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Changing Perceptions of the Euro

Related positions: Long Germany via EWG; Short France via EWQ; Long Gold via GLD


While a common currency in Europe has been contemplated as far back as the League of Nations in the 1930s, it wasn’t until the Maastricht Treaty of 1992 that established a framework that led to the Euro’s official launch on January 1, 1999 and general circulation via notes and currency in 2002. Importantly, it’s worth emphasizing that the Euro is just over a decade old.


In that time period, the Euro has quickly become the world’s second largest reserve currency after the U.S. dollar.  In fact, the Euro has taken consistent reserve share from the U.S dollar over the past decade, going from roughly 18% of global currency reserves in 1999 to just over 28% in 2009.  Currently, roughly 330 million Europeans use the currency on a daily basis and almost 175 million additional people use currencies that are pegged to the Euro.


This strength and scale of the Euro led former Federal Reserve Chairman Alan Greenspan to opine in 2007 that it was “absolutely conceivable that the euro will replace the dollar as the reserve currency, or will be traded as an equally important reserve currency.”  Not surprisingly, Greenspan’s statement is, in hindsight, at best a contrary indicator.


The current sovereign debt crisis in Europe is creating some rightful questions about the future of the Euro and whether its structure is fundamentally flawed.  While the recently approved €750 billion plan to backstop European debt by the European Central Bank seems to signal that the Eurozone will protect its common currency at all costs, this action also highlights the key structural flaws associated with the Euro. 


As stipulated by the Stability and Growth Pact, which grew out of the Maastricht Treaty, certain monetary and budgetary requirements were mandated for Euro adoption, including that each nation has a budget deficit as a percentage of GDP below 3%, debt as a percentage of GDP of less than 60%, and inflation over the trailing twelve months of less than 3.2%. 


Interestingly, and as outlined in the table below, many of the most prominent nations in the Eurozone currently far exceed the stipulations outlined in the Stability and Growth Pack.  This obviously shines the light on the lack of fiscal discipline of the European Union as whole, and presents two main questions:  1.) What are appropriate targets for fiscal imbalance reduction?, and 2.) Should these parameters be adhered to at all? 


Changing Perceptions of the Euro - 1


In addition to the specific fiscal requirements for entrance into the European Union, the Maastricht Treaty also mandated that no country would ever be bailed out.  The intention of this was, it seems, to protect the broader fiscal order of the Eurozone and to ensure that there were consequences for bad fiscal policy.  Obviously, with the recent ECB sovereign debt bailout, this tenet of this Maastricht Treaty has been willfully ignored.


In ignoring this key tenet of the Maastricht Treaty, the Eurozone is revealing one of the key risks to the Euro -- interconnectedness.   Most nations within Europe borrow from, and lend to, each other.  So, while in theory, the Eurozone should likely let Greece restructure based on the Maastricht Treaty, most major banks within the Eurozone hold Greek debt, and would feel the pain of a Greek debt restructuring.


And this interconnectedness goes well beyond Greece: one-third of Portugal’s debt is held by Spain; Italy owes France more than $500 billion; Spain owes Germany $238 billion and so forth.  Therefore a restructuring or writing down of the debt of any nation will impact the banks and economies of many other Eurozone nations.


The primary structural flaw that is being revealed with the Euro is that because of the disparate economies in Europe, a one-size-fits-all monetary policy is ineffective.  As an example, while Spain may require a monetary policy that attempts to combat its 20% unemployment, Germany may require monetary policy that ensures its economy doesn’t begin to heat up.  In essence, without a political union that can manage the disparate economic goals of each member nation, the monetary union is destined to be weak, which is what we are seeing evidenced by it not adhering to the Maastricht Treaty.


In summary, the issue is not really whether the Euro will fail or disband, because the European sovereign debt bailout package suggests the Euro will endure for the longer term.  The issue, rather, is that the ongoing illumination of these structural flaws will create a growing lack of confidence in the Euro and reverse any perception that one day the Euro would surpass the U.S. dollar as the world’s reserve currency.   And with this change in perception, it is likely that Euro is revalued and continues its slide towards its all-time lows versus the U.S. dollar and beyond.


Daryl G. Jones
Managing Director


Changing Perceptions of the Euro - USDEUR Reserve Currency


Gaming revenues still on track for 85% YoY growth in May.



According to our contacts on the ground in Macau, preliminary numbers through May 23rd have reached HK$11.9bn, and still look on track to hit HK$16bn for the month of May.  So far, there doesn't appear to be any gaming slowdown in sight for VIP volume even though Golden Week has ended.  Wynn Macau (HK:1128) and MPEL, our favorite Macau names, continue to retain their share gains from LVS. 


Below are the MTD market shares:



R3: DSW: Quick Take


    May 25, 2010





    Conclusion: At face value, this might seem like a positive report. $0.67 eps vs the Street at $0.51. Earned $0.16 last year. Comps accelerated, GM% gained momentum, and SG&A was up, but DSW still leveraged due to top line. But on the flip side, guidance was rough. I’m not one to get caught up in the ‘guidance game’ but consider the following… DSW earned $1.23 last year, and about $1.07 in final 3 quarters of the year.  Now they grow EPS by 300%+ in Q1 with a $0.67 eps number, while keeping $1.65-$1.75 for the year. What does that tell you about the back half? It says that they are guiding to a range of $0.98-$1.08 for the remaining 3 quarters. That’s flat to down vs. last year.  My sense is that they’re being conservative. But for a small cap, high beta retailer with an awful track record of consistency, you simply can’t play that game in this tape.



      Clean/Street/LY:: $0.67/$0.51/$0.16

      Guidance: Reaffirmed the raised guidance from preannouncement on 4/27/10 of $1.65 - $1.75. The reaffirmed preannouncement raised full year guidance by $0.30. Increased to $1.65 - $1.75 from $1.35 - $1.45.

    Street $1.74


    Sales growth: +16.5%. Sq footage +2%, Comp +16.2%. New store productivity 160% -- -improving on the margin. Revs on the higher side of guidance — 5 store openings in Q1. Comps had easy compare of -4.7% which was down due to -4.7% comps in women’s, 10.2% in men’s, and -4% in athletics.  Only bright side to last year was a +11.6% comp in handbags.


    GM %: 32.8%, up 557bps yy. 1 and 2 year sequential deceleration. Last year’s margins were actually up from decrease in markdowns from enhancements in clearance markdowns but hurt by increased store occupancy and distribution expenses from the dsw.com fulfillment center.


    SG&A: +5.8%, SG&A margin -222 bps, 2 year SG&A dollar growth slowed for 2nd straight quarter.  Last year’s marketing and depreciation expenses grew SG&A. Marketing was up from media and broadcast production spending.  Depreciation was up from capital investments from the dsw.com infrastructure. 


    Balance sheet: Inventories up 3% on 16.5% sales growth. Good spread, sequentially better.


    SIGMA: In clean up mode, mixed SIGMA move with better sales-inventory spread but sequentially worse margins. Now about to go up against another easy compare followed by tough compares from Q3 onward.


    R3: DSW: Quick Take - DSW SIGMA





  • Consolidation continues in sporting goods retail as Sport Supply Group acquires its third business so far this year targeting Kattus Pro Team Sports in the upper Midwest already matching last year’s activity. Tracking the rate of roll-up will become increasingly more difficult once the pending acquisition of RBI by Onex is completed, but our sense is the trend of struggling mom & pop stores will continue to offer growth potential for better capitalized retailers.

  • While health and beauty aids have traditionally been a tough category to sell profitably online, a new and large player has emerged with an interesting twist.  Procter & Gamble has launched a transactional e-commerce site, with prices that appear to be in some cases better than their retail partners.  The site offers reasonable $5 flat rate shipping as well as the ability to take advantage of click-to-use store coupons.

  • According to Comscore, e-commerce sales picked up in 1Q with total revenues up 10% to $33.98 billion.  This double digit growth marks the strongest year over year quarterly gain since 2Q08 when overall e-commerce sales rose 13%.  One of the biggest growth drivers in the quarter was strong spending from the $100K+ households, which increased by 14%.

  • In an effort to drive 2H sales, HIBB announced it will be growing its outdoor offering into more than 50% of its stores by the fall driven by The North Face as well as Columbia. While management did not disclose the penetration of outdoor this time last year, the company’s commitment suggests a 2x-3x increase in the category according to our estimates. While not likely to offset toning inflated 2H sales alone, to the extent TNF jackets continue to outperform in apparel HIBB will not be solely reliant on an improved product cycle in athletic footwear to comp.

  • Despite a cautious outlook for Q2, FL is seeing comps store sales exceed expectations so far through the first two and a half weeks. With the trend shift from casual/lifestyle to running footwear accelerating YTD according to management, we expect domestic athletic footwear to lead continued category improvement and ASP growth over the near-to-intermediate term.




    R3: DSW: Quick Take - Calendar





    Chinese Textile Company Buys 41% Stake in Japanese Apparel Manufacturer and Distributor - Japanese apparel manufacturer and distributor Renown Inc. said Monday it will issue about 4 billion yen, or $44.4 million, worth of new shares to Chinese textile manufacturing company Shandong Ruyi Science & Technology Group. Shandong Ruyi will become Renown’s largest shareholder with a stake of 41%. Shandong Ruyi’s current client base includes international brands and retailers such as Hugo Boss, Oxford Shop, J. Philipp and El Corte Inglés. Renown said it hopes to take advantage of the transaction to grow its presence in the Chinese market. The Japanese company said it plans to capitalize on Shandong’s sales network in China and its experience manufacturing high-quality, low-cost textiles and clothing products. Renown has been battling losses and has been attempting to restructure its operations over the past few years. <wwd.com/business-news>


    India lifted a month-long ban on cotton exports on Friday, prompting cheers from Indian farmers and global garment manufacturers who are feeling the effects of a worldwide cotton shortage. India retained a tight control on its exports of raw cotton, however, by demanding that all exporters must now apply for a license. India’s ban on raw cotton exports was introduced on April 19 in a bid to cool down domestic cotton prices. Prior to the ban, Indian apparel manufacturers complained that unusually high exports had limited the availability of cotton within India, while pushing up the price. <wwd.com/business-news>


    Zappos Suffers Loss of $1.6 mm from Pricing Mistake - Zappos.com created a lot of buzz this weekend, due to a pricing mistake on sister site 6pm.com. From midnight to 6 a.m. Friday, the majority of items listed on the site — which typically sells products at discounts of up to 70 percent off — had a price cap of $49.95. The problem was eventually corrected, but the company still suffered a loss of more than $1.6 million in sales during that six-hour time frame, according to a blog posting by Aaron Magness, director of brand marketing and business development for Zappos. <wwd.com/footwear-news>


    Patagonia Boasts its 2 Best Years Ever - Patagonia had its "two best years ever" during the downturn, according to an interview by Entrepreneur Magazine with founder and owner Yvon Chouinard. Sales are expected to reach near $340 million in its year ended April 2010, up from $315 million over the same period a year ago. <sportsonesource.com>


    Sport Supply Group Acquires Kattus Pro Team Sports - Sport Supply Group has acquired Kattus Pro Team Sports. Eric Kattus, owner of Kattus Pro Team Sports, will be joining the Sport Supply Group with his sales team.  <sportsonesource.com>


    M&S Profit Tops Estimates on New Fashions and Market Share - Marks & Spencer Group Plc , the U.K.’s largest clothing retailer, reported earnings that beat analysts’ estimates on improved sales of fashions and ready meals and said it had a “satisfactory start” to the first quarter. M&S Increased its clothing market share by value across all categories by 30 bps to 11%. <bloomberg.com/news/retail>


    Nautica Signs Footwear Licensing Deal for Men's and Kids' - Nautica Apparel Inc. has entered into an agreement with New York-based E.S. Originals Inc. to manufacture and distribute men’s and children’s footwear starting in spring 2011. Both collections will be available at department stores and specialty retailers. <wwd.com/footwear-news>


    Nike Kicks Off World Cup Campaign on Facebook - Nike today kicked off its FIFA World Cup campaign with a 10-minute film on Facebook, featuring Cristiano Ronaldo, Didier Drogba, Wayne Rooney and other top soccer stars. The video, viewable only when a visitor clicks the "Like" button, includes a 3-minute advertisement, called "Write the Future," with some of those top stars. It intersperses on-field action with reaction from viewers all over the world. Roger Federer, Kobe Bryant and Homer Simpson also make cameos. That spot will eventually roll out on TV programming in 32 countries. In June, Nike also plans to roll out an Elf Yourself-type online experience that lets consumers generate ripple videos and visuals from their own photos.  <brandweek.com>


    UK's Asda Starts Price War with England World Cup Shirts - Asda is gearing up for a price war after the supermarket started retailing England World Cup shirts for half the recommended retail price. <drapersonline.com/news>


    E-retail Sales Rose 10% in Q1 - Online retail sales grew 10% to $33.98 bn in the first quarter, marking the first time growth rates reached double digits since the second quarter of 2008, according to web measurement firm comScore Inc. <http://www.internetretailer.com/>


    Walmart Launched a New One-Stop Web Destination for Exclusive Video Game Savings and Sneak Peeks - At walmart.com/gamecenter, consumers can find special savings on a number of video games, as well as view previews and first-look exclusives of the latest titles. In celebration of the launch, Walmart is offering a $50 e-gift card to shoppers who pre-order a total of three or more of this year's popular titles, including Medal of Honor, Assassin's Creed: Brotherhood and Fallout: New Vegas. Also, all video games ordered on Walmart.com will be shipped for 97 cents each.  <licensemag.com>


    Gen-Yers Are Forcing the Industry to Push the Digital Envelope - Fashion companies catering to tweens and Gen-Y consumers — an age range spanning 7 to 30 — are in the vanguard of exploring technology’s multiplatform boundaries. These firms are trying to build their brands by enticing consumers who may be the most savvy and demanding about the Internet, the latest apps, video and social media.  Among the latest initiatives:

    • After launching at Kmart in July, Dream Out Loud by Selena Gomez will unveil ads and store displays featuring so-called snap tags, or special dove-shaped logos that users can photograph and then send to an e-mail address for prizes and coupons.

    • The Wet Seal Inc., based in Foothill Ranch, Calif., tapped into young women’s fascination with styling clothes through an iPhone app that lets them search and buy outfits in its stores.

    • Wholesaler NewBreed Girl, whose fashion tops and accessories retail from $20 to $40 to stores such as Topshop, is bypassing Facebook and revamping its Web site, where users can upload photos and videos to what it dubs “a chat room of images.”

    • London’s Scarlett & Crimson, in tandem with the launch of a 90-piece cosmetics line in the U.S. next spring, is developing an app for the iPad that would show tweens how to apply makeup.

    • Pittsburgh-based ModCloth.com, which sells vintage items and clothes by indie designers, lets users vote for designs “American Idol”-style in its “Be the Buyer” program, adding the pieces receiving the most votes to its collection. <wwd.com/retail-news>


    Prada Q1 Profit Jumps Almost Sixfold Driven by Sales in Far East - Prada SpA, owner of the eponymous Italian fashion label as well as the Miu Miu, Car Shoe and Church’s brands, said first-quarter operating profit rose almost sixfold, driven by increased sales in emerging markets.  EBITDA climbed to 64 mm euros from 11 mm. Revenue increased 26%.  A 36% jump in retail sales was led by a 62% increase in the Far East, where Prada has focused on opening new stores. Store sales rose 33% in the U.S. and 18% in Europe. <bloomberg.com/news>


    TSA Launches Review of Creative Media Account - The Sports Authority has launched a review of its $35 million to $40 million creative and media account, according to Advertising Age. <http://www.sportsonesource.com/>




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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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