Incompetent Pilots

“We are entering upon waters for which I have no charts and in which I therefore feel myself an utterly incompetent pilot.”
-James Warburg
When a 37-year old James Warburg made that comment, it was a similar time for the US currency market as the one you are witnessing today. With the critical clean cut difference being that FDR made his intentions to devalue the Dollar explicit. President Obama’s cast of politicized characters at both the Fed and the US Treasury do not have that Currency Credibility to serve up alongside fire-side chats.
James Warburg was the son of Paul Warburg (one of the founding fathers of the US Federal Reserve) and, at the time of this quote in 1933, he was the youngest chief executive on Wall Street. He was considered to be one of the “smartest” men in New York. That’s not always a good thing to be…
There was this other guy overseas who was Warburg’s age by the name of Keynes. The two men couldn’t be more different in their views of what a Burning Buck might mean for capital markets. Keynes wasn’t a banker – he was a currency trader who happened to be signed off on by Bank of England bankers.
The point of this historical contrast is that you can get emotional and enraged by the US Government Burning the Buck, or you can simply understand its implications and make money on them. Bringing your politics or emotions into your portfolio is going to do absolutely nothing but erode your returns. To date, the bottom line for 2009 has been that Dollar Down = almost everything priced in US Dollars up. That’s it.
In the long run, Sir Keynes will remind you where you’ll be – 6 feet under. In the immediate and intermediate term, you are best served trading the game that’s in front of you. Do you think for a second that the politicians in Washington or those at the NY Federal Reserve in Manhattan give a damn about the long term implications of US Dollar Devaluation? Of course they don’t; so neither should you.
Being patriotic in your portfolio won’t help you any more than your politics. So, roll up your sleeves this morning, like Keynes did in 1933 and make sure that you aren’t missing out on the easiest carry trade in the world. Being short the US Dollar and long anything priced in those dollars.
Theoretically, at a point, the US Federal Reserve should raise rates and end this Massive Macro Diversification trade away from US Dollars. Theory and some lip service about how you think things might play out in certain weather conditions might just render you a 59-0 loser like the Patriots made the Titans yesterday in Boston. So be aware of Practitioner’s Rules and re-read that Warburg 1933 conclusion before getting too theoretical about this…
Last week the Buck Burned to lower-lows, taking it down for the second consecutive week and eight out of the last ten. This morning, no matter where you go, there that Burning Buck is again, trading down another -0.21% at $75.44 and hanging on to hopes that another hedge fund manager doesn’t get YouTubed in Sri Lanka.
When any of the perpetually and willfully blind US Dollar bulls tells you that the marked-to-market price of the US Dollar isn’t what you see on the chart (testing a breakdown to its lowest levels in 38 years), ask them what they think the Credibility side of this US Dollar analysis looks like. Madoff, Stanford, Rajaratnam… the Transparency list of what it is that some American financiers have been doing for the last decade is getting longer…
If the Buck’s Bulls don’t see Credibility as a factor in the fundamental analysis of say the Chinese or Brazilians, maybe some of the following factors will help:
1.      The US Federal Reserve’s Balance Sheet went up another +$55B last week, with MBS buys being the highlight (up +10% week over week!)

2.      Bank of America and General Electric’s low quality levered earnings reports

3.      US Federal Reserve rhetoric being explicitly dovish again with weekly comments out of Donald Kohn (Vice Chairman)

At 11AM EST today, Ben Bernanke will have one more opportunity to prove the likes of Warburg and my long term monetarist understandings on inflation wrong. Reading the tea leaves, unfortunately, there is nothing but hope that Bernanke keeps the long run in mind. Hope is not an investment process…
Across durations, the US Dollar remains broken. Here are my risk management levels:
1.      TAIL (long term) =  82.39

2.      TREND (intermediate term) = $78.29

3.      TRADE (immediate term) = $76.54

Yes, maybe there is a hope that Bernanke being objective gets the US Dollar above the TRADE line. If it does, I suggest you keep all of your REFLATION shorts at just that – a trade. We don’t want to have to call ourselves “utterly incompetent pilots.”
Throughout last week, I took down my Asset Allocation to US Cash. What’s the point in being theoretical on the wrong duration (long term) when using Burning Bucks to buy things priced in bucks can make us right? My immediate term upside/downside risk management levels in the SP500 are now 1103 and 1074.
Best of luck out there this week,



XLU – SPDR Utilities We bought low beta Utilities with a reasonable dividend yield on 10/13.

EWT – iShares Taiwan
With the introduction of “Panda Diplomacy” Taiwan has found itself growing closer to mainland China. Although the politics remain awkward, the business opportunities are massive and the private sector, now almost fully emerged from state dominance, has rushed to both service “the client” and to make capital investments there.  With an export industry base heavily weighted towards technology and communications equipment, Taiwanese companies are in the right place at the right time to catch the wave of increased consumer spending spurred by Beijing’s massive stimulus package.

EWG – iShares Germany Chancellor Angela Merkel won reelection with her pro-business coalition partners the Free Democrats. 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.

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.

FXB – CurrencyShares British Pound Sterling
The Pound is the only major currency that looks remotely as precarious as the US Dollar. We shorted the Pound into strength on 10/16.

XLP – SPDR Consumer Staples Strong day for Consumer Staples on 10/16, prompting a short versus our low beta long position in Utilities (XLU).

XHB – SPDR Homebuilders We were the bulls on a Q2 housing turn but, as the facts change so do we: now we are getting cautious on 1H 2010 US Housing. Rates up as access to capital tightens is not good for new home builders as we enter into a new year and series of potential catalysts for renewed pressure in the secondary market, including the expiration of the $8,000 tax credit.

USO – US OIL Fund WTIC Oil traded just north of our overbought line on 10/12. With the US Dollar hitting another higher-low, we shorted more of oil’s curve.

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.



Despite recent indications from the Macau government that additional regulation of the gaming industry could be implemented soon, MGM Mirage and partner Pansy Ho are considering expanding their operations in Macau.  Part one of the plan would be to expand their current operations.  Part two would be to search for sites for a potential casino resort. 


In light of Wynn Resorts’ successful initial public offering, MGM’s future plans also include an IPO.  Some commentators have stated that operators could be looking to expand before authorities clamp down on the industry. 

Retail Productivity Is Worse Than It Appears

Employee Productivity Is Worse Than It Appears


I’ve been hammering the US Retail industry for excess SG&A cutting. This analysis suggests that it might not be cutting enough.  


It’s easy to look back at the past 5 or 10 years and nitpick the changes in retail employee productivity. But Zach went back to the Johnson administration to see how these trends have ebbed and flowed since the late 1960s through today. The answer? Yes, overall productivity is certainly higher, as it should be given inflation and technology’s impact on productivity. But over 40 years, the year/year trend has only gone negative 3 times before the current recession – and the math adds up in a way such that the erosion in the preceeding 3 periods combined just about equals what we’re looking at today.


What does this mean? How does it tie into a stock call? I’m really not YET sure. But I know that I’ve been hammering the US Retail industry for excess SG&A cutting over the past six months. This analysis suggests that either 1) perhaps the industry has not even cut enough SG&A (polar opposite to what I thought), or that 2) the revenue hit was truly more massive and perhaps anomalous than I gave it credit for.


I’m gonna stew on this one…but in the interim I figured I’d throw it your way in case you’d like to do the same.  


Retail Productivity Is Worse Than It Appears  - Retail Sales Per Employee Historical


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UA: How Have Expectations Changed?

UA: How Have Expectations Changed?


Expectations are growing less apocalyptic, though the fundamental story is shaping up as it should. The one factor that could derail near-term earnings (SG&A spend around footwear) is the biggest revenue catalyst for 2010.



UA has been one of our favorites for most of 2009. As we do with all of our ideas, we step back daily, re-evaluate the facts, and see how reality does (or does not) synch with expectations. The bottom line is that this is still one of our favorites, and the only thing that has changed since we rolled out our Under Armour Black Book is 1) the price has gone up, and 2) evidence that the story is, in fact, playing out with the company’s fundamentals. As quantified in our report, we still believe that next 2-years’ estimates are low by 15% and 25%, respectively. Looking at this on an EV/Total Addressable Market Value basis, we still think that there’s no cheaper stock in Consumer Discretionary.


But looking into the quarter, what we won’t do, however, is turn a blind eye to changes in near-term expectations. Over the last month, consensus 3Q revenue growth forecasts have risen to 6-7%, about in line with our model. Though we still think that the Street is off with margin estimates, now we’re looking at around 7% EPS upside instead of the 10-12% we had after the last print. Also, while this name remains very much hated (only 2 of 20 Analysts have it rated ‘Buy’) short interest has come down to around 20% of the float (still understated, we think given certain long term holders that won’t sell), Is sentiment ugly? Yes. But it has grown somewhat less apocalyptic as the stock has more than doubled off its low.


So what could UA do or say on Oct 27th to change the thesis? Over an intermediate-term (and certainly a long-term) duration I don’t think there’s much that can slow this beast down. Over the near-term, we’d have to see either a meaningful slowdown in core apparel, or UA back off of footwear goals. We have 13 weeks of POS data under our belt, and the trends look good for UA. Tack that onto in-line inventories at the end of last quarter, and it smells fine by me – especially with 4Q starting off on a positive note as it relates to apparel growth industrywide.


As for footwear, the biggest and baddest thing the company can do is have Gene McCarthy get on the conference call and talk about how he is hiring 50 people to fill out his new footwear organization, which will take up the SG&A base this year.


Is this possible? Yes, very (as stated in our Black Book), and will make my EBIT numbers be too high. But the other numbers it will make unrealistic are my 2010 revenue numbers for footwear – they’ll prove too low. You see… this guy ‘gets it.’  How many times have we heard companies like Columbia Sportswear talk about ‘hiring a new footwear guy’ to solve their ills and capitalize on a ‘great brand opportunity’? Something that is consistently ‘a great brand opportunity’ but is never realized is not really an opportunity afterall…


McCarthy went in to Plank’s org chart with the understanding that he would build out his talent pool. Note that he started to do this with TBL’s Authentic Youth biz – and it started to work immediately. Then they made him Co-President of the company, did not back fill his efforts in the Authentic Youth segment and pulled resources accordingly in that area. 


Simply put, the ‘rock star’ approach does not work here. It takes a team, and McCarthy will build it. If people freak out because of higher spending to get this team built – then this will be a gift for a risk manager.


Revenue Analysis

Historically, the correlation between reported UA wholesale apparel revenue and the corresponding Sportscan athletic apparel data (lagged by one full quarter to account for wholesale to retail timing) is 76% based on analysis of the last 12 quarters. 


With the benefit of the late 1Q09 launch of running shoes, footwear revenues are forecast to benefit from an incremental $15 million in the quarter.  We’re assuming the legacy footwear base (cleats & trainers) will decline by 30% to ~$9 million due in part to difficult comparisons and insight we’re gleaning from the channel.  On the whole, we are modeling 85% growth in footwear during Q3.  While revenues are still challenging to pinpoint with a high degree of accuracy given the lack of history for running, we believe the directional trends highlighted in the weekly scan data support our estimates. 


Furthermore, while running and additional category expansion in footwear remains key to our longer-term thesis, we’ve got to keep in mind that we are still in the very early stages of the footwear maturation curve.  Anecdotally, in a recent meeting with Dick’s management, they candidly discussed their surprise that UA’s footwear launch was met with such mixed reviews, and that it met their launch expectations.


Take a look at the chart below depicting the historical relationship (spread) between UA reported results and Sportscan trend data.  It’s important to note that over the last four quarters the spread has been within a +/- 5% range, reflecting a fairly high degree of correlation.


UA: How Have Expectations Changed? - UA apparel1


UA: How Have Expectations Changed? - UA Footwear1


Margin Analysis


Despite a smaller portion of lower margin footwear sales compared to the 1H, higher reserves, and increased liquidation activity will weigh on margins, which we are modeling down 200bps in Q3. Offsets will include strong higher margin direct-to-consumer sales that were impacted by ~100bps last year related to IT interruptions as well as fewer discounts in the outlets for apparel liquidation due to tighter inventories and a more stabilized retail environment. In addition, product costs are starting to swing the other way, which could lead to upside.  At the same time while UA will continue to invest in the brand growing SG&A roughly in-line with revenues, we expect modest deleverage of 90bps in the quarter as the company manages costs while the top-line recovers.


UA: How Have Expectations Changed? - UA Rev Waterfall


UA: How Have Expectations Changed? - UA EBIT Waterfall


UA: How Have Expectations Changed? - UA FCF Waterfall

“Weighty” Euro


Position: Long Germany via EWG


Although rear-view, it’s worth looking at today’s Eurozone trade balance release as a preview of the impact that a strong Euro is having  — exports were down 5.8% in August month-over-month, with imports declining 1.3%, dropping the trade balance to 1 Billion EUR from 6 Billion EUR in the previous month when exports rose 4.7% sequentially.


We’ve been hitting on the implications of currency strength in our European posts. With the Euro trading at an increase of +6.3% YTD versus the USD or +15.4% over the last 7 months, the impact on trade will be pronounced. As noted in yesterday’s post, ECB President Trichet has recently signaled his displeasure with a strong Euro, yet has not made explicit comments on raising rates in the near term.  


In order of absolute EUR of trade, exports from the Eurozone in the first seven months this year versus a year earlier declined to the UK by 26%, followed by a -20% contraction to the US, and declines of 10% and 4% to Switzerland and China respectively, according to Eurostat.


We continue to monitor the Euro versus major currencies. Certainly for Germany’s export-led economy, a strong Euro is a major headwind.  Today’s report shows that from January-July 2009 versus a year prior Germany far exceed any other country in the EU with a trade surplus of 73.4 Bill EUR, followed by Ireland (+23.3 Bill EUR) and the Netherlands (+20.9 Bill EUR). Conversely the UK far exceeded any other country with a trade deficit of -54.4 Bill EUR over the same period, followed by France (-30.4 Bill EUR) and Spain (-26.9 Bill EUR).


We’ll have our EYE on the Euro and its impact on trade, especially as it relates to Germany, which we’re currently long in our model portfolio.


Matthew Hedrick



“Weighty” Euro - a1



“Weighty” Euro - a2





The Economic Data calendar for the week of the 19th of October through the 23rd is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.  


THE WEEK AHEAD - week ahead oct 19



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