This note was originally published at 8am this morning, November 23, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“No matter what you do I'm gonna take you down.”
Bob Seger is a 65-year old American singer-songwriter from Detroit, Michigan. In 1987, he released “Shakedown.” It eventually became a #1 hit on the Billboard Hot 100. Most movie-soundtrack buffs will recall this song from Beverly Hills Cop.
This morning the Fun Cops of global risk management have apprehended the perma-bulls. Lest the bulls who don’t do mean-reversion forget that the SP500 is still up +77.1% from the March 2009 lows and, as Seger sings, “everybody wants into the crowded line.”
This morning’s headlines are multi-factor, multi-duration, multi-risk:
- Korea sees both civil and military casualties overnight as a 27-year old boy-king in the North makes a statement to the South.
- Asian stocks continue to breakdown with China closing down another -1.9% overnight, taking its cumulative decline since 11/8 to -10.5%.
- Sovereign yields 3-mth Spanish debt rocket to the upside in a terribly received bond auction yielding 1.74%! versus 0.95% prior.
What does this mean? What do we do? I think those of us who have seen the confluence of the following Top 3 global macro factors colliding for the last month are already positioned:
- Global growth is slowing
- Global inflation is accelerating
- Interconnected risk is compounding
There are plenty of other risk factors causing a Global Shakedown in the immediate term TRADE lines across our interconnected global risk management model (Quantitative Guessing, Financials freak-out, Yield Spread compressing, etc.), but before we revisit the aforementioned Top 3, let’s look at those breakdown lines in some of the major country indices:
- SP500 Index = 1,997
- Dow Jones Industrial Avg = 11,199
- China’s Shanghai Composite = 3,008
- Hong Kong’s Hang Seng = 23,902
- India’s BSE Sensex = 20,386
- UK’s FTSE = 5,792
- Spain’s IBEX = 10,591
- Italy’s MIB = 21,181
- Brazil’s Bovespa = 70,929
In risk management speak, we call this Geographical Risk Factoring. Weakness in one country doesn’t always interconnected risk make in others. However, sustained weakness across geographies on our most immediate-term risk management duration (TRADE) is usually a very early signal for global risks to compound. These risk factors include: Style Factoring, Size Factoring, Liquidity Factoring, etc…
I’m not saying this market is going to crash today. I’m simply saying that the probability of a correlated and compressed-crash continue to climb. To a degree, this has already happened in Chinese and Spanish equities (down -10.5% and -9.5%, respectively, from their recent peaks in very short order). Again, these are equity market signals. But the equity bulls will have a hard case to make that the Mr. Macro Bond Market has been flashing anything bullish for the last three weeks.
Back to my Top 3 fundamental risks:
- Global Growth Slowing – After seeing broad based slowdowns in Asian Q3 GDP reports yesterday (Indonesia, Malaysia, Thailand), this morning South Africa reported a sequential slowdown in Q3 GDP to +2.6% (vs +2.8% last quarter).
- Global Inflation Accelerating – The good news here is that post Bernanke’s QG = INFLATION experiment taking plenty of commodity prices at or above all time highs, prices have come down in the last 2 weeks. The bad news is that the global inflation genie is out of the bottle and she’s hard to stop. Consider this Bloomberg News quote from a Chinese noodle shop dude this morning: “Standing near his 12-table noodle shop on Beijing’s Yonghegong Avenue, ower Liu Heliang says meat and vegetable prices have climbed 10% in a year and staff wages are up 40%.”
- Interconnected Risk Compounding – review all of the factoring I have gone through so far. In the US we think it all equates to Jobless Stagflation.
Now a bull could say that Germany’s GDP growth of +3.9% for Q3 was outstanding on both a relative basis to the EU (and the US) and on an absolute basis as the Germans continue to drive exports into a friendly Chinese relationship (Exports up +2.3%). I’ll agree with that. That’s why we have a 6% position in our Hedgeye Asset Allocation Model to German Equities (EWG).
While we have plenty of short positions to express the Global Shakedown risk (see my Early Look Note from November 8th titled “Tightly Squeezed” where we published our top 15 short ideas across asset classes), there are some things that we really like on the long side (alongside Germany) on a day like today:
- Long the US Dollar (UUP)
- Long the Chinese Yuan (CYB)
- Long Gold (GLD)
From yesterday’s price levels, I also think a 64% position in Cash is the right position to be in. Most asset managers will quibble with that for obvious reasons that are structural to their business models, but I really think the better benefit of the doubt this morning should go to the Thunder Bay Bear.
“Shakedown… Breakdown…Takedown… Everybody wants into the crowded line…”
My immediate term support and resistance lines for the SP500 are now 1172 and 1197, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer