This note was originally published at 8am on February 17, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“We are firmly convinced that monetary and fiscal policy will continue to debase the dollar.”
-Ted Kelly (CEO of Liberty Mutual)
Liberty Mutual is an American insurance company that was founded in 1912 and currently sits at #71 on the Fortune 500 list. It has over 45,000 employees servicing global insurance products worldwide and has over $100B in consolidated assets. Their CEO made the aforementioned comment in a Bloomberg article yesterday by Noah Buhayar. No, Liberty didn’t pay me an advertising dollar for this paragraph.
Unlike The Ber-nank attempting to trade US Treasury bonds, this isn’t Ted Kelly’s first rodeo. He’s been CEO of Liberty Mutual since 1998 and his job is to manage bond market and duration risk. On the topic of real-time risk management, he went on to add that, “we are positioning our portfolio and our business to respond if inflation emerges.”
Notice Kelly didn’t say “when inflation emerges.” He said “IF” - and that’s a critical differentiator between a proactive risk manager (a portfolio manager) and a reactive one (a professional politician). Kelly isn’t alone in this line of thinking. Almost every world class risk manager in the world understands that governments that debauch their fiat currencies will impose an inflation tax on their citizenry.
The US Dollar Index backed off hard right where it should have yesterday. It closed down another -0.54%, keeping it below its intermediate-term TREND line of $78.98. Call me lucky or call me right in understanding how to manage risk around the price of the world’s reserve currency. Since starting the Hedgeye Portfolio 3 years ago, I’ve gone 18 for 18 in making profitable long/short calls on the US Dollar (UUP).
I’m not calling this out to pump my own tires. I’m calling this out so that the pundits who are out there cheering on Bernanke’s stock market inflation policy pay attention. Making calls on US Dollar declines helped predict bubbles in both US stocks (2008) and US bonds (2010). Sadly, unless President Obama starts listening to the likes of Ted Kelly, Bill Gross, and Jim Grant, it may very well take another US Dollar currency crisis to stop these Big Keynesian Central Planners in their tracks.
As a reminder, we first made our call on Global Inflation Accelerating in October of 2010, and from here on in we’ll be acutely monitoring the slope of inflation accelerating or decelerating with the following assumptions:
That’s it. That’s the deep simplicity we’ve found in our multi-factor, multi-duration model. Remember, in principle Chaos Theory is grounded in uncertainty – so every risk management exercise starts with IF and every decision follows the THEN that’s driving correlation risk.
On our most immediate-term duration, some of the correlation risk associated with US Dollar Debauchery has burned off in the last 2 weeks. That’s primarily because the US Dollar was UP for the first week out of the last four. IF we debauch it from here, THEN that will change. Correlation risk gets fired up when the Buck Burns.
On the heels of yesterday’s US Dollar decline, here were some important Global Macro reactions to consider:
Again, this isn’t complicated. Debauched Dollar is bullish for inflation (Commodities) and bearish for Bonds and Emerging Markets…
As you can see in the Hedgeye Portfolio (attached), alongside re-shorting the US Dollar this week, we re-shorted the following Macro positions:
Now as sure as the sun rises in the East, you can bet your Madoff that The Ber-nank won’t be talking about the interconnectedness that his Central Planning Policies and a Debauched Dollar have on Asian and Emerging Market currencies and/or their exports.
Let me illustrate this point (generally) with the example of how the USD is affecting South Korea:
South Korea’s stock market isn’t what we’d call an “emerging market.” Per capita GDP is 10x that of China and it’s an economy levered to both US Tech and Industrial demand (bearish leading indicators?). Since it’s the world’s 12th largest economy, the KOSPI recently moving to bearish TRADE and TREND in our risk management model is something worth paying attention to as you watch Bernanke and Geithner continue to erode the credibility of America’s currency today.
My immediate term support and resistance lines for the SP500 are now 1324 and 1339, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
“The natural progress of things is for liberty to yield and government to gain ground.”
I went into this President’s Day weekend writing an intraday note at 3PM EST on Friday titled “Exhaustion.” I wasn’t talking about my physical state. Ex-snow shoveling, I’ve been managing with my peg leg in an air cast just fine. I was writing about the US stock market’s risk management setup.
In the most immediate-term duration (today), US stock-centric investors are going to realize that there is indeed risk to a market that’s been rallying to higher-intermediate-term highs on low-volume and negative skew. From a long-term TAIL perspective, US stocks are simply making lower-highs.
Lower-highs can be lethal to returns, particularly if confirmed by fundamentals that perpetuate lower prices. While plenty a perma-dancing-bull can tell you that the US stock market is “cheap” (if they use the wrong margin and earnings assumptions in their SP500 estimates), this type of storytelling isn’t new to your average American.
After all that we’ve been through in the last 3-years my sense is that Americans get it. Americans get leadership. Americans get liberty. Americans get transparency, accountability, and trust.
Before I take a step back recapping last week’s most important weekly moves, allow me to remind you what risks Main Street Americans see to the US economy:
So when the S&P Futures are down 18 points like they are this morning, there are obviously more than a few relatively large risks that the “fundamentalist” might point toward.
There is also this other little risk management critter called The Rest of The World that central planning folks in Washington, DC seem to think are simply being affected by “supply and demand” as opposed to anything that’s right here in our own back yard.
Given that 85% of all foreign exchange transactions are in US Dollars, and the US Dollar continues to be debauched, we think the following week-over-week moves in Global Macro are critical correlated risks to manage around:
So how could US investors bid up volatility at the same time as the institutional performance chasing community bids up the price of US stocks? Maybe it wasn’t US only investors…
Maybe, just maybe, The Rest of the World remembers that deficit spending and dollar devaluation strategies don’t work out so well in the end. Maybe some Americans themselves remember what Presidents Nixon and Carter did to the US Dollar in the 1970s. Maybe history remembers The Inflation.
In terms of other important perspectives, this is what The Economist had to say this weekend in its commentary about US Leadership:
“Neither the President nor Republican leaders have had the courage to support them. In the absence of statesmanship, the chances are that only a crisis in the bond markets will provide the necessary impetus. Economic management by fiscal heart attack is not a very prudent remedy.”
This is what a massive international pension fund manager (Gerald Smith, Deputy Chief Investment Officer of Baillie Gifford, who oversees $117 Billion in assets) had to say about American monetary policy:
“If Bernanke wants inflation he’s going to get it.”
And, finally, for all of the professional politician fans who are still left out there in America, this is what Presidential candidate, Mitch Daniels, had to say about US deficit and debt spending:
“We face an enemy lethal to liberty and even more implacable than those America has defeated before.”
It’s all out there now. You don’t need this Canadian with an American family and firm to remind you of the risks. You get it too.
In the Hedgeye Asset Allocation model, last week I invested 6% of our large Cash position in a combination of Swedish stocks and soft agricultural commodities, taking the cash position down from 61% last Monday to 55% this morning.
The current exposures in the Hedgeye Asset Allocation Model are a follows:
As you can see in the Hedgeye Portfolio (see attached), I’m short both emerging markets (EEM, IFN, EWZ) and US Treasuries (SHY), so that’s one of the main reasons why I have such a large asset allocation to Cash – I don’t own any fixed income or emerging market exposure as I realize that inflation can and will continue to be lethal to these markets.
As to whether or not the Almighty Central Planners of America are infusing interconnected Global Macro market risks into our way of life … that will be an American history that writes itself on its own time… In the meantime, deficit and debt spending will remain lethal to our liberty.
My immediate term support and resistance levels for the SP500 are now 1330 and 1346, respectively. If the SP500 breaks down and closes below 1330, I have no support to 1306.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Slightly below consensus quarter due to lower hold but VIP volumes were up 40% sequentially and Mass volumes grew as well.
HIGHLIGHTS FROM THE RELEASE
CONF CALL NOTES
This note was originally published at 8am on February 16, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“Epidemics are sensitive to the conditions and circumstances of the times and places in which they occur.”
Epidemic might be the right word to describe the environment in the USA that has ensued since Bernanke’s speech in Jackson Hole and the 96.3% move in the S&P 500 since March 2009. There are many corners of the world that are looking at the USA and the policies of the Federal Reserve and clearly believe that we are pouring gasoline on a blazing hot fire.
The past month’s protests in North Africa and the Middle East were partly linked to surging agriculture costs and according to the UN, countries in Latin America are most at risk of food riots as prices continue to head higher. According to the World Bank, rising global food prices have pushed 44 million more people into “extreme” poverty in developing countries since June. Yet the USA and the S&P 500 continue to power forward like they are impervious to these issues.
Not so fast…. The question is when, not if, Chariman Bernanke will pull the punch bowl on the current liquidity binge. The increased civil unrest that ensues around the world will continue to put incremental pressure on him to alter the current policy. The scary part is he needs to do it sooner rather than later and chances are it’s going to happen at exactly the wrong time.
Just by chance, what if we get a hint of a FED exit strategy today at 2 pm just as the “storytelling” is reaching a feverish pitch? I’m hearing people talk about stocks, saying, “This time it’s different!” Or how about this one, “margins don’t matter!” Or better yet, “consumer companies are impervious to rising input costs!” Over the next 12-months we are going to be able to produce some serious You-Tube moments that will last a lifetime.
Of course margins don’t matter – until they do. Consumer companies are impervious to rising input costs – until they are not. And we are at the tipping point!
It seems like yesterday that Malcolm Gladwell published The Tipping Point: How Little Things Can Make a Big Difference. Gladwell describes a tipping point as “the moment of critical mass, the threshold and the boiling point.” In nearly every situation there is that moment in time when the world is ready to follow the leader or “the trend.” Right now, that leader is Chairman of the Federal Reserve, Ben Bernanke and the trend is excess liquidity that is leading to higher inflation and higher stock prices.
The critical element of the U.S. economy that is not benefitting from the Federal Reserve’s actions, in real terms, is the consumer. I believe that the consumer is reaching a tipping point. Accelerating demand is critical to maintaining profitability in an accelerating cost environment. What we saw yesterday from the retail sales data was perhaps an indication that the consumer is beginning to slow down.
In the face of non-confirming data, observers with a conflicted or biased view often look for any other metric, or any other narrative, to justify a prior perspective. Revisionist versions of the truth are offered with adroit semantic maneuvering and frantic searching for the comfort of a confirming thesis.
One narrative being promoted at the moment is that consumers are willing to pay above market for “green” products from “socially responsible” companies. This may be true to a degree, but deflecting the clear truth behind the data, be it Retail Sales or otherwise, with qualitative narratives that are entirely subjective, is not a practice I subscribe to. If consumers see raising prices in the absence of a corresponding growth in personal disposable income, there is likely going to be a change in consumer behavior.
As Gladwell wrote, "Ideas and products and messages and behaviors spread like viruses do.” At present, it is clear that many ideas and messages have spread rapidly around investor circles. Sectors of the market are trading at premium multiples largely because of the free-money policy of the Federal Reserve. The confidence that this instills in investors seems to trump any concern about companies’ ability to control their input costs from now on.
For many companies, the cost of raw materials is rising at a faster pace than revenue and we have only just begun to see the impact on margins. Rising costs take time to flow through to the bottom line. Rhetoric from management teams, against all of their incentives, has been decidedly cautious with respect to their commodity cost outlook. As we move through the balance of 2011, the squeeze on profit margins will be more pronounced than most analysts expect.
The Empire Index' Prices Paid index, which climbed to a two-and-a-half-year high of 45.8, was supportive of my theory yesterday. Quoting directly from the press release, "The prices paid index climbed to a two and-a-half-year high in February, but the measure for prices received was little changed, suggesting some pressure on profit margins." That’s right – margins are contracting, not expanding.
How the consumer reacts to increased inflation pressures will be the tipping point for the market. Across a wide spectrum of the S&P 500, companies are seeing margins contract, and some are more confident than others in their ability to pass on price to customers. A growing percentage of companies will be unable to increase price at all, or fast enough to offset margin contraction, without hurting top line trends. The economic recovery is in its embryonic stages, unemployment remains high, and consumers are keeping a tight rein on spending. How much inflation can they take before spending begins to suffer?
I heard some supposed experts on CNBC say that $5.00 gas will not affect consumer spending. It’s this kind of storytelling that is sign of pure excess.
Perhaps yesterday’s Retail Sales was the first glimpse of this trend. Retail Sales growth missed Street expectations. The trajectory of 4Q10 sales trends cannot continue with inflation accelerating and job growth proving to be highly inadequate as an offset.
Over the next two days we will be getting more inflation readings from the PPI and CPI. While these two numbers are conflicted calculations, they will both point to accelerating inflation. For proof of this trend, last night in an interview on Bloomberg, Richmond Fed President Lacker (non-voting FOMC member in 2011) said that US inflation may accelerate in H2 of 2011 as firms seek to recoup higher commodities and health care costs.
And Joe six pack is going to roll over and say thank you very much!
Function in Disaster; finish in style
In preparation for MPEL's Q4 earnings release Tuesday morning, we’ve put together the pertinent forward looking commentary from MPEL’s Q3 earnings call.
Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.