Governing The Government

This note was originally published at 8am on January 19, 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 Constitution was designed to govern the government, not the people.”

-Steve Hanke


In a concisely written piece of Complex Simplicity, Steve Hanke penned this quote in a paper I was reading yesterday titled “Reagonomics Goes Global.” Hanke is a professor of applied economics at Johns Hopkins University and a Senior Fellow at the Cato Institute. I interviewed him while I was running a radio show for Bloomberg Radio last year and have been reading his work ever since. He gets government math.


The white paper featured different opinions from different authors and I think Hanke’s chapter, titled “Lessons from America’s Founding Fathers and US Experience” is well worth taking the time to read. Hanke takes a crack at differentiating the definitions of American style democracy and liberty. He also highlights Alexander Hamilton’s original US fiscal convictions:


“The United States was born in a sea of debt. A majority of the public favored a debt default . Alexander Hamilton, acting as Washington’s Secretary of the Treasury, was firmly against default. As a matter of principle, he argued that the sanctity of contracts was the foundation of all morality. And as a practical matter, Hamilton argued that good government depended on its ability to fulfill its promises.” (Reagonomics Goes Global, page 8)


I call this to your attention this morning because it draws a historical bridge between THE most important US Economic question that’s on my mind right now (can the US Dollar Index hold its newfound intermediate term TREND line of support at $78.66?) and what I am going to talk about on our Q1 Macro Theme call this morning under the umbrella of a theme called American Sacrifice (email if you’d like access to the call and/or the slide presentation).


Duration matters. That’s why I try my best to make sure my team is Duration Agnostic when considering risk, probability, and uncertainty. That’s why we have developed our TRADE, TREND, and TAIL model. It’s not perfect, but at least it’s an evolution of legacy Wall Street research and risk management processes gone bad. What the US stock market is doing in the immediate-term is not the most important long-term US Economic factor that’s on my mind.


Seeing the stock market going up every day isn’t the solution to this structural mess (stock market fans should remember that 1/3 of this country (102 MILLION Americans) have ZERO moneys in a retirement account and 1/2 of Americans have $2,000 or less). Neither is inflation – that’s a policy. What I think we ultimately need is a strong currency, balance sheet, and handshake that the world can trust again. If we have those, the jobs will come.


We can hope and pray that the new Republican leadership can be depended upon to “fulfill its promises” of spending cuts, but we must remember that hope is not an investment process and trusting a conflicted and compromised politician better have some serious prayer attached to the exercise. The foundations of morality matter (repaying your debts) to a lot of people in this country. So does protecting whatever integrity remains of her currency.


It’s time.


So, let’s roll with that this morning and figure out whether the intermediate-term strengthening of America’s currency (US Dollar Index is up for 8 out of the last 11 weeks since the midterms) is a leading indicator to a long-term TREND of American Sacrifice and fiscal sobriety.


Governing the Government on Global Macroeconomic risk management matters sounds like both a painful and herculean task – but I think it’s achievable.


Here’s what we need to execute:

  1. A Real-Time Accountability Mechanism (Twitter – check)
  2. An Analytically Competent and Independent Research Firm With Real American Clients Who Care (Hedgeye and The Buy Side – check)
  3. Freedom of Speech and email forwarding (iPhones, Crackberries, etc – check)

The messaging is out there folks. The People have already voted. Americans want spending, deficit, and debt cuts – and this is our last chance to Govern the Government so that we get all three of those things no matter what the intermediate-term American Sacrifice.


By “last chance”, I’m not trying to be dramatic either. With the upcoming debt ceiling and deficit/debt commission debates, this is it - for the US Dollar, America’s balance sheet, and her handshake with the world as its fiduciary of the world’s reserve currency that is…


I am a Canadian-American, so I have no allegiances to any person, politician, or party on this matter. If the US Dollar starts to break down again, sustainably, below my $78.66 TREND line, I will sell it faster than you can say Thunder Bay Bear.


Another debauchery of the US Dollar will equate to $120 oil, global food inflation riots, and plenty of other unintended consequences that I, for one, have no patience seeing my firm and family endure under the willfully blind veil of no one could have seen this coming.


My immediate-term support and resistance lines for the SP500 are now 1280 and 1298, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Governing The Government - 7

Golden Silence

“Silence may be golden, but can you think of a better way to entertain someone than to listen to him?”

-Brigham Young


We’re looking forward to the listening to the President of the United States at tomorrow night’s State of The Union address. It’s time to focus on US Jobless Stagflation. It’s time to cut the US deficit. It’s time to strengthen America’s handshake with the world via the credibility of her currency.


It’s time.


Not only is it time because America is out of time to cut spending, but it’s Game Time for the US Dollar Index’s price. The US Dollar closed down -1.1% last week and was down for the 3rd week out of the last four. It’s testing what we call its intermediate-term TREND line of support at $78.66, and if this week’s comments from both the President and the Fed don’t support it, this country could be heading toward a very dark place again.


What’s darkening? The math.


My defense partner, Daryl Jones, wrote a great summary updating the math on Friday (send an email if you’d like the full note). Currently, the Congressional Budget Office (CBO), which we consider consensus for this purpose, projects that the federal budget deficit for 2011, 2012 and 2013 will be $-1,066BN, $-665BN, and $-525BN, respectively.  This is a combined deficit of $-2.3TN.  (Yes, that is a big number.)  So, all else being equal and setting aside any maturities, the United States will have to issue $2.3TN in treasuries to fund the CBO’s projected budget deficit over the next three years.  So if we accept that there is ~$14TN in government debt outstanding (Source:, then the outstanding government debt over the next three years will grow 16%. That is, supply is going up.  Given this outlook, it does make sense that interest rates on 30-year Treasuries are moving higher.


Interestingly, we think that the CBO’s budget deficit projections are low, and perhaps meaningfully so. Currently our U.S. budget deficit projections for 2011, 2012, and 2013 are $-1.2TN, $-1.0TN, and $-0.9TN, respectively.  Combined, this is a total deficit for the ensuing three years of $3.1TN.  In aggregate, our projections are $800BN more than the CBO, or 34% higher for the three year period.  The implication being that the issuance of U.S. Treasuries may be almost 34% higher than “consensus” expects over the coming three years.  No doubt some of this is priced in, but our models have supply growing at an accelerated rate relative to what is likely priced in. And the question remains, who is going to buy these US Treasuries?


The cover of The Economist this weekend had a title that represents what we have been belaboring for the last 3 months – “The Rich and The Rest” – and, without going into every detail, we see this simply as a function of a US Government policy to print debt and inflate. Sure, inflation is great for some of us – but it’s really bad, in the end, for most of us. Global inflation is perpetuated by a policy to abuse and debauch the world’s reserve currency.


For the last 3 years, as a way to express my distaste for who I have labeled the Fiat Fools, on balance I have been short the US Dollar and long Gold. Since US Mid-term election promises were made to cut spending and address our fiscal imbalances, I have been long the US Dollar (bought it on November 4th) and short Gold (sold long position December 6th and shorted GLD on December 29th).  


Today, I am long the US Dollar and flat out frightened. Being in the hands of professional politicians who lie and backpedal on their promises is never a good place to be. It’s time, Mr. President. This Burning Buck stops with you.


Looking back at last week’s action in Global Macro prices, Dollar Down wasn’t good for much else than a low-quality European short squeeze:

  1. US Dollar Index = -1.1%
  2. Euro = +2.3%
  3. SP500 = -0.8%
  4. Nasdaq = -2.4%
  5. Russell 2000 = -4.2%
  6. Spain’s IBEX = +4.3%
  7. Italy’s MIB = +3.0%
  8. Greece’s Athex = +6.3%
  9. China’s Shanghai Composite = -2.7%
  10. Indonesia’s Jakarta Composite = -5.3%
  11. Philippines PSEi Index = -4.4%
  12. CRB Commodities Index = FLAT
  13. Oil = -2.6%
  14. Gold = -1.4%
  15. US stock market Volatility (VIX) = +19.3%
  16. US Treasury Yields = UP again, across the board

And for a US centric stock market investor, while it’s always nice to say ‘hey, look at the Dow’ and extrapolate that reading as a barometer for the rest of the world’s health, remember the simple arithmetic associated with the Dow (a sample of 30 stocks) where General Electric (GE) had a monster +7% day Friday. That’s a great day for what’s been a dog since 2008; not what’s going on in terms of Interconnected Global Macro Market Risk.


What the aforementioned weekly moves meant to me was:

  1. US Jobless Stagflation Continues – Commodity prices are sticky because the US Dollar is weak; US unemployment remains bearish.
  2. The Great December Beta TRADE – It’s a problem when stock market reflation becomes Global Inflation (Russell2000 down YTD).
  3. Volatility Is Back, Because Risk is Never “off” – VIX up +19.3%, with Bond and Emerging Markets getting smoked by inflation is self evident.

Again, if the Dow closing up +0.7% on the week is the risk “on/off” bogey that people who missed all of the Global Risk Management signals of early 2008 are still using – all I have to say about that is Godspeed. I’m keeping a big fat position in Cash as it’s the only way to protect against that dogma.


From an asset allocation perspective, I did take some weakness in market prices to invest some of my Cash position. Last Monday, I had a 67% position in Cash. This morning that position is down to 61% with the following allocations in the Hedgeye Asset Allocation Model:

  1. Cash = 61%
  2. International FX = 18%
  3. International Equities = 6%
  4. US Equities = 6%
  5. Fixed Income = 6%
  6. Commodities = 3%

And yes, if this country’s Golden Silence on the obvious breaks tonight like the price of gold itself has, I’ll be the first to get in line and get more invested. A strong US Dollar will make Global Inflation deflate. It will also strengthen America’s balance sheet and have the international investing community believe in America’s handshake again.


My immediate term support and resistance levels for the SP500 are now 1267 and 1295, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Golden Silence - aaaa

CHART OF THE DAY: Mr. President; The Burning Buck Stops with You


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Notable news items/price action moves from Friday’s trading

  • RRGB holder, Oak Street Capital Management LLC, seeks additional board nominees.  Oak Street also sought a temporary moratorium on new unit expansion and a buyback of shares.
  • YUM is facing legal action after a class-action lawsuit was filed against Taco Bell over the “beef” it uses as food and advertises as such.  The lawsuit alleges that the “beef” is, in fact, a concoction with multiple fillers”.
  • SBUX is still in disagreement with Kraft over the termination of their distribution agreement.  SBUX has been highlighting diminished market share as a result of Kraft’s mismanagement.  Kraft’s general counsel has stated that market share “has no bearing on the question of whether they have the right to terminate and walk away for nothing on their own timetable”.
  • CMG faced protesters at one of its downtown Minneapolis restaurants in response to having fired a number of employees after an audit by the U.S. Immigration and Customs Enforcement agency. Eight protesters were cited for trespassing.
  • RT insider selling news – Grant Kimberly, Vice President, filed to sell ~19k shares.
  • COSI 4Q10 sales results were strong; company-owned restaurants saw comparable store sales increase 6.1%
  • In a quiet day of trading for restaurant stocks, the most notable moves were CAKE (up 1% on accelerating volume) and BWLD (declining -3.6% on accelerating volume). 



Howard Penney

Managing Director


TODAY’S S&P 500 SET-UP - January 24, 2011

Equity futures are trading marginally above fair value ahead of a very busy week for corporate earnings, key speeches and a number of macro releases. Among highlights, President Obama makes his State of the Union address tomorrow and on Wednesday the FOMC's holds its first meeting in 2011.  The World Economic Forum kicks off in Davos on Wednesday and around 120 S&P 500 companies are scheduled to report earnings.  As we look at today’s set up for the S&P 500, the range is 28 points or -1.27% downside to 1267 and +0.91% upside to 1295.



  • 11 a.m.: USDA export inspections (corn, soybeans, wheat)
  • 11:30 a.m.: U.S. sells $29b 3-mo. bills, $28b 6-mo. bills


  • Apple (AAPL): Fred Alger Management CEO Dan Chung sees AAPL reaching $500-shr as corporate customers buy the iPad for business applications and international sales increase, Barron’s “Trader” column reports
  • Berkshire Hathaway (BRK/A, BRK/B) may begin paying dividend of 2% or less in next 12-18 months as available cash increases, Barron’s reports
  • Citigroup (C) raised CEO Vikram Pandit’s base salary to $1.75m from the $1 he earned for each of past two years
  • Genomic Health (GHDX) presented data that supports the use of its Oncotype DX test in some colon-cancer patients
  • Navigators Group (NAVG) sees 4Q charge of $9.2m related to GoM spill
  • (CRM) may fall 20% or more on rising expenses and a growing number of diluted shares outstanding, Barron’s reports, without citing anyone
  • Southwest Airlines (LUV) in tentative agreement with US Airways to extend Philadelphia airport leases by two years


  • Bank of Hawaii (BOH) 7 a.m., $0.69 
  • Steel Dynamics (STLD) 7 a.m., $0.09 
  • Wintrust Financial (WTFC) 7 a.m., $0.20 
  • Halliburton (HAL) 7:04 a.m., $0.63 
  • Sealed Air (SEE) 7:30 a.m., $0.45 
  • McDonald’s (MCD) 7:58 a.m., $1.16 
  • Swift Transportation Co (SWFT) PreMkt, $(0.05)
  • Woodward Governor (WGOV) 4 p.m., $0.39
  • CSX (CSX) 4:01 p.m., $1.09
  • FNB/PA (FNB) 4:01 p.m., $0.14
  • VMware (VMW) 4:01 p.m., $0.44
  • Sanmina-SCI (SANM) 4:02 p.m., $0.41
  • Albemarle (ALB) 4:06 p.m., $0.88
  • Amgen (AMGN) 4:06 p.m., $1.11
  • American Express Co (AXP) 4:08 p.m., $0.97
  • Zions Bancorp (ZION) 4:10 p.m., $(0.36)
  • Cathay General Ban (CATY) 4:30 p.m., $0.13
  • Packaging of America (PKG) 4:30 p.m., $0.53
  • Texas Instruments (TXN) 4:30 p.m., $0.63
  • STMicroelectronics (STM) 5 p.m., $0.24
  • Crane (CR) 5:10 p.m., $0.65
  • Equity Lifestyle Properties (ELS) PostMkt, $0.72
  • RLI (RLI) PostMkt, $0.98
  • SL Green Realty (SLG) PostMkt, $0.89


The XLB remains the only sector that is broken on the Hedgeye TRADE - 8 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND.

  • One day: Dow +0.41%, S&P +0.24%, Nasdaq (0.55%), Russell (0.63%)
  • Last Week: Dow +0.72%, S&P -0.76%, Nasdaq -2.39%, Russell -4.26%
  • Year-to-date: Dow +2.54%, S&P +2.04%, Nasdaq +1.38%, Russell (1.34%)
  • Sector Performance - (6 sectors up and 3 down): - Industrials +0.81%, Financials +0.81%, Energy +0.53%, Consumer Discretionary +0.24%, Healthcare +0.09%, Consumer Staples +0.17%, Utilities (0.09%), Materials (0.25%), and Tech (0.58%)


  • ADVANCE/DECLINE LINE: 151 (+873)  
  • VOLUME: NYSE 1265.93 (+6.36%)
  • VIX:  18.47 +2.67% YTD PERFORMANCE: -4.06%
  • SPX PUT/CALL RATIO: 1.57 from 1.65 (-4.71%)


Treasuries were stronger, especially in the belly of the curve, as buyers mentioned Thursday's selloff as "overdone".

  • TED SPREAD: 15.51 +0.203 (1.327%)
  • 3-MONTH T-BILL YIELD: 0.16%      
  • YIELD CURVE: 2.81 from 2.82


  • CRB: 334.80 +0.66% (+0.36% last week)  
  • Oil: 89.11 -0.54% - trading -0.82% in the AM (-3.74% last week)
  • COPPER: 430.90 +0.87% - trading +0.43% in the AM (-2.33% last week)
  • GOLD: 1,343.55 -0.64% - trading +0.23% in the AM (-1.15% last week)


  • Cocoa Jumps Most Since 2008 in London Following Ivory Coast Ban on Exports
  • Metals Traders Worth $3 Million Amid Shortages as Wall Street Pay Shrinks
  • Ivorian Export Ban May Drive Up Cocoa Prices 10%, Hackett Financial Says
  • Copper Climbs in London Trading on China's Demand, Recovery in Europe
  • Wheat Extends Advance to Five-Month High as La Nina Threatens Global Crops
  • Gold Advances as Longest Weekly Losing Streak Since July Prompts Purchases
  • Cooking Oil Imports by India May Decline in First Two Months, Patel Says
  • Bullish Gold Bets by Funds Slump on Worst Price Slide Since Start of 1997
  • Cotton Soars by Daily Limit on Signs Global Supply May Fail to Meet Demand
  • Rubber Advances to Record as Persistent Rains May Threaten Thai Production
  • Natural Gas Producer Bearish Bets Jump to Three-Year High: Energy Markets
  • Oil Drops in New York After Saudi Arabia's Al-Naimi Signals More Supplies
  • Sugar Output by Kakira, Uganda's Biggest Producer, May Climb 13% This Year
  • Hedge Funds Cut Bullish Cotton Bets to Lowest Level Since July After Rally


  • EURO: 1.3621 +1.12% - trading -0.46% in the AM (+1.74% last week)
  • DOLLAR: 78.213 -0.77% - trading +0.24% in the AM (-1.20% last week)


  • FTSE 100: +0.14%; DAX: -0.65%; CAC 40: -0.26% (AS OF 6:45 AM EST)
  • European markets are trading mixed following disappointing Q4 earnings from Phillips Electronics.
  • Ireland up 0.72% as the date of the general election will be brought forward following the decision of the Green Party to pull out of Government.
  • Manufacturing and Services PMI numbers across Europe for January continued to show signs of growth though some numbers were below consensus.
  • Eurozone Final Manufacturing PMI 56.9 vs consensus 57
  • Eurozone Final Services PMI 55.20 vs consensus 54.30
  • Germany Jan preliminary Manufacturing PMI 60.2 vs consensus 60.9
  • France Jan preliminary Manufacturing PMI 54.3 vs consensus 56.9
  • ECB President Jean-Claude Trichet signals in WSJ interview that bank won’t react to temporary jump in inflation caused by higher commodity prices as long as it doesn’t fuel wage increases. Says benchmark interest rate remains “appropriate” at record low 1%. Story
  • Portugusese Economy Minister Jose Antonio Vieira da Silva tells El Mundo newspaper the country doesn’t need a bailout
  • Greek Finance Minister George Papaconstantinou reiterates Greece doesn’t need to restructure EU300b of debt


  • Asian markets are blowing up one by one; Thailand down -4.3% last night, joining China, India, and Indonesia as markets get hammered by inflation.
  • Indonesia down another full 1% last night and is now -10% for 2011.
  • Japan rose +0.69% on bargain-hunting, especially for resource stocks. Honda rose 4% on news it will start producing at a new plant in Argentina in March and a broker upgrade.
  • Miners and banks led Australia up +0.69. Australia Q4 PPI +0.1% seq vs +0.7% consensus, +2.7% y/y vs +3.3% consensus.
  • On fears of a rate hike in China, Hong Kong declined 0.31%, as falls in resource and insurance shares outweighed rises in property developers and local banks.
  • Banks and small caps took China down -0.72% on worries that a rate hike is coming very soon.


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