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Obama's Populist CPI Balloon

This morning’s Consumer Price Index was actually a lot higher than I expected it to be, and it's bearish for stocks. As soon as Obama gets back from his Hawaiian vacation, the attached chart will be on his desk.

Main Street consumer confidence continues to tank, despite falling gas prices and rising stocks. Unemployment is their main concern, and inflation is a close second. The Democrats know this ring tone.

The headline CPI reading of +5.6% year over year may very well be a lagging economic indicator (it was the highest monthly report since January of 1991), but that doesn't mean that Obama won't use it to his advantage. Bernanke is “data dependent”, remember?

KM

YUM - THE CASH FLOW STORY IS CHANGING.

I have always wondered why the street is enamored with a company that can only grow EPS 10-12%, when they are reducing shares outstanding by 8% (company FY08 guidance). This raises so many red flags!

I recently ran my sustainability analysis on YUM, only to conclude that there is shift in how the company is going to allocate is cash flow over the coming years. Quietly, YUM’s has been allocating more cash toward capital spending - this increases the risk profile of YUM (relative to the past) and drives lower incremental returns for shareholders.

Here are some of the facts regarding YUM's uses of cash over the past 12-months:
Dividends paid declined by 3% (partly due to a lower share count).
Yum has burned thru $1.4 billion in cash (Cash from ops - Cap Ex. - Share repo - Dividends)
Interest expense increased 8% (due to higher debt levels to fund the cash burn)
Shares outstanding declined by 2% (despite spending $1.9B on buying back stock)
Capital spending has increased 13%

First, YUM’s capital spending needs are growing and that will come at the expense of the share repurchase program. Second, if interest expense in up 8% (due to higher debt levels to buy back stock) and the share count has only declined by 2%, how is that accretive to shareholders?

This dogs hunting day are over.

Charting the Chinese Yuan vs. USD and Euro

Chinese Industrial Production growth slowed again in July, moving down to +14.7% year over year growth versus +16% in June. The Chinese currency continues to be better for sale as of late, and this is a new path.

Given that consensus is that the Chinese slowdown is driven by the timing of the Olympics, the simple question to ask here is whether this new data point is an immediate "Trade" or a developing intermediate "Trend"?

Andrew Barber put together both short term and intermediate term charts of the Yuan versus the US Dollar and the Euro below.

KM

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European GDP Growth Rates Continue Their Decline

Below we have attached both the French and German GDP growth rate charts. The Euro Zone reported trailing news this morning, that Q2 GDP growth contracted. I think Q3 and Q4 will look worse.
KM

Things

One of my favorite investment process quotes comes from Warren Buffett, where he likens investing to playing bridge, “the approach and strategies are very similar in that you gather all the information you can and then keep adding to that base of information as things develop.”

Depending on your investment style, these “things” that Buffett alludes to, can most certainly vary. While it is sad that some still use a whisper of “Blue Horseshoe” as their dominant sourcing mechanism for information, there are plenty of investors out there who are well equipped with process oriented picks and shovels that combine global macro with bottoms up stock picking.

This morning is a great example of how we use both here at Research Edge. Yesterday, in our “Hedgeye Portfolio” you’ll see that we repurchased our Wal-Mart (WMT) position, ahead of their quarterly report today. This has been a fundamental bottoms up call that we have been bullish on since November of 2007. Yes, we have disclosed when we have sold strength into Street euphoria a few times, but we have also consistently bought weakness because my teammates, who are some of the best global consumer sector analysts in the world, like it. Buy Low, Sell High.

At the same time, we’re short Japan, which closed down another -51 basis points overnight. We’re also long a bag full of waterproof US Dollar denominated cash that has appreciated +6% in the last month. I outlined a proactive plan of moving to 85% cash ahead of what I thought was going to be a volatile 2 weeks of trading into a negative unemployment report and out of what should be a positive inflation report this morning. Once this CPI number is printed today, the “things” I care about will have indeed “developed”, and I can start considering the redeployment of capital.

With US Earnings Reporting season out of the way, we are going to get back to “macro” time. Obama will be back from his vacation in Hawaii, the Russians will be trying to explain why they are behaving like its 1968 all over again (when they invaded Czechoslovakia and took the capital), and John Thain at Merrill will contemplate whether or not to cut his dividend. So, what do we do next?

My first plan is always to wait. As a friend of mine likes to say, “the plan is … that plans will change”. I am data dependent, and that’s just the way that it is. On the global trading front, there are a few interesting developments to consider. One is re-shorting India. I have been out of this position for a month, and the BSE Sensex Index has rallied +17% during the same period that the S&P 500 put in that “bottom” that so many of the hopeful bulls are starting to call it from July 14th. India’s industrial production growth numbers are decelerating faster than a Chinese synchronized diver slicing into the Olympic pool – now you see it, then you don’t!

At -2.8% for August to date, the Singapore Dollar is chasing the Japanese Yen lower for worst Asian currency performer of the month. The world has slowed and Asian trading, across asset classes, is a leading indicator informing us that “things are developing” at a deteriorating pace!

Europe doesn’t look any better, so don’t expect me to be buying anything there anytime soon. The Euro is only a decade old don’t forget, and the newly formed Team “Euro Zone” is entering its first significant recession of consequence. Do you expect the Europeans to hold hands during times of adversity or point fingers? Russia’s answer is neither – they’d rather just start a war and get on with it.

Fundamentally, the US market still has some interesting pockets of security specific opportunity. I like liquidity; I like Wal-Mart; I like Hershey (HSY); and Tom Tobin and I still like Big Cap Pharma (Johnson & Johnson (JNJ), in particular). For the rest of our solidly positive year to date portfolio, you’d have to be a client to get a look at the “things” we like.

Best of luck out there today,
KM



WHEN OIL IS NOT THE CATALYST

Check out the correlation between oil prices and gaming stocks on the chart below. The correlation at -0.87 over the past year is almost as high as the cruise/oil correlation at -0.89. The relationship is hugely significant statistically with a T Stat of -27 and an R Square of 0.75. Basically, changes in oil explained 75% of the moves in gaming stocks over the past year.

It is all about oil, for now. I’m not sure it should be. At some point this negative correlation will weaken and probably turn positive again. As can be seen in the chart, up until the past year, the price of oil has moved in the same statistically significant direction as gaming stocks, both indicative of strong economic growth. When this correlation regresses to its mean what will these stocks trade on? Presumably, direct fundamentals will again be the driver. I’m not sure even oil at $80 solves the fundamental issues, particularly for Las Vegas.


Big reversal in the correlation coefficent beginning last year

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.28%
  • SHORT SIGNALS 78.51%
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