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We were asked by a subscriber why we covered our Warnaco short so quickly. Let’s be clear…fundamentally, our retail team does not like this story. There are secular margin headwinds here, license loss risk, mediocre brand portfolio, limited cushion if things go south, and downright poor quality of management. As it relates to the stock, sell sentiment is quite high (80% of ratings are Buy), short interest is re-testing lows, and management is selling. To cap it off, yesterday there was a sell-side upgrade, which Keith shorted in to. I’m surprised that the stock is only off by 1.2% today given the big miss at Iconix (another questionable quality model that is tied to a licensing model) just 2 months after a secondary.  But we are mildly concerned about event risk into an analyst event WRC is hosting on Friday. What you see here is Keith managing risk around his TRADE duration (3 weeks or less). Just because he covered a TRADE for a gain, it does not mean that it is no longer on our bench as a fundamental short. It will take more than a few percent in the stock for that to happen. Unless the bottom falls out from under this stock very soon, my sense is that we will be more vocal on WRC in the not-too-distant future.is that we will be more vocal on WRC in the not-too-distant future.

Trust Volcker!

I say this a lot and I’ll say it again. I am grateful to be at the hub of our growing exclusive research network. Every day provides a tremendous opportunity to learn from my investment strategy mistakes.


It builds confidence to know that we can take a point of view, put it on the tape real-time, and receive real-time feedback. We learn what we don’t know first, then we evolve our thinking. Below is a note from a man who I have a great deal of respect for. He’s been in the macro “fire” for years. He says “Trust Volcker.”


Unedited, from Mark.





Keith –


Your morning perspective got me thinking.  In 1979, I was an up & coming executive at a mortgage bank that now is the core of Chase’s mortgage lending operation.  It was quite a time.  The certifiably worst president in our history was dealing with one crisis after another, running around and crying “Oh, me…Oh, my”.  His political crony, G. William Miller, had sacrificed the Fed’s independence and the US economy was on the verge of collapse.  My job, at the time, was to manage our firm’s secondary marketing + sales & trading.  Hedging an inventory of mortgages was quite an experience.  GNMAs traded in at least a ½ point spread (bid to ask) and markets for FNMA/FHLMC securities were as thin as Twiggy (are you old enough to remember her?).  Daily volatility was in the stratosphere.  Gov’t changes in the FHA rate (it was set by fiat then, not by the market) were occurring in matters of weeks instead of years as in the past.


Then along came Paulie. A real grown-up took charge.  And, saved America’s financial system.


During that time, I wrote a weekly market letter for our national sales operation + an addendum for our executive committee regarding hedging opportunities, risks and costs.  I remember one day being challenged by our CEO about my belief that rates were headed higher, but that the impact would be incredibly positive for the economy.  The CEO was an ardent Keynesian and had a hard time with monetarist prescriptions (he was a very quick study, though, and changed fast – even became a devotee of Milton Friedman & Jude Wanniski).  As I tried to make my case, I finally spurted out “TRUST VOLCKER!”


That became a byword for our management for years and years.  Our company managed through the era and came out the other side in fantastic shape.  My career took a decidedly upward tilt, too.


When Volcker came out in support of Obama last year, I was willing to hold back my visceral dislike for our new president.  After all, the man I believed saved our financial system couldn’t be a radical.  So I tempered my view.  What a mistake!


You used the word “muted” when discussing the lack of influence PV is having right now.  A better choice would have been “ignored”.  All the measured men who are supporting the ideologues in the WH are enablers.  When and if PV disowns the Obama Administration, I’ll trust him again.  Until then, I’ll chalk it up to old age.  It’s sad to see so many thoughtful people become apologists for the indefensible.  Volcker knows better and may yet be willing to stand athwart the establishment and yell “STOP!”  I sure hope so.  He is one of my great heroes.  I hate thinking he has become another hack in Washington.


Hope to see you again soon. 




Trust Volcker! - pv


We Are Short Of Oil

Position: Short etf USO (United States Oil Fund)


Yesterday in our morning meeting that we host for clients, we had an interesting debate regarding some of the global macro signals that we are seeing these days relating to oil.  We seem to be clearly seeing signs of heightened global tensions with the Iranians announcing that they have a second facility for converting uranium and are also testing longer range missiles this week.  Despite these events, the price of oil has completely shrugged off any longer term implications from Iranian chain rattling.  This is partially due to the strength in the U.S. dollar, as the U.S. dollar has been one of the key fundamental drivers for oil prices this year.


Setting aside the U.S. dollar, over time supply and demand metrics in the world’s largest oil markets, the domestic United States and China, should also be key drivers for the price of oil.  As we’ve noted a number of times in the last few months, oil fundamentals are actually quite bearish. The most recent date from API, the EIA, and China are bearish as outlined below:

  • According to the most recent date from API, gasoline inventories in the United States are 12.6% higher than a year ago and 5.6% higher than the five year average;
  • According to most recent date from EIA, oil inventories are more than 10% above year ago levels (at 335MM bbls) and gasoline inventories are 19.7% above year ago levels; and
  • The Chinese reported today that crude oil inventories hit a record 39.9 million tonnes at the end of August, which equates to a rather significant 278MM barrels.

Despite the bearish date, the price for oil, as we’ve discussed, has had an incredible move this year and as a result we are starting to see an uptick in drilling activity for oil, which is also bearish as it relates to future supply. To this point, the EIA noted last week that:


“As of September 18, Baker Hughes Incorporated reports 293 rigs drilling for oil and 705 rigs drilling for natural gas. The current oil rig count reflects a 64 percent increase from the lowest 2009 level reached in early-June, while the natural gas rig count is only 6 percent above its mid-July level (Figure 1). Rigs drilling for oil now account for 29 percent of the total, up from 21 percent at the beginning of the year. Despite the uptick in oil drilling, both oil and natural gas rig counts remain substantially below their peak levels in 2008.”


Interestingly, for the first time in nine years, we have also seen oil drilling activity surpass natural gas on a relative basis in the domestic U.S. and is up an amazing 64% from its lows.


As Keith noted in The Early Look this morning, we’ve also had three separate statements from Fed Governors recently suggesting that rates will have to go higher.  That is, they’re starting to get hawkish.  In the short term, higher rates should be positive for the U.S. dollar, which will be, all else equal, bearish for those commodities that are priced in U.S. dollars.  So, we are shorting oil today because: a) supply is building, b) the likelihood of a rate hike has increased, which is good for the dollar and bad for commodities priced in the dollar, and c) oil is largely shrugging off heightened geo-political news flow.


Daryl G. Jones

Managing Director


We Are Short Of Oil - a2


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China is not a communist state. China is an autocracy --one with a governmental system that incorporates communist philosophical roots and social policies combined with a unique experiment in state managed capitalist economics, but an autocracy nonetheless. The entire nation is ultimately overseen by an unelected politburo selected through a process of patronage and nepotism.


Tomorrow’s celebration of the victory over the Nationalist forces and founding of the People’s Republic will provide the country’s leaders the opportunity to embrace the exploded myth of the socialist workers’ state while in the background the wheels of rapid private sector development continues at a  frantic pace. In short, tomorrow’s parades, with displays of cold war nostalgia like missiles on trailers as well as thoroughly modern features such as female soldiers decked out in chic pink uniforms with white boots and tights, will be a national exercise in delusion.


The fundamental failure of the state founded 60 years ago was brought home during the cold war as the economic might of the US and its western allies provided technological and military development that the communist nations could simply not keep pace with. Although the introduction of economic reform began in the late 1970’s when Deng Xiaoping began the painful process of recovery from the madness of the cultural revolution, it was the collapse of the Soviet Union under unrelenting pressure from the west that heralded the end of economic isolation as the Communist party leadership acknowledged the new reality of competing on the global stage.


The system that was ultimately adopted could be described as an attempt at having one’s cake and eating it as well. Beijing continues to control every aspect of life and ultimately owns all property while embracing the economic clout and prosperity brought by private enterprise. The bubbles of social discontent that have been amplified in international media coverage in recent years are a constant reminder to the party of the golden rule of benevolent despotism: the people will only be content to surrender personal freedom if the social contract (universal employment, steadily improving living conditions, social justice etc.) is fulfilled. The global economic crisis could have disrupted internal harmony, and this threat spurred Beijing into pouring massive amounts of money into the system in an attempt to buy growth. Buying growth is the most expensive thing that a government can do short of war and, to date, it appears to be working and to have been worth the cost. 




Last night the HSBC PMI Index for September was released with a level of 55.1, showing that manufacturing expanded for the 6th consecutive month and demonstrating that the stimulus policies adopted by Beijing last year to spur internal demand are continuing to reverberate through the system.


When we issued our call on Chinese equities in July, we wrote that we anticipated that the market was due a correction, and that specific sectors and industries would outperform. Of our four picks, three--Automotive, Consumer Staples/Food & Beverage  and Technology Stocks--have handily beaten the broad indices while Basic Materials have lagged under deflationary pressure. In the chart below, we have broken out these components from the CBN 600, an index comprised of the 600 largest equities by capitalization on the Shanghai and Shenzhen exchanges.




We continue to be bullish on the developing internal demand: with CAAM recording more than a million new cars monthly since March, increasing evidence of demand for nutritional diversification and the continuing transition to a society of internet surfing smart phone users, our outlook has not changed. We anticipate that the massive amount of infrastructure improvement needed in Central and Western regions will ultimately drive Basic Materials, aided by our expectations for returning global inflation in the coming quarters.



Andrew Barber




When I previewed DRI’s fiscal Q1, I said that sales would come in worse than consensus expectations.  Sales came in even lower than my expectations with blended same-store sales down 5.3%, which would explain DRI’s stock performance today.  Comparable sales slowed on a 2-year basis at each concept.  Red Lobster’s underperformance was the most surprising with same-store sales growth coming in down 7.9% in the quarter, which represents a 540 bp sequential decline on a 2-year basis.  Management attributed the softer than expected sales trends to the difficult economic environment and the company’s decision to not participate in the deep discounting tactics of its peers.  DRI’s CEO Clarence Otis even stated that DRI does not want that type of unprofitable customer in its restaurants.  Highlighting just how prevalent industry discounting has become, management commented that in fiscal Q1 the casual dining industry’s average check declined 1.5% on a sequential basis and was down 3.5% YOY.   


Despite the fact that DRI delivered worse than expected sales numbers, the company, like so many of its peers, beat the street’s EPS expectations by $0.01.  Although this was not surprising given the benefit from favorable YOY commodity costs and cost saving initiatives implemented in 2Q09, I continue to maintain that the street’s full-year EPS estimate of $2.80 is too high.  After these Q1 earnings results, this number is sure to come down.  The question now is will it come down by enough. 


Despite lowering the low end of its full-year same-store sales growth guidance range by 1%, DRI maintained its EPS growth range of -2% to +8% as a result of lower than expected food costs.  Going into the quarter, I did not think DRI would have to revise its EPS guidance given the wide range of DRI’s EPS forecast.  Management did say, however, that the lower end of the range is now more likely.  Based on current sales trends, achieving -2% EPS growth is no longer a given.   DRI’s new blended same-store sales guidance of flat to -3% assumes an acceleration in same-store sales trends.  Management stated that some of this improvement will result from the “arithmetic” or easy comparisons, but in this environment, I am not sure that easy comparisons matter.  Instead, I am looking at 2-year trends and a -3% number assumes an improvement in 2-year trends as well.


Management stated that blended same-store sales growth in September is running similar to August, which was down about 4% to 5% versus the reported -5.3% number in Q1.  Based on those quarter-to-date trends, Q2 is not going to fare as well on an earnings basis relative to Q1.  EBIT margins improved on a YOY basis in Q1 but even with the continued favorability in commodity costs, margins will likely decline in Q2 to the magnitude of about 100 bps.  Fiscal Q1 was also helped by the cost saving initiatives that the company implemented in 2Q09.  Management said that it is still finding increased cost saving opportunities but not of the same magnitude as last year so the YOY benefit of these initiatives will moderate in Q2 and beyond.  As DRI correctly stated on its earnings call, it is one of the few casual dining restaurants that is still growing.  This growth will make it increasingly more difficult for the company to continue to cut costs. 





Sports Apparel Numbers: Quick Take

Not a good week, as the deceleration continued. The 3-week trend – which is our focus – remains reasonably healthy in the sports retail channel. Mass channel is still a mess, and there was a disproportionate downturn in the family channel – which is a notable divergence.



Sports Apparel Numbers: Quick Take - 1


Sports Apparel Numbers: Quick Take - 2


Sports Apparel Numbers: Quick Take - 3


Sports Apparel Numbers: Quick Take - 4




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