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Credit Default Swaps Morning Coffee

Not surprisingly, given the negative equity market performance in Europe this morning, European credit default swaps are widening this morning quite dramatically.  As we mentioned in our Sovereign Debt Call in April and our May call on Spain, watching the pricing of credit default swaps are key to understanding the fundamentals of debt markets, and the direction of equity markets.  Yesterday, we noticed that Italy’s CDS spreads were widening dramatically and we are seeing continued follow-through this morning.  At 784 basis points for 5-year credit default swaps, Greece is, in our opinion, clearly pricing in something well beyond a bail out of its debt at par.


The chart below outlines the key equity market performances this morning in Europe, % change day-over-day of 5-year CDS, and the more recent fiscal metrics of each country:


Credit Default Swaps Morning Coffee - 1


Italy is once again a key call out this morning as its CDS spreads continue to widen at an accelerated pace.


Daryl G. Jones
Managing Director

Looking Good

“The best thing about the future is that is comes only one day at a time.”

-Dean Acheson, 51st United States Secretary of State


For those that don’t know, Hedgeye Risk Management holds a  18-20 minute Morning Macro conference call for clients every morning which synthesizes and prioritizes the world's economic, market, and political opportunities and risks (the Hedgeye Blue Orb is now tweeting live comments from the AM meeting).  We approach risk management one day at a time, taking all factors into consideration on a daily basis.


Following that meeting, we hold our own internal meeting where the analyst team goes over industry-specific themes and individual stock ideas.  At the beginning of yesterday’s meeting, Keith mad a one off comment that “Hillary Clinton was looking good.” It was a commentary that she looked very comfortable in her role as Secretary of State.   


From a risk management perspective, the fact that we were talking about the Secretary of State was a negative.  Ms Clinton’s task isn't easy: coax the Chinese to back a tough response to North Korea’s sinking of a South Korean warship, while keeping the Chinese on board for new United Nations sanctions against Iran.


Dean Acheson was Secretary of State from 1949 until 1953, and heavily impacted the course of the Korean War and American foreign policy during the Cold War.  His tenure as Secretary of State was fraught by uncertainty and risk; he had to identify the two on a day-to-day basis and advise President Truman through a tumultuous period of foreign relations.  Acheson was heavily criticized for his perceived softness on the spread of communism and for allegedly implying that South Korea lay beyond America’s defense line and, as such, U.S. support for the new government in South Korea would be limited.  Acheson’s legacy is a point of contention.  We are not historians, but it is interesting to look to the past for clues as to how we might proceed today. 


In global risk management, it is clear that there are no insignificant markets – none lie beyond our defense line.  During our morning call, Keith will refer to “minor” countries like Romania, Poland or Greece (before it was cool) because the global markets are too interconnected to pick and choose which factors to look at.  Today, we are waking up to see global markets in a free fall after the South Korean won declined 4.3% following the Yonhap news agency reporting that North Korean leader Kim Jong Il ordered military bodies to prepare for battles.  It was a year ago today that North Korea conducted a nuclear test and several other missile tests that were widely condemned by the international community. 


Yesterday, we made the intraday risk management decision to go back to ZERO percent US equities.  On the basis of quantitative and qualitative factors, some of the same factors that led to our Q2 theme “April Flowers/May Showers”.


Quantitative Factors


(1)    What was interesting about the second meaningful short squeeze (100bps or more) since the closing low of 1071 last Thursday was that volume and volatility studies were flashing bearish on the second squeeze.

(2)    Volume continues to slide.

(3)    The VIX is running ½ the percentage drop it saw at this stage of Friday’s rally.

(4)    For the first time in the last 3 days of trading, yesterday the Hedgeye Risk Management models were registering a lower-low of immediate term TRADE support at 1055.


Qualitative Factors


(1)    The Chinese government needs to step up measures to avert asset bubbles and cool its economy

(2)    Europe is levered to the hilt - “Sovereign Debt Dichotomy”

(3)    It’s only a matter of time before the dollar is not a safe haven (future theme?)

(4)    Iran’s nuclear tensions

(5)    North Korea wants to push buttons

(6)    We are facing the greatest natural disaster the planet has ever seen…


The same risk management process also led us to short Thailand (THD) yesterday.  Thailand continues to have serious risk associated with social unrest. Yesterday, we used strength as an opportunity to get hedged in Asian equities which remain broken from a TREND perspective.


With all of this said, we see no support to 1018 (down 5.1% from yesterday’s close) on the S&P 500 and we are maintaining our zero percent allocation to US equities.  For the time being, geopolitical tensions, social unrest, economic and market expectations will over shoot to the downside in the short-term; and long-term recovery expectations are unclear and the intermediate-term game goes on.


Function in disaster; finish in style.


Howard Penney


Looking Good - KIM





The Macau Metro Monitor, May 25th, 2010



Sands China said in a statement that it had awarded more than 20 contracts, total worth more than MOP1BN (US$120 MM), to contractors working on sites 5 and 6. Sands reiterated that the construction project would create 10,000 direct jobs and another 10,000 indirect jobs.  According to IM, the MOP1BN only represent 5% of the budget allocated to lots 5 & 6.  In addition,  IM believes that, until the government has approved Sands' foreign labor quotas, it is difficult to believe that sites 5 and 6 will open by 3Q 2011.



This figure is the highest ever recorded for April according to STB.  Visitors from Thailand increased by 57.5%, while visitors from Malaysia and India grew 50.8% and 30.8%, respectively.  Singapore's top five visitor-generating markets in April were Indonesia (with 163,000 visitors), China (92,000), Malaysia (77,000), India (73,000) and Australia (70,000).



Foreign visitors--ex. HK and Mainland--continue to grow. According to IM, Japanese and Korean visitors account disproportionately for a large percentage of direct-VIP gamers. Also, the Macau government has tried to promote Indian visitation by giving incentives to Indian airlines to fly direct.


IM also noted that mainland visitors under IVS would pass through Hong Kong, thus implying a reduction in shopping expenditure in Macau.


GOVT'S CUP FLOWETH OVER Intelligence Macau

IM is not worried about the latest drop in government spending since social pressures, infrastructure projects such as those on the light rail and the Taipa ferry terminal, and the added benefit of a ballooning surplus will boost spending.


Due to lower home sales in large and mid-sized cities, the National Development and Reform Commission (NDRC) does not see tougher rules on the Chinese property market in the near future. 

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FL: Don’t Be Guided by Conservatism

In the midst of market jitters, European concerns, and a flurry of retail earnings reports, Foot Locker delivered a solid first quarter.  Results were well ahead of the Street, driven by three key factors.  First, sales came in slightly better than expected, with same store sales up 4.8%.  Domestic results came in ahead of expectations while international was at the upper end of plan.  Secondly, gross margins came in better than expected, improving by 140 bps.  Recall that the coming out of 4Q, inventories were in the best shape they’ve been in nearly a decade from both a quantity and quality (aged) standpoint.  Finally, SG&A expenses were only up slightly on a dollar basis (essentially flat) and leveraged by 100 bps due to the 5.3% increase in total sales.  All in, this represents a solid start to the company’s turnaround and it’s encouraging to see early positive results from the company’s strategic efforts. 


The biggest criticism here is likely the fact that the entire athletic footwear and apparel space appears to be producing similar, if not better, results.  While this is true and well documented, we continue to believe the COMBINATION of Foot Locker specific drivers such as improved apparel assortments, distinct banner segmentation, and inventory management will ultimately lead to a continued string of upside over the next several quarters.  Importantly, this is the first quarter to be reported since Ken Hicks unveiled the company’s strategic plan on March 9th.  As such, management remains conservative with its forecast on both the top and bottom lines, preferring to use a still “uncertain economic” backdrop as a reason for which to be reserved.  While management may be conservative, we are more aggressive both on the opportunity to see meaningful earnings upside over the next couple of years as well as the commensurate opportunity for share price appreciation.  Our estimates remain comfortably ahead of the Street for this year at $1.05 vs. $0.87.  We’d use the market weakness and any healthy skepticism surrounding management’s conservative outlook to revisit the intermediate term opportunity. 


A few highlights from the call on Friday:

  • FL remains in the very early stages of reaping the gross margin benefits from reduced promotional activity.  The result should be continued improvement in gross margin rate as well as the opportunity to strategically re-direct markdowns toward clearing slower moving SKU’s.  Importantly, 1Q was only the second quarter in almost a decade in which sales grow faster than inventory.
  • Lady Foot Locker (LFL) was called out as having the best performance domestically.  Recall that LFL has received the most attention so far as it pertains to an upgraded apparel strategy.  Yes, excitement from the toning category does help, but the opportunity to convert traffic into additional purchases by the female customer is the holy grail.  There are early signs of success here and we believe this is still early in the process of upgrading the brand’s merchandise and image.
  • With the Easter shift in the past, early May sales are trending towards a mid single digit increase through two and a half weeks.  Recall that comparisons become increasingly easier over the next two quarters, with FL posting its worst quarterly same store sales results in history in 2Q09 and 3Q09, down 12.1% and 8.1% respectively.  Putting easy compares aside, even a modest comp store increase with similar gross margin assumptions to 1Q gives us an earnings estimate $0.10 head of the Street. We shake out at $0.15 vs. the Street at $0.05.
  • Performance/technical running remains a key category, with management noting that the trend towards this higher price point footwear accelerated in the quarter.  This bodes well for future sales growth, as these products are accretive to ASP’s.  Furthermore, management confirmed that a new and innovative product pipeline across a variety of suppliers is key to the momentum exhibited in the category.
  • Management noted that the company is about 30% through the efforts to reposition the company’s apparel offerings and should be closer to 50-60% complete by the Fall season.  Domestic apparel sales, while still down low single digits, showed a huge improvement in trend from 4Q’s double digit decline.  We continue to believe the opportunity to improve apparel sales will be meaningful to both the top and bottom lines.   Lady Foot Locker is most developed here but we expect to see additional efforts in place for back to school across additional nameplates.
  • With 68% of the company’s business tied to Nike, it was encouraging to hear “the relationship [they] have right now is probably the best it’s been in some time”.  Importantly, this echoes positive commentary from Nike’s team on recent conference calls and at the company’s analyst day.  A healthy NKE/FL relationship goes a long way not just for these two companies, but for the entire competitive set.   We continue to believe exclusive content in the form of merchandise, marketing, and actual store formats (i.e. House of Hoops) will further develop in partnership between the two companies.  

- Eric Levine, Director


FL: Don’t Be Guided by Conservatism - FL S 5 10



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