It's Time For Change

"Not everything that is faced can be changed. But nothing can be changed until it is faced."
 ~ James Baldwin
It is year end. Performance results are on the scoreboard, and it’s finally time for the said leaders of the American Financial System to face the facts. This interconnected global marketplace of risk factors has a new proactive boss in town – she doesn’t look like Sheila Bair, but her principles rhyme with Bair’s approach – transparency, accountability, and trust are the new rules of “The New Reality.”
Chrysler’s Bob Nardelli and the US Treasury’s Hank Paulson were ‘You Tubed’ by The New Reality yesterday, begging for bailout moneys from sea to sea. There isn’t much difference in their respective (and reactive) left brained, “task oriented”, management approach. When you see these billionaires of yesteryear perform live, you can’t help but wonder what you are missing.
For me, the wonder of it all ended last year. I had already sat in a “small group meeting” with Nardelli and shorted his stock while he was blowing up Home Depot. I had already been to the vaunted “invite only” buy side Paulson lunches of 2006, where he was speaking a language that was even more confusing than that which you hear coming out of his mouth today. Been there, done that.
My conclusion to leave the Street in November of 07’ was not that complicated. I was overpaid to over-analyze companies and the people who ran them. I was underpaid to consider global macro risks. My conclusion was simply that groupthink had become unbearable, and that the leadership in this business needed to change. “Not everything that is faced can be changed”, of course… “but nothing can be changed until it is faced.”
Let’s face it for what it is. The river cards have been turned face up on the table for all to see. This is no longer a trivial exercise in analytics. The old boy network has rendered itself conflicted, compromised, and constrained. It’s time to move forward. It’s time for new leadership. It’s time for change.
The Chinese are providing an ample amount of leadership. While I doubt Paulson dropped to his knees like he did for Madame Speaker, Nancy Pelosi, he didn’t have to. His bowing to the smiling men in suits in Asia is what a great banker does when he knows who has the cash. Paulson didn’t ask them to stop letting their currency appreciate. He begged them for bailout moneys. Thank God December ends in a few weeks. Hank will be gone. It’s time for change.
This $20B “China Pledges to the US” headline has predictably warmed the hearts and minds of the hopeful CNBC futures entertainers. I have never seen one of the “money honeys” or Dillan Radigan use a calculator, so I am not upset with them for not having done the math. Their investment process is what it is – an embarrassment to the profession. The math here is simple. China’s $20B pledge = 3% of what they have committed to their own domestic stimulus spending plan ($586B). They have the cash. They will do with it as they please. It’s time for change.
Despite the USA closing down another -2.9% yesterday, taking the SP500’s December to date deflation to -5.7%, China’s stock market closed higher for the 3rd consecutive day, taking the Shanghai Stock Exchange Index inflation from the first week of November to +18%. For those of us with calculators, we know that the US market is down -16% over that same period of time, and is now sitting on the edge of a precipice ahead of this morning’s US Employment report. This is not a time to panic. We have proactively prepared for this. It’s time for change.
Japan was down again last night. Their economy is stagflating, and their stock market is running head to head with Hank “The Market Tank’s” US market performance – since the beginning of November, the Nikkei is down -17%. The Japanese bailout resolve isn’t new. They have taught economic historians that a negative real interest rate and a flat yield curve doesn’t work.
Unfortunately, Hank and “Heli-Ben” didn’t get that history memo. Bernanke clearly spent too much time studying the Great Depression, and not enough time studying the last 20 years in Japan. Paulson’s Goldman cronies are depressed, and they should be. So at least “Heli-Ben” is qualified to moonlight as their depression shrink.
The most depressing development in the US market is that the slope in the US Treasury’s yield curve is beginning to flatten again. Since 3-month Treasuries are yielding 0.01% this morning (ZERO), the only place for short rates to go from here is UP. That should continue to pressure the only American Capitalists that we have left standing – those who are liquid long cash, who might be willing to borrow short and lend long in search of a risk adjusted return. It’s not a time to disenfranchise those Americans who have managed through this cyclical downturn responsibly. It’s time for change.
We shorted SPY yesterday into the hope associated with the intraday print we picked up at SP500 874. Could this morning’s employment report be better than bad? Sure. But that’s not going to get me to be a raging bull on US Equities folks. When it comes to buying US stocks, I simply want to buy low and sell high. Let whoever told you that managing money is all about buying high and selling higher deal with their own year end accountability check. We have a tremendous opportunity to get back to doing what prudent American investors have done since the days of Marcus Goldman. That’s change I can be long of in the United States of America. It’s time for change.
Have a great weekend,
Long ETFs
GLD -SPDR Gold Shares – Spot gold prices gained 0.5% reaching 770.55 this morning g in London.
OIL iPath ETN Crude Oil – Front month NYMEX Light Sweet Crude futures fell as low as 43.39 in early trading this morning. So far this week oil contracts have lost nearly 20% of market value –the largest one week drop since 2003.
EWG – iShares Germany  --The DAX declined 2.62% this morning to 4444.26. Bundesbank’s semiannual macro report projects an economic contraction of 0.8% for 2009. Auto parts supplier Rheinmetall AG (EWG: 0.17) will eliminate 750 jobs due to slowing automotive demand.
EWH –iShares Hong Kong  --Hong Kong home prices are down almost a quarter from their five-year high in March. HSBC raised mortgage rates as much as 75 basis points to 5.75% this week, the most in a decade.
 FXI –iShares China – US officials, led by Secretary Paulson, pledged to cooperate with China on a $20 billion package to stimulate trade in talks in Beijing.
Short ETFs
SPY-S&P 500 Depository Receipts--Futures traded as low as 843.6 this morning in advance of Payroll data due at 8:30 Am.
IFN -iShares India –Infosys (IFN: 11.09%) dropped 4.9% on news it will freeze hiring in the next fiscal year. The Rupee has rebounded slightly to 49.725 per USD since its slide following the terrorist attacks.
EWU – iShares United Kingdom –The FTSE is trading down 1.14% this morning to 4116.43. Royal Dutch Shell Plc (EWU: 5.68%) lost 4% as crude oil traded below $44 a barrel.
UUP – PowerShares U.S. Dollar Index – The dollar declined to 1.277 EUR, putting it on course for the second weekly decline in a row.
EWJ – iShares Japan –The Nikkei closed down 6.73 or 0.08% at 7,917.51 in trading today on news of a dimmer earnings outlook for lenders. Mitsubishi UFJ Financial Group (EWJ: 3.36%) dropped more than 5%.


KEITH - DIN, massive resistance at the 12.64-14.99 range... short with impunity.
Howard – DIN - Last week I posted a note that said casual dining could perform better in early 2009... In that environment DIN will participate in any rally. That being said, I think the fundamentals of this company are very questionable and the balance sheet is choking the life out of the company.

KEITH - DRI flashing a + divergence here... needs to hold 18.27, I'm holding my breath
Howard – Fundamentals suck but I like DRI here for a trade. I highlighted DRI and EAT in my casual dining note.

Keith - CMG, I am going to short at 53.10
HOWARD - CMG - $8.00 in cash on the balance sheet will provides some stability in this market, but a 6% menu price increase will hurt traffic trends. Margin comparisons in 1H09 are very difficult.

KEITH - STZ - you like wine? STZ shaping up very bullish
HOWARD – No real opinion other than I’m a consumer. Going to do some work on this one!

KEITH - your ole friend Ruby, RT, looking ripe to be shorted again... anything new there?
Howard – RT is still on the bankruptcy watch list.

SBUX - ever passionate and overly convincing

On its 4Q08 earnings call, SBUX management made a comment regarding early fiscal 2009, “Over the past few weeks, signs of improving comps have appeared episodically, though it is too early to call a trend particularly with the important holiday period still in front of us. That said, October did not show further deterioration to comps or traffic, a possible indicator that Q4 may have represented a bottom coming out milestone for our company.”

Unfortunately, SBUX had to take back those comments at its analyst conference today because the company has since experienced a further deterioration in its U.S. same stores growth in November. For the first 9 weeks of Q1, U.S. comparable sales are down 9% relative to the 8% decline in Q4. On a 2-year average basis this represents a significant sequential decline to down 5% in Q1 from down 2% in Q4. Additionally, the U.K. continues to worsen as well. Management did not provide specific Q1 EPS guidance except to say that it expects to fall short of current Q1 consensus EPS estimates of $0.22. The company attributed its expected earnings shortfall to the significant investment incurred in the quarter for its leadership conference, to the fact that it is lapping its most difficult comparison in Q1, and of course, to its deteriorating comparable sales trends, the future of which management has little visibility. So, the main takeaway from today’s meeting is that Starbucks has not yet found a bottom.

The only piece of new good news that emerged from the conference stems from the company’s expectation to generate $400 million in cost savings in FY09, up from SBUX’s initial guidance of $200-$210 million. On an EPS basis, this translates into about $0.36 of costs cut out of the P&L relative to the company’s prior forecast of $0.17-$18. Importantly, management highlighted that these savings are engineered to be ongoing and not just a FY09 benefit. The projected savings will come from four sources. SBUX expects to cut $150 million out of its $2.5 billion annual labor expense (For reference, this was the first time the company ever provided the investment community with its total annual cost of labor). An additional $50 million of savings will come out of its waste expense, or what SBUX calls its “cost of quality,” $150 million from procurement and $50 million from manufacturing/logistics. In aggregate, the company expects to cut $200 million of costs at the store level (labor and waste) and $200 million of costs out of its supply chain (procurement and manufacturing/logistics).

Due to these aggressive cost saving initiatives, management stated that even if same-store sales declined 7% for the year, it would still expect FY09 EPS to exceed FY08’s reported $0.71. However, management was quick to point out that it is not providing guidance but instead providing parameters around how to think about the impact of its expected $400 million in costs savings. The savings will provide more leverage to the P&L and offset some same-store sales weakness. Although I would agree that this is a positive development as it relates to improving margins, I don’t think the stock will really rebound until same-store sales growth returns.

From my math, it appears that the company plans on flowing the entire amount of its cost savings to the bottom line. The motivation for doing this most likely stems from the fact that SBUX wants to offset its top-line weakness and grow earnings. I would argue, however, that in this challenging and competitive environment that it would be more prudent for the company to reinvest some of these savings in the brand as the long-term success of the brand would benefit more from increased national advertising. Going forward, Starbucks will require a larger share of voice in order to combat the Dunkin’ Donuts and McDonald’s of the world, each of which will be spending a significant amount of money promoting its respective brand.

Outside of its not investing enough in advertising, I think SBUX is finally properly managing for the long-term. The company will continue to experience near-term pressure from same-store sales weakness, similar to other retailers and restaurants alike, but at some point SBUX will benefit from its renewed focus on operations within its four walls. Slowed unit growth, the closure of over 600 underperforming units in the U.S., reduced capital spending and a more efficient cost structure will all lead to improved store unit economics and inevitably, to stronger returns. At the risk of sounding like the ever passionate and overly convincing Howard Schultz did during his closing comments today, I would agree that two years from today we will be talking about where the stock was and the significant returns that have been made.

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GES 3Q Ammo For You

In prep for the Guess? quarter, here’s a margin walk and our SIGMA analysis. This company has one of the worst top line trajectories and biggest 2-year margin risk in retail, in my opinion.

Yeah, the stock looks cheap at 2-3x EBITDA. But short interest is down to only 6% of the float, and I think margins are going from 17.7% to the low teens over 2 years as the extent to which the company has overearned in a favorable FX and sourcing environment puts the margin structure back in check (simply put, GES printed too much profit at the expense of reinvesting). There are other names that are nearly as cheap with margins and returns heading in the right direction (i.e., Ralph Lauren, and smaller cap names like Payless, Hibbett Sporting Goods and Finish Line).

US Employment Trends: Still Dancing with the Bear

When I shorted SPY’s at 11am this morning, my inbox caught a bid. For whatever reason, people don’t like it as much when I am on the bearish side of the “Trade” versus the bullish side. I’m cool with it though. This is a full contact sport.

Anyway, one of the main counterpunches I am getting today is that “Keith, look at the math, jobless claims were better.” While this is true in isolation (on a one week basis), this math doesn’t confirm anything other than the negative “Trend” in the US employment picture. Weekly jobless claims were down week over week to 509,000, but that’s because last week was a nosebleed peak (look at the chart). The way my math works is using the 4 week moving average. On that score, jobless claims we’re UP by another 6,000 jobs testing new cycle highs at 525,000.

Math and narratives dance to whatever tune the assigns them. My process is what it is. If you want to get long this market ahead of tomorrow’s monthly employment report, have fun with that. I’m short that idea at SP500 874.

Quote Of The Day: On UVA's Endowment

“To be sure, this is a startlingly large loss... When put into appropriate context, however, it starts to seem less disturbing.”
-Chris Brightman, CEO of The University Of Virginia Investment Management

Apparently Mr. Brightman has lost a "B" in the last 4 months... as in one billion dollars. But, when you consider that within the realm of his own narrative fallacy, it's not so bad. Everything is relative right?

Disturbing times we live in, indeed. Thank God that the governing principles of Transparency and Accountability are finding their way into the once hallowed halls of institutional investing.

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