Thursday, November 4, 2010

Morning Note...


Futures are ~85bps higher this morning as global markets digest Tuesday’s U.S. elections, yesterday’s FOMC announcement, and today’s coordinated (probably) ECB and BofE rate decisions.  Initial Jobless Claims for the week ended October 30th were slightly higher than expected, at 457k vs. 442k/e.  Continuing Claims were 4.340M vs. 4.378M expected.  Nonfarm Productivity for Q3 beats expectations, at +1.9% vs. +1.0%/e, and trumped Q2’s -1.8% reading.  Finally, Unit Labor Costs were a very deflationary -0.1% vs. the +0.6% expectation and the +1.3% prior reading.  October same-store-sales from retailers were also released this morning, and were generally in-line to slightly worse than expected.  (See summary below.)  Overseas, the European Central Bank (ECB) kept rates unchanged at record low 1% levels and the Bank of England (BofE) also maintained record low 0.5% rates.  Europe is up nearly 2%.  Asia also higher overnight.  Oil +2%.  Gold up 3%.  U.S. Treasuries bid higher, thus yields are lower. The USD is down 80bps.  Elsewhere, Ben Bernanke’s Washington Post op-ed is generating some buzz…see full text below.  For the “conference watchers,” check out the quote section summary below from a recent charity event in Chicago.  Of particular note are Meredith Whitney’s state and municipal bearishness, especially in light of similar commentary from Meg Whitman yesterday.  Today’s earnings winners are Qualcomm (QCOM; +8%) and Whole Foods (WFMI; +8.5%). 

Same store sales summary from MSCO:

5 Themes and Stocks to focus on:

(1) KSS was the dog of the day.  They missed badly and were the only company to guide below the street.  Expectations were low going in but we still expect it to be weak on this release.  The question is will they buy back stock ?!?!

(2) ANF missed the comp.  However, on the call they said AUR was flat.  That is positive development for them and we expect stock to be green.  ARO and AEO were similar with AUR better than expected so bulls will latch onto that.    

(3) LIZ reported a worse than expected quarter eps number but beat the gross margin line (which was bear case post JNY).  Expect strength today.

(4) The best performance today came from ROST and GPS.  We think both stocks should act fantastic today despite high expectations for ROST going into print

(5) TGT much better than whisper.  It was interesting to hear apparel not improving though.  Is P-Fresh actually starting to work? 

Movers Pre-Open:  AEO +0.2%, ANF +1%, ARO (2.7%), BIG (3.7%), GPS +6.5%, JCP +0.1%, KSS (2.0%), M +2.6%, SKS +1.0%, TGT +0.8%

OCTOBER SALES QUICK AND DIRTY SUMMARY:

COMPS BETTER:       LTD, BJ, GPS, TJX, ROST
            COMPS IN-LINE:      COST, DDS, TGT, M, JWN
            COMPS WORSE:        BIG, ANF, AEO, DDS, KSS
            *SMALL CAP Better:  BKE, WTSLA, ZUMZ
            *SMALL CAP In-line: CATO
*SMALL CAP Worse:   FRED, HOTT, SSI, SMRT, BONT

            GUIDANCE BETTER:    LTD, GPS, ROST
GUIDANCE IN-LINE:   TJX, M, AEO, ARO
            GUIDANCE WORSE:     KSS
            *SMALL CAP Better:  ZUMZ
            *SMALL CAP In-line: CATO, FRED, SSI, WTSLA
            *SMALL CAP Worse:   HOTT

Bernanke’s Op-Ed:

What the Fed did and why: supporting the recovery and sustaining price stability

By Ben S. Bernanke
Thursday, November 4, 2010;

Two years have passed since the worst financial crisis since the 1930s dealt a body blow to the world economy. Working with policymakers at home and abroad, the Federal Reserve responded with strong and creative measures to help stabilize the financial system and the economy. Among the Fed's responses was a dramatic easing of monetary policy - reducing short-term interest rates nearly to zero. The Fed also purchased more than a trillion dollars' worth of Treasury securities and U.S.-backed mortgage-related securities, which helped reduce longer-term interest rates, such as those for mortgages and corporate bonds. These steps helped end the economic free fall and set the stage for a resumption of economic growth in mid-2009.

Notwithstanding the progress that has been made, when the Fed's monetary policymaking committee - the Federal Open Market Committee (FOMC) - met this week to review the economic situation, we could hardly be satisfied. The Federal Reserve's objectives - its dual mandate, set by Congress - are to promote a high level of employment and low, stable inflation. Unfortunately, the job market remains quite weak; the national unemployment rate is nearly 10 percent, a large number of people can find only part-time work, and a substantial fraction of the unemployed have been out of work six months or longer. The heavy costs of unemployment include intense strains on family finances, more foreclosures and the loss of job skills.

Today, most measures of underlying inflation are running somewhat below 2 percent, or a bit lower than the rate most Fed policymakers see as being most consistent with healthy economic growth in the long run. Although low inflation is generally good, inflation that is too low can pose risks to the economy - especially when the economy is struggling. In the most extreme case, very low inflation can morph into deflation (falling prices and wages), which can contribute to long periods of economic stagnation.

Even absent such risks, low and falling inflation indicate that the economy has considerable spare capacity, implying that there is scope for monetary policy to support further gains in employment without risking economic overheating. The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed. With short-term interest rates already about as low as they can go, the FOMC agreed to deliver that support by purchasing additional longer-term securities, as it did in 2008 and 2009. The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

While they have been used successfully in the United States and elsewhere, purchases of longer-term securities are a less familiar monetary policy tool than cutting short-term interest rates. That is one reason the FOMC has been cautious, balancing the costs and benefits before acting. We will review the purchase program regularly to ensure it is working as intended and to assess whether adjustments are needed as economic conditions change.

Although asset purchases are relatively unfamiliar as a tool of monetary policy, some concerns about this approach are overstated. Critics have, for example, worried that it will lead to excessive increases in the money supply and ultimately to significant increases in inflation.

Our earlier use of this policy approach had little effect on the amount of currency in circulation or on other broad measures of the money supply, such as bank deposits. Nor did it result in higher inflation. We have made all necessary preparations, and we are confident that we have the tools to unwind these policies at the appropriate time. The Fed is committed to both parts of its dual mandate and will take all measures necessary to keep inflation low and stable.

The Federal Reserve cannot solve all the economy's problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector. But the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability. Steps taken this week should help us fulfill that obligation.

The writer is chairman of the Federal Reserve Board of Governors.

QCOM +8% on earnings.  UN higher on earnings.  POT lower on news that Canada may block BHP bid.  Airbus maker EADS lower overseas on Qantas plan troubles on Singapore-Sydney leg.  GPS higher on same-store-sales.  WFMI higher on earnings.  ZUMZ higher on earnings.  KGC higher on earnings.  ALU lower on earnings.  CHK lower on earnings.  BCAP ups HIG, cuts LEAP.  BofAMLCO ups MTA.  CITI ups KIM.  CITI cuts CEL, CTCM.  JEFF cuts CVD, SVR.  BARD cuts CPLE, LOPE.  UBSS cuts ACGL, AHL, COCO, XL.  LIZ lower on earnings.  PPO lower on earnings.  PT cut at CITI, DBAB. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 

Today’s Trivia:  How many eggs per year does an average hen lay?
                                                                                                                                                           
Yesterday’s Question:  What percent of globally mined salt is used on American roads each winter?

Yesterday's Answer:  10% of globally mined salt is used on American roads each winter.   

Best Quotes:  CNBC commentary from a guy in the futures pit this morning… “just because the Fed is forcing everyone into the pool of risky assets does not make them any less risky”… and (I am paraphrasing here) “if the single biggest player in the stock market is the US gov’t, how does that makes us any diff’t from a place like China?”

Kids Conference here in Chicago. Several respected local and national investment professionals shared their investment picks to help raise money for local children’s charities.


William Browder – Hermitage Capital Management

Browder is a famed emerging markets investor. He made a name for himself finding picks and pans in the Russian market until he was kicked out of the country for being a “threat to national security.”

Browder first gave his world view, noting that governments have spent almost 23x as much in this financial crisis than they had in all other (Argentina, Brazil, LTCM, Russian debt, etc) combined. He notes that historically, most economic indicators make new highs three years after a recession begins; however, we remain far below there. In their effort to help the economy, the government currently can’t cut taxes, cant cut rates, can’t borrow more, and their only option left is quantitative easing. He says he’s “very disturbed” by QE because his experience with Russia and Poland tells him nothing good can come out of it. He says there’s an 80-90% correlation between printing money and inflation.

So where do you want to invest in an inflationary environment? Once the USD is diluted, you want something they can’t delute: gold.  His first pick is Koza Gold, a gold miner in Turkey. It has a $1.5B market cap and 11.4 P/E , 26% EPS growth and no debt. He said they are one of cheapest gold miner in the world and enjoy some of the cheapest production costs at $320/ounce.  They have only been mining a few years in Turkey since when the mining laws changed.

His second pick was Renhe Commercial Holdings, a company that develops shopping malls in China. The company has a $4.7B market cap, 8% dividend yield, 24% 2011 earnings growth rate and trades at a 54% discount to NAV. What’s the catch, right? In China, every city must have a bomb-shelter. Well, Renhe gets the government to give them the land for free, then develops shopping malls underground in what would become bomb-shelters in the event they were needed. So they get the land for free and are able to pre-sell the units. Browder believes it “could be a 3-5 bagger over some period of time.”

Brian Feltzin – Sheffield Asset Management

Feltzin described Sheffield as a long/short value, deep value contrarian firm that looks for stocks mispriced by as 50%.

His pick was C&C Group, an Ireland and UK based manufacturer, marketer and distributor of branded long alcoholic drinks, including the internationally-marketed Magners cider brand. The company has a 1B euro market cap, great management team and is in the third inning of a turnaround. They have a debt free balance sheet, 10% FCF and possible end game is M&A. Feltzin says part of the reason for the low valuation is that the company is based in Ireland where no one is paying for growth right now. He believes the company has 50% upside, maybe even more in a takeout.

C&C has new management that came to the firm after success at Scottish and New Castle where they jumped on the cider bandwagon after seeing the success C&C was having. Four main reasons to own the stock: 1) The cider market is attracting growth, 9% CAGR, fills the gap in the market as a “unisex beer.” 2) The turnaround is working due to a focused portfolio, improved routes, lower costs, and two smart deals acquiring Tennent’s and Gaymer to drive growth. C&C also divested non-core businesses. 3) You’re getting a “free option” on potential M&A as a second round of consolidation is expected in the beer industry and the international market for cider is growing especially in the US and Australia. 4) C&C could be a takeout candidate as beer sales decline and cider sales see 12% growth. Feltzin believes a deal would make sense and notes that management’s options vest at the end of next year.  The risks to the stock: Macro issues, integration issues, and the competitiveness of the business.

William Ackman – Pershing Square

Ackman titled his presentation “How to Make a Fortune” – a tongue in cheek reference as he was clear to point out. While much of the audience was expecting him to pitch FO, he actually discussed his bullish stance on the housing market.

He mentioned how home affordability is at its highest level in decades and ownership is cheap versus renting. We’re seeing the lowest mortgage financing ever and mortgages are still non-recourse loans. The government is committed to housing. You’re able to buy a house with a loan of terms of 20% down, 30 years and 4.4% rate. He even joked that with the USD declining its an even better deal. He believes household formation trends signal growth as the recovery accelerates. The number of owner households will rebound (i.e. college grads moving out from with mom and dad). He cited a Harvard study that predicts significant demand for long-term housing. While supply is temporary elevated, new growth will be slow as builders’ production rates are the lowest in 50 years.

Ackman doesn’t believe interest rates will stay low forever as new monetary easing increases the risk of inflation. Forced selling will abate as lender balance sheets improve. He says its always easier to find liquidity on the way down and an economic recovery could cause housing to recover sooner.

Ackman notes how investors are drawn to investments with current yield, those that offer diversity, hard assets and provide long-term gains. He suggests maybe institutions will start investing in single-family homes the way they do in such things as timber. Not sure if I got this right, but he said something along the lines of if institutions put just 1% of their assets to buy single family homes, they would absorb the entire US for-sale inventory of single family homes.

He closed by saying how good Chicago has been to him – made 30x investment in GGP, 2-3x investment in MCD and is already up 25% in FO without doing anything.

John Rogers – Ariel Investments

Rogers said what a big influence Warren Buffett has had on his investment philosophy and the idea to “stay in your circle of competence.” His three picks were CBS,VIA, and GCI.

CBS has an extensive library of tv shows, Showtime network, Simon and Shuster, and 100k billboards. He still likes the stock even with it up 23% YTD; it’s trading at 14x next year’s numbers. He says re-transmission fees will be good. He believes a natural move for the company could be to go private as Sumner Redstone gets older.

He believes Redstone could also take VIA private. VIA has a great line-up with several channels, the Rockband franchise, IronMan and Waiting for Superman. He says VIA is cheaper than CBS and has extraordinary upside.

GCI is Rogers most favorite and yet most unpopular pick. He gets it – everyone hates print media, but he sees value in the owner of the USA Today, Captivate Network, Metromix, and controlling interest in CareerBuilder. GCI is down 20% and he is still buying, he loves buying things on the way down. Rogers believe that talk of the death of print media is pre-mature and you saw how important local content was in the recent elections. He believes GCI will be a beneficiary of an economic recovery as retailers and autos will need to protect their brands by runnings ads. He also noted GCI’s “extraordinary” management team and strong balance sheet.

Josh Friedman – Canyon Partners

Friedman’s expertise is in bankruptcy and distressed investing. He gave a pretty technical presentation on the Lehman bankruptcy. He mentioned how Lehman’s leverage grew from 25x – 34x from 2004 to 3008, not counting off balance sheet situations. He also noted how the balance sheet became opaque and its size doubled. He said it was the most complicated bankruptcy ever – was 7x the size of GM and 10x the size of Enron. There’s ~$65B market value of debt and traded claims and it can’t be controlled by distressed funds alone.

He said one thing to look for in bankruptcy/ distressed investing is what are people’s incentives because everyone is always overstating something and be careful of what the claims actually buy. Look for intercompany circularity.

Again, this was a pretty technical presentation.


Meredith Whitney

For as bullish on housing Bill Ackman seemed to be, Meredith Whitney let the air out of the optimism balloon. Her presentation was on state and local government’s fiscal issues. She says people are way too complacent on the topic in the way they were about the housing market four years ago. People love to say a municipality hasn’t defaulted in 30 years, but that’s like when people would say housing prices never go down. She said state and municipal debt has doubled from 2000 to today. State and local government spending to GDP is at the highest level ever recorded. She called it “generational robbery” as our kids will have to pay for it. Whitney said state budget gaps will total $300B in FY11 and 12, the largest on record. While state’s expenses are fixed, revenue are volatile. State spending is up 60% since 2000 while receipts are only up 45%. States have used over $500B in pension contributions to delay spending cuts and have been using accounting gimmickry to underfund the pensions. Underfunded pension liabilities are now over $1T.

Whitney noted that the states most levered to real estate are experiencing the highest unemployment. Michigan is also experiencing high unemployment but their issue is more structural. Whitney estimates state and local job cuts are headed to the 1-2M range, with 400k already announced. In past recessions, government jobs have been a tailwind for the labor market – not this time around. Jobs are actually getting cut.

States are dealing with weak income and sales tax revenues and property tax weakness is soon to follow.What can states do? Raise taxes (33 already have in 08 and 09), cut programs (46 states have cut their budgets) or ask for federal bailout. Federal grants to state and local governments are at highest levels. Rainy day funds are bust. The question is are states “too big to fail?”

One-third of municipal funding comes from the state and when states are really struggling it’s the municipalities that will pay.

Short-term takeaway
There will be municipal defaults
Job losses at state/local level could be an impediment to an economic recovery

Long-term takeaway
Tax hikes and state spending cuts will result in long-term pro-cyclical effects on states
State “haves” and “have not” status will drive business risk
Next to housing, Whitney says no issue is more critical to the US than the health of the states

David Herro – Harris Associates

The goal at Harris Associates is to own quality companies that can be bought at significant discounts to true economic value. He looks to buy stocks trading at 30% discount to intrinsic value, but today is finding stocks at 50% below intrinsic value.

Herro is well aware that Japan is dealing with several structural issues. Their population is aging, the country is not open to immigration, not very productive, debt is 2x GDP, etc. However, ROE’s are rising in Japan and price-to-book ratios aren’t reflecting it. If I got this right, he said 70-80% of companies in Japan are trading below book value. Herro mentioned how the Japanese government owns huge assets and that 98% of the country’s debt is internally held and the country has a huge savings rate.
Daiwa Securities and other financial institutions are benefiting dramatically from a structural change from low yielding savings accounts to investment products. He thinks the management team is overcapitalized and could announce a buyback.

Herro closed by noting there is over 3x as much disposable cash in Japan than the the country’s market cap.

Doug Silverman – Senator Investment Group LP

Senator is a distressed and event driven fund. They focus on distressed debt, value equities and event driven equities. Silverman estimated 80% of their focus is in equities today, away from credit a few years earlier. Silverman said 2010 has been a year of learning how to live in the new normal. This is evidenced in asset sales and other moves as organic growth is tougher to achieve.

Silverman gave a bullish presentation on the car rental industry market. He said managements have been able to cut supply to maintain prices, consumers preference for used cars has cut fleet costs, and the companies have durable balance sheets. He believes the industry is ready to thrive.

Hs favorite pick is CAR as travel demand grows and costs decline. Since the beginning of the recession, management has taken nearly $500M out of the cost structure through savings initiatives. He believes they’ll have spring loaded cash flow when demand recovers.

While airlines, auto rental and hotel revenues are highly correlated, YTD stock performance is not – CAR has underperformed. He believes this is due to the overhang of the DTG bidding war. With three main players (DTG, CAR and HTZ) involved, pretty much every investment bank on the Street has a roll in advisory and has therefore abandoned coverage.

Silverman believes the FTC would spend 2-3 more months reviewing the CAR bid for DTG and that CAR will do all that it can to close the deal, making necessary concessions because the deal makes so much sense.

Outcomes for DTG.
  1. CAR gets approval to acquire DTG – Silverman says it will be accretive for CAR
  2. If the FTC rules CAR cannot acquire DTG and HTZ does, CAR still benefits as there are now less players in the car rental space
  3. Even if no deal is done the M&A confusion overhang will be listed and more investors will come back to the space and focus on the industry they didn’t want to deal with before

Silverman did note that they own 6% of CAR shares.

Richard Driehaus – Driehaus Capital Management LLC
Driehaus spoke to his focus on momentum investing and always keeping an eye out for companies that could deliver an earnings surprise. He mentioned Hardware and Motricity as two companies that fit this realm. He focuses more on income statements than balance sheets. He has high turnover and believes it is a risk reduction measure.

Citing John Rogers speech, he mentioned his firm owns CBS and just bought VIA.
Driehaus looks for companies where change can happen very quickly. One sector where this is possible is cloud computing and cited RVBD and FFIV.

Driehaus said he owns SIRI, a turnaround situation which he likes because its FCF is improving, car sales have been strong and the company has been adding subscribers.

He also looks for companies with intellectual property and recurring revenues like GMCR.

Driehaus presented two picks. His first was TZOO, a $500M market cap company that is similar to PCLN or EXPE. They are benefiting from their new business Local Deals which they market to their 18M subscribers. The second company he pitched was Iguatemi Empresa de Shopping Centers (IGTA BZ), a Brazil based shopping mall operator. He cited an improving Brazilian economy and continental Greenfield expansion projects to provide further upside.

Larry Robbins – Glenview Capital

Robbins spoke very quickly and was somewhat technical with his presentation. He discussed mortgage put-backs which allow you to recover some of the losses on mortgage products due to material misrepresentations . He believes banks will be solvent though will feel the effect of any put-backs.

His top three picks were MCK, ESRX and LIFE. He said MCK is a good growing business driven by demographics, generics and HCIT, valuation is cheap and is using dry powder to aggressively accelerate per share earnings growth. He said ESRX has had the best share price performance of the companies they follow, they’re well positioned for 2012 generic boom, and have $6B of dry powder. He likes LIFE because it is cheap, driven by large research budgets, and I believe he said should be doing a large repurchase.


Sam Zell

Zell closed out the conference with more of a philosophical presentation than one where he presented ideas. He said there’s a lot of truth to the line “this time its different.” He said 2008 and 2009 will not be something that will be quickly forgotten. The developed world is heavily indebted and we have run out of time to “kick the can down the road.” The next few years are going to be ones of slower growth and less leverage. The new era is one of less risk and more appreciation for absolute return. He said emerging markets are not a fad. He said adaption is key right now and we must re-think all assumptions. Diversification is more important than ever and for the first time, we in the US, are investing with political risk. There will be more regulations and more populace sentiments.