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No More Free Moneys?

Indian equities have broken the immediate term TRADE line…

 

As India’s central bankers shift to a more hawkish rate stance and government stimulus programs expire, the bloom appears to be disappearing from the equity market.

 

If inflation levels revert towards positive readings, the storm clouds could grow darker as consumer inflation has continued to remain stubbornly high despite record low wholesale prices this year. Consumers are already bracing for higher staple prices in the wake of another disappointing harvest cycle. Another weak crop next year could create real pressure.

 

From a quantitative perspective, the SENSEX has broken down. There is no support for the BSE Sensex until the TREND line outlined below.

 

Andrew Barber

Director

 

No More Free Moneys? - a1


Bombed Out Buck: Changing Dynamics

When we first began pounding the table about the relationship between the US Dollar and the equity market  (“Breaking the Buck” Q1 09, “Burning the Buck”  Q2/Q3 09 and our present “Bombed out Buck” thesis)  what was a matter of debate has become consensus and it seems like every pundit on CNBC has been talking the subject up. We were early to the game on this call, we are also now likely to be among the first to walk off the court: as the facts change, so do we.

 

The reality is that over time the Dollar oscillates between a role as a driver and that of a reflection of the US asset markets (including equities) with great frequency.  To help illustrate this point, I have put together the crude illustrations below. The chart shows the rough correlation between the S&P 500 and the US Dollar Index on a rolling 250 day basis.

 

As you can see, the relationship flips between strong positive and negative correlation with a very high frequency.  In the background of the second chart I have charted a rolling measure of the absolute difference between year-over-year returns for the two indices to map out periods of long term performance convergence/divergence. Intuitively the periods of broadest divergence tend to coincide with period of strong negative correlation and vice versa (with the notable exception of Volker’s interest rate crusade in the early 1980’s).

 

Obviously there is a huge difference between calculating positive and negative correlation and understanding when the dollar is the driver for this, but it does serve to illustrate how volatile this relationship is. 

 

Bombed Out Buck: Changing Dynamics - barber1

 

Bombed Out Buck: Changing Dynamics - barber2

 

Early this year we realized that the US Dollar was setting up to assume the role of equity market driver and the strong negative correlation between the two indices has proved us right. We now see the fundamental dynamic between shift starting and expect that –just as the USDI/SPX relationship can easily revert to a reflective measure as we move forward, so too can the correlation between the two weaken. This is supported by recent declines in shorter term r2 calculations.

 

Our point is simply, it would be a mistake to assume that the relationship between US equities and the dollar is static. Our process is one of risk management and a critical part of that is understanding when a trend is changing.

 

Andrew Barber

Director


PNRA – BUCKING THE TREND

I see no reason to fight the trends at PNRA.  The concept operates in a segment of the industry that has very little direct competition.  The breakfast day-part is being challenged by rising unemployment but PNRA’s customers appear more loyal than the bottom feeder customers that are causing MCD some difficulties.

 

PNRA reported 3Q09 earnings after the close yesterday and there was little not to like.  Following the recent trend in restaurant earnings, PNRA’s earnings of $0.65 per share easily beat the street’s $0.58 per share estimate.  Bucking the trend, however, PNRA’s same-store sales growth at both the company and franchise operated restaurants also came in better than expectations.  And, the good news did not end there.

  1. Same-store sales have improved sequentially on a 2-year average basis each quarter this year.
  2. Same-store sales growth also improved on a sequential basis throughout the quarter (+2.6% in July, +3.0% in August and +4.4% in September).
  3. Unlike its peers, this growth was fueled by both traffic growth (+1.8%) and average check growth (+1.5%).  This transaction growth represented a significant sequential improvement from 2Q’s 1.4% decline.
  4. Same-store sales continued to improve in Q4 with quarter-to-date underlying trends up 6.9%.  This is a strong number on its own, but it is even more impressive relative to the soft October trends cited by both SONC and MCD. 
  5. Q4 same-store sales guidance was difficult to decipher as the company provided both calendar and fiscal ranges but the given 5%-6% range seems to be the more important range to consider as it represents underlying business trends.  This guidance assumes continued sequential improvement in both transaction and average check growth in Q4.
  6. Mix turned positive in September and has remained positive in October.  Management attributed this mix improvement largely to the tick up in catering trends.  PNRA’s soft catering trends have been a drag on mix as it is typically a low transaction/big ticket business.  PNRA expects catering to be up 5%-10% in Q4 (was running -5% in 1H and positive in Q3), which should add about 30 bps to average check growth.
  7. Operating margins improved 230 bps in the quarter and PNRA is guiding to an additional 75-125 bps of improvement in Q4 and 25-75 bps in 2010.
  8. PNRA’s full-year 2010 EPS guidance of $3.05-$3.15 is above the street’s $3.03 estimate and assumes 3.0%-5.0% same-store sales growth (flat to 2% transaction growth).

Being the resident bear, I have a hard time believing this Q4 and 2010 guidance but the company’s Q3 same-stores sales and traffic trends were pretty unbelievable as well!  This company is driving both traffic and average check growth in an extremely challenging environment.

 

I would say the only somewhat concerning issue discussed today stems from the company’s decision to accelerate company-owned unit growth next year.  PNRA announced that it would increase its new company-owned units by more than 50%.  Yes, the company’s margins have gotten significantly better in the last two years, but I would attribute a lot of that improvement to its having slowed new unit development.  PNRA opened 89 company-owned restaurants in 2007, 35 in 2008, an estimated 25 in 2009 and is now forecasting about 40-50 new units in 2010. 

 

Management said it must take advantage of the current real estate opportunities and that current returns warrant becoming more aggressive with growth now.  Management also highlighted my concerns about doing so, however, when it said that new stores often generate lower returns initially due to opening costs and higher training costs.  This accelerated growth will lead growth-related costs right back into the P&L and put increased pressure on returns.  This might help explain why the company is forecasting 25-75 bps of margin growth in 2010 with 3%-5% same-store sales growth after driving nearly 180 bps of growth on only 1% comparable sales growth year-to-date.

 

 I am not saying that growth is never warranted, but I would have preferred to see the company take up its new unit growth goals in a more conservative manner.  That being said, this company’s current trends continue to surprise me and time will tell whether returns will hold.

 

PNRA – BUCKING THE TREND - PNRA SSS 3Q09

 

PNRA – BUCKING THE TREND - PNRA EBIT 3Q09

 


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Relax: SP500 Levels, Refreshed...

The tones and frequencies of my inbox are relatively good indicators of the behavioral side of this market. Some people are a little freaked out here. So, take a deep breath, and realize that what you are feeling isn’t unique.

 

The Bad, the Good, and the Relax lines (see chart below):

  1. Bad – two days ago, the SP500 broke our immediate term TRADE line at 1067; that’s not new
  2. Good – the SP500 has an immediate term TRADE line of 1049; that’s the same line I had in this morning’s note
  3. Relax – the intermediate term TREND line = 1017

TRADEs are what they are, trades. They are 3-weeks or less in duration. They matter.

 

TRENDs are much more dominant. They are 3-months or more in duration. They are very difficult to break.

 

Understanding that I only have a 6% Allocation to US Equities means I can probably be more relaxed here than the guy who got fully invested at the top of October 19th. But the fact of the matter remains that Mr. Macro Market couldn’t care less about my or his individual portfolio position.

 

As risk managers, all we can do is manage the risk that’s in front of us. From the lows of this morning (1054 on the SP500 as I type this), you have another -0.5% of immediate term TRADE downside, and another -3.5% downside to a fortified TREND line.

 

Relax, and wait for your price. This is not a crash, yet…

KM

 

Keith R. McCullough
Chief Executive Officer

 

Relax: SP500 Levels, Refreshed...  - SP10 28

 


SAFM – RAISING ESTIMATES?

Ahead of the company analyst meeting tomorrow, corn is testing two-week lows. 

 

It was just two-weeks ago that the “street” was cutting estimates and downgrading SAFM due to higher corn prices.  Now look what is happening to corn. 

 

According to Farm Futures Daily, “Corn should open lower this morning, with more chart-based weakness emerging after a failed rally attempt overnight. Futures tried to bounce back at the onset of the electronic-only session, but lost ground after stock market losses in Europe deepened.  December futures are testing two-week lows below $3.65."

 

I certainly don’t expect the street to adjust estimates or ratings weekly on SAFM, but corn has a broken TAIL and a bullish TREND.  Within an industry that’s been wrecked/consolidated, broken TAIL prices are positive for producers.

 

We are LONG SAFM.  As we said two weeks ago, we do not agree that corn is headed much higher.  At the current prices for crude oil, Ethanol is not a concern and the bumper crop for corn will ultimately dictate the future of corn prices, which is likely lower.   Tomorrow, SAFM will be holding an analyst meeting updating the investment community on where the company is headed and on the state of the industry.  The industry dynamics are positive and SAFM is one of the best managed companies in the space.

 

SAFM – RAISING ESTIMATES? - safm

 

 


US Strategy – Volatility, Take Two

On Tuesday, the S&P 500 closed at 1,063, down 0.3%.  Yesterday’s was the third down day in a row for the S&P 500 and it finally broke the trade line.  The heightened volatility continued yesterday with the VIX up 2.1% yesterday and has now moved 18.8% in the past week.       

 

On the MACRO front, the drag on the market seemed to be the weaker-than-expected October Consumer Confidence data. For now, Consumer Confidence continues to make a series of lower-highs (see the chart in our post from yesterday). Americans are not as stupid as Washington thinks they are. The Conference Board’s index of Consumer Confidence fell to a three-month low of 47.7 from 53.4 in September.

 

Yesterday, the Case-Shiller report showed that the composite index of home prices in 20 metropolitan areas rose 1.2% month-to month in August, above the consensus estimate of a 0.7% increase.  The magnitude of the increase, however, declined on a sequential basis for the first time in four months.  In July, the index improved 1.6% month-to-month.  Nonetheless, the rate of annual decline in home price values continues to improve. 

 

The question about whether these trends will continue to show sequential improvement rests on the upcoming November 30 expiration of the government's $8,000 tax credit for first-time home buyers.  Also impacting these housing numbers are the anticipated higher unemployment rates through year-end and the apparent trend toward lower consumer confidence numbers, which was more evident today following the disappointing conference board reading. 

 

These issues, coupled with a new wave of foreclosures hitting the housing market in early 2010, suggest that the improvement in pricing trends are sure to slow down and may even begin to deteriorate further.

 

Yesterday, four sectors outperformed the S&P 500 and three sectors were positive on the day.   The three best performing sectors were Energy (XLE), Healthcare (XLV) and Consumer Staples (XLP), while Industrials (XLI), Consumer Discretionary (XLY) and Materials (XLB) were the bottom three. 

 

The Energy sector was the best performing sector despite the pick-up in risk aversion and dollar strength.  Also helping performance was better-than-expected earnings and cost-savings guidance from BP. 

 

Managed care rallied today with the HMOs up 3.7%, following a decline of 2.7% yesterday.  Healthcare reform continues to be a major headwind for the group. 

 

Today, the set up for the S&P 500 is: TRADE (1,060) and TREND is positive (1,015).   The Research Edge quantitative models have 9 of 9 sectors in the S&P 500 positive on TREND and 3 of 9 sectors are positive from the TRADE duration.  The only sectors positive on both durations are Energy, Technology and Consumer Staples.     

 

The Research Edge Quant models have 2% upside and 1.5% downside in the S&P 500.  At the time of writing the major market futures are poised to open to the down side. 

 

The Research Edge MACRO Team.

 

 

US Strategy – Volatility, Take Two - S P500

 

US Strategy – Volatility, Take Two - s pperf

 

US Strategy – Volatility, Take Two - sv oct 28

 


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