US STRATEGY – DAY 2 – Dollar up, Stocks up

The S&P 500 finished higher by 1.1% in light, pre-holiday trading yesterday.  The news worthy items in focus yesterday were the amended healthcare reform legislation out of the Senate, continued M&A activity and the sell-side generally getting more bullish at the end of the year. 


Yesterday, Sanofi-Aventis agreed to acquire Chattem for $1.9B in cash.  In addition, TreeHouse Foods gained 12.3% after announcing that it had signed a definitive agreement to acquire Sturm Foods, a private label manufacturer of hot cereal and powdered soft drink mixes. 


For the second day in a row the Dollar index was higher and stocks followed.  Yesterday, the Dollar index rose 0.3% to 78.03.  Every sector was positive on the day with the high beta Financials, Materials and Consumer discretionary leading the way.  Utilities and Consumer staples were the two worst performing sectors.   


The Healthcare (XLV) underperformed on a relative basis, but managed care stocks were among the best performers with the HMO index up 3.0%. The performance was driven by developments out of Washington as Senate Democrats reached a deal on healthcare reform legislation.  The news of the demise of the elimination of the public option was welcome news.  Also showing strong relative outperformance were the PBMs such as CVS +3.6%, ESRX +3.3% and MHS +1.7%.


The Materials (XLB) was the second best performing sector yesterday despite the continued bounce in the dollar. Upbeat sell-side commentary provided support for the steel and fertilizers sectors. 


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 16 points or 0.5% upside and 1.0% downside.  At the time of writing the major market futures are slightly higher.


In early trading crude oil dropped after OPEC agreed to maintain production targets at a meeting in Angola.  OPEC will hold total production quotas at 24.845 million barrels a day.  The Research Edge Quant models have the following levels for OIL – buy Trade (69.71) and Sell Trade (74.31).


Gold declined $15.00 to 1,097 in Hong Kong; gold is trading at its lowest level in six weeks.    The Research Edge Quant models have the following levels for GOLD – buy Trade ($1,090) and Sell Trade ($1,151). 


Copper fell in London as stockpiles expanded to almost a seven-year high, signaling demand related issues.  The Research Edge Quant models have the following levels for COPPER – buy Trade (3.08) and Sell Trade (3.14).


Howard Penney

Managing Director


US STRATEGY – DAY 2 – Dollar up, Stocks up   - sp1


US STRATEGY – DAY 2 – Dollar up, Stocks up   - usdx2


US STRATEGY – DAY 2 – Dollar up, Stocks up   - vix3


US STRATEGY – DAY 2 – Dollar up, Stocks up   - oil4


US STRATEGY – DAY 2 – Dollar up, Stocks up   - gold5


US STRATEGY – DAY 2 – Dollar up, Stocks up   - copper6



The Macau Metro Monitor.  December 22nd, 2009.




In an interview in Singapore yesterday, Las Vegas Sands Corp Chairman Sheldon Adelson forecasted that Sands China may generate revenues of $4.5 billion to $5 billion next year.  Sands China had revenues of $3.05 billion in 2008.  Recently, record new loans in China have boosted spending and a recovery in visitation to Macau has led to gaming revenue to climb 6% in the first 11 months of 2009, according to the news agency Lusa.  Adelson also said that he does not expect its Singapore operations to cannibalize Macau’s mass casino market




Sheldon Adelson has said that LVS could finish “all the [Cotai] properties easily within five years”.  The five projects, including two that are half way through construction, will complement the company’s two existing casinos in Macau.  Sands has said that it expects to open phase one of the two half-constructed projects on Cotai by June 2011. 




Harrah’s Entertainment Chairman and CEO Gary Loveman wants to bring the Caesars Palace brand to Macau.  While Harrah’s owns a golf course in Macau, entering the gaming market would require working with an existing operator because the government limits the number of licenses to six.  A spokesman for MGM Mirage said that he was “unaware of any contact with Harrah’s about Macau”.   Spokespeople at other Macau operators were unavailable for comment. 

Google, Apple Eroding Microsoft's Dominance

real-time alerts

real edge in real-time

This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.

FDO: The Ultimate Catch-22

FDO: The Ultimate Catch-22


With Keith re-shorting FDO last week, here’s some quick insight into why we are (and have been) so fundamentally negative on this name.


At this point in the cycle, it’s no surprise that the weak economy and its disproportionate impact on low and middle income consumers has been a key driver to the dollar stores and deep discounters over the past 12-18 months.  The weak macro environment makes this sub-sector of retailing the ultimate Catch-22 when it comes to success.  Essentially, as our nation’s economy faltered and less people were employed, retailers like FDO and DG benefited.  In other words, one man’s pain is another man’s pleasure.  And while morally it’s a bit conflicting to bet on the fragility of the American consumer, we know that placing bets is what the Street is all about.  So morals aside, outsized same store sales gains (relative to history) driven by sharp pricing, EBT usage (food stamps), and quite simply necessity have propelled the topline performance of FDO, DG, DLTR, and NDN beyond “normal” levels.  Along the way, gross margins and expense leverage have benefitted and EBIT margins have inched their way towards historical highs.  This all sounds like a perfect set up, but how long can this last? 


Within the context of the cash strapped consumer, Family Dollar has been a relative laggard.  Yes, the same store sales did accelerate late in 2008, resulting in historically high sales growth for three of the last five quarters.  However, the company has been unsuccessful in maximizing this trend on a consistent year over year basis.  For two quarters in a row now, same store sales have been disappointing, missing both company guidance and Street expectations.  What is more troubling is that momentum in the most recent quarter slowed on easier comparisons, and now the company faces its toughest compares (through June) in the past seven years!  Quite simply, Family Dollar’s pace of share gain has slowed and it’s only going to get tougher.  Same store sales are likely to turn flat through the first half of the year, leaving little room for expense leverage, let alone multiple expansion.  At the same time FDO (and others) are ramping up unit growth in 2010, which will not only put pressure on the P&L but increase the likelihood for cannibalization and competition.  We’re all for being opportunistic, but can the U.S retail landscape really handle an additional 1,100 units annually for the next few years?


 FDO: The Ultimate Catch-22 - FDO  DG  WMT comp chart 2yr


To be fair, maybe we’re being too harsh and should consider the other side of the story.  Let’s look at the biggest risk factors associated with a negative view on FDO and the space in general:


  • The classic Depressionista set up. The economy takes another leg down, leaving more middle and upper middle income consumers in the sweet spot for dollar store shopping.  Incremental traffic is getting harder to come by, but a new wave of potential customers seeking deep discount consumables would enable FDO, DG, and others to extend their runs. 
  • The trade off scenario. The economy improves and along with it sales of higher margin discretionary products pick up.  This affords FDO the opportunity to drive higher average transactions and also a more profitable basket.  Offsetting this pick up is the likelihood that some portion of the FDO’s middle income customer base sees economic relief as the overall macro backdrop improves.  This results in slowing traffic and sales as this consumer begins to shop elsewhere, returning to a routine that likely involves more trips to a Target or a Kroger.  In a perfect world, sales slow, margins expand, and the Street is OK with it. 
  • The growth trumps all thesis.  After 4 years of moderating new store growth, management regains confidence that there is ample opportunity to grow the FDO store base.  Although expectations are for a modest ramp to 500 new stores per year over the next 2-3 years, management decides to seize the moment and ramp up sooner.   With DG and DLTR also growing rapidly, one must really be on board with bullet #1 to get comfortable with over 1,100 new units opening across the U.S each year.  There is no other sub-sector of retailing that will see as much square footage growth over the next 3-4 years.  We just wonder if growth for the sake of growth can drive multiples at this point. 


So at the end of the day that leaves us and Keith (with his re-initiated short position) with a negative bias on FDO shares in the near to intermediate term.  We’re carefully watching for the risk factors associated with a name that it is so highly leveraged to the most economically challenged consumer in the U.S economy.  For now though, we’re comfortable that the reward for slowing sales far outweighs the risk of the Catch-22.


FDO: The Ultimate Catch-22 - FDO SIGMA




Back in August, CKR started to go after MCD by name when it warned “consumers not to fall for the McHype.”  The burger war, which is thus far a one-sided battle, started with CKR saying, “The Original Six Dollar Burger at Carl’s Jr. has 24 percent more meat than McDonald’s Third Pounders, yet costs the same - $3.99.  And at Hardee’s, the 100% Black Angus beef Original Thickburger has just as much meat as McDonald’s Angus burger, but costs 60 cents less. Those are the facts and that’s the value of our burgers.”  Since then, CKR has introduced both The Big Carl and The Big Hardee, which it calls a counterpunch to MCD’s iconic burger, the Big Mac. 


When CKR first launched this attack, I offered the following warning:


MCD can and will beat CKR at the advertising game if it so chooses.  In the near-term, CKR may get some attention from its mudslinging tactics as everyone enjoys a good corporate battle!  And, the money-back guarantee may increase trial at Carl's Jr., but in the end, MCD will likely win the battle as you can never underestimate the company's marketing muscle.


Along these same lines, Crain’s published an article today titled “McDonald's rivals launch barrage of ads attacking quality, price,” which discusses whether MCD should and/or will fight back as other competitors, including Wendy’s and Burger King, have joined CKR in going after their biggest competitor.  Specifically, the article states, “Ads for Wendy's, Burger King, Hardee's and Carl's Jr. take direct aim at the quality of McDonald's fare.  It's an unusual scrum of comparative advertising that comes as McDonald's U.S. sales slide and the battle for marketshare intensifies.  Most of the ads call out McDonald's burgers or breakfast items by name — Wendy's alone stops just short of identifying its target — and all attack the quality, freshness, taste or price of McDonald's food.”


The article correctly points out that MCD spends more than twice as much on advertising as its fast-food rivals with MCD spending $856.1 million in the October 1, 2008-September 30, 2009 timeframe according to TNS Media Intelligence relative to BKC’s $316.5 million, Wendy’s $289.6 million and Carl’s Jr.’s $38.3 million.  With this level of spending, I continue to believe that MCD can and will win this advertising battle if it so chooses.  I don’t think MCD will go after its competitors by name because the fact that many of its peers are going after them only highlights its leadership position.  And, relative to the article calling this “an unusual scrum of comparative advertising,” MCD’s CEO James Skinner would disagree as he said on the company’s 3Q09 earnings call that these types of naming names advertising tactics are “nothing new for us, by the way, just so you know, but we've consistently been providing Dollar Menu to our customers over the last seven or eight years. It's a consistent approach. We have value across our menu and we're very pleased with the customer reaction to our Dollar Menu and the expectation for us is to be able to stay the course on this and continue to communicate everyday affordability everywhere in the world really, not just here in the United States…But it's not unusual for our competitors to name names regarding McDonald's. We've been through this in previous periods and we will continue to take share and continue to grow and our Dollar Menu will be a big piece of that.”


In discussing whether MCD will fight back, the article raises what I think is the more important question about how the company will allocate its marketing spending going forward when it states “But every dollar spent on a defensive ad is a dollar that won't be spent on McDonald's other priorities: launching its national $1 breakfast menu, ballyhooing its new beef snack wrap and touting its ambitious lineup of fancy coffee drinks.”  Without even considering the need to defend its name, I have concerns about how MCD will be able to continue to support its core menu while also promoting its McCafe launch.  MCD has stated that it has been able to continue to advertise its core menu while also allocating more marketing dollars to breakfast and specialty coffee.  The company did increase its total dollars spent, but lower media rates really enabled MCD to focus on both its core menu and McCafe launch in 2009. 


As of the company’s 3Q09 earnings call, management stated that the trend of slowing media costs was already starting to slow and that pricing was beginning to move up.  Specifically, MCD said that “the spending rate, the spending trend for [MCD] is if anything going up, not going down.”  MCD’s decision to go aggressively after the beverage category diluted the company’s marketing message in 2009.  I think this increase in media rates could make this more of an issue in 2010 and impact the company’s ability to continue to spend behind McCafe without giving up some level of spending behind its core menu, which drives the bulk of MCD’s business. 


Add to that the fact that MCD has already said that it will launch a Dollar Menu at breakfast supported by national advertising.  We also know that the company will be completing its rollout of frappes by mid-2010, which will require media support.  MCD said at its November analyst meeting that it will allocate more advertising dollars to its Dollar Menu (to 15%-20% of resources from its current 10%-15% level).  This increased spending behind the Dollar Menu could include spending behind the launch of the Dollar Menu at breakfast, but management had not yet announced that it would be launching the Dollar Menu at breakfast when it made this comment about advertising spending.  Then, there is the Angus burger which was launched in July, which might require increased marketing support.  If MCD then also chooses to spend to defend its name, some part of the menu will suffer from a marketing support perspective.




Slouching Towards Wall Street… Notes for the Week Ending Friday, December 18, 2009

The Boy In The Bubble


We are interested in policy decisions because they direct the way markets and market participants behave.  Every piece of legislation is anchored in a principle of social philosophy, and sometimes we need to tease apart the policy rhetoric before we figure out what lies beneath.  We have had a bit of fun lately at the expense of Fed Chairman Bernanke, dubbing him “He Who Sees No Bubbles” for his steadfast refusal to acknowledge that his no-interest interest rate policy is stoking market excesses (we can’t say “bubble” – what do we call them?)


We call your attention to the Law of Unintended Consequences.  This is what happens when you planned for nearly everything – but not quite.  Those who fail to plan get to wriggle through another Ivy-League loophole – the Unknown Unknowns.  This is a six-figure way of saying I did a poor job on the analysis, but the graphs looked awesome…


When it comes to the Chairman of the Federal Reserve, the nation and the world have a right to expect that there be no unintended consequences.  Chairman Bernanke is exceptionally learned, intelligent and thoughtful.  We can only conclude that the bubbles occurring on his watch are intended consequences.  To borrow an unfortunate military term, they are Collateral Damage.


The bubble in low-grade debt is a case in point.  According to the Financial Times (16 December, “Distressed Debt On The Wane In US Markets”) debt trading at under fifty cents on the dollar, “is rapidly disappearing from the US financial markets as yield-hungry investors push up prices.”  The article cites high-yield managers as reporting the highest returns on their portfolios in history.  The lowest-grade paper has had the biggest jump: the worst-rated bonds have more than doubled in price this year.


“Bonds trading at less than 50 cents on the dollar account for only 1.1 per cent of the high-yield market” reports the FT.  A year ago, they represented 27.5% of that sector.  In real numbers: today there is market value of $8.9 billion in distressed debt; a year ago there was $202 billion.  Somebody bought an awful lot of it, and bankers have raked it in as “high-yield bond issues in 2009 have brought in $171bn.”


Obviously, the trashing of the world’s patrimony through trillions of dollars of subprime debt securities has neither crimped anyone’s appetite for yield, nor made folks more discerning in where they place other people’s money.  Perhaps we should keep mum and let the Chairman stay on course.  If the world wants to relieve us of the burden of our trash – and pay us a premium for the privilege – that may be the best policy solution.  We recall Chairman Bernanke’s testimony that the Federal Reserve is not responsible for preventing bubbles in other nations’ economies.


Even the Fed can not prevent the proverbial Fool being parted from his Money.  Nonetheless, it appears the Chairman has accomplished what the marketplace could not, which is to uncover the market-clearing price for the worst-rated debt.  Who’d a thought it would be a 100% premium?


Take that, Efficient Market Theory!    





The Epistle Of Paul


In hoc signo vinces.


Our modern-day Saint Paul is an aging giant – a man of great stature, both physically and morally.  No stranger to tribulation and danger, he voluntarily charges back into the fray to save the world.  Having put himself on the chop-chop block when his career truly hinged on it – and having pulled off what the world acknowledges to be a heroic feat of economic derring-do – Paul Volcker has returned to teach us the lesson of history.  He is already suffering the consequences of his choice.


Wall Street is full of smart people.  It is even fuller of smart-asses who, at critical junctures are fond of spouting statements like “Those who can not remember the past are condemned to repeat it” before heading off to print the next trade with someone else’s money.  There’s this to say about teaching lessons: the students have to actually be in the classroom.


Business Week reports (15 December, “Volcker: Financial Fix ‘Like A Dimple’ So Far”) the aging warrior has trekked across five nations, visiting nine cities in the past eight weeks, warning that financial authorities “have not come anywhere close to responding with necessary vigor” to the world’s financial situation.  He scolded a gaggle of financial executives at the Wall Street Journal conference in West Sussex, England, for proposing changes that were “like a dimple.”


Far from being a revelation on the road to Damascus, Volcker came by this knowledge the hard way – he lived every bruising moment of a global fiscal crisis and withstood the shocks largely alone.  With the death this week of Professor Samuelson, “Dimples” Volcker is perhaps the only world-class economist alive who actually was an established economist during past crises.  Harvard’s Niall Ferguson observes that potentially civilization-ending or society-disrupting events happen just far enough apart that those in power today were not around to experience it last time.  Add to this the standard 30-minute (interrupted by commercials) memory span of Wall Street, Washington, and television-addicted America, and it’s a wonder anyone can remember how to use an ATM, much less rescue a damaged economy.


We wish our knight errant, Sir Paul, God speed as he pursues the dragon risen from its lair.  On that famous trek to Damascus his namesake, Saint Paul, saw a heavenly vision, the words of which ring down through the ages.  Indeed, part of that same message applies directly to the task Mr. Volcker has taken on, and it is a blazon the US would do well to bear in mind.  We may not yet see the Sign of Victory, but we are surely In Hock.





The Bair Witch Project


Sheila Bair, FDIC Chairman, remains one of our heroes in the world of financial markets regulation.  Her view of the world is vastly different from almost anyone else’s in Washington.


It is all a bit unreal to be sitting in your kitchen sipping your morning coffee and reading about the pitched battles being waged across conference tables in London and Washington over how many trillions will be spent over the coming decade.  When the only bank servicing your community is forced to shut its doors, that’s reality.


According to the Wall Street Journal (16 December, “Bank Agency Boosts Budget 35%”) “more than 130 banks have failed this year, and the agency’s inventory of assets in liquidation has more than doubled” to a current $36.8 billion.  The agency will also share losses on an additional $108 billion of damaged assets from more than 80 failed banks.  It’s no wonder Ms. Bair keeps coming up short in the till.  Indeed, twice this year the agency took down billions in stepped-up fees from its member institutions, as cash drained from its coffers.


The FDIC insures 8,041 institutions (figures from the FDIC website Institution Directory page) with combined assets of approximately $13.3 trillion, and deposits of $9.1 trillion.  Requested staffing and budget increases would bring FDIC manpower to 8,653 employees, almost double its 2006 level.


The math is not encouraging, and the nation desperately needs Chairman Bair’s knowledge and dedication.  The FDIC’s “problem list” of troubled banks is at 552 and expected to rise.  We could be looking at ten percent of the nation’s banks being close to the brink.  Gee, sounds like a crisis to us. 


The FDIC doesn’t announce publicly which banks are at risk of failure – that task is ably handled by members of Congress who precipitate crises by “outing” weak institutions for their own political purposes.  It can’t be easy being the only regulator whose agency actually deals with real people.


FDIC teams are widely acknowledged to be highly professional, and sensitive to the reality that they are taking people’s lives in hand.  They are also efficient.  In the past, Chairman Bair has made a point of bringing in retired bank examiners or professionals who moved on after a decade or more at the FDIC.  Teams often have failed banks up and running in short order, with minimal disruption to the grateful community.


Chairman Bair is managing this full-blown crisis while staging a fight for survival.  The Journal (18 December, “Agencies In Brawl For Control Of Banks”) reports that Senator Dodd “has proposed revoking all of Ms. Bair’s powers to supervise banks.”  Ms. Bair, widely praised for being perhaps the sole financial regulator not asleep at the switch, is now in danger of being unseated and left with nothing more than a dustpan and brush. 


We figure it must be that testosterone thing.  It can not be a coincidence that, for over a decade, no one in a position of authority was troubled by the Lori Richards’ mediocre management of the SEC Office of Compliance Inspections and Examinations.  You know, the guys who didn’t look at Bernie Madoff?  Nor was anyone up in arms about SEC Enforcement Director Linda Thomsen, on whose watch the Pequot Capital investigation went up in smoke.  Chairman Bair is fighting a multiple uphill struggle in Washington: she is a woman, she makes sure she has command of the facts, and she does not back down when Groupthink is the required order of the day. 


We think Chairman Bair is the target of a Capitol Hill witch hunt.  Why does she have to go begging for a $4 billion operating budget and assure Congress that her staff increases will all be temporary workers?  Who will Senator Dodd turn to when Ms. Bair has been sidelined? 


A run on the banks is a scary thing. We urge Congress not to stage a run on the bank regulators.




Stocking Stuffers


Financial industry participants are characterizing this year’s SEC initiatives as an all-out war on the securities industry (, 17 December, “Washington Strikes Back: Washington On The Warpath”) in which the very underlying structure of the markets has come under attack.  Fingering Congress as the driver of this mule team, Traders Magazine observes that the topics currently under attack include over-the-counter derivatives, short selling, dark pools, and co-location high frequency trading operations. 


The politicization of the markets is, itself, damaging the world economy.  The financial markets issue is not a mere question of liquidity, but of societal stability.  Greed rules the day.  For Congress and the regulators, it is greed for grandstanding and confrontation for its own sake.  For the bankers, it is cold cash.  But this is not a confrontation from which anyone will emerge a winner.  Failure to stabilize the financial market will lead to profound social unrest.  In a worst case, neither the Washington elite nor the Glock-toting investment bankers will survive.


Over-the counter derivatives might be moved to exchange-style trading, and can be centrally cleared.  The industry complains that this would put the members of the clearing houses at direct risk for every trade.  This is called Self-Policing and is what those who call themselves Capitalists complain Washington would take away from them.  If the market is in fact all wise, then it will not long tolerate dishonest or inefficient participants, and those left standing will be the better for it.  The alternative to making the entire derivatives marketplace responsible for every trade, is to make no one responsible for any trade.  We already tried that. 


The transparency and standardization offered by exchange trading will have other consequences.  Once derivative contracts are quoted in real-time, firms will immediately retailize them.  In short order, armies of retail brokers will be sent forth to pump derivatives into 401Ks.  This will lead to a bubble of abuses, as there will be a lag between the time these instruments are set among the population, and the time FINRA and the SEC identify them as a risk.  We take as our paradigm the failure on the part of the regulators to require any kind of training or registration of sales people, any special type of account treatment, or any suitability standard or risk disclosure document in putting individual investors’ dollars into ETFs.


Short sellers, the canaries in the gold mine of Wall Street, come under attack whenever there is severe market turbulence.  Regulators the world over dutifully took them to task in 2008-2009, and the cudgels were taken up by those who most profited from the legitimate pursuit of this practice.  It was laughable to watch Dick Fuld, then-CEO of Lehman, shrieking at Washington to reign in the shorts who were “ganging up” on Lehman stock.  Those of us who have spent years in the game recognize that the shorts are, in nearly every case, better informed than the longs – and always better informed than the target companies themselves, as the managements are subject to Groupthink, while short sellers’ only guide is Profit-think. 


As one of the regulators who slapped on a ban on short selling in the market meltdown of September 2008, the London Financial Services Authority (FSA) assessed the effects of its policy and concluded (FSA Discussion Paper 09/1, “Short Selling”, February 2009) that that the greatest risks posed by short selling are lack of transparency, which can be cured through simple reporting regulations, and illegitimate market manipulation during extreme market conditions – which is to say, market fraud.  Notably, the FSA “are firmly of the view that the positive benefits of short selling outweigh the negative impacts.”  Finally, they found the economic impact of the September ’08 short selling ban was negligible. 


Domestically, as we have pointed out, Chairman Schapiro appears to be dispensing a healthy dose of benign neglect to the whole short selling kerfuffle, so perhaps it will die the quiet death it deserves.


One side-note on the short selling story is reported in Floyd Norris’ blog (, 9 December, “Overstock Claims Victory”).  Norris, NY Times chief financial correspondent, has waged a running battle with Overstock CEO Patrick Byrne.  This time around, he reports a $5 million settlement of’s lawsuit against Rocker Partners, a short selling hedge fund.


CEO Byrne, one of the more entertaining CEO’s, advises shareholders to stay tuned for the lawsuit against the prime brokers, in which Overstock is alleging the major Wall Street firms “facilitated naked short selling through their prime brokerage operations.”


Dark pools are part of a fundamental debate over the nature of the marketplace: should government provide a level playing field, or should government force everyone to play at the same level?


The public marketplace, as exemplified by the NYSE and NASDAQ, is a social contract in which the investing public agrees that this is the proper way for a marketplace to operate.  We submit that few investors have ever given much thought to this, with the exception of those most disadvantaged by it, which are the ones who opt into the Dark Pools.


Dark pools are part of third market trading which has offered investors such benefits as cheaper executions, better pricing on large orders, anonymity of orders, and the ability to work very large blocks without the hangers-around in the crowd picking off their trades.  Professional investors, many of whom handle the retirement money and, through mutual funds, personal investments of a large number of American private investors, have flocked to the dark pools for the solid business reason that they are getting better executions.  We note that the requirement to obtain Best Execution for client trades is a primary market obligation imposed on money managers.


The vested interests are clamoring for relief.  But they also are believers in self-help.  The NYSE has constructed a football stadium-size facility at an “undisclosed” location to house high-frequency traders whose strategy hinges on being physically closer to the exchange floor than their competitors, thereby giving them an edge in timeliness of execution.  To the lay person, this expresses itself as



E = MC2 + 100 yards


where “E” is “Superior Execution.”


Can it really be that transactions that are already being processed at the speed of light can be bested by a technology that moves… er… faster?  In the warp-speed world of high-frequency, low-latency trading, firms are lining up for a literal front seat at the exchange floor. 


The exchanges have attacked the dark pools for creating a “bifurcated market.”  Bifurcating the market used to be the sole prerogative of the registered exchanges, which are striking back by creating their own private trading venues.


FINRA, which inexplicably mustered out 300 of its most seasoned regulators in an early retirement program this year, has flexed its remaining muscles in going after the First Call practice.  The Wall Street Journal (18 December, “Wall Street Trade Huddles Probed”) reports FINRA has requested information regarding the practice of giving certain trading indicators to certain customers, and not giving them to others. 


There can only be one “first call.”  That is not a Wall Street fiction, but a physical reality, and the biggest commission dollar always comes from the customer who gets that first call.  If FINRA wants to change the fundamental character of Wall Street relationships, this is a good place to start.  As they get closer to undermining the way Wall Street works, they may find Congress suddenly uncooperative when they realize how much it will cost them in future campaign contributions.  


Which brings us to the Usual Suspects in Washington, headed by the Usual Suspect In Chief.  We were not the only ones who found our President less than Presidential when he addressed the CEOs of three of the nation’s largest financial institutions as “you guys.”  These executives, unlike Jamie Dimon, did not take the corporate jet to the Monday Morning Massacre.  Goldman CEO Blankfein, John Mack of Morgan Stanley, and Citigroup’s Richard Parsons were grounded in New York due to fog.  Instead of spending an entire day shuttling back and forth to Washington to participate in a public Presidential woodshedding, they called in, took their lumps telephonically, and reported back to work at their desks.  Their investing acumen notwithstanding, Goldman Sachs apparently can’t get a reliable weather forecast.


President Obama’s remark “I did not run for office to be helping out a bunch of fat cat bankers on Wall Street” had us thinking of the millions contributed to Obama’s presidential campaign by Wall Street.  According to “”, contributions from Goldman Sachs employees in 2009 were just shy of one million dollars.  The Top Twenty also feature Citi ($701,290), JP Morgan Chase ($695,132), and Morgan Stanley ($514,881)


As far back as the primaries (LA Times, 21 March 2008, “Democrats Are Darlings Of Wall Street”) the giving was clearly skewed, and the press raised the specter of Wall Street buying the Democrats’ acquiescence in softening financial regulatory reform.  What a silly notion, since these were the same Democrats who sent Glass Steagall to the gallows.  One, in fact, the spouse of the very President who kicked away the stool.  We are tempted to make a joke about Getting in bed with the Powers That Be, except in the case of President Clinton that does not appear to have been such an exclusive venue.


President Obama may not care to help out the Fat Cats, but the Fat Cats certainly helped him.  Riffing on Matt Taibbi’s characterization of Goldman in Rolling Stone, we think Goldman might be entitled to a “Squid Pro Quo”. 


Anyway, the President announced that he impressed upon the bankers that they need to start lending money to business – at the same time the banking regulators are admonishing them to tighten lending standards.  And perhaps most important – and most meaningless of all – he was able to show that the bankers of America are at his beck and call.  Well, a lot of them, anyway.


On the regulatory front, under the leadership of Chairman Schapiro, the SEC has made visible progress.  It now appears to be able to identify Shinola – something it significantly failed to do for a decade.  The present insider trading cases have much riding on them.  If new Enforcement Chief Khuzami manages to bring the Galleon case over the goal line, it will go far towards asserting a new age of credibility for the agency.


The  stage is set for what should prove an interesting year.  What we don’t yet know about 2010 is what regulatory bungles, what Wall Street scams, what international criminal transactions, what collusion between lawmakers, drug dealers, prostitutes and financiers have not yet been uncovered and will come to light next year.  We are rubbing our hands in anticipation. 


What’s under your tree this year?


Wishing you Happy Holidays, and a healthy, prosperous 2010.



Moshe Silver

Chief Compliance Officer

investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.