Borrow To Finance

“My job is to make sure we can borrow to finance.”

-Timothy Geithner, July 25, 2010


That’s what US Treasury Secretary Timmy Geithner told Meet The Press host David Gregory yesterday. Timmy has already told us that he “isn’t an economist.” He’s not a mathematician or risk manager either. He’s simply a professional politician who is doing his job.


In another article by Bloomberg’s Daniel Kruger this morning titled “Deficits Don’t Matter as Geithner Growth Gets Lowest Yield”, Timmy expanded upon his aforementioned job description explaining that “if you look at financial markets, say, look at how much the Treasury is paying to borrow today, there is a lot of confidence, not just of Americans but investors around the world, that we’re going to find the political way to do it… there’s no alternative for us.”


There may not be an alternative to marking-US-interest-rates-to-model, yet… but the days of seeing American politicians borrow from their citizenry’s long term future in order to finance their short term political agendas are numbered. Borrowing short to lever yourself up long of debt doesn’t work.


Geithner must not realize that his financial outlook and fiscal policies contradict one another. If US economic growth were to, as he said yesterday, “gradually strengthen for the next year or so”, what in God’s good name are US bond yields doing at all time lows?


This is already getting priced into political polling expectations, but Timmy and the Administration of Groupthink Inc. will meet their maker come the fall (unless they change the reporting date, Q3 US GDP is going to be reported 4 days before the mid-term elections and we think that US GDP growth will slow sequentially). I think global risk managers already get that, but do they get how this game of US currency and interest rate manipulation ends?


Without reviewing his entire book this morning, one way to start answering the question of how this gigantic game of over-leveraged countries playing a Fiat Fool version of Monopoly ends is reading Richard Duncan’s, “The Dollar Crisis.”


Originally published out of Asia in 2003, Duncan’s International Bestseller has recently been revised and updated, but it gets a real-time update that is marked-to-market by the US Dollar, deficit, and debt balances every day. The upshot of Duncan’s answer is that this game will not end well.


Lets score these 3 D’s (Dollar, Deficit, and Debt) as of this morning’s levels:

  1. DOLLAR: US Dollar Index was down for the 7th consecutive week last week, closing out the week at $82.46, down -7% since June.
  2. DEFICIT: In their mid-year review, the OMB revised its 2011 budget deficit HIGHER on Friday to $1.42 TRILLION (versus $1.27 TRILLION prior).
  3. DEBT: US Debt (which now shows US State Debt/GDP ratios) continues to tick higher by the second ($13,240,034,568,703 and counting).

By any long term historical measure, this global experiment of having a Washington Squirrel Hunter make sure he can “borrow to finance” a Fiat Republic is new – so just keep that in mind when you consider the great US financial empire of treasury debt “safe”…


This, of course, is not safe (if you want the real-time wakeup call on this, pull up that site while you read this note – it’s very distracting - and it should be). Ever since Nixon undermined Bretton Woods and abandoned the gold standard in 1971, the US government has given itself the global entitlement to print moneys in order to finance unfunded liabilities.


Before 1971, as Duncan succinctly explains, “the crucial difference between the reserve assets then and now is that gold could not be created by a government or by any other entity to finance a balance of payments deficit.”


On Friday, we’ll get the BEA’s overstated estimate of Q2 US GDP. As a reminder, our Q3 Macro Theme of American Austerity continues to forecast that A) the denominator (US GDP) will slow in Q3 and B) the numerators for both the 2011 deficit and debt to GDP ratios will continue to worsen as a result.


My immediate term support and resistance levels for the SP500 are now 1085 and 1112, respectively.


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


Borrow To Finance - debt




As we look at today’s set up for the S&P 500, the range is 27 points or 1.6% (1,085) downside and 0.8% (1,112) upside.  The equity futures are trading mixed ahead of the housing data point and little earnings news. 




Hedgeye 2Q10 Theme “Housing Headwinds” - An important data point is out today with  consensus estimates showing sales of new U.S. homes up 3.7% to an 311,000 annual pace last month. The report is due at 10 a.m.


Other economic events today:

  • Chicago Fed Nat Activity Index 
  • Dallas Fed Manufacturing Activity
  • U.S. to sell $30b each in 3-mo., 6-mo. bills
  • Crop progress

With oil up 8.6% over the last three weeks, the average price of regular gasoline at U.S. filling stations rose to $2.73 a gallon.    


Over the weekend Treasury Secretary Timothy F. Geithner said U.S. companies scarred by the financial crisis remain “very cautious” and are trying to get more productivity from current employees before hiring new ones. Job growth is “not as fast as we need.”


India’s central bank is likely to raise interest rates for the fourth time since March after a strike to protest rising prices brought much of the nation to a halt this month.


Pound is finally overbought at 1.54 and the Euro at 1.30; In the Hedgeye virtual portfolio we are still short the USD and long the FXB, but will call overbought as it is.


In early trading today, Europe having a tough time deciding what to do today now that the stress test "news" isn’t news; FTSE flat and remains broken TREND.


Overnight China closes up for the 6th consecutive day and is now trading above Hedgeye's immediate term TRADE line of 2484 (Shanghai COMP).




Of the 149 S&P 500 companies that have reported so far, 124 beat consensus estimates on earnings, while 103 beat on revenues. The 81% beat ratio on the bottom line was down slightly from the 86% last week, while the 69% revenue beat ratio also fell from the 75% seen during the first week of earnings season.   This week's beat ratio on both the earnings and revenue lines remained well-above the long-term average and near the high end of the historical range.


So far this earnings season, the largely positive takeaways from earnings seem to have taken a backseat to some of the pushback surrounding a double-dip scenario as the big directional driver for the market.


Earnings were a headwind for Healthcare (XLV), which was the worst performing sector last week and the only sector in the Hedgeye models not to positive on TRADE. 


Industrials outperformed most sectors on strong earnings reports. Aerospace and defense one of the stronger spaces. The notable outperformers were HON up 2.0% on a beat and raise and GE rose 3.3% after the company announced a 20% dividend increases. 


Howard Penney

Managing Director


US STRATEGY - EARNINGS ERODING - levels and trends














AC has seen 33% of its slots exit the market over the last 5 yrs including 2k or 7% since the end of 2009; yet, overall slots in the Northeast have grown.



The number of slot machines in Atlantic City has fallen from 42k to 28k in only 5 years.  That’s a 33% decline including a 7% decline just since December.  Atlantic City is a market long under pressure from slots in Delaware, New York, and Pennsylvania, and expansion in CT.  While this is probably a smart strategy to improve productivity in a declining market and save on taxes since New Jersey levies an annual $500 per slot license fee, fewer slots is not a positive trend for the equipment suppliers. 


While everyone tries to figure out whether the “new” replacement cycle is 7, 10, or 12 years, what if the slot base starts declining?  We guess that’s the potential partial offset to the new market thesis.  However, as the following analysis of the Northeastern market shows, new markets are the more powerful theme.  Despite the huge drop off in AC slots, non-AC slots in the northeast outnumbered AC beginning in Q4 2006.  Since then, AC lost 8k more slots through Q2 2010 while the other states gained 25k.




Our point is that the US slot market is a growth market, as it is internationally.  To be sure, mature markets tend to lose slots over time due to rationalization and more importantly, the opening of new and competing markets.  However, the US is not slot saturated.  New markets have always brought incremental slots.  Replacements ebb and flow but they remain.  Despite the Great Atlantic City Depression, per our conversations with the operators, casinos there are still replacing roughly 8% of their floors annually.


With the state budgets in serious decline, more and more states will legalize or expand gaming.  This may not be good for existing operators, but as the Northeastern market shows, it should be a big net positive for the slot suppliers.

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The Week Ahead

The Economic Data calendar for the week of the 26th of July through the 30th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - c1

The Week Ahead - c2

Bear Market Macro: SP500 Levels, Refreshed...

It’s kind of getting fun to watch this market trade between its TRADE (1085) and TREND lines (1144). Fun enough to be sitting here at 3PM on a Friday afternoon in July. Provided that 1144 remains overhead, I’ll call the US stock market a bear with refreshed immediate term TRADE resistance at 1109.


It was also fun watching American and European professional politicians make things up all week. I wrote two Early Look notes this week with one name in common, Fiat – the Fiat Guns and the Fiat Republic – but it’s really all one and the same. There is a very serious group of conflicted and compromised politicians in the Western world who genuinely believe that government is the answer to economic problems.


Next week’s big catalyst on the American Austerity front will be the National Commission on Fiscal Responsibility and Reform meeting in DC on Wednesday. Don’t forget that Clinton’s ex-Chief of Staff, Erskin Bowles, has already served up the opening volley on the deficit spending front by calling America’s debt and deficit balances “a cancer that can destroy the country from within.”


It’s the weekend – at least our long positions are safe until Monday.


Have a great weekend with your families,



Keith R. McCullough
Chief Executive Officer


Bear Market Macro: SP500 Levels, Refreshed...  - S P

R3: RL… Another Move People Will Underestimate


July 23, 2010


Korea gives yet another leg of growth to one of the most consistent growth stories in retail. Will RL sandbag integration costs, etc…1Q print? Yeah…probably. But there’s enough gas in the tank in this model that it shouldn’t matter. Consensus numbers are too low. 





RL’s announcement to repo its South Korea license from Doosan Corp is a slam dunk.  The price seems fair, and the integration costs are likely to be relatively small in light of RL’s ability to leverage recent structural investments in China.  Consider the following…

1)      This is spot on with the company’s strategy to control all of its brands, at all price points, in all channels of distribution, in all regions of the world. Have you ever visited a RL store in Korea? Not pretty…

2)      Korea is one of the more attractive ‘accessible luxury’ markets in the world. For comparison, Korea’s per capita spending is #30 in the world at $27,978, China is #95 at $6,567.

3)      Doosan has 5 freestanding locations and 175 shop in shops through S. Korea. By way of comparison, the Chinese license got RL 40 stores and 100 shop in shops.

4)      Interestingly enough, the risk profile in Korea is meaningfully less than in China – largely due to a more established and sophisticated consumer.

5)      Not only is the Korean consumer base more stable, but as of January 1 2010 RL has a major DC open in China. This allows them the luxury of materially ramping utilization of a new expensive asset.

6)      If you’re living in Europe or Asia, try going online and buying RL product. Good luck… is not yet ‘turned on’ there. They’ve only got the US humming. International in begins later this year. As it relates to Asia, try selling a 60% margin business when there is an unconsolidated partner who has full control over retailing similar product in a given region. 

7)      The price tag here seems reasonable. Keep in mind that most of these license acquisitions seem very expensive at the time as RL is buying an underloved asset who’s real growth potential has not been realized due to lack of integration with the rest of the company. The license cost $47mm (including $22mm of variable inventory and assets) compared to $18mm for China, and $26mm (10 years ago) for Japan.

8)      Two geographical licenses remain. One controlling Oceania, and the other controlling the Virgin Islands and parts of Latin America. The LatAm license makes sense next (tourist shopping markets), but Oceania is likely a rounding error.


The punchline here is that this gives yet another leg of growth to one of the most consistent growth stories in retail. Will the company start sandbagging integration costs, etc…when they print their upcoming quarter? Yeah…probably. But there’s enough gas in the tank in this model that it shouldn’t matter. Consensus numbers are too low. 





Adidas Preannounces Postive Earnings From World Cup - World Cup success isn't limited to Spain. Releasing preliminary results on Thursday, Adidas AG, the world's second-largest sporting goods company, said second-quarter profit jumped to 126 mm euros , from 9 mm euros during the same period a year ago, boosted by sales of soccer gear. Sales increased 19% and first half of 2010, profit reached 295 mm euros. Adidas outfitted 12 of the national teams competing in the FIFA World Cup in South Africa, including Spain.  <>

Hedgeye Retail’s Take: Lets not forget the impact of Easy Tones boosting Reebok sales, either.  World Cup goes away next year. Let’s hope for Adidas’ sake that the ‘toning’ category accelerates.


Fashion World To Experience Inflation - Life is getting more expensive in the fashion world, and consumers could get stuck with some of the bill. “The era of apparel deflation is now over,” said Richard Noll, chairman and chief executive officer of Hanesbrands Inc. Cotton prices are up more than 50% from a year ago, labor and transportation expenses are rising and factories that closed during the recession remain dark, keeping a cap on supply as demand perks up. To top it off, Chinese officials have become more willing to allow the yuan to appreciate against the dollar, which could make goods made in the country even more expensive. “You’re starting to see price increases come through the entire supply chain, not just from commodity costs, but also from a supply and demand imbalance,” Noll said. “There is no question that costs are working their way through the supply chain and you will see a broad-based increase, I think, in retail prices for apparel in 2011.”


Hedgeye Retail’s Take: If ‘The era of apparel deflation is now over’ is not the quote of the year, then I don’t know what is. Now someone answer me this… If cost deflation is history, then it means that to purchase the same number of units, consumers to stomach a price increase for apparel. Anyone want to check the record books and see when the last time was that consumers took an apparel price increase?


New Balance Concept Store Opens in Dedham - New Balance opened its new concept store in Dedham, MA. The Dedham store will showcase a new design concept that highlights New BalanceÂ’s strong performance and technology brand story. <>

Hedgeye Retail’s Take: Too bad New Balance still can’t make money.


Supply-Side Limitations in Asia Hit the Top and Bottom Lines at LaCrosse Footwear - BOOT reported a second-quarter net profit of $0.1 million, or 2 cents a share, which is down 94% from $1.7 million, or 26 cents, in the same period a year ago. Net sales were down 11% with both the work and outdoor categories suffering declines in the quarter. Sales in the work market were down 15% due primarily to the timing of U.S. government orders. Sales in the outdoor market declined 2% from constraints on the supply of finished goods caused by capacity limitations at the firm’s manufacturing partners in China. <>

Hedgeye Retail’s Take: Capacity limitations = harbinger of higher prices.


Skechers Hires The Licensing Company To Oversee European Expansion - The Licensing Company has been appointed to oversee a European-focused merchandise program for Skechers. As agent, TLC will seek partners for the brand in apparel, fashion accessories, hosiery, bags, outerwear, sporting goods and luggage for men, women and kids. Skechers joins TLC's other clients, including Airwick, Bic, Jim Beam, Umbro, Cosmopolitan, Lysol, Jelly Belly, Perrier, Jeep, Michelin and Welch's. In the U.S., Skechers licensees include children's apparel, bags, eyewear, legwear, medical scrubs and leather accessories.  <>

Hedgeye Retail’s Take: SKX smells really bad to me here. A) They’re riding a massive unsustainable wave, b) They’ve underinvested in the base (ie they’re overearning), and c) are now outsourcing the job of finding ways to license out content in foreign markets.


Gilt Groupe Continues App Success With a Droid App - The limited-time sale retailer is building on its iPhone app’s success with a new Droid app. “We are starting to see downloads of the Android app and sales through it already this morning,” Shan Lyn Ma, senior director of product development at New York-based Gilt Groupe Inc., said earlier today. “The main insight we’re seeing so far is that the orders have been primarily from men.” That wasn’t surprising because men are known to be strong users of smartphones that run the Android operating system. And they’ve been an important part of the early growth in mobile activity on Gilt’s iPhone and iPad apps, which the retailer launched in August 2009 and April 2010, respectively.  <>

Hedgeye Retail’s Take: These retailers continue to fascinate me. They’re definitely doing the right things to navigate the fact that their models are not scalable.

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