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R3: AMZN, GPS, Reebok, DECK, Online Sales Tax

R3: REQUIRED RETAIL READING

September 9, 2010

 

Several moves again this morning by Amazon – this time on the technology front. One, a demand based pricing technology, another providing cross merchant purchasing flexibility using one’s Amazon account…these guys remain ahead of the curve. 

 

RESEARCH ANECDOTES

 

- The introduction of next-gen Checkout is the latest technological advance from Amazon and one that will greatly streamline the purchasing process and, importantly, avoid the pitfalls associated with redirection. Customers will now be able to make purchases on other merchant’s sites using their Amazon.com account. Not only should this enhance customer retention, but also help to increase conversion.

 

- In a rare sign of denim vitality, Van Heusen mentioned that its fall order book is up a healthy 10%+ in the category contrary to what we’ve heard from other retailers. What’s notable here is the price point, which at $59-$79 at retail puts CK jeans right in the middle of the void that has typically existed between $50 or less and $100+ premium brands that have reported the most significant weakness.

 

- With companies embracing the move towards ‘greener’ more sustainable processes, consumers should start to expect these efforts to become more apparent in the form of product packaging. With cost, originally one of the gating factors, no longer an issue (it’s actually cheaper now in most cases), change itself now appears to be the primarily deterrent for retailers. While only a small percentage of Amazon’s products come in “frustration-free packaging,” expect other retailers to follow suit as consumers become accustomed to ease of green.

 

 

OUR TAKE ON OVERNIGHT NEWS 

 

Amazon Tunes In a Deal for AimeStreet.com - Amazon.com Inc. has made another acquisition and this time the deal is meant to bolster the biggest online retailer’s digital music business. Amazon acquired AimeStreet.com, an online music store and social media site featuring independent artists. AimeStreet.com featured a unique pricing model that used a software algorithm to set pricing on recordings by independent artists based on demand. The more times a recording was downloaded, the more the artist could charge up to a maximum of about $1.  <internetretailer.com>

Hedgeye Retail’s Take: More important than the brand and its content is the technology behind this one – online demand driven pricing. The model sounds almost auction-like, but could prove effective in accelerating inventory turns across other categories as well (think Zappos). Certainly meaningful given the sheer volume of SKUs Amazon runs through its model daily.

 

Reebok Launches NFL Maternity Collection at Pea In The Pod - Reebok has partnered with A Pea in the Pod to offer an NFL maternity collection, with Elisabeth Hasselbeck, co-host of ABC's The View as the face of the line. <sportsonesource.com>

Hedgeye Retail’s Take: Only a day after the NFL indicated they might open up its apparel licenses to bid, Reebok broadens its net - this one could start to get interesting (and potentially expensive for Reebok) if not resolved quickly.

 

Gap Links With Valentino - Gap is celebrating its arrival in Italy by partnering with one of the country’s most famous couture houses — Valentino. The company will today reveal that the House of Valentino has created a capsule collection of women’s wear for the brand that will bow in late November to coincide with the launch of Gap’s flagship on Milan’s Corso Vittorio Emanuele. The collection has been designed by Valentino’s creative directors, Maria Grazia Chiuri and Pier Paolo Piccioli, using “iconic Gap pieces” as its basis, the company said. Stylist Karl Templer, who works closely with Gap and Valentino, introduced the two brands.  <wwd.com/retail-news>

Hedgeye Retail’s Take: This is a notable partnership for GAP – best known for its khakis and white shirts. To say that GPS has struggled to gain traction and relevance with its designs of late would be an understatement. Even with Valentino as an ambassador, Italy will likely prove to be a challenging market to penetrate given its fashion bias.  

 

UGG Steps Up NYC Presence - Ugg is spreading out across New York. The shearling boot brand is planning to open its third Manhattan location on Oct. 28, at Madison Avenue and 59th Street. A VIP kickoff event is also in the works and will be hosted by Vogue. For her part, Ugg Australia President Connie Rishwain said the company has high hopes for the new concept store. <wwd.com/footwear-news>

Hedgeye Retail’s Take: Just in time for the holiday season. With practically every brand now offering their own version of ‘the shearling boot,’ dedicated retail stores should play in important role in driving demand for new models that will undoubtedly be made exclusive at UGG branded stores.

 

Sales Tax Amnesty Falls Flat - North Carolina invited 450 web retailers to join a program that would forgive uncollected taxes, but only 27 signed up. The state could go after the other merchants for taxes, interest and penalties tied to past transactions. Only 6% of invited online retailers have taken up North Carolina on its offer to forgive uncollected sales taxes in exchange for a promise to remit taxes later. Retailers who signed up do not have to worry about the state trying to collect sales taxes, penalties or interest for online purchases made by North Carolina residents prior to Sept. 1. <internetretailer.com>

Hedgeye Retail’s Take: With the Delahunt Bill introduced July 1st and many states already passing the Streamlined Sales and Use Tax Agreement (SSUTA) the day that online retailers have to collect taxes is quickly (on a relative basis) becoming a reality. Interestingly, with only 6% of retailers stepping forward on the sales tax amnesty offer in North Carolina there appears to be significant disparity between perception and reality.

 

(if you are interested to read more on this topic, please contact to inquire about our e-Commerce Black Book released last month).

 

Import Cargo to Rise 16% in September - Import cargo volume at the nation’s major retail container ports is expected to be up 16% in September over the same month last year, but 2010 has already hit its peak and numbers will decline through the remainder of the year, according to the monthly Global Port Tracker report. <sportsonesource.com>

Hedgeye Retail’s Take: With inventory levels coming out of 2009 lean and heeding supplier warnings of 2H constraints, retailers ramped orders driving cargo traffic to unsustainable levels in the 1H. Needlessly to say, a gradual decline in 2H traffic is to be expected.

 

Mayor Bloomberg on Fashion - New York City Mayor Michael Bloomberg offered an impromptu address on the state of the industry and its future by discussing how New York City’s overall environment affects shoppers, Seventh Avenue manufacturing and how Friday’s festivities could rev up shoppers’ interest. The mayor said NYC has had record-breaking tourism figures. Despite being in a worldwide and national recession, New York City is on track to meet Bloomberg’s goal of bolstering tourism to 50 mm visitors in 2012. For 2010, the final tally should be about 45.5 mm , a slight gain compared with 2009, Bloomberg said. Emphasizing how shoppers’ spending is intrinsically tied to the overall environment, Bloomberg noted that real estate, stores and restaurants are showing signs of improvement. In addition, the city’s unemployment rate for July was down for the seventh consecutive month and (at 9.4%) is lower (by a hairline) than the national average (of 9.5%,). <wwd.com/business-news>

Hedgeye Retail’s Take: A little pep rally ahead of Fashion Week is no surprise given how meaningful tourism is to the city. With events more staggered over the course of the week than in years past, it will be interesting to see how many fashion goers that usually opt to attend the New York show stay local to their international markets this year as a result.

 

Live TV Losing Younger Adults - Millennials and younger Gen Xers now report spending well under half of their video viewing time watching live TV, turning instead to online sources such as Netflix and other timeshifted options. <emarketer.com>

Hedgeye Retail’s Take: Live television adverting is starting to look much like newspaper did 10-15 years ago. Retailers and brands will have to continue to evolve towards online and mobile channels to capture customers. Interestingly, street-side and interior billboards are also seeing a resurgence in demand as technology enables these mediums to advertise ‘smarter’ with profiling capabilities as already seen in Japan.

 

R3: AMZN, GPS, Reebok, DECK, Online Sales Tax - 1

 

Total Apparel Group Faces Liquidity Crisis - Total Apparel Group, the U.S. master distributor for FIFA and FIFA licensed product in the U.S. and North American licensee for Kappa and Robe Di Kappa, released its results for the last two years and also indicated it is going through a liquidity crisis. The company has not reported its public-figures since it was founded in 2008. <sportsonesource.com>

Hedgeye Retail’s Take: Recall just last week that the China Dongxiang Group Co., a Chinese footwear company and owner of the Kappa sportswear brand in China, announced that they were looking to buy European and U.S. brands – sound like a fit? Total Apparel Group should be expecting a call…

 

US Senate Introduced Industry-Backed Bill to Protect Fashion Designs - US Sen. Chuck Schumer (Democrat-New York) introduced in early August new legislation to strengthen copyright protection for fashion designs, with the support from both the American Apparel & Footwear Association (AAFA) and the Council of Fashion Designers of America (CFDA). <fashionnetasia.com>

Hedgeye Retail’s Take: Passing these bills is arguably the easiest step in the process, enforcing it is a whole other issue. As in most industries, smaller little known designers most often at risk of someone ripping off designs are typically capital constrained.

 

South Africa Deals With Wage Disputes - As South African president Jacob Zuma visited China last month to court investors to his country, Chinese companies were closing 85 apparel factories they own in Newcastle in the province KwaZulu-Natal because of a wage dispute. The factories employ about 8,000 workers who produce an estimated three million garments a month. Zuma is under fire because his three-day trade mission coincided with a strike by an estimated 1.3 mm South African civil servants — nurses, health and education workers and police — who are demanding higher pay. Workers are seeking an 8.6% boost. <wwd.com/business-news>

Hedgeye Retail’s Take: Bangladesh is certainly not alone though South Africa accounts for far less of the global apparel export market.


MCD: GLOBAL SALES SLOW

McDonald’s sales results were announced this morning and while trends were maintained in the United States, they flattered to deceive.  Europe and APMEA showed softness.

 

In my preview note posted early yesterday, I outlined some GOOD, BAD, and NEUTRAL ranges for MCD same-store sales in August.  It is worth noting that a calendar shift from August 2009 to August 2010 (one less Saturday and one additional Tuesday) adversely affected results by approximately -0.6% to -1.2%, varying by area of the world.

 

In the U.S., August sales increased 4.6%.  In my preview, I wrote that any print between 4 and 5% would be a NEUTRAL result because two-year average trends would be roughly in line with those in July.  The print of +4.6% implied a sequential slowdown in reported two-year average trends, however, on a calendar-adjusted basis, top-line performance actually accelerated sequentially in August by ~58 bps.  Looking forward to September, a result of approximately +4.5% in the U.S. would be required to maintain two-year trends when adjusting for calendar shifts.  September 2009 included no meaningful calendar shift and I would expect the same in 2010 (although this may vary by area of the world).

 

Europe is undoubtedly the fly in the ointment for August results; same-store sales came in at +2.2% versus consensus +5.2% and my NEUTRAL range of +5.5% to +6.5%.  This is certainly a concern for investors given the renewed attention on Europe’s sovereign debt and financial sector woes.  On a calendar adjusted basis, two-year average trends sequentially decelerated by ~185 bps.  Tellingly, the reported same-store sales number for MCD was the worst since February 2009.  Looking forward to September, a result of roughly +0.5% in the U.S. will be required to maintain two-year trends, on a calendar-adjusted basis, since August was so weak. 

 

APMEA’s same-store result came in at +7.8%.  This was slightly below my NEUTRAL range of 8 to 10% and above the Street at +7.4%.  Two-year average trends in August decelerated, on a reported basis, to +3.7% which is considerably below the +6.1% two-year average trend in July and just above the disappointing +3.2% two-year average trend in June.  Looking forward to September, a result of roughly +3.7% in APMEA will be required to maintain two-year trends next month when accounting for calendar shifts.

 

All in all, MCD’s results in August were disappointing.  Despite +4.6% being a decent number in this retail environment, it is important to note the composition of the results – particularly in the U.S. – being levered to smoothie sales which are likely to slow as we move into fall and colder weather.  Comparisons in September step up sequentially from August in all three geographical areas; it will be interesting to see whether the company can bounce back in September.

 

Howard Penney

Managing Director


Initial Claims Fall 27k Last Week - A Big Step In The Right Direction

Initial Claims Fall 27k Last Week - Progress to be Sure

Initial claims fell 27k last week to 451k (falling 21k net of the revision).  Rolling claims came in at 478k, a decline of 9k over the previous week. Reported claims have moved to the low end of the YTD range of 450-470k that the series has occupied for all of 2010, while rolling claims remain on the high end of the range. This is a big step in the right direction.  Ultimately, we are still looking for initial claims in the 375-400k range before unemployment meaningfully improves.

 

This being said, the reality is that we've seen two better than expected data points in the last two days: yesterday mortgage applications were up 6.3% and today jobless claims were down 27k. For investors interested in how best to play a short-term sentiment reversal on the long side, the table below shows Financial subsector performance over multiple periods. Investors interested in beta exposure may want to consider those subsectors near the bottom of the column on the far right as these are the highest beta names that have come under the most significant pressure since the April 14 high in the XLF.

 

Initial Claims Fall 27k Last Week - A Big Step In The Right Direction - 1

 

Initial Claims Fall 27k Last Week - A Big Step In The Right Direction - 2

 

Short term rallies notwithstanding, our firm remains of the view that US economic growth is slowing markedly between now and into 2011. We think this will keep a lid on new hiring activity as management teams focus on cost control. All of this raises the risks that a prospective slowdown in GDP will precipitate an incremental slowdown in hiring/pickup in firings, which will, in turn, further pressure growth. We continue to look to claims as the best indicator for the job market, as they are real time and inflections in the series have signaled important turning points in the market in the past.

 

In the table below, we chart US equity correlations with Initial Claims, the Dollar Index, and US 10Y Treasury yields on a weekly basis going back 3 months, 1 year, and 3 years.

 

Initial Claims Fall 27k Last Week - A Big Step In The Right Direction - 3

 

As a reminder, May was the peak month of Census hiring, and it will continue to be a headwind through the end of the month as the Census winds down.  After September, it should mostly cease to be a factor. 

 

Initial Claims Fall 27k Last Week - A Big Step In The Right Direction - 4

 

Joshua Steiner, CFA

 

Allison Kaptur


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LABOR FORCE PARTICIPATION DROP A 200 BPS HEADWIND TO UNEMPLOYMENT

Fudge Factors: The Labor Force Participation Rate

Yesterday Howard Penney and Rory Green of the Hedgeye Macro team presented their insight on how significant the decline in the labor force participation rate has been in understating unemployment. To summarize, the marked reduction in labor participation has shaved around 200 basis points off the reported unemployment rate. Said differently, unemployment will need to improve 200 basis points before the unemployment rate begins to move lower. While claims improved sharply this morning, they remain in their YTD range of 450-470k, which is 50-75k above where they need to be for unemployment to improve, suggesting we are still a long, long way off from any meaningful drop in unemployment. The following is taken from their note yesterday.

 

There are two ways (maybe more) the government can manipulate the jobs data to make things look better than they appear.  The first way was highlighted in a post entitled, “FRIDAY MACRO MIXER: THE PAYROLL FUDGE FACTOR”, where I discussed the implications of the Birth/Death model on the credibility (or lack thereof) of the payroll data.  As I wrote on Friday, the last benchmark revision released by the BLS indicated that the Birth/Death model numbers were grossly understating job losses and, as such, is not reliable. 

 

The second way the BLS distorts the numbers is through the headline unemployment rate, which is being deflated by changes in the Labor Force Participation Rate. 

 

Since BLS unemployment data begins, 1948, the proportion of the civilian population working or seeking work has generally been growing.  This is largely as a result of women entering the workplace and long-term growth in the U.S. economy through the 20th century.  The 1950’s saw year over year increases in the labor force participation rate of 210 bps – more than three standard deviations from the mean of all available data (January 1948 to present).  Recently, there has been a period of precipitous decline in labor force participation rate, peaking at a year-over-year decline of 120 bps – two standard deviations from the mean – which is important to note. 

 

The chart below details where the unemployment rate would be if the labor force participation rate was at its ten-year average level of 66.1%; for the year-to-date, it has been averaging 64.8%.  This implies that many folks are losing heart and dropping out of the job hunt.”

 

 

LABOR FORCE PARTICIPATION DROP A 200 BPS HEADWIND TO UNEMPLOYMENT - LRPR adjustment

 

LABOR FORCE PARTICIPATION DROP A 200 BPS HEADWIND TO UNEMPLOYMENT - LFPR

 

Initial Claims Fall 27k Last Week - Progress to be Sure

Initial claims fell 27k last week to 451k (falling 21k net of the revision).  Rolling claims came in at 478k, a decline of 9k over the previous week. Reported claims have moved to the low end of the YTD range of 450-470k that the series has occupied for all of 2010, while rolling claims remain on the high end of the range. This is a big step in the right direction.  Ultimately, we are still looking for initial claims in the 375-400k range before unemployment meaningfully improves.

 

This being said, the reality is that we've seen two better than expected data points in the last two days: yesterday mortgage applications were up 6.3% and today jobless claims were down 27k. For investors interested in how best to play a short-term sentiment reversal on the long side, the table below shows Financial subsector performance over multiple periods. Investors interested in beta exposure may want to consider those subsectors near the bottom of the column on the far right as these are the highest beta names that have come under the most significant pressure since the April 14 high in the XLF.

 

LABOR FORCE PARTICIPATION DROP A 200 BPS HEADWIND TO UNEMPLOYMENT - rolling

 

LABOR FORCE PARTICIPATION DROP A 200 BPS HEADWIND TO UNEMPLOYMENT - raw claims

 

Short term rallies notwithstanding, our firm remains of the view that US economic growth is slowing markedly between now and into 2011. We think this will keep a lid on new hiring activity as management teams focus on cost control. All of this raises the risks that a prospective slowdown in GDP will precipitate an incremental slowdown in hiring/pickup in firings, which will, in turn, further pressure growth. We continue to look to claims as the best indicator for the job market, as they are real time and inflections in the series have signaled important turning points in the market in the past.

 

2-10 Spread a Headwind for 3Q Margins

The following chart shows 2-10 spread by quarter while the chart below that shows the sequential change. The 2-10 spread (a proxy for NIM) has been coming under growing pressure in the past two quarters.  Yesterday’s closing value of 214 bps is up from 208 bps last week. For reference, 3Q to date is tracking down 36 bps sequentially vs. a sequential decline of 19 bps in 2Q10.

 

LABOR FORCE PARTICIPATION DROP A 200 BPS HEADWIND TO UNEMPLOYMENT - 2 10 spread

 

LABOR FORCE PARTICIPATION DROP A 200 BPS HEADWIND TO UNEMPLOYMENT - 2 10 spread change

 

The table below shows the stock performance of each Financial subsector over four durations. 

 

LABOR FORCE PARTICIPATION DROP A 200 BPS HEADWIND TO UNEMPLOYMENT - subsector perf

 

Below we show the correlations between initial claims and each of the 30 Financial Subsectors. We have refreshed this table to reflect prices through the end of July. Using this updated measure, Credit Card and Payment Processing companies remain the most correlated to initial claims, with R-squared values of .63 and .65 over the last year, respectively. Surprisingly, some subsectors show a positive correlation coefficient to initial claims - i.e. Financials that go up as unemployment claims go up.  These names are concentrated in the Pacific Northwest Banks and Construction Banks, though these correlations are usually not very high.  

 

LABOR FORCE PARTICIPATION DROP A 200 BPS HEADWIND TO UNEMPLOYMENT - init. claims subsector correlation analysis as of 8.4.10

 

Some investors will note that in some cases the R-squared doesn't seem to reconcile with the square of the correlation coefficient. This is a result of finding the correlation and then averaging. For example, Pacific Northwest Banks have an average correlation coefficient of .33 and an average R-squared of .52 (with CACB, CTBK, FTBK, and STSA strongly positively correlated and UMPQ strongly negatively correlated). The different directions have the effect of canceling out each other out when finding the average correlation coefficient, but do not cancel out when finding the average R-squared. 

 

The following table shows the most highly correlated stocks (both positively and negatively correlated) with initial claims. Note that the top 15 negatively correlated stocks have a much stronger correlation on average than the top 15 positively correlated stocks - as you would expect, given that most of the Financial space is pro-cyclical. 

 

LABOR FORCE PARTICIPATION DROP A 200 BPS HEADWIND TO UNEMPLOYMENT - init. claims company correlation analysis as of 8.4.10

 

As a reminder, May was the peak month of Census hiring, and it will continue to be a headwind through the end of the month as the Census winds down.  After September, it should mostly cease to be a factor. 

 

LABOR FORCE PARTICIPATION DROP A 200 BPS HEADWIND TO UNEMPLOYMENT - census chart

 

Joshua Steiner, CFA

 

Allison Kaptur


THE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - September 9, 2010

As we look at today’s set up for the S&P 500, the range is 21 points or 1.17% (1,086) downside and 0.74% (1,107) upside.  Equity futures are trading higher tracking gains across European equities as the region’s banking and mining stocks rebound. Today's macro highlights include: Initial Jobless Claims and July Trade Balance.

  • AvalonBay Communities (AVB) said its AvalonBay Value Added Fund II unit bought an apartment community in Calif. for $98.5m
  • Fuqi International Inc. (FUQI) got SEC subpoena from for failing to file periodic reports on time
  • Men’s Wearhouse (MW) forecast 3Q adj. EPS 40c-47c vs est. 41c
  • Questcor Pharmaceuticals (QCOR) said FDA delayed a decision on its application to sell its Acthar drug as treatment for seizures in babies
  • TNS (TNS) agreed to buy Cequint for as much as $112.5m and said it will buy back up to $50m of its stock

 

PERFORMANCE

  • One day: Dow +0.45%, S&P +0.64%, Nasdaq +0.90%, Russell 2000 +0.79%
  • Month-to-date: Dow +3.72%, S&P +4.72%, Nasdaq +5.43%, Russell +5.35%
  • Quarter-to-date: Dow +6.27%, S&P +6.61%, Nasdaq +5.67%, Russell +4.06%
  • Year-to-date: Dow (0.39%), S&P (1.46%), Nasdaq (1.78%), Russell +1.42%

EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: 1183 (+2599)
  • VOLUME: NYSE - 879.91 (+5.96%) - No conviction and a light economic calendar
  • SECTOR PERFORMANCE: All sectors were up yesterday except XLU.  Tough to find a specific catalyst for yesterday’s performance, though an improvement in the risk backdrop surrounding Europe and the momentum behind the M&A rumor mill also offered some upside.
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: NY Times +7.99%, Priceline +5.53% and Huntington Bank +4.48%/Visa -4.13%, Nisource -3.86% and Tereadyne -3.53%
  • VIX: 23.25 -2.31% - YTD PERFORMANCE: (+7.24%)            
  • SPX PUT/CALL RATIO: 2.04 from 2.00  

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD: 16.67 -0.101 (-0.604%)
  •  3-MONTH T-BILL YIELD: .14% trading flat
  • YIELD CURVE: 2.14 from 2.12  

COMMODITY/GROWTH EXPECTATION:

  • CRB: 274.27 +0.17% - Coffee at a 13 year high
  • Oil: 74.67 +0.78% up for the first day in three
  • COPPER: 344.65 +0.86%
  • GOLD: 1,255 -0.07%

CURRENCIES:

  • EURO: 1.2750 +0.14%
  • DOLLAR: 82.585 -0.28%

OVERSEAS MARKETS:

ASIA

  • Nikkei +0.82%; Shanghai Composite (1.44%)
  • Asian markets were mixed today even though concerns about European debt problems were addressed by successful bond auctions yesterday.

 

EUROPE

  • FTSE 100: +0.51%; DAX: +0.12%; CAC 40: +0.35% (as of 04:55 ET)
  • European markets opened lower, seeing some profit taking after yesterday's strong gains.
  • Ireland's Finance Minister looked to reassure markets over Anglo Irish Bank saying the government hopes to produce definitive figures on the cost of its restructuring by the end of October.
  • No movement on the part of the BOE; 0.5% benchmark interest rate and the £200B asset purchase program remains unchanged.
  • Banks and technology groups are amongst the leading gainers with all but four sectors trading higher. US futures trade higher.
Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends

 

THE DAILY OUTLOOK - S P

 

THE DAILY OUTLOOK - VIX

 

THE DAILY OUTLOOK - DOLLAR

 

THE DAILY OUTLOOK - OIL

 

THE DAILY OUTLOOK - GOLD

 

THE DAILY OUTLOOK - COPPER


Feeling Strange

“Is it not strange that desire should so many years outlive performance?”

-William Shakespeare

 

This morning’s global macro risk management setup feels as strange as it has since September of 2007.

 

As most market historians will recall, the S&P 500’s run from Labor Day of 2007 until the first week of October 2007 was the final countdown to get out. That’s not to say that the shorts who pressed the August of 2007 lows didn’t get run over in September of 2007 by the way. I, for one, got crushed.

 

I’m not one to say that market history repeats, but I am a big believer that patterns of market behavior rhyme. Think about both the absurdity of the prices paid by Private Equity and LBO firms in 2007 and then rewind the quality of yesterday’s “rumor mill” about everybody buying everybody. The sad reality of our business is that the hopes and desires of low quality market players trying to make a living on rumors is many years outlived by actual performance.

 

The performance of the S&P 500 from September 4th – October 8th of 2007 was +4.3%. The month-to-date performance of the S&P 500 for September of 2010 is +4.7%. You can tell me what parts of the “M&A” rumor mill is driving this low-volume rally to lower-highs. I can tell you that it’s not insignificant.

 

I can also tell you that there are significant and strange developments occurring across global markets this morning. Remember, managing the risk associated with a rally in US Equities requires analyzing the multi-factor and multi-duration price action that’s driving this globally interconnected ecosystem. The best I can do this morning is summarize how strange this is all feeling by major geography.

 

Before I dig in geographically, it’s worth mentioning that there is one major factor governing news-flow worldwide right now – professional politicians fundamentally believing that they are the arbitrators of all our desires. Strange.

 

1.       Asia

 

Other than Japanese equities crashing again (Nikkei 225 down -20% from its April peak) and few in the Manic Media acknowledging that Japan is a much larger long term issue than Greece, isn’t the following comment from Japan’s Finance Minister, Yoshihko Noda, this morning strange?

 

“I feel strange that China can buy Japanese government bonds while Japan can’t buy theirs.”

 

Capitalistic note to bureaucratic self: the world’s largest creditor can buy whatever they damn well please. You, Captain Debtor Nation, shouldn’t feel strange at all now that you have compromised and constrained your economic system with systemically impairing levels of leverage.

 

By the way, this is how a spokesman at China’s Foreign Ministry, replied in Beijing today. “We will decide whether or not to buy one country’s bonds according to our own needs.” There’s nothing strange about that.

 

2.       Europe

  

Watching Bloomberg TV’s Andrea Catherwood interview Greece’s Director General of Public Debt Management Agency, Petros Christodoulou, this morning was beyond strange. Never mind what a professional politician is doing with a title that long, what in God’s good name do market participants expect him to say about Greece’s debt?

 

In Q2 of this year, we introduced a Hedgeye Macro Theme called “The Sovereign Debt Dichotomy.” The long term cycle work on the sovereign debt default cycle was backed by Reinhart & Rogoff and our core thesis remains long term as cycles like these are. The bottom line is that sovereign debtor nations will be forced into restructuring or default at different points in time for the balance of the next 3 years. They won’t all happen at once!

 

Is it strange that Denmark (up +22% YTD) is trading up +0.79% this morning and Greece (down -28% YTD) is trading down again after getting clocked yesterday? Is it strange that Petros “rules out restructuring”? or is it just strange that a professional politician like this actually matters to markets?

 

3.       USA

 

Price action in US Equities is definitely improving. I can call that strange – I certainly did in 2007! But strange can remain longer than a short seller can remain solvent. Learning from my mistakes and evolving the risk management process is where I’m focused on improving.

 

Both the weekly ABC/Washington Post Consumer confidence (-43 vs -45) and MBA Mortgage Application (+6.3% week-over-week) reports were better than expected yesterday. For the two big things that matter for US economic growth (consumer spending and housing), there should be nothing strange about the fact that the only moves I made in the Hedgeye Portfolio yesterday were buys and covers. As facts change, I need to.

 

While these data points appear strange in the immediate term, they are real. It’s also important to Distinguish Our Immediate Term Duration from the Intermediate Term bearish TRENDs we continue to forecast in both US consumer spending and housing.

 

While I don’t think it’s strange that the US market won’t focus on something like Harrisburgh, PA defaulting on its September 15th payment until they actually miss the payment, it’s sometimes strange to just think about these things out loud from the fishbowl that is my office in New Haven, CT.

 

Whether its in CT, IL, or AZ, these states and the municipalities that they house are going to be feeling more and more strange as they march down the Road To Perdition that many European states have already trekked. Will Illinois be the next Greece?  Will the US Federal Government be forced to bail out municipalities and states like the EU had to with Greece, Spain, and Portugal?

 

If China is selling US Treasuries and buying Japanese Government Bonds, where will we get the money? There should be nothing strange about asking yourself these risk management questions.

 

My immediate term support and resistance levels for the SP500 are now 1086 and 1107, respectively. If 1086 can hold, I’ll continue to be far less aggressive with my shorts this September than I was in 2007. This Time Is Different.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Feeling Strange - 1


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

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