Looking Under the Surface to Find Differing Trends



Over the past few weeks we have heard from many companies speaking at conferences, reporting earnings, or just in our normal course of research.  The economic health and purchasing behavior of the American consumer remains top of mind for everyone.  As I listened to Rite Aid’s call yesterday, I was reminded that there is still a tremendous amount of uncertainty facing many U.S consumers.  Non-discretionary, consumables driven retailers are painting quite a different picture than those in the mall.  Contrary to grocers, most anecdotes and data points suggest sales of apparel and footwear are showing signs of acceleration during September.  Many of us have heard the talk about improving trends, but let’s take a look at some quotes highlighting the other side of the story:


9/10/09, Mike Duke, Wal-Mart CEO:  “…we talk about even years past that the end-of-month cycle, when you would see some drop-off in selling and then on the first of the month, when customers get paid, then you see acceleration. Of course, during this period of time, that is exaggerated even more. So the drop-off at the end of the month and the pickup at the first of the month on the paycheck cycle is even more pronounced than it would be in the past.”


“And it is really interesting seeing the customers that come in on midnight and the increase in sales of that period after midnight on the first of the month. I think in some ways, it really shows that strain on that end-of-month cycle.”


“When you look at specific product sales, it is in some ways challenging for all of us to think about, but it is part of getting to know customers with the drop-off in sales of even very basic items like infant formula at the end of the month and then the spike in sales on the first and second of the month. And it shows that, over these last few quarters, our customers have been under strain, but our customer now is smarter and enjoys being smarter about purchasing even during difficult times and this will continue on into the future.”


9/10/09, Steve Burd, Safeway CEO:  “Our private label volumes have routinely been running at a growth rate 10 times that of national brands.”


“I would, however, say that I think the trading-down that took several quarters to become complete across all categories is now pretty pervasive and it's hard to imagine that there's more room to trade down from where we are.”


In response to a question about growth in food stamp usage, “Yes. I would tell you that the last time I looked at those numbers, it was more pronounced than 50%. I don't know if the number I have in mind -- is it the US number? We're probably closer to 70%.”


9/15/09, Randy McMullen, Kroger President/COO: “Consistent with the past two quarters, customers are buying more of what have they need and less of what they want.” 


“Another trend we are seeing is in food stamps and other benefits. Government data indicates an increase in these benefits due to the economy. At Kroger, we are seeing an even sharper increase in our sales from customers using food stamps.”


“We're seeing a change in the customer behavior in our store a little bit. For instance, the end of the month selling is noticeably lower levels than what it used to be. So, it's more impacted. We saw that through this last quarter and we actually saw earlier signs of it before but I think it's even more clear now.” 


“But the picture, as we see it, is people are spending money when they need to. That is for meals for the day or for the week but they're only spending what they need to. And then, they're having to come back a little bit more often.”


“…it's a pretty clear picture that the consumers around the US and the customers of Kroger are experiencing some trauma in this environment.”


9/24/09, Mary Sammons, Rite Aid CEO:  “As for front end sales although we've seen improvement in September they continue to be negatively impacted by a value driven customer searching for discounts buying more items on sale than they have in the past.”


- Eric Levine


an they have in the past.”


Some Notable Call Outs

  • Pearl Jam’s latest album, Backspacer, was released Sunday and is on track to become the No. 1 album in the U.S in its first week of sales. Interestingly, this success was achieved through exclusive distribution arrangements with Target, iTunes, Pearl Jam’s website, and independent music stores (are there that many left?). As part of Target’s marketing and merchandising of the album, the retailer is also selling a limited edition t-shirt in collaboration with Loomstate with all proceeds going to charity.


  • Zappos’ prospects for growth, tie-in with Amazon, and unique brand positioning all likely contributed to a hotly contested competition for the company’s advertising business. Approximately 100 agencies participated in the recent review. Most surprising was the relatively small amount of business that was up grabs, at least for now. Zappos spent only $12 million on measured media in 2008 on a gross sales base of over $800 million. So far this year, Zappos has only spent $2 million. As the facts continue to come out post Amazon’s acquisition, the uniqueness of Zappos certainly continues to be revealed.


  • In an interview this week CEO Susan Lyne of Gilt Groupe, the luxury online discount retailer, discussed the concept of retail as ‘repackaged entertainment’ whereby better retailers are able to grab customers in the ‘first act.’ With new product daily and no inventory to speak of, Gilt’s concept allows it to do just that. When asked for other retailers that stand out in this regard, Lyne highlighted offline retailer J. Crew’s The Collection Store in NYC and Zara.  Whether you consider it ‘entertainment’ or not, the company’s growth leaves it looking to fill more than 100 positions, as the concept continues to gain share of wallet and mind. (Check out the interview)




-Signs of export-led recovery in China - The China Leather Industries Association (CLIA) has reported that the value of the sector's exports (including footwear) for the month of July fell by 10% compared to July 2008. In the overall context of collapse in world trade since September 2008, a fall of 10% is almost comforting. When seen in terms of the total value of industry exports for the first seven months of 2009, the total export decline was just 7.5% compared to last year. Total exports for the first seven months of 2009 still managed to reach US$22.1 billion. In addition, the CLIA pointed out that the pace of year-on-year decline is now slowing, having reduced by 0.8% from the previous month.



-Big Names Join WWF Climate Savers Program - Nike is one of 22 participants, including HP, National Geographic, The Coca-Cola Company, IBM, and Johnson & Johnson, in WWF’s Climate Savers program. Collectively, WWF’s Climate Savers partners will reduce emissions by an estimated 50 million tons by 2010, an amount equivalent to the annual emissions of Switzerland. Overall, the partners say these efforts are resulting in greater operational efficiency and significant cost reductions. <>


-Unilever to Buy Sara Lee Soaps in Biggest Purchase Since 2000 -  Unilever, the maker of Dove soap, agreed to buy Sara Lee Corp.’s personal-care and European detergent unit for 1.28 billion euros ($1.88 billion), gaining Sanex shower gel in its biggest purchase in nine years. Unilever, based in London and Rotterdam, will pay cash for the business, which makes Duschdas and Radox soap and had sales of more than 750 million euros for the year ending June 2009, according to a statement today. Sara Lee, which has been shedding units to focus on coffee and food, said the proceeds would help it buy back up to $1 billion in stock. <>


-JBS merges with Bertin to form the world’s biggest tanner - JBS, the world's leading beef and protein products producer, has agreed to merge with Bertin SA, following the recent purchase earlier this year of Brazilian tanning group BMZ by JBS, combined with the tanning capacity of Bracol, Bertin's leather division, to become the largest leather processor in the world by volume.  <>


-Rite Aid Lowers Its Forecast, Citing ‘Tough Economy’ -  Rite Aid Corp., the third-largest U.S. drugstore chain, cut its full-year forecast, saying it expects customers will remain focused on discounts in a “tough economy.” The shares declined 12 percent. The net loss for the fiscal year will be $390 million to $615 million, the Camp Hill, Pennsylvania-based company said today in a statement. Sales will be as much as $26.2 billion, Rite Aid said. In June, the company forecast a loss of $265 million to $490 million.



-ASICS to Open First U.S. Store, Expands into Golf and Lacrosse - ASICS plans to open its first store in the U.S. this fall. At an event showcasing its spring 2010 collections in New York City,  ASICS officials also revealed plans to enter the golf and lacrosse categories in the U.S. for the first time.  <>


-H&M Third-Quarter Profits Rise 4 Percent -  Hennes & Mauritz AB, the world’s third-largest fashion retailer, beat expectations with a 4 percent rise in third-quarter net profit, but reported a worse-than-expected sales drop in August, reflecting a shortage of marked-down inventories. Without providing a specific outlook for 2009, H&M said it remains “positive toward future expansion” and accelerated its store expansion plan to open 240 stores in the full year, up from 225 previously expected. The Swedish fast-fashion company also revealed plans to start online sales in the U.K. beginning next fall, following rival Inditex’s move to sell its cheap-chic brand Zara online in 2010. H&M’s online shop is available for customers in Sweden, Denmark, Finland, Norway, the Netherlands, Germany and Austria. <>


-Finish Line Struggles in Q2 - The second quarter was unkind to the Finish Line Inc., as a tardy back-to-school season kept spending at a minimum. As a result of a $12.6 million loss, or 23 cents a share, from the discontinued operations of its Man Alive unit, Finish Line reported a second-quarter loss of $900,000, or 2 cents. During the second quarter of 2008, the Indianapolis-based company posted a $13.1 million profit, or 24 cents a share. Same-store sales dropped 9.9 percent for the quarter, versus a 4.9 percent increase last year. Sales dipped by 11 percent to $298.7 million, from $337 million in the year-ago period. <>


-Foot Locker Opens Fourth House of Hoops;  Plans Stores in Europe - Foot Locker opened its fourth House of Hoops store at the Cherry Hill Mall in South Jersey. The location is only the fourth House of Hoops in the U.S. and the first in the suburbs. <>


-Hanesbrands Agrees To Pay $13.8M To Strengthen Pension Plan - Hanesbrands Inc., the parent of Champion, reached a $13.8 million settlement with the Pension Benefit Guaranty Corp., agreeing to strengthen the funding of its retirement plan. Under the agreement, the underwear and hosiery apparel maker put $7 million into the pension plan this month and will make an additional $6.8 million payment within a year. The payments are in addition to any required contributions to the plan. <>


-Shoppers reluctant to splash out at Christmas - A third of consumers intend to spend less this Christmas than they did last, indicating retailers will need to be at the top of their game to reap rewards during the traditional golden sales period. Exclusive research by ICM for Retail Week shows that consumers remain reluctant to splash out. Last December was the worst Christmas on record for the sector, when like-for-likes fell 3.3%. The ICM study reveals that only 9% of consumers plan to increase their spending this year, but half plan to maintain it at last year’s level. <>


-Geiger Stepping Down at Aéropostale - Julian Geiger, the only chief executive officer in the history of Aéropostale Inc. and the chief architect of the growth and success of the teen retailer, will step down from his post at the end of the company’s current fiscal year on Jan. 31. Geiger, who has been ceo of the specialty store chain since 1996, will continue to serve as chairman. He will be succeeded by two of the firm’s existing managers, Mindy Meads and Thomas Johnson, who will serve as co-ceo’s upon Geiger’s departure. On the same date, Michael J. Cunningham will be elevated to president and chief financial officer.  <>


-Gordon Bros. Wins Finlay Auction - Gordon Brothers Retail Partners on Thursday won the bidding auction for Finlay Enterprises Inc. The liquidation firm had been the stalking-horse bidder for the liquidation of Finlay’s assets. Finlay filed for Chapter 11 bankruptcy court protection in August in Manhattan. Manhattan bankruptcy court approval of the winning bid is still required and a hearing is set for today. According to Finlay, Gordon Brothers will conduct “store closing” sales at all the jewelry firm’s retail locations and its two distributions centers. <> looks to raise $47.7 million through an IPO - Online vitamin and health products retailer Inc. is planning an initial public offering of stock to repay debt, fund capital expenditures and provide working capital. The company expects to raise about $47.7 million, based on an average share price of $12. <>


-Canada refusing import ban on cat and dog fur - Canada will continue to import cat and dog fur despite a ban adopted by the United States and the UK to avoid undermining the country's position against the implementation of foreign import bands on Canadian seal products. This summer, the European Unionvoted to ban seal products from Canada, upsetting Canada's Conservative government, which plans to contest this at the World Trade Organization. <>


-Li & Fung to participate at first-ever Sustainable Fashion Forum - Fashion Access, a fair organized by APLF Ltd, is launching Sustainable Fashion Forum in order to meet the evolving needs of the fashion professionals. The event will bring together industry experts to explore the challenges of achieving sustainable fashion, and present ideas that are accessible and practical to fashion businesses.  <>






LULU: John Currie, CFO, sold 20,000shs ($460k) after exercising the right to buy 22,000 shares nearly 50% of total common holdings.


JCG: Jenna Lyons, Creative Director, sold 56,848shs ($2.1mm) after exercising the right to buy ~71,848 shares roughly 25% of total common holdings.


ROST: James Fassio, EVP, sold 8,225shs ($399k)after exercising the right to buy 8,225 shares less than 5% of total common holdings.


Pleasure's Hook

“Do not bite at the bait of pleasure, till you know there is no hook beneath it.”
-Thomas Jefferson
Among other things, Thomas Jefferson was an archaeologist, an architect, and a horticulturalist. He was a Macro Man, of sorts, who subscribed to a multi-factor model of self education. Per Wikipedia, “he idealized the independent yeoman farmer, distrusted cities and financiers, and favored states’ rights and a strictly limited federal government.”
As the 3rd President of the United States, Jefferson’s writings certainly left an impression on me. I think the man left one on a lot of other people too. Whether his vision of America fits into today’s Gong Show of American style Financial leadership is not clear. That’s sad.
When I write about the US Federal Reserve being as politicized as it has ever been, or when I chirp about the Hank Paulsonites at the US Treasury, I am not being politically partisan (remember, I am a Canadian hockey player!). When it comes to the perceived financial wisdom of this nation’s “leaders”, its not about Bush or Obama. It’s not about Republicans versus Democrats either. It’s about competence. It’s about being right.
Is it right to value a country’s economic health by measure of her stock market? Is it right to measure it by the value of her currency? Is it right to use one measurement and not the other?
In 2009, whether you came to understand the inverse correlation between America’s currency and everything priced in that currency or not, you are now forced to pay attention. From a macro perspective, this call makes or breaks your year. As the Buck Burned, now we know that US Debtors, Bankers, and Politicians got paid. Eventually, investors taking advantage of this twice in a 40 year US Dollar Sale did too. All the while, bullish or bearish, we all knew there was a hook.
What’s the hook? It’s Pleasure’s. Unless you are a reptile, it’s stored nicely right there in your thick mammal neocortex. When prices of things you own go up, you feel good. When those prices go down, you don’t. That’s it.
Now that the US Government has completely crashed America’s currency, you know the hook was America losing her credibility as the long standing fiduciary of the Global Financial System. How does that feel? Or does anyone’s limbic system feel that?
The headlines coming out of today’s G-20 meetings in Pittsburgh are going to be what the Germans, Chinese, and Russians make them. As I sit here and watch the replay of Timmy Geithner’s remarks, I am simply saddened. America’s voice of thought leadership in financial matters has been compromised and diluted. That’s the hook.
Pleasure’s Hook is the US Dollar. Since 2:45PM EST on Wednesday, post Ben Bernanke pandering to a Japanese style rate of return (ZERO), the US Dollar marked and rallied +1.5% from her YTD low. Over that same time frame, the SP500 has corrected -2.5%. That’s the hook.
To be clear, the US Dollar remains broken, across all 3 of my investment durations, and it will continue to be unless it can find some level of hope coming out of the G-20 that stops the Chinese from selling their credits. China is now The Creditor. America is the Debtor. That’s the hook.
Hope is not an investment process, so don’t bet on my selling everything I own (that’s priced in US Dollars), until the math tells me that the US Dollar has bottomed. This morning, after the Squirrel Hunter Secretary of the Treasury proclaimed his mystery of faith: “We expect, as I think countries expect around the world, the dollar to retain that position for a very long time”, guess what the Buck did? You got it – it Burned. It’s embarrassing.
Having met with plenty a Chinese business person, I will assure you of this. They will do a lot of 3 things in the next 3 days into and out of the G-20: 1. Smile, 2. Nod, and 3. Sell.
Sell? Sell what? The Chinese are a net seller of US Treasuries and US Dollars. This is something that anyone who isn’t paid to be willfully blind to the actual data knows. This is not good, but this is also not new. This Chinese stopped buying in Q1. They started selling in Q2. Since. Since March, the US Dollar has lost -15% of her value.
With the US Dollar Index trading down another -0.23% so far this morning (Germany’s Merkel comments pending), here are my levels on the US Dollar Risk Management:
1.      Immediate term support at the YTD low of $75.81. Immediate term resistance at my TRADE line = $77.53

2.      Intermediate term TREND resistance= $78.91

3.      Long term TAIL resistance = $82.79

So what do you do with these lines? Well, I wait and watch for the real-time US Dollar price to move around them. Then I manage risk accordingly. In hockey, my Dad called this “Read and React.” When the USD goes up like it did yesterday (+0.76%), I cover and buy stuff. When the USD goes down, I short and sell stuff. Some people call that trading. I call it Risk Management of my invested exposure. Johnny Keynes himself was a currency trader don’t forget.
Burning Man, US Dollar style, has plenty of unintended consequences. As the Japanese Yen hits new intermediate term highs (at 90.45 this morning versus USD), Japan’s bureaucrat bankers are managing a little risk for themselves. Some in Asia are calling this “repatriation.” Having been the poster child of currency carry trading abuse for lost decades, if anyone understands what happens to foreign fund flows into your country when you debauch your currency, its Japan!
Nomura, Japan’s largest banking/brokerage outfit, is ah, NO-MORa this morning! In one of the largest liquidity raises I have seen in a long long time, the Japanese bankers issued 800 MILLION shares (30% of the outstanding) to whatever lost soul had it in them to buy these shares last night. Nomura’s stock dropped -16% on the “deal”, leading Japan’s Nikkei to a -2.6% smack-down close overnight.
I know what John Mack at Morgan Stanley thinks about all of this. Check out the risk management of his resume as of late and, while you are at it, don’t forget that MS is part Japanese now too!
I wonder what Thomas Jefferson would think of Japanese style banking meeting the American kind that he never thought he’d see…
My immediate term risk/reward levels for the SP500 are 1045 (TRADE line support) and 1061 resistance. I’ll be selling into the strength associated with Pleasure’s Hook, at a price.
Have a great weekend with your families,



EWG – iShares Germany
Chancellor Merkel has shown leadership in the economic downturn, from a measured stimulus package and balanced budget to timely incentives such as the auto rebate program. We believe that Germany’s powerful manufacturing capacity remains a primary structural advantage; with fundamentals improving in a low CPI/interest rate environment, we expect slow but steady economic improvement from Europe’s largest economy. Merkel looks to be in the driver’s seat for re-election on September 27th, while her coalition partners are less certain.

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.

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.


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.

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 commission cap, according to DM, will help the concessionaires become more profitable.  There is a valid fear that side-betting could become more prevalent but overall the cap should result in EBITDA growth for the operators.  While the authorities have made it clear that the cap applies to all forms of compensation, cash and non-cash, it is very difficult to measure the non-cash side of the business let alone police it.


DM sees credit as the most important factor for players; they will go wherever they can get the longest credit line.  Having deep pockets and having good debt-collecting agents could now be more crucial to concessionaires’ profitability than ever.  SJM and Galaxy shot up when the commission cap news emerged this week.  Wynn could benefit from the return of customers previously lost due to more aggressive commissions elsewhere. 





SJM has announced its intention to raise HK$2bn from a convertible bond.  With visitation and revenue numbers looking healthy, commission caps coming into place, and the 60th Anniversary of modern China approaching, valuations are being pushed up.  DM speculates that the money will be used either to play the stock market or to fund credit lines for junkets. 

The five-year bond will have a zero coupon and be convertible to SJM stock at a price of HK$2.25 from December 8.  Today’s share price was HK$4.35.





DM cites an analyst’s warning that Macau gaming stocks are becoming inflated and becoming a bubble as overcapacity threatens to drive down ROIC and over-excitement about visa-easing and commission caps push share prices up rapidly.  The one stock that is recommended by this commentator is SJM.  The reasons include, dominant market share, superior ROIC, right market-segment focus, improving profitability and a superior balance sheet. The source also claims that SJM is trading at a discount compared to its peers.





Steve Wynn held a press conference during the week prior to Wynn Macau’s IPO on the Hong Kong stock exchange.  When asked if he feared losing direct-VIP clients to the Singapore resorts when they open early next year, his response was that he has Linda Chen and the don’t (fear losing business to Singapore).  DM exalts Wynn and Chen’s track record in the VIP baccarat business and believe they will continue to outperform in that area when Singapore is open. 


Regarding the stock price, some commentators are claiming that once the stock starts trading at HK$10, much of the upside is priced in.





L’Arc has had a strong few days since opening.  The mass floor is said to have done quite well. It remains to be seen how the business will far when the SJM new business operations team hand over to the L’Arc team.



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Japanese August Trade data was released this morning, with export levels registering at a year-over-year decline of 36%. This is the 10th consecutive month in which exports have shown a decline of greater than 25% from the same month in the prior year.


There were some slender positive data points in the otherwise abysmal data, including Motor vehicle exports headed for China which turned positive on a year-over-year basis at 0.53%, although shipments to “The Client in total still declined by 27% over last August. At only slightly more than 5% of the total (greatly diminished) car shipments heading abroad, not enough cars are heading to China to offset the slack demand elsewhere and total vehicle exports came in at -49.8% Y/Y, a marginal sequential improvement after the seven prior months of levels lower than -50%.


We have maintained a short position in Japanese equities via EWJ since the first week of July, sticking to our conviction as the data emerging has continued to indicate nothing but stagnation and frustration for the land of the rising sun regardless of stimulus band aids concocted by the last administration (and with eth ones being proffered by the new government looking equally impotent).


Andrew Barber




HOUSING – Getting Too Comfortable At Home

Today, the NAR reported that sales of existing homes dropped 2.7% month-over-month in August.  Consensus expectations were for home sales to rise 2% in August.


After last month’s bullish new home sales data, we had to take a step back and question the sustainability of the improving housing trends when most consumers continue to suffer.  Clearly, the one big sticking point continues to be high unemployment, which puts real consumer demand in question. 


The slowdown in August (which will likely continue into September) can be attributed to a couple of reasons.  First, we are past the home sales PEAK SEASON (for those consumers with “need based” moves).  Second, the NAR said “first-time” buyers purchased 30% of homes in August which remains unchanged from July.  To that end, it appears that the Government home-buyer stimulant is ending and having less of an impact on sales trends.   


Given the time it takes to buy a new home, it’s less likely that “first time” buyers are going to close in time to take advantage of the Government subsidy.  Therefore, as a % of total buyers, “first time” buyers are going to fall off rather significantly in the coming months. 


Howard Penney

Managing Director


HOUSING – Getting Too Comfortable At Home - a2


We are short the Pound


One of the mottos inscribed on the side of some Pound coins, “decus et tutamen” is a Latin phrase meaning: “an ornament and a safeguard”, a reference to the ridged edges that were developed in centuries past to prevent thieves from clipping tiny pieces of the valuable metal before passing the debased coin back into circulation. In the present, the coin of the realm has been debased by forces that will require more than clever minting techniques to correct.


The Pound Sterling initially collapsed in the vacuum leading up to and following the collapse of Lehman Brothers in September of 2008, and bottomed in late January; conversely the dollar began its burn in March of this year and currently teeters with lows not seen since the abolishment of the gold standard in 1971, except for those of mid ’08. On 9/22 we shorted the Pound via the etf FXB.


This year we’ve repeatedly discussed the imbedded financial leverage associated with the UK economy. Not only have we failed to see leadership from the likes of Brown and King to direct fiscal and monetary policy in a direction that could move the country out of recession, but also ballooning public debt—which currently stands at 13% of GDP (according to a Alistair Darling’s most recent budget statement)—worries us not only in the near term, but on the TAIL (3 years or less) as it should hover well over “acceptable” levels well into 2010 and 2011. Below we’ll discuss our fundamental view on the UK, which we shorted via the etf EWU on 9/9, and our rational for shorting the Pound.


Certainly the extent of the UK’s financial leverage (as opposed to its Western European peers) has prolonged the ability of its major financial institutions to recapitalize and restore confidence, including the ability to extend credit into the broader economy (from first time home owners to larger institutions) to get the economy moving.  As in the US, this process has been rocky and politicized, with pressure ultimately exerted on the banking community to ensure that credit trickled into the consumer markets. This easing may have stemmed the trajectory of the contraction, but did little to spark recovery: Q2 GDP figures saw a clear divergence with Germany and France improving +0.3% Q/Q while the UK contracted -0.7%.


While the cost of mortgages and loans have been reduced parallel to the BOE benchmark as it descended to its lowest level ever, 0.5%, broad fundamentals still appear anemic (despite some areas of measured improvement) and we believe they’ll contribute to the country’s ongoing underperformance. 


Consumer and business confidence measures for the island economy (not unlike the Eurozone) have improved over the last few months, especially on future expectations, yet there are a slew of data points and metrics that suggest the pain is not over. Unemployment continues to increase sequentially in the UK, not unlike some of its more diversified continental neighbors. Should it continue its upward trend in the next two quarters, which we expect, we’re likely to see erosion in sentiment that will likely carry over to broader fundamentals. Retail sales and housing have yet to yield a discernible trend in either direction over the year, yet should sentiment fade, spending, the housing market, and output could follow with a pullback.  UK inflation (CPI) currently stands at 1.6% in August Y/Y and although it’s come down on an annual basis over the last months, it is still well ahead of the Eurozone average of -0.2% in August. We think in the near-term that UK inflation has gotten ahead of growth and that in the intermediate term it will stay there.


Finally, it’s worth considering the components of GDP.  The UK economy is a net importer and from January to June 2009 registered the largest deficit of the 27-country EU, at -46.4 Billion EUR. With Investment and Consumer spending down, this leaves government spending as the sole component to generate growth. As we’ve noted above, the ballooning debt, with borrowing at 175 Billion Pounds this year, and a cocktail of “socialist” measures from Brown like raising the income tax on top earners (150,000+ Pounds) to 50% from 45%, shall hinder GDP performance. We think this TAIL risk has contributed to discontent with the Brown government and the underperformance of the FTSE against most global indices.


From a currency perspective, despite the low interest rate environment in Europe [BOE at 0.5% and ECB at 1.0%] both the Pound and Euro have outperformed the degraded US Dollar during its YTD descent.  We’ve made our thesis on “Burning the Buck” abundantly clear and the chart below helps illustrate the gains for currencies on the other side of the trade.  Versus the dollar the Pound is up +13.3% YTD, while the Euro has gained +6.4% in the same period.  In the Chart below, the BOE trade weighted Index reflects this pressure.  While the Pound is well off its 2008 levels versus the USD and Euro, affording cheaper cost for buyers of UK exported goods, we’ve yet to see a noticeable pick-up (with some notable exceptions) due to the poor competitive stance of many sectors of the country’s industrial sector.


Along Keith’s call for reflation to morph into inflation in Q4 in the US, with it we expect to see (literally or rhetorically) a boost in interest rates. Associated with a hike should be a stronger dollar, which we believe should depreciate the value of the Pound as it has moved significantly against the USD, but also versus the Euro (+5.4% YTD), despite a negative fundamental outlook in the UK. Price momentum dictated our call to short the Pound, yet we believe the fundamentals support our call.  



Matthew Hedrick





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