As I said going into the quarter, I think MCD’s reported September results will be the primary driver of the stock’s performance today.  I was wrong on the direction though.  September comparable sales growth came in better than the street’s expectations across the board and MCD reported 3Q09 EPS of $1.15 relative to the street’s $1.11 estimate so the stock is moving higher. 


Relative to my own expectations, the U.S. came in surprisingly strong, up 3.2%.  On a 2-year basis, this implies trends that are about even with what we saw in June and August.  Investors were not happy with what they saw in June and August (MCD traded down in reaction to both sales releases), but people were expecting continued deceleration in September and that did not happen.


In Europe, MCD reported 6.9% same-store sales growth in September, which came in better than the street’s expectation but light relative to my expectations.  Based on the ranges I laid out in my September sales preview, I view this 6.9% number as BAD because it points to a 160 bp sequential slowdown on a 2-year average basis.


APMEA’s reported 5.3% same-store sales growth beat both consensus and my expectations by the biggest magnitude and relative to my ranges, is a GOOD number because it signals an acceleration in 2-year average trends.  On a 2-year basis, this September result does not point to a return to the 7%-plus 2-year trends we saw earlier in the year, but it does show sequential improvement.




Like a broken record, Starwood beat and lowered again. Contrary to current Street projections, HOT pointed to lower 2010 margins and EBITDA.



HOT reported Adjusted EBITDA of $179MM, $4MM above the high end of guidance and the Street, and adjusted EPS of $0.14, $0.04 above the high end of guidance and Street. As has become customary, HOT lowered guidance for the following quarter.  New Adjusted EBITDA guidance of $190-$200MM or full year guidance of $735 to $745 is below the $750MM they guided to last quarter.  Would anyone be surprised if after the Street lowers their numbers for next quarter, HOT comes out and beats again?


Starwood missed our estimates by $2MM on Adjusted EBITDA but beat our Adjusted EPS estimate by $0.02 given the artificially low 7.1% effective tax rate resulting from a reversal of deferred taxes.  Using a "normalized" tax rate of 28%, we estimate that HOT's Adjusted EPS was really $0.09 for the quarter.  If we use their numbers and tax away the $10MM tax reversal, which isn't recurring, we come up with $0.08. In any case, we realize that no one attaches much significance to EPS, so let's move on to the details of the quarter.



Owned, Leased, and Consolidated JV

  • Revenues came in $3MM light of our estimate but HOT more than made up for the revenue weakness with tighter cost control
  • ADR for Owned hotels was 2% lower than our estimate, while occupancy was 3.5% better. 
  • The change in mix shift away from group was evident in the 34% y-o-y estimated decline in F&B revenues
  • Total COSTPAR (total expenses per occupied room) decreased 13.5%, compared to 8.3% in 2Q09, which was certainly impressive


Management, Franchise Fees, and Other Income

  • Fee income came in $3MM below our estimate, with the entire miss attributable to lower incentive fees
  • Management, Franchise and Incentives fees ("real fee income") were $124MM, down 23% from 3Q08
  • Managed & franchised rooms grew 4.4%, adding 11,216 rooms y-o-y to the system
    • Growth in managed and franchised rooms was roughly 2,200 rooms light of our count due to more hotels exiting the system and possible delays in announced openings
    • New brands contributed 5,103 of the room addition, or 2%
  • Across the brands, ADR results came in below our estimates (by roughly 2.5%) while occupancies came in better, net RevPAR declines were only 40bps below our estimate
  • The "junk" (deferred gains/ termination fees/ and bliss revenues/ etc) was flat year-over-year, hence management comment of fee income only being down 17%
  • Amortization of deferred gains was $21MM, same as last year, we suspect that the other $11MM in "Other Management & Franchise Revenues" consisted mostly of termination fees
  • Bliss and other miscellaneous revenues were $25MM, down 26.5% from 3Q08




  • Came in largely in line with our numbers
  • Originated sales declined slightly less than we expected but deferred revenues were a lot higher, bringing down the net number
  • Originated sales margins where higher than our expectations, so net operating profit of $24MM was $2MM better than our estimate



Other details

  • SG&A was $8MM higher than our estimate, as HOT neared the end of its cost containment efforts
  • Starwood's effective tax rate was only 7.1% in the quarter due to some tax reversals.  Since this is clearly not a normalized number, we wouldn't use it to calculate "Adjusted EPS"
  • Starwood stopped providing a RevPAR breakdown for "other systemwide" hotels which we thought included some of the new brands and non-branded properties



4Q09 Guidance

  • As we already mentioned, the mid-point 4Q09 guidance is below Street numbers and below Starwood's guidance given last quarter
  • RevPAR guidance was left unchanged
  • EPS guidance was lower
  • D&A guidance was tweaked down a bit, due to asset sales and write-downs
  • Everything was roughly the same



2010 Outlook


" While business conditions have clearly stabilized, it is very hard to forecast the pace of recovery, especially rate. While group bookings have picked up for 2011 and beyond, booking pace for 2010 has continued to lag below 2009. And booking windows for both transient and group business have shortened considerably. As such, late breaking business is a larger
component of what will drive our performance next year making forward looking predictions four quarters out particularly challenging."

  • SS Company Operated WW Hotel RevPAR expected to be flat to down 5% (same as MAR's guidance) in local currency (FX will help though)
    • US and Western Europe are expected to be at the lower end of that range and emerging markets are expected to be at the high end
    • At current exchange range, HOT estimates a 2% benefit to reported RevPAR
  • Management and Franchise fee growth is expected to be in line with RevPAR growth
  • RevPAR at SS Owned WW Hotels also expected to be flat to down in local currency (and 200 bps better in current dollars)
  • Margins at owned hotels will likely be DOWN
  • Timeshare origination sales are expected to be flat, but interest income will be down assuming that Starwood can complete another securitization sale in 4Q09.  However, under the new accounting rules, timeshare operations will get an estimated boost of $10-15MM with no associated cash flow benefit
  • Most SG&A increase
  • Possibly more asset sales


Adjusting for the timeshare we expect Street numbers to come down (again).  Consistent with our 10/15/09, Street margin expectations for 2010 were too high.

US Strategy – Financials Breaking Down

On Wednesday, the S&P 500 closed at 1,081, down 0.9%.  The S&P declined for the second straight day on accelerating volume, although the market was in positive territory for most of the day.  Yesterday’s move at the end of the day was on outside reversal, which is also a bearish sign. 


On the MACRO front, the global RECOVERY theme provided the upside support ahead of the release of the Chinese economic data. Chinese GDP rose 8.9% in the 3Q; the median of 34 estimates in a Bloomberg News survey was for a 9% gain. 


Yesterday, portfolio activity included buying GS and shorting MS. Keith also shorted TOL, AAPL and PENN.  We also shorted more of the USO. 


The dollar weakness continued yesterday as the UUP declined 0.6%.  Yesterday the VIX surged 6.3%.  With dollar weakness, Energy (XLE) outperformed the S&P 500.  December crude finished  up $2.25 at $81.37 a barrel, the highest settlement since October 9th 2008.  The materials (XLB) did not benefit from the dollar weakness, as an earnings miss from Dow Chemical (DOW) weighed on the chemicals.  Further weakness is expected in the XLB today as Potash (POT), which is one of the world’s largest fertilizer companies, missed numbers this morning. 


Yesterday, only two sectors were up on the day (XLU and XLK) and five sectors outperformed the S&P 500.  The three best performing sectors were Utilities (XLU), Technology (XLK) and Energy (XLE), while Healthcare (XLV), Consumer Discretionary (XLY) and Financials (XLF) were the bottom three. 


The Financials have been the worst performing sector in the market in 4 out of the last 5 days and is now broken on the TRADE duration.  The regional banks have been dragging down performance of the XLF on real estate and credit concerns, which has been further emphasized by Fifth Third Bank this morning who reported weak earnings on the back higher than expected bad loans.


On the political front related to financials, Elizabeth Warren was on CBS’ Early Show this morning discussing compensation for “piggy” bankers.  Warren, whom heads the Targeted Asset Relief Program's oversight committee, stated: "Guys, you have to understand that you can't party on like it's 2007. If you're going to take taxpayer dollars, then the game has to change. In that sense it's real." Indeed.


Today, the set up for the S&P 500 is: TRADE (1,065) and TREND is positive (1,007).   The Research Edge quantitative models have 9 of 9 sectors in the S&P 500 positive on TREND and 8 of 9 sectors are positive from the TRADE duration.  Yesterday, Financials broke trade.           


The Research Edge Quant models have 0.5% upside and 1.5% downside in the S&P 500.  At the time of writing the major market futures in the U.S. are lower.


The Research Edge MACRO team.


US Strategy – Financials Breaking Down - S P500


US Strategy – Financials Breaking Down - s pperf

US Strategy – Financials Breaking Down - s plevels


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.



October 22, 2009





With the sports apparel data showing large increases and an acceleration yesterday, we suspect that there is some underlying strength in the licensed apparel business. It has been sometime since the licensed business has been mentioned as a positive, but we believe there are some interesting trends developing that give the fan-based merchandising business a tailwind. While we are not making a call that license apparel is back in full force like it was three to four years ago, here are few reasons why we could see a pick up:


  • Season to date, NFL viewership has increased the most since 1989, with average games being viewed by 17.4 million fans.
  • CBS and Fox have averaged 22.3 million viewers for their doubleheader games on Sundays, which makes these broadcasts television's most-watched each week.
  • The MLB playoffs have benefitted from close games and extra innings helping to increase viewership 13% over last year.
  • The New York Yankees could add a boost to the licensed business as its fan appeal spans far beyond the local NY market. Participation from other large market teams such as the LA Dodgers is also a plus.


We don’t want to get too carried away, but the beginnings of the trend should not be overlooked. Companies that could benefit from the surge in licensed apparel and fan based apparel:


  • Adidas - it’s impact might be insignificant on the grand scheme of things, but owning the NFL license helps.
  • Sporting good retailers: DKS, HIBB- the big winners who benefit from all fan based apparel,
  • UA: although the brand isn't being displayed across the headlines or on the jerseys, Under Armour is closely associated with football and could benefit from a rub-off effect. Fans identify with their favorite athletes and ultimately attempt to mimic their look.







Some Notable Call Outs


  • It’s not often that a retailer shares its weather forecast for the upcoming quarter with the Street. However, Tractor Supply included its weather outlook along with other more traditional guidance on its 3Q conference call. The company’s weather analytical provider is forecasting a slightly colder October followed by a slightly warmer November and December. I wonder if they get an hourly breakdown as well…


  • As M&A continues to heat up in the retail and apparel space alongside a growing IPO calendar, capital raising also appears to be building momentum. (supposedly the fastest growing retailer in the U.S over the past 3 years) just secured $30 million in financing from existing and new investors including Accel Partners and Bessemer. The company intends to use the capital to secure its position as a leading online merchant of baby products. Looks like Babies R Us and BuyBuyBaby are in for some formidable competition.


  • In case you missed it, Kroger hired General Motors’ former head of Global Human Resources to lead its human resource efforts. On the surface it appears there are many similarities between the two businesses. Large union workforces, outsized cost structures, and aggressive competition are just a few worth mentioning. Oh, the irony…





China’s Economy on a Road to Recovery - China’s economy grew by 8.9 percent in the third quarter of this year, the government announced, shoring up the notion that the world’s third-largest economy is on a road to recovery. Still, questions remain about the sustainability of China’s recovery from the world economic downturn, with much of the growth dependent on massive government spending and public works projects. Central government leaders have not ruled out funneling more money into stimulus spending, and have repeatedly said recovery is in its initial stages. <>


USTR to Address Counterfeiting at U.S.-China Talks - Amid rising trade tensions, Obama administration officials plan to raise concerns about intellectual property rights and enforcement at high-level meetings in China next week. The U.S.-China Joint Commission on Commerce and Trade, set for the industrial city of Hangzhou on Oct. 28 and 29, is a forum to address bilateral trade issues. U.S. Trade Representative Ron Kirk and Commerce Secretary Gary Locke will cochair the meeting with Chinese Vice Premier Wang Qishan. Secretary of Agriculture Tom Vilsack also will be in the U.S. delegation. <>


Germany May Apply VAT Charge to Municipal Services, FTD Says - Germany’s new coalition government may require municipal companies to pay value-added tax on services they provide, Financial Times Deutschland reported, without saying where it got the information. Under the proposal, services including state sewage and refuse collection would no longer be exempt from VAT and would pay a 19 percent tax, the same rate as private firms, the newspaper said. The move may provide federal and regional authorities with as much as 4 billion euros ($6 billion) in added revenue, the newspaper said. <>


China: Textile, garment exports' biggest plunge in 3 decades - China's textiles and garments exports are expected to shrink by 10% this year, the biggest decline in 30 years, said Sun Ruizhe, vice president of the China National Textile and Apparel Council. Data from the General Administration of Customs of China show that the value of the country's textiles and garment exports in the first nine months of 2009 amounted to $121.64 billion, down 11.17% year-on-year. The export value of textiles and garments in the first eight months of 2009 amounted to $104.89 billion, down 11.81%, compared with the same time period of 2008. <>


Holiday Survey Suggests Shopping Early and On the Cheap - Retailers are squaring off with both their consumers and their landlords this holiday season, and so far they’re winning only half the battle. A new survey from Accenture showed that, even though more shoppers might come out on Black Friday, consumers generally plan to make gift purchases early this year with a focus on discounted goods. And the Federal Reserve’s Beige Book showed consumer spending was weak in most of the country in September and early October. Already, projections place holiday sales at about even with last year’s dismal take and well below 2007 levels. Meanwhile, stressed-out stores are asking for deals from their landlords and getting them. Accenture, which surveyed 526 consumers last month, found that 69 percent expect to do the bulk of their holiday shopping by Dec. 7, up from 60 percent last year. <>


Sears enters the online books price war - Amidst the online book price war between, and—and Barnes & Noble’s Inc. entry into the electronic book reader business— is launching its own merchandising tactic. Once customers have purchased a book online from any of those retail sites, they can e-mail the receipt to and receive a credit equal to the purchase price of a $9 book and apply the credited amount toward a purchase of $45 or more on “The $9 credit can be used at on the purchase of any items, so it`s like getting the books for free,” says Sears senior vice president of online Imran Jooma. <>


Best Buy and Netflix partner to stream movies to TVs on the Internet - Best Buy Co. and Netflix Inc. have taken a step to bridge the gap between Internet and television. Best Buy is now selling online and in stores exclusive, Insignia-branded Blu-ray disc players that enable Netflix members to stream movie and program picks over the web to their televisions. <>


China: Implementing anti-dumping measures on nylon imports - To protect local companies, China is planning to impose anti-dumping duties up to 36% on imports of nylon 6, which is widely used in the production of hosiery and knitted garments, from the US, EU, Russia and Taiwan. While tariffs for the other countries will be between 4% and 9.7%, the highest duties will be given to products from US companies. <>


Bob Pressman Among Fred Leighton Bidders - On Monday, a set of investors that includes former Barneys New York principal Bob Pressman asked a judge to approve its $25.8 million bid for the 38-year-old vintage fine jewelry brand in U.S. Bankruptcy Court in Manhattan. According to court documents, the prospective offer came from a group made up of Och-Ziff Capital Management Group, jewelry firm Kwiat and Triton Equity Partners, where Pressman serves as chief executive officer. <>


Designers Rally to Save Garment Center - “This is the game changer.” That’s how Yeohlee Teng summed up Wednesday’s Save the Garment Center rally that drew 750 supporters including Michael Kors, Diane von Furstenberg, Nanette Lepore, Elie Tahari and other designers onto Seventh Avenue to raise awareness of the New York neighborhood’s plight. “This will change the conversation with the city,” Teng said after the event. “It won’t just be about square footage anymore. It will be about issues that are more indicative of what is going on now — saving jobs, being American and cultural identities.” <>


Nigeria: Textile revival fund aims to boost economy - Speaking at an International Conference on Nigeria's Textile Industry in Lagos, the Minister of State for Commerce and Industry, Mr. Humphrey Abah, said the Nigeria's Federal Government is planning to launch a revival fund to save the country's shrinking textile industry, which aims to inject $57 billion growth to the economy, according to Minister of State for Commerce and Industry Humphrey Abah. <>


Under Armour Settles Sunglasses Lawsuit - Under Armour Inc. settled the trademark infringement lawsuit against a Denver company’s sunglasses. The suit alleged Navajo Manufacturing Co.’s “Ultimate Action” shades copied the design and style with a logo like an italicized version of Under Armour’s interlocking “U” and “A.” Navajo’s lawyer, Simor Moskowitz, told the Daily Record in Maryland tha “the parties had a meeting of the minds.” Terms of the settlement were not disclosed <>


PSS Tops WWD Growth in Brand Strength List - Landor Associates studied 2,500 brands to determine which showed the greatest increase in brand strength from 2005 to 2008. All were selected from Young & Rubicam Brands’ BrandAsset Valuator database. Top scorers, called Breakaway Brands, were evaluated on the basis of relevance, how necessary the brand has been in a consumer’s life, and what made it special or unique. 1 PAYLESS SHOESOURCE: Growth in brand strength 58 percent, “Payless was thought of as a not nice, but cheap place to get shoes,” said Landor’s Nelson. “They transformed into a shoe shop that democratizes fashion.” Matthew Rubel was hired as chief executive officer in June 2005, and promoted to ceo of parent company Collective Brands Inc. in 2008. He sparked the change to redesign dark stores, created children’s play areas, and expanded offerings to name brands, including Airwalk and Dexter, along with designer labels Lela Rose and Alice + Olivia. For his spring runway show, Project Runway alum Christian Siriano paired couture gowns with shoes from his Payless collaboration. In 2010, new Payless stores are planned in Russia through Collective Brands and franchise partner M.H. Alshaya Co. <>


Billionaire Green’s Arcadia Says Profit Rose on Young Fashions - Arcadia Group Ltd., the U.K. fashion retailer owned by billionaire Philip Green, said full-year profit rose 2.1 percent as the Topshop and Miss Selfridge chains increased sales of cut-price fashions to young shoppers. Operating profit climbed to 266.2 million pounds ($441.6 million) in the year ended Aug. 29 from 260.7 million pounds a year earlier, the London-based company said today in an e-mailed statement. Arcadia didn’t report net income. Revenue increased 2.7 percent to 1.89 billion pounds, while sales at stores open at least a year were unchanged. <>

Dancing With The Bear

“Problems cannot be solved by the level of awareness that created them”
-Albert Einstein

I’m in beautiful Camden, Maine this morning. It’s getting chilly up here, and the bears don’t like it.
Born and raised in the northwestern woods of Ontario, I know a thing or two about Black Bears. My Dad likes to say that you “don’t want to dance with the bear” and, although that’s probably local consensus, that’s not a consensus you want to try fighting. Consensus can be right.
What is consensus? Is consensus when everyone is long or short something? Or is it when you think everyone is long or short something? Is it consensus when you aren’t making money alongside people you deem to be consensus? Or are you consensus when you say something is consensus?
After making enough mistakes hunting in global markets, I have come to conclude that I can either be Bullish, Bearish, or Not Enough of one of those two things. My daily risk management task is to figure out how to not to be mauled. If that means being called consensus on my bearish US Dollar stance at this stage of the hunt, so be it. I remain short the US Dollar this morning because I don’t think consensus is Bearish Enough.

To be truly Bearish Enough on the Buck requires some reading beyond your latest tweet. You can listen to the Johnny-Come-Latelys on CNBC, who are now running segments with lead-ins like “When Nixon abandoned the Gold Standard in 1971” (sound familiar?), to truly appreciate that consensus still has no idea how to analyze this fundamentally. “Problems cannot be solved by the level of awareness that created them.”
On the topic of the Burning Buck, Niall Ferguson at Harvard is amongst the most aware. Ferguson is what I would call Bearish Enough. He’s looking for a -20% drop in the price of the US Dollar in the next 6-12 months. That would put the US Dollar index at $60!
Let’s think about what a -20% drop, from here, in the US Dollar would mean. We call this TAIL risk. Since March, the US Dollar has crashed, losing -16% of its value. Over the same time period, the price of oil (priced in those dollars) has had a Minsky Meltup of +102%. Let’s say Niall is not right, and the Dollar only loses another -16% of its credibility. Using the same leverage ratio of down dollar to up oil, that could equate to $160/barrel oil. Is that consensus?
Required reading from Fergusson would be his book titled the Ascent of Money. This fantastic analysis of economic history was all part of the studying we did to make this Burning Buck call 9 months ago, but my having been early on this doesn’t matter anymore. What matters is the here and now.
The US Dollar remains in what we call a Bearish Formation. That’s simply when then TAIL sits on top of the TREND, and the TREND sits on top of the TRADE. Bearish Formations are very powerful because they force all types of investor durations (from 3 weeks to 3 years) to either pay attention or “dance with the bear.”
My updated risk management levels for the US Dollar are as follows:
1.      TRADE (immediate term) = $76.39

2.      TREND (intermediate term) = $78.03

3.      TAIL (long term) = $82.29

So what do you do with these levels? You definitely don’t run from them. That’s what consensus does when being chased by a Black Bear. Instead, you hold your ground, and stare at them. Start yelling too, if you want.
Provided that the US Dollar cannot breakout above the TRADE line ($76.39); the Volatility Index (VIX) can’t breakout above hers (VIX immediate term TRADE line = $24.19); and the SP500 cannot breakdown and close below her TRADE line at 1065, I think US equities will make another higher-low during this correction.
Sometimes, doing nothing – waiting, I mean – can be the best option in avoiding a dance with the bear. In Thunder Bay, Ontario, that’s local consensus – but it’s a consensus that I’m more than happy to be called.
Best of luck out there today,



XLU – SPDR Utilities
We bought low beta Utilities on discount (down 1%) on 10/20. Bullish formation for XLU across durations.

FXC – CurrencyShares Canadian Dollar We bought the Canadian Dollar on a big pullback on 10/20. The currency ETF traded down -2%, but the TRADE and TREND lines are holding up next to Daryl Jones’ recent note on the Canadian economy.

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.

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.

UUP – PowerShares US Dollar
We re-shorted the US Dollar on strength on 10/20. It remains broken across all 3 investment durations and there is no government plan to support it.

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).

USO – US OIL Fund We shorted oil on 10/12 and 10/21 and are currently off sides, but with oil getting more over bought we are adding to the position.  Ultimately, the threat of higher interest rates, will be bearish for oil.  In addition, we are concerned with the bearish supply in the shorter term.

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.

A Tale of Two Asset Classes: The Dollar and Oil




“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.” –Charles Dickens, A Tale of Two Cities



Despite being a knucklehead hockey player, I have found time over the years to read a few classics, and Charles Dickens’ A Tale of Two Cities is one of them.   The longish quote above is, of course, the well known first paragraph of this book.   The book was set in Paris and London during and before the French revolution and would go on to become the most printed original English book with over 200 million copies. 



I won’t endeavor to make too many parallels between investing, and Dickens’ classic, but I do think the opening paragraph is an apt description for what we have seen in the oil and U.S. dollar markets in the year-to-date.  For oil bulls, it has been the best of times, while for U.S. dollar bulls it has been the worst of times.



Our Lead Desk Analyst, Andrew Barber, prepared the chart below, which outlines the performance of oil, the U.S. dollar index, and the U.S. dollar versus the Canadian dollar over the past three years.  We referenced the chart at 100 to start and then graphed the performance of all three over the past three years.   Not surprisingly, the peak of oil last summer coincided with the trough of both the U.S. dollar index and the strength of the Canadian dollar versus the U.S. dollar.  This is a theme that we have been harping on consistently all year, but was really set in motion in 2008 with the meteoric rise, and then crash of oil.



Interestingly, both the U.S. dollar index and the Canadian and U.S. Dollar exchange rate are once again near the extremes of last summer when the oil hit its all time highs.  In fact, on a weekly basis the U.S. dollar index is 87.73 as of Oct. 20th and the Canadian Dollar to U.S. Dollar ratio is 91.687 as of Oct. 20th.  These are close to the all time lows for both ratios, which imply a weak dollar. In fact, when oil peaked in July of 2008, the U.S. dollar on both ratios was at very close to the same place.  Oil, on the other hand, was north of $140 per barrel versus its current price of just under $80. 



In our Oil Black Book from September, we cautioned about using expert projections for Oil, as collectively they tend to converge around the current month price and project that forward based on recent price action.  The consensus projections for the spot price of crude oil in early September were:



A Tale of Two Asset Classes: The Dollar and Oil - a6



Obviously based on where we are today, those price targets seem way off.  And likely they will be adjusted upwards if they haven’t been already.  Now the point is not to highlight that 35+ experts in aggregate were way off (although that is important to remember), but rather just to emphasize that consensus itself can be way off, and in a much shorter period of time than anyone could have imagined.



A question we often get is whether the U.S. dollar is a consensus short.  While its weakness may be well known and the reasons for that weakness as well, the question remains, even if consensus is bearish, is it bearish enough?  While we have shorted oil recently and are currently off sides, our longer term view is that oil price has an upwards and to the right trajectory, primarily for supply reasons.



When I look at the U.S. dollar market and oil market over the last three years, I am certain of one thing, they will move together and the move will be on a larger scale than anyone expects.  So, if your thesis is that oil will retest its July 2008 highs in the coming months, a primary factor will be the U.S. dollar and in the scenario of parabolic oil prices, no one is currently bearish enough on the U.S. dollar.




Daryl G. Jones
Managing Director


A Tale of Two Asset Classes: The Dollar and Oil - a2

Early Look

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