The Stream and The Rock

This note was originally published at 8am this morning, November 26, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“In the confrontation between the stream and the rock, the stream always wins.”



Global equity markets are a riskier place than they were 48 hours ago. The North Koreans are calling this an “escalated confrontation.” The Europeans are calling this post Thanksgiving trading day a mess.


Since the Fiat Fools in Europe introduced their 750 BILLION Euro rescue plan in May, the confrontation between the Fiats and those of us who loathe leverage has been crystal clear. Some people call this debate political. Some people think it’s ideological. I think it’s a marked-to-marked battle between The Stream and The Rock.


If Piling Sovereign Debt-Upon-Debt is the stream and Big Keynesian Government Intervention is the rock, we think those levered to the liability side of this trade are going to eventually get wiped out.


Spain’s Prime Minister of a leverage-fest gone global, Jose Luis Zapatero, begs to differ with the Thunder Bay Bear on this matter. This morning, as Spanish 10-year sovereign yields (5.24%) hit a record wide spread versus German bund yields (+258 basis points), this is what Mr. Zapatero has to say:


“I should warn those investors who are short-selling Spain that they are going to be wrong and will go against their own interests”


Gee, thanks for the warning.


Markets, as we like to say at Hedgeye, don’t lie; politicians do. So let’s look at our expert network called Mr. Macro Market for the score:

  1. Spain – stocks on the Spanish IBEX Index are down another -2.1% this morning, taking their cumulative losses since October 22nd to down -13.0%. For the YTD, Spain is down -20.4%.
  2. Italy – stocks on the Italian MIB Index are down another -1.9% this morning, taking their cumulative losses since October 21st to down -9.4%. For the YTD, Italy is down -15.8%.
  3. Greece – stocks on the Greek Athex Index are down another -1.3% this morning, taking their cumulative losses since October 25th to down -13.1%. For the YTD, Greece is down -35.2%.

Pundits may be quick to point out that I didn’t use Ireland’s unequivocal disaster to make my point. I don’t need it. The big boy talk that’s going on with the Euro in the market today (the Euro is breaking my intermediate term TREND line of support of 1.33) has a lot more to do with the big nuts of European sovereign debt (Spain and Italy) coming down the stream than the rock that is another compromised Irish politician.


I say this every other morning on the Hedgeye Morning Macro Call to our clients, but I think it’s worth repeating in print today – I think Italy and Spain will be the biggest sovereign debt concerns in the world for the next 3-6 months.


In terms of 2011 share of Eurozone gross investment debt for 2011, Italy, Spain, and Greece represent the Top 3:

  1. Italy = 23%
  2. Spain = 9%
  3. Greece = 4%

Nope, that Italian number isn’t a typo. Neither is the fact that Italy has the highest labor costs in the Eurozone by a country mile (second place on that score goes to Mr. Zapatero’s Spain).


Next to Japan, Italy is also the oldest country in the world today. These people are old, levered, and expensive. If you were looking for a company to invest in, I don’t think this place would be your rock.


Sure, there are plenty of issues sacking markets from Portugal to Hungary this morning as well (Hungary’s stock market is down -3.5% this morning and its Fiat Currency, the Forint, is down a full -1.2%, after the government issued an ultimatum to it’s citizenry to move their pension savings to the state’s accounts!), but The Stream of sovereign debt that’s piling up in Italy, Spain, and Greece override all of that.


Interestingly, ECB hawk Axel Weber said in Berlin this morning that, while he considers it “inconceivable”, if they needed to re-finance the entire wad (Greece, Ireland, Portugal, and Spain), they’d need 1.07 TRILLION of EU bailout moneys.


Nope, Weber leaving Italy’s mother-load of liabilities out of this calculation isn’t a typo either. And, from Capua to California, no matter where conflicted and compromised charlatans of government leverage go this morning, there it is – The Stream.


My immediate term TRADE lines of support and resistance for the SP500 are now 1173 and 1209, respectively. I re-shorted the SP500 (SPY) into Wednesday’s extremely low-volume rally.


Best of luck out there today and enjoy the rest of Thanksgiving with your loved ones,



Keith R. McCullough
Chief Executive Officer


The Stream and The Rock - capua

The Week Ahead

The Economic Data calendar for the week of the 29th of November through the 3rd of December is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - cal1

The Week Ahead - cal2

The Week Ahead - cal3

Geopolitical Risk Update: Korea & Brazil

Conclusion: Geopolitical tensions continue to heighten in Korea and violence continues to flare up in Brazil.


On a sleepy Friday that equates to a half-day for many U.S. market practitioners, it’s important to remember the old adage, “markets wait for no one”. While it may be en vogue to chat about “Black Friday” and how many handbags Coach is going to sell this year, the fact of the matter is that there’s a great deal of geopolitical risk globally that you should keep on your radar screen as you head into the weekend.


First, an update on the situation brewing on the Korean peninsula:


North Korea’s state news agency KCNA warned that any “escalated confrontation” will lead to war and that the government is “greatly enraged at the provocation” from South Korea. Further, it strongly reiterated that any further encroachment of its sovereign territories will lead to retaliation. This marks the fourth time this week Kim Jong Il’s regime threatened further strikes against its Southern neighbor. In a show of bravado following the aggressive rhetoric, the North fired a few explosives on Yeonpyeong as part of its regular artillery drills from 12:00-3:00pm local time.


In the latest move to counter mounting political pressure for a stronger response, South Korean President Lee Myung Bak appointed former Joint Chiefs of Staff Chairman Kim Kwan Jin to defense minister. Jin, 61, replaces Kim Tae Young, who quit amid criticism that the response to Tuesday’s attack was inadequate. Young originally offered his resignation back in May, two months after the S. Korean warship Cheonan was sunk by the North and South Korea failed to respond in kind.


This latest appointment may potentially be a step in the more aggressive direction, which, on the margin, increases the probability of a full-out military conflict in the region.


From a quantitative perspective, South Korea’s KOSPI index remains bearish from an immediate-term TRADE perspective and ever-so-slightly bullish from an intermediate-term TREND perspective:


Geopolitical Risk Update: Korea & Brazil - 1


We remain bearish on Korean equities for two main reasons: 1) growth looks to slow sequentially for the next 2-3 quarters; and 2) inflation will continue to be a headwind and will require more aggressive tightening of monetary policy.


Moving over to Brazil, we see the death toll from the violence in Rio has increased to over 30 from as few as 13 on Wednesday. In response, President Lula has dispatched 800 army troops into the region to join forces with the 17,000-plus police that are swarming the city’s streets. Newspapers from Germany to Spain to Australia (i.e. nearly everywhere, but the U.S.) are calling the move both “unprecedented” and “desperate” and are also calling into question Brazil’s ability to guarantee security for visitors of the upcoming World Cup.


Other reports cited in the Brazilian press point to the estimated tens of millions of reais of lost revenue in Rio’s businesses.  The umbrella organization representing the trade, retail and tourism industries said one day’s closure of the major outlets in the areas of Rio affected by the violence represents R$ 39 million in lost revenue. The violence is having a broad effect as other companies not in the affected areas let workers return home early to avoid the evening hours when the streets are more dangerous.  This includes such major enterprises as Petrobras.  Companies are reporting worker absences of up to 30% and schools and universities have cancelled classes as terrorized residents remain indoors to avoid the danger of traveling across Rio.


Brazilian intelligence sources report Rio’s two major criminal gangs are planning a “mega-action” for tomorrow.  Presumably the military was called up in anticipation.  This could be incredibly ugly, as Rio’s heavily-armed police are reputed to have zero regard for human life once they enter the favela neighborhoods.


From a quantitative perspective, Brazil's Bovespa is bearish from an immediate-term TRADE perspective and bullish from an intermediate –term TREND perspective, though it is trading below its TREND line of support of 68,826 intraday. A close below that line is an explicitly bearish quantitative signal – particularly if it is confirmed by further weakness:


Geopolitical Risk Update: Korea & Brazil - 2


We remain cautious on Brazilian equities for the intermediate-term TREND. While we stand behind the robustness of Brazil’s bullish consumer story, we are cognizant of the intermediate-term inflation risks and the potential for further tightening of monetary policy in 1H11.


Darius Dale



Moshe Silver

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Not Interested in Sweater Sets? - Europe’s Mania Continues

Position: Long Germany (EWG)


Hungary Turned the Wrong Way?


-In what appears like a last ditch effort to cut its public deficit and debt levels, Hungary’s PM Viktor Orban ordered the shift of $14 Billion (3 Trillion Forint) in assets from private pension funds to the state budget. The government’s move appears more akin to a Communist-era decision, and rightfully has investors spooked. The country’s main equity index (Budapest Stock Exchange Index) fell -3.2% today (or -10.7% in the last month) as the yield on the government’s 10 YR bond ran up to 8.1% versus 7.3% one week ago (see chart below).


Not Interested in Sweater Sets?  - Europe’s Mania Continues - mh1


Hungary, which was the first EU member to obtain an IMF-led bailout in 2008, did cut its budget deficit from 9.3% of GDP in 2006 to 4.4% in 2009, however strong disagreements between the government and the IMF have ensued over the years.  The latest disagreement includes Orban’s decision to tax certain industries, including the financial, energy, retail and telecommunication industries until at least 2014 to cut the deficit to 3% of GDP. In particular, a 16% bank flat tax was met with extreme push-back, especially considering that western European banks make up the lion’s share of the country’s banks. According to Economy Minister Gyorgy Matolcsy, the government plans to announce spending cuts of as much as 800 billion forint at the end of February, without providing details.



Spain’s Pain, cont.


-As the sovereign debt contagion remains front and center in Europe, it’s worth note that yields in Spanish and Irish bonds rose 10 and 18bps respectively, day-over-day, outpacing yields from their peer countries that were flat to up +2bps day-over-day. Suffice it to say, we see a long road ahead of Sovereign Debt in Europe. 


Not Interested in Sweater Sets?  - Europe’s Mania Continues - mh2



Irish PM Cowen’s Majority Ever Slimmer


-Initial results show that Sinn Fein candidate Pearse Doherty won a 40% majority in a by-election on Thursday to take a seat away from PM Cowen’s ruling party, Fianna Fail, to narrow his party’s parliamentary majority to two seats.


Doherty’s opposition to Cowen’s proposed austerity plan for 2011, to be decided by vote on December 7th,  will put further pressure on the passage of a €6 Billion austerity package, which is conditional for an estimate €85 Billion EU/IMF bailout agreement. As we’ve stated before, this is an explicit sign that Cowen is being Voted Off the Island, and will test the waters as the country attempts to secure a bailout.  We expect volatility in Irish markets into and out of the December 7th date.



Euro Broken


-The EUR-USD broke its TREND line of support today of $1.33. As our TREND lines back test with the highest probably in our models, this is certainly a meaningful move to keep front and center on your screens!  (We booked a gain in the Hedgeye Portfolio on our Euro short position via the etf FXE on 11/23).


Not Interested in Sweater Sets?  - Europe’s Mania Continues - mh3



Portugal (Finally) Passes Austerity


-Today, Portugal’s parliament approved the 2011 budget, scheduled to shave €5 Billion off the budget next year through such measures as:

  • 5% wage cut for public workers earning more than $2,005/month
  • Hiring freeze of government jobs
  • Raising VAT 2% to 23%

The long awaited passage of the budget from PM Jose Socrates’ Socialist government still leaves a main question unanswered—to what extent can the government reach its target to reduce the deficit from 9.3% in 2009 to 4.6% in 2011?  Data indicates that the budget gap increased +1.8% in the first ten months of this year.  The next weeks will tell just how quickly dominoes can fall…


Matthew Hedrick


Bearish: SP500 Levels, Refreshed...



Unless the SP500 can overcome today’s weakness and rally and close above my immediate term TRADE line of 1197, I think being on the short side of this market will continue to be the right place to be.


Next week’s bearish macro catalyst is the Case/Shiller US Home Prices Report which comes out on Tuesday. Prices should be very weak as it will be the first month in which April activity falls out of the data series entirely. Like the SP500, both the Homebuilders (XHB) and the Financials (XLF) are broken from an immediate term TRADE perspective, foreshadowing Josh Steiner being right on this Housing call ahead of the “news”…


In addition to the PRICE and EVENT (calendar) risks, VOLATILITY (VIX) continues to have a very high intermediate-term inverse correlation to the price of US Equities. The immediate-term TRADE line for the VIX = 19.81 and we’re seeing the SPY break down as the VIX breaks out above that line.


My most immediate-term TRADE line of support for the SP500 is 1173 and the intermediate term TREND zone of support is closer to 1130.


Yours in risk management,



Keith R. McCullough
Chief Executive Officer


Bearish: SP500 Levels, Refreshed...  - 1


Looking at the table below, it is clear that there has been a high level of covering in the restaurant space.


I would call out the following moves as noteworthy in our table:

  • Short covering is driving CMG and CAKE higher over recent weeks
  • MCD and YUM have low short interest but the level is slowly building
  • DRI, EAT, and BOBE have seen short interest grow over the past two months of reported data
  • DIN’s short interest has declined markedly following their debt refinancing and strong 3Q performance

SHORT INTEREST UPDATE - restaurant short interest


Howard Penney

Managing Director