This note was originally published at 8am on January 24, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“Silence may be golden, but can you think of a better way to entertain someone than to listen to him?”
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.
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 email@example.com 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: usdebtclock.org), 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:
- US Dollar Index = -1.1%
- Euro = +2.3%
- SP500 = -0.8%
- Nasdaq = -2.4%
- Russell 2000 = -4.2%
- Spain’s IBEX = +4.3%
- Italy’s MIB = +3.0%
- Greece’s Athex = +6.3%
- China’s Shanghai Composite = -2.7%
- Indonesia’s Jakarta Composite = -5.3%
- Philippines PSEi Index = -4.4%
- CRB Commodities Index = FLAT
- Oil = -2.6%
- Gold = -1.4%
- US stock market Volatility (VIX) = +19.3%
- 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:
- US Jobless Stagflation Continues – Commodity prices are sticky because the US Dollar is weak; US unemployment remains bearish.
- The Great December Beta TRADE – It’s a problem when stock market reflation becomes Global Inflation (Russell2000 down YTD).
- 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:
- Cash = 61%
- International FX = 18%
- International Equities = 6%
- US Equities = 6%
- Fixed Income = 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