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Fantasy Forecaster

“We have two classes of forecasters: Those who don’t know – and those who don’t know what they don’t know.”
-John Kenneth Galbraith
I was flying back to New York from Seattle last night, and for the life of me could not shake this ‘dude’ they have on Fast Money who keeps pronouncing China, “Chi-nar-r.” We’re not asking much from these Fantasy Forecasters, but for the love of God, CNBC, get us someone who at least knows what they don’t know about basic spelling and pronunciation. The Chinese are watching.
Rebecca Runkle’s vision of Mobility is a wonderful thing but it can really infuse some distractions to my research while I am on the road. After getting what I needed from CNBC’s broadcast (closing prices for factors in my macro model), I promptly moved back to the country music channel.
Some people call me a forecaster. Some people call me names. Most people are starting to call me their Risk Manager. After spending a lot of time on the road in the last few weeks with Global Macro investors from Calgary, Alberta to Kansas City, Missouri, that’s where people say my team adds the most value.
Howard Marks has been adding value for Oaktree Capital Management investors for a long time. He founded the firm in 1995 and runs $60B in a way that a lot of people respect. They should. He is no Fantasy Forecaster – this man is a world class risk manager. In his recent letter to investors, Marks outlined some thoughts on risk management. Here were two that found their way into my notebook:
1.      “Ignoring bubbles is a special case of ignoring risk in general.”

2.      “I say we never know where we are going, but we sure as heck ought to know where we are.”

No matter where we go this morning, there those real-time, marked-to-market, prices are. Ultimately, this is a very simple way to start knowing what you may not know. Never forget that market prices don’t lie; people do. Price action is a leading indicator for something. Our daily task, as risk managers, is finding a way to understand what it is about those prices that we don’t know.
After being on the road meeting with a lot of people who are in the know, I thought I’d start to share my list of what seems to strike investors as something they didn’t know:
1.      Japan’s stock market is breaking down at the same time as her sovereign default swaps have doubled since August

2.      Japan’s stock market is down -5.4% for the month of November vs. China’s being up +10.5%

3.      Japan’s debt/GDP has gone from 50% in 1988 to 196% today, and government debt could top 240% within the next 3 years

That’s just Japan. And I have to keep this morning missive under 1000 words, so I better jump to another country. What is it about America that Washington doesn’t want anyone to know?
1.      Ben Bernanke’s new nickname is “He Who Sees No Bubbles” (see Daryl Jones, note titled “Geronimo” from Tuesday November 17th)

2.      America’s debt/GDP is tracking the exact same path as Japan’s, from 50%, to 80%, to … ?

3.      America’s debt, all in, per the Federal Reserve, is $53T (includes government, corporate, and consumer debt) actually close to 380% versus GDP

Wait. We know this – or do we? Do we know that levering ourselves up with debt is bad? Do we know what one TRILLION dollars is? How about $53 Trillion, and counting? Do we know what we don’t know?
Do American politicians know what off-balance sheet debt obligations are? If I throw those into the mix (Medicare, Social Security – you know… that other stuff), I can get to $56 TRILLION. That’s not a Fantasy Forecast either. That’s a number that “we sure as heck ought to know” we are running up here!
What does Timmy Geithner know? He claims to know that he “brought America back from the brink.” But the minute that Texas Congressman, Kevin Brady, insinuated that Timmy may not know what he doesn’t know… well… you saw that Squirrel Hunter get all fired up Rouge didn’t you. I have never seen a squirrel turn red before. Heck, I guess that’s just one more thing I didn’t know.
What most Americans know is that they are getting the bill. The Piggy Banker Yield Curve gets the Bankers, Debtors, and Politicians paid. Geithner’s job was to ensure the top 3 banking firms in America got their $30B in 2009 bonuses. Enough with your having brought us back from the brink already, ‘dude’.
Back to Bernanke. Depending on what slope you want to look at, the ‘He Who Sees No Bubbles’ yield curve is 2-4x its historical slope. If you didn’t know, that’s steep. There is a bubble forming in US Treasuries.
This morning you are seeing massive politicization on the short end of that yield curve. The 2-year US Treasury rate is plummeting to new lows (0.69%, levels not seen since the crash). The Yield Spread (10-year yields minus 2-year) is +265 basis points wide (11bps from its widest spread EVER), and the Term Structure (30-year yields minus 3-month) is +401 basis points wide (the historical median is 129bps!).
By any historical measure – government debt, yields, spreads – America has never looked more like Japan did in 1989. Rather than hiring a student of the Great Depressionista “brink” school to run this country’s debt levels up and into monstrous bubble proportions, maybe we should get someone who knows something about Japan to explain this to our President.
President Obama,
If one of your aides passed you the Early Look, I am satisfied – because now you know.
Ignoring America and Japan’s debt bubbles is, as Howard Marks can teach you, a special case of your in-house Fantasy Forecasters “ignoring risk in general.”
My immediate term TRADE support and resistance levels for the SP500 are now 1082 and 1115, respectively.
Enjoy the weekend with your families and best of luck out there today,




EWA – iShares Australia We remain bullish of Glenn Stevens at the RBA and how Australia is issuing its citizenry a rate of return. With growing confidence in domestic demand recovery and a commodity export complex with strategic proximity to China’s reacceleration, there are a lot of ways to win being long Australia.

XLU – SPDR Utilities We bought low beta Utilities on discount on 10/20.

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.   

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.


EWY – iShares South Korea South Korea has joined Japan in the ominous position of broken TREND and TRADE. This is not China or Taiwan. This is an early cycle economy that we want to be short against China/Taiwan.

XLI – SPDR Industrials We shorted Industrials again on 11/9 on the up move as the US market made a lower-high.  This is the best way for us to be short the hope of a V-shaped recovery.   

EWU – iShares UK Despite areas of improvement, broader fundamentals remain shaky in the UK: government debt continues to expand, leadership in critical positions lacks, and the country’s leverage to the banking sector remains glaringly negative.  Q3 saw its GDP contract by -0.4%. Further bank stimulus and the BOE’s increase in its bond purchasing program suggest that this will not end well.

XLY – SPDR Consumer Discretionary We shorted Howard Penney’s view on Consumer Discretionary stocks on 10/30.

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 and 11/16.

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.


The Macau Metro Monitor. November 20th, 2009.



A press release from Asia Properties Inc., a Nevada-registered company listed on the Over-The-Counter exchange in the US, has revealed that an agreement has been reached for them to buy a majority share in the “casino VIP club” from Sing Hou.  DM had thought that these VIP rooms were operated by one of Macau six concessionaires and that gaming promoters, licensed by the DICJ, were remunerated by the concessionaires for bringing in customers. 


There is obviously a host of regulatory questions surrounding the ownership of a VIP room in Macau by a listed company that is not licensed as a gaming operator in either Nevada or Macau.  While some VIP rooms in Macau operate “cages” within their rooms, so the concessionaire does not know who it is that is playing, regulators have not yet acted.  DM wonders if a US-listed VIP room operator might be treated differently. 





After a slow second quarter, the real estate market seems to be back on track with sale and purchase results from the third quarter this year rising considerably.  According to information released by the Statistics and Census Service, 5,345 building units were purchased and sold at MOP8.98 billion in the third quarter – up by 44% and 96.3% sequentially quarter-over-quarter.  The majority, 3,681, were residential units amounting to MOP7.66 billion – up by 61.7% and 103.5% quarter-over-quarter. 


JACK’s 4Q09 6% same-store sales decline at its Jack in the Box concept came in significantly worse than my estimate, street expectations and management’s guidance of -2.5% to -4.5%.  Making matters worse, trends have deteriorated further with management forecasting a 10% same-store sales decline in fiscal 1Q10 based on trends in the first seven weeks of the quarter.  We have a seen significant slowdown in QSR trends, particularly at the concepts that have relatively more premium product offerings and relatively more geographic exposure to California.  To that end, maybe I should not be surprised by these results, but JACK’s underperformance did shock me because trends fell off so dramatically from the prior quarter, with comparable sales declining 500 bps on a 1-year basis and 270 bps on a 2-year average basis.  A -10% number in Q1 would imply another 245 bp sequential decline in 2-year average trends.


Like last quarter, management attributed the sales weakness to rising unemployment (12%-plus level in California) and increased industry discounting with the biggest fall off in trends continuing to stem from lower breakfast, side item, beverage and mid-tier priced sales.  Specifically, management thinks its sales suffered from its strategic decision to go off air with its new product news as the company allocated more advertising dollars to its value offerings, which according to management, were just not compelling enough.  In response to a question, management stated that BKC’s $1 double cheeseburger, which was launched nationally in October, could also be impacting JACK’s sales trends in the current quarter.


Going forward, management thinks it is extremely important to balance its advertising budget behind both its premium and value messages.  In this environment, it is somewhat surprising to think that more advertising behind premium offerings would help, which is concerning because even the significantly lower same-store sales guidance for full-year 2010 of -3% to -7% assumes a sequential improvement in 2-year average trends throughout the year from current Q1 trends. 


If the economic environment does not improve in the near-term, I have a hard time believing that premium offerings will drive traffic higher.  According to management, being more promotional and offering an increased number of value items are not helping either.  JACK was only on air with its value promotions and traffic has not improved in Q1.  And, management said that significant check erosion was responsible for the sequentially worse trends quarter to date.  This leaves the company in a difficult position.  Increasing value at the expense of average check only makes sense if it is getting more people in the restaurant.


JACK’s full-year 2010 guidance of 15%-16% restaurant level margins implies that margins will be flat to down 100 bps YOY despite the expected 3%-7% decline in same-store sales at Jack in the Box.  As I pointed out last week in reference to CKR, these operators cannot continue to hold margins (even considering current refranchising initiatives) with demand decreasing so significantly.  Keep in mind that food cost favorability will moderate and go away.  For reference, commodity costs were down about 5.5% in 4Q09 with beef and cheese down 17% and 31%, respectively.  This level of YOY commodity favorability drove food and packaging costs as a percentage of sales down 320 bps YOY in 4Q09 and helped to push restaurant level margins 220 bps higher on a YOY basis despite the 6% decline in comparable sales.  This favorable offset to declining sales will not last.



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SCVL/PSS: Yet Another Family Footwear Retailer Smokes

SCVL/PSS: Yet Another Family Footwear Retailer Smokes


There’s a lot of smoking going on these days in family footwear, a space we’ve favored for two quarters now. PSS is the way to play it. I am getting worried that hype is growing – but in the end it is still not in the numbers.


SCVL crushed the quarter on every item, lining up fundamentally to exceed the street and guidance for at least the next 2 quarters.


EPS: $0.59 vs. Street of $0.30 and Research Edge estimate of $0.40

                Comps were up an impressive +10%, or 2.5% on a 2-year trendline basis. Average price per pair sold was up 5.5%, footwear units sold were up 4.3%, and traffic was up 5.7%.  Favorable product mix shift towards high priced footwear such as boots and athletic helped drive the comp. This represents the largest comp number in the company’s history.  Comp guidance was low to mid single digit comp increases.


Revenue: +12.6%, massive sequential increase from -3.6% in Q2, 2yr jump as well. 


Stores: Opened 4 stores and closed 1.  Planning on closing 6 stores in 4Q, an increase of 1 store closure compared to previous guidance.  Stores are working efficiently as sales per square foot grew by 11% for 3Q which was the first positive growth point since Q2 07. 


Gross Margin: increased by 260bps to 29.8% compared to 27.2%.

  • The merchandise margin increased 110bp primarily as a result of:
    • Less clearance product (inventories +5% on 12.6% sales growth)
    • Strong boot sales, which carry a higher margin.
  • Buying, distribution and occupancy costs decreased 150bps, which was largely due to comp leverage.

SG&A: SG&A dollars grew by 6% but as a percent of sales fell by 150 bps, on top of a 3% decline in the year-ago quarter.  The increase in SG&A was due to additional costs related to incentive compensation and employee benefits and to a lesser degree advertising and added store operational costs.


Commentary from CEO Mark Lemond: "Our large selection of value priced name brand footwear resonated well with consumers resulting in the highest third quarter comparable store sales gain in the Company’s history. We experienced higher than expected sales of athletic product during the back-to-school season and very strong boot sales later in the quarter. Our 10.2% comparable store sales gain was significantly above our expectations for a low to mid single digit comparable store sales increase for the quarter. The sales increase, combined with a higher gross profit margin and controlled expenses, resulted in our second best quarterly earnings in the Company’s history."


We’re looking at $0.32 for Q4 versus the $0.03 that the street was estimating before the results were announced. 



Comps +3% to +5% in 4Q, which suggests -4.4% in underlying trend. CEO admitted on the call that guidance was very conservative.  {note, I’ll give them the benefit of the doubt on good 4Q comps given that 3Q inventory was positive. We need to be weary of retailers whose inventory is TOO lean at end of 3Q. It there’s a snap in pos demand in holiday some companies might (ironically) be leaving money on the table.}


SCVL/PSS: Yet Another Family Footwear Retailer Smokes - SCVL SIGMA


SCVL/PSS: Yet Another Family Footwear Retailer Smokes - SCVL image 1


SCVL/PSS: Yet Another Family Footwear Retailer Smokes - Table for SCVL


SCVL/PSS: Yet Another Family Footwear Retailer Smokes - comp trends chart SCVL




Takeaways from G2E Las Vegas trip



All the manufacturers had impressive content, but I’m not sure anything we saw at the show will change ship shares IN THE NEAR TERM, grow the market, nor will good content change the fact that.

  • There aren’t many new facilities opening up in FY2010
  • None of the new domestic markets will really come to fruition in FY2010
  • Manufacturers are hopeful but have yet to see a real pick up in the replacement market


In the longer term we think that manufacturers are cognizant of the need to reach younger players and are attempting to reach that player through features like:

  • Skilled or the appearance of skilled gaming
  • More community elements to bring some of the excitement of table games to slots
  • Personalization
  • Greater use of sound and color


One of the trickiest things is figuring out whether the better content we saw this year will actually grow the market or just cause existing players to migrate away from older games they were playing.  I don’t have the answer but I think, in the short term, it’s very hard to grow the market in the current economy.


Most manufactures showed a large number of games which utilized past hit titles and added additional features to enhance level of excitement surrounding the game (bonusing, wheels, community features, tournaments etc).


More focus on participation games and more talk about bundling.


All the manufacturers had touch screen features that I thought were pretty cool.


What’s the difference between BYI’s iView DM and IGT’s Service Window?

  • To the player, these two “windows” look roughly the same and have the capability of providing the same services and applications.  The major difference is that BYI’s window has a bar across the bottom of the screen as well as a pop up on either the right or left side of the base game.  IGT allows each player to customize the look and feel of their service window and only comes across the left side of the monitor
  • To the operator there some major differences, IGT’s Service window is built into the game CPU so if it’s not a new AVP box or a new WMS box that comes with the built in feature you can’t add it.  BYI’s iVIEW DM is a standalone hard drive that sits on top of a game’s CPU.  This means that you can add the service window feature to any new or old video slot machine and while opening the box of an IGT or WMS game voids the warranty on the game we would wager that if operators really wanted to do this than IGT and WMS would probably need to work with them… we’ll wait and see what they do at Pechanga
  • IGT has developed a server window interface which will allow operators to get the service window on non-AVP IGT machines through the Next Gen hardware which will come to market in June 2010…. They are not currently developing a similar bridging solution for non-IGT games


New markets:

  • Illinois: shipping to this market should begin in Sept 2010.  IGT already has a distributor agreement signed as does WMS (Betson).  Aristocrat (ALL.AU) and BYI in negotiations with distributor
  • All the manufacturers are in talks with Italian concession holders.  We should see some shipments in FY 2010
  • Australia:  WMS is testing products that will address the ~ 130k club market, believe that IGT and WMS are addressing the smaller casino market (20k games)


Manufacturer highlights:




For sale games:

  • BYI has a nice looking new Pro-series (alpha 2 cabinet) being launched this year
  • More than just one title for the V32 cabinet should translate into more traction in video sales
  • While the new reel product (replacing the aging S6000s) may have looked boring to the video player or investor, we heard some good feedback from the operators

Participation games:

  • The U-Spin game definitely stole the show for games that are going to be ready for commercialization within the next few quarters
  • Two-seater games “Meet in the Middle” and “Move around the Board
  • Digital Towers
  • Hot Shots Progressive with a wheel bonusing features

Future games (12 -18 months away):

  • The iVIEW Display manager was impressive.  Instead of a button panel, BYI has a touch screen panel that has the feel of an iPhone.  Players can customize the panel and have multiple options of how to initiate spins.  The new touch functionality will also allow them to introduce more “skilled based” games where players can “roll” balls etc.  Remember that BYI still has rights to the Atari library
  • Alpha 2 pro-series box – great graphics/sounds and touch functionality
  • BYI has a “MLD” like product – with LCD projection over curved glass behind an LCD screen.  This curved glass really creates a similar feel to traditional spinning reels - we expect that BYI will develop interesting transmissive overlays on the front screen in the coming months.  We believe that unlike IGT’s MLD, most operators who purchase this game will use it as a true substitute to reels




WMS did a great job on content – big “wow” factor.  The company had obviously focused its R&D on growing the gaming market by appealing to that younger 30-50 yr old demographic.


WMS continued to rollout successful features like adaptive gaming, community gaming, and sensory emersion/“emotion” across more of their content and add more features to updated versions of successful franchises.


New franchises like “Lord of the Rings” and “Price is Right” were particularly impressive and had a number of “hooks” that provided the secret sauce to the success of “Wizard of Oz” and “Star Trek”.


Future games (12-18 months away)

  • WMS is still the only company that recognizes players no matter where they play, but now WMS is going to try to increase player/casino loyalty by allowing players to continue to learn about the game from home… basically tapping into that MMOE universe.  This should attract younger players, create enhanced player loyalty, venture into online “gaming”, without the wagering, by letting players to continue the game experience at home
  • WMS will be using the top LCS screen on top of base games to create new bonus game content (mega multipliers, community mega multipliers/Meta Screen, Winner’s Share) which they will sell on a fee per day per license basis in FY2011.  Should materially enhance the performance of base games…currently in trial at a few locations





Consolidating platforms should boost cash flow generation as they refresh roughly 20k games every year.


The MLD/AVP platform is really letting IGT produce some great for sale product.


Introduced new participation product that uses some of WMS’s success of episodic gaming and player recognition.


New “Sex in the City” and “Cougar” titles were intriguing.


The 103/70 FT screens can be used to refresh participation content with minimal cost (“American Idol”, “Wheel of Fortune Spin”, “Wheel of Fortune Puzzle”).


“Skilled based” reel game with the joystick driven “star” bonus round that should appeal to the younger 30-50 crowd.


IGT is really utilizing and sharpening their MLD technology, we expect that they for an extra $3K many casinos will opt for the AVP MLD games vs the regular video product.  IGT is expecting that 25% of total game sales will be MLD in 2010; we wouldn’t be surprised if it’s even higher with the new bonus features and enhanced content/titles available on that platform.


IGT has something called “discovery gaming” which is similar to WMS’s adaptive gaming concept.  Discovery gaming isn’t truly server based – since the game will only recognize players at a particular facility.  IGT said it will take them roughly 24 months to become truly server based with this concept.  Discovery gaming will be featured on the “Quest for Lost City” game.


The multi-play (4 games occurring at the same time) and press and play features on many of IGT’s for sale titles were interesting. 

Where’s Waldo?

I happened to be watching US Secretary of the Treasury Tim Geithner getting skewered on Capital Hill this afternoon and thought--if Keith weren’t on a plane right now he would be having a field day at “Timmy’s” expense. 


Keith has said in the past that the “New Reality” is that we have a Treasury Secretary who has no qualms watching the Buck burn. In short, Keith has stressed that the long term credibility of the US Financial System has been eroded by flooding the system with dollars. 


Ironically, on the day that Tim Geithner gets hammered the dollar stages a 0.5% rally and the market gets smoked.  I suspect this will be a topic for the Early Look tomorrow…   


Last week the Fed Chairman started talking about "watching" the U.S. dollar.  While Geithner and Bernanke can sit back and watch all they want they only have two options for firming the dollar’s value: intervene or raise interest rates. Raising interest rates would be a fundamental shift the Fed will pursue sooner rather than later, but is not likely right now, given the fragility of the economy and the financial markets.


As the resident bear in the office, the most severe economic downturn in generations continues.  At best, some key statistics such as retail sales and housing have bottomed out at lower levels, yet given the contraction in consumer credit and increased unemployment, the traditional avenues to renewed growth are just not available today to bail out the economy.  Certainly, the current level of the S&P 500 does not reflect the underlying economic and financial-system reality.


Howard Penney

Managing Director


Where’s Waldo? - geithner


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