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Is Bigger Better?

“Any fool can make things bigger, more complex, and more violent. It takes a touch of genius - and a lot of courage - to move in the opposite direction.” -Albert Einstein


Is Bigger really Better? That question can be asked to a lot of constituencies, and I actually don’t want to know the answer to all of them! When it comes to the US Government’s balance sheet however, I think that the marked-to-market price of US Dollars has already answered the question.


Whether you are a Dallas Cowboy or Federal Reserve fan, you are waking up to a little nausea this morning. The Cowboys hosted the biggest fan base to ever see an NFL football game (over 105,000 people) last night, and they lost. The US Federal Reserve expanded America’s balance sheet to her largest size ever last week ($2.14 TRILLION), and the US Dollar lost value for the 3rd consecutive week.


Now I am certain that Cowboys fans will find some wins, but will the USA’s Bigger Debt is Better Plan find a special place in the hearts and minds of fans across the nation? Is Bernanke/Geithner America’s Team?


While America’s Household Balance Sheet expanded by over $2 Trillion Dollars last quarter to $53.1T, a US Dollar ain’t what it used to be. Despite the SP500 ripping the Depressionistas for a +58% loss since March, America’s Household Net Wealth is still -17% from its Q3 of 2007 peak ($64.7 Trillion Dollars).


American Consumer confidence was still tracking down at -49 per the weekly ABC/Washington Post Consumer confidence reading last week (all time low is -54), and after President Obama appeared on every TV show other than Sunday Night Football yesterday, one has to wonder if he scored any points.


Is Bigger Government really better? Is Bigger Debt really better? What do Americans dislike more? Government or Debt? Interesting questions for interesting times…


Last week, the Fed’s Balance sheet expanded by another $52 Billion Dollars. That was the 6th consecutive week of bigger debt taking the year-over-year expansion of the Fed’s Balance sheet to +$1.15 Trillion Dollars. Yes, I am spelling out Billion and Trillion this morning for a reason. Bigger Debt = bigger word count for KM’s Early Look.


In the short term, this is high octane gas for the Burning The Buck tailgate party. In the intermediate term, it has equated to a US Dollar crash move of -14.5% since March, and like I said prior, a +58% REFLATION move in stocks. Debtors, Bankers, and Politicians get paid. Creditors get the bill.


It’s sometimes ok to get the bill if you are winning, but even after a generational move in US stocks, America’s Team is sitting at the bottom of the Global Macro League standings. On Friday, Brazil’s Bovespa hit another new YTD high at +62%. Mid-week, the Russians were staring down a +100% YTD stock market move. In Vietnam last night, stocks added on another +1.2% move, taking their YTD run-up to +83%.


All the while, American politicians are whining, not winning. They thought they’d get paid in political capital if they fixed the stock market. They are getting paid alright – via political football season!


As we head into the two major macro events this week (Fed meeting on Wednesday and the G-20 on Thursday/Friday), President Obama and Ben Bernanke have to find a way to reconcile how to tell both Americans and the World that only 3-6 months ago we were having a Great Depression, but now the Recession is “very likely” to be over…


Bigger Debt and bigger storytelling is what we should expect to see in the coming days. This is what it is. How we can go from said Depression to hoped for Recovery (ostensibly skipping the recession) in 3-6 months? All the while we are Burning The Buck with a reckless “emergency rate of ZERO” percent for our Creditors. America’s financial forecasting team’s storytelling must be far more sophisticated than we fans are…


The US Treasury is going to issue another $112 Billion Dollars in US Debt this week. At the same time, the US Federal Reserve will be politically pressured to maintain their planned $1.25 Trillion Dollar MBS (Mortgage Back Securities) buy-back program. All the while the Chinese will be in Pittsburgh (G-20) smiling at us like I would if I had to look at Timmy Geithner for more than 3 seconds face-to-face…


Alan Stanford has apparently hired a Bigger is Better legal team that they are calling a “Champagne Defense” this morning. When Bernie can set the bar so high, what’s a $7 Billion Dollar lie worth in this country these days anyway? Again, “any fool can make things bigger, more complex” … especially if we let them…


All of this is plain sad and it might just mark the end of the US Dollar going down, for now. Then again, it might not. Real-time market prices will rule my macro model in analyzing it all the while. All Ben Bernanke has to do on Wednesday is change his rhetoric that Bigger Debt isn’t a perpetual plan. Now that he doesn’t have to worry so much about job security, heck, there’s always some hope that he may stop pandering…


With year-over-year deflation morphing into late Q4 inflation, and the USA setting up to print a much larger than expected Q4 GDP number, the Bigger is Better balance sheet policy will be under fire. Bigger American savings accounts are most easily achieved by giving Americans something Bigger than ZERO as a rate of return.


My immediate term TRADE levels for the SP500 are now 1050 (support) and 1079 (resistance).


Best of luck out there this week,
KM

 

 

LONG ETFS

 

CAF – Morgan Stanley China Fund A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the more volatile domestic equity market instead of the shares listed in Hong Kong. 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. Although this process will inevitably come at a steep cost, we still see this as the best catalyst for economic growth globally and are long going into the celebration of the 60th Anniversary of the People’s Republic.

GLD – SPDR Gold We bought back our long standing bullish position on gold on a down day on 9/14 with the threat of US centric stagflation heightening.   

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. We shorted EWU on 9/9.

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.


THE MACAU METRO MONITOR

CASINOS EYE RECORD REVENUE AS BEIJING EASES MACAU VISA RULES scmp.com

The mainland has relaxed restrictions for its citizens from Guangdong travelling to Macau, which has resulted in a strong showing so far for September and big hopes for October, according to two unnamed “top executives at two of the market’s six casino licensees” cited by the SCMP.  The sources also stated that the authorities began to ease restrictions as early as two months ago.  Currently, citizens of Guangdong can travel to Macau once a month.  One of the sources claimed that October could see monthly casino revenues soar to a record high, partly due to the relaxation of visa restrictions.

 

 

WYNN EXPANDS MACAU SHARE OFFERING BY 25% scmp.com

The size of Wynn’s upcoming IPO in Hong Kong for its Macau unit has been increased by about 25%, seeking to raise up to US$1.6billion.  The move comes after positive feedback from investors; the company is now willing to sell 25% of the division, up from the 20% originally intended for sale.  The price range of the offer is expected to be HK$8.52-HK$10.08 per share, with at least 1.25 billion shares being sold.

 

In the prospectus for the IPO, Wynn stated that Encore at Wynn Macau is scheduled to open in the first half of next year.

 

 


WYNN SECURES PLEDGES OF $250M FOR HONG KONG IPO ft.com

Wynn Resorts has secured commitments of $250m for its upcoming IPO from cornerstone investors including Hong Kong tycoons Walter Kwok and Thomas Lau.  Quek Leng Chan, the Malaysian billionaire, is also on the list, according to people close to the transaction. 

 

Las  Vegas Sands is planning its own Hong Kong listing of its Macau casinos later this year.

 

 

 

 


SAFM - WHY DO EXECUTIVES NOW NEED EMPLOYMENT AGREEMENTS?

Last week the Brazilian company JBS SA agreed to acquire Pilgrim’s Pride, making it the world’s largest meat processor ahead of Tyson Foods Inc (TSN).  As expected, TSN played down the potential impact the industry consolidation may have on future business.  Clearly, others in the industry are preparing for further consolidation.  SAFM’s strong fundamentals, some of the best we have seen in years, combined with the fact that management could possibly sell the company, make SAFM a WIN WIN in my book.    

 

The following is a summary from Michelle Leder.        

 

Employment agreements may seem like a pretty standard feature at most public companies. And to be sure, the overwhelming majority of companies provide their executives with employment contracts. But some companies -- for various reasons -- choose not to offer them. Or they only offer them to a few executives. So when a company that has made a point of not offering employment contracts begins to start offering them, you need to ask yourself why.

 

That's exactly the case with Sanderson Farms, which earlier this week entered into employment agreements with CEO Joe Sanderson Jr., Chief Operating Officer Lampkin Butts and CFO D. Michael Cockrell. None of the three executives are new to the company. Nor do they have new jobs -- the logical reasons that companies enter into employment contracts.

 

So that leaves us with the illogical reasons: the company is putting various protections in place for the executives in the event of a deal. All three of the new agreements have fairly standard language about what happens upon a change in control of the company, say if the executive's commute to work becomes longer than 40 miles one-way. Given Sanderson Farm's relatively remote location, it's a pretty safe bet that anyone buying the company would be beyond that distance. There's was also this phrase that caught our attention in the agreement: "the alteration of the Executive’s position in a way that significantly changes his status, offices, reporting requirements, authority, daily routine or responsibilities as they existed before the Change in Control." Under that scenario, even if the person's title remained the same, there would still be a way to trigger the change in control provisions.

 

The stock is down about 20% since mid-June and short-interest remains fairly high at around 9%. But back on Aug. 25, when Sanderson reported its third quarter earnings, my colleague, Howard Penney, put out a bullish note on SAFM, saying that the outlook "looks to be very bullish for the next couple of years if all of the pieces of the puzzle fall into place." Howard's main thesis was that falling feed prices and higher chicken prices combined with robust demand all made for positives, especially if demand from food service companies picked up.

 


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ASCA: TOP LINE STRUGGLE BUT BOTTOM LINE OPP

ASCA is one of the few (maybe the only) gaming/lodging companies with dry powder to improve margins. They’ll need it when the duration of the regional downturn extends longer than people are expecting.

 

 

In a strong stock market, ASCA is 27% off its recent high and is the worst performing gaming stock since early June.  The reasons?  A weak Q2 and soft top line through August.  The soft top line is likely to persist, longer than investors currently think, in our opinion.  That’s a problem for all of the regionals.  At least ASCA still has some dry powder in the form of cost cutting that is probably not available to the other gaming operators, and most leisure companies for that matter.

 

We are of the belief that duration of the regional downturn will be longer than currently anticipated by investors.  The gas price headwind beginning in December, a higher sustained savings rate of the US consumer, and a continued decline in the % of Personal Consumption Expenditures devoted to gaming are the major drivers of that thesis.  Gaming revenues may disappoint in Q4 and through the first half of 2010.

 

On the cost side, gaming operators have done a great job cutting.  It looks like they need same store revenue gains to generate margin expansion from here on out.  They won’t get it.  While ASCA has already generated meaningful cost reductions, there is more to come.  ASCA’s properties operate a significantly larger number of restaurants and amenities than its competitors in almost every one of their markets.  In Kansas City and St. Louis, ASCA owns almost twice as many restaurants as the respective market average.

 

Why is this important?  Food & Beverage (F&B) generate low margins relative to the other functions, and probably negative margins when comped meals and drinks are factored in.  F&B comps represent approximately 80% of the total comps for regional casinos.  No casino operator makes money on F&B.  We think ASCA will close restaurants and reduce operating hours, and has the capacity to do that, should the downturn continue.  ASCA incurred about $75 million in expenses from F&B last year and $33 million through 1H 2009.  We think the company could save another $15-20 million or $0.16-0.21 in EPS next year.

 

I don’t know if the cost cutting dry powder is enough to make the stock go higher in the face of an extended downturn.  The regionals moved out of a horrible fundamental backdrop to “less bad” then to “stability” this year and we were there cheering them on.  Despite no evidence to support “recovery”, the stocks continued to climb.  Top line will continue to be a challenge for the regionals and revenue estimates for 2010 are probably too high across the board.  However, at least ASCA has a potential offset.


German PPI on the Rise

The German Producer Price Index rose +0.5% in August month-over-month and improved on an annual basis to -6.9%, signaling an inflection point in PPI. We believe this inflection is another indication of rising inflation in Q4 for Europe’s largest economy, and expect to see an incremental rise in CPI sequentially in the intermediate term. 

 

It is worth noting that energy costs are a main component of PPI (contributing to some two-thirds in change of the index, according to the Federal Statistics Office) and that the plummet of energy prices off last summer’s highs will define annual compares going into Q4. With PPI peaking in September ’08, the annual reading in August still yielded a discount in energy of 14.3%. However on a sequential basis, PPI gained 1.1%.  

 

As changes on the margin matter for our analytical process, it’s worth noting the divergence between comparing components on an annual versus sequential basis: while heating oil, diesel, and gas fell 34.9%, 20.5% and 8.5% respectfully annually, sequentially the components rose 11.5%, 5%, and 4.6% versus the previous month.

 

We see Germany slowly moving out of a deflationary environment into Q4. We expect a steady rise in CPI, which currently stands at -0.1% in August (annually, Eurostat) and that as inflation moves out to 2010 the ECB will need to raise rates to stem inflation. The danger therein lies that the stronger economies of the Eurozone (ie. German and France) stand to benefit from a rate hike at the expense of the weaker ones (ie. Italy, Spain, Portugal, Ireland, to name a few). 

 

On balance we continue to be bullish on Germany but are not invested in Europe on the long side. Currently we’re short the UK via the etf EWU.

 

 

Matthew Hedrick
Analyst

 

German PPI on the Rise - a2


THE WEEK AHEAD

The Economic Data calendar for the week of the 21th through the 25th is relatively light. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.  

 

 

Monday Sept. 21

 

North America

Leading Indicators for August will be released at 10 AM.

 

Europe

In the UK, Rightmove house prices for September will be released on Sunday evening while on Monday the DMO will be placing its new 2050 Index-linker issue (UK TIP equivalent).

 

Asia

Markets will be closed in Japan on Monday for a holiday.

 

 

Tuesday Sept. 22

 

North America

A FOMC 2 day meeting will commence on Tuesday and the Treasury will be auctioning 2 year notes at 1 PM. Weekly ICSC, Redbook and ABC Consumer Comfort index data will also be released at normal scheduled times. In Canada, Retail Sales figures for July will be released at 8:30 AM.

 

Europe

August trade balance data will be released in Switzerland on Tuesday morning.

 

Asia

August unemployment will be announced in Taiwan on Tuesday morning as will HK CPI for August.

 

 

Wednesday Sept. 23

 

North America

Weekly MBA Mortgage application data will be released on Wednesday morning along with EIA oil gas and distillate stock levels. At 1 PM the Treasury will auction 5 year Notes while the FOMC Policy Announcement is scheduled for 2:15 PM.

 

Europe

Reuters PMI for the Eurozone in aggregate, Germany and France (Composite, Services and Manufacturing) for September will be released on Wednesday morning as will Eurozone Industrial orders. French Consumer Spending figures for July, as well as Business Confidence and production Outlook sentiment index levels for September will also be published.  At 5:15 am Germany will issue a 5 year Bobl (note that last week’s auction saw orders exceed supply by a major margin). In the UK, BBA Mortgage and Consumer Credit data for August will be issued while the BOE minutes from the September 10th meeting will be published at 4:30 AM.

 

Asia

Taiwanese Export orders and Industrial Production figures for August will be issued on Wednesday morning, as will Singapore CPI.  Despite financial markets being closed for Autumn Equinox Japanese trade data for August will be released on Wednesday evening. 

 

 

Thursday Sept. 24

 

North America

August Existing Homes Sales will  be released at 10AM, while at 1 PM the Treasruy will auction 7 year Notes. Weekly Initial Claims, M2 and EIA Natural gas stocks data will be released at the normally scheduled times.

 

Europe

German IFO Business Sentiment measures for September are slated for release on Thursday while September Consumer Confidence figures will be issued in France. In Italy, July Trade data will be issued.

 

Asia

August Trade data will be announced in Hong Kong on Thursday morning. In Japan July All-Industry Index levels will be announced in the morning while in the evening August Corporate Service Prices will be issued. Indian weekly Wholesale Inflation levels are also scheduled for release.

 

 

Friday Sept. 25

 

North America

Durable Orders and Shipments for August will be released at 8:30 AM on Friday while the Michigan Sentiment Final for September will be issued at 9:55. At 10 AM New Home sales Figures for August will be announced.

 

Europe

Eurozone M3, French Q2 GDP (Final) and Italian Retail Sales for Italy are all on the calendar for Friday morning as is UK Q2 Business Investment data.

 

Asia

On Friday morning August Manufacturing data will be issued in Singapore as will Taiwanese August M2.


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