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Bond Bubble?

Andrew Mellon, the banking icon, once famously said: “Gentlemen prefer bonds.”  The implication of this statement was likely that bonds, while less sexy than equities, will generate a predictable return for investors, and not put their investments at serious risk of capital impairment.  Ostensibly the latter part is true since bonds sit higher up in the capital structure and therefore have inherently more downside protection.


Asset allocation decisions are made based on a multitude of factors.  The correct allocation with the appropriate timing can ensure both capital preservation and capital growth for investors.  In the construction of a diversified portfolio, a critical decision relates to the appropriate percentage of allocation to bonds versus equities, and versus other asset classes of course.


Investors have effectively three choices as it relates to bond, or fixed income, allocation: government bonds (all levels of government), investment grade bonds, and junk bonds. In theory, the credit worthiness occurs in that order as well, and yields inversely reflect credit worthiness.  So government bonds will have lower yields than similar duration corporate bonds, and vice versa.


According to the Investment Company Institute, investors have poured almost $400 billion into bond funds since the start of 2009 and in aggregate there is more than $2.2 trillion invested in bond funds. As a result of this massive inflow of money into bond funds and the government’s purchase of government bonds as part of its quantitative easing program, yields in the bond market have come down substantially since the credit crisis of late 2008.  So, given the massive inflow into bond funds over the past, the question remains: are we in a bond bubble?


The answer is nuanced.  From a longer term perspective, bonds are, broadly speaking, at near all-time lows in yield. In particular, given the current loose monetary policy being implemented by the Federal Reserve, Treasury bonds are at close to all time lows in yield, and therefore highs in price.  Given this extreme in Treasury bond pricing, there is clearly bubble potential in the U.S. government bond market.


A quick Google search of “Bond Bubble” indicates that pundits have been suggesting bonds are in a bubble very consistently for the past three years. While it is easy to make a call that an asset class is in a bubble, it is more difficult to be accountable to the timing of such a call.  In addition, a bubble inherently implies that the unwinding of that bubble will be a crash.  So far the pundits have been wrong both counts.


We’ve charted the spread of corporate junk bonds bond versus 5-year treasuries and corporate investment grade bonds versus 5-year treasuries going back to 2002 (which is the inception of the Bloomberg bond indices). Interestingly, while yields for both investment grades and junk bonds are close to their lows in yield for this period, currently at 8.24% versus their low of 7.75% for junk bonds and 4.7% versus their all time low of 4.5% for investment grades, the spreads between 5-year treasuries remains relatively wide.  In fact, these spreads bottomed in 2007 at 0.93% for investment grade and 3.1% for junk, versus their current spreads of 2.30% and 5.74%, respectively.


Since the price of bonds should never be taken in isolation, if there is a bubble in bonds, it is likely related to Treasuries.  The case for the Treasury bubble is effectively three fold.  First, as mentioned, they are being priced based on extreme monetary policy that will not be sustained in perpetuity.  Second, they are incorporating very limited expectations for inflation, which we believe will occur and perhaps in dramatic fashion.  Finally, government bonds will eventually have to reflect the declining credit worthiness of the Unites State based on the United States’ deficit as a percentage of GDP and growing debt to GDP ratios.


Treasury bonds cannot stay at their current yield level forever.  And while we have seen some correction, yields and prices for U.S. government bonds are still at generational extremes.  In reality, though, just as it took decades for interest rates to come down from the meteoric highs of the 1980s, it will take interest rates time to go up, and it is likely that no crash is imminent. This move will be long and sustained.


From an investment perspective, the most effective way to play the re-pricing of Treasuries over time is to be short Treasuries out right, or to play a narrowing of the spread between treasuries and corporate bonds.


The reality is, gentleman only prefer bonds at the right price.


Daryl G. Jones

Managing Director


Bond Bubble? - hy





Malaysia’s consumer prices climbed 1.3% year-over-year in March, after gaining 1.2% in February.  The FTSE Bursa Malaysia Index traded flat last night and is up 5% year-to-date.  Consistent with inflation trends across Asia, most Asian central banks are starting to remove the emergency monetary stimulus implemented last year as inflation returns with stronger regional economic growth. 


India has raised interest rates twice since Malaysia increased borrowing costs on March 4, and Singapore said this month that it will allow its currency to strengthen.


One of our most admired central bankers, Australia’s Glenn Stevens, takes the prize for the most aggressive round of interest-rate increases and he is balancing the risk of faster inflation against a growing economy.  In a speech overnight he said “Our task is now to manage a new economic upswing and this will be just as challenging, in its own way, as managing the downturn.”   The central bank’s next meeting is in early May.  Next week’s reading on first-quarter inflation will have a big impact on the direction of interest rates in Australia.  Last night, the Australian Index was down 0.5% and is marginally higher on the year. 


Howard Penney
Managing Director




MPEL should beat the Street slightly, and 2010 numbers look like they need to go higher



MPEL is reporting next Wednesday before the market open, and they should report a solid quarter. We think MPEL will beat the street's estimate of $91MM of EBITDA by $4MM. This should be the first quarter where neither property has 'hold' issues, so there should be a good read through on what normal operating costs and business leverage look like. If CoD can keep ramping and if Altira stabilizes, then MPEL should handily beat Street numbers and will likely prove to be the cheapest way to play Macau out of all the US listed companies.


For those of you that like the details on our assumptions, please see below.


City of Dreams

  • Net revenue of $347MM 
  • EBITDA of $68MM 
  • RC volume of $10.4BN and 2.9% hold 
  • Mass win of $103MM 
  • Slot win of $24MM
  • Net casino revenues of $335MM, $30MM of non-gaming revenues and $18MM of promotional expenses
  • Variable expenses (primarily taxes & junket commissions that aren’t recorded in net revenues) of $213MM, $11MM of non-gaming related costs, and $55MM of fixed costs (fixed costs were $53MM last quarter)


  • Net revenue of $198MM 
  • EBITDA of $20MM 
  • RC volume of $9.8BN and 2.8% hold 
  • Mass win of $13MM 
  • Net casino revenues of $200MM, $9MM of non-gaming revenues and $10MM of promotional expenses
  • Variable expenses (primarily taxes & junket commissions that aren’t recorded in net revenues) of $153MM, $3MM of non-gaming related costs, and $23MM of fixed costs

Mocha Slots

  • Net revenue of $27MM 
  • EBITDA loss of $7MM


  • Net interest expense of $19MM (compared to guidance of $20MM)
  • D&A of $75MM, including amortization of the gaming concession and land use rights (in line with guidance)
  • Pre-opening expenses of $5MM

4Q09 YouTUBE

  • “Going forward into 2010, I believe our business is in its best shape yet. We are on a solid positive trajectory with significantly improved mass market trends at City of Dreams and a return to strong rolling chip levels under a more profitable commission environment at Altira.”
  • "I’m confident that 2010 will be a great year for us particular given the positive economic outlook in China, the strong political support from both the Macau SAR and the central government and also the geographic advantage that Macau enjoys."
  • “Rolling chip levels have since rebounded and in January, Altira Macau generated 30 billion of turnover exceeding the average monthly load of 25 billion during 2009. Altira Macau earned over US$10 million dollar of EBITDA in the month of January 2010, our best monthly performance of this property since October 2008.”
  • “Now on to City of Dreams, mass market table drop was essentially flat between October and the seasonally weaker November last year. Drop volume improved by 14% sequentially into December breaking a US $150 million for the first time. The performance of our mass market business steps up again in January of this year. Mass table drop increased 11% sequentially from December to over 170 million for the month and mass table revenue increased 20% sequentially to approximately US $31 million. This is translated into improved profitability at City of Dreams. We generated over US$30 million in EBITDA in January of this year.”
  • “We expect to see continued improvement as occupancy at Grand Hyatt approaches to 90% plus levels, which we consistently achieve at Crown and Hard Rock.”
  • “If we normalize fourth quarter EBITDA using 2.85%, the midpoint of the commonly expected VIP home range, we would have reported US$56 million of adjusted EBITDA.”
  • “Guidance on non-operating line items for the first quarter of 2010. Depreciation and amortization cost is expected to be approximately US$75m. Net interest expense in the first quarter is expected to be approximately US$20m. Pre-opening expense will be approximately US$5 million, related entirely to the ongoing pre-production of our House of Dancing Water Theater show which will open to the public in about six months from now.”
  • “City of Dreams has got about 20% of its business being done direct.”

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New home sales exploded in March, beginning what we think will be a major buying push that will run through the next few months as the lagged data around the homebuyer tax credit comes trickling through. Remember, we're now just one week away from the expiration on the tax credit. The March data released this morning came in at 411k (seasonally adjusted annualized rate) vs. consensus for 330k and last month's print of 308k (the lowest level in 12 months).






Inventory fell to 6.7 months from 8.6 months last month (downwardly revised from 9.2 months). While inventory is down significantly off its 1H09 highs in the 11-12 months range, it is still above its normalized range of 4 months.




As was the case with yesterday's existing home sales print, this March print is a lagging indicator as it reflects deals closed two to three months ago (Jan/Feb). In our view, the relevant benchmark is how it compares with August 2009's print of 408k. Against that measure, it's flat. The original tax credit expired in November, 2009, putting August 3 months ahead of that expiration. The current credit (for closing) expires June 30 (April 30 for signing), which means 3 months ahead equals March.


To reiterate our message from yesterday, we continue to expect a pull-forward of activity not unlike what we saw going into last November. However, in the real world of non-lagged data, this means buying activity will have to be wrapped up in the next 7 days. The NAR has indicated that the tax credit has done its job and that a further round of stimulus won't be necessary. We think the jury is still out on that, and we remain rather skeptical. Our view is that this pull forward of activity is setting the stage for a much weaker-than-usual summer housing environment where inventory could back up into the 1H09 levels of the 11-12 months.


Here's a chart showing sales levels in historical context.




And this chart shows inventory levels in historical context.





Joshua Steiner, CFA


Allison Kaptur



Below I have attached a note that doesn’t come to you this morning with a smile from Washington, DC. I’d like to thank one of our rising star healthcare analysts, Christian Drake, for the V-spotting picture of Hospital Services inflation.


Healthcare inflation, of course, isn’t weighted in the CPI in a way that would make a difference to Ben Bernanke’s conflicted and compromised view of “reported” core inflation. Things like “owners equivalent” rent depress the reported inflation numbers at the same time as local government’s inflate your property taxes. How do you like them apples?


Virtually every inflation chart we look at currently emphasizes our Q2 call for Inflation’s V-Bottom.



Keith R. McCullough
Chief Executive Officer


V-spotting - obama

R3: Earnings Creep


April 23, 2010





Earnings season across the retail , apparel, and footwear space is hard to define. At the moment we’re in a period which one may describe as the “Creep”- essentially the build up into the bulk of earnings, and usually the period where the Street looks to take direction for the results on the horizon. With that said, there were a few interesting callouts from the past day or two:


-Decker’s management (and results) were about as bullish as we can remember as it pertains to the Teva Brand. After about five years of efforts to reposition the brand as an outdoor lifestyle product beyond the traditional open-toe sandal, results are beginning to take hold. Sales for the resurgent brand were up 21%, with the company noting that Teva is gaining share as well as traction with a younger demographic. Recall that the big challenge for the brand has been to create credible closed-toe offering, something that is now working in both Spring and Fall (as indicated by the backlog commentary).


-COLM’s backlog was up a strong 19% for the Fall. Importantly, management noted that part of the strength can be attributed to the company’s focus on innovation via the Omni-Heat platform. While the technology is still not proven from a retail sell through standpoint given its impending Fall launch, the company expects to support the product with an extensive integrated marketing effort. Plans call for in-store graphics and fixtures, print and online campaigns, as well as the company’s first new television commercials in two years.


-After indicating that sales momentum was “absolutely encouraging” in March, Sherwin Williams management went on to note that trends have continued into April. Interestingly, there is a bit of a catch-22 with the strengthening of the topline across the industry. Management noted that tight supplies of raw materials in the wake of improved sales will likely keep pressure on costs at least until the back half of the year.


-J Crew’s creative director was on Oprah on Wednesday, with the most interesting part of the segment revealing that Oprah herself is long some good old JCG in her PA. Even better will be the boost she gives the quarter as a result of loyal viewers heading out to purchase J Crew wares as seen on TV. It almost sounds like a conflict of interest on Oprah’s part. In all seriousness, it will be interesting to see if the show has any impact in light of Oprah’s history of having a positive sales impact on other brands in the past. Payless and Deckers are two that come to mind. 


-While the consumer electronics industry and retailers alike are excited about the prospects for 3D TV (and the ability to charge more), another technology is also getting a boost. South Korea’s LG, is ramping up production and investment in OLED- a technology that offers the ability to offer very high contrast ratios, deep black levels, all in a very, very thin profile. The technology is not backlit, which allows for such features. Currently, the technology is expensive to produce and is only available in smaller screen sizes. LG’s investment should pave the way for faster adoption over the next 3 years.


Eric Levine






 R3: Earnings Creep - Calendar





Adidas Preannnounces Large Upside - Adidas Group said its preliminary results for the first quarter showed a 4% gain in sales and significant improvement in profitability. The better-than-expected results prompted Adidas to lift its full-year profit outlook to €2.05 - €2.30, up from its previous guidance of €1.90 - €2.15. Guidance was raised due to better than expected sales and margin with increased gross margin and operating expense leverage.


Largest Hong Kong Listed Clothier Sees Sales Declines Due to European Weakness- Esprit Holdings Ltd. said fiscal nine-month sales fell 1.8% as households in Europe, where it makes 84% of revenue, curbed spending. Consumer confidence in Europe remained weak in the first quarter. February retail sales in the 16-nation Euro region declined 0.6% from January, when they decreased 0.2%, the European Union’s statistics office in Luxembourg said April 8. Sales in Asia rose 5.8% and gained 8.4%. Espirit is pushing expansion in China where it says margins are similar to those in Europe. The company has bought out partner China Resources Enterprises Ltd.’s stake in their Chinese textile venture. <bloomberg.com/news>


UA Hires Senior VP of Apparel - Under Armour announced that Henry Stafford will join the company as senior vice president, apparel in June 2010. Stafford has extensive experience in the apparel industry, which includes top positions with American Eagle Outfitters and Old Navy. <sportsonesource.com>


Sears to Operate Edwin Watts Golf Shop in Shops - Sears Holdings Corp. signed an agreement with Edwin Watts Golf Shops LLC to operate 12 golf shops inside Sears stores. The shops, ranging from 2,700 to 3,000 square feet, will be located near Sears electronics, tools and sporting goods department. <sportsonesource.com>


Should Nike Drop Ben Roethlisberger? - This much is clear. However long Nike's contract with Pittsburgh Steelers quarterback Ben Roethlisberger is, the allegations against him (even if they won't be prosecuted), will assure us that Nike will never use him in a commercial again. Why doesn't Nike drop Ben now? The short answer seems to be that Nike doesn't sever contracts with athletes who haven’t committed a crime or haven't been found to use performance enhancing drugs. And without Roethlisberger being charged or convicted of sexual assault, he fits the bill of still staying under the Nike athlete roster. In July 2007 when Michael Vick was charged in a dogfighting scheme, Nike suspended his contract without pay. But it wasn’t until after he pleaded guilty, that Nike terminated its contract with him. <cnbc.com>


Brazil the Next Hot Spot for Luxury Brands? - Brazil might not offer luxury brands the same potential in terms of size as Russia, India or China, but it provides more near-term opportunities for expansion. Events such as the 2014 World Cup and the 2016 Summer Olympics, both to be held in Rio de Janeiro, could significantly boost local markets and justify additional openings. Although it is Latin America’s biggest economy, Brazil is often overlooked because its population of 192 mm is lower than that of China and India, which both top the one billion mark. Luxury retail distribution is extremely limited, with more than one-third of the companies in a sample of 15 leading luxury brands having no direct retail presence in the country. More than three-quarters of luxury stores are located in the financial hub of São Paulo, mainly in upscale malls.  Brands with no retail presence in the country, such as Prada, Fendi and Burberry, have the option of entering via São Paulo and expanding from there. <wwd.com/business-news>


China Imposes Nylon Tariff - China imposed punitive tariffs on nylon imported from the U.S. and other countries on Thursday, alleging the goods damaged its domestic industry. The Ministry of Commerce said China will impose antidumping tariffs ranging from 4% to 96.5% on nylon-6 imported from the U.S., the European Union, Russia and Taiwan, according to state media reports. Antidumping tariffs are applied when imported goods are sold for less than fair market value or below the cost of manufacture.  Nylon-6, also called polycaprolactam, is used to make products such as hosiery and knit apparel. The nylon tariffs will be in place for five years, extending temporary duties China established last fall. According to the International Trade Commission, in 2009 the U.S. exported $189.6 mm of polycaprolactam chips, which includes nylon 6.  <wwd.com/business-news>


Vietnam's Textile Industry Harmed by Rising Cotton Prices - Vietnam Textile and Apparel Association reports that cotton price is estimated at USD$1.9-$1.92 per kg now, a 35% increase from January, and up to 50% jump in comparison with the same period last year. The price of imported cotton has been soaring since the beginning of the month. The local textile and garment production which relies heavily on imported cotton is threatened by the surge of cotton price. Furthermore, it makes worse situation for those Vietnamese enterprises signed contracts with international partners before the price increase, leading to further profit reduction. <fashionnetasia.com>


BOOT Grows Sales 32% - Sales in the workboot market jumped 38% to $26.3 million, while outdoor market sales increased 15% to $7.9 million. “We’re very pleased with our strong sales and earnings growth in the first quarter of 2010, driven by increased demand across our different channels and markets,” said Joseph Schneider, president and CEO of LaCrosse, in a written statement. “We saw very strong demand from various branches of the U.S. government due to the continued strengthening of our customer relationships throughout the government channel and our strong execution in exceeding their delivery timetables. We also saw much stronger at-once demand from our wholesale channel partners during the first quarter, reflecting the improved consumer spending environment and success of our core products.”  <wwd.com/footwear-news>


R3: Earnings Creep - BOOT SIGMA


Rocky Brands Reports Unimpressive Margins, Impressive Sales-Inventory Growth Spread - Net sales rose 12%, wholesale revenues advanced 5% and retail sales declined 5.8%. “Our first-quarter results were above internal and external projections driven by higher sales in our wholesale and military segments combined with improved operating expense leverage,” said Mike Brooks, Rocky chairman and CEO, in a written statement. "With regard to our bottom line, the seasonality of our business makes it difficult to realize positive earnings during the first quarter, which is typically our lowest volume sales quarter.” Nelsonville, Ohio-based Rocky also said Thursday that its Dickies footwear licensing partnership with Williamson-Dickie Manufacturing Co. will end effective Jan. 1, 2011. <wwd.com/footwear-news>


R3: Earnings Creep - RCKY SIGMA


Tommy Hilfiger Finds a Better Way to Get and Engage Interested Customers - The fashion apparel brand and retailer has long known the value of e-mail marketing, but it has found a new cost-per-lead advertising system of acquiring e-mail addresses a better way to quickly engage prospective customers interested in its brand.  <internetretailer.com>


UK Outdoor Footwear Brand Hi-Tec Grows Big - British outdoor and sports brand Hi-Tec is highlighting its growing strength and performance within the athletic and outdoor footwear markets. According to a company release, Hi-Tec’s Athletic footwear sales rose by 63% and Hi-Tec’s Outdoor footwear sales rose by 48% against the comp period in 2009. <sportsonesource.com>


Luxury Perfume Grows Most in 3 Years at L'Oreal - L’Oreal SA, the world’s largest cosmetics maker, said sales growth accelerated to the fastest pace in almost three years as shoppers spent more on luxury perfume and distributors stopped cutting inventories. <bloomberg.com/news/retail>


Remington Arms Hires New Agency to Contemporize the Brands Image - Campbell-Ewald has added Remington Arms and its subsidiaries and affiliates under the Freedom Group of Cos. following a review. The IPG agency takes over from Brothers & Co., and will handle advertising, media, digital marketing, social-media outreach and product development.

New work is slated to break in the fall, backing the company's waterfowl hunting firearms. The company spends about $1.5 million annually on ads, per Nielsen.  <brandweek.com>


Clogs Hit the Junior Footwear Market - Clogs are hitting the juniors market for fall '10 with styles ranging from the classic wooden platform in neutral leather to freshened-up looks in bright knit. <wwd.com/footwear-news>


R3: Earnings Creep - Clogs Image


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