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Bernanke's Brush Fires

This note was originally published at 8am this morning, November 04, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

"It does not require a majority to prevail, but rather an irate, tireless minority keen to set brush fires in people's minds."
-Samuel Adams

 

While I don’t expect any professional politician in Washington or the manic media that gets paid advertising dollars for stock market cheerleading to call this out for what it is until this stock market is a lot lower, I will. The US Federal Reserve is officially and unequivocally politicized.

 

Yes, Ben Bernanke himself has admitted that Quantitative Guessing (QG) is “unconventional.” But now he is so politicized that he is compelled to write an Op-Ed for the Washington Post on “What The Fed Did And Why: Supporting The Recovery And Sustaining Price Stability.” The Chinese, Hedgeye, and anyone with real-time market quotes, are sitting here staring at their screens this morning with shock and awe.

 

The US Dollar is making new lows this morning (down -15% since June!). The modern day Roman Empire’s credibility is burning at the global stake.

 

Notwithstanding unprecedented timing of the Op-ed (on the day of the Fed’s decision – do you think anyone leaked its contents?), or the fact that the words “US DOLLAR” were not mentioned ONCE in his allegedly objective and politically unbiased analysis, allow me to break down Bernanke’s view for you versus reality:

 

1.  STORYTELLING PREFACE: “Two years have passed since the worst financial crisis since the 1930s…”

 

KM: That’s always the 1st sentence of the fear-mongering message campaign that will lead you to believe no one notices Wall Street’s 2010 bonus pool.

 

2.  OUTCOME: “These steps helped end the economic free fall and set the stage for a resumption of economic growth in mid-2009…”

 

KM: Of course, the professional politicians saved us from the crisis they helped create and now we should pay homage to the banks, never earning a rate of return on our hard earned savings again. Fiscal sobriety and conservatism be damned. Get out there and chase some yield folks.

 

3.  MANDATE: “Notwithstanding the progress that has been made…” (we saved you)… “the Federal Reserve’s objectives – its dual mandate, set by Congress – are to promote a high level of employment and low, stable inflation…”

 

KM: Right, you saved us from the evil-doers and completely screwed up the employment picture by fear-mongering employers to stop hiring. Ok. And now we’re seeing the credibility of the US Dollar collapse and, as a result, global commodity prices hit new YTD highs, DAILY. The CRB Commodities index is up +16.4% since Bernanke’s decision to Burn the Buck on August 27th in Jackson Hole.

 

4.  INFLATION: “Although inflation is generally good, inflation that is too low… can morph into deflation…”

 

KM: Right, right. China, India, and Australia have raised interest rates in the last few weeks specifically because they (like anyone with real-time quotes) see the inflation implied in expectations. The US Treasury Inflation Protection (TIP) auction yielded -0.55% (lowest EVER) in October (implying outright fear of inflation), but Bernanke keeps Burning the Brush Fire of Fear-Mongering about a great depression that no one in finance has remotely experienced.

 

5.  ECONOMIC STAGNATION: “falling prices and wages, which can contributed to long periods of economic stagnation.”

 

KM: How about JOBLESS STAGFLATION (sorry PIMCO, we called it first) = US Government sponsored fear-mongering towards employers + inflation. In the 1970s, Jimmy Carter and the Fed’s panderer, Arthur Burns, didn’t get it. This time around, I don’t expect Obama and Bernanke to either. It’s Keynesian theory versus real-time market realities. The problem here isn’t US Consumer reaction to government policy. It’s government policy itself.

 

6.  QE2: “so far looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action… lower mortgages will make housing more affordable … and higher stock prices will boost consumer wealth …”

 

KM: This is the central narrative fallacy of the Bernanke Brush Fire that really lights up the anxieties of anyone observing growth and inflation data on a globally interconnected basis. Re-read what he’s implying here and your jaw should drop:

 

A)     US Dollar Debauchery – Let’s ignore that chart.

B)     Inflation – I’m willfully blind to that chart too and/or whatever any other major country is currently saying on the matter.

C)     Stock Market – I fundamentally believe that manipulating its price via investor expectation is what drives this economy.

D)     Mortgages – I’m not going to mention that 30-year yields have gone straight UP +65% (from 3.55% to 4.09%) since I moved to QE2 in August.

 

7.  CONFIDENCE: “we are confident that we have the tools to unwind these policies at the appropriate time…”

 

KM: What a joke. While virtually every central banker in the world (ex the Fiat Fools in Japan and the EU) have hiked interest rates multiple times since the mid-2009 recovery that Bernanke pats himself on the back for, I can assure you that if he couldn’t raise rates with 6% US GDP growth, he’ll likely never be able to “unwind these policies” at any time. Sadly, the global markets may very well do that for him. And that will be it for this QG experiment going bad.

 

Don’t take my word for it on all of this. I’m just a man who is selling everything and going to cash. Get some real quotes and study the history of countries who attempted to debauch the currency of their citizenry. Then read some Asian newspapers - or something other than the Washington Post.

 

Overnight, China’s central bank adviser, Xia Bin, said the Fed’s Quantitative Guessing “amounts to uncontrolled money printing.” Even Japan’s bureaucrat PM, Naoto Kan, said this was “the US pursuing weak-dollar policy.” At least those Op-Eds were short and to the point. They also sound just about right.

 

My immediate term support and resistance levels for the SP500 are now 1186 and 1201, respectively. My SP500 short position (SPY) is -0.96% against me in the Hedgeye Portfolio, and I intend on shorting the market again today on strength. Being early on the short side here is also called being wrong. I get that. I was early in October/November of 2007 too. Remember, market tops are processes, not points.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Bernanke's Brush Fires - bern


Natural Gas Inventory Climbs Higher

Conclusion:   Consistent with our thesis of oversupply of natural gas, inventory in the U.S. continues to build.  We tactically covered our short natural gas position on November 1st, but continue to have bearish view on Natty.

 

Consistent with our thesis, as articulated by Energy Sector Head Lou Gagliardi, natural gas inventory in the United States continues to build due to a mismatch of supply and demand.  According the Energy Information Administration, natural gas inventories grew by 67 billion cubic feet for the week ended October 29th. This was slightly more than analyst expectations, which looked for a build of between 61 and 65 billion cubic feet.

 

As we’ve highlighted in the chart below, supplies in the United States are now about 10% higher than their 10-year average and up about 1% year-over-year. Interestingly, according to the EIA, inventory in the producing regions, which includes Alabama, Arkansas, Kansas, Louisiana, Mississippi, New Mexico, Oklahoma, and Texas, was up 2.4% and is now 20% above the 5-year average. This data point clearly underscores our view that producers are overproducing.

 

Furthermore, the EIA provided the following comment today as it related to supply and demand balance:

 

Though supply still exceeded demand during the Thursday-to-Wednesday report week (October 28-Nov 3) as reported by BENTEK, the supply/demand balance continued to tighten as demand rose while supply stayed flat. Total supply rose less than one half of one percent during the report week, as production and liquefied natural gas (LNG) sendout rose slightly. Overall, Canadian pipeline imports fell by an estimated 2 percent, but declines in imports to the West and Midwest were partially offset by a 17-percent increase in imports to the Northeast. Total consumption rose 7 percent, bolstered by a 30-percent increase in residential and commercial consumption, and partially offset by a 9-percent decline in consumption of natural gas for electric power generation. Compared to last year, total consumption is 2 percent higher and total supply is 6 percent higher.”

 

The two key takeaways from this statement for us are that electrical consumption is down 9%, which likely indicates soft economic activity, and the continued imbalance of consumption growth (2%) and supply growth (6%).

 

Additionally, the outlook for production in the United States continues to suggest further growth based on rig count acceleration.  Currently, there are 1,672 rigs working in the United States, which is 600 more year-over-year.   While there is more rig activity chasing liquids (oil), according to Baker Hughes almost 58% of the operating rigs focus on natural gas and almost 57% of those rigs are horizontal. 

 

More rigs and more horizontal drilling means more supply.  It is that simple.

 

Daryl G. Jones

Managing Director

 

Natural Gas Inventory Climbs Higher - nat gas inventory chart


Bear/Bull Battle: SP500 Levels, Refreshed

POSITION: Short SP500 (SPY)

 

Being short the SP500 today would make me wrong. I get it. I’m not going to point fingers or make excuses. The screen tells the score. Ben Bernanke has beaten me today.

 

I’m not always sure how it feels on the days preceding crashes, but today definitely feels as different as a few days did in late 2007. Not only from a price, volume, and volatility perspective, but in that dangerous place that we market practitioners call our gut. Any move beyond the 1215 line in the SP500 equates to a 3.3 standard deviation move on my key immediate term TRADE duration. These happen very infrequently. Someone might be blowing up.

 

I’ll leave getting today wrong for those who want to be focused on yesterday’s mistakes. Right here and right now our immediate term risk management task is to manage toward the risk that will be in this market tomorrow. In the chart below, we have outlined the immediate term TRADE risk to the downside at -3.5% (1173). Could it all happen in a day? For sure. I wouldn’t call it more than a 1.7 standard deviation move, which is normal – put it that way.

 

I’ve moved to 70% Cash in the Hedgeye Asset Allocation Model. However painful, tops are processes, not points.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Bear/Bull Battle: SP500 Levels, Refreshed - 1


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Disconnect

Today’s October sales results can best be characterized by the term, “disconnect”.  A disconnect between the reality of a slower topline and a day in which almost every publicly traded retail stock is moving higher regardless of the quality of its monthly report.  Miss on the topline, stock is up.  Beat on the topline, stock is up.  Pre-announce to the upside, stock is up.  Pre-announce inline, stock is up. 

 

The bottom line is that October was the weakest month of the quarter and yes, weather was partly to blame.  Sales momentum did slow in the month, only to recover a bit towards the end as more seasonal weather patterns emerged.  Promotional activity was also up on the margin, largely the result of retailers such as GPS looking to prevent an inventory overhang as the most critical selling season of the year approaches. 

 

Is there anything major to glean from October?   Probably not.  The consumer remains in a holding a pattern, only to emerge around key events.  Despite retailers efforts to jumpstart holiday shopping at the same time Halloween costumes hit the clearance rack, we believe we have a long way to go before any definitive judgment can be made regarding Holiday 2010. Despite the waiting game also known as “holiday anticipation”, there  are a handful of callouts that are worth noting from today’s releases:

 

  • Same store sales day inches closer to obsolescence with ANF’s announcement that it will cease to report monthly results beginning in fiscal ’11.  That leaves just three more months to trade the lights out on all the speculation, whispers, and channel checks one could possible consume.  The truth is, apparel retail is managed around seasons, not months.  Within the next 1-2 years, it’s likely we’ll see many of the remaining monthly reporters calling it quits as well.  For reference, monthly sales reports are a legacy item, unregulated, not mandated, and unaudited.
  • From ANF’s recorded call, “Sales for the quarter are approximately in line with expectations at the beginning of the quarter.”  Aren’t sales either in-line or not in-line?  Ambiguity.
  • ROST noted that as cooler weather trends materialized, customer traffic increased.  Dresses were once again called out as a leading category, as well has home.  Pack-away levels were also notable, with an increase of 500bps year over year.
  • JCP noted that early sales of the Liz Claiborne exclusive remain strong and ahead of management’s plan. Men’s apparel and shoes were the best performing product categories for the month.   Cold-weather sensitive categories including sweaters, outerwear, and fleece were weak.  Overall, management once again noted AUR pressure as a result of heightened promotional activity.
  • JWN reported that California trends still remain below the company average but that the spread between CA and overall results continues to narrow.  Jewelry, dresses, and women’s shoes were leading categories in the month.
  • Despite pressure on margins driven by increased clearance activity, GPS guided EPS above the Street for 3Q to $0.47-$0.48 (Street $0.44).  Interestingly, the tail end of the quarter and the first week of 4Q have included 40% off promotions at core Gap.  Recall it has been quite some time since a “40% off any item in the store” promotion has been used.  If you haven’t already checked out this coming Friday’s promo, it’s worth taking a look at: http://www.facebook.com/event.php?eid=159056334132258
  • Costco highlighted that food inflation picked up in October, driven primarily by milk, butter, cheese, and deli meats.  Overall inflation for all food and sundries was 1.5%, a measurable increase from prior months.
  • ARO reported that its AUR’s decreased by mid single digits as a result of increased promotional activity as well as a negative mix shift towards lighter weight merchandise. 
  • AEO reported that its average prices on apparel were actually up year over year.  However, the mix impact of higher sales of accessories and Aerie negatively impacted overall AUR.
  • Add Gymboree to the list of retailers noting that a heightened promotional environment had a negative impact on margins.
  • Despite what was believed to be one of the strongest Halloweens in years, only Hot Topic called out the holiday’s impact on the month. Unfortunately, Halloween proved to be disappointing for HOTT.  Historically, the retailer was a merchandising leader for Halloween.  However, decisions to dramatically cut back on punk pants, corsets, and fish nets had a meaningfully negative impact on monthly results.

Eric Levine

Director


INITIAL CLAIMS REMAIN HIGH IN SPITE OF QE2

Initial Claims Rise 23k, Offsetting Last Week's 21k Improvement

The headline initial claims number rose 20k last week to 457k (23k net of revisions). Rolling claims came in at 456k, an increase of 2k over the previous week. This wiped out last week’s improvement, and claims still remain in the same band they’ve occupied for the year. We're still a solid 50-75k above where we would need to be in order to see unemployment fall.

 

QE2 Not Showing Any Signs of Taking Down Claims So Far

Interestingly, in the last round of Quantitative Easing (QE1), we saw almost all of the decline in mortgage rates occur between the time when the program was announced in late 2008 and when the buying commenced in early 2009. We think this time is similar in that mortgage rates have already come in substantially, to all time lows. What's interesting to observe is that mortgage rates have been exceedingly low now for a few months, but we've seen no real improvement in jobless claims. Maybe this is too short a window against which to measure success, but it is interesting to note that so far there appears to have been no transmission of QE2 into lower claims. We would not expect to see long rates drop much further from here, consistent with QE1.

 

INITIAL CLAIMS REMAIN HIGH IN SPITE OF QE2 - 1

 

INITIAL CLAIMS REMAIN HIGH IN SPITE OF QE2 - 2

 

In the table below, we chart US equity correlations with Initial Claims, the Dollar Index, and US 10Y Treasury yields on a weekly basis going back 3 months, 1 year, and 3 years.

 

INITIAL CLAIMS REMAIN HIGH IN SPITE OF QE2 - 3

 

Joshua Steiner, CFA

 

Allison Kaptur


INITIAL CLAIMS REMAIN HIGH IN SPITE OF QE2

Initial Claims Rise 23k, Offsetting Last Week's 21k Improvement

The headline initial claims number rose 20k last week to 457k (23k net of revisions). Rolling claims came in at 456k, an increase of 2k over the previous week. This wiped out last week’s improvement, and claims still remain in the same band they’ve occupied for the year. We're still a solid 50-75k above where we would need to be in order to see unemployment fall.

 

QE2 Not Showing Any Signs of Taking Down Claims So Far

Interestingly, in the last round of Quantitative Easing (QE1), we saw almost all of the decline in mortgage rates occur between the time when the program was announced in late 2008 and when the buying commenced in early 2009. We think this time is similar in that mortgage rates have already come in substantially, to all time lows. What's interesting to observe is that mortgage rates have been exceedingly low now for a few months, but we've seen no real improvement in jobless claims. Maybe this is too short a window against which to measure success, but it is interesting to note that so far there appears to have been no transmission of QE2 into lower claims. We would not expect to see long rates drop much further from here, consistent with QE1.

 

 INITIAL CLAIMS REMAIN HIGH IN SPITE OF QE2 - rolling

 

INITIAL CLAIMS REMAIN HIGH IN SPITE OF QE2 - raw claims

 

Yield Curve

The following chart shows 2-10 spread by quarter while the chart below that shows the sequential change. The 2-10 spread (a proxy for NIM) has recently stabilized with the backup in the 10-year treasury. Yesterday’s closing value of 224 bps is down from 231 bps last week.

 

INITIAL CLAIMS REMAIN HIGH IN SPITE OF QE2 - spreads

 

INITIAL CLAIMS REMAIN HIGH IN SPITE OF QE2 - spreads QoQ

 

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

 

INITIAL CLAIMS REMAIN HIGH IN SPITE OF QE2 - subsector perf

 

Our Macro Team's Howard Penney and Rory Green published the following chart yesterday showing that the AAII Bulls-Bears survey has not been more bullish since February of 2007, suggesting downside risk has grown considerably. For reference, peak bearishness occurred on March 5th, 2009, a day before the market bottom.  

 

INITIAL CLAIMS REMAIN HIGH IN SPITE OF QE2 - bulls bears

 

 

Joshua Steiner, CFA

 

Allison Kaptur


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.64%
  • SHORT SIGNALS 78.57%
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