Respect The Math

“One reason why mathematics enjoys special esteem, above all other sciences, is that its laws are absolutely certain and indisputable… while those of other sciences are to some extent debatable and in constant danger of being overthrown by newly discovered facts.” –Albert Einstein

On Friday I cited Einstein as well. When things get whippy out there, he’s a safe harbor to anchor down to. In that “Early Look”, I said “everything counts in my macro model… my new S&P 500 target range is 1212 on the low end, and 1277 on the high end. Look for shark jumping at the top, and bedlam at the bottom.” And, amidst the past 48 hours of whip lash, that’s pretty much what’s occurred here.

From fertilizers to financials, the Street has had to dance with the Bear in multiple camps this month. As a result, from a volatility perspective, the most positive factor I see for the US stock market is that this month ends tomorrow. Looking ahead always requires the ability to look back – as I look ahead to Friday’s unemployment report, I am reminded of the bear market case that remains in the land of “growth” expectations. When I look ahead two weeks to the pending July inflation reports (CPI and PPI), I am ultra respectful that inflation will finally look like it is deflating. These are two different fundamental points, with two different short term durations.

The volatility that you are having to deal this week is simply a function of expectations on what will matter most, and when. “Growth” investors could freak out again on Friday, then have to deal with a hawkish Bernanke and FOMC meeting verbiage next week. “Value” investors who are long the deflation trade have the timing of reported July data in sight, but can’t ignore the short term storm forecast that lies in between now and then.

You don’t need Einstein’s models to come to the realization that the CRB Commodities Index and crude oil have dropped -13% and -17% respectively in 3 weeks. Virtually every region of the world has been fighting inflation with rate hikes for the numbed US Federal Reserve. Let others fight the good fight for America might be a positive way to spin it. Regardless, the output has been a recovering US Dollar, and spears in the back of commodities futures market contangos. Finding backwardation in those futures curves is what Bernanke needs to see, and if he chooses to back up some rhetoric with action next week, I would not rule out a US rate hike. Regional Fed Head speak in the last 3 weeks certainly supports that idea.

John Thain was willing roll the integrity dice by saying one thing and doing the other, but the reaction to his marking to market yesterday has to be realized for what it was. Merrill (MER) closed up on the day, and the US Financials rose up from the dead again, closing +3.5%. On a close above my short term momentum line of 20.38, the Financials (XLF index) has +14.7% of shark jumping upside. I am not short the financials here. I think it pays to wait until we see Friday’s employment data, and Bernanke’s river card next week. Sometimes doing nothing is the best investment strategy I can choose.

Despite another horrendous factory output number out of Japan last night (down -2% year over year), Asia continues to trade best amongst the world’s geographic regions. Commodity levered country indices from Saudi Arabia to Russia trade the worst. As a leading indicator, this signals that “Deflating Inflation” may very well be the most relevant new investment theme on my sheets.

Trying to get this tape right every day is not an exercise for the faint of heart. Be patient, respect the math, and you’ll do just fine.

Best of luck out there today,


The Form 4s related to SHFL's 17.6 million share offering were filed today. While it was nice to see buy side participation by the Board, the CEO, and some other senior executives, there was one notable asbsence. President and Chief Operating Officer Paul Meyer did not buy any stock on the deal. I also heard from some investors that Mr. Meyer was not involved in the deal roadshow. Hmmmmmm.
In the interest of full disclosure, I own shares of SHFL.


Those of you who know me and/or read my portal, you know I like math. I’ve pulled out my old textbooks and broken some chalk but I still can’t figure out how the analysts’ math works on ROI when “I” goes up by 20%. Somehow, with no scope change, projected ROI remains unchanged and is always 15%. Analysts are young these days so they may not be aware that we used to get away with 20% in the good old days. I guess with a low cost of capital, 15% sounds good enough. Oh wait, cost of capital is likely to bust the budget too.

The following chart displays the estimated cost overruns of some of the major casino projects over the last decade. We tried to adjust budgets for EBITDA enhancing scope changes to be fair. The conclusion is obvious. Casino projects rarely come in at, near, or under budget. Possible explanations are numerous: materials inflation – certainly, unfettered optimism – maybe, aggressive guidance – possibly. In any case, remember to make that adjustment in your ROI calculation the next time a new project is announced.

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While positive on the long-term outlook for the lodging industry, Laurence Geller, CEO of Strategic Hotels recently predicted a weaker 2009 than 2008. His view is consistent with my 6/22/08 portal posting “IF YOU DO MACRO YOU WON’T DO THESE STOCKS”. Mr. Geller is highly respected and a straight shooter so what are the analysts seeing that is so different? By my calculation, the Street projects a median increase of 5% and almost 10% in revenue and EPS, respectively.
  • Street estimates have come down considerably since my 6/27/08 posting “NOT BEARISH ENOUGH, NOT EVEN BEARISH”. The second chart shows the trend of declining estimates. We applaud the more realistic estimates. However, analysts continue to project positive RevPAR and flattish margins in 2009. Lodgers will be lucky to show flat RevPAR in 2009 which translates into some serious margin compression. So I have to ask again; Are analysts bearish enough?

Leather: Price Deflation?

During today’s conference call, Coach CEO Lew Frankfort commented that “leather is a little cheaper to us this year than last year” . We set out to try and quantify what “a little cheaper” means in dollars. We think it was a bit more of a benefit than Mr Frankfort suggested.

Securing accurate data for Leather prices can be tricky –we extrapolated the price data on the attached chart from US government figures covering exports of raw (un-tanned) cattle hides to China (the world’s largest importer). We calculate only a modest raw cost increase -roughly 25% since 2002. While the cost of transport and processing have increased dramatically due to rising oil costs and increasing environmental controls for tanners, we’re still looking at around a 10% decline from 2007 peaks.

The US primarily exports hides raw due to the onerous environmental issues attached to operating a tannery. There are so few leather producers operating in the US today that Redwing, the last major domestic manufacturer of leather footwear, owns dedicated tanning facilities to meet internal demand. Interestingly, press reports from China have indicated increased regulation of tanning operations there has led several firms to invest in tanning operations in Africa –notably Kenya.

One note: Much of the finer leather used by producers for brands like Coach are actually of different, higher grades of hide (“wet blue” etc.) than the one charted here. We used the most common grade as our base for calculating the % change since it afforded us the greatest amount of price and volume data depth by far.

Andrew Barber

HBI: Two Words -- Systemic Change

Is it me, or did HBI's CEO just say that there is a systemic change to cost and pricing dynamics in this industry as it will last beyond 2008? Not news to you, or to me. But this is a massively meaningful change in HBI's public tone. Bad news all around. I think that HBI still has meaningful cost levers which will help it take share in such a climate. I'd hate to be Gildan right now.
There's never been pricing power in this space -- so why start now?

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