This note was originally published at 8am this morning, November 15, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“Never forget that sometimes your greatest victories can come from your greatest defeats.”
Last week was a great week for global macro risk managers. By week’s end, with correlation risk to the US Dollar running at all-time highs (Dollar UP = stock, bonds, commodities, etc. DOWN), a gigantic global mean-reversion trade captured victory.
With the US Dollar Index recouping +1.9% of its value (week-over-week), here were some of the major correlation moves:
- SP500 = -2.1% (the market’s worst week in the last 3 months)
- Russell 2000 = -2.3% (we covered our short position last week)
- Euro = -2.9% (we shorted the FXE on 11/4 and remain short it)
- Commodities (CRB Index) = -3.2% (intra-week we moved up our asset allocation from zero to 3%)
- Oil = -2.3% (no position – we sold our oil on 11/3)
- Gold = -2.2% (no position)
- Copper = -1.3% (no position)
- Volatility = +12.9% (we sold our long VXX position on strength last week)
- 2-year US Treasury yields = +13 basis points or +35% to 0.50% (we remain short SHY)
- 10-year US Treasury yields = +26 basis points or +10% to 2.79% (we remain long PPT)
Putting price moves in context is always critical. Having been short the Burning Buck from June 7th to November 2nd, I get the bear case (DEFICITS + DEBT = CONGRESS). Inclusive of the US Dollar closing UP for the 2nd consecutive week, it’s important to acknowledge that the Debauched Dollar is still down for 19 out of the last 24 weeks and has plenty to prove before it regains any semblance of credibility.
That said, THE risk management question this morning is: Can a TRADE higher in the US Dollar become a TREND?
TRADE, in Hedgeye speak = 3 weeks or less. Whereas a TREND = 3 months or more. Global macro TRENDs back-test with much higher batting-averages in our risk management model than TRADEs. However, all TRENDs start as TRADEs, so you have to be Duration Agnostic.
I bought the US Dollar (UUP) in the Hedgeye Portfolio on November 4th and I remain long of it this morning. Consensus is still short the US Dollar and I can assure you that consensus is not comfortable with that position.
Here are the lines that matter in my model for the US Dollar Index:
- TRADE = $77.11
- TREND = $80.69
What that means is that what was immediate-term resistance for the US Dollar ($77.11) is now support and there really is no significant resistance (provided that the USD Index continues to make higher-lows) up to the TREND line of $80.69. In other words, there’s another +3.2% upside from Friday’s closing price of $78.08 and, consequently, plenty of correlation risk over the intermediate term for anything priced in US Dollars.
So what can keep an immediate-term bid to the Debauched Dollar?
- The Euro going down on legitimate sovereign debt risks rising (Ireland, Spain, Greece, Italy, Portugal, etc.)
- Fed Heads continuing to get hawkish on the margin (Jeffrey Lacker joins Kevin Warsh and Tom Hoenig this morning)
- US Treasury Yields continuing to breakout to the upside (2-year yields charging higher again this morning to 0.53%)
I’m not looking for bullish catalysts – these simply are bullish USD catalysts - particularly when you consider the “Bye-Bye, Bear” cover story that Barron’s was running on November the 1st. Bernanke’s QG (Quantitative Guessing) experiment has been YouTubed by the entire free and communist world at this point. If you didn’t know that QG = inflation, now you know. US inflation reports (PPI and CPI) will accelerate again sequentially when reported this week.
It’s a mathematical fact that Dollars are priced as a basket of other currencies, so I don’t think I’ll get much pushback on the Euro DOWN trade equating to US Dollar Index strength. I’ll definitely get pushback on the Fed Head thing – after all, the cornerstone of the Bull case on US Equities is built on Begging Bernanke for free moneys as insiders make their highest levels of sales since December.
On that not so little squirrel hunting signal that the world calls Mr. Bond Market however, it will be very difficult for people to ignore these immediate and intermediate-term breakouts in US Treasury Yields. This is very new. And the risks in the Treasury market are very real.
The 30-year bond has been breaking down, big time, since mid-October. Long-term interest rates breaking out in the US as sovereign yields spike in Europe were 2 of the main risk factors associated with my getting out of stocks and commodities altogether in late October. While some of my greatest 2010 defeats came in the first week of November, the greatest victories in global macro risk management are potentially on the come.
My immediate term support and resistance levels for the SP500 are now 1188 and 1211, respectively. I remain short the SP500 (SPY).
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer