This note was originally published at 8am on January 03, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“I know it's hard when you're up to your armpits in alligators to remember you came here to drain the swamp.”
Welcome back to a New Year. It’s Game Time.
While my New Year’s resolution is to remain as far away from professional politicians and academic charlatans as I possibly can, until this game changes I’ll have to remain focused on attempting to understand what Big Government Intervention can do to our markets.
President Obama seems keen on understanding more about what Ronald Reagan thought about the economy. Or at least that’s what the White House says he was reading about this past week. Lou Cannon’s President Reagan: The Role of a Lifetime is officially out of stock on Amazon due to a surge in speculative Democrat buying.
Ironically enough, I read The Reagan I Knew by Bill Buckley a few weeks ago. Don’t worry, I’m neither Republican or Democrat. I’m just a Canadian-American looking for historical perspectives, accepting that they are often decorated with hyperbole.
What will be most interesting to me with this new Obama/Reagonomics Revolution thing is whether or not the President justifies a bloated US budget deficit by reminding the Republicans that “Ronnie used one.” After all, as Danilo Petranovich reminds us in the Introduction of Buckley’s book, “Reagan, of course, had promised to cut the size of government, and yet the budget deficit nearly doubled during his tenure.”
American storytelling and political hypocrisies aside, the non-fiction version of the fiscal New Year is that America is up to its armpits in deficits and debts. It’s time we “drain the swamp”, and I think we can all save and make money while we do it.
In term of percentage allocations, here’s how I have the Hedgeye Asset Allocation Model positioned for what we’ll be introducing as a Q1 Macro Theme in the coming weeks – American Sacrifice (fiscal reform):
- US Cash = 61% (long US Dollar, UUP)
- International FX = 18% (long Chinese Yuan, CYB)
- International Equities = 9% (long Germany, EWG)
- Commodities = 6% (long Oil, OIL; long Sugar, SGG)
- US Equities = 3% (long Healthcare, XLV)
- Fixed Income = 3% (long Treasury Inflation Protection, TIP)
For those of you who follow my day-to-day risk management moves closely, you’ll recognize that I dropped my Cash position from 70% to 61% last week and re-allocated that Cash to Commodities and US Equities. This doesn’t mean I’m bullish on US Equities up here. It means I’m bullish on the Energy and Healthcare sectors at these prices.
There are obviously plenty of negative mean-reversion risks associated with buying anything US Equities after an +86% rally from the March 2009 lows. If you dare to chase equity oriented yields up here, we think you need to protect against 3 critical risk factors that are going to be perpetuated by Big Government Intervention:
- Fed Policy
If we’re going to attempt to find the political spine to “drain the swamp”, these 3 factors will remain omnipresent. Congress will be getting paid to push their own book. Fed Policy rhetoric will trade like a NYC hedge fund. And yes, Inflation, will remain a policy.
Energy (XLE) and Healthcare (XLV) companies have leverage to inflation. Higher selling prices, in theory, help these companies expand margins. While the SP500 is running close to peak margins, these two sectors aren’t. There’s some mean-reversion opportunity there in equity prices for these sectors as a result.
In Energy, I’m not long the sector – I’m long the stocks. We remain bullish on China National Offshore (CEO), Suncor (SU) and Lukoil (LUKOY). In the immediate-term, the Energy sector ETF (XLE) is overbought with immediate-term TRADE support down at $66.29. In Healthcare, immediate-term TRADE lines of support and resistance for the XLV are $31.03 and $31.91, respectively.
From an asset allocation perspective (and I mean your money, not some theoretical Big Broker’s high net fee, commission, and compensation model), being bearish on Congress and bullish on its inflation policy is fairly straightforward to express. If I had to be in one or the other, I’d be in US Equities over US Treasury Bonds here. Fortunately, I don’t have to be in either.
What I am most bullish on is the hard earned Cash that my family and firm has earned over the course of the last 3 years. No, we weren’t the super duper top US Equity performer of the Year in 2010 (although I did win the Forbes stock picking contest!)… but we made money for the 3rd consecutive year, and there’s nothing that smells like America’s Armpits about that.
My immediate term support and resistance lines in the SP500 are now 1249 and 1263, respectively.
Best of luck out there this year,
Keith R. McCullough
Chief Executive Officer