Social unrest occurs when people can't afford the "luxury" of eating.
“Poverty wants some things, Luxury many things, Avarice all things.”
Yesterday, one of our young Jedi analysts at Hedgeye, Kevin Kaiser, sent me a highlight from “The Grocer” (an industry trade rag) that inflating food prices are making ordinary breakfast items like orange and apple juice a “luxury.”
Now a Wall Street analyst at a sell side investment bank would find a way to dress this data point up with a pig’s lipstick and call it an “affordable luxury”, whereas someone working for The Ber-nank in DC probably calls something like breakfast “non-core” or “free.” But we simpleton, non-recipients of government bailout moneys, just call it what it is – inflation.
Six months ago we didn’t have Global Inflation Accelerating…
While I’ll be the first to admit I remained too bearish on US Equities in December of 2010 (but appropriately bearish on emerging markets and bonds), I’ll also be the first to remind the fire engine index-chasers of all the emails they were sending me on August 24th of 2010 that I was “crazy” to be covering my short positions in the SP500 (SPY), Russell2000 (IWM), and Consumer Discretionary stocks (XLY).
Back then, free markets pricing in a strong US Dollar and low inflation was a bullish signal to buy US Equities. Today, you have the latest Big Government Intervention scheme Debauching the Dollar and perpetuating higher inflation. Back then, I dropped my Cash position to 46%. Today, I’ve raised it to 67%. All the while, understanding that I’m not one of these perma-bulls who needs to be invested trying to get back to a 2007 high-water mark gone bad.
Yesterday, we saw a new high-water mark established in the real-world inflation reading. With the US Dollar getting burned at the stake (down 1% on the day, making a move towards a 6 month low), the CRB Commodities Index was hitting a freshly squeezed 6-month high. All Luxury Things considered, if you are one of the 44 MILLION Americans who lives on food stamps, how do you like them apples?
Now setting aside the inconvenient truth that there’s never been a global economic powerhouse that has devalued its way to prosperity, let’s give the ole Ber-nank a little something to bring to his dance with America’s new Chair of the US Financial Services Sub-Committee on Domestic Monetary Policy, Ron Paul, on February 9th. Here are the 6-month price percentage moves in some of the things people need to live with:
Yeah, I guess for the sake of professional policy makers in DC who get dinner for free and a car service to work, I should stop there. To make the Top 10 things that may or may not be considered Luxury Things, you really need to have inflated on the order of +25% or more. Pork bellies are only up +10.7% in the last 6 months – so go have yourself some powdered Keynesian Kool-Aid with some sausage links for lunch and like it.
Over that same 6-month period:
So where does that leave the almighty American Consumer? That’s easy, pull up some charts of US Consumer stocks – and pull up some big ones like Proctor & Gamble (PG), McDonalds (MCD), and Target (TGT).
Sure, since most people in this business read points of view in terms of how it directly addresses their personal positioning, I’m sure you can find me some US Consumer stocks that used to look like Coach (before the man-purse idea didn’t fly Captain Lew to the moon), but overall, Consumer Staples (XLP) and Consumer Discretionary (XLY) are the 2 worst sectors in the entire US stock market all of a sudden for a reason, down -1.84% and -0.97% in the last 3 weeks of trading, respectively.
On a more positive note, this morning The Mu-barak turned on the internet. So now all of our Egyptian friends can start tweeting Hedgeye’s 6-month table of real-world inflation to their friends again. Social networking tools are going to continue to revolutionize the transparency and accountability standards that The People of this world hold their governments to. That’s a Luxury Thing of personal liberty that I can believe in.
My immediate term TRADE lines of support and resistance for the SP500 are now 1290 and 1308, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on January 28, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“No snowflake ever falls in the wrong place.”
- Ancient Zen Proverb
Both the title of this morning’s Early Look and the quote above are very apropos for the current weather gripping New Haven, CT and much of the northeastern United States. Though the mounds of snow which line our streets are several feet high, it’s “business as usual” for those of us who refuse to blame our disappointments on things like “the weather”.
Addressing the quotation specifically, the saying above traces its origins to Zen, a school of Mahayana Buddhism. Per our friends at Wikipedia, what distinguishes Zen from other schools of Buddhism is its search for enlightenment through self-realization in Dharma practice and meditation rather than a reliance on text and intellectual reasoning.
In the asset and risk management industry, an overreliance on intellectual reasoning can get us into trouble, as we often lean towards the conviction we receive from our data analysis and channel checks versus what may or may not be blatantly obvious. In fact, we’ve all been trained to fade the obvious – even sometimes to a fault.
This brings up an interesting topic that is gathering momentum in the marketplace: Muni Bonds. The divergence in sentiment between retail investors and institutional investors seems to get wider by the day, as one group (retail) rushes to avoid what is perceived by some to be a pending crisis while the other (institutional) finds current valuations as a definite reason to “fade the obvious”:
To state it bluntly, we don’t see current prices for muni bonds as an investable opportunity to “fade the obvious”. We’re neither brave nor smart enough to get in the way of a potential wave of defaults, restructurings and credit downgrades (emphasis on potential, as we disagree with Whitney that $50-$100B worth of defaults is a foregone conclusion). You don’t need defaults for the price of a bond to go down.
Even for those brave investors who possess the analytical firepower to find value in the muni market at current yields – including the highly-regarded Lyle Fitterer – we think many of them may actually be using faulty data in their analysis. Fitterer, the top muni bond fund manager of the last decade, remarks, “The baby has been thrown out with the bathwater”; as such, he’s using the current back up in yields as a buying opportunity for specific revenue bonds.“If a State were to file bankruptcy, I have a bond with a dedicated revenue stream,” he says.
Fitterer’s comments beg the question, “What’s a revenue bond worth when it doesn’t meet its revenue target?” Probably the same as an equity that misses estimates amid bullish sentiment: less. While we’re not yet calling for a spate of “misses” across the nation, we do think the confluence of slowing domestic growth, rising interest rates and a rapidly deteriorating housing market will weigh heavily on the finances of States, municipalities and municipal authorities alike in 2011:
Speaking of borderline accounting fraud, a very alarming trend has emerged over the course of the most recent economic downturn. Rather than lie about their deteriorating finances, a growing number of municipalities have opted to hide them instead.
A recent study done by DPC DATA Inc. revealed that over 56% of municipal issuers did not file a financial statement in any given year between 2005 and 2009. Over 33% of them skipped filing in three or more of the past five years. In the latest year (2009), the percentage of non-filers jumped +360bps to 40.2%. An additional 30% filed “extraordinarily late” that year, according to the analysis.
It’s tough to analyze what you can’t see. Moody’s Managing Director of Public Finance, Robert Kurtter, agrees, saying on CNBC’s Squawk Box that 2/3rds of all muni issuers are unrated (1/14). And even if they we’re “rated”, we’re not buyers in blind faith of America’s ratings agencies!
Regardless of your perception of the fundamentals, the “snow” is falling in the muni bond market and the thick coat of snow accumulating serves as a metaphor for the opacity that’s associated with issuer finances. When the ice melts in the coming months, will you be holding a bag full of “unforeseen” risk because you bought the first dip after a 30-year bull market in muni bonds? We definitely won’t be – that’s for sure.
Remember, no snowflake ever falls in the wrong place.
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TODAY’S S&P 500 SET-UP – February 2, 2011
Equity futures are struggling to find clear direction in the wake of yesterday's surge which saw the Dow close back above the 12K level for the first time since Jun-08. As we look at today’s set up for the S&P 500, the range is 18 points or -1.35% downside to 1290 and +0.03% upside to 1308.
MACRO DATA POINTS:
TODAY’S WHAT TO WATCH:
Both consumer ETF’s, XLP & XLY remain BEARISH TRADE - 7 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND.
CREDIT/ECONOMIC MARKET LOOK:
Treasuries ended a two-day decline on concern over U.S. unemployment and speculation that data will show the recovery isn’t strong enough to bolster the labor market.
OTHER COMMODITY NEWS:
The increase of commodities continues to be fairly broad-based with most of the items we follow gaining significantly week-over-week. With the exception of Chicken Wings, all of the foodstuffs in the table below show either flat or significantly positive week-over-week price changes.
Egypt is obviously front-and-center of the geopolitical picture at the moment and commodity investors obviously keep a keen eye on geopolitical proceedings. There is speculation about food shortages due to a lack of access or movement of ships. At Egyptian ports, an absence of customs officials is exacerbating the disruption.
Rice gained 8% after trading flat last week, and relative to the other commodities at the top end of the table, its year-over-year price change is quite benign. PFCB locks in rice and, as of most recent guidance on the item, management stated that the commodity was locked in slightly favorably for 2010 and the contract continues through September of 2011.
Wheat narrowly missed out on the top spot this week, gaining 7.8% over a week ago. There is speculation that Egypt unrest may delay shipments and that is why prices have come down. However, it is unlikely that the recent pullback will persist if one shares Hedgeye’s bearish view of the dollar and if speculation that the cold snap in the central U.S. plains may adversely affect dormant crops is to be believed. PNRA expects wheat costs for 2011 to be roughly flat versus 2010, as the company currently has nearly 75% of its wheat costs locked in for 2011, modestly below the 2010 price. Looking at the chart below, it is clear that the company is hoping that the easier comps, from a wheat cost perspective, offer them some relief. If prices go higher, wheat could cause some margin pressure for PNRA in 2H11.
Chicken Wings continue to offer BWLD a nice boost here in 2011. Following a decline of almost 5% on the week, prices are lagging those of a year ago by 36%. The chart below shows clearly that this favorability is likely to continue for BWLD through the first half of the year if prices remain roughly stable.
Position: Short Italy (EWI); Short Euro (FXE)
In a post on 1/27 titled “Playing Europe’s Mismatch on Duration” we noted that our short positions in Italy (via the etf EWI) and the EUR (FXE) were working against us as three catalysts were giving a boost to European equity markets (especially the PIIGS) over the immediate term:
In the note we also cautioned that over the intermediate term TREND our negative outlook on Europe, especially for the countries with high fiscal imbalances (Italy, Spain, and Portugal), remains intact.
These positions remain unchanged, and due to recent uprisings in Tunisia and Egypt European markets have received the proverbial hall pass on headline risk, and its equity markets, especially from the PIIGS, have outperformed. The threat now is significant mean reversion risk!
After all, the top 3 global equity indices year-to-date are:
Also, some of the fundamental data we follow to gauge the region’s “health” is showing signs of slowing, a concern over the intermediate term. We’ve hit on the pressing threat of inflation in our work, but forward looking indicators such as PMI surveys are signaling a topping, particular Germany, THE country “supporting” the region and divergent from Europe’s sovereign debt issues.
Final January PMI Manufacturing figures were released today from Markit (see chart). Although we’ll be more focused on the services numbers (released on Thursday 2/3), both Manufacturing and Services are indicating a slowing on the margin (despite the majority of countries reporting Manufacturing PMI improving month-over-month). Importantly there’s a heavy line of resistance at 60 that Germany is bumping up against, and increasing the mean reversion risk.
Although a lagging indicator, unemployment rates across many nations, but in particular in Spain and Ireland are moving in the wrong direction. Germany remains the exception, falling 10bps month-over-month to 7.4% in DEC. Beware that austerity programs throughout Europe, which include job strikes, wage reductions and freezes, and consumer tax hikes could further bolster these figures.
The EUR and ECB Catalyst
On Thursday (2/3) the ECB announces its refi rate. We do not expect a hike from the current 1.0% rate, despite Trichet’s recent hawkish rhetoric, which could pare back recent gains in the EUR-USD. We’d be shorting the currency (again) at its current level of $1.38 and covering it at $1.35 for a TRADE.
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