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The Golden Haze

“A question that sometimes drives me hazy: am I or are the others crazy?”

-Albert Einstein


Per our friends at Wikipedia, “haze is traditionally an atmospheric phenomenon where dust, smoke, and other dry particles obscure the clarity of the sky.” That just about summarizes what I think about the US stock market right here and now.


When I say now, I mean yesterday’s closing price. The SP500 inched up another point above its YTD closing high, taking its YTD gain to +11.4%. If you’re looking at this market price through The Golden Haze of ‘everything is going to be ok’ from here, you must be saying that higher-highs in a market price are bullish. They are, until they aren’t.


Up until 2 weeks ago, The Golden Haze was quite tranquilizing in another asset class market price – Gold. Then the music of bullish price momentum started to fade away. It didn’t stop suddenly. It didn’t stop hastily. It just started to stop…


The price of gold is now hitting a 2-week low this morning and is officially broken on my immediate-term TRADE duration. What were bullish higher-highs before December the 6th can now be considered bearish lower-highs. Again, until they aren’t.


Since I sold our entire gold position on December 6th  (+3.4% higher at $138.55 GLD), I suppose I have some credibility in attempting to make another “call” on gold from here. So let’s take a shot at this and consider the why and where from here:


Why is Gold down?

  1. CORRELATION RISK: Over the long term, Gold tends to underperform when real interest rates are positive.
  2. RELATIVE STRENGTH: Real-interest rates (domestic and global bond yields) have been blasting to the upside since November.
  3. CURRENCY COMPETITION: Don’t look now, but the US Dollar is up in 6 of the last 7 weeks as Fed Fighting becomes fashionable.

Where does Gold go from here?

  1. Immediate term TRADE: as of this morning my immediate term TRADE lines of support and resistance are $1362 and $1391, respectively. Trade the range.
  2. Intermediate term TREND: I introduced this line to investors in Calgary and Vancouver in a slide presentation on December 5th and 6th and the TREND line hasn’t changed. There’s intermediate term mean-reversion risk in the price of gold down to $1313.
  3. Long-term TAIL: there is a world full of support down in the $1 range and I’d love to buy back my gold there.

Now anyone who knows me well knows that I probably won’t have the patience to wait for $1230 gold on my buyback program. Heck, I may not have the patience to wait for $1313 either. But, provided that I remain bullish on the US Dollar (long UUP) and US Treasury Yields (short SHY), I’ll have a very hard time explaining why I’d buy back gold anytime soon. Being short gold on the next rally to lower-highs may be the better bet. We’ll see.


Back to The Golden Haze that is being long US Equities here… I think it’s instructive to think through the same CORRELATION RISK, RELATIVE STRENGTH, and CURRENCY COMPETITION scenario analysis that I went through for gold.

  1. CORRELATION RISK: using an intermediate-term TREND duration (6 months), the SP500 has an inverse correlation to the US Dollar Index of -0.77 and an r-square of 0.60. In other words, sustained USD strength should be bearish for US equities.
  2. RELATIVE STRENGTH: since March of 2009, the SP500 has outperformed gold by a lot (SP500 is +83.7% from its March lows, whereas gold is up 53%). So if Gold can go down in the face of Fed Fighting (competing with higher real interest rates), US stocks can.
  3. CURRENCY COMPETITION:  seasonal spikes in the US Dollar Index have happened in both of the last 2 years (2009 and 2010). It wasn’t cool to be levered-long US Equities in either of those January-February periods.

Never mind the obscurity of making the “valuation” case for stocks here; valuation isn’t a catalyst. Never mind the atmospheric phenomenon of short-term politicking and its effect on stoking “growth” hopes in the US economy either. That’s now consensus.


Take the “call” to sell US stocks here from a man who is already -3.37% too early in his short position (that would be me), as every Big Broker’s “strategist” is now officially calling for the US stock market to be up next year.


My immediate term support and resistance levels for the SP500 are now 1234 and 1248, respectively. If the SP500 makes another higher-high in the coming weeks, look for me to short it again. Yesterday I moved to a 70% position in Cash in the Hedgeye Asset Allocation Model.


Enjoy your weekend and best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The Golden Haze - 1

The Enemy of Growth

This note was originally published at 8am on December 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.

“Conformity is the jailer of freedom and the enemy of growth.”

-John F. Kennedy

I’ve heard a lot about “growth” in recent weeks. After a March 2009 trough to December 2010 peak rally in the SP500 of +83%, the US centric stock market bulls say “growth is back.” As a result, conforming to an institutionalized consensus weeks before our profession receives its year-end bonus check is a mounting pressure in my inbox. I’ve seen this movie before.


The Enemy of Growth isn’t going away. It’s called debt. Sovereign debt. And, no matter where you go in the new year, there will be more and more of it…


You don’t have to take my word for it on this. The longest of long-term data series we can find on sovereign debt default cycles and their correlations to fiat currency issued debts and structural inflation can be found in Reinhart & Rogoff’s “This Time Is Different.”


No, this is not a new thesis this morning. It’s a critical reminder. Because US stock market consensus is choosing to ignore it for a few more weeks doesn’t mean it ceases to exist.


The Enemy of Growth isn’t a Thunder Bay bear. It’s marked-to-market on your globally interconnected macro screens every day. While it’s convenient to assume that a +10% YTD return in the SP500 is a leading indicator for growth, one can easily argue that US style Jobless Stagflation won’t lead America to sustainable economic growth in 2011.


Remember, “inflation is a policy.” Or at least that’s what an ole school Austrian economist by the name of Ludwig von Mises said. Before your big Keynesian cheerleader of a global liquidity trap leads you to believe otherwise, don’t forget that it was von Mises who already called out Bernanke’s strategy to inflate 50 years ago when he said:


“The fact is that, in the not very long run, inflation doesn’t cure unemployment.” (Economic Policy, 4th Lecture, “Inflation”, page 53).


The Enemy of Growth is inflation. We know that, much like Jimmy Carter and then Fed Head, Arthur Burns, once tried to argue in the 1970s, some people think inflation is cool for some people. Some of those people aren’t the poor or middle-class however.


Currently, there is no more obvious threat to Global Growth Slowing than what you are seeing in emerging markets. Heck, some of these markets (like Hong Kong) might not even be considered “emerging” anymore. That’s not the point – what’s happening on the global macro scoreboard to emerging market stocks and bonds in the last 6 weeks is…


Since the beginning of November, here’s the score:

  1. Hong Kong’s Hang Seng Index has dropped -8.1% since November the 8th.
  2. India’s BSE Sensex Index has dropped -8.3% since November the 5th.
  3. Brazil’s Bovespa Index has dropped -7.1% since November the 4th.

Now, the first thing you’ll hear coming out of US-centric stock market bulls right now has nothing to do with:

  1. Spiking Sovereign Debt Yields in Spain, Italy, Portugal, Argentina, America, etc…
  2. US Treasury and Global Commodity markets flashing clean cut inflation signals.
  3. The BRIC’s (Brazil, Russia, India, and China) falling, well, like bricks.

No, no, no. It’s all about a short-term year-end bonus “pop” in US growth associated with cutting taxes so that the world worries more and more about America’s long-term sovereign debt risk. Short term political resolve perpetuating long term systemic risk. Nice trade.


Markets “pop” then “drop”… most emerging stock and bond markets are already dropping…


Like the broken European promises of reducing their deficit/GDP ratios when European bond yields started breaking out in December of last year (when Hedgeye introduced our “Sovereign Debt Dichotomy” Macro Theme), now professional US politicians are promising you this time is different. This time it’s all about “growth”…


This time, The Enemy of Growth is a government inflation policy itself.


My immediate term support and resistance levels for the SP500 are now 1232 and 1246, respectively. I continue to be a seller of bonds, reducing my asset allocation to bonds from 6% to 3% as of yesterday’s close. Inflation is bad for bonds.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The Enemy of Growth - 1

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Hard Lessons from Japan

“The world is awash with liquidity.”

-Anonymous Investor, circa late-2007


Conclusion: New proposed measures to stimulate the Japanese economy will result in nothing more than smoke, mirrors, and further economic stagnation. Further, taking a dive into Japanese corporate balance sheets and psyches reveal some interesting takeaways on where the U.S. may be headed.


Position: We remain bearish on Japanese equities for the intermediate-term TREND and are currently short the Japanese yen via the etf FXY.


Today Japan, the world’s leader in Big Government Intervention, reminded us of the long term consequences of trading away long-term, sustainable prosperity in exchange for short-term, levered growth. In addition, they reminded us just how hard it can be to wean ourselves off the fiscal and monetary stimulus drug that many investors recklessly clamor for.


This morning a panel led by Finance Minister Yoshihiko Noda unveiled a tax stimulus package that is designed to “increase hiring” and “spur economic growth”. The measures include: 

  • A to-be-determined corporate tax rate cut (latest rumor at 5%);
  • A ¥200,000 tax write-off per person for small firms that hire at least five people or increase their workforce by 10%; and
  • A 300bps tax rate reduction for compliant small businesses. 

Of course, with Japan struggling to contain the world’s largest public debt burden, there were compromises to help recoup the ¥1.4 to ¥2.1 trillion in proposed lost revenue: 

  • The government will cap income deductions for those earning in excess of ¥15 million annually;
  • Income deductions for corporate executives earning in excess of ¥40 million annually will be cut in half;
  • The minimum inheritance tax will rise +500bps to 55%; and
  • Levies on energy will increase as part of a broader environmental tax hike. 

Combined, these measures are supposed to promote growth and stimulate the economy. From our vantage point, it looks like Japan is merely robbing Peter to pay Paul – at best. As we have shown in our Japan’s Jugular slide deck, the Japanese economy has not responded well to a bevy of Keynesian stimulus measures over the years:


Hard Lessons from Japan - 1


Why has Japan not responded well? Pundits point to a multitude or reasons, including demographics, overcapacity and a weak property market. The single most important factor we highlight is the lack of business and consumer confidence resulting from nearly two decades of fear-mongering and government intervention.


In classic liquidity trap fashion, Japanese consumers have been reluctant to spend and borrow, banks have been reluctant to lend, and firms have been reluctant to invest (all on the margin, of course). Take Japanese corporation’s cash levels, for example; cash and equivalents at members of the Nikkei 225 climbed +8% this year to a record ¥1,309 ($15.60) per share. Further, companies cut bond sales 17% YoY even as corporate yields hit a five-year low earlier in the quarter.


The lack of interest in investing has been driven by weak domestic prospects for growth and a lack of favorable rates of return. Anecdotally, the comments of Kazuto Tsubouchi’s, the CFO of Japan’s largest mobile phone operator, NTT DoCoMo, should not be taken lightly:


“We have more cash than we need, but no growth investments… This is a great time to issue bonds and we would if we had no money.”


Apparently sitting on mounds of cash is not equivalent to finding and extracting an actual rate of return on that money. Keep that in mind the next time you hear the tired bullish argument that “companies are sitting on loads of cash and balance sheets are pristine”.


While we’d be remiss to refute either point (S&P 500 cash holdings have risen +10% YTD to $261.68 per share – the most since at least 1998), we are offering a contrarian view to the consensus belief that suddenly the world’s excess liquidity will magically translate into positive investment returns. If the Japanese experience is any guide, we’re likely to see more of the same cash hoarding by U.S. companies, as our burgeoning public debt north of 90%/GDP looks to structurally impair U.S. economic growth going forward.


Of course U.S. companies could follow Japan, China, and other cash rich nations into hunting for growth via emerging market acquisitions. Japan, for one, has increased its overseas investments by +18.3% over its full-year 2009 total of $22.9 billion.


As more and more corporations from slow-growth, developed economies look to buy growth via overseas transactions, expect the prices of those assets to be bid up. Emerging market assets will be overpaid for and “goodwill” will join “cash” as another bloated part of corporate balance sheets.


Lastly, we saw Japan’s Tankan Survey register its first drop since 1Q09 among large manufacturers and large non-manufacturers, coming in at 5 and 1, respectively. The 1Q11 forecasts point to outright negative sentiment in the range of (-1) to (-2).


Hard Lessons from Japan - 2


From a quantitative perspective, Japan's NIkkei 225 is bullish on both the TRADE and TREND durations, aided by recent yen weakness. We continue to caution investors that Japanese equities are setup for a sucker punch once the tide turns on equities as an asset class in early 1H11. We strongly recommend you don’t buy the storytelling associated with “Chinese acquisitions of Japanese firms” or yen weakness. Japanese exporter’s profits are likely to slow in 1H11 right alongside global growth – irrespective of the yen. 


Darius Dale



Hard Lessons from Japan - 3

No Longer Just a Hoop Dream

Another month of strong sales and unit growth for basketball footwear, marking the fourth in a row of positive increases.  This should not be too surprising given the resurgence in excitement surrounding the NBA (TNT ratings season-to-date are up 40% y/y), the launch of UA’s basketball shoe, and recent wave of new product introductions (Lebron VIII, Reebok Zig, Hyperdunk 2010, etc…).  Importantly, we remain confident that this remains the beginning of a longer term trend. 


As shown below, the category suffered declines in 14 of the prior 16 months beginning in April 2009.  While comparisons remain easy, the emergence of key product and technology launches coupled with increased marketing  keeps us especially bullish on the prospects for Foot Locker .  Importantly, year to date unit sales remain below levels recorded over the past couple of years, leaving room for further recovery.  FL is the biggest the beneficiary of the hoops recovery given its industry leading penetration of the category.  However, this is not a zero sum game and we believe the rising tide will also benefit additional retailers including DKS, HIBB, and FINL with exposure to basketball.


No Longer Just a Hoop Dream - basketball


Eric Levine



I know food inflation is only a small part of the CPI but I’m using this as an example to make a bigger point, the current government data does not reflect reality.


We already know that the weights assigned to different components of CPI do not accurately reflect consumers’ share of wallet among those components.  On another note, recurring seasonal patterns, which are present in numerous time series data presented by the government, obscure the underlying behavior given the current economic climate.  If the 2010 data is seasonally adjusted using 2008 or 2009, you end up with one conclusion, and if seasonally adjusted using pre-2008 data – one likely has a different interpretation given the difference in volatility during these two respective periods.  These distortions are very clear in the recently reported CPI data. 


Yesterday's CPI came in below expectations, thanks partially to gasoline inflation that was reduced by seasonal adjustments. 


The issue here is that in November 2009, gasoline inflation was boosted by seasonal adjustments, but it was reduced in November 2010. Specifically, a non seasonally-adjusted 4.1% monthly gain in November 2009 gasoline prices ended up as a seasonally-adjusted gain of 6.4%. In contrast, a not-seasonally-adjusted 2.0% monthly gain in November 2010 gasoline prices ended as a seasonally-adjusted gain of 0.7%.


If you are a consumer that drove to work in the month of November 2009 and again November 2010, you paid 8% more for gas at the pump in November 2010 on a year-over-year basis.  The government CPI figure is clearly divergent from this figure.  Considering how integral a line item gasoline is for the consumer in his/her P&L, it is ridiculous that the divergence between gas prices and CPI is so stark. 


As a client of Hedgeye once said, “there is no inflation if you are an anorexic pedestrian”.  Per Wikipedia, CPI is representative of changes through time in the price level of consumer goods and services purchased by households.  Not so much.


Howard Penney

Managing Director


CPI - SMOKE AND MIRRORS - hedgeye inflation index1

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.