Thinking Chinese

"Learn without thinking begets ignorance. Think without learning is dangerous.”
I often quote Confucius because he usually has the most impact with the least amount of words. As an amateur writer in a crack-berry country, I want to keep my word count down!
This weekend, The Economist focused on Confucius and China’s image in a 14 page special report on “China and America – The Odd Couple”. I have cited Harvard historian, Niall Ferguson, in recent weeks – he calls this “Chimerica.” Putting the “Chi” before the “merica”, capitalizing the “C”, is an important point to think about.
Some of the points of focus from The Economist were:
1.      “America is the world’s biggest debtor and China its biggest creditor”

2.       “China is building its first aircraft carrier”

3.      “Economic freedom is one value that Mr. Obama should not sacrifice on his first visit to China next month”

>Ok. So. What’s new about any of those points? Nothing.
China, or The Client as we like to call her, has $800 Billion in US Government Debt, and she doesn’t have to buy any more of it. China won’t let the Pentagon see what’s underground at her military headquarters in Beijing. And China certainly doesn’t need a lesson from Bush or Obama on what the Greenspan version of “free markets” can inspire!
All this said, it is important to recognize that the world is figuring all of this out. Like a Confucius’ quote, it’s pretty straightforward. China has economic leverage. China wants to build some form of military leverage with that economic leverage. And China’s want for a globally managed economic system that diversifies away from a US centric “free market is the best path to prosperity” (Kudlow/CNBC) view is becoming an important geopolitical consensus.
So how do you make (or not lose) money understanding this? My answer, throughout the year, has simply been this - follow the money.
As long as you understand what the US Dollar is doing, and can handicap what it could do next, your hard-earned capital will be fine. On Thursday, the US Dollar was down, and the SP500 closed up +1.1%. On Friday, the US Dollar was up, and the SP500 closed down -1.2%. No, this inverse correlation won’t last forever (the R-Square actually dropped this week to 0.79, using a 6 month duration); but for now, this continues to be the macro factor that matters most to your portfolio.
Correlations aren’t perpetual, so when does this all end? There are plenty of times in recent US history (as in the last 40 years) where the US Dollar had a positive correlation with the SP500. In fact the R-Square, using a 5-year duration, is only 0.05! Duration always matters. We know this. But do we learn without thinking?
“Think without learning is dangerous.” The Economist exemplifies this in another piece they did this weekend titled, “The Diminishing Dollar.” This was what I would call the popular, US centric consensus view, of why the US Dollar has been decimated:
“This dollar declinism is overblown. It exaggerates the scale of the slide and misunderstands its cause. Much of the recent weakness simply reverses the earlier safe-haven flight to dollars, a sign of investor optimism about riskier assets rather than their fears about America’s currency.”
There are so many Washington/Wall Street narrative fallacies embedded in that editorial view that I can’t waste your time going off on it this morning. Understanding that the words “declinism” and “misunderstands” are more metaphors for how incompetent financial journalism has become is probably the most important point. The Economist is a great magazine, but they should stick to what they do well.
The dollar isn’t “diminishing” – it’s burning. The US Dollar getting remotely close to Lehman levels is the lowest price it has ever seen – EVER is a long time. The US Dollar representing some form of “safe-haven” is a long lost hope – hope is not an investment process.
Is the Buck going to keep Burning, or has consensus made this a Bombed out Buck that’s ready to recover? Unfortunately, in the immediate term, only Ben Bernanke can answer that. Will he move to where marked-to-market prices have in recent months? Or will he pander to the most politicized wind that the American citizenry has ever realized as a rate of return for her Savings Account?
November 4th is the Game Time date. Until then, rather than depending on someone’s said “inside information” about what he is going to do with the FOMC’s “exceptional” and “extended” political language, just let the real-time price of the US Dollar tell you. The Burning Buck will lead the way.
So far this morning, the US Dollar is trading down pre-US stock market open. Prices of US futures are indicated higher, as a result. Now is the time to study the histories of global reserve currencies. Whether they be gold bars, pounds, or dollars, the reality is that when it comes to Americans understanding currencies, “more than half of the respondents said they had learned ‘not too much’ or ‘nothing at all’ about financial issues” (Niall Ferguson, Ascent of Money, page 13). Thinking, “without learning is dangerous.”
My immediate term support and resistance levels for the SP500 are now 1072 and 1103, respectively.
Best of luck out there this week,



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.

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.

XLY – SPDR Consumer Discretionary Consumer Discretionary has rallied from the freak-out “short everything consumer” lows, prompting a short on 10/22 as a hedge for a TRADE.


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).

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.


Trends decelerated slightly in September.


Malcolm Knapp reported that September casual dining same-store sales declined 6.1% with traffic down 5.5%.  These reported numbers represent a slight deceleration in trends from August. 


We don’t yet have too much visibility on how October is faring for the casual dining restaurants, but we learned from both McDonald’s and Sonic that trends remain soft quarter-to-date with Sonic citing weather as a problem.  PFCB did say that trends had improved slightly from 3Q but that average weekly sales at the Bistro were still running down 6.5%.  Based on these few comments, I am not expecting much improvement in October.


Comparable guest count growth results in September again came in better than same-store sales growth for the fifth consecutive month, which points to negative average check growth.  Restaurant operators are doing everything they can to drive traffic. 


This weeks we have DIN, BWLD, PEET, PNRA, CEC, RUTH and THI reporting earnings. 


FASB 166 & 167 go into effect on January 2, 2010.  Income will increase but cash flow will not change.  Here's why



Under the current accounting rules, companies underwrite timeshare loans and collect interest on those loans at an average rate of 13-14%. Periodically, around 2x per year, that company will sell bonds that are backed by those loans. Typically some sort of over-collateralization is required, meaning that if I have $200MM of loans, I can only sell $150MM of bonds; the difference is the "over-collateralization" amount. The over-colleratization pool is meant to absorb any losses that occur in the loan pool that backs the bonds.  The bonds that are backed by the timeshare loans pay a much lower interest rate than the rate paid by the loan holder.  For example, MAR's on Oct 21st pays interest of 4.809%.  The underwriter of the loans and residual holder (i.e. MAR/ HOT), book a gain that consists of the present value of the spread between what they collect on the loans (14%) and what they pay the bond holders (let's say 4.809%) over the duration of the loan pool (2.5 - 3 years on average).  Once the securitization is done, the loans come off the balance sheet (they're typically in receivables), MAR/HOT books a gain on their residual interest, and they receive the cash proceeds from the bond sale.


Under the new accounting rules, those receivables (loans) come back on the books, as do the bonds that are backed by those receivables and non-recourse to MAR/HOT.  MAR & HOT will no longer book a gain that is the PV of the interest spread but rather recognize interest they collect on the loan pools and report interest expense associated with what they pay to the bond holders.  So actually, income statement accounting will more accurately reflect cash flow on timeshare loans.  This is why they will recognize more earnings from timeshare in 2010 versus booking gains and then amortizing those gains over time. The the securitized receivables will come back on the balance sheet, so there will be new line item titled as such.  The securitized debt will also come back on the balance sheet but it will not effect covenant calculations or the way ratings agencies treat this debt - since it remains non-recourse. There will also be a small increase in shareholder's equity, since the receivables exceed the securitized debt amount (due to the over-collateralization issue we already discussed).


We like the new accounting rules since earnings better reflect cash flow and big gains on timeshare note sales are eliminated.  Hope this helps.




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PSS: WMT Price Gap Widening

The WMT price point gap is the key call-out of our ongoing survey of like-for-like product in the value-zone. PSS seems to be more closely aligning its competitive price positioning with TGT, KSS and JCP.



Interesting change this week in our survey of price points on like-for-like product at a select group of low-price/discount footwear retailers.  We track this specifically as it relates to Payless, as its strategy is to sell at a 20-30% discount to its competition. That’s when it has historically realized optimum traffic and conversion.  The one thing that did not change is something that is really worth calling out, which is the consistency in price movements between Payless, Target and JC Penney. As the chart below suggests, PSS sells consistently at a discount to Kohl’s, but in a more volatile range. The big notable, however, is Wal*Mart is tracking at a 32% discount to PSS. This is starting to turn into a head-scratcher for me. Over time, I want to see PSS’ price gap with WMT widen and move closer to the TGTs, KSSs, and JCPs of the world, but that won’t happen overnight. But such material fluctuations so quickly require that I at least stay on guard to ensure that I’m not missing something. It helps that we’re so early in the season. If it was December and we saw this price gap, or I did not have the confidence that Rubel and team are proactively managing this price strategy, then I’d be raising a yellow flag about now. But I'm not. Numbers still need to come up.


And yes, I completely realize that our survey can’t adequately forecast the comp in such a complex business with thousands of stores and hundreds of thousands of SKUs. But not only has this been a directionally accurate tool for us, but most importantly it helps us make sure we’re asking the right questions.


Darius Dale and Brian McGough


PSS: WMT Price Gap Widening - 10 25 2009 8 50 30 PM

JNY: The Quantamental Shark Line

JNY: Bullish Formation


Oh the irony that Keith mentions 'The Shark Line' while I sit here watching Jaws on cable with my kids (while going through earnings models). I gave my take on JNY. Here's his...


TRADE = 18.35, so pretty close here – the catalyst will decide its fate

TREND = 15.22, a lot lower… so this one isn’t for the faint of heart as we are testing the TRADE shark line

JNY: Every Dog Has Its Day

 I will put JNY in the top 3% of worst-managed retail companies of the past decade.  It was so textbook how the company was robbing its brands of capital, acquiring marginal content to give the optical illusion the its top line was growing, and printing unsustainably high margins. But we all know that already. That fateful July day when Boneparth was ousted in the Summer ’07 and the Street realized that $3.00 in EPS was only a pipe dream and the stock subsequently plunged to $13 is proof enough of that. What we also know is that every dog has its day, and even though the current management team is average at best, the trajectory of the P&L here is still a winner.


We’re coming in at $0.36 for the quarter versus the Street at $0.28, and we’re 35% above the Street next year at $1.50.  A couple of things to consider on the model that people might not be considering…


1)      First, Liz Claiborne is walking away from about $400-$500mm in business at wholesale with its new deal with JC Penney. JNY is the obvious beneficiary. Not a 3Q event, but it’s on the immediate horizon.


2)      The most powerful part of this story is that JNY is accelerating its store closure program – simply because the commercial real estate market (or lack thereof) has created a window for JNY to bail on money-losing businesses.  We’re talking 240 stores out of about 1,000 – and the stores in question are losing money to the tune of a -10% EBIT margin. You do the math…$1.5mm per store *240 stores *-10% EBIT mgn. Yes, that’s about 5points in margin accretion to retail – even with the sales base dropping by a third. This is a business that had a -7% EBIT last year.


3)      Not sure if anyone noticed, but t his is the best boot cycle we’re seen in years. A primary beneficiary? 9 West – about a billion in sales.


Do I love this company? Course not. But my feelings about a company have nothing to do with my analysis of its financials.  Numbers need to head higher here. Mr. Market knows this to a certain extent, as short interest is sitting at a measly 5% of the float – low for JNY.  But an offsetting factor there is the simple fact that (until late last week) no one has asked me about the company in six months.


JNY: Every Dog Has Its Day - 10 25 2009 8 03 46 PM 

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