Europe’s Band-Aid Rollercoaster

Position: Short Euro via FXE; Long Germany (EWG)


We want to make the quick point that although European equity indices look to be pricing in some form of bailout for Ireland today—most indices closed up +1.5% today across western and eastern Europe and Greece's ATHEX gained +2.6%—Europe’s sovereign debt crisis is far from over.


While this is an obvious point given the media’s attention on Europe’s debt and deficit ails, it’s worth restating our position that we believe there is a fundamental economic flaw in the Union of unequal states (the Eurozone), whereby states are effectively handcuffed from using monetary policy measures, such as inflating away debts or increasing trade competitiveness through currency debasement, to better maneuver economic developments.


While Greece got its €110 billion band-aid in May of this year and Ireland will soon get its own, the underlying “issues” afflicting the region cannot be solved with one-off bailout packages. On the contrary, we think that piling more debt upon debt is only going to compound the interconnected risk associated with the long-term issue.


While it could be argued that the Union of different parts proved beneficial to the whole in “good” economic times, the downturn from the world’s great recession is demonstrating a far different outcome and outlook for the Eurozone’s bound states.  


In particular, we’d expect that bond yields for Europe’s fiscally imbalanced countries to maintain a wide spread over credit-worthy German paper as sovereign debt concerns persist into 2011.


As the chart below shows, despite the performance of today’s equity market across Europe and a slight decline in government bond yields from the PIIGS since an immediate term high on 11/11, we’d expect government yields across Europe’s periphery to continue to rise.


As yields push up so too does the cost of capital which further strains a country’s ability to refinance and raise debt, which in turn snowballs the perceived sovereign default risk. And so the cycle of credit risk, short of bold austerity measures to cut debt and deficit levels, persists gravely…  


Matthew Hedrick



Europe’s Band-Aid Rollercoaster - mh1

Bear/Bull Battle: SP500 Levels, Refreshed...

POSITION: no position in the SPY here


I’m doing a lot of waiting and watching today when it comes to my index and macro short ideas. I’ve started selling immediate term TRADE longs that are overbought (SU, FL, etc), but feel like I need to be much more surgical about my re-entry point on the short side of positions like the SPY.


In the chart below I have outlined 4 important immediate term levels for the SP500: 

  1.        Intermediate term TREND resistance = 1225 (the YTD closing high, which is red because now we are making lower-highs)
  2.        Immediate term TRADE resistance = 1203
  3.        Immediate term TRADE support = 1191
  4.        Immediate term TRADE support = 1171 

The reason why I have 2 immediate term TRADE lines of support is that I don’t yet know if today’s market confirms (closes at or above) 1191. If it doesn’t, that’s immediate term bearish and there is no support to 1171. If it does, its immediate term bullish and carries risk that the SP500 can melt-up to 1203. Beyond 1203, there’s no resistance to 1225.


Aggressive selling/shorting was a better strategy a week ago. Tactical and timely selling/shorting is what I think you should be doing today.


Yours in risk management,



Keith R. McCullough
Chief Executive Officer


Bear/Bull Battle: SP500 Levels, Refreshed...  - 1

Are We Kookoo for Shorting Cocoa?

Positions: Short cocoa via the etf NIB; Long corn via the etf CORN

Conclusion: While there is currently an imbalance in supply and demand for cocoa that appears bullish for its price, we believe supply and demand will come back to more normal levels and the price of cocoa will correct.


Yesterday in the Virtual Portfolio, we added a short position in cocoa via the etn NIB.  Our position in the soft commodities also currently includes a long position in corn. 


The core fundamental thesis for shorting cocoa is related to the potential for an improving political situation in the Ivory Coast – the world’s largest producer of Cocoa – and the potential for slowing demand as global growth slows sequentially.


From a consumption perspective, both the U.S. and Europe are the large consumers of cocoa.  In fact, 16 of the 20 world’s top consumers (on a per capital basis) are European countries; by some estimates Europe consumes more than 40% of the world’s cocoa.  In aggregate, developed countries consume more than 65% of the world’s cocoa, with North America being the second largest consuming region after Europe.  In total, the world will consume somewhere on the order of 3.6 million tons in 2010.  Interestingly, while developing countries are growing demand at a slightly higher rate than developed countries, it is only marginal, as developing demand is expected to grow at under 2% this year. (This is in comparison to higher demand growth for more essential commodities such as oil, copper, etc.)


From a demand perspective, since chocolate is considered a specialty item and not a necessity, we would expect demand for it to wane in slower economic growth periods.  As we’ve noted many times, we expect both U.S. growth and global growth to slow sequentially going into 2011, which will curb consumption patterns, particularly for nonessentials such as cocoa.  As a case study of what can happen to cocoa demand in slower economic times we can look to Germany.   The demand for cocoa in Germany grew at an annual rate of -2.8% from 1990 to 2000 and then accelerated to annual growth of 0.9% for the ensuing decade.  As the economic growth patterns of German improved, so too did its demand for cocoa.


But the real story in cocoa is production.  Almost 70% of global cocoa production occurs in Africa – the top five producers globally are the Ivory Coast, Ghana, Indonesia, Nigeria, and Brazil.  The Ivory Coast, though, dominates production with approximately 45% of the world’s production occurring within her borders.   So, as the Ivory Coast goes, so too goes the price of cocoa.


Currently, things are not going well in the Ivory Coast.  As of November 14th, according to statistics from the Ivory Coast government, arrivals of cocoa crops at ports in the Ivory Coast slated for overseas transports are down almost 15% y-o-y.   This negative news, though, we believe is priced into the commodity, as it was expected that production was lagging due to new quality standards.


Prospectively, the recent Ivory Coast elections are likely a key driver of future supply growth.  The elections, which had been on hold due to political turmoil since 2005, were certified by the United Nations.  According to the UN:


“Despite some minor incidents and anomalies, it was peaceful and in line with international standards.”


In fact, more than 83% of eligible voters went to the polls.  The result of the Presidential election was that no candidate received more than 50% of the popular vote, but a runoff is scheduled for November 28th between Incumbent President Laurent Gbagbo and rival Alassane Ouattara.  It seems likely that peaceful and democratic transition of government will occur.  The implication of this is that government can begin to function at a normal level again and start to mandate, and support, a much needed modernization of the cocoa industry.  In time, this should lead to a cocoa production boom in the region.


So, are we kookoo for shorting cocoa? We don’t think so, but only time and price will tell.


Our levels on the cocoa etn, NIB, are outlined below.


Daryl G. Jones

Managing Director


Are We Kookoo for Shorting Cocoa? - nov 18 cocoa

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Conclusion: Yum has seen strong sales performance lately in its China division.  The downturn in consumer confidence in the People’s Republic is worth monitoring for a view to how 4Q is trending.


Chinese consumer confidence fell for the first time in six quarters in the third quarter.  The drop is believed to be largely attributable to inflation expectations.  Pan Jiancheng, deputy-general of the National Bureau of Statistics’ monitoring center, said, “Inflation has been triggered mainly by increases in food prices which has pushed up inflation expectations, especially among low-income workers”. 


Specific to YUM, management has consistently called out consumer confidence in China as a key driver of sales.  On October 6th, from the 3Q10 earnings call transcript: “we continue to benefit from the improvement of the Chinese consumer where consumer confidence has now been positive year-over-year in the last nine months”.  During the 2Q09 earnings call, in discussing the top  line trends of -4% in China, management said, “when you look at consumer confidence, actually it’s kind of bumping along the bottom.  So that may be a reasonably good indicator of the consumer side of the equation”.  Later, during the 4Q09 earnings call, management again called out the bottoming of consumer confidence in China in the early part of 2009 and same-store sales subsequently posted strong gains in 1Q10.   Just as the inflection in consumer confidence proved to be an indicator of Yum China sales in 2009, the recent sharp downturn should also be taken into account when thinking about future quarters. 


While 4Q09 was a difficult quarter from a  top line perspective, and therefore may be easily comped by Yum in the upcoming quarter, 1Q11 will present a difficult challenge for Yum China if consumer confidence does not rebound in the interim.  Additionally, MCD announced yesterday that it has increased prices in China by between 0.5 yuan and 1 yuan to offset higher raw material costs.  YUM management stated on the most recent earnings call that it expects inflation to be a headwind in 4Q10 and 2011.  Should margins compress under rising costs, that would obviously present an additional challenge for the company.  Alternatively, following MCD’s lead and raising prices could negatively impact sales trends, particularly if consumer confidence does not rebound.


YUM – WATCH CHINA CONFIDENCE - china consumer confidence


YUM – WATCH CHINA CONFIDENCE - yum china sales


Howard Penney

Managing Director

Initial Claims Approach YTD Lows

Initial Claims Approach YTD Lows

Initial jobless claims seem to be getting better. The headline initial claims number rose 4k last week to 439k, but rolling claims fell 4k to 443k. As the following two charts show, both reported and rolling claims are knocking on the door of their YTD lows, but have yet to break through. Claims still need to be in the 375-400k range for unemployment to meaningfully improve - still well below where we are now.


Initial Claims Approach YTD Lows - 1


Initial Claims Approach YTD Lows - 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 Approach YTD Lows - 3


Joshua Steiner, CFA


Allison Kaptur


Initial Claims Approach YTD Lows

Initial jobless claims seem to be getting better. The headline initial claims number rose 4k last week to 439k, but rolling claims fell 4k to 443k. As the following two charts show, both reported and rolling claims are knocking on the door of their YTD lows, but have yet to break through. Claims still need to be in the 375-400k range for unemployment to meaningfully improve - still well below where we are now.






Yield Curve Widening

The following chart shows 2-10 spread by quarter while the chart below that shows the sequential change. After falling sharply for two quarters, the 2-10 spread has stabilized thus far in 4Q.  Yesterday’s closing value of 238 bps is up from 224 bps last week.






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






Joshua Steiner, CFA


Allison Kaptur

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