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# INITIAL CLAIMS DROP 11K BUT REMAIN IN THEIR YTD RANGE

Initial Claims

Initial claims fell 11k last week to 445k (falling 8k before the revision of last week’s data).  Rolling claims came in at 455.75k, a decline of 2k over the previous week. While the rolling claims number was incrementally bullish, 455k rolling is still within the year-to-date range of 450-470k.

One caveat to the bullishness of today’s print is the frequency of adverse (upward) revisions to claims the following week. Financial blog Zerohedge.com points out that of the last 24 weekly initial claims announcements, 23 have been revised higher.  If we assume that an upward revision is as likely as a downward revision, the odds of this happening by chance are approximately one in 699,000 (x = 24 / 2^24).  On a year-to-date basis, the picture isn’t quite so skewed, but the cumulative revisions (sum of each week’s revision) is nevertheless greater than 80,000. For reference, and for those interested in our probability methodology, we determined the probability by calculating the total number of possible outcomes, given that each week’s revision was equally likely to be upwards or downwards and was independent, which is 2^24.  Of those, 24 outcomes include 23 upwards revisions and one downward revision ("24 choose 23" or 24 choose 1 for combinatorics geeks).  24/2^24 is 1.43x10^-6, or 1 in 699,000.)

To reiterate, our firm's expectations for an ongoing economic slowdown relative to the first half of the year and into 2011 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.

On a related note, we are publishing below a post from our Macro team on the Food Stamp program participation. To quote from that post: "Whether the NBER says so or not, the recession persists for many Americans.  A record 41.8 million participants received food stamps in July as part of the Supplemental Nutrition Assistance Program, according to government data.  Furthermore, the White House estimates that an average of 43.3 million people will get food stamps each month in the twelve months that began October 1st, 2010.  The rising costs of food and energy (dare I say it, “inflation”), and the lack of job creation, continues to hurt the consumer – especially those at the low end of the spectrum."

Yield Curve

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 under significant pressure for the last few quarters and that pressure is showing no signs of abating. Yesterday’s closing value of 201 bps is down from 207 bps last week.

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

Joshua Steiner, CFA

Allison Kaptur

# MAR STILL POSTURING

Q3 was good but not great.  Q4 EPS guidance is a little disappointing.  But 2011 top line will be fantastic?

Despite the whispers of a big beat this quarter, MAR’s 3Q results and 4Q guidance was simply in line with consensus.  In fact, management lowered the high end of guidance across a number of line items.  The bulls will point to 6-8% RevPAR guidance for 2011 which is nice but a bird in the hand is worth two in the bush.  The bird in the hand is the near term while lofty RevPAR expectations for next year are clearly “in the bush”.

We continue to think MAR is posturing for its ongoing corporate rate negotiations.  Thus, 2011 RevPAR guidance is on the aggressive side in our opinion and conference call commentary regarding the status of negotiations will likewise be bullish.  However, as we wrote about yesterday in our note, "WE'VE GOT A BRIDGE TO SELL YOU," we think corporate pushback is stronger than expected and the lodging companies may not have as much leverage as investors have been led to believe.  RevPAR visibility is not high enough to be so bullish, in our opinion.

As we’ve written about, we think there is empirical evidence to show that absolute seasonally adjusted RevPAR has been slowing since July.  The April to July period was above RevPAR trend, in our opinion, which will make RevPAR comparisons very difficult in Q2 and Q3 of 2011 and could actually go negative in some months.  We think 3-4% RevPAR growth is more likely than 6-8% and as such, we remain below the Street in our EPS estimates beginning in Q2 2011.

Tidbits and Takeaways from 3Q2010:

• There was a deceleration of room growth across almost all brands
• Occupancy growth is decelerating as comps get harder.  The real question is whether ADR will pick up where occupancy growth left off to continue the 8%ish trend.
• Owned, leased, corporate housing and other revenue, net of direct expenses of \$7MM came in \$3MM below MAR’s \$10MM guidance.
• Even if we remove the \$6MM of cancellation fees that benefited 3Q09, revenues would have been flat YoY
• We estimate that owned and leased room revenues should have been up around 6% given the relatively flat YoY room count and the increase in RevPAR.  Therefore, if branding fees were flat around \$19MM, this implies that food & beverage & other revenues declined almost 5% YoY at these properties.
• Total fee revenue came in at the high end of guidance
• Incentive fee growth slowed to 23.5% from over 30% last quarter, although to be fair the company indicated that growth would be a little less in the 3Q than in the 2Q.
• Only 23% of hotels paid incentive fees vs. 25% in 2Q2010 and 20% in 3Q09.
• Timeshare segment results of \$37MM, which investors care about the least, happened to come in above MAR’s guidance and our expectations.  The outperformance came purely from better margins.  Top line was actually disappointing in our opinion.
• Contract sales were down 7% YoY, sales & service revenue was down 5%, and base fee revenue was flat
• However, timeshare sales and services, net margin was 25% - which was almost 400bps stronger than what MAR reported in 1H2010
• Below the line items also helped the quarter.
• As we expected, G&A came in lower than management’s guidance of \$155MM – we modeled \$150MM the actual number was \$149MM.
• Reported net interest expense of\$37MM was \$3MM lower than MAR’s guidance
• Tax rate was 35% vs. guidance of 36%, adding another \$1MM
• The 3 items above added \$10MM to MAR’s net income vs. their guidance.  These items were slightly offset by lower gains and equity earnings coming in at the low end of MAR’s guidance.
• Bottom line:
• Total revenues came in \$44MM lower than our estimate. Actually, revenues were a little lower across every business.  However, timeshare margins were materially better, so operating income was only \$14Mm lower than we estimated.  Lower G&A also helped.

Thoughts on 4Q/FY guidance

• How does MAR’s FY 2010 guidance stack up to what they gave us last time?
• MAR took up the low end of EBITDA guidance for FY2010 by \$5MM but lowered the high end by \$20MM
• Gross room openings will now be 30,000 vs. prior guidance of at least 30,000
• Timeshare GM guidance was reduced by \$4MM at the low end of the guidance range to \$201MM and by \$9MM at the high end of the range to \$206MM
• MAR took up the low end of total fee guidance by \$6MM while reducing the high end of the guidance range by \$4MM
• G&A guidance was reduced by \$1-6MM
• MAR took up the low end of their operating income guidance by \$3MM but lowered the high end by \$17MM
• Guidance for gains and other income increased by \$12MM
• EPS guidance is now \$1.09 to \$1.12 compared to \$1.05 - \$1.13
• So basically, most of the business’s top end results are projected to be below the prior high end of expectations, but the gain on the timeshare note sale is expected to be higher, G&A a little lower, and tax rate a little lower.
• We’re not blown away by the guidance

# THE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - October 7, 2010

As we look at today’s set up for the S&P 500, the range is 17 points or -1.1% downside to 1147 and 0.3% upside to 1164. Equity futures are trading mixed to fair value in cautious pre market trading ahead of interest rate decisions in Europe and the start of the Q3 earnings season which sees Alcoa and Micron report after the close.  On the macro front, weekly Jobless Claims and Sep Chain Store sales are today's main highlight.

• Horace Mann Educators (HMN) says CEO Louis Lower has resigned after being jailed for driving under the influence
• Immucor (BLUD) cut FY 2011 EPS forecast to \$1.08-\$1.18, vs est. \$1.28
• InterMune (ITMN) sold worldwide devt., commercialization rights for dannoprevir drug to Roche for \$175m
• NeuStar (NSR) sees 3Q rev. \$129m-\$130m, vs est. \$131.8m
• Regeneron Pharmaceuticals (REGN) filed to sell 4.5m shares

SEPTEMBER RRETAIL SALES:

September comp sales - Retail Metrics estimates sales up. 2.3% in September vs. 1.1% last year and 3.5% in August.  Department store comp sales likely helped by cooler weather and back-to- school shopping.  Discounter’s (ex-WMT) expected to see biggest gain up 3.8%, followed by the Department stores up 3.1%; Specialty apparel up 1.2%; apparel up 1.1% and teen retailers up 0.5%.

PERFORMANCE

• One day: Dow +0.21%, S&P (0.07%), Nasdaq (0.80%), Russell 2000 (0.58%)
• Month/Quarter-to-date: Dow +1.66%, S&P +1.64%, Nasdaq +0.51%, Russell +1.36%
• Year-to-date: Dow +5.17%, S&P +4.02%, Nasdaq +4.91%, Russell +9.58%

EQUITY SENTIMENT:

• ADVANCE/DECLINE LINE: -187 (-2089)
• VOLUME: NYSE - 979.93 (-20.92%)
• SECTOR PERFORMANCE: Mixed performance (4 sectors were up on the day), but long live the reflation trade!!
•  MARKET LEADING/LOOSING STOCKS YESTERDAY: Massey energy +6.09%, Canstellation +4.28% and CB Richard +3.11%/Citrix Systems -14.07%, Salesforce.com -7.87% and Red Hat -7.66%.
• VIX: - 21.49 -1.24% - YTD PERFORMANCE - (-0.88%)
• SPX PUT/CALL RATIO: - 1.43 from 1.16 +23.62%

CREDIT/ECONOMIC MARKET LOOK:

• TED SPREAD - 17.91 0.406 (2.318%)
• 3-MONTH T-BILL YIELD 0.13% +0.01%
• YIELD CURVE - 2.03 from 2.09

COMMODITY/GROWTH EXPECTATION:

• CRB: 289.15 +0.25%
• Oil: 83.23 +0.50%
• COPPER: 375.30 +0.71%
• GOLD: 1,346.70 +0.48%

CURRENCIES:

• EURO: 1.3925 +0.69%
• DOLLAR: 77.386 -0.47%

OVERSEAS MARKETS:

Europe

• European Markets: FTSE 100: 0.04%; DAX: 0.16%; CAC 40: 0.22%
• European markets currently trade slightly in the green after being down early
• The majority of sectors trade lower on the day with retail and industrial goods amongst the leading fallers. Basic resources and autos are amongst the gainers.
• UK Sep Halifax House Price Index (3.6%) m/m vs consensus (0.2%) the largest monthly fall since records began, annual change +2.6% vs consensus +3.9%
• UK Aug Manufacturing Production +6.0% y/y vs consensus +5.8% and prior revised +5.0%
• UK Aug Industrial Production +4.2% y/y vs consensus +3.2% and prior +1.9%

Asian

• Asian Markets: Nikkei (0.07%); Hang Seng +0.02%; Shanghai Composite closed
• Asian markets were broadly lower as investors remain sidelined ahead of Friday's US jobs data and the reopening of China's markets.
• The Nikkei opened lower but managed to finish the morning session in positive territory before falling back into negative territory during the afternoon session as the effects of the BOJ's rate decision couldn't stop the dollar from falling to a 15-year low against the yen Wednesday in the face of expected further Fed easing.
• Australian job numbers came in ahead of expectations, adding 49,500 jobs in September vs expectations of 20,000, though the jobless rate remained 5.1% as expected.
• Shanghai markets remain closed.

Howard Penney

Managing Director

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# LV LOCALS: SEQUENTIAL PICK UP? DEPENDS ON HOW YOU MEASURE IT

YoY change will certainly look better in the coming months. We prefer to look at seasonally adjusted absolute volumes to monitor sequential performance.

There is no evidence that underlying business levels in the Las Vegas locals market have improved sequentially (or year over year for that matter).  In fact, with the exception of April, actual monthly volumes have underperformed sequentially every month since October 2009 per our analysis.  August revenues have not yet been released by the State of Nevada, but anything less than a 4.5% YoY volume drop in August should be seen as another disappointing month.

The extreme volatility since 2007 in the monthly numbers coming out of the Las Vegas market render YoY comparison analysis fairly irrelevant.  As we’ve done for the regional markets and hotels, we prefer to look at seasonally adjusted sequential metrics to try and ascertain whether business fundamentals are improving.  For the Locals, we focus on volumes since hold percentages can be volatile and Nevada is not consistent in its revenue counts when months end on weekends.

The chart below shows monthly YoY gaming volume changes for the LV locals market as well as a seasonally adjusted projection of where volume should have been based on the average of the previous three months.  Since actual volume trailed predicted volume in most of the recent months, this is indicative of sequential slowing in seasonally adjusted volumes and is not a positive sign for the market.

The problems with Las Vegas are well known.  Housing, which we’ve determined has been the number #1 driver of gaming revenues in the market historically, remains under pressure.  The Las Vegas metro area suffers from one of the worst unemployment rates in the country, another statistically significant variable in determining gaming revenues.  Even population growth has gone negative.  Our analysis here supports the sad state of the economic environment there.

We don’t mean to pile on BYD since the stock is not expensive, short interest is high, and investor sentiment is awful.  We would love to be contrarian on the name.  Possible catalysts include refinancing its credit facility – we actually think they are making progress – and buying the other half of Borgata on the cheap – should happen.  The real catalyst of course will be improvement in the LV locals market which, unfortunately, hasn't ocurred.

# American Bliss

“There are two ways of being happy: We must either diminish our wants or augment our means - either may do - the result is the same and it is for each man to decide for himself and to do that which happens to be easier.

-Benjamin Franklin

It is nearly impossible to get away from talking about QE – believe me, I tried.  But the quote below from Ben Bernanke is the first story that caught my eye today.

"Raising the inflation objective would likely entail much greater costs than benefits.  Inflation would be more volatile, bring more uncertainty and possibly create destabilizing moves in commodity and currency markets that would likely overwhelm any benefits arising from this strategy."

Am I missing something or is this just another case of watch what I do, not what I say?

Mr. QE is doing nothing but destabilizing commodities and currency markets.  Our contention has been for some time that quantitative easing leads to reflation, which can lead to inflation.  Gold continues to signal high inflation expectations among investors.   The Hedgeye math says: QE =Reflation = Inflation

Pick your duration of one day, one week, one month, or three months; as quantitative easing expectations have ramped higher, so has the outperformance of commodity-driven equities and the global recovery-leveraged Materials and Industrials sectors.  Yesterday was no exception.  With the S&P trading flat on light volume, the best performing sectors were Energy (XLE), Materials (XLB) and Industrials (XLI).  The worst performing sector yesterday was Consumer Discretionary (XLY).  Yes, inflation is bad for consumer spending!

Rhetoric from Federal Reserve officials on the need for quantitative easing may affect the markets but consumer behavior, and confidence, remain impervious to Washington, DC Groupthink.  Downturns such as the one we are living through today (41m Americans on food stamps) deeply affect consumer confidence and attitudes towards debt accumulation in the name of consumption.

As I said on our 4Q10 themes call, the Consumption Cannonball implies that consumers will continue to save more and are “reconsidering” their living standards; the policies of the FED and the Obama administration are perpetuating this trend.  While creating windfall returns for paper assets and financial institutions, quantitative easing has not met the expectations touted by many of its initial proponents.  By failing to improve the unemployment picture (as was promised), the administration’s policy of quantitative easing is a failure as far as Main Street is concerned.   The effect on the dollar (and commodities) of this policy is further hampering a consumer recovery.

The lack of traction in the labor market was reinforced yesterday after ADP reported that private payrolls fell 39,000 last month following a 10,000 gain in August, while consensus expectations were for a 20K increase.

Charles Evans, President of the Federal Reserve Bank of Chicago said because unemployment is not coming down nearly as quickly as it should, his conclusion is that “we need more monetary accommodation than we’ve put in place!”  Yet there is no connection between QE and the ability to reduce unemployment!  As Albert Einstein said, “The definition of insanity is doing the same thing over and over again and expecting different results.”

Despite the S&P 500 being up 8.7% in September, the consumer macro factors were mixed as confidence, employment and housing data all added further to our conviction that recent governmental policies are failing to produce a real consumer recovery.

For all the valuation junkies that will tell you that the market is cheap on a P/E basis, that metric will be fighting the gravitational pull of slowing growth.  Despite all of the QE talk, 3Q10 will likely represent the last double digit EPS growth quarter for the S&P 500 for the next one, maybe two years.  Which begs the question, have you factored in enough of a slowdown in earnings growth?

Looking out over the next 6 quarters, consensus is projecting S&P 500 earnings growth of 20% in 3Q10, dropping to 11.8% in 4Q10 and sub 10% for the balance of 2011.  In a slowing growth environment, how do you manage risk around the fact that these estimates might be too aggressive?  This is the question every portfolio manager/analyst needs to be thinking about as we head into the current earnings season.

As it relates to our 4Q10 Consumption Cannonball theme and the implied year-over-year deceleration in discretionary spending, Brian McGough asked the question: are management teams being conservative enough?  How do you manage risk around 2011 guidance that companies might throw out to the Street before they know; (1) what will happen to the consumer, and more importantly, (2) how will they behave when desperate competitors react in a weak consumer environment?

How will you manage risk around this?

We are likely to get a small preview of these trends with today’s retails sales data.  Most retailers are expected to meet estimates that are not viewed as overly aggressive; although difficult comparisons will also play a role as September 2009 was the first month of positive comps in some time for many retailers.

For the time being many American will be forced to diminish their wants in order to be happy.

Howard Penney

# RT – STRONG START TO THE YEAR

Conclusion: Ruby Tuesday has seen a solid start to their fiscal year; time will tell how the new business pans out.

RT’s fiscal 1Q11 top-line and bottom line results came in better than I was expecting, but relatively in line with street estimates.  Same-store sales grew +1.2% during the quarter, which implies a 50 bp acceleration in two-year average trends from the prior quarter.  This performance is impressive given that Knapp trends decelerated 10 bps on a two-year average basis during the same timeframe.  During the quarter, RT widened its gap to Knapp to +2.5% on a two-year average basis versus -1.8% in the year ago quarter.

Restaurant-level margin improved 210 bps YOY to 18% (excluding the \$1.7 million in accounting gains from franchise partner acquisitions).  I was expecting restaurant margin to improve in 1Q11, but this growth exceeded my expectations, largely as a result of better-than-expected comp growth and “lower levels of promotional activity.”

Given this positive margin and comp growth, RT operated in the Nirvana quadrant of our restaurant sigma chart for the second consecutive quarter.  Going into the quarter, I thought the company could fall out of Nirvana as early as 2Q11, but given the strong current trends, RT could potentially remain in Nirvana in the next quarter (if the company can sustain its current sales momentum).  The margin comparisons, however, do get more difficult in the back half of the year.  For reference, RT is now guiding to flat full-year restaurant-level margin versus its prior guidance of a slight YOY decline.  This flat guidance implies that the company will have to give back some of the gains achieved in fiscal 1Q11 as it progresses through the year.

Management maintained both its full-year same-store sales growth guidance of flat to +2.0% and its EPS outlook of \$0.76-\$0.86 (street is at \$0.85).  Although RT got a head start during the first quarter in achieving this comp goal relative to my expectations, I continue to believe that this target, particularly the high end of the range (street is at +1.9%), will be difficult to accomplish as it implies a continued improvement in trends on a two-year average basis for the balance of the year.  The Hedgeye view is that the consumer will face increased pressure in calendar 4Q10 and into calendar 2011.  At the same time, RT will face increasingly more difficult comparisons as it progresses through the year, particularly in the back half of fiscal 2011.

RT seems to be doing all of the right things to increase its guest satisfaction scores, add sales layers and improve operations within its four walls.  The company has made a lot of progress in growing same-store sales and started the year with a lot of momentum.  To that end, my concern around the company’s ability to achieve the high end of its comp guidance, as expected by the street, is more a function of the economic environment and the potential for a further slowdown in top-line trends for the casual dining industry as a whole.

Howard Penney

Managing Director

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