The Courage to Listen

“Courage is what it takes to stand up and speak; courage is also what it takes to sit down and listen.”

-Winston Churchill


For those of you unfamiliar with the story of Aung San Suu Kyi, she is a widely admired opposition politician in Burma and a former General Secretary of the National League for Democracy in her country.  The ruling military junta has oppressed Suu Kyi and her allies in order to maintain political control of the country. 


I am not a student of South East Asian politics but in the past few days I have found Suu Kyi’s story fascinating to delve in to.  What is most striking is her unwavering courage and commitment to serve her country; she refused to leave Burma for fear of being denied reentry by her political opponents.   After spending fifteen of twenty-one years in captivity, that courage and commitment is still as strong as ever. 


Upon her release from nearly 15 years of house arrest, Suu Kyi was quick to focus on making progress, saying of junta leader Senior Gen. Than Shew, “We have got to be able to talk to each other…real genuine talks, not just have some more tea or this or that”. 


Needless to say, Suu Kyi could offer a lesson in leadership to many politicians in the rest of the world.  Coincident with events in Burma, politicians throughout the West have been hastily passing blame, prematurely accepting plaudits, and wantonly pleading ignorance in accordance with the direction of the political winds.  From the Irish and Greeks to the Americans, it has been a tough time for political leadership in the Western Hemisphere. 


We have now witnessed a “compressed crash” of 3.87% in the S&P 500 since 11/05 and the carnage is even worse in some of the commodity markets: 


(1)    Gold -4.22%

(2)    Corn -10.26%

(3)    Oil -5.19%

(4)     Wheat -13.56%


The three worst performing sectors have been:


(1)    Financials -5.30%

(2)    Materials -5.09%

(3)    Technology -5.06%


The “compressed crash” is partly a function of the “blow off QE2″ euphoria that has been building since Bernanke’s speech in Jackson Hole, the David Tepper CNBC interview and the embarrassing Bernanke op-ed in the Washington Post which was nothing more than the FED admitting their intention to manipulate the stock market --no matter what the consequences.   


Following an open letter from a group of stock market practitioners and economists that was published in the WSJ demanding the FED to end QE2, the FED deployed two of its most senior officials to defend its policies on TV.  Both Janet Yellen and William Dudley (Federal Reserve Vice Chairwoman and President of the New York Fed, respectively) dismissed concerns that quantitative easing was aimed at Burning the Buck or that it could ignite inflation. 


It’s truly embarrassing what we are witnessing from some of the leaders of this country.  The perfunctory denial of what has been shown in real-time market prices for weeks now is a disgrace and an affront to our intelligence. 


The QE2 debate has been divisive in this country but its implications are global.  If it were solely another example of partisan politics why would Germany, China and Brazil all oppose the move too?  What is even more embarrassing is Representative Barney Frank having accused Republicans of “lining up with China and Germany in opposing the Fed’s credit easing!”  You couldn’t make this stuff up even if you wanted to! 


Overnight China declined 1.92% (now down -7.51% from 11/05) as Premier Wen Jiabao is now drafting measures to curb inflation, which means higher interest rate and slower economic growth in China.  I don’t think Wen picked up the phone to call the republican leadership to seek counsel on his inflation problems.  This becomes a problem for the USA because our “sick” economy cannot survive a slowdown in the economic engine of emerging markets.


We shouldn’t feel special, though; our friends across the pond are receiving the same treatment.  European Unity, the dream of Jean Monet, lies in shambles as “fellow Europeans” are turning out to be fair-weather friends with fingers pointing en masse across the once-again obvious borders that divide the 27 nations.  Whether it’s Greece “reclassifying” statistics or Ireland clinging to hope of retaining some vestige of autonomy throughout this episode, tensions are fraying.  Unelected politicians in Brussels are most distressed; Herman Van Rompuy, President of the European Council, struck a tone of desperation yesterday when he said “we’re in a survival crisis”. 


From a U.S. perspective though, the spotlight will be back on America’s problems soon enough.  Obama, by the sheer volume of the message the American people sent him from the polls earlier this month, has been forced to become somewhat more conciliatory in tone.  The Republicans, for their part, have been emboldened by their recent success, which is likely to be detrimental to getting anything accomplished in Washington.


Sadly, America’s ills are grave and should take precedence over the perpetual campaign for fame that politicians are now engaged in. 


These are important days for the United States and the ability of the country’s leaders to inspire confidence for a sustained period of time will be imperative for any real recovery to stand the test of time.  While the history of American Leadership is not without its blemishes, it is true to say that this country has been fortunate to find, more often than not, great leaders at the helm of political and social movements in times of national strife.  Abraham Lincoln, Franklin Roosevelt, John F. Kennedy, and Ronald Reagan are just a few of the Presidents that come to mind when one thinks of courage in a time of difficulty.


Sadly, our political system is broken and it seems gridlock is what we are faced with.  Gridlock is not good for equity prices.  Since November 2006, voting in Congress has become more and more tied to party lines.  There is no political leader with the courage and the backbone to bring together the needed cooperation to enact the change that can right size the listing ship. 


I will end with a thought from Jean Jacques Rousseau, a man who lived through times of crises: “The inflexibility of laws, which keeps them from bending to events can in some cases render them pernicious, and through them cause the ruin of a State in crisis”. 


From the FED, to Congress, to the White House, “politicking” is making a difficult situation very grave indeed.  Sadly, none lack the courage to speak.


Function in disaster; finish in style,


Howard Penney


The Courage to Listen  - HP EL

Stepping On Cocaine

This note was originally published at 8am this morning, November 16, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Sean: See you Monday. We'll be talking about Freud and why he did enough cocaine to kill a small horse.”

-Good Will Hunting


Yesterday, the Italian police reported intercepting 1 ton of pure cocaine inbound on 4 tractors from Brazil.  The street value was estimated at 250 MILLION Euros ($341M USD). That’s a lot of Fiat currency. That’s a lot of coke.


Since it was the largest intercepted transaction of cocaine in 15 years, I figured I’d start to analyze the matter. After all, Quantitative Guessing (QG) has many unintended consequences, not the least of which are moral.


Like creating “sugar highs” in markets for those who are levered-long of them, cocaine is a stimulant of the central nervous system. It suppresses the addict’s appetite to manage reputational risk. When it’s uncut, or “pure”, some really wild and crazy stuff starts happening post consumption.


According to one anonymous tweeter with knowledge in the crystalline tropane alkaloid space, pure cocaine “has no filters to increase the weight of the product. Dealers will usually “step on” their product to the tune of 30 or 40% of some other substance (usually Demerol, baby laxative, or B12) to increase their profits.”


As I dug deeper into my research, I couldn’t help but remember that this is exactly what 18th century Coin Clippers used to do to the their citizenry’s currency. Before we had central banking dealers clean up the messaging and delivery of the coin clipping business it was, per Wikipedia, “considered by the law to be of similar magnitude to counterfeiting, and was occasionally punishable by death.”


The good news here is that Americans are starting to figure this whole matter of feeding free money to debt addicts out. It actually didn’t take very long for consensus to come to realize that QG and Burning The Buck are bad things. This is progress.


We’re long the US Dollar (UUP) here and covering some of our US Equity short positions, not because we trust the alchemy of Alan Greenspan or Ben Bernanke, but simply because we are starting to see some of the cocaine highs of the last few weeks wear off. After all, over time, a stronger sovereign currency that isn’t being clipped by charlatans of government sponsored volatility is a good thing for America.


As risk managers, we are tasked with measuring real-time market prices, volatilities, and volumes. The output of this research results in probability-weighted market timing. As correlations and r-squares change, we start to change our positioning.


Today is November the 16th. To understand where markets can go next, we have to contextualize where they came from. So let’s look back at global macro correlation risk relative to the US Dollar on a THEN and NOW basis versus October 16th…


THEN (immediate term TRADE correlations to USD):

  1. SP500 = -0.80
  2. CRB Commodities Index = -0.88
  3. Brazil’s Bovespa Index = -0.92
  4. Oil = -0.91
  5. Gold = -0.96
  6. Copper = -0.95

NOW (immediate term TRADE correlations to USD):

  1. SP500 = -0.29
  2. CRB Commodities Index = -0.20
  3. Brazil’s Bovespa Index = -0.60
  4. Oil = -0.11
  5. Gold = -0.08
  6. Copper +0.10

The way to read this is very straightforward. Copper is undergoing the most glaring mathematical change, swinging from an INVERSE correlation of -0.95 to a POSITIVE correlation to the USD Dollar of +0.10 in only one month. This is a major new development in the risk management landscape.


While I wasn’t brave enough to buy Copper yesterday, I did buy-back my long Gold (GLD) position (email if you’d like my intraday note titled “Gold Diggers: Gold Levels, Refreshed”).


Last Tuesday, my asset allocation to Commodities was a Bernanke (ZERO percent). This morning, after seeing the CRB Commodities Index correct by -4%, the Hedgeye Asset Allocation to Commodities is back up to 6% (GLD = 3%, CORN = 3%). Managing your cash position dynamically isn’t rocket science. It’s called contrarian sobriety.


One of the most critical lessons I’ve had to learn in making global macro calls on markets is that the derivatives, correlations, and divergences embedded in the math are never perpetual. In other words, once it gets so easy that a coke-head can do it, it ends…


The SP500 is down for 5 out of the last 6 days and should test a critical level of immediate term TRADE support this morning. In the Hedgeye model, that line of support is 1190. If it holds, that’s bullish. If it breaks, that’s bearish. My immediate term TRADE line of resistance is now 1212.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Stepping On Cocaine - coke

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Republican Headwinds for State & Local Governments

Conclusion: The Republican landslide in the recent election all but guarantees State & local government fiscal headwinds will continue to materialize in 2011. These headwinds will likely result in material spending cuts and tax hikes going forward, which will create a drag on the economy going forward and increased risk for State and local bond defaults.


Position: Bearish on Muni Bonds


With the incoming 112th Congress coming in overwhelmingly Republican on the margin, State & Local governments will likely see their fiscal troubles deteriorate into FY12 (which starts on July 1st, 2011 for all but four States), due to an erosion of federal budgetary support. States have only a remaining $6 billion in American Recovery and Reinvestment Act funds left to patch the FY12 budget gap of an estimated $140 billion. Incremental funding from H.R. 1586, the August 2010 Jobs Bill, buoys State spending on Medicaid only through June 2011 and adds only $10 billion to the State Fiscal Stabilization Fund.


Republican Headwinds for State & Local Governments - 1


If State & Local government revenues come in in-line with our bearish estimates, where will the much needed additional funding come from as States evaluate their budgets mid-year and as they prepare FY12 budgets? Likely not from the federal government, given the Republican Party’s platform of cutting spending and lowering taxes. Given this material erosion in funding sources, we outline below some key programs and sources of funding that may disappear in 2011 as well as some proposals that will exacerbate State and local government fiscal headwinds going forward:


Build America Bonds


The Build America Bond program has helped fund $158 billion into local public works projects since its inception, with the federal government subsidizing 35% of the interest on these taxable securities. The program is set to expire at the end of the year, unless it gets extended. Twice this year, the program has passed the House only to be shot down in the Senate (likely due to it being wrapped in with other contentious programs). If it does not make it past the lame-duck session of Congress (which began yesterday), it will likely not be extended when the 112th Congress takes session.


The program has been quite popular thus far from issuers and underwriters alike; should it fail to be extended, current estimates suggest tax-exempt muni bond issuance would increase roughly 30-35%. That’s not good for muni bond yields – especially when taken in the context of bearish underlying fundamentals of many State and municipal governments across the country.


Republican Headwinds for State & Local Governments - 2


Pledge to America is a Pledge to Cut Discretionary Spending


House Republican leaders have pledged to cut non-security discretionary spending by 21.7% in FY11. If adopted, the program would provide roughly $105 billion less for all non-security discretionary programs than Obama’s current 2011 budget. According to the Center for Budget Policies & Priorities, that translates to roughly a $32 billion haircut for State & Local government budgets, given that State & local government grants represent nearly a third of all non-security discretionary funding. If transportation programs are factored in, the haircut is a full $11.8 billion larger, for a total of $43.4 billion of lost funding in 2011. States are already projecting a $134 billion deficit in FY12; needless to say, an incremental 32% addition to the gap will require further cuts and/or tax hikes going forward, as States are mandated to have balanced budgets (w/ the exception of Vermont).


Republican Headwinds for State & Local Governments - 3


Obama’s Business Tax Break


President Obama’s proposed tax break for businesses to deduct the full cost of capital investments in the year expenses were made (rather than a full depreciation schedule) may end up costing states $20 million in tax revenues through 2013, according the Center for Budget Policies & Priorities. Further, the center suggests States may end up recouping only about 85% of the funds despite the immediate write-offs being replaced by those of later years, due to NPV calculations among other factors. All told, 24 States automatically change their definition of taxable income to conform to federal government code and another 22 update it every year to reflect any changes made on the federal level, meaning that 46 States will be directly negatively impacted by this proposal should it pass.


Getting Up To Speed


With the struggles of State & local governments making more and more news of late, we’ll continue to remain diligent in keeping you appraised on this topic. We’ve written extensively on State & local government fiscal headwinds YTD; email us if you’d like to receive copies of any/all of the following reports:


February 24: DOMESTIC PIGS – A recent release by the PEW Center on the States shows a $1 trillion gap between the $3.35 trillion in pension, health care, and other retirement benefit-related liabilities currently on States balance sheets and the $2.35 trillion in assets they have to cover them. While we are not calling for the U.S. to default on its sovereign debt, the likelihood of a State and/or local government defaults(s) may potentially lead to a downgrade in the U.S.’s credit rating.


April 20: GOVERNMENT’S MARKING TO MODEL – Property tax rates and property tax receipts continue to rise in the face of a weak domestic housing market, showing just how much the government marks their “assets” to model. We break down the convoluted municipal property value appraisal system and highlight the oncoming headwinds to local government property tax collections in the coming years.


July 21: IN A SORRY STATE INDEED - Waning federal funding, slowing tax receipts, and declining home prices will put additional strain on State and local government budgets, which have an incremental negative effect on the U.S. economy at large.


September 13: BREAKING DOWN MUNI BONDS – We firmly disagree with the relative “safety” of muni bonds, as current yields are at a disconnect with the underlying negative fundamentals that will begin to reveal themselves over the next 2-4 quarters.


October 13: CONTRACT FOR AMERICA: EVEN SLOWER GROWTH AHEAD? - Careful analysis of State & Local Government fiscal headwinds suggests that a Republican takeover of Congress may lead to decisive spending cuts, which could negatively impact U.S. economic growth in the intermediate term. Furthermore, State and Local Government’s FY11 revenue projections are very out of line with economic reality, which suggests further cuts are on the way. In this report, we analyze this divergence in great depth.


Darius Dale


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 80.52%
  • SHORT SIGNALS 78.67%