December 29, 2009





We quantified yesterday why the ‘group call’ will matter in 2010 far less than it did in 2009. In that vein, as the year draws to a close, let’s keep a keen eye on incremental changes in sentiment on specific names in retail. The chart below triangulates sentiment on the sell side (ratings), buy side (short interest), and inside (management buy/sell activity).  Here are some notable callouts…


  1. SHLD: No major changes, but how can I not mention 32% of the float short with not a single sell-sider on the Buy bandwagon. I’m firmly in the ‘why does this business need to exist?’ camp, but let’s not ignore these factors.
  2. BKS is a close second with 30% of the short float, a 6% increase from a month ago.
  3. UA sentiment is still overwhelmingly negative, but its 5 buy ratings is markedly higher than the lone Buy rating we had earlier this year. It’s still hated with 19 other ratings that are NOT Buy, but the short interest failed to move meaningfully higher over the past month, which is also notable. All-in, this is worth calling out, and it tells me that the direction on the top line is gaining in importance here.
  4. TRLG: Sell side loves it, Buy side hates it. Fundamentally this margin structure is almost as sustainable as Timmy Geithner as our Treasury Secretary.
  5. There’s no shortage of big, liquid names with low short interest that are universally loved by the sell side: M, KSS, JCP, TJX, ROST, COH, MWT, TGT, VFC   


    R3: GETTING SENTIMENTAL - R3 12 29 09 Sentiment Chart




    • With the holiday shopping season now behind us, retailers are now in clearance mode as reflected in ‘Final Sales’ on popular on-line luxury discount sites Ruelala and Gilt.  While discounts over 50% are more rule than exception this season, of particular interest is how retailers with e-commerce site are balancing clearance activity. Some popular retailers like J. Crew are actually discounting more significantly in-store compared to on-line perhaps as a tactic to drive traffic. There are a few notable exceptions, however, such as Patagonia where I did not see one single sale tag.
    • In an aggressive move to turn inventory, private furniture retailer Raymour & Flanigan is now offering a deal for no money down and no interest until 2014! While an alternative to further discounting, the likelihood for rates to move higher over the next 4 years may result in retailers wishing they had taken the pain upfront in hindsight.




    Stay Union-Free’ Pushed by Target, Michaels as Obama Law Looms  - Target Corp. retooled a training video to warn workers against a bill that would make union organizing easier. Michaels Stores Inc. told investors “our businesses could be impacted” by the measure. Enrollment in Jackson Lewis LLP’s “How to Stay Union-Free” seminars tripled. Companies are rallying to fend off a so-called card-check law sought by labor leaders and backed by President Barack Obama. While the bill stalled in Congress this year as health- care legislation dominated debate, anti-union groups say they expect the president and Democrats to deliver next year on a compromise version of the legislation. “As we approach the 2010 elections, the unions are really going to want their pound of flesh,” said Randy Johnson, who handles labor issues for the U.S. Chamber of Commerce, the nation’s largest business lobbying group. “Even if we defeat the card-check bill, it’s entirely possible that other changes to the National Labor Relations Act will come up, and some of those will likely make it easier to organize the workplace.”  <>


    Electronic books outsell paper volumes at Amazon for the first time - Many consumers who found new Kindle e-book readers under the tree Christmas Day rushed to fill up those devices with e-books the same day. The result: for the first time ever, Inc. says it sold more e-books for the Kindle on Christmas than paper books. Amazon, which has featured the Kindle prominently on its home page since introducing the device in November 2007, says more shoppers bought the Kindle as a gift this holiday season than any other item on Amazon. "We are grateful to our customers for making Kindle the most gifted item ever in our history," says Jeff Bezos, founder and CEO of "On behalf of employees around the world, we wish everyone happy holidays and happy reading!" <>


    Claire's to go for European expansion drive in 2010 - Accessories retailer Claire’s intends to open significantly more stores during 2010 than this year. Keny Wilson, the US-based retailer’s European president unveiled plans to maximise the label’s European presence by concentrating on stores openings in Spain and Germany, which he believes are well-placed for expansion. Noting that Claire’s opened 25 stores in Europe during the last year, Wilson said: “We’re going to open significantly more in the next year.” In order to expedite this, Wilson also plans to beef up the company’s executive base and will be looking for management with “pan-European expertise.” Currently, Europe, has 953 Claire’s stores, the bulk of which are in the UK and France, against over 2,000 in the US. The European business accounts for close to a third of the retailer’s annual sales. It is owned by private equity firm Apollo Management, which acquired it for $3.1bn in 2007.  <>


    JD takes over Australian and New Zealand Canterbury distributors - The sports retail group has acquired stakes in the Australian and New Zealand distribution companies for rugby brand Canterbury. The move is a futher step by JD to increase its stake in the rugby clothing brand as well as to consolidate control of its global distribution. The retailer has taken 100% of the issued share capital of Canterbury International Australia and 51% of Canterbury New Zealand. Both companies were previously subsidiaries of New Zealand-based company Herald Island. Ross Munro, who has control of Herald Island will hold the remaining 49% stake in the New Zealand organisation, along with CCC Nominees, and has agreed to become the CEO of CNZ. In a statement to the London Stock Exchange, JD said that it did not expect the acquisitions to be “materially earnings enhancing in the short terrm”, but that they would add to the group’s control of the Canterbury brand and its global marketing properties. <>


    Fast-Fashion Retailers Eye New Concepts - Despite surviving the economic downturn better than luxury brands, fast-fashion retailers aren’t resting on their laurels. As customers’ spending patterns become unpredictable despite the receding recession, fast-fashion giants are turning to concepts that until now had been untapped or were considered marginal to their main businesses. Despite the recession, Inditex SA, H&M and Japan’s Fast Retailing Co. Ltd. managed to grow total sales in 2009, helped by new store openings, particularly in emerging markets in Asia. But the rise of competition, especially from low-cost and online retailers, combined with fickle consumer confidence, has persuaded fast-fashion retailers to sharpen their product offerings.  Fast Retailing’s flagship chain Uniqlo — with the stated goal of becoming the world’s largest fashion retailer by 2020 — is both shifting upscale with its premium Jil Sander-designed collection, +J, and expanding into thrifty apparel retailing with the low-cost g.u. chain in Japan. H&M has expanded its successful one-off designer collaborations beyond apparel, with a footwear collection by red-carpet shoemaker Jimmy Choo and a lingerie collaboration with Parisian designer Sonia Rykiel. And Inditex is finally catching up with competitors by bringing its main label, Zara, online for the first time.  <>


    Dept. Store Sites Score Big Increases - While broadline retailers struggled to top their November 2008 sales figures last month in their brick-and-mortar stores, many of their e-commerce sites enjoyed tidings of comfort and joy as the holiday season began in earnest. Department store e-commerce sites scored the fifth largest increase in unique visitors in November compared with October, rising 29.9 percent to 80.9 million from 62.2 million the prior month, according to a report released Monday by comScore Inc., which specializes in the measurement of digital traffic and purchasing. Overall in e-commerce, there was a 1.5 percent increase in “uniques” to 201.14 billion from 198.22 billion in October. E-commerce sites offering jewelry, accessories and luxury goods had the ninth largest increase, up 15.2 percent to 17.7 million visitors. <>


    Online retail was the holiday season’s big winner, MasterCard says - Online retailers were the big winners this holiday season, as their sales grew significantly faster than those at stores, according to the MasterCard Advisors SpendingPulse report released today. E-commerce sales were up 15.5% over last year for the period Nov. 1-Dec. 24, and 18% since the Friday after Thanksgiving, says the report from MasterCard Advisors, the consulting arm of MasterCard Inc. Overall, retail sales increased 3.6% during the period, a substantial improvement from a 2.3% drop-off during the 2008 holiday season, MasterCard says. The e-retail segment registered double-digit growth in all but one week during this holiday season, MasterCard says. Several major winter storms that kept shoppers from bricks-and-mortar stores seem to have boosted online sales, says Michael McNamara, vice president of research and analysis for SpendingPulse. <>


    Retailers Shoot for Top-line Growth in 2010 - It hasn’t been a cakewalk, yet after the final big shopping weekend of the year and the onset of steeper markdowns, retailers are easing out of holiday selling into clearance mode feeling OK about business and ready to bring on spring. The verdict is a preliminary one, of course, with December sales not being reported until Jan. 7, and about five weeks remaining in the fourth quarter that ends Jan. 31. Not to mention double-digit unemployment and difficulties for consumers getting credit. However, there’s been a discernible shift in the tone among retail executives in the last few weeks. Many predict improved margins and profits for the fourth quarter even with flattish sales, a consequence of lower inventories and demand. Beyond that, some suggest real and long-awaited top-line growth occurring in 2010, most likely in the second half. <>


    Online Vintage Stores Bucking the Economy - Britain’s high street clothing stores might be struggling, but Internet business is brisk for a new clutch of vintage stores. The Web sites are proving popular among those who love the idea of wearing important pieces of 20th-century fashion, but who don’t have the time or energy to trawl through shops or markets. The sites are also doubling as vintage clothing libraries, offering video clips, editorial comments and research on the pieces they carry. Many are creating a real world presence by staging exhibitions and salon events, as well as permanent and pop-up stores.  <>


    Study: Women to Spend Less on Cosmetics in '10 - American consumers will maintain and even intensify their focus on thrift in 2010, and their frugality is expected to reduce cosmetics purchases by women by nearly 9 percent. According to a survey of 600 Americans, age 25 and up, by AlixPartners’ consumer products group, women are expected to reduce spending on cosmetics by 8.7 percent next year, greater than the 7.5 percent decline expected for prepared food and prepackaged meals or the 3.4 percent drop foreseen for health and personal care items among all respondents. Seventy-five percent of those surveyed said they expected to be more frugal when shopping for food in 2010 and 55 percent said they would reduce their spending on household-care products. <>


    McCarran Airport showed a scant gain in traffic in November. It doesn't mean revenues will be up but baby steps...



    Last week, McCarran Aiport released monthly data showing the number of enplaned/deplaned passengers actually increased 0.1% in November.  This is the first uptick since February of 2008.  Yes the comparison was easy - down 14.8% last year - but the trend is moving in the right direction.  See the chart below.


    STABLE NOV AIRPORT TRAFFIC - mccarran nov chart


    Before we get too excited, realize that gaming revenues likely still fell, assuming a normal hold percentage, and gaming volumes almost certainly declined.  Based on our proprietary model, we project a mid-single digit decline in gaming revenues as shown in the table below.  The comparison of down 16% was easy, although moderate on a relative basis to the recent monthly comps.  Hold percentage last year was normal for both slots and tables last year.  We expect a slight uptick in slot hold for November 2009 due to the timing of the 10/31/09 count.  When the count falls on a weekend, slot revenues tend to be understated in that month (October) and overstated in the following month (November).


    STABLE NOV AIRPORT TRAFFIC - nov est strip metrics


    Of course, November is not the most critical month of any year, and particularly not this year since CityCenter opened in December and added quite a bit of supply to the market.  Moreover, the air capacity into McCarran is on the decline which will not be helpful as supply increases.  More on that later.

    Frightening Faith

    “It’s frightening to think that you might not know something, but more frightening to think that, by and large, the world is run by people who have faith that they know exactly what’s going on.”

    -Amos Tversky


    The world lost a wonderful mathematical mind in June of this year. Amos Tversky was a pioneer in many of the not yet accepted halls of cognitive science and  behavioral economics. Not yet accepted by the Perceived Wizards of Wall Street Oz that is…


    Whether it was my having to endure Larry Kudlow’s market call last night on CNBC, or scanning this Bloomberg article on my desk about Legg Mason’s Bill Miller making a “comeback” this morning, it’s all one and the same. These guys apparently don’t have mirrors or a YouTube. They both missed calling the crash. They are both perpetually bullish. They, sadly, are both part of the incompetent old boy club that aids and abets an American culture of recklessly buying high.


    I could not make this up if I tried, but this is a direct quote from Bill Miller after the SP500 closed at a year-to-date high of 1127 last night: “There is a lot of upside left.” After the most expedited 9 month rally in modern stock market history (+66.7% from the March 9th lows), that’s what you get. That advice, and Kudlow calling for a “mini-boom” last night are classic contrarian indicators.


    Legg Mason’s marketing machine will be the last to remind you, so I’ll be the first this morning. Miller lost -55% of his clients’ money in 2008, and has been beat by 99% of his peers on a 5 year basis. To his defense, he also remarked that “we positioned the fund for a recovery.” Thank God for that proactive plan, Bill.


    Whether it’s Kudlow, or Miller, or Larry Summers (whose interest rate swap positions that he signed off on in 2006 almost blew up the Harvard Endowment), it’s all one and the same folks. As your favorite market savants roll out their “2010 predictions”, here’s mine: these guys will miss calling out most of the 2010 risk, and swing with the monkeys from the market highs. They do not have a repeatable risk management process to do otherwise. They never have.


    Back to being your risk manager…


    Higher-highs in the SP500 and the Nasdaq were bullish confirmations of a bullish intermediate term TREND in US equities yesterday. However (and yes old boys, there is always a however), these higher-highs were not confirmed by small caps or the financials.


    The Russell 2000 (IWM) closed down small on the day, and the Financials Sector ETF (XLF) closed down another -0.34% at $14.48. The XLF remains the worst sector out of the 9 we assign risk factors to in our SP500 Sector model. The Financials are broken from both an immediate term TRADE and an intermediate term TREND perspective. There is a long term TAIL line of support for the XLF down at $12.05/share. That’s -16.8% lower than last night’s close.


    When Josh Steiner, our new Sector Head of Financials Research, launched last month, he came out bearish on the money center banks. We took a lot of heat from a certain corridor of the hedge fund community with that call, so we knew the Street was long some of the brokers and government sponsored banks (BAC, C, GS, etc…). After a +128% rally from her early 2009 lows, seeing bulls chase price was no surprise whatsoever.


    Since October 14th, the financials (XLF) are down -8.3% and the SP500 is +3.2%. If you aren’t living in the land of perpetual bullishness, for the financials that’s what we call a nasty negative divergence. If you have been short the financials and long the market, that’s called alpha.


    Now, from a global risk management perspective, what else is interesting about October 14th?


    1.       The stock market in the United Arab Emirates peaked, and has since lost 24.6% of its value

    2.       The stock market in Greece peaked, and has since lost 24.3% of its value

    3.       The stock market in Vietnam peaked, and has since lost -22.4% of its value


    Yes. If you have your calculator out doing your own work Larry, you’ll realize that I purposefully just made an inaccurate statement. Vietnam peaked on October 22nd. I just wanted to make sure you are reading my work extra closely this morning. These cross market macro correlations are not ironic. They are leading indicators that not all is going “mini boom” in global macro – or wait, maybe some things are…


    I’m all for a country that’s everything that we want it to be. But when it comes to your financial freedoms and safeties, I think you need to start with either your own investment process or augmenting it with people who do their own work and are accountable to it. That’s it. It’s that simple.


    To ignore risk for the sake of sounding positive may not deserve the capital punishment that the Chinese gave that British drug lord last night, but it certainly deserves your losing the ability to manage other people’s capital or to broadcast your views to a national audience of impressionable young Americans.


    From the US financial stocks falling, to the price of oil hitting a 5-week high post plenty of geopolitical risk being reflected via oil price premium, this game is all about risk. Real-time prices are always telling us where to look for those risks. Its hard work. The days of looking to the likes of Kudlow, Miller, and some Robert Rubin disciple are thankfully ending. For far too long this country upheld some Frightening Faith in their hope based bullishness.


    Remember, hope is not an investment process. God bless Amos Tversky.


    My immediate term TRADE lines of support and resistance for the SP500 are now 1113 and 1133, respectively.


    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 BrazilAs 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.

    GLD - SPDR GoldWe 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.

    RSX – Market Vectors Russia
    We shorted Russia on 12/18 after a terrible unemployment report and an intermediate term TREND view of oil’s price that’s bearish.  

    EWJ - iShares JapanWhile 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 Discretionary We shorted Howard Penney's view on Consumer Discretionary stocks on 10/30 and 12/2.

    SHY - iShares 1-3 Year Treasury BondsIf 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.


    Early Look

    daily macro intelligence

    Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

    US STRATEGY - MACRO pre-open levels

    The range for the S&P 500 is 20 points or 0.5% upside and 1.0% downside.  At the time of writing the major market futures are slightly higher. Below you'll find our Macro pre-open TRADE levels for the S&P 500, US Dollar Index, VIX, Oil, Gold, and Copper.


    Howard Penney

    Managing Director


    US STRATEGY -  MACRO pre-open levels  - sp1


    US STRATEGY -  MACRO pre-open levels  - usd2


    US STRATEGY -  MACRO pre-open levels  - vix3


    US STRATEGY -  MACRO pre-open levels  - oil4


    US STRATEGY -  MACRO pre-open levels  - gold5


    US STRATEGY -  MACRO pre-open levels  - copper6


    Slouching Towards Wall Street… Notes for the Week Ending Friday, December 25, 2009

    The Committee To Trash The World


    There ain’t no way to find out why a snorer can’t hear himself snore.
      - Mark Twain


    “Economist heroes?  It all sounds silly unless you understand how close the world came to economic meltdown last year.”  That quote is not Fox News’ latest endorsement of Bernanke and Geithner, nor is it the Wall Street Journal’s grudging acknowledgement of Paul Krugman.  No, it is Time magazine trumpeting “the Committee To Save The World”, as they praised Alan Greenspan, Lawrence Summers, and Robert Rubin on February 15, 1999.  Ten years later, they anointed successor Ben Bernanke as Person Of The Year for 2009.


    For many observers, the handing on of the politicized economic legacy could not have been more explicit if a puff of white smoke had issued from a turret atop the Fed building, for Ben Bernanke is the child of his Trinity of spiritual fathers. 


    A glimpse into the world of ten years ago is instructive.  Making him seem like some international sex symbol, Time describes Summers sitting in the Frankfurt airport on his way back from “a hectic trip to Moscow.”  After presenting a litany of the globe’s financial woes, the article gives us this prescient gem: “awful as the Asian correction is, it was, in a sense, inevitable because those economies had trundled billions of dollars into useless real estate and industrial development.”  Apparently Summers – returned to Washington with the Obama Administration – failed to see a correspondence to the real estate excesses, coupled with the overbuilding in the financial sector that combined to tip America and the world into the toilet this time around.  We aren’t economists, and even we get it.  The scary thought is, perhaps the reason that we get it is because we are not economists.


    “We start with the idea that you can’t repeal the laws of economics” says the Ghost of Larry Summers Past, “even if they are inconvenient.”  Astonishingly, even as he spoke those words, Summers and his two partners were in the process of giving that fundamental point the official heave-ho.  Indeed, as this triumvirate was directly responsible for the government policy of abandoning regulation, one might say the laws of economics had been suspended by government fiat, even as they were being touted.


    Tracing the waves of financial disaster as they emerged from the “Asian Contagion”, Time identifies the “breathtaking” speed of the global collapse as proof that markets had changed and become fundamentally much more volatile.  Quoting Summer’s favorite analogy, the article likens the global capital markets to a jet plane.  “They are faster, more comfortable, and they get you where you are going better.   But the crashes are much more spectacular.”


    The fact is that this team of three Really Smart Guys had also been credited with some major accomplishments.  The Time story credits Rubin, for example, with single-handedly preventing the Korean debt panic from morphing into a crash in the US marketplace.  Students of economic history disagree about the extent to which Rubin also directly caused that crisis by forcing the Korean financial markets to buy up derivative contracts created by US investment banks as a condition of Korea receiving $57 billion in loans from the IMF. 


    A fourth RSM (“Really Smart Guy”) makes a cameo appearance in the article.  Tim Geithner, then a 37-year-old Undersecretary for International Affairs, is quoted as saying Rubin ran Treasury “more like an investment bank”.  We are not told what Geithner meant by that remark, though in the next sentence, other staffers credit Rubin with fostering discussion and eliciting ideas from his staff.  It is astonishing to think that the development of brilliant ideas might not be what the job of governing is supposed to be about – and perhaps equally surprising to realize that investment banking is less about coming up with brilliant concepts than it is about forcing someone else to hand over their money.

    The remaining question is: how did these RSM’s get it so wrong?  And maybe the answer is simply that they blurred the distinctions between government and business with the conviction that the private sector knows best.


    President Clinton supposedly found Hillary’s friend Brooksley Born too boring to make her his Attorney General.  As a consolation prize, she was put in charge of the Commodity Futures Trading Commission.  She has long refused to speak for the record, but her staffers were unequivocal that in her first meeting with Greenspan, the Fed Chairman attacked the notion that free markets need any kind of regulation at all.  Free markets, he is supposed to have told the newly-minted CFTC chief, do not need regulation.  They will regulate themselves.


    As with every other idea the RSM’s came up with, this notion of self-regulated markets worked really well. Until it didn’t.

    Let’s face it, Wall Street executives think politicians are a bunch of idiots, so going into politics is seen not so much as making a contribution, as showing them how to really run the system properly.  Folks like Rubin really believe that the best “service” they can perform is to show government how it’s really done.  As young Tim Geithner said: run Treasury more like an investment bank.  You know, winners and losers…  It’s a short step from bringing private sector know-how into government, to placing government at the service of the private sector.


    Fade out, fade in.  Ten years have gone by and the latest RSM, Bernanke, is on the cover of Time magazine.  While we have admiration for his intellect, and for his academic achievements, both Mr. Bernanke and those who rely on him would do well to keep an eye on the interface between Government-Think and Wall Street-Think.  If the Fed’s job is to manage inflation, then its brief is to permit growth, not stimulate it. 


    The place of speculation in the marketplace is to add liquidity, resources, information and a certain depth to the markets.  The social policy reason banks are allowed to engage in investment banking – and in lower-risk ways of making outlandish returns, such as overdraft charges and ATM fees – is to provide low-cost capital for lending, which is the legitimate purpose of banking.  Indeed, this is the clear social policy reason for what we have dubbed the “piggy banker spread” – the lopsided yield spreads that are pouring billions of dollars of revenues into the pockets of Wall Street were supposed to stimulate lending and business investment.  Instead, they are going to year-end bonuses to managements who have generated staggering losses, drawn down a trillion dollars in government bailouts, and wiped out their shareholders.  Financial institutions whose existence is predicated on speculation were transformed into banks by regulatory legerdemain that would make Harry Potter jealous.  Now that they have the backing of people’s life savings, and the guarantee of the Fed, they can continue to speculate without jeopardizing their bonus pools.


    The fundamental – though far from simple – job of financial regulation is to keep speculation as a layer in a functioning marketplace.  Speculation, from a regulator’s perspective, should serve the market.  Our markets are being run with the express purpose of serving the speculators. 


    As we wave farewell to an eventful year, we suggest Time’s new Person of the Year would do well to look closely at his predecessors’ mistakes.  Events have a nasty habit of proving over and over again that no one is smarter than the market, though quite a lot of folks have turned out to be dumber.


    Happy New Year, Chairman Bernanke.






    The B.S. Artists Of The Possible


    It is by the goodness of God that in our country we have those three unspeakably precious things: freedom of speech, freedom of conscience, and the prudence never to practice either of them.
      - Mark Twain


    We have to admit to a bias in favor of SEC Chief Schapiro.  We always thought she was decent, and were impressed by what the market professionals engaged reported about her handling of the NASD/NYSE regulatory merger that gave rise to FINRA.  While we are the first to admit that even we are susceptible to having the wool pulled over our eyes, we think it would be a shame if Mary Schapiro gets knocked down from her pedestal.


    A shame – though, in the world of Wall Street, not a total shock.

    Slouching Towards Wall Street… Notes for the Week Ending Friday, December 25, 2009 - CS

    Bloomberg filed a story on the first day of winter (21 December, “Hot Seat For SEC Chief Schapiro Won’t Cool Off”) reporting on two lawsuits claiming that Schapiro colluded with other senior NASD officials to dupe the membership out of substantial amounts of money in the lead-up to the merger of the NASD and NYSE regulatory regimes that resulted in FINRA.


    Those who were NASD members at the time will recall the hoopla about the $35,000 demutualization payment that the NASD doled out to its member firms.  Firms were disdainful, demoralized and disgusted at the pittance they were being handed for their trouble as Schapiro et al showed them the door.  At the time, the NASD insisted that was the maximum the IRS would permit them to pay.


    Fade out, fade in, and enter who of all people but Judge Jed Rakoff – will no one rid me of this meddlesome jurist?! – who is hearing the case against Schapiro.  He has instructed FINRA’s counsel to tell the court what the real IRS number was.  The IRS letter on which Schapiro based her statement – which Bloomberg reports was not even issued by the IRS until three months after the number was announced to the membership – is presently under seal, at the request of guess who (hint: not the IRS).  Judge Rakoff is due to rule in January whether the seal will come off. In the meantime, he instructed FINRA to indicate to the court whether the IRS’s number was, in fact, as represented by FINRA, or perhaps somewhat different.  In response to Judge Rakoff’s instruction, FINRA’s counsel said the actual IRS number was “something like $35,000 to $76,000 on top” of the $35,000 figure the member firms actually received.

    A stalwart member of the legal profession, a warrior who has crouched in his fair share of foxholes in the Wall Street wars, attorney Bill Singer offered a doozy of a piece on (8 December, “Regulators Plead Poverty”) in which he tossed around some of FINRA’s numbers. 


    In November of 2008 – right at the time then-SEC Chairman Cox was admonishing Wall Street firms not to cut back on compliance as a cost-saving measure – “FINRA asked 300 of its senior staff (about 10% of its staff) to take voluntary early retirement.”  Singer estimates this to be a savings on the order of $30 million – taken precisely at the time Chairman Cox was wagging his well-manicured finger at Wall Street about maintaining the Culture of Compliance.


    Why did FINRA need all that money?


    Singer references an investigative report from Investment News that claims FINRA “spent some $13 million on salaries for just 13 of its heavy hitters” in 2008, the same year that FINRA reported a $696.3 million loss.  The Chief Administrative Officer alone made $4.4 million.  Singer muses “how the hell does a regulator lose $696 million?”  We muse: how does a regulator pull down seven figures?  And when can we apply for the job?


    Having that kind of hole in the budget explains FINRA’s need to save cash.  We wonder whether early retirement was also made attractive enough that none of the senior staffers who were mustered out will be disappointed with what they are getting.  These are precisely the folks who know where the bodies are buried.  It is presumably in FINRA’s best interest to keep them happy – and hence, quiet.


    As to the magnitude of FINRA’s losses in 2008, loyal readers of this Screed will recall (week ending May 8, 2009, “An Offer We Can’t Refuse”) disgusted FINRA member firms speculating that the reason for a sudden surge in FINRA examinations – and their attendant laundry list of nit picking procedural fines – was not regulatory zeal, but an empty till.  “I can’t believe how many times they’ve been here so far this year,” one incredulous compliance officer said.  “FINRA must be broke!”  How zealous can a regulator be, after all, if it gave its top 300 executives the chop in the midst of the greatest financial crisis in generations? 


    In that column we reported on speculation that FINRA had been a substantial investor in Madoff’s hedge fund – a logical connection, given how deeply enmeshed Madoff was in NASDAQ/FINRA, not to mention a straightforward explanation of where such a large loss came from.  We also pointed out the coincidence that FINRA had sold out its entire position in auction rate securities – some $800 million in its $1.5 billion endowment portfolio – before this market segment melted down, and before securities regulators in New York and Massachusetts – ultimately even FINRA – issued public warnings to investors on the risks of investing in auction rate securities.


    Returning to Singer’s piece, he gives FINRA Chair Mary Schapiro’s compensation as on the order of $3.3 million in her last year at the agency, plus over $7 million in accumulated retirement benefits.  This is a gracious exit, though not excessive for a senior regulator of Schapiro’s stature and accomplishment.  Indeed, the NASD/NYSE consolidation alone was worth millions, and she gets the lion’s share of the credit for making it a reality.  In should not be forgotten that NASD was a private corporation, not a government agency.  Its officers’ compensation was really an issue for the membership, not the public.  Not for nothing, in comparison to what NYSE head Dick Grasso walked away with, Schapiro’s compensation package is an insult. 


    Among the losses FINRA racked up, Singer also points out a $1 million item in the budget for lobbying.  This was for their trips to Washington to press for more resources.


    On balance, we are more a fan than a critic of Chairman Schapiro.  She has trod the difficult path of being an intelligent, effective woman in the world of both Wall Street and Washington, and has retained her composure.  No mean feat.  In the politics of her current job, she steps far too gingerly to be effective.  Still, if politics is the Art of the Possible, we understand the attitude that believes it better to do 10% of a good job, and do it well, than fight for 100% of what one believes is right, with the assurance that one will lose.  We don’t like it, but we understand it.  In an environment where Congress are looking not for solutions, but scapegoats, and the President is running a severe testosterone deficit, it would be mean-spirited to criticize Chairman Schapiro for not being more like Sheila Bair.


    We think the Bloomberg article heralds a coming press onslaught that will savage the regulatory agencies and reveal politicians in all their dirty little pettiness and greed.  Why on earth would anyone want to do that?


    There has been much talk in the press about financial reform. Re-Regulation.  It is largely, we note, in the press.  It is not yet a Washington reality. Indeed, Washington seems to be doing everything in their power not to address financial regulatory reform.  On the heels of the greatest financial disaster our generation has known, President Obama immediately mobilized his political troops in an all-out assault on… health care reform.  Having set that well in motion, President Obama then turned his full attention to… climate change.


    Now that President Obama has participated in the Copenhagen fiasco, and is on the verge of having his health non-care, non-reform bill signed, he will, like his predecessor, be able to proudly announce “Mission Accomplished!” to the American people and head off to slay the next dragon.  Which will be… financial reform?  Well, in case you forgot, January was the drop-dead date for negotiating with Iran.


    We think that ultimately the changes on Wall Street will be far milder than threatened or feared.  When the dust settles, it will emerge that AIG and their ilk were well served by the muscle flexing of Pay Czar Feinberg.  This one-time slap – really a chump change grab in the grand scheme of things – will take most of the wind out of the sails of re-regulation, and will still leave the US looking more hospitable to crooks and capitalists than the UK and its Euro-buddies. 


    The US is the only country in the world that does not require hedge funds to register.  So will they now have to do so?  Certainly.  Except for those who do not.  Private equity and venture capital, for example, are likely to be exempted because – so Senator Dodd – they do not pose systemic risk.  Final word on that will likely come only at the end of the SEC rule-making process. 


    For those advisers who do register, will the SEC and FINRA become much more of a nuisance?  Certainly, since their examination and inspection functions will likely be run by the same kind of uneducated staffers who have traditionally been in charge.


    This is good news for compliance professionals who have been in the business for a long time.  Note to hedge fund principals: you want to seek out compliance people with broker dealer experience, as they have spent years dealing with FINRA staff – of whom least said, soonest mended.  The SEC will no doubt be beset by a new zeal to get the Bad Guys, and cool heads and well organized compliance programs will be the order of the day.  If the past is anything to go by, FINRA and the SEC will hire more people, but not smarter ones.


    But this is small stuff.  Wall Street, don’t worry.  This too shall pass – and quickly.  President Obama has not had the intestinal fortitude either to spank his own party for their bad behavior, or to strong-arm the opposition into submission.  As America’s leading Artist of the Possible, Obama has abdicated on both health care and climate change, merely to achieve a vote.  And there are bigger problems looming – problems where Wall Street will be able to play the role of a good citizen by expressing concern and outrage, and by financing the political campaigns of those who agree with them.


    Who are you more scared of – Lloyd Blankfein with a registered handgun, or Ahmadinejad with an atom bomb?


    Uh-huh.  We thought so.



    Moshe Silver

    Chief Compliance Officer


    Oil: Eye on the Dollar, But . . .

    In 2009, oil was driven by one primary factor, the U.S. dollar.  As the dollar weakened, those global commodities that were priced in U.S. dollars strengthened, namely oil and copper.  We measured this inverse correlation at almost 4.5:1.  Time will tell whether this relationship holds for 2010, but it is likely safe to assume any major move in the dollar will continue to impact oil in a similar manner.


    Obviously, the price of oil is a critical component to any sustained consumer spending recovery.  The dramatic decline in oil in early 2009, on a year-over-year basis, was a key component of our theme, the MEGA squeeze, which played out in the first half of 2009 as the key components of consumer spending improved leading to a major short squeeze in consumer discretionary stocks.  Gasoline pricing in the back half of 2009 was incredibly stable, which is likely the best case scenario for consumers as one can plan their spending with a stable input.  From July 2009 to December 2009, gasoline was in a range of $2.46 to $2.69, which if sustained into 2010 would be a positive scenario for consumers.


    Fundamentally as it relates to oil supply and demand, incremental growth in global GDP will lead to incremental growth in global oil demand, which should tighten the global oil market.  The inventory balance in the U.S. over the past 4-weeks may be foreshadowing a tighter supply and demand picture globally in 2010.  Inventory has fallen from 339MM barrels to 327MM barrels and days of supply has fallen in the same vein from 24.5 to 23.7.  While inventory levels are still slighly above their 5-year range, they are only marginally above that range.


    Two weeks ago, the Department of Energy highlighted a key point as it relates to supply in their weekly statistical note, This Week In Petroleum.   According to the DOE:


    "The majors’ upstream capital expenditures declined relative to Q308 but by much less than the fall in net income, and were about equal to the third quarter average for 2004-2008. In particular, worldwide oil and gas production capital expenditures fell 35 percent relative to Q308 and by a much smaller 1 percent relative to the third quarter average for 2004-2008."


    Interestingly, according to this analysis, while capital expenditures for the world's major oil companies was down dramatically from 2008, in aggregate it was at a comparable level to the prior 5-years.  The implication of this is likely that while the oil price was volatile in 2009, companies continued to spend on exploration and development of future oil reserves, which is a signal that these major producers still believe supply in the future will be tight.


    As the article goes on to note, despite this year-over-year drop off in capital expenditures, production is still growing:


    "Notwithstanding the reduction in capital expenditures, oil and natural gas production in Q309 continued to show growth. In each of this year’s quarters (Q109, Q209, and Q309) the reporting companies’ aggregate domestic oil production, foreign oil production, domestic natural gas production, and foreign natural gas production all increased over the comparable quarter in the prior year and are the only quarters in which this has happened since Q401. Further, domestic and foreign oil and gas production in Q309 all exceeded the third-quarter average over the previous five years. The increases in production, despite the sharp drop in capital expenditures, resulted from the lagged effects of higher capital expenditures in earlier periods."


    While the U.S. dollar will likely continue to drive the price of oil for the forseeable future, as oil comes back into balance on the demand side and the reduced capital expenditures in 2009 have some, even if muted, impact on supply, it seems likely that supply and demand data points become more important for the price of oil in 2010.


    Daryl G. Jones

    Managing Director