at negative levels.

 “I think the Mexican consumer is somewhat more confident…We have seen month over month continued improvement in our sales, and I don't think there is anything we need to do differently there.”

“In Germany I would say, again, a challenging economic environment there. We continue to move more towards affordability, and I would say there is more we can do on that front. I wouldn't say we're as far along as we are in Mexico. We certainly moved in that direction, but I think we can go further, and again I believe we have seen improvement over the last two or three months.”


Comments about Q1 Comp:

“I think we're not going to give you a number obviously on what we think from a comp standpoint for the quarter. You can tell from our comments we're saying the U.S. has gotten better month by month. We talked in our comments about the fact that Mexico and Germany had improved all be it we're still negative, so I think that gives you a sense of roughly how the quarter is looking, but that's all the color we really want to give at this point.”


Fiscal 2010 Outlook:

Management anticipates the current challenging environment will continue into fiscal 2010.  Due to the lack of visibility, the company is not providing specific EPS guidance for the year.


-most difficult to forecast is comps but expected to be soft in 1H10 and improve in the second half if consumer sentiment improves

-250 to 300 net new restaurants (represents a growth rate below long-term guidance due to commercial construction delays) with 80%-90% of net new units outside the U.S.

-U.S. commodities expected to be flat to slightly better (improve in the first half of the year and be up slightly YOY in 2H)

-Commodity costs outside the U.S. will be up a few percentage points YOY

-Capex of approximately $175-$200 million



After experiencing a rapid decline in traffic starting in March, BKC shifted its promotions to focus on satisfying the need for affordability with the $1 whopper junior in the U.S. and affordable combo promotions in Germany and Mexico and throughout many of the company's other international markets.

-also offering local market value promotions in the U.S., such as 2 for $3.50 Whopper® sandwiches and 2 for $3 chicken sandwiches, across many cities. Since implementing these value offerings, the company stated that it has seen a progressive improvement in traffic.


4Q09 commentary:

-U.S. and Canada Company Restaurant Margins: up 130 bps, benefited from 120 basis points improvement in food, paper and product costs, a 100 basis points improvement in occupancy and other operating costs primarily due to the lower accelerated depreciation expense related to the reimaging program incurred this year compared to last year and to a significant decrease in utility expenses partially offset by increases in labor costs.

-EPS increased 16% to $0.43 as compared to $0.37 in the same quarter last year. Currency translation negatively impacted earnings per share by $0.03 within the expected range for the quarter. This quarter's EPS was positively impacted by $0.07 due to a lower than forecasted tax rate of 21.6%, the result of the dissolution of in-active foreign entities. Without this tax benefit EPS would have been $0.36 for the quarter and within the company's previous guidance given in April.



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