Again! Higher Highs

“Success is how high you bounce when you hit the bottom.”

-General George S. Patton


In this game, there is no better measurement for success than the rate of return on an investment. Undoubtedly, people who live their lives making excuses and pointing fingers will take issue with that; particularly on Wall Street, where some people like to keep a relative score. In the arenas of professional sport however, the score is absolute. I think that professional accountability model has higher standards.


When considering investment opportunities, I tell my team that they can be one of three things: Bullish, Bearish, or Not Enough of one or the other. I, for one, have not remained Bullish Enough on US Equities into yesterday’s closing YTD high. That’s no one’s problem other than my own.


I made multiple sales at the YTD highs established between November 17th and December 3rd (multiple tests of SP), but was relegated to watching us make a higher-high yesterday from the cheap seats.


Higher-highs, in my macro model, are bullish until they aren’t. One day, we can all look back at the YTD high for what it was – an event in the rear view mirror. Tops are processes, not points. If you need a Wall Street/Washington economist, strategist, or academic to give you a replay of it all, we are choke full of those in this country. They are called revisionist historians.


My role as a global macro risk manager is to proactively call out probable outcomes, before they occur. Sometimes I am wrong. Sometimes I am right. We called the topping process in both Gold and Oil this year. We also called the bottoming process in short term Treasury yields. At the same time I feel shame for missing yesterday’s SP500 ringing the register at 1114.


Yesterday’s higher-high in the SP500 coincided with a higher-high in one other major global equity market – Brazil. That’s the only country we are currently long on the International Equity side of our Asset Allocation. It’s the only major country index, other than the USA, to hit a higher-YTD-high in the last few weeks. The rest of the world’s Great REFLATION trades have started to unwind.


Brazil’s stock market bottomed just inside of a week before the US stock market did back in March. Since, the EWZ (Brazilian ETF) is up +146%. Meanwhile, the SP500 has tacked on one of the most expedited 9 month moves ever (+64.5% since March the 9th). Yes, ever is a long time. And, yes, the absolute score here has been a monstrous success for those who didn’t buy into the Groupthink Inc. fear-mongering. “Success is how high you bounce when you hit bottom.”


Today, my risk management task isn’t to live in some of the mistakes I made yesterday. It’s to wake up, smell the coffee, and make moves based on the most probable outcomes for tomorrow. Today, is just another opportunity to play the game that’s in front of me.


My favorite scene in the movie Miracle is when Kurt Russell lines the boys up on the goal line and makes them skate until they puke. “Again” … “Again” … “Again”…


Over and over again, I have learned through the lessons of my own mistakes that chasing higher-highs doesn’t work; particularly when they are not confirmed by the rest of the market prices in my global macro model. Here are some risk management thoughts for you to consider before you hit the ice out there this morning:


1.       China’s A-Shares closed down -0.86% overnight, failing to make a higher-YTD-high

2.       Japan’s stock market was down -0.22% again overnight; it remains the worst performing major equity market in the world YTD

3.       Hong Kong’s H-shares were down another -1.2% overnight; they have recently broken their immediate term TRADE line, making lower-highs

4.       Greece, turned sharply lower again this morning after their PM’s assertions of budget cuts were voted on negatively by Mr. Macro Market

5.       UAE resumed selling its stock market down another -1.5% after 1 up day of hope that Dubai’s debts for 2010, 2011, 2012 don’t matter

6.       Russian stocks continue to lose price momentum, having recently broken their immediate term TRADE line, and now making lower-highs

7.       Oil is now broken from both an immediate term TRADE ($76.91) and an intermediate term TREND ($74.30) perspective

8.       Gold has broken her immediate term TRADE line of $1148/oz and looks ripe to continue making a series of lower-highs

9.       US Dollar Index is now breaking out of its intermediate term TREND line base ($76.31), making a 2-month high, and a series of higher-lows


“Again”… “Again” … “Again”…


Its 630AM right now and I’m just getting started here. This is a short list of risk management factors that my model has flashed to me in the first few hours of what we call the grind. I know my style and process is not for everyone, but you know that I know it has edge. Closet indexers don’t grind.


The only way to solve for making a mistake like I have in not being long the SP500 at the YTD high is to find a different way to win this morning. Real men and women of this gridiron know that this is all that matters. Not losing is always the highest probability position to be in if you want to start winning.


My immediate term line of TRADE support for the SP500 is -1.5% lower at 1098. I’ll buy and cover US stocks if we hold that line. A strong US Dollar is going to lead this country to higher real-rates of return on American fixed incomes. It’s also going to expedite the exit of losing players who we need to get off the ice. I look forward to that. “Again”!


Best of luck out there today,






VXX – iPath S&P500 Volatility For a TRADE we bought some protection at the market's YTD highs by buying volatility on 12/14.


EWZ – iShares Brazil As Greece and Dubai were blowing up, we took our Asset Allocation on International Equities to zero.  On 12/8 we started buying back exposure via our favorite country, Brazil, with the etf trading down on the day. We remain bullish on Brazil’s commodity complex and believe the country’s management of its interest rate policy has promoted stimulus.


XLK – SPDR Technology We bought back our position in Tech on 11/20. Rebecca Runkle has an innovation story in Mobility and Team Macro has an M&A story in our Q4 Theme, the “Banker Bonanza”. We’re bullish on XLK on TREND (3 Months or more).


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.





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.


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.   

XLY – SPDR Consumer DiscretionaryWe shorted Howard Penney’s view on Consumer Discretionary stocks on 10/30 and 12/2.


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.

Required Retail Reading: NKE: FX Context


December 15, 2009





With the USD putting in a near-term bottom, that might seem naturally bad for Nike. But the delta remains positive from Nike's last EPS report -- even though the stock has not moved and estimates have bottomed.



With a 4% move in the dollar since the recent November 24th low, how could we NOT acknowledge this as it relates to Nike? A 4% move might not seem like much in the grand scheme of things -- but lets not forget that we're talking a currency here, not a stock. 4% over 2 weeks is big.  With over half of its sales coming from outside the US, a stronger dollar is clearly bad for Nike over a shorter time period.  I stress 'near term' as a strong US Dollar is ultimately going to lead this country to higher real-rates of return on American fixed incomes. It's also going to expedite the exit of losing businesses who don't have much of a reason to exist, which is good for companies like Nike.


A very important near-term point to consider is that since Nike's last print, the currency delta is a net favorable one in spite of the fact that we've seen recent strength. The chart below shows what the FX outlook was three months back vs. today (our analysis weights forex based on every relevant country where Nike does business).  


Required Retail Reading: NKE: FX Context - NKE FX 12 15 09


On top of that, add the fact that this is the first real quarter where Nike has some SG&A runway due to its layoffs earlier this year (though much will be reinvested), downward earnings revisions have (justifiably) slowed materially, and we're now only 1-2 quarters away from when we think both futures and EBIT should improve substantially as Nike starts its next 'burst' of growth. Package all that together and its getting tougher to find a reason not to like this stock. This should be a winner in 2010.




  • In a survey based on the volume and number online posts, as well as the overall tone of the posts (positive/negative),, Target, Nike, and Wal-Mart were the retail brands included in the top 10 for 2009. The top 10 list compiled by Zeta Interactive, is often used as a measure of which brands or companies are utilizing social media to effectively generate positive “buzz” surrounding their brands.
  • This is the last week to take advantage of the broad-based free shipping offers in order to deliver gifts by December 25th. Many online retailers will end their free-shipping offers by December 18th, which is also the last day retailers will allow orders guaranteeing Christmas delivery for those using free shipping options. 62.3% of retailers will expire their holiday shipping offers exactly one week before Christmas.
  • While conventional wisdom may suggest that the premium denim trend has passed, the ability to sell privately owned premium denim brands may still be a possibility. West Coast based denim company, J Brand Denim is reportedly in the process of being sold. The rumored sales price is $90 million with the buyer rumored to be a private equity firm.




Barneys' Extended Temporary Lifeline as Abu Dhabi Bails Out Dubai World - As the retailer’s ultimate parent company, Dubai World, on Monday revealed a $10 billion lifeline from Abu Dhabi, speculation continues to swirl over Barneys’ future and whether it will be sold. While sources said a sale isn’t imminent, they’re not ruling it out down the road. There have been signs of a pickup at Barneys, with business up 7 percent in October, although sales slid back into the negative column in November, approximately in the high teens. Factors and vendors continue to show support and ship with extended payment terms. For now at least, all of this enables Barneys to put off a sale, a bankruptcy or some other restructuring, and hold off on announcing a strategy for the future until after the luxury chain digests its holiday business, according to sources. The state of limbo is heightened by the fact that Barneys has strangely operated without a chief executive officer since July 2008, and there is no one in line for the job. <>


Kohl's Said Eyeing Broadway Site - Kohl’s Corp. is stepping up its search for its first Manhattan location. “They were in town last week,” said one real estate source familiar with the property search. The focus seems to be on 1775 Broadway, which is being fully renovated by Moinian Group, the landlord, and is located between 57th and 58th Streets and between Broadway and Eighth Avenue, just south of Columbus Circle. Comp USA was the last big-box retailer on the site. “The building has a pretty good size footprint. Most of the space is vacant. They could assemble a block of space over 100,000 square feet,” which would consist of three levels at around 33,000 square feet each, the real estate source said. Typical Kohl’s stores contain 80,000 to 90,000 gross square feet. WWD first reported in August that Kohl’s was scouting Manhattan and Broadway. Crain’s New York and The Real Deal reported last month that 1775 Broadway was the focus.  <>


Timberland launches campaign to make people aware of climate change - Timberland has just launched a global campaign to get citizens mobilized. The slogan is "Don’t tell us it can’t be done!" The aim is to impact the 192 governments attending the UN Climate Change Conference taking place in Copenhagen. Timberland’s proposal is aimed at having the greatest number of governments sign an agreement outlining the norms for greenhouse gas emissions. The initiative also encourages citizens to become involved in this public debate via a Global Action Center and have an active presence in social networking sites such as Facebook, Twitter, YouTube and print media as well as in all its outlets throughout the world. <>


Adidas names a head of global e-commerce to accelerate its online sales - Athletic footwear manufacturer Adidas Group is creating a new e-commerce team alongside its existing wholesale and retail units. To lead the new initiative, Germany-based Adidas has selected company veteran Christophe Bezu, who since 2003 has been the CEO of Adidas’ Reebok brand in the Asia-Pacific region. Bezu, who also was recently named the company’s managing director for Greater China, will head up a global project called Excellence in e-Commerce. He will report to Herbert Hainer, Adidas Group CEO and chairman, who will chair the steering committee for the new e-commerce group.  <>


Israel Departs Sears - Sears, Roebuck & Co.’s top apparel executive, Craig Israel, has left the company. Israel was president of apparel and recently began reporting to John Goodman, who last month joined Sears Holding Corp., the parent of Sears and Kmart, as executive vice president of apparel and home, a new post. A spokesman for Sears said Monday that with Israel’s departure, Goodman will serve as interim leader of the Sears apparel business until a successor is found. Goodman is also serving as interim president of Kmart Apparel until a permanent officer is named to that post.  <>


Saks Ends 'Poison Pill' Provision - Saks Inc. on Monday ended a “poison pill” provision in its shareholders’ rights plan that it had adopted last year to prevent a takeover. The luxury retailer enacted the condition, meant to kick in if a single investor held more than 20 percent of its shares, in November 2008, shortly after Mexican billionaire Carlos Slim Helú upped his stake in the firm to 18.3 percent. Chairman and chief executive officer Stephen I. Sadove said the rights plan had served its purpose and was no longer necessary because the firm increased a change-of-control threshold to 40 percent when it altered its revolving credit agreement on Nov. 23. In December 2008, Saks distributed a preferred share purchase right for each outstanding share of its common stock. The right would have only been redeemable if an investor acquired 20 percent or more of the firm’s shares and was designed to dilute such an acquirer’s stake. In a Securities and Exchange Commission filing at the time, the company said it had done so to “protect shareholders from coercive or otherwise unfair takeover tactics.”  <>


Korean Retailer Who.A.U. to Open in N.Y. - One little-known youth-oriented foreign retailer trying to break into the U.S. market is taking over the retail space of another little-known youth-oriented foreign retailer that failed in its bid to enter the American market. Who.A.U. California Dream, a South Korean brand with two mall stores in the U.S., will open a 12,000-square-foot multilevel flagship at 22 West 34th Street between Fifth and Sixth Avenues. Kira Plastinina, the Russian brand designed by the teenager of the same name, was the last tenant to occupy the space. Kira Plastinina shuttered the location in December 2008.  <>


Kahn Named Wet Seal Chairman - Foothill Ranch, Calif.–based The Wet Seal Inc. announced the retirement its chairman of the board, Alan Siegel on Dec. 14. Harold Kahn, another member of Wet Seal’s board, has been named as his replacement. Siegel served the young woman’s retailer for 20-years. He decided to resign because of his age. He will be 75 in January. He also will devote more of his time to working as the executor of the Wade F.B. Thompson Charitable Foundation based in Niantic, Conn. <>


Online Shoppers Moving Away from Credit - The quest for fiscal fitness is leading online shoppers to increase their use of cash and debit cards even as issuers’ own policies and consumers’ desire to avoid debt have discouraged credit card use. According to a survey of more than 2,000 U.S. Internet users conducted in October by comScore Inc., 65 percent of respondents have changed the way they pay for items online because of concerns about the economy, down from 67 percent in the previous year. Of those who indicated they had altered their behavior, 42 percent said they are more likely to use cash, versus 50 percent in the 2008 study, and 40 percent said they are more likely to use a debit card, up from 34 percent. Twenty-three percent said they were more likely to use a credit card, up from 18 percent last year, and 13 percent said they had begun to consolidate spending to fewer credit cards, up from 12 percent. The percentage saying they had spread their spending among a greater number of cards advanced to 6 percent from 5 percent.  <>


Online holiday spending is up 3.4% compared to a year ago - Shoppers have spent nearly $19.94 billion online this holiday shopping season, which began Nov. 1, a 3.4% percent jump from $19.28 billion a year ago, reports comScore Inc. Of the 10 largest shopping days on record, four have taken place this year (in $mm USD):

  • Monday, Nov. 30, $887
  • Tuesday, Dec. 1, $886
  • Thursday, Dec. 10, $852
  • Tuesday, Dec. 8, $828

Online sales shot up 4% last week when consumers spent more than $800 million on two separate days, says comScore. Since comScore began tracking e-commerce spending in 2001, it has recorded 13 spending days that have eclipsed $800 million. <>


CIT Sweetens Small Business Loans - CIT Group Inc., back after fewer than six weeks in bankruptcy court, said it would waive a $1,000 packaging fee on loans approved under a Small Business Administration program. The lender, which last week emerged from bankruptcy as a public company, said it would waive the fee on the federal agency’s 7(a) loan applications through March 10. CIT previously committed $500 million to support government-guaranteed loan programs for the sector. “The small business sector remains a key driver of job creation in America,” said Chris Reilly, president of the lender’s small business unit. “These recent announcements reflect our commitment to bringing much needed credit to this sector, and to helping small businesses access the capital they need to weather this difficult economic environment.” CIT said small businesses employ nearly 59 million Americans. <>


The Macau Metro Monitor.  December 15th, 2009




The People’s Bank of China yesterday relaxed restrictions on yuan transactions for Macau residents.  The central bank said Macau residents would soon be able to exchange the equivalent of 20,000 yuan (HK$22,704) per person per day, up from 6,000 yuan.  Macau residents will also be allowed to write yuan-denominated checks for purchases in Guangdong.  The PBOC announcement of the yuan business expansion comes as Beijing prepares to celebrate the 10th anniversary of Macau's handover to the mainland on December 20.




Hong Kong Chief Executive Donald Tsang Yam-kuen has said that the government will try to keep toll rates for the Hong Kong-Zhuhai-Macau Bridge as low as possible.  Tsang said the three governments would continue to work together to ensure the bridge was properly managed.

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.43%
  • SHORT SIGNALS 78.34%


Across the board the market finished higher on Monday; the S&P 500 closed up 0.7% on the day.  The tone was set early with an energy M&A deal where XOM is buying XTO.  Also, news that Abu Dhabi will provide $10B to Dubai provided an easing to sovereign debt contagion concerns.  While the S&P 500 closed at a higher-high, the financials are still broken on both TRADE and TREND, while Energy is broken on TRADE.


For the balance of the week the MACRO calendar will dominate the news cycle.  We are looking forward to several key data points in the next two days, including inflation numbers (PPI on Tues, CPI on Wed), Housing Starts on Wed and the results from the FOMC meeting on Wednesday. 


Looking at the Producer Price Index (PPI), the most recent reports have been generally to the upside of expectations.  Currently, Bloomberg has a 0.8% MoM number versus 0.3% the month before.


On Wednesday, Consumer Price Index (CPI) for November 2009 will be reported.   The consensus estimates for the seasonally-adjusted November CPI is 0.4% according to Bloomberg versus 0.3% in October.  Given the implied relative strength of gasoline and food prices in the November retail sales data, an upside surprise to consensus is a better than average possibility.


This is what matters most.  A consensus report would boost year-to-year CPI inflation from minus 0.2% in October to roughly a positive 1.9% in November.  The November CPI data will officially end the recent period of formal DEFLATION.


The RECOVERY trade was in full force yesterday as the Materials (XLB), Industrials (XLI) and Energy (XLE) were the three top performing sectors.  The bottoms three were Financials (XLF), Utilities (XLU) and Consumer Staples (XLP).  It’s noted that every sector was up on the day and six sectors outperformed the S&P 500. 


Yesterday, the natural gas sector benefited from XOM’s acquisition of XTO.  Naturally the transaction increased speculation concerning further M&A activity in natural gas.  Materials (XLB) was the best performing sector, with Metals and Mining stocks leading the way. 


The Financials (XLF) continue to underperform, after being among the worst performers last week, but managed to end the day with a small gain. C and MBIA were the two worst performing stocks in the XLF. 


From a risk management standpoint, the ranges for the S&P 500, the Dollar Index and the VIX are seen in the charts below.  The range for the S&P 500 is 17 points or 0.5% upside and 1.5% downside.  At the time of writing the major market futures are trading slightly lower.


In early trading today, crude oil is trading lower as the dollar is moving higher.  The Research Edge Quant models have the following levels for OIL – buy Trade (68.78) and Sell Trade (74.30).


In London Gold is trading lower by 0.7% to $1,118.  The Research Edge Quant models have the following levels for GOLD – buy Trade ($1,089) and Sell Trade ($1,148). 


Copper in London is lower as the dollar strengthened.  The Research Edge Quant models have the following levels for COPPER – buy Trade (3.10) and Sell Trade (3.26).


In early trading today the US Dollar is up trading at +0.7% amid speculation improving economic data in the U.S. will require the Federal Reserve to signal an exit from easing policies intended to combat the recession.


Inflation is back!


Howard Penney

Managing Director















YUM used its annual analyst meeting to focus the investment community on where the growth is.  Pizza Hut and KFC in the US – forget-about-it. 


Last week, Yum Brands hosted its annual analyst meeting in New York City.  Prior to the meeting, the company put forth its 2010 EPS growth goal of at least 10%.  So, the focus of the meeting was on the company’s ability to get to 10%.


At the analyst meeting, YUM quantified its same-store sales assumptions underlying the earnings target.  In 2010, YUM sees 2% same-store sales growth world-wide.  Given the current environment and the pickle the US business is in, this target is aggressive.  To management’s credit, they even stated that they have no clue when comps will turn positive…


Looking at the three key business units, management’s outlook assumes 2% comparable sales growth in China, 3% at YRI and 2% for the US.  Let’s just say management is counting on a consumer recovery in 2H10 and the benefits of easy comparisons.  The current trends and outlook suggest that this will be very difficult to attain.


Global unit growth is the key driver to incremental profitability at YUM, especially in China.  In 2010, YUM expects at least 475 new restaurant openings in mainland China, or 13-14% growth.  Guidance is for 15% operating profit growth.  Currently, China generates about 33% of the company’s operating profits. 


Not to be to myopic but I was very interested to see how management handled the issue over sales trends in China.  I would note that they don’t talk about cannibalization anymore.  That being said, they have not changed their stance – it’s an economic issue.  As management sees it, the Chinese consumers have not recovered from two specific economic shocks.  The first one came in the middle of 2008 after the earthquake struck.  Prior to the earthquake, the company was posting double-digit same-store sales growth and 20% unit growth.


The second one came at the end of 2008 when the financial crisis struck and the consumer got even more cautious.  Same-store sales growth in China slowed rather significantly in 4Q08 on a 1-year basis and has remained weak for all of 2009.  The company was lapping difficult comparisons in the first half of 2009, but same-store sales were flat in Q3 and are expected to be -3% in Q4, despite the relatively easier comparisons in the back half of the year.   


Regardless of comparisons, 2-year average trends more accurately show where trends are headed.  Last year on YUM’s 4Q08 earnings call, CEO David Novak highlighted this fact when he said, “Given the strong results we were lapping in the second half of 2007, it makes sense to look at two-year growth rates to gain a greater understanding of China trends. When examining two-year trends for the China Division’s system-sales growth you will find that fourth quarter growth was 49%, just three points below the first half’s strong results, an improvement of four points over the third quarter.”  It is important to remember that Mr. Novak pointed us to look at 2-year trends when comparable sales growth in China came in at 1% in 4Q08 following 12% growth in 1Q08, 14% in 2Q08 and 5% in 3Q08.  On a 2-year basis, same-store sales trends improved in 4Q08 on a sequential basis from 3Q08 so Mr. Novak highlighted this improvement to justify the slowdown in 1-year numbers.  To that end, two-year average trends have gotten sequentially worse every quarter since then and will turn negative in 4Q09, assuming management’s outlook for -3% is correct. 




At its meeting last week, management said the continued softness is just a function of “lapping what we were running against.”  To that, I would respond that YUM is already lapping easier comparisons in 2H09 and more importantly, two-year average trends continue to come down.


Management also said the real test of current trends will come when they start to lap “the bad bad economy.”  We are already there.  As management stated in its presentation, the second “economic shock” came at the end of 2008.  Same-store sales in China were -1% in December 2008 so we are lapping the beginning of that impact in Q4 and comparable sales are expected to come in -3%. 


Importantly, management said “we still feel that there's no basic fundamental change in China,” which I viewed as justification for continued unit growth.  The extent at which management is bound and determined to keep the unit growth machine going was summed up when Mr. Novak said “We could drop our sales 20%-25% and open restaurants until the cows come home - So that's what we plan on doing.”    


My biggest take away from the meeting was that YUM management will do its best going forward to keep the investment community focused on China, YRI and Taco Bell.  Yum’s U.S. business accounts for 40% of the company’s global operating profits and Taco Bell accounts for 60% of the US.  With the US KFC and Pizza Hut businesses in secular decline, I would not be surprised if these businesses combined account for less than 20% of US operating profits in the coming years.  If it were not for the overseas potential of these brands, I see no need for the company to keep either brand.  For now, however, these businesses still matter.  Management may want to divert our attention to other areas of growth, but current trends at KFC and Pizza Hut are extremely concerning and need to be addressed.


Yum expects to focus much of its domestic efforts on refranchising KFC and Pizza Hut and expanding business at Taco Bell.  Thus, higher scrutiny on where Taco Bell is going is important.  According to management, Taco Bell’s success relies largely on its “branded value” perception and new products offering multiple proteins, a launch of balanced options (drive-thru diet) and day part expansion (breakfast).


I have a hard time believing that the latter two – the drive-thru diet and breakfast - will have any impact on sales any time soon.  Breakfast is so competitive and the real estate strategy for Taco Bell over the years did not contemplate offering breakfast (locations not conducive to morning rush hour traffic).  Therefore, the company will have a very difficult time building that day part.    The idea that YUM will be able to shift consumers’ mindsets to believe that they can lose weight at Taco Bell seems crazy to me and will not “change the category.” 


The Drive-Thru Diet will launch December 27 in order to take advantage of consumers making New Year's resolutions.  On January 1st Christine Dougherty will be to Taco Bell what Jared is to Subway.  According to YUM, Christine has lost 54 pounds over the last two years eating off the Drive-Thru Diet!  She has apparently been eating fast food between 12 to 15 times a month.  Some of those occasions were at Taco Bell, while others were at other brands.   


YUM is calling it the Drive-Thru Diet because they are trying to take on Subway directly while highlighting that Subway does not have drive-thrus.  The two key attributes of QSR are convenience and value.  With Taco Bell being the value leader in the category, management is trying to capture some “better for you” food customers.  Good luck with this one!


What will have in impact will be the new value product offering and new proteins being introduced in 2010.  Taco Bell will be generating a significant amount of new product news and three new proteins – (1) the Beefy 5-Layer Burrito (which could sell for 89 cents each), (2) Pacific Shrimp Tacos ($2.79 each), its new seafood entry and (3) Grilled Cantina Tacos (includes pork).  All of the new products will shift the concept away from the typical “spicy” Mexican flavor. 


All in all the investment community was very bullish on YUM and they do communicate a positive story.  The “growth till the cows come home” strategy is China will one day be a problem for YUM -- timing on this issue is critical.  Same-store sales trends in China are weak in 4Q09 despite easy comparisons. 


The trends in the US have put incremental pressure on management to keeping the China operations without issues.  For now management is getting a free pass on sales trends in China, but for how much longer?

Slouching Towards Wall Street… Notes for the Week Ending Friday, December 11, 2009

Bubble, Bubble, Toil And Trouble


A new front is opening in the credit wars.  The twist is that the much-maligned ratings agencies are starting to look as much like the heroes of this crisis as they were the bad guys of the last one.


We now live in a supercharged economic reality.  Our financial system has left such stale concepts as the Business Cycle in the dust.  Financial collisions that used to occur with some predictability every few years are now piling on thick and fast as the linkages between crises become more entangled.  Hallucinatory whorls of active, developing, and incipient bubbles in our economy surround us.  Think: Hyman Minsky on a very bad acid trip.


Masterfully overseen by Great Chief He Who Sees No Bubbles (Bernanke), the braves are mustering, sharpening their weapons and daubing themselves liberally with war-paint.  But so far the war drums have yet to sound.  Meanwhile, there’s trouble brewing in the Badlands of Credit.


The National Association of Insurance Commissioners has, as we anticipated, approved the plan to change the classification of certain tax-deferred assets on the books of insurance companies, a move “expected to add more than $11 billion in capital to life insurers’ balance sheets at year-end” (WSJ, 8 December, “Accounting Change Boon For Insurers”).


We note that this measure was initially proposed by the American Council of Life Insurers, an industry group, as a temporary emergency measure designed to tide insurers over as last year’s financial meltdown roiled the markets.  The purpose at the time was to avoid insurers being forced to liquidate portfolio holdings at fire sale prices.  Simply put, they wanted to buy time.  The NAIC didn’t go for the idea at the time.  Now, on consideration, they made it permanent.  Now the insurers have all the time they need.


The simple message is either: we are in a permanent state of crises; or, everyone else is scamming the markets left and right, why shouldn’t you guys?  Either way, this represents a clear step down in the quality of actual financial coverage of insurers’ obligations.  We are trying to figure out how the insurers can use this to best advantage.  Maybe they will do a program like frequent flyer miles.  Did you lose your husband?  Oh, and we see he had a million-dollar policy.  Well, you can either get the payment all in cash, or, if you prefer, we will give you $1.5 million in tax credits that you can use to offset your income, thereby freeing up your other money.


Before you laugh, the Journal reports “consumer groups have complained that these are paper assets that won’t help pay claims if companies hit the skids.”  The obvious solution is to transfer the tax benefit to the beneficiaries, in lieu of cash.  Obviously, at a premium.  Consumer advocates take note.  Lobbyists, start your engines.


We note that, in all the brouhaha about financial markets reform, there has been no recent mention of cracking down on the ratings agencies, no serious discussion of addressing the deeply conflicted model that let – inexorably, many would maintain – to the debacle wherein trillions of dollars’ worth of AAA-rated paper went up in smoke. 


On the other side, we are getting the nasty feeling that Health Care Reform may turn out to be nothing more than a government-sanctioned multi trillion-dollar gift to the insurance industry that will make Secretary Paulson’s bait and switch with the bank rescue dollars look like chump change.  If, in fact, 30-40 million new policy holders are to be added to the rolls, private insurers will need to bolster their capital significantly.  How handy if, instead of socking away cash reserves, they can get regulators to redefine assets.  In the world of money, a tax break is only an “asset” once it is realized, cashed and deposited in the bank.  The insurance commissioners appear to be swapping one moral hazard for another.


The NAIC is not alone.  The Journal also reports (8 December, “What Zions Considers A Loss”) the tribulations of Zions Bancorp, who apparently have avoided recognizing hits to their capital by taking advantage of the new rule for valuing “stressed debt securities.”  You may remember that Congress, which loves tinkering with things they don’t understand, beat the Financial Accounting Standards Board liberally about the head over the subject of “mark to market” accounting which, Congress scolded the FASB, was causing undue hardship to companies that really had their portfolios under control, and were being forced to take unreasonable write-downs.  (Goldman Sachs was not one of them, by the way.  You may remember that they mark everything to market every day.  It’s called managing risk.)


The Journal story reports that Zions held $2.12 billion of preferred securities issued by banks, all in a CDO (collateralized debt obligation) structure.  While the current market value of these CDOs is $1.1 billion, “Zions has taken $712 million of market losses on the CDOs through equity,” which means it does not affect their regulatory capital.  Thus hath Congress wrought.


In the current climate it is exceedingly difficult to see how Washington is supposed to impose restraint in the form of new financial markets oversight and tightened regulation.  No sooner does an industry show itself to be fiscally impossibly irresponsible, than Congress steps in and does its own legislative engineering, every bit as clever as Wall Street’s financial engineering.  It makes sense that Bernanke continues to pander.  He’s up against the brickest of brick walls.  What’s a central banker to do?


There’s more.  Morgan Stanley says that Zions’ risk model predicted a 35% chance of default by United Commercial Bank, one of the issuers whose preferreds are in Zions’ CDO portfolio.  United was seized by regulators last month which, as the Journal observes, “almost certainly means its preferreds are worth zero.”  In their defense, a Zions spokesman said “modeling default was hard, because ‘fraud was involved’ at United Commercial.”   Fair enough, though if we were bank regulators, we would immediately demand to see Zions’ due diligence file on United Commercial. 


Now, it can only be a total coincidence that, right next to the WSJ story about the accounting change benefiting the insurers to the tune of $11 large, is a headline that reads “Moody’s Puts US, UK On Chopping Block.”  The story refers to “an effort, spurred by investor demand, to examine the creditworthiness of the world’s most highly rated countries.”  There are currently 17 AAA-rated countries, and Moody’s said the US and UK ratings largely depend on “the vigor of the economic recovery and the willingness of governments to shrink the deficits.”  Moody’s says the US requires a “credible fiscal consolidation strategy” to curtail both the amount of our debt outstanding, and the associated interest costs.


Deficit shrinking, in our simplistic model – have we reminded you lately that we are not trained economists? – emanates from having cash on hand.  Which is to say, savings in the bank.  People saving money – paying themselves first.  Which is to say the implication of the Moody’s report is that a zero interest rate is not working.  It would also seem to imply that, contrary to President Obama’s exhortation of this week, it may not be feasible for us to “spend our way out of this recession.” 


Rather, by spending borrowed money, we will be beggaring our neighbor all the way to – at least – a credit ratings downgrade.  Oh yes, and then there’s the part about the US no longer being Top Dog.  Chief He Who Sees No Bubbles will need great medicine if he is going to keep this country from going to the Happy Hunting Ground.




A Load Of Bull?


Former Merrill Lynch employees are “delighted” at Bank of America’s decision to restore the old Merrill bull logo.  The Wall Street Journal (8 December, “BofA Yields On Return Of Merrill Bull”) reports that Merrill bankers may now have the bull logo restored to their business cards.


We couldn’t help recalling the famous Business Week cover story “The Death Of Equities” that coincided with the launch of the great bull market of the 1980’s.  That cover, famously, was graced (or should we say “disgraced”?) with a snorting bull.  Is the new-old Merrill thunderer likewise a contrary indicator?  Of course, if the business of managing money is really the business of having money to manage, then it’s all about marketing, don’t you see.  Which means that the bull on the business card is a darned sight more important than what they are actually putting into your portfolio.


Lest you take this as a cheap shot against Merrill’s brokers, let us remind you that financial firms create their own product, then pump it through their distribution pipeline, right into your retirement account.  Merrill, in case you forgot, is the company that sold itself in a desperate last-ditch transaction because they lost… we forget… how many billions was that?  They lost this money by leaping into the various derivatives markets with both feet because defrocked Chairman Stan O’Neal couldn’t see Merrill not participating in what everyone else was doing.  In fact, Merrill’s only really smart market transaction in years was selling itself to BofA at what turned out to be a way above-market price.  Brokers are led by their management.  Beware the next round of packaged product bearing the bull.


In what has to count as one of the daftest statements to emerge from a banking firm this year, the Journal story quotes a Merrill staffer as saying “Merrill without the bull is like Superman without a cape.”  BofA declined to comment.  No kidding.




Light-Saber Rattling


The on-line edition of the German magazine Der Spiegel (10 December) reports a ghostly light bursting in the Norwegian sky on Wednesday night.  Residents of the Arctic Circle town of Tromso beheld what many of them believed was a UFO.  The appearance is captured nicely on a video clip featured in the story, courtesy of Reuters/Scanpix.


Slouching Towards Wall Street… Notes for the Week Ending Friday, December 11, 2009 - norge


The story mercifully did not make a connection between the rising, flaming, bursting and quickly vanishing star in the Norwegian skies, and the appearance the following morning on Norwegian soil of President Barak Obama.  Obama has disappointed his host nation by spending a mere 24 hours on Norwegian soil, rather than staying on for the customary several days of pomp and festivities surrounding the Nobel Prizes.  To be sure, the world hopes the disappointments will end there, and that Obama’s star will gain in intensity, and not flicker out like the apparition.


Tromso is at the northern tip of Norway, almost as far away from Oslo as a Norwegian city can be.  Still, it was Norway.  Not, for example, Finland.


Thoughts of ghosts, meteors and visitors from outer space were  dispelled when it turned out the phenomenon was a failed test firing of an atomic rocket from a Russian submarine.  The rocket, an SS-N-30 Bulava, faltered and exploded in midair, bringing a spectacular show to the residents of the northern Norwegian town, and an ignominious end to the test shot.


The Bulava rocket, with a reach of 8000 kilometers, stands at the forefront of Russia’s modernization of its atomic arsenal.  It is no doubt important for Russia to show renewed atomic might as they head to the table to negotiate a replacement for START, which expired on December 5th.  It is interesting to note that the Bulava rockets have failed in most of their test firings.  The Spiegel quotes sources saying that nine of the 13 test firings have been failures just like this one.


It can only be a coincidence that Russia blows up a rocket in the sky over Norway on the eve of President Obama’s appearance in Oslo.  No one would be so crass as to do such a thing on purpose.


President Obama, for his part, acknowledged that there is such a thing as a Just War, in pursuit of a Just Peace – perhaps an oblique hint to America’s potential adversaries.  We wish to encourage careful attention to grammar.  Sometimes a war is a Just War.  Sometimes a war is Just a War.




Damned If You Don’t


To turn a million dollars into ten million dollars is work.  To turn a hundred million into a hundred and ten million is inevitable.

                                      - Edgar Bronfman


It makes money to take money.


In days of yore, when the likes of Lehman, Bear and Goldman were partnerships, the business model was custodianship.  No more.  The standard model on Wall Street for a generation now has been the Exit Strategy model.  Exiting one’s old model only makes sense once that model no longer has vitality.  As the economic dynamism underlying the partnership model started to erode, partners of old-line Wall Street firms regretfully started moving towards the exits, trying to salvage what was left of the value of the holdings that generations of their predecessors had so lovingly husbanded.


Oh, wait… that wasn’t what happened at all.  As the bull market of the 1980’s spun out of control, price became a primary factor, and the recognition of how great a valuation could be realized in the public market replaced the partnership model.  Under the old model, the partners as a group were rewarded based on the overall performance of the partnership.  What they took out was a function of what they had contributed.  Making money to take money.  No longer.


Ace Greenberg, CEO of Bear Stearns, famously observed during the market ramp-up of the early 80’s that such large concentrations of wealth would necessarily attract society’s most undesirable elements.  Little did he realize that he and his partners in Investment Banking Inc. would come to be seen as the very thing he warned against.


Bear Stearns, early to the party, went public in 1985, Lehman in 1994, and Goldman Sachs – the great ogre, to read the popular press – in 1999.


Now Bear is gone, and Lehman is gone.  We can not tell what the future holds for Goldman Sachs, but the immediate future looks like a long unpleasant slog through the press where they will be ceaselessly vilified – by populists for a token act that means nothing; by capitalists for caving to the populists.


The top thirty Goldman executives will take this year’s compensation in what the firm is calling Shares At Risk.  The Risk is that the shares can be taken back if the management committee deems that an individual executive “engaged in materially improper risk analysis or failed sufficiently to raise concerns about risks.”  In other words, Goldman’s management committee are once again behaving like partners.  Just in time, perhaps, to see their franchise crumble.


Still, it is not clear what the determining factor will be to bring a charge of “materially improper risk analysis.”  Since that is not the Goldman way, we are left with the uncomfortable feeling that it will come down to profitability.  If a partner lose money for the firm, they can take his shares away.


Not only the popular press (think “giant face-sucking squid” in the pages of Rolling Stone), but even the government – replete though it is with Goldman alumni – is squaring off versus Blankfein & Co.  We are not the only ones who think it significant that the Geith-father, interviewed on Bloomberg TV, pooh-poohed the notion that Goldman would have survived without the TARP.  Tim Geithner’s presumed exit strategy from Washington, as a future executive at Goldman Sachs, suddenly looks in doubt, and he appears not to care.  After all he has done for them, Goldman embarrassed him by not showing proper (read “any”) gratitude. 


Meantime, we wonder why it is Goldman that everyone loves to hate, while other financial firms are being waved under the wire.  In what appears to be a race to the bottom, BofA gets to trash their shareholders by raising billions in the public equity marketplace.  Citi is going to be next.  The government is playing this new game of one-on-one with the big failed banks, yanking them this way and that as they scramble to repay the TARP.  In the short term, Geithner and his paymaster President Obama can point to the “profits” the “taxpayer” has reaped (we are waiting to see the line item in our 2010 tax return), meanwhile they are conspiring to wreck the markets.  The difference is they are doing it with toxic equity, not toxic debt, so the only ones to suffer will be the Greater Fools – that is, those who actually buy the stuff.  Wonder how much BofA stock your pension fund manager has bought recently?  They don’t have to disclose that.  You can see their positions at year end, but not the timing of purchases or prices paid.  Conspiracy?  Perish the thought…


If there were a World Series of finance, Goldman would be the winner hands down.  Goldman is the New York Yankees of Wall Street, with a profile and a track record of success that make other banks drool – and, like the Yankees, folks who don’t love ‘em, really, really hate ‘em.  Rather then being patted on the back for making risk management the mainstay of their business, they find themselves in the tumbrel heading for the execution ground.  Meanwhile, untold numbers of financial firms are being loopholed through in the Swiss cheese document that is the Financial Reform Act.


According to the Wall Street Journal (11 December, “Loopholes Lurk In Bank Bill”) there are provisions buried in the House financial regulatory reform bill that, while not specifying individual companies, are clearly designed to exempt specific financial firms from the provisions of the newly beefed-up regulation.  The articles cites GE and USAA as two examples. 


GE we have all heard of.  Its CEO, Jeff Immelt, no doubt has not been advised that apologies are so Last Year.  The Financial Times (10 December, “Immelt Rues ‘Terrible’ Executive Greed That Fuelled Inequality”) quotes Immelt as saying “We are at the end of a difficult generation of business leadership… tough-mindedness, a good trait, was replaced by meanness and greed, both terrible traits.”  Wall Street has the historical memory of a gnat, and no objection was raised to Immelt’s eulogy of Sound Management.  This, even though his predecessor Jack Welch left a conglomerate on the verge of collapse, but which for years had been flogged as the paragon of sound corporate management.


The other company mention in the Journal article – USAA – “caters to members of the military and their families, to so-called fraternal benefit societies.”  The article reports that USAA is “one of the country’s 50 largest federally insured financial companies.”  It is also one of the top dispenser of lobbying dollars, spending $5 million in the first 9 months of 2009 alone, which the WSJ reports is more than Wells Fargo and more than – get this – Bank of America.


As far as risk management at USAA is concerned, one need look no farther than the assurance from none other than Financial Services Chairman Barney Frank: “There’s no remote prospect of them being a problem.”  Feel better?


Goldman Sachs, meanwhile, is probably best served by being most hated.  We encourage them to embrace this status, keep their chin on their chest, and keep swingin’ at the ball.


Goldman traditionally has the best information in the marketplace.  Not inside information, just plain good market information.  They are literally everywhere, and they see everything.  We are mindful of this as we read reports of Goldman bankers buying guns.  Bloomberg columnist Alice Schroeder reported that “very senior” Goldman executives are acquiring guns for “a combination of personal protection and wealth protection.”


Goldman’s efforts at PR are a clear waste of effort.  Their recent half-billion forkover to help out small businesses got not a Thank You.  Maybe, as Schroeder suggests, they should be bailing out underwater homeowners.  Maybe – speaking of underwater homeowners – they should divert a few billion to save the people of the Maldives before their island nation is swallowed by the ocean.  One might think that, given their track record of success, Goldman could single-handedly cure global climate change.


But no one is inviting them to make a contribution.  Where would Geither, Summers, Obama et al be if Goldman actually succeeded?


The barricaded lives of Goldman’s executives are a chilling metaphor for the future of capitalism in America.  In the irrational world of regulatory incompetence, government and press dishonesty, and misdirected public rage, Goldman’s executives buying guns is the best proof of the Efficient Market.  Let us hope it will not be the last.


Moshe Silver

Chief Compliance Officer


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