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HEDGEYE EDITORIAL: "LONG TERM OUTLOOK FOR THE US DOLLAR"

On behalf of my teammates here at Hedgeye, I'd like to thank all of you - our subscribers, partners, and friends - for giving us all of the research feedback that you do. Today, we would like to share with you some interesting and well-thought out feedback on the U.S. Dollar’s long term outlook from one of our subscribers, as well as our responses to that subscriber.

 

We remain long the U.S. Dollar via the etf UUP in the Hedgeye Virtual Portfolio.

 

Hedgeye Editorial

To: Darius Dale

Subject: Long Term Outlook for the U.S. Dollar

 

JEFF: “You guys do great work and are providing a fantastic service to the investor/wealth manager marketplace.

 

Question for you, has Hedgeye considered doing a longer term prognosis for the USD and what that entails from an investment thesis perspective? You have been very adroit at calling short term inflection points and directional changes in the USD, but what about longer term?  The reason I ask this is that despite the recent fall off in correlation between the $$ buck and commodities and metals, hasn't it typically been a higher correlation (since all this "stuff" is dollar denominated?) Longer term, so goes the dollar, so goes (inversely) oil, gold, silver, PGMs, most agriculture, etc. Is that truth or myth?”

 

HEDGEYE: We have done a great deal of longer-term work on the $USD, none more powerful than our August Monthly Strategy Call – Should U.S. Government Debt Be Rated Junk Status (email us if you need a copy of the replay and presentation materials).

 

It’s true that commodities have historically moved inversely with the $USD (see chart below).

 

HEDGEYE EDITORIAL: "LONG TERM OUTLOOK FOR THE US DOLLAR" - A

 

JEFF: “Not to come off as overly cynical, but for all the rhetoric by politicians on cutting government spending and fiscal responsibility, we have heard this before. Deficit spending in and of itself isn't disastrous, but long term sustained and growing deficit spending eventually is, and that's the situation the U.S. is in.  I couldn't tell you precisely when the US began it's sustained deficit spending binge (aside from WW2), but my sense is that it has been going on at least since Ike and has been virtually unabated, except for a year or two during the Clinton administration, for the better part of 50 years.  

 

At this point I would venture several observations:  1) 50 years is a long time, 2) it is both a republican and democrat problem, both parties are guilty of it, so simply changing the political guard is not a solution, and 3) it has been aided and abetted by a willing electorate, of which 45% of households now pay little to no income taxes (WSJ). To think that the U.S. will suddenly find the "new religion" of austerity and fiscal responsibility on the heels of half a century of spending beyond it's means, one would have to suspend one's faculties. People have gotten too used to getting free stuff, and politicians have gotten too used to giving stuff away to get re-elected, and government has gotten too big and bloated and wants to sustain itself and the populace, like the proverbial frog in the slowly boiling water, has grown to increasingly think we actually need this government. And with enlarged government, comes the need to spend, and spend the U.S. has like no government before it in the history of the world. Obviously, this has major implications for where we find ourselves and equally major implications for where we go from here.

 

And this is where I come to the crux of my question(s) for Hedgeye.

 

The Reality on U.S. Deficit Spending

First, ignoring unfunded liabilities (or maybe not?), if you graphed annual U.S. government deficit spending since the 60's I think you might find pretty quickly that deficit spending was a structural problem in the U.S.  All rhetoric to the contrary is simply that: rhetoric. The question in the U.S. is not "will there be a deficit?" It's how LARGE the deficit will be?  I believe I am correct in saying that if you look at the data, one would have to believe in elves in the forest to believe for a moment that the U.S. is capable of balancing a budget. "Fiscal restraint" is political code for running smaller deficits. It just doesn't seem do-able.”

 

What's the Run-Rate on U.S. Debt (where are we going?)

With Washington essentially gridlocked for the next two years, what is the run-rate on U.S. Government Debt? David Stockman has said that we are adding $1T to the national debt every 15 months. That actually seems low to me. Today we are at $13-$14T national debt, by end of 2011 where will we be? $15T ? Where will we be by the end of 2012? $16T + ? With a slowing global economy and the U.S. economy with more drags on it than a farm tractor (housing, high unemployment, de-leveraging, major state level budget issues, banks with huge loan impairments still sitting on their books, etc.), what is your outlook for US GDP to government debt? Looks like we are getting ready to flip upside down with government debt soon to exceed GDP. Maybe that's already happened. It used to be that people justified spending as long as economic growth exceeded it. "It's not how much debt you have, it's how much GDP you have." Now the runaway train of debt appears to be getting ready to race past GDP (isn't this a historical and somewhat foreboding event?) and while it's hard to grow an economy by $1T of GDP in a year, our run-amuck government  doesn't seem to have any problem exceeding that in debt creation (year after year).  In fact the US is now buying it's own debt . This all seems to be pushing us to some kind of tipping point.”

 

HEDGEYE: It’s downright frightening to consider that the U.S. government debt will soon exceed GDP – especially when you consider the seminal work of Reinhart and Rogoff, who have shown empirically that debt > 90%/GDP structurally impairs economic growth by nearly half in advanced economies. We could blow by 100% debt/GDP much sooner than consensus thinks, as our deficit/GDP projections for the next two years are significantly greater than the likes of the CBO and OMB (see charts below).

 

HEDGEYE EDITORIAL: "LONG TERM OUTLOOK FOR THE US DOLLAR" - B

 

HEDGEYE EDITORIAL: "LONG TERM OUTLOOK FOR THE US DOLLAR" - C

 

JEFF: “What's the Historical Correlation of U.S. Debt Growth to the Decline of the USD?

Seems like a pretty clear correlation, not every year, but over time. You out-spend your economic growth, you run structural deficits year after year, you pile debt upon debt. You ultimately create a drag on economic growth and de-base your currency.  Is this the case with the USD? “

 

HEDGEYE: The $USD has responded as you would expect to long-term debt buildup and structural deficit spending.

 

HEDGEYE EDITORIAL: "LONG TERM OUTLOOK FOR THE US DOLLAR" - D

 

JEFF: “What are the Implications of all this?

IF deficit spending is a structural problem in the U.S. with a lengthy history going back a half century (I think the data suggests it is); and

IF little progress can be made over the next 2 years due to Washington gridlock, in any case, the current deficit run-rate is a complete runaway train regardless; and

IF there is a longer term correlation between growth of public debt and devaluation of the USD

 

Then what are the longer term implications for investing in things that are denominated in the USD?

 

HEDGEYE: One would think up, but the likelihood that the USD gets replaced as the world’s reserve currency grows with each passing day (see recent SDR adjustments). Why not crude oil denominated in Chinese yuan? It’s not that far of a conceptual leap as it was even five years ago. This is a very long term call, of course, so there will be a lot of volatility to weather from here to now. That’s why we proactively manage risk on a duration-agnostic basis.

 

I know this is a complicated question. It's actually a bundle of questions. On one hand, in the context of history, it seems quite simple: you run up unsustainable debts, you ultimately hammer your currency, maybe create a crisis and put a drag on economic growth (Japan). But on the other hand, currencies are baskets of other currencies, it's all relative. In the short term what matters is how you stack up relative to everyone else and Europe clearly has significant problems, but it seems like our time is coming, perhaps a couple of years down the road. Perhaps it's just a question of duration.  The SS United States is sinking more slowly, taking longer, but sinking nonetheless.”

 

HEDGEYE: You hit the nail on its head here, particularly with your points on duration. Duration Mismatch gets a lot of super-duper smart investors ran over because they don’t realize the fundamental difference between investment research and actually investing. Japan and one/all of the PIIGS could blow up before the U.S. has its day of reckoning.

 

JEFF: “Does US debt (excluding unfunded Liabilities) now exceed GDP?  Will that be a seminal event in U.S. economic history? Does it matter?”  

 

HEDGEYE: No, not yet, and yes, this will be a seminal event in the U.S.’ economic history. Whether the markets lend the appropriate focus to it or not will be another story. At any rate, anyone who understands the effects of leverage on the way down will arrive at the conclusion that piling debt upon debt will always matter and it is a negative thing once the Rubicon of 90% Debt/GDP is crossed.

 

JEFF: “While the dollar may be breaking out to the upside in the short term, what is your longer term take on the USD in light of mounting U.S. debt problems?” 

 

HEDGEYE: Bearish.

 

JEFF: “What is your take on the run-rate for U.S. debt? Do you see a tipping point? Even if we waved a magic wand over Washington and political contention ceased and harmony and singleness of purpose suddenly prevailed, isn't the best case that we run $500-$600B annual deficits?  Is the US debt a runaway train at this point even under better circumstances?”

 

HEDGEYE: Yes, the boat has left the dock. As we uncovered in our call w/ Peter Orszag, former director of the OMB, we can only cut so much – perhaps to the tune of just 1% of GDP. To really rein in the deficit, we need a revenue adjustment – and a major one at that. Whether or not there will be any political spine to implement such a solution is, at best, up for debate and, at worst, unlikely. 

 

JEFF: “If this is the case, what is the investment implication for usual suspects like oil, gold and other commodities?”

 

HEDGEYE: We are bullish long term on both crude oil and gold – but not at every price. There will be alpha to uncover on both the long and short side of all three (USD, gold, oil) over various durations within the context of the long-term structural decline of the USD.

 

I could be totally wrong here and some of the comments I put forward as facts may not be fully accurate and may in fact be pseudo-facts (I think they are substantially accurate, but I may be wrong), but this overall question on debt, the dollar and it's implications for investing seem like the "elephant in the room". Hedgeye has proven itself quite skilled at making macro calls and you certainly aren't afraid of calling BS when you see it. It seems like "having a take" and being positioned for where we are headed a few years down the road, would be an extremely worthwhile endeavor.  Food for thought.

 

All the best to Hedgeye,

 

Jeff


Daily Oil & Gas Perspectives

From the Global Oil and Gas Patch: November 30, 2010


Current positions in the Hedgeye Virtual Portfolio: long LUKOY, long CEO


Chart of the Day……

 

Daily Oil & Gas Perspectives - nov 30 chart


Key Metrics……

 

Daily Oil & Gas Perspectives - nov 30 table


North American Energy News……


Husky to Buy Assets from XOM……Husky Energy (HUSKF ADR) – Canada’s 3rd largest oil producer and refiner – will buy ExxonMobil’s (XOM) oil and gas properties in Alberta and British Columbia for $860M.  The deal will add 21,900 boe/d and 113 Mboe of reserves to Husky’s portfolio.  Husky raised its 2011 capex budget by 20%.  The company will raise $1B through an equity offering.  (Reuters)

 

Hedgeye Energy’s Take: Husky has struggled the last few years to grow through the drill-bit and XOM’s desire to shed non-core and conventional assets fits HUSKF’s immediate needs. Additionally, the company intends to scrap a spin-off of its South China offshore discoveries in Liwan-3 Block and will submit a joint development plan with CNOOC (CEO).


BP to Fund Oil Sands Project……BP (BP) will provide the first $2.5B for the Sunrise oil sands project in northern Alberta, Canada – which it owns a 50% stake in.  They will collaborate with Husky Energy (HUSKF ADR) on the project, which cancelled plans in Southeast Asia to focus on the Canadian sands (see above post).  This is BP’s first major commitment since the Deepwater Horizon disaster.  (Financial Times)

 

Hedgeye Energy’s Take: As BP is forced to sell assets for Macondo GOM liability, oil sands, as a low political and exploratory risk environment, looks increasingly appealing.  Husky and BP have a joint venture: HUSKF works in the Sunrise oil sands and BP contributes its Ohio Toledo Refinery.


Seadrill Increasing Investment……Led by billionaire John Fredriksen, Seadrill (SDRL) has invested $2B in the past two month on oil rigs, leading the jump in orders as safety concerns over BP’s spill has sparked demand for newer, safer platforms.  Deepwater rig companies like Seadrill and DryShips (DRYS) have ordered 20 deep and shallow-water rigs since BP’s disaster, raising global orders by 22%.  Deepwater rig rates have stabilized after a 30% plunge after the Macondo spill and may return to pre-recession levels in three years.  (Bloomberg)

 

Hedgeye Energy’s Take: New rig demand is being driven by the need to retire the majority of the existing aging rig fleet, the need for more complex rigs to operate in deeper waters and more remote and difficult terrain, and an increasing concern for operating rig safety post-Macondo.


In U.S. West, Oil Rush could Exacerbate Gas Glut…… The promise of oil and liquids-rich shale plays in the U.S. West has resulted in a rush of E&Ps to the region, and some analysts believe the production of associated gas could exacerbate regional competition in a market already awash in gas.  (Platts)

 

Hedgeye Energy’s Take: We have voiced this concern in earlier energy notes as a very real issue, that will continue to weigh on natural gas prices into 2012. This is a particular concern in the Rocky Mountain areas that are oversupplied with gas and are hot targets for liquids plays.


World Energy News……


Lukoil Beats Estimates……Russian oil giant Lukoil (LUKOY ADR) reported Q3 net profit of $2.82B vs. Reuters $2.11B.  Revenue and EBITDA also beat estimates and year-ago levels.  The company says it plans to gradually increase their dividend.  The profit increase was due to higher oil prices, a $438M one-off gain, and a large disposal of crude from the company’s inventory, the company said.  (WSJ)

 

Hedgeye Energy’s Take:  We are currently long LUKOY in the Hedgeye Virtual Portfolio. This 87% oil weighted Company is living within its means, with 2010 net cash flows (NCF) after capital spending expected to grow nearly threefold to ~$7.70/ADR, and 2010 expected earnings to soar ~40% to ~$11.80/ADR. Stock trades at an attractive eight times enterprise value to NCF.


Russia Approves XOM Budget……ExxonMobil’s(XOM) production budget in Russia’s offshore Sakhalin 1 field has been approved by the government.  The budget calls for a long-term development until 2055 under which expenditures are to be $95.3B.  The Kremlin monitors the budget strictly because they share in the revenue – an increase in expenditures leads to a cut in the state’s share of revenue.  (Platts)

 

Hedgeye Energy’s Take: Despite rumors that XOM would be replaced as the operator in Sakhalin (30% working interest) due to project cost increases, XOM’s technical expertise is too important to the development of the complex offshore Sakhalin fields and will remain the leader there.  The Kremlin realizes how critical production growth from the Sakhalin Fields has been to Russian domestic production – one of their few fields not reporting a net decline.


Anadarko Finds More Mozambique Gas……Anadarko Petroleum Corp (APC) has made its third gas discovery in offshore Mozambique this year, making the total great enough to warrant an LNG development.  This will be East Africa’s first LNG project.  (Platts)

 

Hedgeye Energy’s Take: Abundant gas resources in offshore East Africa are valuable because the region is an attractive export destination for gas-hungry Asia.

 

Lou Gagliardi

 

Kevin Kaiser


THE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - November 30, 2010

As we look at today’s set up for the S&P 500, the range is 24 points or -1.24% downside to 1173 and 0.78% upside to 1197.  Equity futures are pointing to a weaker opening following a choppy pre market session. Declines in Asia and directionless trading in Europe are contributing to early uncertainty although several macro releases due later in the session may determine whether the market can break out of a narrow trading range.

  • Altera (ALTR) reaffirmed 4Q rev. forecast 
  • Clinical Data (CLDA) said it was selling its genetic and pharmacogenomic testing and biomarker development unit for ~15.4m, plus milestonoes to Transgenomic. 
  • Interactive Brokers (IBKR) declared a special dividend of $1.79-shr
  • J&J Snack Foods (JJSF US) boosted its quarterly dividend to 11.75c-shr, matching BDVD est.
  • Seagate Technology Plc (STX) ended talks to be taken private and authorized the repurchase of as much as $2b of its own stock

 PERFORMANCE

  • One day: Dow (0.36%), S&P (0.14%), Nasdaq (0.37%), Russell (0.11%)
  • Month-to-date: Dow (0.59%), S&P +0.38%, Nasdaq +0.71%, Russell +4.07%
  • Quarter-to-date: Dow +2.45%, S&P +4.08%, Nasdaq +6.61%, Russell +8.25%
  • Year-to-date: Dow +5.99%, S&P +6.52%, Nasdaq +11.28%, Russell +17.04%
  • Sector Performance: Financials +0.57%, Energy +0.52%, Materials +0.47%, Industrials (0.06%), Consumer Staples (0.31%), Healthcare (0.34%), Utilities (0.37%), Tech (0.59%), Consumer Discretionary (0.61%), and Telecom (0.95%)

 EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: -500 (+579)  
  • VOLUME: NYSE - 924.59 (+115.66%)
  • VIX: - 22.22 +13.60% - YTD PERFORMANCE - +2.49%)
  • SPX PUT/CALL RATIO: - 2.24 from 2.07 +&.79%  

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD - 13.67 -0.406 (-2.886%)
  • 3-MONTH T-BILL YIELD 0.18% +0.02%  
  • YIELD CURVE - 2.32 from 2.36

COMMODITY/GROWTH EXPECTATION:

  • CRB: 302.89 +0.58%
  • Oil: 85.73 +2.35% - NEUTRAL
  • COPPER: 376.75 +0.13% - BEARISH
  • GOLD: 1,367.14 +0.52% - BEARISH

CURRENCIES:

  • EURO: 1.3104 -1.04% - NEUTRAL
  • DOLLAR: 80.835 +0.59%  - BULLISH

OVERSEAS MARKETS:

 

EUROPEAN MARKETS:

  • FTSE 100: +0.03%; DAX +0.45%; CAC 40 +0.07%, IBEX +0.09%
  • Major indices are mixed with investors unsure how to react to attempts by EU leaders to stem the threat of contagion within the EU.
  • Questions remain about the likely effectiveness of the permanent European Stabilization Mechanism and debt markets have seen bond spreads widen again. Debt worries have also pushed the euro to a 10-week low against the dollar, Swiss Franc and Japanese Yen.
  • Gains in Basic Resources and Autos are offsetting weakness in financials although there is no clear pattern to trading
  • Portugal's banks may face an "intolerable risk" if the country fails to consolidate its public finances, the Bank of Portugal warned
  • OECD's chief economist said Italy does not face serious problems handling its debt burden in either the short or long term and does not need to do as much as other countries to control its public finances
  • Eurozone Oct Unemployment +10.1% vs cons +10.1%, CPI +1.9% vs cons +1.9%
  • Germany Nov Jobless Total (9K) vs cons (20K), Jobless Rate steady at +7.5%
  • France Oct PPI +0.8% m/m vs consensus +0.4% and prior +0.3%

ASIAN MARKTES:

  • Japan (1.87%); Hang Seng (0.7%); Shanghai Composite (1.6%)
  • Most Asian markets fell today, on worries that the Irish bailout would not stem the European debt crisis.
  • China dragged the region down when it dropped on fears interest rates will soon be raised and credit is going to tighten.
  • South Korea rose on oil refiners and brokerages. But chip makers fell.
  • Miners led Australia down on lower metals prices.
  • China fell as a shortfall of cash in the money market caused a liquidity squeeze in the stock market. Financials lost 2-3%. Small cap drug shares were sold off when the government announced measures to cut the prices of 17 types of medicines.
  • Decliners led advancers, 6-to-1, as Japan fell on Wall Street’s weakness and the euro’s slide against the yen. Europe-linked shares lost 2-3%.
  • Japan October industrial output (1.8%) m/m vs survey (3.3%). October jobless rate 5.1% vs 5.0% survey. October household spending (0.4%) y/y vs survey (0.7%). 

Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends

 

THE DAILY OUTLOOK - S P

 

THE DAILY OUTLOOK - VIX

 

THE DAILY OUTLOOK - DOLLAR

 

THE DAILY OUTLOOK - OIL

 

THE DAILY OUTLOOK - GOLD

 

THE DAILY OUTLOOK - COPPER



investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

THE M3: MELCO OPTIONS; SJM; BELLE; HENGUIN OCEAN RESORT; PACKER

The Macau Metro Monitor, November 30th, 2010

 

MELCO INTERNATIONAL GIVES LAWRENCE HO SHARE OPTIONS DUE TO "FINANCIAL SACRIFICE" macaubusiness.com

Melco International Development Limited’s board has granted 51,600,000 share options to the directors of the company; in particuarl, Chairman and CEO Lawrence Ho, the largest shareholder, is granted 38,000,000 share options.  The company stated that Mr. Ho has given financial support and sacrifice for Melco through his waiver of interest on the HK$1.18BN convertible loan notes, his loan of HK$250MM on an unsecured basis, and his decision to accept no salary from Nov 2008 until the company generates profits continuously for at least two years.

 

SJM ADVANCES ON INCLUSION IN MSCI HONG KONG INDEX Bloomberg

SJM gained 10.5% yesterday, the biggest gain since Nov 18.  SJM will be added to the MSCI Hong Kong Index tomorrow.

 

BELLE EYES MACAU PARTNER FOR MANILA BAY PROJECT macaubusiness.com

Belle Corp. is in discussions to team up with a Macau gaming firm for its Manila Bay Project.  Alfredo Benitez, majority owner of Leisure & Resorts World Corp. (LRWC), said he expects to conclude a deal before the end of the year.  LRWC is the local partner for the gaming component of Belle’s IR project.

 

HENGUIN OCEAN RESORT TO OPEN IN 2013 Xinhua News

The RMB 10BN Chime-Long International Ocean Resort will open in 2013 on Henguin Island, which sits directly across from Cotai.  The "Ocean Kingdom" project will be completed in two phases.  The first phase mainly involves the facilities in Fuxiang Bay. The “Ocean Kingdom” will have eight theme zones, each of them consisting of the three main components of amusement designs, performances and animal watching. The dolphin‐themed hotel after completion is set to become the largest ecological‐themed hotel in mainland China.  Angela Leong On Kei announced earlier this year that The Macau Theme Park and Resort Ltd will build a MOP 10.4BN theme park on Cotai.

 

PACKER'S HIGH-ROLLER WARNING Business Spectator

James Packer is concerned that the two S'pore IRs are hurting Crown's VIP business which fell 10% in turnover volume from July to November.


Old Austerity

“You never see the old austerity. That was the essence of civility; young people hereabouts, unbridled, now just want.”

-Moliere

 

That’s an old quote from a famous French playwright who has long been dead. “Moliere” was Jean-Baptiste Poquelin’s stage name. His urban legend was born when he collapsed and died in the middle of a play in 1673. He was 51 years old.

 

I’ll take some editorial liberty this morning and evolve Moliere’s quote for the Age of American Millenials and Baby Boomers: ‘You’ve never seen austerity. That was the essence of our grandparents; Millenials and their parents, unbridled, now just want.’

 

This is obviously a generalization but, in principle, I can’t imagine that an analyst from outer-space wouldn’t see the hypocrisy in Americans door busting each other on Black Friday for i-Pads at the same time as their Congress fights to keep interest rates on my savings account at zero percent as a result of an alleged depression.

 

Want, want, want. What can I get out of this market? Pretended Patriotism be damned, what’s in this for me?

 

The good and the bad news on this front is that we have leaders in this country who can enforce change. Some of that change is going to be slow. Some of it is going to hurt. Some of it is needed or what you’re seeing in European stock and bond markets is going to be playing at an American “Lifestyle” Center near you in 2011.

 

In proposing a 2-year pay freeze for US Federal employees, President Obama did the right thing yesterday in implementing the first stage of what we have been calling for since July of 2010 (when we were short the US Dollar on reckless government spending). Our Q3 of 2010 Hedgeye Macro Theme was titled “American Austerity” and we think that fiscal conservatism is the only path to US Dollar driven prosperity.

 

The debauching and devaluation experiments of the Big Government Interventionists have been tested and tried. From Japan to Europe and back home again, they have not worked. We need to fix these deficit and debt to GDP ratios, or the global bond market is going to fix us.

 

This morning you are seeing Greece’s stock market test its lows from June 2010 when the European Fiats made a conflicted and compromised promise to the world that Piling more short-term Debt-Upon-Debt was the elixir of life. Apparently 8 centuries of Reinhart & Rogoff data has once again trumped political storytelling. This time isn’t different.

 

Why me? Why now? Shouldn’t this be someone else’s problem?

 

I get that line of thinking, but I also get what wearing a team jersey means  - and, as legend USA Hockey Coach Herb Brooks said:

 

“You're looking for players whose name on the front of the sweater is more important than the one on the back.” 

 

Back to the construct of our intermediate-term global macro forecast…

  1. Growth Slowing
  2. Inflation Accelerating
  3. Interconnected Risk Compounding

We don’t have a choice but to do this now. European and Emerging Bond markets are telling you this and so are American Bond yields:

  1. European Sovereign Debt Yields continue to make a series of higher-highs as concerns push rightly towards Spain and Italy.
  2. Emerging Market Debt just had its worst month in 2 years (NOV down -2.9% on the EMBI Index with Brazilian and Russian weakness).
  3. US Municipal Debt funds just flashed their 2nd consecutive week of outflows, taking the 2-week total to north of $5 BILLION.

Yes, we recognize that a BILLION or a TRILLION dollars isn’t what it was to our grandparents, but these are still big numbers to consider on the margin. Remember, everything in global macro that matters happens on the margin.

 

US Treasury yields are bullish on both our immediate and intermediate-term durations (TRADE and TREND) again this morning as well (yes, that’s a very bad leading indicator for bond funds in your 401k). Despite The Ber-nank’s JapanEuro style political promises, Mr. Global Macro Market is saying hey, dude, remember The Lehman Brother?

 

If you or your parents are baby boomers, you know what a double digit mortgage rate means to your family’s discretionary income. God knows you don’t need a Johnny Come Lately Wall Street “economist” to warn you about that. Maybe it’s time to dig into those Old Austerity boxes of our forefathers this Christmas to remind ourselves that as good as it gets may be gone if we don’t stop ourselves from just want.

 

My immediate term support and resistance levels for the SP500 are now 1173 and 1197, respectively. I’ve maintained my ZERO percent asset allocation to US Equities. I’m still long the US Dollar (UUP) and short the SP500 (SPY) in the Hedgeye Portfolio.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Old Austerity - 1


Knock Knock Knocking on Austerity’s Door

Conclusion: Today’s proposed federal employee pay freeze by President Obama is an early step in what we expect will be increasing austerity over the coming years.  American Austerity is bullish for the U.S. dollar.

 

Positions: Long the U.S. Dollar via the etf UUP

 

In early July, we announced our Q3 2010 investment themes, which included Bear Market Macro, Housing Headwinds, and American Austerity.  On the last theme, we presented at the time that due to burgeoning debt and deficit issues domestically, the U.S. would have to implement fiscal austerity measures.   At the same time we noted in one of our slides that some of the PIIGS in Europe were leaving the trough and implementing aggressive austerity issues, which was bullish for the Euro and bearish for the U.S. dollar versus the Euro.

 

In the chart below, we’ve highlighted the U.S. dollar index going back 9-month.  As it shows, the U.S. dollar weakened versus the Euro following our presentation in July and then began aggressively strengthening ahead of and in conjunction with the U.S. midterm elections where the Republicans gained 63 seats in the House of Representatives.  The massive shift in political power was and is an indication that there would be, at least, an attempt at implementing austerity measures domestically.

 

Knock Knock Knocking on Austerity’s Door - 1

 

Earlier today, President Obama introduced a preliminary austerity step as it relates to the pay of federal employees.  Obama is proposing to freeze the pay of federal employees for the next two years.  Not surprisingly, in the current politically-charged environment the response to this pay freeze was mixed at best.  Speaker Designate John Boehner (R-OH) responded with the following:

 

“I welcome President Obama's announcement, and hope he will build on it by embracing much-needed steps to reduce both the size and the cost of government, including the net federal hiring freeze Republicans propose in our Pledge to America. Without a hiring freeze, a pay freeze won't do much to rein in a federal bureaucracy that added hundreds of thousands of employees to its payroll over the last two years while the private sector shed millions of jobs.”

 

The message from Boehner, the defacto leader amongst elected Republican politicians, is clearly that they will be looking for more austerity measures as the new Congress opens in January.

 

The reality is, though, independent groups have analyzed the Republican Pledge to American and it, too, appears to fall short as it relates to reducing the deficit.  In the chart below, which appeared in Reason Magazine online and was put together by the Congressional Budget Office, the deficit is looked at as if the Pledge to America were fully implemented.  In aggregate, while spending does narrow, it is only marginally and federal government revenue is not projected to increase, so the outlook for the deficit, and growing federal debt balance, does not change dramatically.

 

Knock Knock Knocking on Austerity’s Door - 2

 

While the U.S. dollar will continue to strengthen with incremental American Austerity measures as we are seeing proposed today, the dollar will eventually require some dramatic measures to sustain its climb and for us to remain long term bullish of the U.S. dollar.  While their report was widely derided from the left (too much cutting in spending) and from the right (too many implied tax increases), the Presidential Fiscal Commission lead by Alan Simpson and Erskine Bowles presented a number of dramatic proposals to narrow the deficit, which included: 

  • Index the retirement age to longevity -- i.e., increase the retirement age to qualify for Social Security -- to age 69 by 2075;
  • Index Social Security yearly increases to a lower inflation rate, which will generally mean lower cost of living increases and less money per average recipient;
  • The co-chairs suggest capping both government expenditures and revenue at 21% of GDP eventually;
  • In their second plan, they would increase the personal deduction to $15,000, create 3 tax brackets (15, 25 and 35%); repeal or significantly curtail a number of popular tax deductions (including the state and local deduction and the mortgage interest deduction); and eliminate other tax expenditures;
  • They also suggest raising the federal gas tax by 15 cents per gallon;
  •  Eliminate all earmarks;
  • Freeze federal worker wage increases through 2014; eliminate 200,000 federal jobs by 2020; and eliminate 250,000 federal non-defense contractor jobs by 2015; and
  • Reduce procurement by 15 percent, or $20 billion. 

While today’s proposal by President Obama is incremental, for austerity to be long term bullish for the U.S. dollar it will require more dramatic and politically unpopular measures such as the ones outlined above.

 

Daryl G. Jones

Managing Director


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