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Rogoff’s Two Percent Prediction

We have enjoyed reading “This Time is Different” by Carmen Reinhart and Kenneth Rogoff.  In fact, we have often quoted the astute historical studies in this book over the past quarter.  That said, we were taken aback by some recent statements by Kenneth Rogoff.  According to Bloomberg:

 

“China’s economic growth will plunge to as low as 2 percent following the collapse of a “debt- fueled bubble” within 10 years, sparking a regional recession, according to Harvard University Professor Kenneth Rogoff.”

 

In the hypothetical everything is of course possible, but  what is concerning about this prognostication is that it does not seem to be based on any of Rogoff’s fine quantitative studies.  By making this statement, Rogoff is suggesting that Chinese growth decelerating to a level of 2% is in the realm of real possibility.

 

Below we’ve charted Chinese GDP growth over the past 20-years.  The story from this chart is actually quite simply that a deceleration to of GDP growth to 2% would be way out there on the tails of probability.  While certainly not impossible, Rogoff’s statement reeks more of that of fear mongering than an accurate assessment of probability.  Over this time period, China’s GDP has average 9.2% and the range has been between 3.8% and 13.5%.  So 2% . . . possible, but probable? We aren’t so sure.

 

In terms of context, it is also critical that this period of Chinese growth includes a massive debt bubble.  In fact, according to Reinhart and Rogoff, in the late 1990s:

 

"China's four large state owned banks, with 68% of banking system assets, were deemed insolvent.  Banking system nonperforming loans were estimated at 50%." 

 

So, despite the Chinese financial system basically being insolvent in the late 1990s, Chinese GDP never dipped below 6%!

 

We certainly mean no disrespect to Professor Rogoff, but as we have found, and not dissimilar to his analysis of rating agencies, when academics start to call the markets, it is more often than not a contrary indicator.  Not a shot at Rogoff, but just a fact of reality. Timing is everything in this business.

 

Daryl G. Jones

Managing Director

 

Rogoff’s Two Percent Prediction - china29

 


MCD FACING TOPLINE PRESSURE

As we discussed in our 2/24/10 post, “MCD – NEGATIVE $ MENU POINT”, MCD is using significant discounting to drive transaction counts during the breakfast day part.  MCD comparable store sales trends have been in decline since October and, while it seemed that discounting initiatives would help stymie the decline in the company’s comps, it seems clear that this will be a difficult task until (at least) June or July. 

 

The success of the current dollar menu at breakfast will not be enough to turn around the deceleration in top line trends in the USA.    

 

MCD FACING TOPLINE PRESSURE - Mcd US

 

In Europe, MCD is seeing slowing sales trends also.  The most recent economic data points from Germany suggest that this trend is likely to continue for the immediate future.  In addition, The China Daily reported today that MCD is now accepting some coupons issues by other fast-food chains at its China stores.  The promotion began on February 24th and ends on March 23rd.  McDonalds has also cut prices on some products in the midst of severe competition with QSR rivals, local, and street vendors.  In 1H10, lower commodity costs will somewhat offset the top line pressure in margins.  See below for charts on Europe and APMEA top line trends. 

 

MCD FACING TOPLINE PRESSURE - mcd europe

 

MCD FACING TOPLINE PRESSURE - MCD APMEA

 

 

 


R3: February Shaping Up Nicely

R3: REQUIRED RETAIL READING

February 26, 2010

 

February is shaping up to be a solid month for both athletic footwear and apparel, with the latest data points showing a slight acceleration in trend. Additionally, most retailers reporting earnings over the past couple of weeks (across a wide range of product categories) are noting that February has been solid, even with record snowfall.

 

 

TODAY’S CALL OUT

 

By now you we hope that you have seen at least one announcement for our 11 AM conference call this morning to discuss one of our top ideas for 2010, Nike (if not, please contact for access). In addition, we’ll be releasing our Blackbook, which takes an in-depth look into how the company’s actions over the past three years are now setting up for an re-acceleration in earnings growth.

 

We have plenty to discuss later today, but in the meantime we thought it would be useful to take a quick look at the latest weekly data points for the athletic apparel and footwear sectors. Bottom line, February continues to be a solid month for both product categories. We’d also point out that strength in February, despite abnormal snowfall across much of the country, has been consistently noted by retailers that have reported earnings over the past couple of weeks.

 

THE WEEKLY UPDATE

 

Athletic footwear industry dollar sales growth accelerated sequentially by +200bps for the week ended 2/21. On a rolling three-week basis, the rate of industry sales growth has accelerated on the margin, which is consistent with sports apparel trends in the sporting goods channel, as well as ICSC weekly retail sales.

 

On the brand front, this week’s data shows a slight divergence between Nike Brand dollars sales and the sales of Brand Jordan and Converse. The latter two have both shown decelerating trends over the past couple of weeks. Under Armour dollar sales improved markedly for the week, increasing by 5.9% (after being down about 3% month to date). We expect this trend to continue as the company’s comps become sequentially easier over the next month or so.

 

R3: February Shaping Up Nicely - 1

 

R3: February Shaping Up Nicely - 2 

 

As a reminder we will be hosting a conference call today, Friday (2/26) at 11am highlighting one of our Top Ideas for 2010 – Nike. Please contact to request access.

 

 

Eric Levine

Director

 

 

LEVINE’S LOW DOWN

  • In advance of the launch of Carter’s first e-commerce effort in the first half of this year, management noted that they already have a head start on target marketing. The company has an above-industry standard capture rate of 80% for gathering customer information (email addresses, etc…) in its stores. Additionally the company’s customer database doubled in 2009. Management believes it is not unreasonable to assume the .com business can be a $100 million business with 10% EBIT margins over a five year time frame.
  • Kohl’s highlighted very strong growth in its e-commerce business in 2009. The platform delivered a 38% increase in sales on top of a 48% increase in 2008. Total sales for the business are now $500 million. Given the rapid growth, management indicated it will be investing in additional infrastructure to support future growth as well. Interestingly, Kohl’s now believes its online opportunity is substantially greater than it originally envisioned.
  • Steve Madden indicated that it expects the boot trend to continue in 2010, but with different styles than those that drove strength in 2009. Additionally, the company noted that the men’s casual category is seeing a dramatic rebound.
  • Safeway’s CEO Steve Burd indicated that there are some signs that the company’s customers are beginning to trade up in certain more discretionary categories. Evidence of “trading up” is taking place in the company’s floral departments, where volumes have picked up dramatically. Additionally, the company continues to see an uptick in its licensed Starbucks locations as well is trading up within its wine department.
  • Gap indicated that it will not being returning to television this Spring with an advertising campaign. Management also noted that while TV ads during the holiday did have some return, the impact came in at the lower range of expectations. Advertising and marketing for the Gap brand will be centered around denim for the Spring.
  • Decker’s management indicated that the company is more focused on acquisitions than they have been in the past, especially with a growing cash balance. The company believes they are now in a position to look both larger potential deals as well as lifestyle brands that lead with either apparel or footwear. 

 

MORNING NEWS

 

Li & Fung Buys UK Producer - Li & Fung Ltd. extended its U.K. reach Thursday, acquiring Manchester-based private label producer Visage Group Ltd. for as much as 173 million pounds, or $266.9 million at current exchange. Bruce Rockowitz, president of the Hong Kong sourcing giant, said the deal would generate business with the majority of leading British retailers. “This acquisition dramatically strengthens LF Europe’s growth platform,” Rockowitz said. “It will add substantial scale to our existing operation and further our objective of developing a significant European onshore presence.” Visage designs and produces men’s, women’s and children’s apparel for high street and mass retailers in the U.K. The firm, which has about 500 employees and branch offices in Hong Kong, Shanghai, Guangzhou, Dhaka and Delhi, posted profits of 14 million pounds, or $21.6 million, for the year ended Jan. 31. Annual sales tallied 186 million pounds, or $287 million. The initial purchase price was 57.5 million pounds, or $88.7 million, and future performance-based payments could total up to 115.5 million pounds, or $178.2 million. Li & Fung funded the deal itself. Shares of the firm dipped 0.1 percent to 35.70 Hong Kong dollars, or $4.60, Thursday. This is the latest in a string of acquisitions for Li & Fung. Although it has a cash stockpile of about $1 billion and an itch to buy, the firm has also been cutting sourcing deals with companies such as Wal-Mart Stores Inc., Hudson’s Bay Trading Co. and Liz Claiborne Inc. <wwd.com>

 

John McCarvel Named President and CEO of Crocs - Crocs, Inc. promoted John McCarvel to president and chief executive officer effective March 1, 2010. He succeeds John Duerden, who is retiring from the company and resigning as president and CEO and also from his position on the company's board. Duerden will assist with McCarvel's transition as needed. McCarvel has spent the last six years in various executive management positions at Crocs, serving as chief operating officer and executive vice president since 2007. Previously, McCarvel was senior vice president for global operations from October 2005 to February 2007, and as vice president for Asia from January 2005 to September 2005, after providing consulting services to Crocs during 2004. "In 2009, we made significant progress in strengthening both our financial position and our market position," said Richard Sharp, Crocs chairman of the board. "John Duerden has led this remarkable turnaround. With his leadership, we have taken steps to strengthen our product line, re-engage the consumer and reposition our iconic global brand. We also have improved our capital structure and liquidity significantly, repaid all of our debt and entered into a three-year asset-backed securitization agreement. On behalf of our board, I want to thank John for his leadership and contributions during the past year."  <sportsonesource.com>

 

Skechers Expanding Across the Globe - After launching a subsidiary in Brazil and establishing a successful joint venture in China, Skechers USA Inc, the California-based lifestyle footwear brand announced the launch of the fashion footwear brand Skechers in India. Along with its current distribution in Indonesia and powerhouse brand status in the United States, the launch in India will establish Skechers as a global footwear leader with a major presence in the world’s five most populated countries. Skechers will be available at leading footwear multi-brand footwear retailers such as Regal, Metro, Lifestyle, Planet Sports, Pantaloons and Central and other leading footwear and department stores across India.  SKECHERS USA,also announced that the Company has opened a flagship store in the heart of Covent Garden, London’s premier destination for culture and leisure. Exclusively located on the Royal Opera House property across from the famed Covent Garden Market, the new SKECHERS location is a central magnet for shoppers worldwide. “SKECHERS Covent Garden is the ultimate sales and branding tool,” said Michael Greenberg, president of SKECHERS. “Consumers can’t get enough of this world-famous district because it’s known for having it all – shops, restaurants, architecture, entertainment. And now, it’s also got SKECHERS – which means that millions of new customers and fans of the brand can enter our world, try on our styles, buy our product, and take the SKECHERS experience home to their countries.” Designed to infuse the Opera House’s architectural design with SKECHERS’ sensory retail philosophy, the flagship store showcases sculptured gypsum wall panels and premium solid black oak flooring, as well as signature SKECHERS looks such as blue florescent acrylic wall displays and table tops, LCD screens, color-changing LED lighting, and light box graphics. <businesswire.com>  <indiaretailing.com>

 

 Conaway Fined $10M in Kmart Case - A federal judge on Thursday ordered former Kmart chief executive officer Charles Conaway to forfeit more than $10 million for deceiving shareholders, but stopped short of banning him from future front-office jobs altogether. In June, a jury found that Conaway had misled investors in the run-up to the retailer’s 2002 bankruptcy. The verdict came after a civil trial in U.S. District Court in Ann Arbor, Mich., over a 2005 Securities and Exchange Commission lawsuit. In his opinion on remedies in the case, U.S. Magistrate Judge Steven D. Pepe ordered that Conaway repay a $5 million retention loan Kmart gave him and eventually forgave, $2.6 million in interest and a $2.5 million civil penalty. Pepe ruled against an SEC motion that sought to prohibit Conaway from working as an executive at a public firm. “I was considering a 10-year injunction or bar from the time of the offense,” Pepe wrote in his 70-page ruling. “Yet, in reality I cannot find that there is a realistic likelihood that Mr. Conaway in the short term will be hired to serve as an officer or director of a publicly traded corporation given the serious damage to his reputation this case and the jury’s findings have caused him.” Conaway’s attorney, Scott Lassar, said Thursday he was “very disappointed” by the ruling and noted an arbitration panel had exonerated his client before the SEC filed suit.  <wwd.com>

 

H&M Launches Sustainable Line - The fast-fashion retailer’s theme of flowers and nature for spring will be delivered to all U.S. stores on March 25 with The Garden Collection, its first fully sustainable line. The bright designs made from organic cotton and linen, recycled polyester and Tencel feature prints with splashes of deep color, generous embroidery and rosettes and appliqués on shoulders, skirts and necklines. When H&M began manufacturing apparel made from organic cotton in 2004, it unveiled a goal of increasing its organic cotton use by 50 percent each year through 2013. The retailer last year used 3,000 tons of organic cotton, a spokeswoman said, adding: “We want to invest in a better environment.”  The Garden Collection, she said, is also “a response to demands from our customers.” “The demand for organic cotton is much higher than the supply, globally,” the spokeswoman said. “All retailers are attempting to add more organic materials to their collections. We are also trying to broaden the range of sustainable materials that we use, including recycled wool and recycled polyester, which is made from recycled PET [polyethylene terephthalate] bottles and textile waste.”  <wwd.com>

 

Debenhams Eyes More Acquisitions - Debenhams, the U.K.'s second-largest chain of department stores, has said it may acquire more chains, in a similar move to its acquisition of Denmark's Magasin du Nord in January for $19 million. Expansion this way would leave the retailer less dependent on the slack U.K. market. Debenhams is rolling out its strategy of featuring exclusive designer ranges to branches of Magasin du Nord, which is a more upscale shop than the U.K.'s Debenhams. Debenhams has 142 shops in the U.K., and until the acquisition, just 11 others in Ireland and about 50 run by franchise partners elsewhere. The chain said that franchising was another route. Four new Debenhams-branded outlets are due to open in the spring in Slovakia, Egypt, Malta and Azerbaijan. <licensemag.com


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WYNN LOSING A LITTLE MASS APPEAL

The conf call discussion conveniently omitted high hold and market share decline in the Macau Mass segment.

 

 

We found the quarter somewhat disappointing.  Not so much Las Vegas, which was a disaster, but more Macau and more specifically, Wynn Macau’s Mass performance.  Wynn Las Vegas/Encore was legitimately bitten by the low hold bug and normalizing hold would’ve resulted in EBITDA in-line with our projection.

 

Wynn Macau EBITDA of $142 million was right in-line with our estimate so why are we disappointed?  Well, we knew Mass revenues were going to be north of $500 million but we didn’t know that the property played as lucky as it did.  Indeed, Mass volume at Wynn Macau was only up 5% in Q4, which means the property lost a lot of market share in Q4.  Hold percentage was 290bps above the midpoint of the normal range which benefited the property by about $8 million in EBITDA.

 

The high Mass hold was not discussed on the conference call.  Rather, management pointed out that low hold cost Las Vegas $14 million in EBITDA, and VIP hold in Macau was at the low end of the range (resulting in only a $3 million EBITDA hit per our calculation).

 

Back to the Mass market share issue:  in Q4, Mass revenue for the Macau market increased 35%.  We don’t know what the overall hold was for the market but the law of big numbers tells us it was probably closer to normal than Wynn Macau's.  Wynn only grew its Mass volume by 5% while overall Macau Mass revenue increased 35%.  That’s a pretty big drop. In January, we know that the overall Mass business grew 42%, but Wynn Macau only generated a 2% increase.  We don’t know what Wynn’s hold % was in January but it would have to be extremely low to fully explain the loss of market share. It does look like Wynn’s overall market share will bounce back a bit in February but we don’t have the details yet.

 

In the following chart, we’ve normalized Wynn’s Mass revenue for variances in hold percentages – 20% is assumed normal.  The market share degradation can be clearly seen.

 

WYNN LOSING A LITTLE MASS APPEAL - wynn macau normalized mass market share

 

Why do we care so much about Mass market share?  Wynn does very well in VIP but the profit margins are so much higher in Mass.  Moreover, we are expecting a pretty sharp deceleration in VIP volumes for the market, consistent with past tightening of liquidity and sequential economic slowdowns in China.  Also, comparisons get more difficult in 2H 2010. 

 

In the interest of objectivity, we would point out that management’s Q1 commentary was very positive regarding Macau.  However, we already know that Macau revenues ytd are up about 60% so this should not be a surprise.  What may surprise people is that Wynn Macau’s revenues are likely up less than that of the market.  Due to low hold and Mass volume share declines, Wynn Macau was able to generate a revenue increase of only 27% in January vs. the market at 66%.


THE M3: LOWER UNEMPLOYMENT RATE

The Macau Metro Monitor, February 26th, 2010


EMPLOYMENT SURVEY FOR NOVEMBER 2009 - JANUARY 2010 DSEC

Macau's unemployment rate for November 2009 - January 2010 was 3.0%, a gradual improvement from 3.1% from October-December 2009 period and a 0.4% improvement YoY. The underemployment rate was 1.7%, lower than the 1.9% from the previous period and a decrease of 0.1% YoY. Labor force participation rate stood at 70.8%, a 2.1% drop YoY. Analyzed by industry, employment of the Manufacturing Sector and Restaurants & Similar Activities increased from the previous period, while that of Wholesale & Retail Trade registered a decrease. The number of the unemployed decreased by about 400 from the previous period to 9,500.


Fashionable Fear

“There is nothing new except what is forgotten.”

-Rose Bertin

 

Marie-Jeanne Rose Bertin was the first fashion designer of consequence in Europe’s 18th century. Some argue that she deserves to be credited with bringing “haute couture” to our lives.  Bertin’s success story is an inspiring one. She didn’t come from much. She didn’t do group-think.

 

As our in house fashionistas, Eric Levine and Mick Malisic, often remind me, popular culture finds its way into and out of our wardrobes. Fashion, like investing, is cyclical. The faces and the names may change, but inspirations are often born out of “what is forgotten.” This is a great metaphor for measuring the amplitudes and durations of market risk.

 

On Wednesday, I titled my strategy note, “Selling Fear” – and that’s exactly what the manic media delivered to you yesterday. This was proactively predictable. Selling Fear is currently very fashionable and I think that you should continue to capitalize on understanding that.

 

Let’s start with what’s become the most consensus fear in the Federal League – sovereign debt default in Greece. Yesterday was unique in that you saw two huge contra-indicators permeate the market’s early morning trading at the same time:

  1. Fears of Moody’s and S&P downgrading Greece’s debt rating
  2. Fears of 3 million Greeks striking in the streets

So, let’s consider the second fear first, because the groupthink associated with it is the most glaring. Anyone with a college education knows that Greece is not a large country. There are only 11.3 million people in Greece, so when you see 3 million of them on strike, it’s neither a positive event or a unique thought to consider it one. Both the Greek stock and bond markets have been discounting this national strike for weeks. Mr. Macro Market looks forward.

 

The first fear is what Harvard’s Ken Rogoff himself labeled the “worst early warning indicator of banking and currency crises” (for those of you who have the reference material for Sovereign Debt For Dummies on your desk, Reinhart & Roggoff have Moody’s sovereign ratings outlined in a nice table for us on page 280).

 

Now any real player knows that Moody’s and S&P are contra-indicators in this global macro game of risk management. What’s most frightening about this week is that the peak in fears about Greek debt defaults were, in fact, partly driven by Ken Rogoff himself! (The #1 Bloomberg headline on Tuesday morning was “Harvard’s Roggoff Sees Bunch of Sovereign Defaults”).

 

David Einhorn at Greenlight Capital recently gave a speech where he too outlined the implied value of Moody’s as a contra-indicator. In his speech at the Value Investing Congress on October 19, 2009, he captured the reality of Moody’s Perceived Wisdoms with this:

 

“My firm recently met with a Moody’s sovereign risk team covering twenty countries in Asia and the Middle East. They have only four professionals covering the entire region. Moody’s does not have a long term quantitative model that incorporates changes in the population, incomes, expected tax rates, and so forth.”

 

Canadian hockey knucks to Mr. Einhorn for backing up the risk management point that both we and Ken Rogoff have signed off on. Marked-to-market prices are the best leading indicator of risk. Moody’s remains a lagging groupthink indicator, at best.

 

So what do we see this morning from a real-time price perspective that’s bullish?

  1. Greek credit default swaps (CDS) are making lower-highs
  2. Greek bond yields are making lower-highs
  3. Greek stocks are making higher-lows

Hmmm… I wonder what those who were dressed up like Marie Antoinette talking about their revisionist risk management process on CNBC yesterday have to say about that? Risk management works on both sides of the puck folks. Backcheck – Forecheck – Paycheck! Beware of those one way players Selling Fear.

 

I have taken this week’s global fear factor as an opportunity to invest 12% of the cash in the Asset Allocation Model into global equities and currencies. Our cash position has dropped from 67% at the beginning of the week to 55% this morning. I now have a 9% and 3% asset allocation to US and International Equities, respectively.

 

My immediate term support and resistance lines for the SP500 are now 1093 and 1119, respectively.

 

Best of luck out there today and go Canada and USA hockey tonight!

KM

 

LONG ETFS

 

FXC – CurrencyShares Canadian Dollar — Canada's currency was on sale on 2/25/10 and we are bullish on the Loonie's long term TAIL, at a price. Look for rate hikes in Canada in the coming 6-9 months.

 

TUR – iShares Turkey — Turkey has been pounded in the last week and fears were delivered upon with the inside information of 40 retired military officers arrested on 2/24/10. We'll buy the fear for a trade. The long term TAIL for Turkey is bullish, from a price.

 

XLF – SPDR Financials — With sentiment negative and a Piggy Banker Spread hitting a record wide spread on 2/23/10, we bought red.

 

XLK – SPDR Technology — Technology is underperforming the SP500 YTD; a down day on 2/22/10 prompted us to buy more. We expect to see some positive mean reversion for Technology as M&A picks up.

 

UUP – PowerShares US Dollar Index Fund — We bought the USD Fund on 1/4/10 as an explicit way to represent our Q1 2010 Macro Theme that we have labeled Buck Breakout (we were bearish on the USD in ’09).

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 mispriced and that TIPS are a efficient way to own yield on an inflation protected basis.
 

SHORT ETFS

 

GLD – SPDR Gold We re-shorted Gold on this dead cat bounce on 2/11/10. We remain bullish on a Buck Breakout and bearish on Gold for Q1 of 2010, as a result.

 

XLP – SPDR Consumer StaplesGiven how many investors own Consumer Staples stocks because it was a "way to play the weak US Dollar" last year, we have ourselves another way to profit from a Buck Breakout with this short position.

   

IEF – iShares 7-10 Year TreasuryOne of our Macro Themes for Q1 of 2010 is "Rate Run-up". Our bearish view on US Treasuries is implied.


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