"Every organization must be prepared to abandon everything it does to survive in the future."
~ Peter Drucker
The worst part about the long weekend is that it’s over. Time with my family is always the most important to me. This Thanksgiving we had plenty to be thankful for, including this wonderful opportunity to be a part of a great team that’s fighting the good fight, helping rebuild of one of America’s most precious industries, the US Financial Industry.
As it has been for the last 6-9 months, studying the Depression was part of my weekend reading assignments. I am definitely thankful that my wife puts up with me on this front – losing myself in “The Forgotten Man” or “FDR” doesn’t exactly make me the most exciting husband to be around! The more I study Roosevelt, however, the more I have come to appreciate his challenging the loss of corporate America’s moral compass.
American history always finds its hero. For whatever brief period of time, Franklin Roosevelt earned that respect. Let me be clear, I am not making the case here for FDR’s economic accomplishments. I am calling out a man who calmed a nation. He was an objective man who found answers in what he used to call his “brain trust” – a group of academics and intellectuals that weren’t part of the Wall Street groupthink. He was a man of principle whose voice powered over his physical ailments. He was a man of integrity. He led by example.
The summary point of my studying FDR’s rise to the Presidency is that the economic realities between now and the Great Depression are very different; however, the credibility issues associated with American leadership are very similar. Roosevelt said that the Depression was the result “of the lack of honor of men in high places.” Think about that. Then think about what we have gone through in the last 12-18 months.
When I woke up this morning thinking about whether or not it’s the right call to be completely sold out of my US Equity position (we are now short the S&P500 via the SPY), I couldn’t help but conclude that the depression some are feeling in the halls of their own financial institutions is very real, because it should be. Inflexible organizations that don’t change will probably go away.
Now that November has passed, we’re looking back on an S&P500 that was down almost 8% for the month while the Chinese stock market appreciated closer to +9%. History is always crystal clear. Facts remain the toughest tonic for compromised credibility to swallow. Gold shone brightly in November as well, closing the month +13%. How could that be? Maybe the clear cut answer for Obamerica’s “New Reality”, like Roosevelt’s “New Deal”, is going to be to attempt to re-flate.
Re-flation isn’t a word… at least not one that has found its way into the Street’s narrative fallacy yet. Everyone from CNBC to Prince Alalweed is busy trying to convince you that deflation is going to last forever and that bankers who have flip-flopped jerseys are the answer to your leadership prayers. Re-flation is what Roosevelt initially tried to accomplish in 1933 by inflating gold and de-flating the US Dollar. Since there was a cat named Hitler introduced into the global macro picture in 1934, it’s not entirely clear how the domestic re-flation story would have played out. As Hitler’s regionalist and racist intentions became clear, the world hunkered down and repatriated their dollars closer to home.
Fortunately, today’s “New Reality” doesn’t have a Hitler. While we have the nuisances of Chavez, Ahmadinejad, and Putin, the power of their collective voice diminishes alongside the price of oil. Re-flating will most definitely turn up their non-sensical volume again, so if you’re in that inflation camp, be careful what you wish for.
In Asia, those living in India and Pakistan are waking up to the dire realities that are associated with expedited deflation. Commodity price erosion is not only a function of weakening economic demand, but it ignites the beasts of social unrest. When people are losing money and killing one another, bad things happen. If these two countries weren’t stationed at the heart of the world map’s panic button, I’d be less concerned. Make no mistake, the canaries in these coal mines have nuclear capabilities. No matter what the mass media told you on Friday doesn’t change the fact that a major geopolitical risk card was just turned face up on the world’s economic table.
Whether it’s old geo-political associations or old boy networks, we need to be prepared to “abandon everything” to survive in this uncertain future. This Thanksgiving allowed us all to pause, and give thanks… but today is December 1st… and “The New Reality” of a globally interconnected marketplace will be waiting for no one. We need to open our minds to new ideas, or someone in China will first. Americans want to win and so do I. I’ll take the lead from FDR, “I pledge you, I pledge myself to a new deal for the American people.”
Best of luck out there in December,
GLD -SPDR Gold Shares –LME Gold fell by 1.7% in trading this morning, the first decline in 3 sessions.
TIP –iShares Lehman TIPS Bond –2 & 10 year treasury yields sank to record lows of 0.95% and 2.88%, respectively.
OIL - iPath ETN Crude Oil –Light Sweet Crude futures fell below $52 per barrel in trading this morning despite statements made by OPEC leaders that further production cuts in December were likely.
EWG – iShares Germany - Retail sales fell by 1.6% s.a. in October from September, according to data released today by the Federal Statistics Office.
FXI –iShares China – PMI data issued by CLSA declined to 40.9 in November from 45.2 in October, the largest one month decline since the purchasing manager’s survey was begun in 2004 (a PMI managed by NBS declined by a comparable amount). The yuan declined by 0.7% to 6.8848 USD, the largest single day drop since the fixed exchange rate ended in 2005.
SPY –S&P 500 DR –S&P 500 futures traded as low as 870.9 before 7AM this morning.
IFN - iShares India – Export data for October showed a year-over-year decline of 12.1% , the first decline since 2001.Finance minister Palaniappan Chidambaram has been appointed to head the Home Ministry after in the wake of the terrorist attacks in Mumbai, with Prime Minister Singh assuming control of the finance portfolio personally. The seven month ban on trading futures for basic commodities such as rubber and soybean oil was lifted by Prime Minister Singh’s administration in light of declining inflation levels.
EWU – iShares United Kingdom – PMI data measured by the The Chartered Institute of Purchasing and Supply was released today at the lowest level since 1992, with the Index registering at 34.4.
UUP – U.S. Dollar Index – The USD is weakening against the Yen this morning.
EWJ – iShares Japan –The BOJ board will hold an emergency meeting tomorrow to discuss options to increase liquidity for corporate borrowers. Labor ministry statistics show that monthly wages declined by 0.1% year-over-year in October, the first decline YTD.
FXY – CurrencyShares Japanese Yen Trust – The yen climbed 1.2 % to 119.18 EUR and 94.13 USD this morning.
Keith R. McCullough
CEO & Chief Investment Officer
"Every organization must be prepared to abandon everything it does to survive in the future."
The chart below shows that The North Face dollar share in the sporting goods channel is on a downtrend – hitting parity with year-ago levels after 12 months of impressive share gains. Average price point (a proxy for retailer discounting activity) is flattish to down slightly. Conversely, we’re seeing both average price and dollar market share pick up for Columbia. Note that Columbia’s 20% share of the category in this channel is dwarfed by TNF’s 65%.
I usually don’t get too bent out of shape about this data, but there a couple of things I’d point out. 1) I track the real trends on a trailing 3 week basis, and this is the 3rd week in a row we’re seeing such gains for COLM. I think we can say that this is more than a simple blip. 2) I’ve warmed to COLM in a more meaningful way over the past six months, largely due to the increased investment spending it is allocating to its core content. COLM has been a share loser for a long time – bc it has not invested enough. This share gain is probably not an accident.
As it relates to TNF – it is important to note that the Brand is incrementally growing in its own retail stores. As such, more marginal distribution channels (some of which are in the sample analyzed) are likely seeing smaller allocations. That’s smart from where I am sitting. But that said, I’m not sold yet on TNF’s retail strategy. The company has not proven that it ‘gets retail.’ It’s easy to make money in a store when a brand is hot. But when a brand is cooling, that’s where being a good retailer makes a difference, and is where I think VFC will expose its weakness.
On the surface, this looks pretty bad for Boyd Gaming and Station Casinos, both of which have significant exposure to the LV locals market. The sharp decline in gas prices probably won’t help this troubled market. Changes in gas prices have had an immaterial impact on gaming revenues historically. The reason is probably that since Nevada is an unlimited license jurisdiction, unlike other markets, most Las Vegas residents are probably only a die’s throw away from a casino.
Of course, the more obvious piece of the bad news puzzle is housing. The LV housing index has fallen on a year over year basis since February 2007, and the YoY change is down sequentially for a whopping 48 consecutive months. The good news is that Las Vegas housing prices began declining much earlier than the average US market and there are some signs of stabilization. Prices barely fell in October vs. September. Prices have been down so much (30%+) and for so long that gaming revenues probably already reflect the housing impact. Analysts’ projections probably do as well.
The positive for Boyd is that expectations for the LV locals market are very low. Moreover, it’s main competitor in the market is Station Casinos, a private company near bankruptcy. Whether Station goes into bankruptcy or not, Boyd has a huge competitive advantage because of its liquidity. See our recent post, “HOW TO STEAL MARKET SHARE”. Station doesn’t have the cash to upgrade the slot floor or be competitive on the marketing/promotional front. Boyd does.
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Given the deteriorating economic climate in the Eurozone, anti-immigration sentiment is on the rise in Europe, as are the feelings, by immigrants, of being unwanted. Our review of this “Trend” will begin with Germany, a country we are currently long via the EWG exchange traded fund.
In Germany, these immigrants are referred to as Gastarbeiter, or guest workers. They are mostly men recruited by the German government in the 1960s and 1970s to meet the demands of a labor shortage after the Second World War. This period, which become known as the Wirtschaftswunder (or economic miracle), saw the active recruitment of individuals from Italy, Greece, Turkey, Portugal, and Yugoslavia for unskilled industrial sector jobs in West Germany.
Turkish citizens quickly held the lions-share of the Gastarbeiter quota, most of whom were given temporary visas for a couple of years. However, what the government didn’t account for was the reluctance of employers to let trained workers leave, nor the desire on the part of the workers to make Germany home. Instead of heading to their home countries with pockets full of D-Marks, guest workers stayed and brought over their families. Children born to Gastarbeiters received the right to reside in Germany but were not granted citizenship.
This immigration story is an important one that plays out on German streets today. Tour any German city and you’re likely to see Kebab stands—a traditional Turkish sandwich like a gyro—which Germans eat like fast food. Or check out any major German publications and you’re likely to see various exposés about integration issues in Germany, the catch-phrase being multiculturalism (Multikulti), defined as the recognition, celebration and maintenance of different cultures or cultural identities within a society to promote social cohesion.
It’s fair to say that such terminology as multiculturalism exists because there is a concerted effort to reduce the fractious relations between Germans and Turks (as well as other minority groups) over political, religious, and cultural differences. Many of these differences stem from the treatment and perception of the Turks as “guests” of Germany, not citizens, since arriving as far back as 50 years ago.
Certainly citizenship is an important mark in defining a society. In the US we have conveniently devised the terms Salad Bowl and Soup Bowl to describe a people with varied foreign roots; most of the original settlers in this country were not refused citizenship based on ethnicity or religion. Yet within historically more homogeneous European countries, like Germany, such definers as ethnicity (especially skin color) and religion can play an important role in determining “Who is German”.
It is under similar pretext (who belongs and who doesn’t) that many European nations have reservations accepting Turkey (a predominantly Muslim country) into the European Union. In 2000 legislation passed conferring German citizenship to German-born children of foreigners who have lived in the country for at least eight years, and in addition made the naturalization process easier, though dual citizenship is not tolerated. Now, any person possessing it by virtue of birth to foreign parents must choose between the ages of 18-23 which citizenship he or she wishes to retain, and forfeit the other.
Today Germany is home to 2.7 million people from Turkish families (of Germany’s 82 million residents), with an estimated population of 3.4 million Muslims. The city section of Kreuzberg in Berlin has such a high concentration of Turks it has been named “Little Istanbul”.
The crux of the Germany’s most profound social problem is that the guest workers who arrived in the postwar years never really integrated. This has carried over in the form of isolated communities but, more importantly, has had massive repercussions on successive generations. These include children who aren’t exposed to the German language in the household, and therefore are a step behind their German peers as they begin their education, and complex identity issues resulting in integration handicaps.
From the initial movement to bring unskilled laborers to Germany in the 1960s and 1970s, the German landscape has changed. Today, Germany recruits outside its borders for highly skilled workers, generally in the sciences or high-tech fields. Unemployment, which has been high in Germany, especially in the “former” East Germany, today stands at 7.5% (av. Eurozone 7.6%), with Turkish unemployment rates generally double the national average.
The German-Turkish debate as it plays out in politically, economically, and culturally on the street is an important one to follow. Telling is a quote from Turkish Prime Minister Recep Tayyip Erdogan at a mass rally held for Turkish immigrants during his visit to Cologne in February 2008, in which he said: “Assimilation is tantamount to a crime against humanity”. German Chancellor Angela Merkel quickly responded saying she didn’t share the PM’s view. Was it really just a slip of his tongue?
We’ll be monitoring economic fundamentals alongside a host of risk factors (like immigration) in our ongoing evaluation of our long position in the German etf, EWG.
In the shadow of the steeple I saw my people.
By the Relief office, I seen my people.
As they stood there hungry, I stood there asking
Is this the land made for you & me?
We sat at our table this Thanksgiving surrounded by family, aged twelve to 95, and friends from as far off as Bosnia and Israel. We spoke about what makes America great – and about those who have never been part of the Thanksgiving narrative. Lincoln said this nation was “conceived in Liberty…” yet, some deformation appears to have taken place in the birth canal. This is not the place to dwell on issues of race, ethnicity, and dual national identity as part of the uniquely flawed – and yet uniquely great fabric of this nation. But we acknowledge that societies are defined by access: who Gets In, and who Doesn’t Get In, and in every society there are groups that we define as Structurally Dispossessed.
As much as anything else, the recent election is the result of self-assertion by groups who heretofore never believed themselves to be full participants in American society. One need only look at the hundreds of thousands of people who had been registered to vote for years, but who never actually pulled a lever until this year. The rules remain the same. Yet, by broadening to include as “Americans” the Structurally Dispossessed, the American narrative may change dramatically. Many are shocked by this handing of political clout to large groups of people who have never participated in the process. It is the ultimate Trickle Down. Next Thanksgiving will see a different United States of Obamerica.
With all the changes we anticipate at every level of society, what might the implications be for the world of market regulation?
We Americans are unusually prone to injecting morality into our political discourse, no less in our view of securities regulation than elsewhere. We damn short sellers as being evil. When markets get choppy, we outlaw them – despite the fact that short selling is one of the fundamental mechanisms that has made our markets superior to any other securities markets in the world. We can quibble over data sets used to analyze the effectiveness of the Uptick Rule, but the fact is that Shorts are always smarter, as a group, than Longs. Their activities force realistic pricing in the markets, and their capital sustains market liquidity. Thus, regulation trashes the very markets it attempts to salvage.
The Obama Administration promises some tough new regulation. Media reports are full of words like “broad” and “sweeping”. But what philosophy will that regulation support? Rules, as we see over and over again, are meant to hide behind. It is striking to note that the violation of securities rules is often viewed as a business decision. Owners and management assess how much they will make if they violate a rule, versus how much it is likely to cost them if they get caught. It is the nature of the current regulatory process that regulatory penalties paid out by Wall Street firms generally fall short of the profits generated by the behavior that led to regulatory action.
The new Obama administration has assembled an impressive economic team. Now they must define their Narrative. We often hear that Business is more effective than Government, because of the Profit Motive, as though this were an alchemical formula for fiscal policy. As discussed in the Wall Street Journal (“Government By Contractor is a Disgrace” – 11/26/08) paying the private sector to do government work is not only not efficient, but leads ineluctably to corruption and excess. The observation that Government has a lot to learn from the private sector is dead on, but the profit motive is not the silver bullet.
The constant seeking after profits is not what makes businesses successful. It is what makes them lose sight of their long-term objectives, and often it is what makes them corrupt. The success factor in capitalism is neatly summed up by Secretary Paulson’s testimony to Congress on why he diverted TARP funds away from their original intended purpose of buying up toxic mortgages: “When the facts change, I change my mind.” The true genius of Capitalism is its ability to reinvent itself. The key question a successful entrepreneur asks is not “How many of these can I sell?” but rather: “What business am I in today?”
In the current shouting match we have heard some regulators pushing for principles-based regulation, as opposed to the standard rules-based regime, which is inherently prone to abuse. Perhaps government can do no greater service to the people and the markets by guiding the discussion about What Country Are We In? This is by its nature a fluid conversation. It is an ongoing discourse, and the principles by which we will regulate our markets in the future must emanate from that discourse. Put another way: law and regulation are an outgrowth of how the country defines itself. We now have an opportunity to make a conscious decision of what we want America to look like, to be, to do. The Obama narrative rests largely on increased Access for more Americans. If this is to succeed, it will have to very visibly undo Business As Usual, and push creative reinvention. The new administration must lead the national dialogue in asking over and over again, What Country Are We In?
O Lord, won’t you buy me a Ford Pinto?
Are we the only ones who found it odd that the UAW came to Washington together with the CEOs of the No-Longer-So-Very-Big Three? This looks like an ex-spouse looking over one’s shoulder and checking the numbers on a lottery ticket. As curious as it was to see the UAW and the Soon-To-Be-Downsized Three waltzing in arm-in-arm-in-arm-in-arm, it is shocking to us that Congress even debated their proposal. But then, this is the same Congress that approved $700 billion for Fannie and Freddie, but did not summarily fire their bosses. The auto industry conversation, in a nutshell, is: “Our business model doesn’t work. Please give us $25 billion to sustain our unsustainable business, until we can convince you to give enough of your other $700 billion to enough people to force them to buy our trash.” As we all know, What’s good for General Motors…
We note with interest that the President of the atoll nation of the Maldives is actively looking about for a new homeland – and willing to pay for it. The 350,000-odd inhabitants of this island nation feel all too keenly the imminent risk of being swallowed up by a rising sea level. One modest proposal might be to have them move to the interior of China. Half of China’s population now lives in the cities, and more are fleeing daily. The 750 million or so people still living inland are largely older – their children went to Beijing, they stayed behind. They are also largely dependent, in traditional Chinese society, on their children taking care of them as they age, a phenomenon that looks just about to go by the boards. Would they not welcome a new family into their midst, if they came bearing cash? The 350,000 people fleeing the Maldives would be a tiny blip on the radar of a nation whose population is one-fifth of all humanity. “When the facts change, I change my mind.” President Mohamed Nasheed could teach Detroit a thing or two.
Twenty-five billion dollars is a fair chunk of cash. If it is handed to the Big Three it will likely vanish in a puff of smoke. On the other hand, it is approximately $40,000 each for the 620,000 or so members of the UAW. Instead of buoying a sinking ship, we could set up a combination home mortgage guaranty and professional retraining program for auto workers. We could sock $25 billion into an artificially high-paying interest bearing account – say ten percent – and require the auto manufacturers to match the revenues. They should have no trouble doing so. As they have not tired of telling us, if they get rid of their losing US business, their profitable overseas operations will restabilize their finances. With $250 million a year from Government, matched by an equal amount from each of the Three, we have an ongoing stream of $1 billion a year to dole out to UAW members while they redeploy.
Black, Black Friday
This weekend marked the beginning of the holiday shopping season. Preliminary figures appear to indicate that reports of the death of the American consumer have been somewhat exaggerated. Bloomberg quotes the market research firm ShopperTrak RCT as saying sales were up 3% over last year. This would be the smallest increase ever recorded – but an increase, nonetheless. Retailers are on tenterhooks and will be counting every penny of revenues, hoping to pull out a profitable year.
The Bloomberg story reports that retailers advertised “doorbuster” sales nationwide. At least one location proved true to this name, as shoppers at a Wal-Mart in Valley Stream, Long Island, literally not only tore the doors off the building, but trampled a worker to death as they surged into the store. Fellow workers who tried to break up the flow of stampeding shoppers and rescue their colleague were met with angry shouts of “We’ve been waiting all night!” This gives new meaning to the concept of Pent-Up Demand, and shows the folly of the current Washington plan. If consumer spending represents 70% of American GDP, then the $700 billion should not be given to the banks, but to those who will spend it. Washington should hold a contest, with consumers being asked to describe their ideal family shopping spree. We could sponsor the ultimate reality TV show – Shopper For A Day – and Washington, as the producer, could sell advertising time, thus generating additional revenues for the consumer bail-out. Why not offer this opportunity to the UAW? The $700 billion package works out to over one million dollars per Union member. Let’s give them a shopping spree. The money will be handed out on the sole condition that it all be spent within no more than thirty days, and all within the borders of the United States.
Instead of appointing Henry Paulson to fix this mess, we should have appointed Sam Walton. He knew how to stimulate spending!
Director of Compliance
* Dedicated to the memory of Jdimytai Damour *
Volatility levels in the options market declined this holiday week with volume slowing to a trickle by Wednesday. Put/call ratios declined for the month of November in the aggregate with the index-option ratio remaining higher by an average margin of 27% --significantly lower that historical averages but still suggesting that investors with broad market exposure are continuing to hedge at these lower price levels.
Some of the major indications of declining volatility for the week were:
•On Wednesday the VIX closed at the lowest level since October 21, declining below its 50 day moving average.
•On Friday, realized 30 day volatility for the cash SPX declined below 71.5 for the first time since Oct. 17th.
•On Friday the VIX traded over 4% lower than its 50 day moving average while second month series VIX futures contracts (January 09) traded 13% lower --the lowest that the contract has trailed the VIX 50DMA since being introduced over four years ago. Other series traded at similar discounts. Clearly the futures market is pricing in declining volatility as we head into year end.
Despite all of this, volatility remains outside any historical corollaries and the options markets retain treacherous liquidity holes that leave plenty of room for short squeezes --this is not a time for amateurs to start selling naked volatility. Conversely, any volatility buyers need to be cognizant of the impact that suspended or decreased dividends will have on long-dated put contracts, while also remembering that the impact of time decay will be massively pronounced on short term contracts at these high vol. levels.
As we said last week, there are still phenomenal opportunities in this options markets for investors with the correct duration and fundamental conviction –it’s just important that they understand all the moving parts before wading in. Feel free to contact me with any question about derivative strategies at
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