Casual Dining Needs a Reinvention
(August 28, 2011)
Dear Subscribers and Readers,
Ben Bernanke's Jackson Hole speech last Friday effectively put the onus of job creation and economic growth back on the politicians' backs—chastising them for their lack of leadership. This leadership void has mired the U.S. in the Iraqi war, spurred the housing bubble, encouraged excessive Wall Street leverage through the lack of regulations, and has finally brought the U.S. federal balance sheet on its knees. Despite the recent financial crisis and the threat of regulations, the financial excesses remain—as exemplified by the rampant speculation in the CDS market and the proliferation in algorithmic trading. The failure of the U.S. to invest and maintain its infrastructure, world-class public universities, the space program, the NIH, and the lack of urgency to do so will further impede future economic/productivity growth. Instead of meddling about in the affairs of others (including telling us how we should lead our lives), perhaps we should get our own house in order first? As we all know, the most important relationship is the relationship to oneself. One must work on this before we engage in other relationships or try to help others (and only those who would help themselves).
Let us now begin our commentary with a review of our 13 most recent signals in our DJIA Timing System:
1st signal entered: 50% short position on October 4, 2007 at 13,956;
2nd signal entered: 50% short position COVERED on January 9, 2008 at 12,630, giving us a gain of 1,326 points.
3rd signal entered: 50% long position on January 9, 2008 at 12,630;
4th signal entered: Additional 50% long position on January 22, 2008 at 11,715;
5th signal entered: 100% long position SOLD on May 22, 2008 at 12,640, giving us gains of 925 and 10 points, respectively;
6th signal entered: 50% long position on June 12, 2008 at 12,172;
7th signal entered: Additional 50% long position on June 25, 2008 at 11,863;
8th signal entered: Additional 25% long position on February 24, 2009 at 7,250;
9th signal entered: 25% long position SOLD on June 8, 2009 at 8,667, giving us a gain of 1,417 points;
10th signal entered: 50% long position SOLD on March 29, 2010 at 10,888, giving us a loss of 1,284 points.
11th signal entered: 50% long position SOLD on April 27, 2010 at 11,044, giving us a loss of 819 points;
12th signal entered: 50% long position initiated on May 21, 2010 at 10,145;
13th signal entered: 50% long position SOLD on December 15, 2010 at 11,487, giving us a gain of 1,342 points; the DJIA Timing system is currently in a neutral position.
The market finally bounced last week, with the MSCI World rising 2.8%, the DJIA 4.3%, and the DJTA 5.7%. Investors' sentiment has gotten a little more bearish (with the exception of the 10-day MA of the equity put/call ratio, which declined to 0.79 from 0.85 the Friday before last). As such, we believe last week's bounce will continue this week, especially given the market's highly oversold conditions. That said, our longer-term liquidity and technical indicators are still flashing “red flags.” Combined with the ongoing European sovereign debt crisis and the slowing global economy, we will remain cautious. We may initiate a 50% long position in our DJIA Timing System should the Dow Industrials decline to the 10,000 to 10,500 level, but we still expect market conditions to remain tough going into early Fall.
As a recent Bloomberg article discussed, the average college-educated “millennial” or Gen-Yer today would not be caught dead in a casual dining restaurant (e.g. Ruby Tuesday, Red Lobster, TGI Friday, Chilli's, etc.). The perceived cheap-quality food, along with an outdated décor and lack of quality service, contains no value proposition, especially compared to the newer and healthier choices such as Panera Bread, Corner Bakery, and on the higher end of the scale, Cheesecake Factory, P.F. Chang's, and of course, independent operators—especially those dishing out more “exotic” and “adventurous” cuisines. Simply put, what they “settled for” when they were kids would not work today.
This generational divide in tastes is now especially evident as the financial crisis cut into restaurant/discretionary spending. Just as important, casual dining operators such as Brinker International and Applebee's ramped up store openings from 2000 to 2006—doubling their sales during the six-year period leading up to the financial crisis. As the millennials come of age and increase their relative spending power, the traditional casual dining restaurants will need to reinvent themselves. This need for reinvention is becoming almost desperate, spurred on by the current U.S. economic slowdown. For example, a recent Goldman Sachs survey (see below) suggests that U.S. consumers intend to spend less in restaurants (compared to an increase in the three prior surveys). More ominously, U.S. consumers did not signal a similar intention to reduce spending in other categories—suggesting that U.S. consumers are sacrificing restaurant spending for the sake of other discretionary spending. With the U.S. economy experiencing a major slowdown, casual dining spending is likely to get hit more than most other categories.
In addition, casual dining restaurants will need to compete on prices again, as suggested by the following two Goldman Sachs surveys. That is, unless a casual dining chain can differentiate itself through better quality or more exotic offerings, margins will likely be squeezed further over the next 6 to 12 months. This is difficult for existing chains such as Ruby Tuesday and Applebee's. With the overall U.S. restaurant market still saturated—and with millennials being more picky and dining out less frequently, I believe there will be a further shakeout in the casual dining restaurant industry over the next several years. At the very least, many of the major chains will need to reinvent their stores or close them altogether.
Let us now discuss the most recent action in the U.S. stock market using the Dow Theory. Following is the most recent action of the Dow Industrials vs. the Dow Transports, as shown in the following chart from January 2008 to the present:
For the week ending August 26, 2011, the Dow Industrials rose 466.89 points, while the Dow Transports rose 238.59 points. While the Dow Industrials managed to retrace all of its decline from the week prior, the Dow Transports remained weak—retracing just 60% of that decline. This confirms the overall weak technical conditions of the market. Given the oversold conditions, the market is likely to bounce further going into the Labor Day weekend. However, the combination of our weak liquidity indicators, the festering European sovereign debt crisis, and the stubbornly optimistic investors' sentiment suggests the market action is likely to remain tough going into early Fall. We remain neutral in our DJIA Timing System; although we may initiate a 50% long position should the Dow Industrials decline to the 10,000 to 10,500 range.
I will now continue our commentary with a quick discussion of our popular sentiment indicators – those being the bulls-bears percentages of the American Association of Individual Investors (AAII), the Investors Intelligence, and the Market Vane's Bullish Consensus Surveys. The four-week moving average of these sentiment indicators declined from a reading of 5.1% to -0.2% for the week ending August 26, 2011. Following is a weekly chart showing the four-week moving average of the Market Vane, AAII, and the Investors Intelligence Survey Bulls-Bears% Differentials from January 2001 to the present:
This sentiment indicator has finally pierced below its July 1st low, and is now at its most oversold level since last September. That said, the four-week MA is still relatively optimistic given the global economic slowdown and the market action over the last five weeks. We would like to see this reading decline to at least its July 2010 lows (when it bottomed at -9.9%). Given this overly bullish sentiment, we will retain our neutral position in our DJIA Timing System, although we may initiate a 50% long position in our DJIA Timing System should the Dow Industrials decline to the 10,000 to 10,500 range.
I will now close out our commentary by discussing the latest readings of the ISE Sentiment Index. For newer subscribers, I want to provide an explanation of ISE Sentiment Index and why it has turned out to be (and should continue to be) a useful sentiment indicator. Quoting the International Securities Exchange website: The ISE Sentiment Index (ISEE) is designed to show how investors view stock prices. The ISEE only measures opening long customer transactions on ISE. Transactions made by market makers and firms are not included in ISEE because they are not considered representative of market sentiment due to the often specialized nature of those transactions. Customer transactions, meanwhile, are often thought to best represent market sentiment because customers, which include individual investors, often buy call and put options to express their sentiment toward a particular stock.
When the daily reading is above 100, it means that more customers have been buying call options than put options, while a reading below 100 means more customers have been buying puts than calls. As noted in the above paragraph, the ISEE only measures transactions initiated by retail investors – and not transactions initiated by market makers or firms. This makes the indicator a perfect contrarian indicator. Since the inception of this index during early 2002, its track record has been one of the best relative to that of other sentiment indicators. Following is the 20-day and 50-day moving average of the ISE Sentiment Index vs. the daily S&P 500 from May 1, 2002 to the present:
The 20 DMA declined from 96.8 to 92.1 last week—further piercing its recent low of 97.6 six weeks ago—and is now at its most oversold level since mid-June 2010. Meanwhile, the 50 DMA is near its low of six weeks ago, and is hovering at its most oversold level since early August 2010. Both the 20 DMA and 50 DMA remain highly oversold. While this indicator's oversold condition suggests the market should rally (we expect a technical bounce going into Labor Day weekend), the fact that our other sentiment indicators is not as oversold is troubling—and suggests caution is warranted, especially given the weak liquidity and technical conditions. However, if the Dow Industrials decline to the 10,000 to 10,500 range, we may initiate a 50% long position in our DJIA Timing System.
Conclusion: The Schumpeterian concept of “Creative Destruction” strikes again—this time, in the form of our “eating out” habits as the Millennials come of age and as U.S. consumers demand healthier and more exotic restaurant options. The typical casual dining chain, such as Applebee's and Ruby Tuesday is being commoditized, and will need to differentiate itself through reinvention to survive. This trend became evident in the recent financial crisis; and should accelerate as the U.S. economy slows down and as restaurant spending declines over the next 6 to 12 months. The fact that the casual dining chains embarked on a major expansion phase leading up to the financial crisis does not help either. In the meantime, I expect the recent market bounce to continue into Labor Day weekend. However, we still don't believe the U.S. stock market has made a sustainable bottom. We will thus remain neutral in our DJIA Timing System; although we may initiate a 50% long position should the Dow Industrials decline to the 10,000 to 10,500 range. Subscribers please stay tuned.
Henry To, CFA, CAIA