Gift cards may provide after-Christmas boost

Gift cards have become very important to retailers business. Card sales are a key way for stores to drive traffic in the first quarter, a typically slow time of the year, and consumers typically spend more than the card's value. But the recession has been difficult for the gift card business for three reasons

• Reduced consumer spending has extended to cards
• Frugal shoppers are buying discounted gifts so they can stretch their budgets
• Card recipients will likely focus on deeply discounted items when they redeem them

To add to retailers problems, more shoppers are giving cash this season, because they couldn't get to the stores or they also want to be even more practical. It's estimated that about 75 percent of those dollars go towards paying bills or to restaurants rather than to stores.

Despite these headwinds, according to a consumer survey conducted for the National Retail Federation, gift cards still remain the most requested holiday item.

"Gift cards' popularity hasn't died, but the recession has changed the way that people give gifts," said Craig R. Johnson, president of Customer Growth Partners and Chair of Roulston Research's Consumer community.

Best Buy reported that gift card sales rose 40 percent in November, following a big drop last year as consumers cut their spending as the financial crisis escalated. Wal-Mart is extending holiday deals such as a selection of top Blu-ray movies for under $20. It's also offering a $50 gift card with an Xbox 360 purchase.

Craig Johnson Says U.S. Blizzard May Have Benefited Retailers

Craig Johnson president of Consumer Growth Partners and Roulston Research's Consumer Chair, says "The effect of the storm is neutral, not negative." He also believes that while many stores in the mid-Atlantic region, particularly Virginia and Washington, D.C., closed halfway through Saturday, the storm shifted trips among weekend days but did not halt shopping.

Check out a video of his comments

Despite this activity it seems that most retail analysts still expect sales industry-wide to be relatively flat this holiday but profits to climb on increasing margins.

Oracle's 2010 - 2011 Outlook From Roulston Technology Chair

Bart Perkins, Roulston Research's Technology Chair shared his thoughts on Oracle's 2010 - 2011 outlook:


"I check with several of my consulting colleagues regarding Oracle ERP installations. None of my colleagues' clients (mostly F500) are planning big ERP installations over the next few years.


The government situation is different. I am on the Board of a DC based company that installs Federal Financial Systems. At the board meeting last Wed, we discussed the outlook for Oracle in the Federal government. To remain compliant with current regulations, agencies have to move to Oracle R12. Assuming the agency is paying Oracle maintenance, there are no additional licensing fees to Oracle. However, Oracle has made Hyperion, Projects, and Budgeting complaint with Federal accounting. A number of agencies will install these as part of the R12 migration resulting in some additional revenue for Oracle.




Bottom line - Even with the additional Federal revenue, I don't see a lot of growth in Oracle's ERP business."

Earnings from Fedex and General Mills

Craig Johnson of Customer Growth Partners and the Roulston Research Consumer Chair breaks down the latest corporate earnings from Fedex and General Mills on Fox Business. Watch it here.


http://news.yahoo.com/video/business-15749628/fedex-general-mills-report-earnings-17190082

CMTL: Attractively Priced

Our Boston presenter continues to be bullish on Comtech's prospects (Nasdaq:CMTL, $34.12). Last week the company raised its earnings and revenue guidance for fiscal 2010. Comtech is seeing solid demand from the US government and international customers. Management anticipates sizable increases in government orders for its MTS and Blue Force Tracking Systems in the near term. The stock has gained 3% since the presentation in early October. Based on the current valuation, the presenter believes the company is a likely acquisition target for major defense players.

Tatum/Roulston Report

We mentioned last month that we were seeing signs in the Tatum Survey and in our corporate conversations that were concerning to us in regard to the corporate outlook for 2010. Issues ranging from carbon emission standards to health care reform to taxation not to mention the whole regulatory environment and access to capital are weighing heavily on corporate decision making. Rarely have businesses had so much uncertainty in their outlook. It has labored companies coming out of the credit squeeze as to how to allocate their assets. This month the survey reflected an unusual and sudden downturn in the outlook for capital access, capital spending, backlogs and the strength of the dollar. Employment although maintaining current stability seems to be stable due to current conditions. There is little in the corporate outlook to reflect confidence or predictability.

It is hard during the Christmas season to side with the bears. But with a strong market recovery after the fall 2008 credit meltdown, reality is starting to be influenced by an activist government policy that is clearly causing concern in the corporate outlook for 2010. It is our belief at Roulston that we continue to be in an “L” curve with very little visibility and credit access. Without those features we find any significant economic upside to be very dependent on relatively new economic factors from foreign demand to government stimulus to see growth beyond 1-2%. These factors will contribute to some growth no doubt. But it still means strong headwinds for the economy over the next 12 months.

To read the full survey click here.

Johnson Sees Sales Growth at Non-Mall, Value Retailers

Craig Johnson, our Consumer Chair and President of Customer Growth Partners, was on Bloomberg TV Friday morning with his opinion of the propsects of Non-Mall, Value Retailers. Check it out here.

Cloud computing

Cloud computing.

Over the last several years, Amazon, Google, Microsoft, AT&T and many others have started offering cloud capabilities. There is lots of discussion about the merits of the cloud with individual IT professionals on both sides. Small and mid-sized companies have been quick to embrace it. Start-ups in particular find it a great way to ramp up quickly and cheaply. F500 companies are not so sure. They have a huge investment in their existing IT infrastructure that the cloud has the potential to render obsolete.

Nicholas Carr, who is not the most popular person in the IT community, makes a compelling case that the computing cloud will make the traditional IT infrastructure obsolete. In his new book, The Big Switch: Rewiring the World, from Edison to Google (W. W. Norton, 2008), he states, "In the end, the savings offered by utilities become too compelling to resist, even for the largest enterprises. The grid wins."

If Carr is correct, and I believe he will be, IT companies that embrace the cloud will be winners while those that cling to the older models will lose. This will this include companies that supply servers, storage, communications, middle-ware, and other infrastructure components. In addition, it will also include companies that supply applications. It will no longer be enough to sell software that can be installed an operated on a corporate server. Successful companies need to sell the software as a service either directly or through a partner.

Natick Mall tour with Arnie Cohen

From Mall tour yesterday winners –JCrew, Chico’s, Nordstom, Amer Eagle, Metro, Guess, Limited 2, Losers Aero, Hollister, Abercrombie,TAlbots, Ann Taylor, Pier One, Macy’s, Gymboree, Victoria Secret,Under Armour, Coldwater Creek

This is not traffic driven but look of the store, Merchandise, appealing to target customer and trends Arnie is seeing in other malls and what he is hearing from his contacts. Yesterday became a three hour tour and very worthwhile as Natick Mall is rallyexpansive. So we got to see other concepts like Justice, Jack and Jill, and all the Liz concepts like Juicy and Lucky and others that Arnie got to talk about how the model have drifted or been institutionalized causing a lot of niche players to lose their luster or get off course like Justice who should not be in the malls but back in strips. We talked a lot about the concepts that are authorities or clubs to their constituency versus a commodity covering space. I would be happy to shed more light if you wish.

United Air Lines learns the power of viral revenge

Bart Perkins, Chair of our Technology group, wrote an article about an incident involving a rock band travel experience aboard United Air Lines. It's an interesting take on companies and their PR issues in this age of social media.

This article was originally published in Computerworld
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Have you seen the YouTube video "United Breaks Guitars"? Besides being genuinely funny, it's a great example of viral revenge, the flip side of viral marketing. The video accompanies a song by the band Sons of Maxwell that describes how United Air Lines' baggage handlers carelessly treated band members' checked instruments. A valuable guitar belonging to band leader Dave Carroll was broken. For over a year, United repeatedly declined his requests for compensation.

That's when the band turned to social media for revenge, posting its complaint on YouTube. United Breaks Guitars has a catchy tune, clever lyrics and memorable images. The video has gone viral and broken the band out of relative anonymity. After only three days, it had almost 1.5 million views and 10,000 comments, virtually all siding with the band. The story was picked up by CNN, NPR and CBS.

Faced with this social media juggernaut, United dropped the ball. It issued a single tweet stating, "This has struck a chord w/us and we've contacted him directly to make it right." So far, the company hasn't posted a response on YouTube or its own Web site. Dave Carroll knows how to take full advantage of the power of social media. United doesn't, and the cost is a PR nightmare. Lessons abound. For starters, corporations that long have monitored the media to understand public perception can't ignore social media, everything from blogs to video sites. And responses have to be in the appropriate channel. In this case, United needed to do a YouTube posting. Even something stiffly corporate like an apology from a contrite executive would have been helpful (provided it was sincere). But to be truly effective, United needed to try to match Carroll's creativity and good humor.

Companies probably fear giving things like the Sons of Maxwell video any extra attention, but by choosing not to engage, they are letting the opponent win all the debate points. And in this case, a lot of points are being scored.

Every PR professional knows how in 1982, Johnson & Johnson addressed the Tylenol scare in a way that actually improved public perception of the company and increased product sales. But United didn't apply that lesson to the new media and clearly lost this confrontation. It ultimately agreed to pay (Dave donated the money to charity), but the whole affair tarnished rather than burnished United's public image.
-----------------------------------------------

Bart Perkins is managing partner at Louisville, Ky.-based Leverage Partners Inc., which helps organizations invest well in IT. Contact him at BartPerkins@LeveragePartners.com.

San Francisco Mall Tour

Went thru the Westfield Downtown Mall with Arnie Cohen and after doing these now for the last few weeks some things definitely becoming clear. The traffic in malls is just not happening other than weekends. This is historically the lull but like we saw in NY at Westchester there is not "normal" traffic happening like past years right now. The spend will be smaller and trend line is flat in general with last year's lower numbers as of right now. That being said there are some above trend and some under. Here's Arnie's take:
Winners
Nordstrom's, American Eagle, JCrew, Chico's, Black/White, Guess, Metro
Tough Season
Aeropostale, Talbots,Ann Taylor, Pir One, Macy's Gymboree, Victoria Secret, Abercrombie
Inventories, store presentation, product mix, recognition of target customer and appeal are all issues we discussed in detail on our walk thru. Lots of details on all of these companies and more we can discuss in more detail. The bottum line is it will be a selective Christmas.

Energy Roundtable in San Francisco

with our chair Steve Percy former CEO of BP America and Peter Robertson former Vice Chair of Chevron we discussed the stat of oil and natural gas. Refining business is vey bleak as CAFE, margin pressure and ethanol growth has taken out any industry growth.Globally gas trades differently than the self sufficient USA and both experts just dont see natural gas prices changing much. Majors will see reserves drop by 30 million barrels by 2030 so even if demand stays flat the industry has to find 3x Saudi production to make up the shortfall. Much of the new deep well and other new finds are in the $60-$70 production cost category and other 3rd world production has other costs. For example security numbers 20,000 for Chevron in Indonesia to protect their workers. They need four security people there for every worker. Although OECD demand down 2 milllion barrels this year the increased demand of 1.6 million barrels in developing countries will continue to put pressure on oil prices. Carbon plans can change everything but in general oil prices in $70-80 range looks to be very applicable and stable to support current demand.

Electronics reign supreme

Craig Johnson believes that "despite the media hype surrounding Black Friday, the weekend is critical to the holiday season only for one major merchandise category -- consumer electronics -- which will see some 20% of Christmas sales over the three-day weekend,".

As expected, flat-panel televisions and other electronics were the most popular purchases last weekend.

Initial reports show 25% of overall shoppers who purchased a TV buy it at a Best Buy. This compares to half of overall TV buyers purchasing their TV at Wal-Mart. This shows a big win for Best Buy, given that the chain has far fewer stores than Wal-Mart.

Craig also notes that Best Buy proved strong in the home appliances category, a sector starting to show signs of a recovery.

Holiday forecasts tend to be unreliable

This season the National Retail Federation calls for a 1% decline in holiday sales from last year. The group uses Commerce Department data for November and December, excluding auto dealers, gas stations, restaurants and Internet sales. Craig Johnson our Consumer Chair and President of Customer Growth Partners forecasts 2.4% growth.

Craig believes that industry forecasting "is a sport". The reason for the wide range of forecasts is that they rely on different pools of data. One survey might use government data, which is often revised, while another may use cameras mounted on the ceilings of retailers to gauge store traffic.

To complicate matters, for economists, the holiday shopping season starts much earlier than Black Friday. Their forecasts usually include November and December, and some include January to capture gift-card redemptions.

Industry forecasts also emerge months before Black Monday, which is after most chains have placed their holiday orders. Therefore economist and industry predictions serve almost no function for retail executives that need to make merchandising decisions. In the end institutional investors seem to know this already, they typically rely on guidance reported by individual companies.

Mall tours with Arnie Cohen

The year of plaid and costume jewelry. At the Westchester Mall you could have blown a cannon off on the Wednesday a week before Thanksgiving and there would not have been 50 people to hear it. Although traffic was minimum floor diplays and inventory was telling. The same mall according to Arnie was cooking over the weekend and based on follow ups appeared to be strong traffic again the weekend before Thanksgiving(as was Beachwood Mall in Cleveland). JCrew was a standout with inventory rolling down but new deliveries due the next day. Presentation was particularly strong at Express where the client is clearly teenage "date bait" Chico's where new merchandising management is obviously making a difference, Bath and Body Works that just screamed to buy a candle gift and White and Black. GAP was mediocre(but in Cleveland was hopping) as was Nordstom who in Men's is pushing Robert Graham at the young male-interesting. Liz is riding Lucky, Banana Republic has no conviction, Pottery Barn is missing the Christmas thought, Ann Taylor better be making it in the Outlets and Abercrombie has no greeters, alot of arrogance, little inventory and no customers- ouch. Stay tuned next week San Francisco and then Boston. Lots of updates in the meantime.

Customer Growth Partners 2009 Holiday Forecast / Black Friday Report

To be released: Wednesday morning December 2

Ahead of the Thursday November retail sales summaries

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Since 2001, Customer Growth Partners has prepared an annual forecast of Holiday retail sales, focusing on major specialty, broadline and discount chains. On December 1, CGP updates that forecast based on its proprietary surveys of November results—including Black Friday weekend activity at key mall and off-mall venues across the country.

The past year has seen unprecedented change in the retail industry, with Holiday 2008’s retail debacle followed by sharp downsizing, cost take-outs, revitalized merchandise and marketing strategies, and now—perhaps—the return of topline growth.

As we approach the traditional Black Friday kickoff to the Christmas shopping season, CGP invites you to subscribe to our annual Holiday forecast, including our real-time recap of Black Friday weekend retail traffic—ahead of the curve.


CGP’s 2009 Holiday Forecast/Black Friday Report will cover:

I. Consumer Spending Environment
· Economic Factors
· Key Behavioral Drivers

II. CGP Holiday 2009 Retail Macro Forecast
· Base Case Total and Sectoral Projections
· High/Low Scenarios/Sensitivity Analysis

III. November Retail Recap
· Pre-Thanksgiving
· Black Friday Weekend

IV. Holiday 2009 Outperformers
· Broadline
· Discount/Big Box
· Specialty Apparel and Other

V. Holiday 2009 Laggers

------------------------------------------

Customer Growth Partners has been featured in:

Chain Store Age (10/27)
CNN (11/5)
New York Times (11/6)
Bloomberg TV (11/12)
WWD (11/14)
Wall St. Journal (11/14)
Barron’s (11/16)


To Order the CGP's 2009 Holiday Forecast / Black Friday Report:

For subscribers as of 5pm, November 27
Charter subscription cost: $495 payable in advance.

After November 27
Regular subscription cost: $595 payable in advance.

Paid subscribers will receive a For-Internal-Distribution-Only copy of the report by email the morning of December 2.

Methodology
CGP’s Retail Macro Forecast is based on proprietary models, and includes factors such as disposable income growth, personal consumption expenditures, savings rates, energy prices and unemployment trends. CGP’s November field survey data, including the Thanksgiving weekend, are based on its team’s on-site observations, using proprietary sales estimation models, at key mall and off-mall venues in a minimum of six states across the U.S. including locations in the East Coast, West, Midwest and South. Its data includes no confidential or non-public data obtained from any retailer or retail affiliate.

To confirm your participation, please email Jeff Resnick at jresnick@trustnavigator.com, and CGP will reply with remittance information. To discuss, please feel free to call CGP at 203.801.9567, or contact Craig Johnson directly at Johnson@customergrowthpartners.com. CGP looks forward to working with you.

Tatum/Roulston Report

This month the Tatum survey continued to show the “L” curve with an upward bias is the state of business conditions. The economic recession that technically started in late 2007 in reality struck most businesses in “full force” in September and October of 2008. Although from the outset the year was a slow downturn, in the fall of 2008 business as measured by orders and activity fell suddenly in a 20-30% range across virtually all sectors. Earlier this summer the Tatum survey reflected that credit conditions, orders and backlogs had bottomed. Most other surveys and economists seem to concur.

But unlike so many past downturns and subsequent recoveries, the sudden drop last fall set a new lower baseline. We believe there is a new mindset in most boardrooms. Simply put it seems it does not seem there are catalysts to bounce back. Government stimulus was spotty and limited to random sectors in the last year. Government intervention and regulation are creating a sense of uncertainty not seen since the late 1970s. Budget deficits and Fed stimulus is creating anxiety with little confidence in capital spending and virtually no visibility in order patterns. The Tatum Survey reflects this in the trends of just general sloppiness for the last six months in terms of backlogs, employment and capital expenditures. Companies are reluctant to hire except selectively in spaces of unusual strength (ex. mortgage workout departments). Reduced employment has spurred margin improvements and in the survey there are signs of technology spending to further improve employee productivity.

The bottom line is that the government must extricate itself from the current role in business of perceived obstructionist and concurrently in some cases the sole short term stimulus. Businesses need visibility and confidence in a sustainable future. In this scenario the Fed loose policy supports balance sheet building with mixed signals of improvement. The markets will only digest so much of this before investors will want to see revenue growth.

Dice Holdings: Significant Upside If Unemployment Improves

Our Boston presenter is adding to his position in Dice Holdings (NYSE: DHX, $5.88). The NY-based provider of online recruiting and career development services exceeded the consensus estimates in Q3. Operating results will continue to lag a turn in unempoyment. We've seen a bottoming in demand for the company's services, but no pick up yet, according to the presenter. DHX just did a small acquisition in healthcare, which expanded the company's addressable market from its two core businesses targeting finance and tech professionals. The presenter believes that if and when the economy starts picking up in earnest, the stock will reach low $10's. DHX was presented at $4.00 end of July.

The decline of the "aspirational consumer" and rise of predictive software

Tom Madigan, a Roulston Research Consumer expert, recently attended the WWD (Women's Wear Daily) conference in NY and reported back to us some points that came up. The overwhelming consensus at the conference is that the "asprational consumer", the consumer with the "leased car and rented suit", is gone. As a result, for example, Neiman Marcus's business went from 5 Billion to 4 Billion overnight. These retailers that catered to this psychographic have to restructure their businesses to find a model that will be sustainable without them.

Most retailers claim that they've taken a lot of cost out of system. But the challenge now is how do they appeal to a larger share of the wallet of their now smaller customer base? They believe the answer lies in better aligning their inventory with demand. It's a combination of selling "wear now" clothing, which means smaller runs with more frequent deliveries and "fast fashion" clothing which can be worn year round.

"Wear now" is about better matching the weight, color and quantity of their stock to demand. Stocking items that consumers believe that need to buy now, before the store sells out of the item. It's about getting better at localization, literally taking retail back to where it was 50 years ago. Better knowing the attributes of the customer, so that the store can make a better stocking decision.

Some stores still base the stocking decision on employee opinions, but many have moved this function over to software. Computers crunching the demographics and buying habits for an individual store produces more accurate results.

Retailers hope that these changes will get their customers off of their "addiction to sales". If the customer sees something in the store they need immediately, and understand that it may not be in the store the next day, they (the retailers hope) will be more likely to buy it based on need rather than based on price.

Craig Johnson, Roulston Research's Community Chair, Sees Walmart Growth in International Markets

Finisar: Adding to Position

Our Boston presenter has been adding to his position in Finisar (NASDAQ: FNSR, $8.07). The stock has dropped about 10% since the presentation in early October, but the presenter believes that shorting that commenced after a 1-for-8reverse split back in September is likely over. The company has been working through capacity constraints. FNSR increased output for its ROADM-related products in each of the recent quarters. Reports from other industry players point to improvements in long-haul and metro market demand. The presenter's current target is $12.

ERTS: Still a Buy Despite Weak Quarter

Our NY presenter is still positive on Electronic Arts' prospects (NASDAQ: ERTS, $18.29). The stock dropped 6% yesterday, following the release of fiscal Q2 results. The presenter stresses that the weak guidance the company offered was not entirely unexpected. He believes the stock will start gaining after one last month of negative NPD data for the videogame industry. Agressive job cuts just announced by the company is a positive development.

Cinemark: Positioned for 3-D Transition

Cinemark (NYSE: CNK, $12.43) is up about 10% since the name was presented at our NY small cap idea forum back in early October. The company's Q3 results topped the Street's estimates.
The presenter also highlights CNK's outperformance versus peers. The key near-term catalyst is the closing of the funding arrangements to facilitate a quiker roll-out of 3-D screens across the country.

Retailers take a conservative approach to the upcoming holiday season

Retailers have taken a much more conservative approach to the upcoming holiday season as they have in recent years. Sellers have up to 30% less merchandise stocked for the upcoming months. As a result, many are predicting that we will not see big 50%, 60% or 70% sales like we have in previous years.

Despite economic conditions, Craig Johnson, Roulston Research's Consumer community chair believes the recent pick-up in monthly sales, coupled with consumers that have "frugal fatigue", could make it hard for many to resist opening up their wallets this holiday season. If this happens, it could bring a run on some merchandise in the coming weeks.

If some retailers are caught with product shortfalls, Johnson believes that they may introduce spring merchandise in December to fill empty shelves. Johnson points out that this is not a new phenomenon. He has heard rumors that some teen-focused retailers may bring in spring products by mid-December.

Johnson also believes that E-readers, whether it's Kindle or Barnes & Noble's Nook e-reader that's coming out later this year, are going to be big sellers this season.

Valassis: Good Q3 Keeps Story Intact

Our Dallas presenter says there's been no change to his thesis for Valassis (NYSE: VCI, $18.33). The company's numbers in Q3 were above the Street's expectations. Full year EBITDA guidance was raised by $20 million. In July, a Michigan judge ruled in the company's favor in its litigation against News America. Two more lawsuits against News remain pending. NWS has asked the judge in the state case for a retrial this Friday. The decision was put off, but according to the presenter's legal advisors, NWS's arguments are not likely to be sufficient. The stock has made a 15% move since the recommendation in late September, but much more significant gains are possible over the long-term.

Warehouse clubs report the best October retail sales

Despite the stock market rally, retail sales last month were good for warehouse clubs and some high-end sellers, but not as good for much of the rest of the sector. Retailers are now concerned that consumers may not really open their wallets for the 2009 holiday shopping period, which officially starts the day after Thanksgiving.

Typically the November-December gift-buying months is the most critical annual sales period for sellers. It can account for 50% or more of retailers' sales and profits for the year.

Craig Johnson, our Consumer community Chair believes that for well over a year, consumers have been in shellshock. he thinks that "they are now starting to come out of the bunker, but they still are wearing their body armor and shopping smartly".

He believes that better-than-expected sales results from some high-end sellers shows more people are becoming comfortable spending a little bit more money again. He believes this trend bodes well for the holiday season.

Johnson expects holiday sales to grow about 2.4%.

Knight Capital: No longer recommended

Our Dallas presenter is no longer recommending Knight Capital Group (NITE: NASDAQ). The company has unexpectedly increased its investment in growth opportunities, which won't yield results in the next several quarters, hurting margins in the meantime. Payments for order flow have also gone up. The story still has long-term appeal, but the risk/reward ratio in the near to medium term is no longer favorable, in the presenter's opinion.

SWK acquisition of BDK won't hurt HD or LOW

Craig Johnson, Roulston Research's Consumer community chair believes that Stanley Works' $4.5 billion acquisition of Black & Decker Corp. shouldn't hurt results at Home Depot or Lowe's. He does not see this transaction as a negative for either of the retailers.

He believes HD and LOW should benefit from a tool-maker that is financially and operationally stronger as a merged entity. By combining their sales forces and eliminating duplicative distribution systems, Stanley and Black & Decker should be able to get their products into stores more efficiently. In addition, Stanley and Black & Decker's products are mostly complementary rather than competitive.

Electronic Arts: Gains in Online Gaming and Wii

A New York presenter likes Electronic Arts (ERTS: NASDAQ, $18.70). The gaming industry has been hit by the weak economy, but there are indications of bottoming in the space. The company has made significant gains in the digital area and on the Wii platform and is in a great position as we're entering the all-important holiday season. New releases have been selling very well, with FIFA 2010 breaking records as the fastest-selling sports game in history. The company's impressive balance sheet allows it to both support the established franchises and make significant investments in pursuit of growth opportunities. The presenter targets $25, or 30% upside form the current level, based on forward earnings estimates.

UnitedHealth: Trading at Discount to Peers While Lower Risk

Our New York presenter likes UnitedHealth (UNH: NYSE, $26.47) at this level. This leading managed care player is trading at a discount to peers, but its diverse business model holds less risk in light of some of the upcoming regulatory changes facing the industry. The company has improved its service levels recently and customer retention reflects that trend. The scale of UNH's operations and the reach of its provider network would allow the company to benefit significantly from expansion of coverage under the healthcare reform. Cost pressures are a challenge, but the company has been able to raise prices to offset higher medical costs. The presenter conservatively targets $30, but notes that $35 is possible if more favorable assumptions are proven valid.

Customer Growth Partners - Holiday 2009 Forecast

Craig Johnson, President of Customer Growth Partners and Roulston Research's Consumer community Chair has issued a Holiday 2009 Forecast. Craig believes holiday retail sales will grow by 2.4% y-o-y, a sharp turnaround from last year’s 4.1% decline. In issuing the forecast, Craig noted that his estimate of $502 billion in predicted 2009 November-December sales still lagged the peak $511.1 billion in 2007 sales -- and were barely above the $497.1 billion level seen in 2006.

He believes that Americans have endured a series of economic body blows over the past year, from the housing and credit crises to rising unemployment, but they’re now beginning to pick themselves off the mat, dust themselves off -- and start to shop again. With unemployment near 10%, this will not be a great holiday season, but compared with last year when the economy was in freefall, retailers will see a return of topline growth -- and many will enjoy robust, if not record, fourth-quarter earnings.

Highlights of CGP’s 2009 Holiday forecast include:

• November-December 2009 retail sales will increase to $502 billion, up from $490 billion in the similar period of 2008;
• The 2.4% rise represents a sharp turnaround from 2008’s 4.1% YOY decline;
• 2009 Holiday sales will be paced by 10.8% year-over-year growth in e-commerce and other direct-to-consumer sales, also a strong rebound from last year. According to the DOC, fourth quarter 2008 e-commerce sales fell by 5%, the first ever YOY decline in holiday period e-commerce sales;
• Clothing and accessories sector sales will rise by 8.8%, a major turnaround from 2008’s unprecedented 13% decline -- but still below sales levels achieved in either 2006 or 2007;
• Lagging sectors will include the long-suffering home-improvement retailers, predicted to see a 10.4% YOY decline, and the home-furnishings sector, with a 6.6% drop;
• Discount and other value retailers will shine in holiday 2009, led by off-price retailers such as TJX and Ross Stores, low-price players such as Aeropostale and Forever 21, such Big Boxers as Costco and Wal-Mart, and e-commerce retailers Amazon and Gilt.com;
• Electronics retailers -- from Best Buy and Hhgregg to Apple, Amazon and Wal-Mart -- will see exceptional unit growth, particularly in flat panel TV’s, e-readers, laptops and mobile phones, but will be held back by sharply falling consumer electronics prices;
• The predicted 2.4% holiday season increase represents CGP’s Base Case forecast, which assumes that the unemployment rate remains in the 9.8% to 9.9% range, and that energy prices remain stable at about $2.70/gallon regular gasoline; and
• CGP also prepared two sensitivity analysis forecasts. Under the high unemployment/ high-energy price scenario, holiday sales would decline by 1.5%; and under the falling unemployment/low-energy price scenario, holiday sales would rise by 4.4%.

He notes that last year’s holiday shopping season saw households in almost stark fear financially, as consumers clenched their pursestrings with an increase in the savings rate to 4.7% during the peak December Christmas shopping season, over quadruple the 1.1% savings rate from earlier in 2008. But now savings are now returning to more normalized 3% levels -- and with the third quarter GDP growing at about 2% or 3%, the economic clouds are beginning to lift a bit.

The real wildcards will be if employment takes another leg down, and if energy prices take another leg up -- which will turn holiday sales negative a second year in a row.

Cinemark: Betting on 3-D Uptake

Our NY presenter is bullish on Cinemark's (NYSE: CNK) prospects. This movie chain is perfectly positioned for the long-anticipated transition to the 3-D standard. Consumers have embraced the better viewing experience 3-D offers and are willing to pay a $2-$5 premium for tickets. Attendances for 3-D screenings are twice as high as for regular movies. Movie studios will save on prints and shipping costs to distribute prints around the country. Some majors have already agreed to use their savings from the new platform to help movie chains finance the cost of installing digital projectors. JP Morgan is also putting together a financing package to facilitate this transition.

Cinemark has the best operating metrics in the space. Its presence in Latin America, a less competitive market, helps diversify revenue streams. The stock pays a 6.4% dividend yield. The upside from the $11 level where the name was recommended is 40-70% in the next 2-3 years, depending on how fast the 3-D switch progresses.

Tatum/Roulston Report

Tatum's survey is unparalleled in the ability to capture consistent opinions from Tatum's nearly 1,000 executives across the nation who act as CFOs, Controllers and CIOs in a broad base of industries across the country.

Tatum is a nationwide firm specializing in the providing financial and information technology services and executive fulfillment to companies across the country. For the past seven years Tatum's monthly Survey of Business Conditions has provided useful insight regarding business conditions. Roulston Research has partnered with Tatum LLC to produce abstracts of the business outlook from data collected by Tatum. In the Tatum/Roulston Report, Roulston Research believes most surveys, for example, do not identify a broad spectrum in volume of respondents, regionalism, company size or consistent respondents. In addition government results are usually reported 30-60 days after measurement period before revisions are made 30 days later. Most surveys’ conclusions are thus old news, but more importantly have not had a predictive result on earnings trends. The Tatum/ Roulston Report is not constructed with these issues that may distort or delay results. Instead, it is timely and immediate, with a consistent survey constituency of professionals primarily operating in high levels in the financial and technology departments of companies where the rubber meets the road. This joint effort with Tatum is a unique partnership that will provide a differentiated view of business trends - The Tatum/ Roulston Report.

Visit our website to view the latest Survey.

This month, BusinessWeek featured Tatum's survey in a discussion of current trends among executives, especially in the healthcare and technology industries. Follow this link to the Business Week article.

Changing dynamics alter traditional spreads in US natural gas-crude oil markets

Stephen Maloney
Copyright 2009, Towers Perrin
All rights reserved

While crude oil markets are enjoying a breakout, why isn't natural gas keeping pace? Isn't there supposed to be some kind of multiplier relating the two commodities? Shouldn't rising hydrocarbon prices lift all boats? After all, the recession is over, right?

Maybe it's a storage problem so let's check the numbers.

As of October 9, 2009, US crude oil stocks were 337.8 million barrels, up from 309.2 million barrels a year ago. That's a 9.2% increase over last year and well outside the normal range for this time of year.

Natural gas stocks as of October 2, 2009 stood at 3,658 billion cubic feet (Bcf). That's up from 3,266 Bcf a year ago or a 14.6 % increase and also outside the normal range for this time of year.

So, we're not seeing an inordinate swing in storage volumes relative to normal ranges for this time of year.

Now, let's look at the prices.

WTI spot prices on October 9 were $71.75 a barrel, up from $69.80 the previous week. In contrast, spot prices for natty gas are around $3.82 per MMBtu and not showing much strength above the NYMEX $4 handle.

Let's put this in context. A barrel of oil is worth roughly 5.8 MMBtu. So, $71.75 per barrel of WTI crude prices a barrel's energy content at about $12.37 per MMBtu. On an energy content basis, oil prices are currently about 3.24 times higher than energy prices for an equivalent amount of natural gas. And, crude oil prices are in breakout.

By comparison, a year ago, WTI prices last year were $77.44 and heading south. Henry Hub prices were then around $8 per MMBtu. On an equivalent MMBtu basis, the conversion multiple last year was 1.67.

Natural gas prices are not keeping up with crude oil price increases.

Admittedly, a year-to-year comparison is not really fair. After all, US natural gas prices follow a cyclical pattern timed to the onset of winter. Prices tend to peak in late July-early August. That period also coincides with peak volatility reflecting the uncertain requirements of the upcoming
winter heating season and the uncertain potential for supply disruption associated with the beginning of hurricane season in the US Gulf Coast. So, there should be some risk premium to price into natural gas spot or prompt month prices. And, we should vary that premium through the year. As the winter heating season ends in late winter-early spring, the price topology can be as exciting as riding the "Rebel Yell" (ask Brian Hunter, formerly of Amaranth, to explain why Mar-Apr spreads are called the "widow maker").

Clearly, the evidence is "all hydrocarbons are the same" is NOT true on an equivalent heat rate basis. Maybe they once were, but not at this moment and not at certain times of the year.

What's changed?

First, crude oil is an international market while natural gas is currently dominated by pipelines.

In addition, we're seeing the increasing role natural gas is playing in domestic electric power generation. In contrast, crude oil has no role in electricity generation.

Utilities don't burn oil anymore to make electricity. Rather, they mostly burn US and Canadian produced natural gas and US coal. In fact, roughly a third of natural gas demand goes to generating electricity. And, over the past year, electric generation went down pretty hard due to the recession. When people talk about wind and solar reducing the dependency on foreign oil, they're wearing leisure suits and playing an 8-track tape from the 1970s.

Electricity generation directly taps into the real US economy (i.e., the one that employs working people - not NYSE). With US industrial capacity utilization running below 70%(!), it's not surprising that July net electric generation (a peak demand month) fell off the table some 7.6% this year. Coal was the big loser with its less liquid market taking a stomach churning 15% drop in generation. The (relative) big winner was natural gas demand for generation which was only down 0.4%.

The new dynamics of natural gas markets are breaking a lot of traditional notions. For example, while demand for generation softened, natural gas prices responded to market dynamics quicker than the coal market such that gas-fired generation actually stole market share from coal in many areas, including the Midwest. In effect, the higher spark spreads made gas-fired generators relative money makers this summer compared to coal generation while large segments of the US industrial sat idle. Wild.

We're still a long way from a US economy running at its normal 80% or so capacity utilization. The US economy will need a few years of white-knuckled growth combined with some serious capacity rationalizations to get there. Meanwhile, natural gas rigs are dropping off in an attempt to match supply to demand.

Shifting markets aren't the only change impacting natural gas markets. We also have seen a very quiet tropical storm season which has also moderated the volatility spikes we often see in the summer going into the fall.

All in all, while domestic supplies of natural gas heroically stole some domestic demand from coal it otherwise couldn't keep pace with crude oil's breakout driven by USD collapse and Chinese demand. Still, there may be some late inning hopes - despite threats (or promises - take your pick) of global warming, it may well be a colder winter this year. Cold temps can be beautiful music for natural gas producers.

Clearly, traditional market dynamics for natural gas were impacted by this recession and the "dog that didn't bark" (no headline-making hurricanes to speak of). And, so, the spreads between WTI crude oil and Henry Hub natural gas have widened beyond traditional bands.

What about the future? Will the US natural gas market continue to experience domestic dynamics? Or, will LNG expose the market to the trans-Atlantic spreads and transform US storage into a swing player not unlike the WTI-Brent spreads?

In my next blog, I'll talk about LNG.

Stephen Maloney
Managing Consultant, Risk and Financial Services
Towers Perrin
steve.maloney@towersperrin.com
www.towersperrin.com/energy

Wal-Mart Continues its Aggressiveness

Craig Johnson, our Consumer chair, believes that recent moves by Wal-Mart to demonstrate its desire to continue its aggressiveness by seeking new avenues of competition.

Recently the company started to

• sell dozens of toys for $10 each
• offer a wireless service priced below competitors
• cut prices on 10 highly anticipated hardcover books to $10 on Walmart.com
  

The third action prompted a price war with Amazon.

After both retailers then cut their prices on those books to $9, on Friday Walmart.com shaved a penny off that price to come in at $8.99 each. Walmart.com has threatened to drop prices even further. The company said it would adjust its pricing as needed to ensure it offered the lowest prices on its top 10 pre-selling books.

Craig believes that this is a demonstration that they are "more aggressive and they will cede no ground to the competition, whether it's the Best Buy's of the world, or Toys "R" Us or ... Amazon." He is of the opinion that "any competitor that underestimates Wal-Mart, does so at its own peril."

Belo: Positive Trends in Ad Spending

We have recently posted an update from our presenter on Belo Corp (BLC: $5.47). Another shareholder is encouraged by a pickup in ad spending reported by peers in the space. The positive trends appear to be carrying over into Q4. Belo operates in Texas and Pacific Northwest, areas which have not been hurt by the housing crisis as much as other regions in the US, and where population is projected to expand at higher than average rates. The likelihood of breaking covenants is less of a factor now. Q3 earnings by Gannett and others starting next week should show conditions in the space turning less challenging.

The Tatum/Roulston Report

The Tatum survey this month clearly reflects that businesses are not in the typical mode of positioning their companies for recovery. Current trends are mixed with a lack of consistency by sector and industry. Perspectives indicate regional factors, government behavour and the financial instituional environment weigh heavily on the corporate outlook.

Backlogs have shown improvement as the significant slowdown last fall and winter has now rightsized inventories and corporate overhead. Expense reduction seems to be largely completed to a level that most companies are not cutting further at this point. Instead they seem to be waiting for an indication of better things to come. The Tatum Survey indicates some pent up need for modest capital expenditures for companies to start to maintain maintenance but not much more. Backlogs are up to replenish inventory pipelines, but a lack of confidence in future visibility is clearly widespread. Continuing capital availability concerns weigh heavily on this economy and most concerning to us is that its difficult to identify any factors that will adjust this environment.

Although the markets have bounced back to reflect maybe an overreaction to the downturn, Wall Street seems to have an uncanny confidence in historical precedence that has a disconnect with Main Street. We have written before that the difference between recession and depression is emotional. Middle America has reacted to the market meltdown, unemployment, government activism and lack of access to financial credit much differently than the East Coast. With the exception of export driven stimulus from the weak dollar and some very isolated individual company(seemingly not even industry wide) recovery, the environment is very sluggish.

Confidence in any government action to improve the sentiment is not only non existent, its sarcastic. With virtually no banking predictability most companies are experiencing very little forecasting capability. Optimism is common, but with very little tangible eveidence of sustainable stability. With the last year's experiences still freshly in the rear view mirror, pundits that believe recent history will not be a lasting scar just don't understand how a dog feels after its owner kicks it. The thought process that the economy will soon be back on a historically comparable trend is somewhat ignorant of the effects of the emotional meltdown we saw over the last 12-18 months. It takes time to forgive and forget unless you may not believe things broke down in the first place.

Finisar: Riding Buildout of Optical Networks

Finisar (NASDAQ:FNSRD) is another name from our recent small cap forum in Boston. Explosion in mobile data traffic and ever-increasing capacity requirements for fixed networks play to company's strength as the market leader in optical components. Margins are poised to rebound as some manufacturing facilities are transferred to off-shore locations and the overall product mix continues to improve with growth in revenues from higher-margin products. The company has secured a new credit facility and priced a $90 million notes offering to boost liquidity and retire outstanding debt with near-term maturity. The target is $15-$16 or 60% from the $9 level where the stock has traded since the last week's presentation. FNSRD has just undergone a reverse 1-to-8 split.

Comtech: Military Play with Call Option on Telecom Recovery

Our Boston presenter likes Comtech Telecommunications' (NASDAQ: CMTL, $31.93) strong presence in military communications. The stock fell from $40 to $20 back in March, when delivery under government contracts was pushed back one year. Now, the company is nicely positioned for fiscal 2010. Increased activity in Afghanistan will be an important factor in near-term growth. CMTL's higher-margin commercial sales are dependent on recovery in the telecom space. The company's operations are globally diversified, with solid presence in emerging markets. There is plenty of cash on the balance sheet to finance acquisitions, but Comtech itself is a likely takeover target for a number of companies. Trading at 5x EBITDA, the upside is 50-60%.

Decoupling trans-Atlantic crude oil markets

(From Steve Maloney at Towers Perrin, steve.maloney@towersperrin.com)

The continued decline of the USD has been an important factor in the equity price rally that began in March. We've seen the effects of USD weakness in other commodities, notably gold and crude oil. Storage is the new international bank with excess oil supply serving as a currency hedge. Clearly, this is no way to run a reserve currency but can be a great opportunity for companies positioned to play it.

The Obama Administration is clearly deploying a weak dollar policy in an attempt to restart the US industrial economy. Deficit spending and low interest rates come at a price. The Fiscal 2009 Federal deficit is at least $1.4 billion and next year looks even worse. According to Bloomberg, the dollar lost over 10% of its value on a trade-weighted basis the past six months, the biggest drop since 1991. Worse, the dollar represents less than 40% of new reserves, down from the 63% 10-year average.

With dollars practically free, the flood of USD dollars is fueling talk about restructuring the world's reserve currencies. Long before the 2010 resets and IMF policy changes, markets are already responding by breakouts in crude oil and gold prices.

Crude oil price dynamics can create interesting inter-market effects as well which reinforce the breakout dynamics.

In the US, one of the more important price benchmarks is West Texas Intermediate (WTI). The WTI market comprises pipeline flows gathered in Midland which may be directed to the US Gulf Coast or to the storage facilities in the vicinity of Cushing, Oklahoma. Flow through Cushing continues up towards refineries and other processing facilities in the Chicago area. In 1983, NYMEX created the WTI contract with delivery in Cushing based, in part, on ready access to US refineries then concentrated in the US Gulf Coast. WTI is considered "sweet" in that it has less than 1% sulfur making the grade ideal as refinery feed for the higher resulting yields. With refineries driving US industrial production in the Midwest and the Gulf Coast, WTI prices were excellent marks for the physical product. As formulas-based trading emerged in 1986, financial markets synchronized with NYMEX and later the commodity markets of ICE and Dubai.

Similarly, Brent crude oil is located on the other side of the Atlantic Basin. Like WTI, Brent is a commingled crude with low sulfur content and ideal as refinery feed used for motor fuel and industrial products. Brent was originally drawn from both the Brent and Ninian systems in the North Sea. As the original Brent field declined, Platts introduced a new price benchmark in 2002 combining Brent with production from the Forties and Oseberg. Ekofisk was added to the mix in 2007. So, when we talk about Brent today, we're really talking about North Sea oil from several sources.

Since both WTI and Brent are sweet crude, one would expect the price spreads across the Atlantic Basin would reflect market coupling, modulated by the cost of freight. Consequently, we would expect WTI to price at a premium to Brent. This premium can erode or go negative due to pipeline interruptions, supply chain constraints, and US refinery outages. Such outages occur during the hurricane season impacting the US Gulf Coast in late-summer and early fall which present spikes when refineries or production is halted.

However, those traditional market dynamics have changed, partly due to shifts in the US physical market, amplified by the decline in US industrial production, and amplified by the collapse of the dollar.

The US physical market changed as a result of interconnection with Canadian products increasing the supply to Cushing. This supply enhancement was driven by the strong US economy of several years ago. As this supply grew ahead of the declining US economy, prices sifted to contango. This shift has been amplified by growing storage capacity in the Cushing vicinity. With storage costing some $1.25-$1.75 per barrel-month, the convenience yield was running in the range of ~50% annualized return for much of the past year.

The Brent market has seen similar dynamics, though without the pipeline and hurricane effects. Like WTI, the price curves are in contango which provides incentives for storing crude ahead of demand. While Cushing saw tank farms expand, Platts reported charters by BP and Shell of very large crude carriers starting a year ago mooring off the UK coast.

As crude prices fell, we also saw spikes in the WTI-Brent spread volatilities. These spikes can be explained, in part, by the disproportionate storage additions at Cushing compared to storage available for Brent. However, the final complication has been the decline in the USD, and falling refinery utilizations (and margins) reflecting the overall collapse of the US industrial economy. For example, US industrial utilizations remain stuck below 70%, compared to the long-term average of 80%. By comparison, lows in previous US recessions were in the range of 75%. These lows are even more pronounced in the Midwest where a substantial portion of Cushing flows were directed. US industrial demand has retreated to levels seen around 2002 or so. Today, Cushing inventories have ranged well above 30 million barrels, compared to inventories in the 2004-2005 period of 15 million to 20 million barrels.

By comparison, European industrial utilization declines lagged US declines. The lagging differential injected volatility and anomalous behavior in the spreads.

Looking ahead, the continued weakness of the USD combined with differences in supply chain dynamics between the US and Europe may create arbitrage opportunities in the WTI-Brent spreads that were heretofore episodic. Unless new dynamics emerge, the increased volatility combined with this weakness can continue to drive crude oil into storage ahead of production needs. As long as the industrial economy and the USD remains weak, storage will serve as an attractive currency hedge. But, with increased demand, there may not be as much letup in price pressures.

In my next blog, I'll talk about the effects of recent developments on traditional spreads between natural gas and crude oil markets.

Stephen Maloney
Managing Consultant, Risk and Financial Services
Towers Perrin
steve.maloney@towersperrin.com

Talbots: The Street Underestimates Turnaround

Our Boston presenter highlights Talbot's (TLB: NYSE) margin improvement initiatives under the new management team as the reason to be more confident about the company's prospects. TLB has seen a complete change at the top, which has resulted in refocusing of efforts on the company's core woman business. Strong financial backing on the part of Aeon, a majority shareholder, ensures TLB will have sufficient liquidity. The stock has just been upgraded, but the Street is still underestimating Talbots' recovery potential. TLB has been running, but there is more upside left, possibly 100%+ from the current $11 level.

Seasonal hiring will be spotty

Craig Johnson, the Chair of our Consumer Community, believes that seasonal hiring among retailers will be down overall but healthier in a few segments.

He believes the stores that will do the best, and those that will hire more seasonal workers, will be some of the discount players like T.J. Maxx, Ross, Aeropostale and Kohl's. Also adding payroll will be Toys R Us, which is installing seasonal stores in storefronts recently vacated due to the recession.

Craig believes that retailers across all segments will not hire as many workers as they have in the past. He sees retailers finding new ways that their current staff can be more productive. The most obvious method will be for management to increase their staff's hours. Current part-time workers are expected to see the biggest increases.

Retail Review

Today we have a roundtable with some great thoughtleaders in retail. Travelling the last few days with Chris Lee former SR VP with Forever 21 its apparent the trade down in retail is going to be a prevalent issue this Christmas. Chris likes TJ Maxx and other brand players that compete at the lower end like Forever 21 . But its not just loyalty he cites the fact that some stores he thinks are looking at reallocating space as the consumer shows any move up in buying and also looks for foreign players to come in and take advantage of the dollar and cheap real estate to acquire properties , possibly in bulk and in partnership with big retailers rather than the REITS. Look at Sears, Walmart, or even a Macy's to take space and create some kind of store within a store concept.

BLC is still a Buy

Our presenter still likes Belo Corp (NYSE: BLC, $5.39), despite an impressive move from $2.02, where the name was recommended back in June. He is adding to his holding. The stock was beaten down on concerns the company may not survive, but investors are feeling more comfortable about Belo's ability to service its debt. The key catalysts for Belo will be mid-term elections next year, Winter Olympics, and a pickup in auto advertising, which contributes 25% of local ad spend. Easier comps should also help. The presenter believes the stock might have another $4-5 of upside left

Black Rock's ETFs

Black Rock's acquisition of IShares has implications for the investment management industry. With this purchase, BLK's AUM mix shifts to about 50/50 active/passive. Given that trading is a diseconomy of scale in the investment management business, this mix allows BLK's growth to continue with a smaller impact from this impediment. Cynically, it might be argued that as a firm grows, there's a risk its results become more average, and that passive management will earn better returns for the firm and its clients. But I won't make that argument. BLK clearly expects that ETFs will be used more broadly in the implementation of investment strategies. I was involved in the design of the first ETF at State Street two decades ago. At the time we thought ETFs were an improvement on many aspects of mutual funds. We also thought the wrap account business would offer benefits to retail investors. Finally, the ETF business has developed enough diversity and complexity where there is probably room for an expansion management activity far beyond strategic asset allocation. IShares has been pushing on the 401(k) market, but there is really little penetration of the large end of the market by ETFs. There has always been this fear that too much passive management will affect the price discovery mechanism for stocks. For any given stock, active managers over time should be the marginal pricers, but as more of the stock is tied up in passive portfolios one would expect more market impact from the trading of a position of a given size. This might cause more valuation discrepancies for active managers to take advantage of. Finally, this acquisition may have an effect on the AUM mix of Merrill brokers, with BLK's ETFs possibly gaining share at the expense of other players.

Knight Capital Grabbing Share from Rivals

Knight Capital Group (NITE: Nasdaq) is another small cap name from our recent idea forum. The company has seen its trading volumes jump dramatically in recent months and with retail coming back to market the prospects look bright. NITE offers the best trade execution at the lowest available price. The firm has gained share and is now moving into Europe and Asia. The presenter thinks the stock can move to high $20's from $21 currently, based on earnings and comparison to peers.

Boston Idea Forum

Talbots was brought up today as a company in transition that if they simply finish closing what they can and execute some of their other initiatives could be returing near historic margins. Outlet store concept could help make up lost revenues and within two years have an impact as store base expected to get to near 100 stores.

LabCorp a Good Value at $66

Our Dallas presenter highlights LabCorp's (NYSE:LH) excellent cash flow characteristics and steady if unspectacular growth in top-line. The company's nationwide lab network gives it a clear scale advantage compared to small regional players. As the move to preventative care and personalized medicine gathers pace, LH is very well-positioned to grow its operations. Specialized testing, where prices are a level above regular diagnostics, already comprises over a third of the company's total value and that ratio is poised to increase going forward. Margins are impressive, but recently implemented automation initiatives will further boost LabCorp's bottom line. The presenter's target range is $85-$90, based on historical EBITDA multiples.

Misaligned incentives in healthcare

A Roulston Research technology and healthcare expert has an interesting take on the slow pace for adoption of electronic health care records. He believes that electronic records are not more widely used simply because no one that would use them actually wants them.

Doctors want they very best care for their patients. Pen and paper are very easy to use, allow for accurate notes and are excellent means with which to communicate. The electronic screen makes it harder to take notes, harder to accurately record the specifics of the ailment and harder to use to communicate with colleagues.

Hospitals want to find more revenue streams. More precisely, hospitals only want them for one reason: To direct patients to their in-house pharmacy. Giving patients a paper prescription allows them to walk out and have it filled at their local drugstore.

Our expert believes that this situation is just one example of misaligned incentives in the healthcare space.

Coinstar concerns

Presenter of company and others cite CFO exit and lack of transparency of company on recent asset sale and other issues as reasons for lightening up on positions. A lot of concern here that the company has interesting strategy but transparency during this kind of transition and MCD seeming very cheap sale of position creates concerns.

Dallas visit

Contacts continue to believe pricing just wont change as we go into colder months any more than seasonal adjustments. Now with all new oil finds even more compelling that oil is coming down to historic ratios rather than gas going up. These are locals that might be very close to the trees but they are feeling strongly that a lot of natural gas reserves and needing to be drilled on leased land.

Five Tips for a Recession

Bart Perkins, the Chair of Roulston Research's technology expert community, recently attended a venture capital lunch forum where an editor from WIRED magazine gave a presentation entitled "Five Tips for a Recession". They were:

1. Don't wait for innovation
2. Boost R&D and grab talent
3. Start a company, the technology tools you need are cheap
4. Make innovation central to your business
5. Think like a VC

He used Apple and Dell as examples for #2. During the last recession, Apple grabbed talent and continued to pursue an aggressive R&D program. Dell cut these expenses in response to the economic conditions. For #3, his examples were cloud computing and open source software. Both models have drastically reduced the need to purchase, run and maintain your software. And for #5, his point was that while big companies will kill projects with a 70% chance of failure, VCs will gladly accept a project that has a 30% chance of success.

Dice Holdings Up 70%, but There is Upside Still Left

Our Boston presenter is still very bullish on Dice Hodings (DHX:NYSE). The stock is currently trading at $6.83, a 70% increase from $4 where he recommended the name back in May. This leading provider of online recruitment services is just starting to see a turn in online employment listings, the development which won't show in the results for another 1-2 quarters. The company's platform is a category killer and with the stock trading at 10x its trough EBITDA, 6 times midcycle EBITDA, there is still significant upside left.

At at our last Dallas Small Cap idea forum in June we had 5 stocks presented. One presenter never made it during the horrendous downpour. The five stocks presented(recommendedprice,current price) were;

EMS ($33.89, $47.51)

BLC ($2.02, $4.57)

MIM ($8.36, $13.60)

LFUS ($19.63, $28.07)

FSC ($8.98, $11.17)

Needless to say since June 11 the markets have done well but this is remarkable

FSC No Longer Recommended as a BUY

Our Dallas presenter no longer recommends Fifth Street Financial (NYSE: FSC) as a Buy. The stock is currently trading at $11.04, very close to his target. The company received a $50 million credit facility from Wachovia a week ago. Fifth Street Financial has been approved for an SBIC license, but it hasn't been formally granted yet. Business trends are improving. Still, the presenter has significantly reduced his position and is no longer recommending the name to new investors.

EMS Stable Name with Some Upside

EMS has moved 50% since our Dallas presenter recommended the name in June. He purchased more shares in mid $40's, just below the current price. It's no longer an aggresive buy, but if investors are looking for a stable name with a bit of an upside, EMS certainly fits that criteria. The company raised it guidance by 15% on the last earnings call. The presenter's target is mid $50's, based on 8-9 times next year's EBITDA.

Roulston's Consumer Chair on Bloomberg and Fox

Craig Johnson, President, Customer Growth Partners and the chair of our Consumer Community is a frequent contributor to Bloomberg, Barron's, WSJ and other media outlets. In just the last two days, Craig could be heard and seen on Bloomberg Radio and Fox, giving his perspective on August retail sales, consumer spending, on the recent Best Buy quarterly release. Craig remains unconvinced that we're witnessing a consumer recovery. He believes only the value end of the retail spectrum is seeing some uptick in spending.



Craig's latest Fox appearance can be accessed at
http://www.foxbusiness.com/search-results/m/26433794/is-the-consumer-really-back.htm

Our Boston presenter still likes GLP, despite the stock's 150% move since he recommended it a year ago. GLP has an 8% dividend yield. The dividend is poised to increase after Global Partners have held the payout steady for the past seven quarters. The company has just bought stock around the current price. As long as oil prices stay relatively stable, GLP's inventory carrying costs should remain steady. Whatever the company stores in excess of customer needs, they're making money on it. The big picture is very positive. Global Partners has diversified from a pure heating oil play into gasoline. The company went public at $20 in 2005 and since then its assets have increased dramatically through a number of acquisitions. The presenter targets $30 within a year.

Retail expert sees potential new growth opportunities

Chris Lee is talking to a lot of foreign companies and from his experience with Forever 21 he sees some new changes coming in the US retail environment. Specifically he sees the weak real estate market offering retailers a chance to cross borders in a unique growth opportunity. With real estate pricing cheap world wide foreign players can take advantage to have an immediate impact with more choice locations. REIT's have a lot of vacancy but a new concept may be for the bigger box players who have excessive space and long term leases may look to sub space or reconfigure current locations. As an example WMT's fornt of store 10-15,000 square feet in front of registers where today a lot of fast food and other traffic movers could be replaced in an improving economy to try to keep that customer who traded down in downturn to keep them in subsequent upturn. Does an Apple store replace Pizza express? How about if Federated or Dillards or Sears shrinks their store and brings in Wet Seal, Saphora or others in front of store. With both the need to increase returns and opportunistic foreign tenants potentially available this could be a new paradigm.

The Electronic Trading Debate

The Wall Street Journal published our rebuttal to Senator Schumer's response to our editorial: http://online.wsj.com/article/SB10001424052970203440104574404581166261194.html

Investment management is a business that is easy to leverage, except in the area of trading, where size creates a disadvantage as lack of liquidity can penalize performance. For this reason, I believe managers and their clients all have an interest in defending innovation in trading markets. Innovation provides investors more opportunities to handle their orders according to their preferences, rather than in some monolithic, one-size-fits-all product that we wouldn't even accept for laundry soap. Customers, not Senators, should be the ones to choose which innovations to reward with market share.

Natural Gas feedback in the fields

When the street talks of a 24 month burn off at current prices to allow pricing to return to the natural gas market, our contacts are telling us it looks more like 48 months. A variety of factors from so much new capacity to lower demand. But so much of the capacity now is tied to leases that have to be drilled. To be able to keep leases drillers must move ahead with some drilling even at a loss. There is an issue in next 60-90 days where mark to market rules and loan covenants for reserve valuations and present values (PV10 is present value minus 10%) the haircut at this point will be daunting. High cost reserves are going to force loan covenant resets and the question is does this just affect smaller players or do some of the larger players suffer? Even when wells get shut in they still need to produce at some lower rate. These operate at money losing rates so IRR in whole industry suffers. So much gas has been identified and leased in last few years. if pricing wont change soon the ripple effect as production and reserves cant be turned off eventually has to have iompact on oil prices.

Our San Francisco presenter still likes Fidelity National Financial (FNF). The stock has underperformed since he presented it back in late April, but it's a low risk name so people are not as excited about it in today's market. The refi activity is phenomenal and the earnings power is great.

Chinese Auto Sales

Chinese economic data are sometimes viewed as NINJA loan applications--you need to look to other sources to verify the data. Still the growth in Chinese auto sales, verified by GM (ok, another government enterprise) looks promising in two ways. First, it indicates that china's stimulus and incentive plans may be having some positive demand, and that consumers are spending in China. As the US consumer retrenches from a low savings rate, it is possible that China's consumers might move in the other direction.

What is most interesting about strong auto sales, and it is possible that auto sales in China this year will be greater than in the US, is the transformational effect the automobile can have on society. So much retailing in China consists of very small shops, in walking distance of customers. There is little room for increasing efficiency or developing scale economies in distribution. Walking customers are limited in their shopping by what they can carry, and how far they can travel to find a better price. The automobile changes all that, and begins to facilitate large-scale retailing, as customers develop the means to travel to a mall or supercenter and take advantage of the lower prices and broader merchandise selection. This is also good for the growth of of consumer products manufacturers, as consumer savings can be plowed into more goods and services. As retailers scale, manufacturers will co-evolve and grow as well, and there will be more investable opportunities beyond the typical emerging market menu of power, telephone, and banking companies.

This process should take considerably less time than it did in the US.

Tatum/Roulston Report

The Tatum survey this month clearly reflects the inventory reduction cycle is over and business trends have bottomed. We seem to all know that it has stopped getting worse in the economy. Time has passed and access to capital is available if the balance sheet is there to support it. So now backlogs are improving (seemingly so far to rebuild inventories that had been drastically reduced) and companies thru employment cuts and capital spending reductions have pared costs to the bone. Most executives remember recent downturns and when this one started it seemed worse. Corporate America really downsized in a hurry. With the financial panic that ensued alternatives for capital were perceived to be scarce and budgets were set with as little reliance on outside support as possible. Finally capital spending plans were also ratcheted down dramatically. All of this makes sense. The difference this time is just the quickness and velocity with which this occurred.

Although all signs point to this adjustment period now being over and the downward movement being halted, the fact remains that growth at this point is simply hard to recognize in any numbers to date other than the bounce off the bottom. We have talked many times how the Tatum Survey remains the best real indicator of corporate trends in America. The data base is consistent month to month and the people responding are the same. The data report therefore does not just reflect a mood change but more decision makers and the real data they are seeing day to day. The key is now how does the market, corporate profits and economic growth move forward from here. Government stimulus has had some short term boosting effect but “flat is the new up”. At Roulston, we remain unconvinced that any growth other than a flat environment where cost cutting boosts profits is happening. The most unique aspect of this is how universal this trend is and how many companies seem to be pausing to reconsider what lies ahead. The worst definitively seems to be over not only for their company but everyone they talk to and do business with in their world.

There is a certain calmness in the absence of consumer spending, the bounce in housing numbers and the employment picture that seems so tempting. The question we continue to mull is without a consumer (now saving and not spending) that makes up 70% of the economy and without a healthy financial system (the government tells us 200 banks will fail in the next 12 months) how do we get meaningful growth? Baby boomers inherently know they dont have enough saved for retirement. The numbers tell us this. The savings rate tells us this and the fact that the market scared the ... out of folks. This change has never happened before. It may not be a depression under some terms but it was very depressing. Other than for the economists that continue to point to past cycles where neither of these issues are comparable and we would argue there may be no past precedent, this is a hard time to be doing any forecasting.

Zimmer presented in New York

Our NY presenter likes Zimmer (ZMH) at this level. The company is in a turnaround mode after two years of dealing with issues stemming from 2007 settlement with the Department of Justice. ZMH has seen its market share stabilize in the recent quarters. Demographic and lifestyle trends will help the company return to mid to high single digit top line growth beginning in 2010. The balance sheet is very strong. Zimmer generates $800 million in free cash flow on annual basis.

HealthCare Roundtable

Yesterday had a full house to hear Chris Goff and Andrew Webber tell us that the next 60 days are critical to health reform. Lots of good stuff about hospitals that will benefit and others that wont. What they see happening to doctors, prescription management and other interesting tidbits about why certain parts of legislation may find its way thru while others will not. They think public option is a killer to plan although dems will go down kicking and screaming. Maybe 3-6 year trigger for this option. Maybe employer mandate. To early to tell but politics really creating "dig the feet in" atmosphere. One interesting point. Actions always cause reactions. Some expected some not. Then further reactions as we saw in Massachusetts where the market reactions after initial reactions are where surprises occurred from an investment standpoint as example what about managed care players with high Medicare Advantage exposure like Humana. Are they a winner after all the reactions. Stay tuned.

Market forecasting

Never being one to try to "predict the market" I can't help continuing to ask businesses how the fall is looking. The run up in the market is making folks feel better and as a leading indicator it does seem to be saying the correction overreacted in the winter and that the economy reached bottom in August /September. Thus a spring market recovery indicated not only improvement in the economy but an end to the gloom and doom that the financial/credit meltdown would cause a return to the 30's. So it wasn't as bad as some thought it might get and maybe the worst is behind us. But I am not hearing manufacturers talk about anything other than inventory reductions overshot and rebuilding supply chain. Outside of auto stimulus and government spending economic improvement is very spotty. So how will a market act when it realizes we are not in a "U" or "V" curve and maybe not a "W" even. But what about an "L" what happens in a market. It seems to me after an initial retrenchment it should hesitate to see any signs of sustaining. As a forecaster it seems to indicate stability but from this point earnings wont come from continued cost cutting. Businesses cut fast and hard. Now not much left to cut. Those that cut SG&A the most have outperformed. Now we need revenue growth for any more move. Not seeing it yet in any sustainable form and with consensus saying we are in a recovery the banking system is not going along. When was the last time the economy grew without loan growth or the consumer. Very hesitant right now.

Reasons to Buy?

We have had three down days, for the first time since June. Maybe it's the start of the long-awaited, over-anticipated correction. Or maybe it's not. At any rate, at some point there will be a correction. Given the robust rally we've had, against the backdrop of a halting recovery, we're bound to see a resurrection of D&D (doom and depression) stories in the media if there's a selloff. Just as in March, it will be difficult to pull the trigger and buy stocks at the bottom of the correction. It might be easier to think about the reasons for buying a dip now, before the atmosphere gets poisonous. So we'd like to ask our readers for their thoughts on the reasons to buy the correction. Let us hear your thoughts.

Financial Services Innovation

Talked to a suburban community bank CEO the other day. He's glad his bank is only three years old--very few bad loans. The reluctance of other lenders to commit funds is giving him solid pricing on deals and relationships. He is concerned that a financial products czar will make it difficult/expensive for small financial firms to create new products. This could have the effect of increasing the brand value of big firms by stifling the new product flow necessary for the little guys to compete with the behemoths. But, then, the government owns stakes in the big banks...

Chris Hynes comment on flash trading

Chris's comments on this blog on August 7th appeared in the WSJ today on In Defense of Flash Trading. If you get a chance get onto the comments section of the journal. There is quite a buzz that Chris has created with his comments. Not that they were controversial but it sure is a subject of different opinions.

Private Equity Environment for Middle Market

Talked to some lower middle market private equity guys last week--they said they were having trouble borrowing more than 2 turns on anything--and that is based on recession-reduced EBITDA. They are considering doing deals, taking the 2 turns, praying for a refi opportunity within 12 months so they can keep the excess equity for additional deals. A private wealth sales guy confirms that he's just not seeing new liquidity from business owners--they don't want to sell to private equity firms at the low prices implied by the lack of financing.

In the boom years, the math was interesting. Guy sells a business for $20 million, pays $3 million to the US Treasury, puts $10 million in public equity and $7 million in munis or other bonds. P/E firm put up $7 million in equity, $13 million in debt. Result was more new debt issued than funded. Tody same biz might get $7 million in debt with same EBITDA, or less if cash flows down. Even with 50% equity, P/E firm has a better deal than last year if the growth resumes--same equity, less debt. This only works if current owner takes a haircut,and most of them can wait.

Our Dallas presenter says MI Developments (NYSE:MIM) keeps rolling along. The stock is trading at a large discount to book value and near-term events could unlock significant value.

This fall hostin Xmas shopping previews

we are looking to walk malls in New York, Boston and San Francisco early in the Christmas season. We are hearing very lukewarm back to school is making this an even more important tim ethis year.

China and Banks

Looks like shortly we are going to get a better handle on the China markets. Starting with alternative energy, health devices and consummables and environmental products we are going to be working with a Chinese partner to offer experts on both sides of the pond to talk in these spaces. On a side note I talked to a banker last night who said after all the smoke and mirrors his bank is literally out of the auto and bank business. They were #3 or #4 in the state prior to last summer in both spaces. He said year over year they are doing a fraction(less than 10%) of what they did last year at this time. He was not including refinances which as he said"really distorts" total loan #s.

Decoupling: Has the Time Come?

Decoupling may have finally arrived, a little too late for the believers of two years ago. The "this time its different" crowd argued that the emerging markets could stand alone without the US and Europe. It didn't work that way, and emerging market equities were hit even worse than those in the developed markets. Lately the Asian emerging markets have been moving up faster than the US market, but it also seem the economies are as well. And, funny thing, the Eurozone is growing faster than the US--at least for now. There should be concern for the Chinese market after the big rally--lots of IPOs, bank loans up at high rates, and maybe some of that money flooding into stocks. Global banks are considering listing in Shanghai and floating stock there. Of course, hot foreign markets are always the last place Wall Street goes to sell junk, when they've run out of locals who haven't heard the news. While playing the Chinese market in the short term given the current liquidity bubble is not for the faint of heart, especially with the government warning against speculation and bank loans finally slowing, continued economic decoupling may lead to returns exceeding those in the developed markets over a longer horizon.

Increase in SEC Enforcement Activity

The SEC is increasing enforcement efforts due to the spate of Ponzi schemes. So effective August 11, SEC has made it easier for their staff attorneys to issue subpoenas. They will no longer need formal approvals, just an approval from their senior supervisor. This means investment managers might be more likely than in the past to get a subpoena. So while there might be less reason for alarm, still a good idea to bring in counsel before responding. This bodes well for commercial real estate, as those law firms will be hiring again...We need to get used to the new America, where it's tougher to interrogate suspected terrorists and easier to question businesspeople.

The release authorizing this action can be found here: http://www.sec.gov/rules/final/2009/34-60448.pdf

Mark to market

Now that the government eliminated(albeit temporary) the mark to market rules how would they reinstitute right now? i thought they were going the other direction to get rid of mark to market

Potential New FASB Mark-to-Market Rules

FASB is looking at a further expansion of mark-to-market rules. One of the concepts being discussed is marking all loans to market. This seems like a very difficult task in the absence of much of a securitization market, which we're all rather sour on anyway due to the moral hazard. When a bank makes a loan to the corner drugstore (if it still exists in the future) who else would want that loan the next day? So what would the loan be worth? If banks have capital accounts of about 10% of their assets (wishful thinking these days?), if the marked-to-market loan suffered a 10% drop in value the day after it was made, the imaginary capital assigned to that loan would be wiped out. Anyone care to own a community bank under these conditions?

In the past, if examiners "classified" a loan, there was a capital haircut. This facilitated small business lending. Imagine a bank has a niche in lending to these mythical corner drugstores, a long experience of loan-to-value, credit risk, etc. It's a profitable business, and someone leaves the bank and starts to compete. Being new, corners are cut, rates are lowered and higher risks are taken. Yet the old bank loses some share but doesn't relax it's standards. When the new bank becomes illiquid and has to sell the loans, now the old bank may need to write theirs down to the distress price, even though their portfolio is higher quality. In the past, this sort of marking process was reserved for assets that traded, not all assets.

Now that the government owns stakes in big banks, it's time to look for the moral hazard--a regulatory climate that subtly favors the government-owned enterprises. Big banks might actually be able to securitize loans and have a more favorable mark than an unsecuritized loan from a small bank. The financial products czar, who's supposed to approve products, is another potential change in the environment. Upstarts typically compete on service or product innovation. If a product czar inhibits product innovation, doesn't that bode well for branded service providers over the upstarts?

Axcelis (ACLS) is another pick from our recent small cap forum in NY. This manufacturer of ion implantation equipment for the semiconductor space has been hurt by the severe downturn in the industry, but has signed several important deals in the recent months and its unique products are winning important new customers, particularly in Asia. The upside could reach 200% or more based on the value of assets. With the stock currently trading at cash, the downside appears to be limited. The presenter believes there is a fair chance the company could be acquired in the next 6-12 months.

Our NY presenter still likes Walgreen. The big issues raised in his presentation last year, a slowdon in store expansion plans and reduction in operating expenses are finally playing out. The company is generating excellent cash flow. The stock is undervalued here, in his view, with the upside into the high $40's.

Moving the Economy Forward

This earnings season, estimates have generally been exceeded, but it's been done by lowering costs, and revenues have often disappointed. One could make the inference that biggest cost cuts usually come on the labor line. If that's true, it would lend support to the argument that the worst of the jobs recession may be over. If companies are lean, will they hire if business recovers a little? Supposing they do, the next question is where will they hire? Domestically, or abroad?

There are some factors affecting this decision that are in more than the usual state of flux this cycle. First, there is the uncertainty of a government far more favorable to big labor than we have seen in years. Second is the potential of higher labor costs due to health care reform, although there is an argument that the costs may actually fall on the very rich and small business, and that big business may actually get some relief.

But direct labor costs are not the only factor to consider when siting employees. The cost of land, or the rental prices of office, retail and industrial space are also important. The real estate crash is a positive for businesses seeking to add new facilities. Local governments may now be in a mood to encourage job creation through tax breaks and administrative simplification. When considering overseas hiring, views of future transportation costs are a factor as well as the outlook for relative future labor price increases and the dollar.

I've thought for years that nationalization of social costs like retirement advantage mature, slow growth industries, who avoid the full cost of these issues on their older workforces. At the same time, young industries are relatively encouraged, as they are not saddled with any costs but their own. It struck me that this might be one of many reasons the US did well with innovation, while we exported jobs in mature industries to other countries. If we start nationalizing a larger proportion of social costs, do we risk eroding these advantages for new industries?

Since growth is a product of the growth of the labor force times the growth of productivity, how do we get real growth by encouraging mature industries, where it's harder to get productivity growth? As we pointed out in an earlier post on China, the Chinese economy gains substantially when labor leaves the farm and comes into the city to join the industrial work force--that worker's contribution to GDP can triple. without any true productivity increase. It's simply a portfolio effect. The US needs to make sure it can get a positive growth effect from shifts in our labor portfolio. National policies need to encourage this process.

Our New York presenter recommended Cleveland BioLabs. This small biotech boasts an impressive pipeline, with the leading drug candidate potentialy offering a fast-acting antidot against radiation, a space where there are no effective treatments currently available. The company has partnerships with world-class research organizations, including Roswell Park Cancer Institute and Cleveland Clinic. As any small biotech, CBLI is a speculative play, but early test results show great potential. The company is also developing a family of anti-cancer agents.

Health Care: Unintended Consequences?

A lot of the debate on a new health care system is based on costs. But what's the impact of 40 million new customers on the system's ability to deliver services? First, a lot shorter wait in the ER as uninsured patients learn to stop using the ER for anything that comes up. But where do those people go, and what happens to their resource usage? The way our health care delivery system is structured, they would go first to primary care providers. Of course, these are the people being most economically squeezed by the current system, and it seems that there's already a bit of a squeeze--that many doctors have decided to become specialists for financial and lifestyle considerations.

If 40 million new customers spent an hour per year with a primary care provider, that would require about 20,000 more primary care providers. Looking at 2006 data on physicians, it looked to me as if there are about 300,000 doctors who could fill this demand. So the new demand would require about a 7% increase in the number of doctors devoted to this service. Since it's plausible that the uninsured have a backlog of unmet preventive care needs, and possibly a greater need for consumer education, time demands could be greater. It's interesting that Massachusetts, which requires health care coverage of its citizens, is also the state with the largest number of doctors relative to the population. There are many states with substantially fewer doctors per capita. Their resources may be more fully utilized. Anecdotally, many of us have experience with primary care physicians who aren't taking new patients.

Complex legislation almost always has unintended consequences. This may be one of them.

Our NY presenter still likes IFSIA and ASCMA as long-term holds, but is not recommending either name at current levels. In his view, both stocks have run up too much too fast.

Flash Trading and Private Property Rights

The investment management industry has a lot at stake in the flash order controversy. The freedom to acquire and dispose of one's property is a fundamental right, and property owners must be allowed to determine the methodology by which they will acquire or dispose of their assets. Have you ever been called by a real estate broker who tells you a home you are interested in will be coming on the market soon? That's a form of flash trading. Long before we had electronic trading, we had block desks. These desks often called customers they believed might have the other side of an order before sending the order to the floor. That's a form of flash trading. On the NYSE floor, a floor broker might decide to leave a small bid on the public order book, but whisper to the specialist that he has an interest in size. The specialist might discreetly shop that interest, or discreetly begin to acquire shares in "stabilizing transactions" in order to accumulate enough shares to make an offer in size. Sounds like flash trading, doesn't it?

After the PC was developed, portfolio managers were able to use optimizers to generate hundreds of orders at a time. The original electronic dark pools, POSIT and The Crossing Network, sprang up to help traders defray the cost of executing these orders. Typically, the order list was shown to the dark pool, and the residual was taken to the floor for execution. Dick Grasso at NYSE argued this created fragmentation (the "F" word) and was bad for markets. We electronic traders argued it was the "S" word--segmentation, or "different strokes for different folks." Investment managers, with a fiduciary obligation to obtain best execution, began to have an increasing number of alternative venues on which to place their orders, and the ability to decide which one was best for each of their orders.

Senator Schumer's "little guy" benefited from this enormously. Years ago the little guy called a broker, who took his order over the phone, then walked it down to the wire operator, who sent it to the exchange. Eventually a report came back to the branch, and hopefully the broker called his client to provide the report. Today's little guy sends the order in on his PC and gets a report as fast as browser can switch to the order status page. And instead of quarter-point spreads, the little guy is paying a penny or two in large-cap stocks. A more robust system for handling institutional orders might mean that a 200,000 share order creates less market impact, which protects the little guy, who apparently can't stand the volatility these orders create. In any case, the little guy's feedback loop on an order today is at worst a few seconds longer than an institution's, rather rather than several minutes.

Thirty years ago, most of the trading happened at the NYSE post or in the upstairs market. The upstairs market was fragmented and tricky, as traders had to figure out who really might have the other side of the trade: Goldman, Morgan, Jefferies, or Cantor, etc. If you guessed wrong you could be embarrassed as someone else found a seller first and sopped up the liquidity you were looking for. That's no less an issue today--which dark pool or ATS has the other side? Flash orders are a legitimate technique for finding the liquidity you need. Any trader knows they aren't for all situations, just as any homebuilder knows some jobs take a hammer, while others take a screwdriver.

I'm dismayed by the knee-jerk reaction by the SEC to all of this. Mary Shapiro must have spent too much time at CFTC, where futures exchanges was monoploy contracts could change the rules at will and the customers were stuck with them. Stocks can trade anywhere, and if the SEC is disregards economic necessity and prohibits what are essentially long-standing, sensible trading techniques, that trading could easily move offshore. It's all a matter of where the servers are. And Shapiro was an SEC commissioner from 1988 to 1994, when the electronic markets were first developing. She should understand that traders are for the most part evolving electronic trading structures that replicate techniques developed in the old Analog" days.

Bottom line--I think it's important that the industry stand up for the fundamental freedom of having the right to acquire or dispose of property as you see fit. If you agree, write your Congressman and the SEC, and maybe let Senator Schumer know you're thinking of moving your firm to New Jersey or Connecticut, or at least moving your executions out of state. If you disagree, let me know why. Maybe you're right and I'm not.