Cat Food

“Wake up and smell the cat food in your bank account.”
-They Might Be Giants
At 82 years old, this isn’t Paul Volcker’s first rodeo. Tonight, you can see him interviewed by Charlie Rose on PBS. If you care to see whose US Government views are most closely aligned with ours, these are the ones to hear out. I don’t hear them often.
I’ve called it Squirrel Hunting. Volcker calls it “Herding Cats.” If you have tried either (or observed some squirrely neighbor doing the same), you get the point. With a preview of tonight’s interview in hand, here are Volcker’s 3 main points:
1.      China is the Creditor; America The Debtor - “You cannot be dependent upon these countries for three to four trillion dollars of your debt and think that they’re going to be passive observers of whatever you do,” Volcker said.

2.      The Balance of Power in Global Financial Leadership is shifting – “symbolic of the relative, less dominant position the United States has, not just in the economy but in leadership, intellectual and otherwise,” Volcker said.

3.      Credible American Economic Leadership requires competence, not politicization – “I would like to think that given the history of the past, given the strength, actual and potential of the American economy, we can still provide a kind of indispensable element of leadership here,” …“But it’s not going to be dictatorial, I’ll tell you that. It is very hard to herd these cats together.”

Call it irony or not, Paul Volcker’s views as Chair of the President’s Economic Recovery Board have been largely muted. President Obama’s Administration is much more comfortable with the Hope Model of prancing around his compromised  and conflicted Chief Squirrel, Tim Geithner. Larry Summers then backs Timmy’s views, sometimes, by alluding to what he and his yes Lady, Christina Romer (Chair of the Council of Economic Advisors), call “blue chip estimates.”
“Blue Chip”, you know, as in Wall Street forecasts! After what we have gone through in the last 18 months, the US Government’s full faith and credit in these estimates is that smell of cat food in your bank account.
With all due respect to their theoretical wherewithal, I was raised by a firefighter, and you don’t bring a college professor into the world’s most interconnected risk management fire. When this thing is a blazing, check the theories and cats at the door. When it’s time to go through that burning door, I want someone who has been in a fire before. If America has that someone, it’s Paul Volcker.
Volcker gets it. China gets it. The Germans are getting it. So how in the world are we going to herd these American cats and squirrels? Sadly, unless we start evolving the thought process, I don’t think I have an answer to that question that is any more theoretical than what Romer espoused at Berkeley.
Back to the fire…
Yesterday, we scored one for America’s team, putting a ball in the end zone against the Crash Callers. The Citigroup watch-out below for 1000 on the SP500 was a “call” that was to be capitalized on, offensively.
Yesterday’s meltup in the SP500 was a nifty +1.8% daily move, wiping out almost all of last week’s losses, taking the short squeeze of a generation back up to a +57.1% gain from the March 9th closing lows.
Yesterday’s rally was not supported by accelerating volume studies however, and that makes this morning all the more interesting – as all fires are. So let’s strap on the cat herding gear and our masks and get into it. Here are some critical US market factors to consider before the door opens:
1.      SP500: Immediate term TRADE support = 1045

2.      SP500: Immediate term TRADE resistance = 1077

3.      Risk/Reward (daily) for the SP500 is balanced; stay hedged

4.      Top to Bottom probability studies (weekly) for the SP500 is 33 points; that’s tight and trade-able

5.      VIX (Volatility): downside support 22.63; upside resistance at the intermediate term TREND line is 26.31

6.      Breadth: for the 11th consecutive day, 9 out of 9 sector views in our SP500 model remain bullish TRADE and TREND, but at a price

7.      Yield Curve: 10-year yields minus 2-years continue to compress this morning at +232 bps wide (narrowest in 6 months)

8.      US Treasuries: the Fed continues to keep money on the short end free (0.10% for 3-month UST; we are Japanese)

9.      US Dollar: up small this morning to $77.11 and +1.7% from last Wednesday’s low; TRADE line resistance = $77.39

On the global macro country heat map, here are some critical factors to consider:
1.      Japanese equities have broken their immediate term TRADE line and are now threatening a TREND line breakdown

2.      Chinese equities closed down another -0.33% overnight, making it 3-days in a row, ahead of the 60 year Revolution party at week’s end

3.      Hong Kong closed up a strong +2.1% leading the rest of the Asian equity market higher overnight (Taiwan +2%, Australia +1.5%, Indonesia +1.9%)

4.      Russia cut interest rates for the 7th time since April, taking them down from 10.5% to 10%; Russian equities moved higher on that to +99.8% YTD

5.      Romania cut interest rates from 8.5% to 8%, but their yields remains the highest in the European Union next to Hungary at 7.5%

6.      Brazil is backing off their stimulus plan, and the Bovespa continues to hang out near the YTD high of +64%


Meanwhile in Commodities, we continue to see a worrisome breakdown in both copper and oil prices. West Texas Crude Oil is broken from both an intermediate term TREND perspective and an immediate term TRADE perspective, whereas Dr. Copper is holding his TREND line support of $2.58/lb after breaking his TRADE line of $2.85/lb. The only commodity exposure we have in the Asset Allocation model remains gold, which continues to hold what we call a Bullish Formation.
What does all of this mean? I can tell you what it doesn’t mean. There is no herding cats or hope in this global risk management process. And while hope is not an investment process, that’s all I have left for our President to hear when Sir Paul Volcker is aired with Charlie Rose tonight.
Best of luck out there today,




EWG – iShares Germany
Chancellor Angela Merkel won reelection with her pro-business coalition partners the Free Democrats over the weekend. We expect to see continued leadership from her team with a focus on economic growth, including tax cuts. 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.

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. We like defensible growth with an M&A tailwind. 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 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.



Voters in Taiwan recently voted against casino gaming over the weekend.  Gambling entrepreneur Larry Woolf’s Navegante Group spent nearly four years taking over a 27 acre beachfront site on Penghu island for a potential hotel, casino and resort project. 


The vote kills the option for a casino for at least three more years.  Some commentators have declared the vote to be a small positive for the Macau market given that Macau derives a small portion of its visitation from Taiwan.





Sources have said that the Wynn Macau $1.6 billion IPO is several times covered, with one source saying the institutional portion was more than 10 times over-subscribed.  Pricing is still a day or two away but if priced at the top of the price range of HK$8.52 to HK$10.08 per share, Wynn Macau will raise HK$12.6 billion in the fourth largest global IPO this year.





Buoyed by strong GDP gains and improved global economic conditions, Chinese carriers enjoyed increased traffic in August.  Chinese airlines transported a total of 22.46 million passengers in August, up 41.6% over the same period a year ago.  The Hong Kong and Macau markets also experienced a new peak this year as passenger boarding jumped by 17% year-over-year.  August 2008 figures were negatively impacted by strict security measures implemented in advance of the Olympics.





Figures released yesterday by the Monetary Authority of Macau show that deposits with banks in July increased 2.2% from the previous month to MOP289.5 billion.  Patacas and Hong Kong Dollars comprised of 22.1% and 46.2% of total deposits respectively.  Deposits with banks rose at a faster pace than loans; the loan-to-deposit ratio edged down from a month ago.

NKE: Consensus Wrong on Two Durations

My tune on Nike remains the same. It’s all about duration with this name. This company is setting up to be a big winner – but not yet. The consensus is clearly negative (only 53% buy ratings – lowest in history) and estimate dispersion is at an all time high, but at the same time seems to share the view that after this quarter, Nike is back to the races (easy revenue compares, etc…). I think that the consensus is wrong not once, but twice; 1) the Street is 2-3 quarters too early in any assertion that the worst is behind NKE, and 2) based on how Nike is resetting its chessboard, I also think that the Street is not bullish enough on the financial impact when the engine restarts. Again, pick your duration wisely.


NKE: Consensus Wrong on Two Durations - 9 28 2009 2 55 15 PM


Fundamentally, there aren’t a whole heck of a lot of reasons I can point to today that make this name attractive to anyone with a duration shorter than 1 year. Growth is slowing, and despite the Street’s estimate that suggests business is turning up (even though sentiment stinks, the math does not lie), my sense is that growth might not yet have put in a bottom.


NKE: Consensus Wrong on Two Durations - NKE Futures 2YrTrends 9 09


In fact, I’m at $0.95 for the quarter vs. the Street at $0.98. To be clear, Nike has not missed a quarter since May ’03 and Feb ’02 – each time it missed by a penney. This company does NOT like to lose, and does not take misses lightly – even if they themselves did not set the expectation (no guidance). Can they find wiggle room this time? Yeah, of course they can. But they’re compensated to hit annual internal targets – not quarterly Street consensus.  Meaningful upside this quarter will need to come from a windfall in SG&A or non-operating income as opposed to revenue to beat my number.


For the year, I’m roughly in-line with the consensus $3.55, but barring a similar windfall, my bias is to the downside.  That said, what are we talking… $3.25, $3.35??? That’s as bad as it’s gonna get. I’m pretty darn sure of that. The reality is that the company is doing what it SHOULD be doing, which is investing in its brands to take share as we come out the other end of this cycle, instead of what Wall Street WANTS it to do, which is showing outsized pre-tax income margins from cost saves. The stock won’t go up if $3.25 is a reality (suggesting 18x today), but will be a great setup for those who want to participate in the next multi-year period of wealth creation in this business.


What is it setting up for? Those students of Nike history know how the company has a burst of growth, and then cools off, resets the organization, and then bursts again. This happened between EVERY stage of Nike’s evolution from a $10mm running shoe company in the 1970s, to a $19bn global powerhouse today. But each reset is incrementally more complex than the last, and therefore takes longer. We are currently 9-months in to what I think will be an 18-month reset. That’s been my call here for 2-quarters now.


We’re going to begin to see the meaningful acceleration in top line in fall of ’10. That means it shows up in futures around Spring 10. No, that’s not too far away. But until then, there will continue to be fits and starts. What do I define as a ‘fit or start’? Sales or futures shifting 2-4% in either direction. The market will fight over finding the datapoints ahead of time. But the REAL call will be there when the organization has fully reset, SG&A dollars fully allocated and amortized, capex creeps lower, customer connection strengthens, orders accelerate, revenues grow by 10%+, inventories decline by 5-10%, margins break through former peak, and the path beyond $5 in EPS becomes crystal clear.  I’m certain that there is only one global brand that has this set up. If I were Nike’s competition, I’d be very afraid of the setup – very afraid.


Given that there’s still a full product development cycle between today and when I think business will pick up, I need to more heavily discount the potential for any unforeseen company or industry events. Two come to mind. I’m not trying to be alarmist here, but risk management is the key.


1)      As it relates to company specific drivers, one factor I’m paying closer attention to today is the product pipeline. I’ve always thought that this portfolio can’t be disrupted by a single product, initiative, or region. But one angle is that there was a 4-month time period (Feb-May) where there was uncertainty within the organization as Nike shed 5% of its workforce. My understanding is that few people were ‘left hanging’ with a major question mark, but it was a dynamic inside the company that we can’t ignore. The development and sales window averages about 9 months, which suggests we’ll be seeing over the next few months the result of what could have been lower productivity levels 9 months back (even though they have since improved).

2)      I can’t shake the ‘Ken Hicks Factor’ (new CEO of Foot Locker) from my mind. He’s due to come out with his 100 day plan (or something along those lines), and who’s to stop Foot Locker from closing a quarter of its US stores? I can make a very good case as to why it should. This will largely not impact Nike’s end-demand. But I’d argue that FL is Nike’s best off-balance sheet asset. Any store closures would be bad. Again, I’m worried about this less the closer we get to Spring ’10. But that’s a ways off…


NKE: Consensus Wrong on Two Durations - 1


NKE: Consensus Wrong on Two Durations - 2


NKE: Consensus Wrong on Two Durations - 3


NKE: Consensus Wrong on Two Durations - 4


NKE: Consensus Wrong on Two Durations - 5


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Angie, when will those clouds all disappear?

In case you missed it, German Chancellor Angela Merkel—“Angie” as she’s so affectionately called—won reelection on Sunday to form a new coalition government with the Free Democrats (FDP).


Merkel’s conservative party, the CDU, together with their Bavarian Christian Social Union (CSU) allies, garnered 33.8% of the popular vote, to beat out her most significant challenger Frank-Walter Steinmeier of the SPD, which collected 23%.  The FDP attained 14.6%, and with it as coalition partners of the CDU/CSU a majority in the Bundestag (Parliament).


As we highlighted in our German election preview post on 9/25, “Showmanship”, the CDU/CSU coalition campaigned under:  tax cuts of 15 Billion EUR for the highest and lowest income tax brackets and reduction in the corporate tax (currently around 30%) and support for nuclear energy, while the FDP espoused special attention to small and medium-sized enterprise (Mittelstand) and a 3-tier flat tax.


While campaign promises don’t always materialize, we’re bullish on Merkel’s pro-business platform with the FDP, and believe that her continued leadership (ex the center-left SPD) will buoy equity markets and lead the German economy that saw modest growth of 0.3% in Q2 (Q/Q).  Concerning the energy sector in particular, Merkel has not ruled out the need to work with the Russians for supply and intends to extend legislation that would phase out nuclear plants by 2020. Today, German utility names (like E.ON; RWE; EnBW; and Swedish-based Vattenfall) surged on her victory. 


Still up for question is the ability of tax cuts to stoke the economy, which was a major component of her campaign.  While cash for clunkers was a highly successful stimulus program, it’s now rear-view and the government is facing a public debt next year to the tune of 6% of GDP. While this number is manageable, [in context Spain just announced its figure of around 10%, which incidentally prompt the government to raise the VAT tax to 18% over the weekend]—and while its Eastern European peers are even more extended, fiscally conservative Germans will be highly skeptical if Merkel does not reduce the state’s debt in the next 18 months. Further, a rise in unemployment next year could provide a headwind to Merkel’s credibility.


For now, we’re still bullish on the country’s fundamentals. The low CPI and interest rate environment has encouraged spending and anecdotal reports suggest credit is flowing back into the market.  This trend of low inflation was confirmed today by the Federal Statistical Office that reported initial CPI for September to decline 0.3% year-over-year and -0.4% month-over-month (See Chart Below). In the near term we see this as a net benefit to consumers, driven particularly by the lower energy prices.


With last week’s German (Gfk) consumer confidence rising to a 16th month high (and improving over the past 6 months) along with business confidence (Ifo) showing it highest reading in a year, confidence projections look bullish in the intermediate term.  We’ll be monitoring Factory Orders for confirmation that the export-giant is finding global buyers to propel growth. 


While German stocks, from banks to retailers, gained handsomely today, the DAX, as a reflection of the broader German economy, has been a slow moving force year to date, trading 100-300 bps better than the S&P500 for much of year. We like Germany, which we’re currently long via EWG, as a defensive name for positive (moderate) growth.



Matthew Hedrick


Angie, when will those clouds all disappear? - a1



Tomorrow’s Conference board reading might not live up to expectations.


In August, the Conference Board's consumer confidence index was significantly above the consensus forecast of 47.9, coming in at 54.1, up from 47.4 in July. This August improvement followed two consecutive months of disappointment, and was due to the Expectation sub-index increasing from 63.4 in July to 73.5 for the month.


As it stands right now, economist expectations are for more good news for September,  with a consensus forecast reading of 57, which implies another significant sequential improvement.


I just don’t think we can straight line a consumer recovery, and I have four primary factors that lead me to this conclusion:


First, most consumer companies that have spoken publicly on the topic have stated that they do not believe that consumers are ready to buy into the economic recovery narrative prophesied by the “experts” who are taking their clues from the strong equity market.  Second, most consumers think healthcare reform is bad news; President Obama’s full force effort to push healthcare reform over the past month should have a negative effect on sentiment.  Third, BIGresearch released a survey of over 7,000 individuals today that indicating that that ratio of consumers who are confident/very confident in a strong economy was down more than a point from the August reading of 31.1%.  Fourth, while September looks like it will turn out to be a strong month for stocks, it did not get off to a good start.


While energy prices are less of a concern for most consumers today, more of them are focused on other factors such as employment, housing and credit concerns.  If my assessment is right, continued improvement in confidence is not a sure thing. 


Howard W. Penney

Managing Director






In 3Q09, many QSR operators are struggling to generate incremental visits.  Clearly, the only defense to declining traffic trends is discounting.  This puts QSR margins at risk as companies broaden their discounting schemes.  At the very least, any upside that may have been generated from lower food costs is now being given back to the consumer.


The following new menu changes/promotions signal ongoing guest traffic challenges for the QSR group.


Burger King announced last Friday that starting October 19th, it will be rolling out its $1 double cheeseburger; though some franchisees wanted to shelve the product to protect margins.


Chipotle announced last week that it will be offering free kids meals at its Boston restaurants for three days when a parent purchases a burrito, full-size salad or burrito bowl, or order of tacos.  CMG is running the promotion as a way to test its children’s menu, which is now available. 


I saw a MCD commercial yesterday in Chicago that said drip coffee is now available for $1.  While MCD is testing a $1 breakfast menu in Chicago, the commercial suggested you can get a $1 coffee all day long.  And, I have heard that the company is promoting “2 for 1” children’s meals in some markets. 


In this environment, what MCD does with its current discounting efforts affects nearly every restaurant operator in the country.  A client recently sent me this map of where MCD stores are located.  Yes, we need to pay attention to what MCD is doing!



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