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Want Vs. Need

“The better part of valor is discretion”
– William Shakespeare
 
Thanks Bill, and the better or necessary part of consumer spending is the staples.  Necessity is why staples are also called non-discretionary.  With their discretion, will consumers be so valorous as to empty their wallets for things they want, rather than need?  The almost vertical trajectory of discretionary consumer stocks suggests yes.  On the contrary, sound analysis indicates that consumers face an almost impenetrable ceiling, triple fortified by the Three S’s:  Savings rate, Stagflation, and Share of wallet.  I’d add consumer credit (bad) to the mix but it doesn’t begin with an S, we like 3s, and our macro team will be addressing this topic shortly.
 
So while Geithner may say that “things are better than 3 months ago, 6 months ago, before this recession began”, I would ask two questions:  By what metric and for whom?  Geithner’s preferred metric lately, it appears, is the rate of change or the “less bad” thesis that Research Edge was espousing when everyone else thought the world was falling apart (March 9th ring a bell?).  The stock market has already discounted “less bad”, then “stability”, and now is viewing the consumer as in “recovery” mode.  This is what scares me.
 
“Recovery mode” implies, well…recovery.  I’m certainly not seeing it in the consumer discretionary sectors of gaming, lodging, and leisure that comprise my analytical vertical.  Is business less bad?  Maybe, but I think the comparisons are just getting easier.  The consumer is not necessarily getting stronger.
 
“Recovery mode” also implies some lasting duration.  We are very worried about Q4 from a macro and consumer perspective.  The threat of stagflation is real, maybe coming as soon as Q4.  Stagflation is a consumer killer.  In a stagflation environment, fewer consumers have jobs and the ones that do can’t buy as much as before.  Will you take credit for that too, Mr. Geithner, when it happens?  Your policies and your predecessor’s policies (as well as the Bernanke constant) have created a fertile environment for potentially massive inflation, yet unemployment continues to grow.  Sure unemployment is growing at a slower rate (10% but it could’ve been 10.5%!). Congratulations - pop the champagne – at least the French consumer discretionary industry will benefit.
 
So if I’m out of work (thankfully I’m not) and my purchasing power begins to decline at an accelerating rate (rate of change cuts both ways Tim), am I really going to buy that 2nd boat, 8th Coach bag, or book that 3rd cruise this year, or will I feed my family.  Want versus need.
 
This also gets us to the share of the wallet question. In an inflationary economy, a larger part of consumer spending will go to non-discretionary items.  With stagflation, the size of the wallet shrinks.  One of my industries has a third problem:  even within the consumer discretionary segment, casino spending is shrinking as a % of Personal Consumption Expenditures (PCE) for the first time in 25 years.  Now that’s a triple whammy!
 
So what do we do?  Be careful and manage risk.  We can’t ignore the warning signs just because the stock market and consumer stocks are going up.  Timing, as always, is critical.  This is where I defer to our timing tutor, Keith McCullough.
 
On a separate note, I will be taking many moments of silence today to contemplate what happened exactly 8 years ago on a beautiful, sunny Tuesday morning.  The events of 9/11 had an impact on virtually every American.  The impact was personal for many of us living/working in NYC that day.  We move forward in part by looking back.
 
Todd Jordan
Managing Director


LONG ETFS

VXX – iPath VIX We bought volatility horribly the first time on 9/3. With the VIX testing our 23 level of support on 9/10, we added to the position.  

XLV – SPDR Healthcare We’re finally getting the correction we’ve been calling for in Healthcare. It’s a good one to buy into. Our Healthcare sector head Tom Tobin remains bullish on fading the “public plan” at a price.

EWH – iShares Hong Kong
The 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.  

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.

 
SHORT ETFS
 
LQD – iShares Corporate Bonds
Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates that bonds will give some of that move back. Shorting ahead of Q4 cost of capital heightening as access to capital tightens.

EWU – iShares UK We’re bearish on the UK’s leadership and monetary policy to weather its economic downturn. Although we’re seeing improved fundamentals within the country and across Europe we continue to see the country’s financial leverage as a headwind and increasingly the data suggests that inflation is getting ahead of growth. With the FTSE reaching a YTD high on 9/9, we shorted EWU.

DIA  – Diamonds Trust We shorted the Dow on 9/3.  In the US, we want to be long the Nasdaq (liquidity) and short the Dow (financial leverage).

EWJ – iShares Japan While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. 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.



Range Rover Attack: SP500 Levels, Refreshed...

They are coming right after my Range Rover line of 1041 here intraday (Range Rover is one of our Q3 Macro Themes that states simply that, while everyone runs around trying to call crashes – the only one we’ll see is the one to the upside versus consensus expectations).

 

Almost 6 weeks ago, after having the topside of my Range Rover target penetrated, I moved to 1041. That line of resistance has held up, until now.

 

Now, with the Buck Burning again to fresh YTD lows, the SP500 is making YTD highs. Can the REFLATION traders hold this line and close it here? We’ll have to see. As the data changes, I will – the data that matters most is embedded in closing prices, not intraday ones.

 

For now, the next line of resistance above my 1041 is 1049. Beyond 1049 will make this market finally overbought. Beyond that line will make this generational short squeeze, on a percentage basis, as large a move as we saw (peak-to-trough) in the 2007-2008 crash on the downside.

 

Immediate term TRADE support bumps up to 1018.

KM

 

Keith R. McCullough
Chief Executive Officer

Range Rover Attack: SP500 Levels, Refreshed... - a1


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Eye on Germany: Opel’s Role into Elections

While beer or castles may be your first association with Germany, its auto industry should be a close second. We’ve been following the rhetoric and dealings surrounding the fate of GM’s Opel division in Germany [and Vauxhall in the UK] and today’s decision by GM to recommend Magna International as a buyer of Opel has important implications for German federal elections approaching on September 27th.

 

It was Chancellor Angela Merkel who originally supported Magna, a Canadian auto-parts maker with the backing of Moscow-based Sberbank, over Brussels-based RHJ when the government offered $2.2 Billion in loans to keep Opel afloat in May of this year. Merkel’s support of Magna, which some called “stubborn” support, hinged on the company’s ability to “save” or maintain the estimated 25,000 jobs Opel provides in Germany. This is an important electoral theme since the industry lies so close to the hearts of Germans and a will no doubt serve as a rallying point for Germans concern about the country’s employment picture.  

 

Weekly Forsa polls over the last months have teetered little, with Merkel’s Christian Democratic alliance (CDU-CSU) receiving the most favor, currently at 35% (down a percentage point from last week), a 14% spread over her rival Foreign Minister Frank-Walter Steinmeier of the Social Democrats. And despite a poor showing in the state of Thuringia in regional elections last week, in which the CDU conservatives lost absolute majority for the first time in 10 years, Merkel’s support looks intact and her political weight behind Magna appears well placed.

 

With Merkel’s preferred coalition partners the pro-business Free Democratic Party (FDP) maintaining its support at 14%, if elections were held today the coalition of Merkel’s CDU and the FDP would have a narrow parliamentary majority.

 

Certainly GM’s decision to support Magna as a buyer should boost Merkel’s credibility and provide a tailwind as elections approach towards the end of the month. Despite a 4% spike in support to the far-left Linke Party to 14% in the recent poll, the Left lacks a coalition partner should the center-left SPD pair with the Greens. With this set-up, Merkel’s conservative coalition looks to be in a favorable position as the election nears.

 

 

Matthew Hedrick

Analyst

 

Eye on Germany: Opel’s Role into Elections - GER12

 

Eye on Germany: Opel’s Role into Elections - GER34

 


WHAT GOES UP…

Dusting off our PCE analysis from last year and it’s even scarier now. Could regression to the mean be playing out for national casino revenues?

 

 

Prior to the consumer downturn beginning in the fall 2008, personal consumption expenditures were on a steep twenty-year incline.  The consumer accounts for roughly 70% of GDP, but gaming was even more levered to the upturn than other consumer sectors.  The higher one goes, the more pertinent gravity becomes.  While the downside for many gaming stocks has been swift, in terms of where the American consumer spends his/her cash, there could be more downside in store.

 

For the gaming industry, in our opinion, mean reversion is a highly relevant factor.  As the chart below shows, gambling spend accounted for 0.8% of PCE in July 2009.  The level peaked several times at around 0.85%, most recently in mid-2008.  Mean reversion may already be occurring, as can be seen by the downward sloping blue line in the chart below.  Why should 0.8% be the right number?  Why couldn’t gambling expenditures fall to the 20 year mean of 0.55%? Or even go below that?  After all, we are talking about discretionary spending that has proven to be highly tied to the economy, much to the surprise of many analysts. 

 

Assuming mean reversion occurs, that would translate into a $23 billion annual loss for the industry or 30-35% from the current revenue level.  I’m not making that prediction but I am saying that domestic gaming faces the potential double hurdle of a tight consumer and a smaller allocation of that consumer’s wallet.

 

                                                          WHAT GOES UP… - Gaming PCE July


Stagflating Claims...

This morning’s US jobless claims report was bullish on a few durations and bearish on another.

 

Pick your duration on the chart Andrew Barber and I put together below and you can debate other investors and their durations.

 

1.       Immediate term – bullish (green line)

2.       Intermediate term – bullish (green line)

3.       Long term –bearish (red line)

 

The immediate of immediate terms is the weekly registering a 26,000 improvement on a week-over-week basis. This week’s number was 550,000 claims (last week’s was 576,000). On an intermediate term basis, the 550,000 print slid below the 4-week moving average of 570,000. No matter what your duration, those two are (on the margin) bullish.

 

From a longer term perspective, this is where the Stagflation call remains intact. Unless US jobless claims start to break down through the 500,000 level, sustainably, there is every reason to believe that, at best, whatever recovery the Depressionistas turned Hope Addicts see coming is going to be a jobless one…

 

Please see Mr. Barber’s longer term TAIL work on the demographic shifts that underpin this multiple duration US Employment debate. The US labor force is getting older and the “young people” have less and less of a probability of earning a paycheck.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Stagflating Claims...   - a1

 


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