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MACRO ICEBERGS

This note was originally published at 8am on January 18, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“It's been 84 years, and I can still smell the fresh paint. The china had never been used. The sheets had never been slept in. Titanic was called the Ship of Dreams, and it was. It really was.”
-Old Rose

 

In the quote above from the blockbuster film “Titanic”, an elderly Rose DeWitt Bukater reminisces on the grandeur and splendor of a vessel once described as “unsinkable” – even by God. More deeply, her allusion to the Titanic’s former nickname triggers feelings of grief as she turns to the memories of a lost life that could’ve been so many years ago.

 

Unfortunately global risk managers don’t have the luxury of dwelling on the past like Old Rose here. We must constantly be playing the game in front of us; this week global markets are tuned squarely to Europe’s bond auctions and statement’s from the region’s leaders on its sovereign debt issues as a proxy for market performance.

 

Over the short term we’d expect European markets to continue to make gains on the heels of announcements from China (earlier this month) and Japan (on Tuesday) to buy European bonds and statements from EU Economic and Monetary Commissioner Olli Rehn (yesterday) that EU officials are trying to forge a “comprehensive” plan to contain the sovereign debt crisis and from German Chancellor Angela Merkel who indicated a desire to do “whatever is needed to support the euro.”  Rehn also ruled out debt restructuring for Greece or any other euro-area member state.

 

With this kind of support, it’s no surprise that investors cheered, markets boomed, and the European auctions have found plenty of demand. Yesterday saw substantial outperformance from the peripheral equity markets, with gains from: Spain’s IBEX +5.4%; Greece’s Athex+ 5.0%; Italy’s FTSE +3.8%, as credit markets have improved over the last 3 days.

 

As we head in to earnings season, MACRO seemed to return to the forefront as the high-profile upside driver to global equity prices as concerns over sovereign debt auctions diminish.  The dampened European sovereign contagion concerns fueled a pickup in risk appetite on the back of a better-than-expected Portuguese bond auction yesterday and Spain’s auction today.  This is leading to outsized gains in the financials around the world.

 

Yesterday in the US, financials extended their 2011 outperformance with the leadership coming from the banking sector, with the BKX +1.5% and the broader XLF up 1.7%.  Despite disappointing Machinery orders out of the Japan, the Japanese megabanks followed their American peers higher, leading Japan to +0.73%.  Like in the US, the potential for increased dividends is driving equity prices higher as both Sumitomo Trust & Banking and Chuo Mitsui Trust Holdings rose 5% overnight on the potential of higher dividends. 

 

Macro Icebergs

 

As we’ve seen throughout market history, it’s typically when everyone is expecting smooth sailing ahead that certain “icebergs” tend to derail things. If we’ve learned anything from the movie “Titanic”, it’s that hubris about our top ideas (the ship) and a disregard for risk (not having enough lifeboats on board) can get us into trouble.

 

Certainly a few Macro Icebergs are scattered across our domestic waters. How we navigate them individually will be the key to getting paid in 2011; currently, the collective is “full speed ahead”.

 

Below we’ll highlight one of the largest Macro Icebergs that a) has the potential to capsize our ship; and b) is out of consensus – at least for now:

 

Municipal Debt Dichotomy

 

Yesterday we published an intraday report titled: “The Municipal Bond Market: Silent But Deadly” (email sales@hedgeye.com if you want to see our work on muni bonds). In it, we took a deep dive at the headwinds affecting this sector of our financial markets and the systemic risk therein. The key takeaways from the article were:

  • Fiscal austerity at the State and Federal Government level and a strong political will in D.C. to avoid bailing out States and municipalities will perpetuate budget woes at the municipal level (together, State and Federal support account for ~34% of municipal budgets);
  • Local governments are running out of room with their accounting “tricks” and are staring at potentially 2-5 years of declining property tax receipts, which are ~26% of their budget;
  • Calls for State defaults are overblown; the real issues lie within the municipalities and municipal authorities across the nation; the States that have the most severe fiscal issues will see a disproportionate number of their municipalities go bust (though bankruptcy is not permitted in 23 States, defaulting on payments to vendors and creditors will be the more likely outcome in many cases); and
  • The equity markets are misinterpreting the recent back up in yields as “growth” and not “risk” and this risk isn’t going away any time soon.

While still largely ignored by consensus, it was certainly interesting to see some big names in our industry come out on both sides of this debate yesterday:

 

PIMCO’s Bill Gross: “Ultimately, municipal bankruptcies will be at a lower level. I don’t subscribe to the theory that there will be lots of them.” 

 

JPMorgan’s Jamie Diamond: “There have been six or seven municipal bankruptcies already. I think unfortunately you will see more… If you are an investor in municipals you should be very, very careful.”

 

“Smooth Sailing Ahead” vs. “Icebergs A’Cometh”.

 

We certainly aren’t crying wolf for the sake of attention like some analysts with ulterior motives. We don’t do ratings, banking, trading or manage assets; we only get paid for being right. Considering that we’re still in business after three of the most volatile years in the history of financial markets, we’ve been blessed to be more right than wrong over this duration.

 

For the sake of our economy (yes we are patriots), we hope we are not right on this one. The last thing America needs right now is another financial crisis on its hands perpetuated by blow-ups in the $2.9 trillion dollar muni bond market and Housing Headwinds Part II (not mentioned here; email us for more details). Unfortunately, hope is not an investment process. That’s why we’ll continue to help you navigate these murky waters as Global risk managers.

 

We’ll discuss these risks and how to play them on the long and short side on our Q1 Quarterly Themes Conference Call tomorrow at 1:00pm. Qualified prospective institutional subscribers please email sales@hedgeye.com for more details.

 

Keep your head on a swivel.

 

Howard Penney

Managing Director

 

Matthew Hedrick

Analyst

 

Darius Dale

Analyst

 

MACRO ICEBERGS - MUNI



STRONG START TO YEAR IN MACAU

Expectations for a HK$20 BN+ month as some analysts are suggesting may be high but January should still be a record month.

 

 

Gross table gaming revenues were HK$10.08 billion in the first half of January.  Based on this data we are projecting full month gaming revenues (including slots) will come in at HK$18.5-19.0 billion.  Activity should slow in the last week given the proximity to the February 3rd start of the Chinese New Year celebration.  Still, anywhere in this range would represent a monthly record and generate YoY growth of 36-40%.

 

Market shares shifted significantly in the last month, at least between the two big US operators.  Wynn gave up 300bps compared to its share last week, mostly to LVS which gained 250bps.  Our intelligence in Macau tells us the shift was entirely hold related.  We will note that Wynn’s share remains above its 12 month average although below its recent elevated levels.  LVS is now right in-line with its depressed 3 month average.  We continue to be impressed with MGM and we believe they have been successful in driving bottom line results at the property as well.  Here are the shares:

 

STRONG START TO YEAR IN MACAU - macau


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Complex Simplicities

“I must forever make the complex the simple.”

-Martin Luther King, Jr.

 

Ironically enough, one of my best friends gave me “The Autobiography of Martin Luther King, Jr.” for my birthday a few weeks back. Notwithstanding that he didn’t know I’d be on my back reading for the last week, the timing of this gift was impeccable. Dr. King’s passion has forever made the complex the simple.

 

Complex Simplicities are what we chaos theorists wake up looking for each Global Macro market morning. One of my favorite risk management books of all time (“Deep Simplicity”, by John Gribbin) got me hooked on the basic principles of chaos and complexity theory back in 2006. Thank God for those teachings. They saved our clients and our firm a lot of money in 2008.

 

Investment opportunities in a globally interconnected ecosystem are omnipresent. While there may be Apple days in California and snow days in Connecticut, there is no such thing as “risk on” and “risk off” days in Global Macro markets. In fact, when I hear people say that, all I can do is smile. Accepting chaos theory in risk management means accepting uncertainty, every day.

 

Over the intermediate-term TREND, there is no such thing as market certainty. The only thing you can be certain of, after a +91.3% melt-up in US stocks since March of 2009, is that for the immediate-term groupthink session everyone on the Barron’s Roundtable is going to be bullish.

 

Being bullish or bearish on the amount of uncertainty you think there is going to be in a market price is an opinion. So is doing nothing. For now, from an asset allocation perspective, we’re doing more and more of nothing. As some market prices climb, we’re raising more cash.

 

This is what the Hedgeye Asset Allocation Model looks like to start off this week:

  1. US Cash: UP to 67% (versus 61% last week)
  2. International Currencies: DOWN to 18%
  3. International Equities: DOWN to 6%
  4. US Equities: UP to 6%
  5. Fixed Income: UNCHANGED week-over-week at 3%
  6. Commodities: DOWN to 0% (in the last 2 wks, I’ve sold all our Oil, Sugar, and Corn – and there are no rules saying I can’t buy them back lower)

Being in cash is a simple concept. While I do get some very complex questions about the nature of my cash position, most of the time the real complexity in the questions is born out of the problems associated with many institutions being mandated to be “fully invested.” I don’t have to be.

 

To be crystal clear on this, the Hedgeye Asset Allocation Model represents what I am personally doing with my investable capital. I’d be nuts to put my name on any other advice than that which I abide by myself. Again, from a transparency and accountability perspective, this is very simple.

 

Complex Simplicities: Did I think people who were jamming into bond and gold funds in Q4 of 2010 were nuts? Yes. Do I think people who are fully invested chasing US Equity indices up here are nuts? Yes. Do people who I think are nuts make money in this business? Yes.

 

But, sometimes (1998, 2000, 2001, 2002, 2008), people who get nutso invested blow up. The goal here, if you’ve made money in each of the last 3 years, is to make it a fourth -  not to implode.

 

Last week in Global Macro, other than in the $2.8 TRILLION US Municipal Bond Market, not a lot of things blew up. Here were the most important Global Macro market moves of the week:

  1. US Dollar Index was debauched for a -2.4% loss, taking it down for the 2nd week out of the last 3 as Republicans attempt to break spending promises
  2. Euro rallied +3% from its prior week’s lows of $1.29 (where we covered our short) as “I Have A Scheme” (Zero Hedge coined) on fiat paper goes global
  3. CRB Commodities Index closed at another weekly closing-high of 333; Dear Ber-nank, that was another +3.1% inflationary move in 19 commodities
  4. Oil prices inflated +4% week-over-week, and 71% of Americans say it’s an issue – really?
  5. Gold was down -0.6% and down for the 2nd consecutive week (we remain short of gold, GLD)
  6. US stock market Volatility (VIX) dropped another -9.5% to 15.46, testing its April 2010 lows when US growth bulls were last this horned up

There wasn’t enough pin action in credit spreads (US or Sovereign) for me to call it out and nominal US Treasury Yields didn’t do much on a week-over-week basis either (they remain in what we call a Bullish Formation – bullish on all 3 of our core investment durations: TRADE, TREND, and TAIL). That’s one of the main reasons why we love our cash so much. Global Inflation Accelerating is bad for de bonds, eh.

 

Complex Simplicities associated with our living in a higher-and-lower American society by the week aside, we’re looking forward to watching how this year’s Global Macro picture plays out post the beginning of the year “flows” thing. While in cash, waiting and watching for US stock-centric investors to react to something other than Apples and snow should be, at a bare minimum, worth the immediate-term absolute performance charge.

 

My immediate term support and resistance lines for the SP500 are now 1277 and 1299, respectively.

 

Best of luck out there today – it’s good to be back in the game,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Complex Simplicities - box



STORMY SAILING

This note was originally published at 8am on January 12, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The dogmas of the quiet past are inadequate to the stormy present. The occasion is piled high with difficulty, and we must rise with the occasion. As our case is new, so we must think anew and act anew.”

-Abraham Lincoln

 

I recently pulled off the shelf Doris Kearns Goodwin’s book "Team of Rivals" which looks at the political genius of Abraham Lincoln.  It’s an amazing account of how Lincoln, as president, was able to bring his “disgruntled opponents” together to complete the task of saving the Union.  As Lincoln did, Barack Obama must pull together a team of rivals and win the respect of his competitors to help us navigate the stormy seas ahead. 

 

If the United States’ economy were a vessel, it could be said that she has held up quite well over the past couple of years.  Through the Great Recession, government bailouts, flash crashes, and the most contentious political climate in some time, the United States keeps cruising. 

 

How much secular damage was sustained in the “economic storm” or was simply deferred by the Fed grabbing its cavernous bucket and bailing water from inside the ship back overboard is unknown. 

 

Consumers don’t know, politicians don’t know, CEO’s don’t know, and you can bet a dollar, I don’t know.  What I can tell you with certainty is that at some point the structural problems with the U.S. economy need to be addressed sooner rather than later.  Fans of Big Government enjoy preaching the folly of applying long term solutions to short term problems. 

 

While not ideal, clearly long term solutions that ensure economic progress in the long term, notwithstanding short term pain, are preferable to short term solutions that never address the long term, leaving us and our posterity to forever bail buckets of water over the side of the ship while we hope and pray for a miracle. 

 

All the while, the long term problem grows larger, but politicians and policymakers keep their jobs.  The mounting of debt upon debt by governments around the globe is leading to inflation on a global basis. 

 

I would be remiss to ignore the various supply-side shocks that have occurred around the world related to weather and other factors.  However, simply stated, the inverse correlation between the dollar and commodities denominated in dollars remains high and the U.S. consumer is feeling the effect of that.  U.S. consumers are not alone; India, Brazil, China and many other countries around the world have seen inflation break out to the upside recently. 

 

Food inflation, in particular, is causing significant social unrest in some countries which is drawing political attention.  India’s government has adjourned to address the problem of rising food costs there and Algeria saw riots yesterday over food costs.  For now, consumers’ wallets in the U.S. have been relatively shielded from the impact of food costs increasing over the past 6 months.  However, if and when these costs are passed along in addition to the backdrop of high gas prices, it could greatly impair the “recovery” that is now consensus.

 

Today, Thailand joined the party and raised its benchmark raised interest rates for the fourth time in seven months and signaled it will boost borrowing costs further to contain inflation.  And this morning, officials from Mozambique to China are signaling their belief that rates in their respective countries will be raised in the near-term. 

 

On a more granular note, one company that will begin to feel the pain of higher food inflation in 2011 is McDonald’s and I don’t believe the bullish consensus has fully accounted for this.  Last year McDonald’s saw its basket of commodities decline by 5-6% and, accordingly, restaurant level margin rose by over 200bps from lower food costs alone.  I have other concerns which are more structural in nature and those will be addressed, in detail, on a conference call with clients on Friday. For qualified prospective institutional subscribers, please email sales@hedgeye.com for more details.     

 

Also on Friday, the Hedgeye Macro team will be discussing its three themes for the first quarter of 2011 and they are:

 

(1)    American Sacrifice - We are bullish on the USD and we will focus on how the Q1 macro calendar of events (Ron Paul auditing Bernanke, midterm election spending cut promises, the debt ceiling debate and debt/deficit commission decisions) are supportive of a strong USD as the country begins to address its long-term fiscal problems.

(2)    Trashing Treasuries – We are bearish on US Treasuries.  The breakout in global inflation, sovereign, State, and municipal risk and rising global interest rates are a problem for treasuries.

(3)    Housing Headwinds Phase II – We remain bearish on housing and continue to believe that a decline in home prices will be a governor on consumer consumption in 2011.  We will update our view on how much further home prices have to fall over the next 12-months according to the supply and demand issues facing the industry.

 

It’s now just under two hours before the market opens and equity futures are trading higher in a continuation of yesterday’s modest gains with the early focus centered on Portugal's bond auction which went better than expected.  Also overnight, bullish sentiment increased to 57.3% from 54.5% in the latest Investor's Intelligence poll, while the ABC consumer comfort index improved to -40 from -45; it is now at its highest level since 2008. 

 

While all of this is good news for equity markets, it’s an ominous sign that all of the early dogs of the S&P 500 so far this year (YTD price changes below) are predominately consumer names that have been impacted by either weaker-than-expected consumer spending or inflation pressuring margins or a combination of both.  I expect this list to grow as debt mounts, sovereign debt concerns accumulate, and inflation is passed through to the consumer.

 

SCRIPPS NET: -7.79%

MACY'S: -8.14%

TARGET: -8.22%

GAP: -8.22%

ABERCROMBIE & FITCH: -8.24%

VULCAN MATERIALS: -8.70%

GAMESTOP: -11.76%

FAMILY DOLLAR STORES: -13.02%

CONSTELLATION BRANDS: -13.18%

SUPERVALU INC: -21.18%

 

I’m not the only one using a “stormy” metaphor today as the snowstorm continues outside and CNBC started Squawk Box today with the Doors classic song “Riders on the Storm.” 

 

“Into this house we're born
Into this world we're thrown
Like a dog without a bone
An actor out alone
Riders on the storm”

 

Function in disaster; finish in style

Howard Penney    

 

STORMY SAILING - EL chart of day 1.12.11


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