Confucius Says...

“And remember, no matter where you go, there you are…”

This is one of the simplest, yet most relevant quotes in my investment notebooks. In a word, I call it accountability. Hide from it at your own risk. There’s a new sheriff in this town of global market leadership – her name is ‘You Tube’… and she will hunt you down.

The transparent drama of political life in this country will finally find an apex tonight. Obama will likely be accepting a rock-star victory at a reception in Grant Park in Chicago, Illinois, while the “Straight Talk Express” will be chalking up another Presidential race loss… this time, at the Biltmore in Phoenix, Arizona.

The paths of these two men provide a metaphor for where the United States has been vs. where it’s going. Grant Park is 319 acres of open air which hosts America’s mosh pits at Lollapalooza, whereas the Biltmore is one of our citizenry’s sites of haute couture, Cartier watches, and Cindy marrying the “Maverick” back in 1980. “No matter where you go… there you are.”

Much to the chagrin of the bears who are running around pitching my 9 month old “Macro” thesis’, we’ve been all “bulled up” as of late. We’ve been using Obama’s pending election, credit spreads narrowing, and earning’s season ending, as a trifecta of catalysts for a new beginning. No matter how good or bad a year you are having in this market, you have to have your feet on the floor this morning, proactively managing towards tomorrow. People don’t care about your October anymore. They want to know where you are today, and where you are going next. “No matter where you go… there you are.”

So where to next, “Mr. Mucker”? While it’s nice to be called “Mr.” these days, I do still enjoy the odd crackberry addict firing off at me, calling me names. It inspires me to work harder. So let’s strap on the analyst pants and get back to the notebooks. First, for context, let’s go through the math. Since our “Buy’em” Early Look note from 10/27 (, the S&P500 has rallied from 848 to 966 (up +14%), Volatility (VIX) has plummeted from 80 to 53.68 (down -33%), International stock markets have been squeezed for anywhere from +15-30% moves, the US Dollar has lost -3% from its peak, and international currencies have stopped going down. “No matter where you go… there you are.”

Context is always critical when attempting to proactively predict markets and/or the tail risks implied therein. Respect history, or it will teach you lessons the hard way. With the aforementioned bullish macro backdrop, you have to face the facts this morning and look towards a less dark future. Obama’s win is the obvious catalyst that global stock markets have started to discount, but the less obvious ones are A) that the yield curve continues to steepen and B) inflation readings continue to dampen. This combination is a powerful one. It gives countries from Asia to Europe the objective facts needed to join hands and cut rates. The Reserve Bank of Australia cut rates this morning by another 75 basis points to 5.25%, and on Thursday, both the ECB and the Bank of England will be cutting them again as well. Don’t be short that calendar.

In yesterday’s Federal Reserve Senior Loan Officer Survey, the simpleton’s conclusion should have been more of what we have been calling for the past 9 months – access to credit continues to tighten as cost of capital continues to rise. No, “Heli-Ben” dropping money from the heavens hasn’t done a darn thing for 30 year mortgage rates other than inflate them. No, Paulson’s Biltmore Club collaboration for “Investment Banking Inc.” hasn’t helped one corporate borrower who needs long term debt financing – 10 year Treasury yields are testing 4% this morning - they are breaking out!

No, this won’t make sense to all of the “hedgie” freedom fighters who said they “don’t do Macro”… nor will it help my 60% position that I still have parked in US cash. Cutting rates to zero doesn’t inspire one to save anything. Cutting rates to zero ultimately means you can only RAISE them next! That’s why long rates are headed higher as short one’s nosedive. This, all together, is outstanding news for what we have labeled as a Research Edge Investment Theme for 2009 – “The New Reality.”

“The New Reality” is that yesterday’s Wall Street is going away. They can house it alongside the horse and the buggy whip at the Biltmore museum. Bush’s administration will be gone. Paulson’s team will be too. This is great for those looking for new beginnings. This is great for Americans who are liquid long cash. Borrow short, lend long. Charge those in need of leverage a healthy premium. Rinse and repeat. “And remember, no matter where you go, there you are.”

Our immediate term target for the S&P500 is now 990. A close above that level gets my allocation to US cash under 50%. A failure, and close below that level re-sharpens my bear claws.

Have a great day,

Long ETFs

JO – iPath Coffee – Arabica futures declined on ICE on further anticipated index investment outflows. Vietnam Coffee and Cacao Association warned producers face major bottleneck unless banks open credit lines to wholesalers.

EWG – iShares Germany – Eurozone PPI was reported for September at +7.9Y/Y, lower than expected on declining oil costs. BMW traded up 8% after guiding for ``clearly positive'' earnings after production cutbacks.

FXI – iShares China – CSI 300 index declined over 1.5% as basic material and energy companies guided lower on falling global commodity prices. China’s top tin producers announced significant capacity cuts as demand slackens.

VYM – Vanguard High Dividend Yield ETF – Depository Trust & Clearing Corp. will publish details of the top 1,000 credit default swaps today after 5PM, under regulatory pressure. Information will include gross and net contracts outstanding as well as trading volume.

Short ETFs

UUP – U.S. Dollar Index – The Euro rose against the dollar today on declining money market borrowing cost, anticipated rate cut from the ECB in 2 days further increasing liquidity.

EWU – iShares United Kingdom – Apparel retailer Marks & Spencer up over 10% after reporting smaller than expected loss, continued dividend. RBS declined 9% on write-down’s, declined to forecast full year results.

IFN – The India Fund – SENSEX and the Rupee rose for fifth consecutive day. Finance Ministry reports that the Reserve Bank may open 100 billion INR credit lines to the National Housing Bank and Small Industries Development Bank to increase flows for mortgages and small companies.

Keith R. McCullough
CEO & Chief Investment Officer


We looked at the relationship between gaming operator and supplier stocks over the past 10 years. As one would expect, the relationship was strong. Interestingly, the strongest relationship was gaming operator stocks driving supplier stocks on a six month lag.

Intuitively, this makes sense. When business is bad, cash flows decline, liquidity is a more pressing need, and suppliers cut back on slot capex. Operators do not immediately cut back on slot capex when their business turns down, nor do they immediately communicate to the suppliers that they are cutting back. Hence, the lag.

This relationship could be tested in the coming quarters. As discussed in my post “CAPEX, COVENANTS, AND CORPORATE CONTROL”, I expect corporate managements of the operators to direct slot capex lower in the first half of 2009 due to liquidity issues. Even if gaming trends improve sequentially, I anticipate slot purchases to be pushed back into the second half of the year.

Most significantl statistical relationship is a 6 month lag

RL: This Quarter is All in the Details

There’s never been a quarter with RL where looking at the puts and takes vs. the year-ago period mattered more. Here’s a detailed margin walk to guide the way. Yes, revenue stinks. I can’t imagine anyone on Wall Street thinks otherwise. Tack on the fact that a consistent 6-8% boost in sales from acquisitions and another 2-3% from FX goes away, and the top line ain’t very pretty. But I think there’s enough juice on the cost side to serve up a pretty decent headline number. After adding up the Impact 21 and Small Leather Goods dilution from last year, FX-driven SG&A, and a meaningful step-up in both cash and stock-based comp, RL has about a 150-175bp pad built into margins for the next two quarters. My gut (and my math) gets me to a beat on the quarter, and if there is a guide down, it should not be by much. When I stress test t he model (email me for a copy) I get to a bear case number for this year above $4.00 per share. I’ll almost never pay up for a cost leverage story. But for a global power brand like RL that is coming off a period of investing in both its P&L and balance sheet while many competitors have been doing the opposite, I like its competitive positioning at 6x EBITDA.

Click on images below to enlarge.

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.


I think estimates for the first half of 2009 are probably too high for all of the gaming equipment suppliers, although IGT could save its way there. Revenue estimates look too aggressive as discussed in my post “CAPEX, COVENANTS, AND CORPORATE CONTROL”.
  • IGT could probably get away with a revenue miss since sentiment is already so low. The company guided down last week, but the general feeling is that there could be more downside. The fact that 12 analysts maintain hold or sell ratings on the stock versus only 5 with buys, is not helping sentiment either. The first chart details the ratings breakdown by company.

    WMS, on the other hand, is loved by the sell side. Of the 16 analysts that cover the stock, 14 have buy ratings. I've got to believe the optimism is reflected in the earnings estimates as well. Indeed, analysts are projecting 10% revenue growth in the face of likely Capex resets in 1H 2009 by the operators. I’ve already stated my opinion on that subject.

  • It looks like the analysts have been persuasive with the buy side. As shown in the second chart, WMS trades at a 35-45% premium to IGT and a whopping 65-75% premium to BYI. Despite the potential for a 1H revenue shortfall, BYI looks cheap at under 10x earnings.

    While I worry about the whole group, revenue shortfalls on cheap stocks are likely to be less damaging than for a more expensive one with higher ratings.

S&P500 Levels Into the Close...

The market is annoying the bears today. Every time they try to crack it, she holds, recoils, and recovers… After a +15% squeeze in less than a week, the bears who sold the bottom can’t even muster a -3% down day with some volume behind it. Sorry guys…

As we head into the close, volatility (VIX) has broken my intermediate support line of 58.61, and is trading under the 55 line (-8% on the day). The paint on our S&P500 trading lines (see chart) really hasn’t changed much. My S&P500 trading range is narrowing – that’s also a bullish signal. As we get closer to SPX 997, I make sales. Here are my refreshed levels:

BUY in size = 843
BUY more if support holds = 920
Sell the “Trade” = 997

My name is Keith McCullough, and I support this message.

Turkey Shooting (TUR): Opportunities and Pitfalls...

Turkey faces both opportunities and pitfalls in the new economic reality:

In our Weekend Edge, we initiated a case to be made for Turkey to emerge as a strong developing European economy (on a relative basis).

• External debt as % of GDP has declined to just over 37% since the 2001 crisis.
• Oil prices, a primary driver of the trade deficit, have declined dramatically (Turkey currently produces less than 9% of its daily oil consumption).
• The banking system there has shown relative resilience in the face of the credit crisis so far. Regulation is something they have already proactively managed.
• Skilled labor in Turkey is inexpensive and the labor force is both young and educated. This makes the country well situated geographically to capitalize on trade opportunities with more than just the EU (currently more than 50% of the market for Turkish exports).
• Although consumer inflation remains in low double digit territory, this represents a major decline from the nosebleed levels seen from 2001 to 2003, suggesting that domestic consumption may maintain its current levels in the near term.

There are clearly a number of major issues which face Turkey that could derail the bullish case: bureaucratic and regulatory hurdles which stymie foreign investment; significant security issues on its borders with Iraq, Iran, and Georgia; and a current account deficit that remains troublingly high.

With a stock market battered by the global selloff, Turkey is beginning to look attractive on both a quantitative and a relative value basis to other emerging markets. We will be keeping our eyes on Turkey, looking for data to indicate whether or not Turkish political and corporate leaders are making the right decisions to capture opportunities and avoid pitfalls in the new reality.

Andrew Barber

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