TODAY’S S&P 500 SET-UP - January 13, 2011

Equity futures remain close to fair value in what has been a quiet morning as we await fresh MACRO catalysts ahead of the earnings season.



  • 8:30 a.m.: Initial jobless claims, January 8, est. 410k, continuing claims est. 4088k
  • 8:30 a.m.: Producer price index, December, M/m est. 0.8%, ex. food and energy est. 0.2%
  • 8:30 a.m.: U.S. trade balance, November, est. -$40.5b
  • Net export sales (cotton, corn, soy meal, soybeans, soy oil, wheat), Jan. 6
  • 10:30 a.m.: EIA Natural gas storage change, Jan. 7, est. -149
  • 1 p.m.: U.S. sells $13b 30-yr bonds
  • 1 p.m.: Fed Chairman Ben Bernanke speaks at FDIC panel on small business lending


  • Jury selection begins for Mattel vs MGA Entertainment trial over the origins of its rival’s Bratz dolls.  Mattel’s $100m verdict was thrown out on appeal last year
  • Drug makers, led by Pfizer, pushing for U.S. guidelines to let them post more tweets and online videos without violating marketing rules for print, radio and television
  • AIG said it is set to issue 75m warrants to shareholders by Jan. 19 as it works to repay the $182.3b U.S. rescue
  • U.S., France, Germany and the U.K. need to control their spending on pensions and health care to keep their debt burdens stable over the long term - according to Moody’s
  • Alliance Bernstein Holding LP (AB) CFO John Howard to leave.  Edward Farrell named interim CFO
  • American Capital Agency (AGNC) filed for 18m-Shr secondary; sees EPS for Qtr ex items >$1.20 vs est. $1.21
  • Blackboard (BBBB) completed acquisition of Presidium; sees 1Q adj. EPS 24c, unclear how compares with est. 34c
  • Mercury Computer Systems (MRCY) acquired RF Maker LNX for $31m upfront
  • Universal American Financial (UAM) sees year sales $5.65b vs est. $5.68b


  • One day: Dow +0.72%, S&P +0.90%, Nasdaq +0.75%, Russell 2000 +0.83%
  • Last Week: Dow +0.84%, S&P +1.10%, Nasdaq 1.90%, Russell +0.53%
  • Month-to-date: Dow +1.54%, S&P +2.25%, Nasdaq +3.18%, Russell +2.26%
  • Sector Performance - BULLISH (EVERY SECTOR IS POSITIVE) - Financials +1.7%, Energy +1.2%, Tech +0.9%, Materials +0.9%, Industrials +0.9%, Consumer Spls +0.8%, Utilities +0.5%, Healthcare +0.5%,Telecom +0.5%, Consumer Disc +0.3%   


  • ADVANCE/DECLINE LINE: 1274 (+722)  
  • VOLUME: NYSE 963.60 (+2.09%)
  • VIX:  16.24 -3.85% YTD PERFORMANCE: -8.51%
  • SPX PUT/CALL RATIO: 1.29 from 1.90 (-32.30%)  


Treasuries were weaker today with the pickup in risk appetite. However, some support came from a strong $21B auction of 10-year notes.

  • TED SPREAD: 16.32 0.203 (1.260%)
  • 3-MONTH T-BILL YIELD: 0.15%     
  • YIELD CURVE: 2.79 from 2.73


  • CRB: 334.88 +1.03%  - up over 3% so far this week
  • Oil: 91.86 +0.82% - trading -0.28% in the AM
  •  Oil rose for a second day, as investors’ demand for riskier assets gained with advancing equity markets.
  • COPPER: 441.15 +1.44% - trading -0.82% in the AM
  • Copper Slides as World Bank Predicts Weakening of Chinese Economic Growth
  • GOLD: 1,383.70 +0.10% - trading -0.36% in the AM
  • Gold Buying Shows RBI Losing `Never Ending' Inflation Battle: India Credit


  • Corn Surges to 30-Month High After USDA Cuts Supply Estimates; Wheat Gains
  • Rio Tinto Declares Force Majeure at Australia Aluminum Smelter on Flooding
  • Oil Trades Near 27-Month High on U.S. Stockpile Decline, Alaska Pipe Plans
  • Cocoa Slides for First Day in Five on ICCO Forecast for Increased Supply
  • Steel Output in India May Decline as Australia Floods Reduce Coal Supplies
  • Nickel Supply to Swing Back to Surplus in 2011, Sumitomo Metal Mining Says
  • Lundin Agrees to Combine With Inmet in $9.1 Billion Canadian Mining Deal
  • Cotton Outlook Cut 10% by National Australian Bank After Deadly Flooding
  • India Must `Copy' China, Build Food Stockpiles to Cool Prices, Adani Says
  • Sri Trang Refiles Plan to Sell Shares in Singapore With Rubber at Record
  • Coal at 28-Month High to Beat Oil, Gas on Australia FloodS


  • EURO: 1.3083 +0.88% - trading +0.44 in the AM
  • DOLLAR: 80.031 -1.01% - trading +0.01% in the AM


  • FTSE 100: (0.17%); DAX: +0.02%; CAC 40: +0.41% (as of 7:30 EST)
  • European markets trade mixed with peripheral European markets again leading gains ahead of more peripheral debt sales and the uneventful interest rate decisions at both the BOE and ECB.
  • Spain up 2.6% announced a successful 5-year auction, with yields significantly above the previous auction and market participants await the results of Italy's debt auction.
  • Advancing and declining sectors are even at 9-9, with banks +3% the best performers while basic resources down 2% are leading the decliners.
  • France Dec final CPI +2% y/y vs con +1.9%
  • UK Nov Ind Prod +3.3% y/y and con +3.4%
  • UK Nov Manf Prod +5.6% y/y vs con +5.3%


  • Asian markets rose today on gains overseas and a successful bond auction in Portugal.
  • Australia rose 1.5%, as the Queensland floods’ impact was less damaging than feared for major insurers.
  • Megabanks followed their American peers higher, leading Japan to up 0.73%. But the rise was limited when core machinery orders came in well below expectations. Japan November core machinery orders (3.0%) m/m vs survey +1.6%.  Sumitomo Trust & Banking and Chuo Mitsui Trust Holdings rose 5% each when an executive said the combined entity may offer a higher dividend payout ratio than the individual banks do.
  • HSBC was the biggest lift for Hong Kong for the second day in a row. Tsingtao Brewery, seen as having margins that will be hurt as food prices go up, fell 3%.
  • China increased slightly on strength in oil stocks. Sinopec and Petrochina put on 2% and 1%, respectively. Software companies did well when China’s state council confirmed long-held expectations that it will promote the software and integrated circuit industries.
  • South Korea ended with a small loss when the Bank of Korea surprised people by raising rates 25 bp to 2.75% in a bid to fight inflation. Financials rose. 


The Macau Metro Monitor, January 13, 2011


New Singapore property measures, effective Friday, include:


1) Increasing the holding period for imposition of Seller's Stamp Duty (SSD) from the current three years to four years

2) Raising the SSD rates to 16%, 12%, 8% and 4% of consideration for residential properties which are bought on or after Friday, and are sold in the first, second, third and fourth year of purchase respectively

3) Lower the Loan-To-Value (LTV) limit to 50% on housing loans granted by financial institutions regulated by MAS for property purchasers who are not individuals

4) Lower the LTV limit on housing loans granted by financial institutions regulated by the Monetary Authority of Singapore from 70%to 60% for property purchasers who are individuals with one or more outstanding housing loans at the time of the new housing purchase


U.S. Federal Budget Deficit . . . Not Getting Better

Conclusion:  The U.S. Federal budget deficit sees little improvement with the December numbers reported today.  The Congressional Budget Office’s estimates for the deficit will likely be going much higher when its new projections come out in the coming weeks.


Positions: Long the U.S. Dollar via UUP; Short 1-3YR Treasuries via SHY


While the U.S. budget deficit for December came in line with consensus at a deficit of -$80BN, the question is really whether consensus matters.  As it relates to the budget deficits, we would argue that where the number comes in versus consensus is really irrelevant as compared to the degree of change sequentially and on a year-over-year basis.  The key takeaway for the first three months of the federal budget year is that deficit issue is not getting better.


As it relates to the key line items for the first quarter of the fiscal year, this is what was reported: 

  • Expenditures continue to grow and for the first quarter are up 3% on a y-o-y basis;
  • Net interest expense on debt is up 9.5% y-o-y and is now almost 7% of total government expenditures (we are seeing the negative impact of more debt and higher interest rates); and
  • Finally, if we normalize for TARP, the overall deficit for the first quarter is -$372BN, which is an increase over -$369BN in the same period last year.

To be fair to the federal government, they offered that a number of timing issues that may be distorting this year’s numbers versus last year (calendar issues and the timing of insurance payments).  From our perspective, we would expect these timing issues to normalize over the course of the year and have no real way of backing them out.  Therefore, when we look at the numbers we normalize for 1-time payments or expenditures only, which in the case of our analysis are TARP and payments to GSEs.


A key take away from this report is that the Congressional Budget Office is going to have to take up its budget deficit projections for fiscal 2011.  The last update on annual budget projections came in August of 2010 and fiscal 2011 was projected to have a budget deficit of -$1,066BN, which would have been more than ~ -$230BN less than the actual budget deficit in fiscal 2010, or a 17% improvement.  Given that we are seeing minimal improvement in the deficit the CBO will likely have to dramatically take up its estimates for this year and perhaps the next couple years.  The new estimates are expected to be released later this month and will be a catalyst to be focused on.


Just as a refresher, the current budget deficit projections for the next three years are: 

  • 2011 - $1,066BN;
  • 2012 - $665BN; and
  • 2013 - $525BN

These projections will be going higher, and likely dramatically so in the coming weeks.


This report and its implications that future estimates need to go higher will be coming at a very opportune time for Republicans in Congress who have made deficit reduction one of their hallmark issues heading into the 112th Congress.  This report only adds more credibility to the case of deficit hawks like Ron Paul who will have the conch in coming weeks.


Daryl G. Jones
Managing Director

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The Muni Bond Market: Silent But Deadly

Conclusion: The $2.9 trillion municipal bond market is poised to make headlines and rattle global financial markets in 2011. Keep this threat front and center on your “white board” of interconnected risk.


Position: Short Muni Bonds via the etf MUB


Quite frankly, it amazes us at Hedgeye how little attention investors are paying to interconnected risk over the last 2-3 months. While the trajectory of US economic fundamentals over this time frame can be debated, we don’t see any signs of abatement in some key domestic risks playing out literally right under our collective noses.


Housing Headwinds, originally introduced back in 2Q10 by Josh Steiner, our Managing Director of Financials, continue to matriculate. US housing prices are declining at an accelerating rate in 3 of the 4 indexes we track – even from depressed levels of comparison. We expect something in order of 15-20% further downside by year’s end.


The Muni Bond Market: Silent But Deadly - 1


Identifying the interconnectedness of this risk as it relates to the muni bond market leads us to another interesting chart. Local Government Property Tax Receipts grew +7.7% YoY in 3Q10, the second consecutive quarter of growth. Since their tax assessments and property appraisals operate on a ~3YR lag, this trend is not sustainable, as State & Local Property Tax Receipts correlate positively with a 0.97 r² to the S&P/Case-Shiller Home Price Index when lagged three years.


The Muni Bond Market: Silent But Deadly - 2


The Muni Bond Market: Silent But Deadly - 3


Given that local governments collect roughly 97% of all Property Tax Receipts, representing ~26% of their revenue, we smell trouble on the way for already-strained municipal budgets. Further exacerbating budgetary headwinds is the accelerating amount of fiscal austerity going on at the State and Federal levels, roughly 30% and 4% of municipal government revenues, respectively.


Since January 1st (LESS THAN TWO WEEKS), we’ve seen a drastic amount of fiscal conservatism and budget-slashing proposals at the State & Federal level. Some highlights include (not at all limited to): 

  • FEDERAL: $100B in spending cuts proposed by House Republicans from non-defense, discretionary spending;
  • CA: $12.5B in spending cuts proposed by new Governor Jerry Brown which targets: $1.7B in healthcare, $1.5B in welfare, $1.4B in public universities and community colleges, 10% of all employment costs – each with the intention of approval by March; Additional proposal pushing an extension of 2009’s “temporary” tax increase ($9.3B); Recently ordered the recall of ~48k government-paid mobile phones, which could save ~$20M;
  • IL: Just passed a +67% income tax increase, upping the State income tax rate to 5% from 3% through 2014;
  • OH: Pushing legislation that would ban strikes by public school teachers and a proposal to prevent State-financed social workers from forming unions;
  • NJ: Proposal to undue a 9% pension increase which was enacted in 2001;
  • NY: Proposal to save $200-$400M by implementing a one-year freeze for State workers and a proposal to cut $2.1B in Medicaid outlays in FY12;
  • TX: Plans to cut $4.3B from spending on education and health & human services; and
  • WI: Pushing legislation that would prevent public sector employees from forming unions and bargain contracts. 

Just last week, House Budget Committee Chairman Paul Ryan (R. WI) had this to say on the prospect of a Federal bailout for a distressed States:


“We are not interested in a bailout… Should taxpayers in frugal states be bailing out taxpayers in profligate states? Should taxpayers in Indiana, who have paid their bills on time, who have done their job fiscally, be bailing out Californians, who haven’t? No, that’s a moral hazard we are not interested in creating… If we bailed out one state, then all of the debt of all of the states is not just implied, it’s almost explicitly put on the books of the federal government.” 


In all reality, the likelihood of the Federal government having to bail out a US State in this fiscal year or the next is extremely low (no disrespect to Meredith Whitney, who is calling for 50-100 “meaningful defaults in 2011 on the order of “hundreds of billions of dollars”). In fact, no State has defaulted since Arkansas did back in 1933.


Where this hard line on future aid really impacts the US economy is at the municipal level, where both State aid and Federal support are running dry after two years of stimulus spending. Given this headwind and the upward trajectory of interest rates, we do believe there is a substantial risk for a meaningful amount of local governments and local authorities to default or declare bankruptcy in 2011. By meaningful, we mean enough to make negative headlines and rattle the US debt market, which has far-reaching implications beyond that.


The Muni Bond Market: Silent But Deadly - 4


According to Chapman & Cutler, as Chicago Law firm, only five municipalities sought bankruptcy protection in 2010 (-50% YoY), with the largest being a South Carolina toll road restructuring $300M. We are essentially witnessing (with some ignoring) the calm before the storm. It’s important to note that we don’t think all municipal issuers are created equal; there will certainly be a dichotomy formed amongst issuer credit quality – much like there is in Europe’s Sovereign Debt Dichotomy (PIIGS vs. Germany, Sweden, and Norway).


In light of the Municipal Debt Dichotomy, some of the biggest buyers of municipal debt (including Berkshire Hathaway, Liberty Mutual and Allstate Corp.) have been using the current “calm” as an opportunity to decrease their exposure, unloading muni bonds to some investors who view the 5.67% average YTM as “an excellent source of yield” and “a terrific bargain”.


The Muni Bond Market: Silent But Deadly - 5


When it all said and done, everything has a price. What makes this game fun is figuring out what that price will be at the end of a specified duration. Over the intermediate-term TREND, we at Hedgeye think muni bond yields are poised to continue their upward trajectory at an accelerating rate in the face of material deteriorations in their fundamentals. How much this shakes global financial markets is a question we will attempt to answer each day along the way.


Darius Dale


Greek-Turkish Border Issues

As the world is tuned in to Europe again this week due to the numerous bond auctions and the region’s ever-present sovereign debt risks, an important policy decision was reached on Monday regarding the looming issue to contain the influx of illegal immigrants to Europe via Greece along its border with Turkey.


While Greece had outlined a plan over the weekend to construct a fence or wall along its 206km (or 128 mile) border with Turkey, a stretch of land where the majority of refugees enter the EU, on Monday Greece revised its plans and said it will construct a defense barrier along a 12km stretch prone to the most illegal crossings located in the north-east of the country.


Greece has already made it clear to the EU that it cannot cope with the numbers of migrants (in particular from Asia and Africa) arriving illegally. The European Commission estimates that more than 80% of illegal immigrants enter the EU via the border with Greece, and according to Frontex, the EU border agency that patrols the area, there was a 369% increase in the number of illegal immigrants crossing the northern Greek border in the nine months through September 2010 versus the previous year.


Obviously, the figures are staggering and the problem is real. As it relates more broadly to Europe, we’d expect governments to push measures to limit illegal immigration as growth forecast are strained in 2011 and 2012 and as governments push through budget consolidations (austerity) over the next years. 


While this subject can be debated from a number of angles, the German publication Der Spiegel did a wonderful job presenting commentary from various German media sources that express differing viewpoints, all of which help to frame the debate. We include this commentary below:


The center-right Frankfurter Allgemeine Zeitung writes:


"The fact that Athens is considering the construction of a massive wall along its border with Turkey is absurd, given that both are members of NATO. It gives us a foretaste of what would happen if Turkey is, one day, accepted into the European Union. Europe's doors would be thrown wide open. At the same time, no one should kid themselves that a fence would stop people wanting to cross the border."


The weekly Die Zeit writes:


"This is a trouble spot: More than 100,000 illegal immigrants crossed the border here last year. Nine out of every 10 refugees fleeing poverty arrive in the EU via this route. The placement of 200 border guards here in November has stemmed the number of immigrants but not halted it. Now around 200 illegal immigrants arrive every night, but before the deployment of European Frontex guards, that figure was as high as 450."


The center-left Süddeutsche Zeitung writes:


"The Greek plan was clearly an act of despair… There are clear signs that the erection of a fence or a new wall at the Evros border river will not solve the core problem but rather shift it elsewhere. Illegal immigration does not take place along clearly defined routes; it is controlled by those criminal gangs for whom people smuggling is a profitable business."


"Illegal immigration is closely connected to organized crime -- that is the sad reality. Mafia groups in Turkey, Ukraine and Italy run their human trafficking as an industry. Propagating illusions is a key part of the industry, illusions about what awaits an African or Asian in the rich European countries of France, Germany or England, which are the end destinations of most immigrants. In addition, there is also the fact that people smugglers rarely operate without the complicity of corrupt border officials, who gladly turn a blind eye to some things for the right money. From this perspective, the European Commission is correct to react skeptically to Athens' construction plans and to demand that the Greeks first do something to deter and discourage the traffickers."


But the law is clear: (...) asylum applications can only be made in the country of entry. And so Greece continues to cram more and more refugees into its overflowing camps..."



Clearly, Greece and the EU are just at the tip of the iceberg in determining solutions to the inflow of illegal immigrants via Greece. As Greece is now known for its excessive public debt, we thought this topic is additive to the larger assessment of Europe’s economic health and the issues surrounding the union and policy making of unequal states.


Matthew Hedrick


Playing Japan

Conclusion: Japanese equities are looking good on the short side once again. We think market expectations regarding the yen-weakness tailwind have become substantially overblown, as global fundamentals don’t support a meaningful rebound in Japanese export growth. Further, both economic fundamentals and earnings need to surprise to the upside in Japan in order to sustain this rally in a meaningful way from here.


Since the start of November, long Japanese equities have definitely been one of the top ways to play increasing global demand for US Dollars as US Treasury yields backed up. To the tune of +14.8%, the Nikkei 225 has been the fifth-best performing global equity market since 11/1, showing only marginal abatement in the face of: 

  1. Global growth slowing;
  2. Inflation accelerating globally; and
  3. Interconnected Risk compounding 

Essentially, we have an overrun equity market propped up on the hopes of accelerating US growth and yen weakness aiding Japanese export growth (JPYUSD down -3.5% since 11/1).


Playing Japan - 1


Since we unveiled our Japan’s Jugular 4Q10 Macro Theme on October 5th, we’ve been managing risk around our yen and Nikkei short positions, oscillating between the two. While we remain bullish on the USD over the intermediate-term TREND, we think market expectations regarding accompanying yen-weakness as a tailwind to Japanese exporters have become substantially overblown. Moreover, global economic fundamentals don’t support a meaningful rebound in Japanese export growth: 

  • We don’t see US economic growth accelerating meaningfully from these levels, with decelerating US consumer demand and a slowing inventory cycle becoming headwinds to US growth in 1H11 (US = 16.4% of Japanese export demand); and
  • We are seeing explicit signs of slowdowns across Asia with several key countries on deck to tighten monetary policy meaningfully throughout 1H11 (China, Hong Kong, Korea and Taiwan = 39% of Japanese export demand). 

Playing Japan - 2


One area a weaker yen can “help” Japan with is choking off domestic consumption. Japan is an island economy that imports roughly ~60% of its food needs and roughly ~107% of its crude oil needs. With world food prices at all-time highs and crude oil prices poised to remain comfortably elevated on a YoY basis, we find bullish hope surrounding a weak(er) yen to be misguided at best.


Playing Japan - 3


Playing Japan - 4


Consensus estimates for Japanese 4Q10 GDP growth are closer now to where our expectations were back in October (-0.75% QoQ SAAR). Forecasts for 1Q11 and 2Q11 are +0.50% QoQ SAAR and +1.25% QoQ SAAR, respectively. After a +14.8% equity market move in less than 2.5 months, the Japanese economy likely has to blow-out these low expectations to keep equity investors from getting nervous. It is in our expectation they won’t. Japan, an economy overleveraged to manufacturing and exports, will disproportionately feel the three-factor pain outlined at the onset of this report.


Of course we could be wrong on global growth and the Nikkei’s recent run could be pricing in stronger growth both domestically and abroad. Even still, given the overwhelmingly bullish bias in Japanese and US equity markets, earnings from 1Q11 and 2Q11 (in both markets) need to be phenomenal if this rally is to be sustained meaningfully from here.


Darius Dale


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