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Spinning a Yarn

“A lie has speed, but the truth has endurance.”

-Josh Billings


When someone spins you a yarn, they are trying to deceive you by lying.  While it is strong language to use, it is increasingly obvious to Americans that Washington is spinning yarns in the run up to November mid-term elections almost as frantically as the Fed is printing dollars. 


The seeds are sown by the “Fiat Fools” and other political leaders in Washington for this country to be in for some bad times ahead.  The question is when, not if.


Ben Bernanke might be able to plug a temporary hole in the dam, but he will only be making things worse for the longer term.  The definition of quantitative easing says it all: ‘A central bank does this by first crediting its own account with money it has created “ex nihilo” (out of nothing)’.  Creating something out of nothing – that’s a good policy! You can’t make this stuff up… 


As Keith said in our MACRO call for clients last week, “Pleading for another round of quantitative easing is like the Romans pleading for Caesar to go into his final Senatorial meeting.”  Needless to say that ended badly for Caesar and it’s going to end badly for the USA too.  The death of the Fiat Republic!   


Ahead of the FOMC meeting today, the VIX rose 1.8% yesterday and volume on the NYSE was anemic and declined 16.5% day-over-day.  The 0.5% move in the S&P was the sign of pleading for Chairman Bernanke to come to the rescue.   The FOMC plans to release a statement at 2:15 p.m. today and, in my view, it’s unlikely that Chairman Bernanke will be able to string together the right words to satisfy the market. 


On July 21st he said, “the central bank wasn’t ready to take any action in the near term.” Although, at the same time, his assessment that the “economic outlook remains unusually uncertain.”  The lack of conviction in this market suggests that investors are looking for more clarity from the FOMC today.  KKR backing away from its planned $500 million U.S. offering is just one example of the anxiety evident in the marketplace.


The two key areas we are focused on are housing and employment.  Neither area is showing improvement.  The politicians can spin last week’s labor market report to fit the narrative, but as suggested by the deterioration and downward revisions in the data, the recent economic “recovery” has all but evaporated.


The strategy of increasing the supply of money in an economy when short-term interest rates are near zero is not going to fix the housing or the employment picture. The only benefit from another round of quantitative easing is to provide the banks with even more excess reserves with which they can buy the treasuries that the Chinese are selling.  Coupled with the fact that the Chinese would rather buy Yen than dollars, the current situation is a real problem for the USA.


The global markets’ response to the policies of the Fiat “Wizards of Washington” is a move away from the dollar, which increases the risk for inflation (not deflation) in terms of consumer prices.  A segment on today’s “morning edition” program on NPR with the economics editor of The Wall Street Journal focused on the Fed “watching for signs of deflation”.  I bet they are looking very hard.  We’ve said it time and again: the calculation used for government data for inflation is compromised and does not give an accurate reflection of the reality consumers are facing.  Prices at the pump and at the grocery store are reflecting that.  The forty-one million Americans receiving support from the Supplemental Nutrition Assistance Program (food stamps) are aware of that reality too.


On the inflation front, the market will get a small whiff of things to come on Friday.  There is a very good chance that the July CPI could surprise to the upside versus consensus expectations.   Although gasoline prices were flat month-to-month for July (according to the Department of Energy), a swing in seasonal factors will take gasoline prices higher, which will make the CPI number look inflationary.  Complicating the storytelling on Friday is oil trading at $80 and prices at the pump approaching $3.00.  Numbers don’t lie; politicians do.   


Turning to some important global macro data, yesterday copper traded down 2.1% and could not hold the critical intermediate trade line of 3.32.  Stocks in China fell 2.9% last night; the most in six weeks after data released in China showed real estate sales falling, while prices are rising less than expected. 


Taken together with the sluggish import data, a deepening in the slowdown in China’s economy is a real possibility.  China and copper have been leading indicators for growth globally over the last 18 months and U.S. markets will feel the effects of these moves.


The immediate term TRADE lines of support and resistance for the S&P 500 are 1113 and 1138.


Function in disaster; finish in style,


Howard Penney


Spinning a Yarn - hpel

Structural Unemployment

Conclusion: Even though Hedgeye is hiring, unemployment in the United States is becoming an increasingly structural issue as evidenced by the percent of unemployed that have been out of work for 6-months or more.


We are going to keep this note short and tight even by Hedgeye standards.  I asked my teammates Darius Dale and Matt Hedrick to look at longer term unemployment as a percentage of total employment going back as long as the data would allow us.  The output of their work is the chart below.


The chart highlights the percentage of total unemployed that have been unemployed for more than 6-months.  As can be seen in the chart below, more than 45% of unemployed have been unemployed for more than 6-months.  This is the highest level we’ve seen for long term unemployed going back to 1948.


The conclusion is simply that the unemployment in this nation is becoming structural.  While the credit boom created employment in the housing and construction sector, that entire industry has gone away and been replaced by . . . well, not much at this point.


As the non-partisan Congressional Budget Office stated in a recent paper:


“As a result, gains in employment after this recession will probably rely more than usual on the creation of new jobs, possibly in new firms that are located in different places and require workers with different skills than those needed in the jobs that have disappeared. For workers who have lost jobs to which they cannot return, acquiring new skills can take time. (In contrast, it is easier for workers who have been laid off temporarily to return to their jobs because the employers already know the workers and the workers already have the right skills and are familiar with the work.) For workers who need to move to different regions to find new jobs, the sharp declines in home prices during this recession, combined with the high loan-to-value ratios on many mortgages before the downturn, will hinder relocation. With a significant share of homeowners now owing more on their mortgages than their homes are worth, many people may not be able to sell their house for enough money to enable them to buy one in a new area.”


Further, this trend of longer unemployment comes with major issues because the longer unemployment lasts, the more likely it becomes that complacency sets in and the unemployed person becomes less willing to pursue employment in a traditional sense.


Maybe it’s just me, but I’m not sure quantitative easing is going to get us out of this one.


Daryl G. Jones

Managing Director


Structural Unemployment - Unemployed 6mo


McDonald’s sales came in very strong in July with the U.S. and APMEA showing considerable improvements in two-year average trends.


In my preview note last week I outlined some GOOD, BAD, and NEUTRAL ranges for MCD same-store sales in July.  In the U.S., July comparable sales increased 5.7%.  In my preview, I wrote that any print above 5% would be a GOOD result as it would imply an increase in two-year average top line trends.  The 5.7% number resulted in a 27.5 bp sequential increase in two-year average trends when adjusted for calendar shifts.  As outlined on the 2Q earnings call the momentum in July is due to the recently launched McCafe Real Fruit Smoothies and Frappes along with value-based drinks.  Looking forward to August, at least a 4.4% print will be required to maintain two-year average trends when calendar shifts are taken into account; same-store sales comparisons remain relatively easy in August.  


For Europe, comps came in at 5.3%, which was at the high-end of my NEUTRAL range of 3.5% to 5.5%.  Two-year average trends did increase by 42.5 bps on a sequential basis, when adjusted for calendar shifts.   Management’s commentary on the 2Q release that July global comparable sales were in-line or better than second quarter results was confirmed by a 5.3% print for Europe versus 5.2% in 2Q.  Management attributed the increase to Europe’s “unique premium menu offerings, compelling value and the ongoing modernization of Europe’s restaurants.”  Looking forward to August, a further acceleration to 6.8% comparable store sales number would hold two-year average trends level from July. 


For APMEA, comparable store sales came in at 10.1%.  This number was far in excess of the 7% level I had for a GOOD result.  On a two-year average basis, when adjusted for calendar shifts, trends improved 182.5 bps sequentially.  APMEA’s strong number benefitted from strong sales growth in Japan, Australia and China.  Looking forward to August, a 10.5% print will be needed to maintain two-year average trends on a sequential basis.  August 2009 comparable store sales increased 2.2%, versus 4.3% in July, so it should prove to be an easy compare for APMEA sales.



Howard Penney

Managing Director

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Tailwind Into The Midterms

Conclusion:  It appears increasingly likely that Republicans will gain some political control in the midterms, which should put the Bush Tax cuts squarely in play for an extension.  This would be positive for equity valuations in the short term.


I’m not sure even anyone has ever said this, but I will for the first time, polls don’t lie, people do.  Now, obviously, polls can lie, but in the aggregate they should tell us the story if they are implemented in a statistically relevant manner.  For the sake of argument, we will assume that the polls in the Real Clear Politics aggregate are accurate assessments of the political situation in the United States.


As it relates to the 2010 midterms, the polls suggest that the House Democrats will win 202 seats, and Republicans will win 201 seats, and that there are currently 32 toss-up seats.  While in the Senate, the polls suggest that 49 seats will go Democrat, 43 seats will go Republican and that there are currently 8 toss ups.  Now, obviously, since the full House is up for re-election every two years, it more accurately reflects the political wind of the country.  Currently, the political wind is blowing sharply to the right.  So much so that if the election were held today, the Republicans would have a real shot at regaining the House.


It is likely that the potential for Republican share gains only accelerates into the midterms given President Obama’s approval rating.  According to the Real Clear Politics aggregate for President Obama Approval, the President negative spread, so the difference between the positive approval rating and the negative approval rating, is -4.5.  The math behind this is a 45.1 approval rating and a 49.6 disapproval rating.  This negative differential is the lowest of President Obama’s first term, and is highlighted in the chart below.


Tailwind Into The Midterms - 1


In our morning meeting, Keith posed a fair question to me, which was who is the Republican front runner for the Presidency in 2012, and the answer was, I don’t know.  While President Obama is currently struggling with his approval rating and the Republicans would win in a generic head to head to poll in 2012 by 6.0 points, there doesn’t appear to be a Republican candidate that, as of yet, has stepped into the forefront.  With heightened concern about the debt, it seems likely that a practical and fiscally tested candidate might do the trick, but as of yet we aren’t sure who that person is going to be.


Between now and the 2012 Presidential election, President Obama’s approval rating and potential loss in a generic head to head ballot is most relevant for the upcoming midterms.  Those candidates in tight races will likely not want to be seen as associating with an unpopular President, but as a result won’t have the President’s bully pulpit and funding machine to utilize either.  Regardless, one point is becoming increasingly clear, the Republicans have a tailwind heading into the midterms.


Interestingly, a key implication of the Republicans taking back a combination of either the House (likely) or Senate (less likely) is that an extension of the Bush tax cuts could be firmly in play.  In fact, Paul Krugman, even noted this today in his New York Times column when he wrote:


“But Washington is providing only a trickle of help, and even that grudgingly. We must place priority on reducing the deficit, say Republicans and “centrist” Democrats. And then, virtually in the next breath, they declare that we must preserve tax cuts for the very affluent, at a budget cost of $700 billion over the next decade?”


As it relates to our portfolios, the two key components of the Bush Tax cuts that are relevant are the capital gains tax and the tax on dividends.  In a complete roll back of the Bush tax cuts, these taxes would go from 15% to 39.6% and the capital gains tax would go from 15% to 20%.  Inherently this policy has a direct impact on stock valuations, specifically related to high dividend paying stocks.  To the extent that these tax cuts are preserved, it should be positive in the short term for equity valuations.


Of course the debate and discussion over tax policy is a long and nuanced one, which would take up more wind and paper than this simple research note has allotted to it, but we just wanted to highlight that increasingly it seems that with the Republicans likely to gain political power in the midterms there will be an impact on tax policy, which may be marginally positive for stocks in the short term.


Of course, perhaps the most compelling evidence to keeping the tax cuts in place is that former Fed Chairman Greenspan recently came out against them when he said in a New York Times phone interview on August 6th:


“I’m in favor of tax cuts, but not with borrowed money. Our choices right now are not between good and better; they’re between bad and worse. The problem we now face is the most extraordinary financial crisis that I have ever seen or read about.”


Indeed, Mr. Maestro.


Daryl Jones

Managing Director


August Macau table revs were HK$4.0b through the 8th which projects out to a 40%+ month. Wynn and MPEL continue to move in opposite directions.



We have preliminary August numbers through the 8th and they look strong, although down sequentially.  Total table revenues were HK$4.0 billion which projects out to about HK$14.7-14.8 billion for the month, after considering that the first 8 days contained 2 Sundays.  While 40%+ YoY growth is nothing to sneer about, sequential growth is slowing, owing primarily to tougher comps.  Table revenues in August of 2009 were up 17% versus +3% in June and -17% in May 2009.


Even though the data covers only 8 days, the market share shifts are interesting.  The shifts in table revenue share seen in July seem to have accelerated in August.  Wynn fell to 11.3% thus far in August from 14.6% in July, which was already down significantly from the May peak of 17.2%.  No doubt most of this is hold related.  However, the story of Encore not being additive may begin to gain traction which could be bad for the stock, particularly given the valuation and positive sentiment/momentum already in the stock. 


On the other side, MPEL's table share moved up to 18.3% from 14.6% and 13.1% in July and June, respectively.  Unlike WYNN, MPEL shares suffer from poor sentiment - "these guys can't get their act together" - and a low relative valuation.  The perception that persistent bad hold is a permanent phenomenon at CoD/Altira hasn't helped the valuation.  A couple of months of monthly market share gains should.


Share trends for LVS, SJM, MGM, and Galaxy remained relatively consistent with July.  Here is the detail:



R3: Shoe(less)


August 09, 2010





With most eyes (and feet) still firmly focused on the toning trend, it may be time to begin to pay attention to the latest product innovation to hit the athletic footwear marketplace.  Barefoot running.  While Vibram created the first barefoot product in 2005, the popularity of the goofy looking Five Finger foot coverings is building.  Importantly, “barefoot” or “minimalist” footwear is becoming more mainstream with several brands launching products at the Outdoor Retailer tradeshow last week. Keep in mind, Christopher McDougall’s “Born to Run” book highlighting the benefits of running barefoot launched in May of 2009. With the book in the top 100 of Amazon’s bestsellers list since its launch and still #8 on the top 10 list, it’s fair to say there is considerable interest in merits of this concept. While it is still very early in terms of brand proliferation, it’s likely that we begin to see these shoes showing up in chain stores, after initially being distributed via specialty stores and independents. 


Interestingly, “less is more” certainly holds true here with pricing.  Most of the shoes are commanding premium pricing, hovering around the $100 price point.  While we haven’t had a chance to deconstruct the shoes themselves, we’re pretty sure the margin profile of a shoe designed to contain the minimum amount of material and sewn parts is one of the more profitable shoes on the shelf.  At this point it’s premature to make too big of a deal about this trend, but we do believe that this is further support for the athletic footwear cycle.  Innovation is key to the longevity and pricing power of the category, and this is yet another example of how something as boring/tired as “sneakers” continues to be reinvented. 


R3: Shoe(less) - 1





- Keep an eye on recently introduced legislation aimed at protecting original fashion designs.  The bill introduced by Senator Chuck Schumer, called the Innovative Design Protection and Piracy Prevention Act, is designed to provide limited intellectual property protection to the most original design.  Similar legislation has been introduced over the past four years, but this effort seems to have more support, including backing from the CFDA and AAFA.


- As retailers work to embrace and develop mobile commerce as an additional source of revenue and marketing reach, China has surpassed the US in mobile internet usage.  According to Nielsen, 38% of mobile subscribers access the internet on a mobile device compared to 27% in the US.   Total mobile subscribers top 750 million in China.


- Expect the buzz surrounding Coach’s latest luxury effort to reach new heights as the Reed Krakoff brand opens its flagship store on August 19th.  The Madison Avenue location is still under plywood wraps.





Apparel Retailers Increase Political Contributions for Democrats - In the overall retail category, which includes a broader array of PACs, including apparel retailers, home builders, electronics and drug stores, Republicans have still outpaced Democrats in contributions, but the gap has tightened. Republicans received 52 percent of a total of $3.5 million in contributions in this cycle, while Democrats received 48 percent, according to the center. The split was 55 percent Republican and 44 percent Democrat in the last cycle, so contributions to Democrats have increased proportionally so far. Wal-Mart’s PAC, by far the largest in the industry, has given $460,500 (54%) to Democratic candidates in the run-up to the Nov. 2 congressional elections — when all of the House’s and a third of the Senate’s seats are up for grabs — compared with $390,550 (45%) to Republican candidates, according to the Center for Responsive Politics. During the last congressional election cycle, in 2007-2008, Wal-Mart’s PAC gave more to Republicans ($655,000) than to Democrats ($573,700). <wwd.com/business-news>

Hedgeye Retail’s Take:  Despite the slight shift towards the Democrats, it’s more interesting to note that one of the country’s largest industries (in terms of employment) only spends a paltry $3.5 million in contributions.  Perhaps it’s the lobbyists who are seeing all the cash. 


Intimate Apparel Under Cost Pressures - Although customers appear to be slowly returning, intimates vendors and retailers are under intensifying pressure to keep tight control of spending as costs for raw materials, labor and shipping escalate. Industry executives said they are taking a conservative approach to inventory for fall and holiday because of anxiety about a double-dip recession, chronic high unemployment and weakened consumer confidence. Vendors said they have been absorbing rising costs, for the most part, because retailers are coping with margins constrained by aggressive promotions. But executives speculated they will be forced to raise wholesale prices unless the situation improves in the next several months. The cost-saving initiatives undertaken by innerwear companies include: Committing orders six to 10 months in advance at a fixed price for unfinished greige goods; reinforcing partnerships with major contractors, factories, mills and fabric makers who can negotiate lower prices, package deals with major contractors that can command lower prices for fabrics, trims and laces; and designing with more embellishments such as pleats and ruffles that give a garment the look of added value while using less of an expensive fabric. <wwd.com/retail-news>

Hedgeye Retail’s Take:   Nothing new here but yet another inflationary trend. 


Barefoot and Lightweight Are the Trends from Outdoor Retailer Show - With high-profile collection launches from Merrell and New Balance — and related product from Teva, Terra Plana and Ecco, among others — outdoor players were optimistic the category will fuel sales. The explosion of minimal shoes and footwear designed with some barefoot elements has given running a boost. A few key shoes include: Vibram Five Fingers, Terra Plana, New Balance’s Minimus, and Merrell Barefoot Collection. <wwd.com/footwear-news>

Hedgeye Retail’s Take:   Less is more, always.  Given the limited use of materials for “minimal shoes” we wonder if this might become one of the highest margin categories in all of athletic footwear.  Retail price points hover around $100 for shoes that are essentially rubber socks. 


Footwear Retailers Expanding Product Offerings, Holding More In-Store Events, and Ramping Marketing - Independent shoe retailers are tweaking product strategies for the fall with emphasis on existing brands, adding lines at lower price points, and expanding the number of labels they carry.  Other retailers are growing outside of footwear by selling clothes and accessories for the first time this fall in an effort to bring in more people. Retailers can’t discount much more, so it makes sense to bring in something else that might sell. Still, promotions will be a key strategy for many retailers this season whether through small discounts or packaged deals. <wwd.com/footwear-news>

Hedgeye Retail’s Take:   This sounds like the usual scramble to compete with the bigger chains.  Unfortunately adding apparel into a footwear store is usually not the answer.  Look for apparel markdowns by the time the season is over.


Jimmy Choo May Be Up For Sale - Jimmy Choo Ltd., the luxury shoe brand and retail chain, may be sold for as much as 500 mm pounds ($797 million) by TowerBrook Capital Partners. TowerBrook in 2007 bought a majority stake in Jimmy Choo in a transaction that valued the company at 185 million pounds, the newspaper said. The retailer’s owners, who are considering their options, may decide instead to sell shares in the business in the next few years for 1 bn pounds.  <bloomberg.com>

Hedgeye Retail’s Take:   If true, an impressive return in a very short time for the young luxury brand.  M&A still going strong, despite recent market jitters and an increasingly unclear outlook for the consumer (luxury included).


Tuscan-Based Luxury Retail Group Evanthe Buys Malo - According to industry sources, Evanthe, a general contractor that develops luxury stores for the likes of Louis Vuitton, Prada and Abercrombie & Fitch, bought Malo for between 8 mm and 10 mm euros. Besides the price, the administrators and the ministry were convinced by Evanthe’s industrial plan to grow and develop the brand. Malo is part of IT Holding, which has been in government-backed bankruptcy protection since February 2009.  <wwd.com/business-news>

Hedgeye Retail’s Take:  Interesting ownership change of a fashion brand, now in the hands of the company that actually builds luxury stores.  Sounds like Malo may be coming to a high end mall or high street location soon as part of its revitalization efforts.


Footwear Trend: Camo - Camouflage prints are storming the girls’ market — and in this case, the idea is to stand out, not blend in. Whether in classic green and brown, or fun fashion colors such as pink and blue, the pattern punches up kids’ sneakers and sandals. <wwd.com/footwear-news>

Hedgeye Retail’s Take:   Here’s a trend that never seems to go away.  Hopefully the shoes don’t get lost in the woods (or the closet).


Australian Tennis Brand Expands to US - Australian tennis brand Volley, a staple Down Under since 1939, will have its first broad launch in the U.S. market at the upcoming Project show this month. Created by Australian tennis legend Adrian Quist for on-court use, the simple canvas silhouettes have remained largely unchanged since their introduction. New York-based JM&S Projects LLC brought the line to the U.S. in an exclusive partnership with Steven Alan for this year, but is opening up the distribution for the unisex styles at the show. A $60 low-top will be available for immediate delivery; the $80 high-top will deliver Oct. 1. Both are targeted to sneaker boutiques and independents. <wwd.com/footwear-news>

Hedgeye Retail’s Take:  Another “authentic” canvas shoes enters the competitive marketplace joining KSwiss, Jack Purcell, Converse, and Keds to name a few.


Jambu Enters Barefoot Market - New York-based Jambu is boarding the barefoot bandwagon with the Barefeet Designs collection for spring ’11. With three styles for for women, the $99 range features a memory foam footbed that the company compares to “walking on sand,” and lightweight and flexible outsoles made of a blend of natural and synthetic rubbers and rice husks. The collection will deliver Jan. 15 to independent retailers, e-tailers and sports- and outdoor-focused accounts.  <wwd.com/footwear-news>

Hedgeye Retail’s Take:  How long before Skechers enters the barefoot market? Surely something has to be in the works.