Economic Fallacies

“Economics is haunted by more fallacies than any other study known to man.”

-Henry Hazlitt


This weekend I reviewed one of the classics in my library – Henry Hazlitt’s “Economics in One Lesson.” The aforementioned quote is the first sentence of the book. Hazlitt first wrote it in New York in 1946 then edited it 32 years later from his office in Wilton, Connecticut.


This is a very popular book (over 1 million copies sold) for very good reason. It’s grounded in common sense. And the lesson in 2011 (33 years after Hazlitt reiterated the lesson 32 years after 1946) is the same as it was when the Keynesian Kingdom was imploding in 1979:


“Governments everywhere are still trying to cure by public works the unemployment brought about by their own policies.” (Hazlitt, “Economics in One Lesson”, pg 208).


Have no fear however, the European Financial Stability Facility is here. Or is that the 15 TRILLION in Yen being deployed by the Bank of Japan this morning? Or is that the 223 BILLION in deficit spending by the US government for the month of February? Who cares as long as it doesn’t affect me? Right? Nice moral compass.


Last week’s Global Macro news had plenty of international risks (Risk Management in One Lesson – risk is always on), but a lot of it is staring you right in the face here at home. This should remind you that the highest deficit spending month in the history of America isn’t working:

  1. US Deficit – despite the unanimous call of The People to govern US Government spending. Expenses ran up +5% year-over-year in February to their highest level ever (ever is a long time Mr. President)
  2. US Home Prices – despite the US Government daring Americans to take on more leverage, Corelogic’s reading on US Home Prices fell -5.7% for the month of January (y/y) and are now running at a -18% annualized pace (see our Macro Slide Presentation on Housing Headwinds)
  3. US Consumer Confidence – despite the US stock market rallying +98% in the last 2 years, the Michigan Consumer Confidence reading had its 8th largest drop since the data started getting tabulated in 1978 (falling -12% in March to 68.2 versus 77.5 in February)

“The policy of inflation, as I have said, is partly imposed for its own sake. More than forty years after the publication of John Maynard Keynes’ General Theory, and more than twenty years after that book has been thoroughly discredited by analysis and experience, a great number of our politicians are still unceasingly recommending more deficit spending in order to cure or reduce unemployment.” (Hazlitt, pg 204, 1978)


Last week, we learned that the tough short-term love associated with a strengthening US Dollar may not be what stock market inflation fans like The Bernank want, but it’s definitely what the other HALF of Americans who don’t own stocks need – a Deflation of The Inflation.


Here’s what happened to the price of things we actually need to buy (with the US Dollar Index trading up +0.5% week-over-week to $76.78):

  1. CRB Commodities Index = DOWN -3.0%
  2. Oil = DOWN -3.1%
  3. Copper = DOWN -6.3%

No, that probably didn’t make anyone who is long of The Stock Market Inflation happy, but it did give the rest of us lower prices at the pump this weekend. Contrary to manic media delusions of common sense, gas hitting $4/gallon is negative for consumer confidence (see the score).


The Deflation of The Inflation was also good for those of us who raised a high asset allocation to CASH when everything from US Equities to Commodities were locking in their intermediate-term cycle highs last month. In the last 3 weeks, with the SP500 deflating -2.9%, I’ve taken the CASH position in the Hedgeye Asset Allocation model down from 61% to 43% (Risk Management in Another Lesson – buy red, sell green).


On a week-over-week basis the Hedgeye Asset Allocation moved to the following position:

  1. Cash = 43%  (down from 49% last week)
  2. International Currencies = 27% (Chinese Yuan and Canadian Dollar  - CYB and FXC)
  3. Commodities = 15% (Gold, Oil, Corn, and Grains – GLD, OIL, CORN, and JJG)
  4. International Equities = 6% (Germany – EWG)
  5. US Equities = 6% (Energy and Healthcare – XLE and XLV)
  6. Fixed Income = 3% (US Treasury Flattener – FLAT)

I’m definitely not saying that this was the perfect setup. I am saying that managing risk proactively in a risk management environment of Heightening Price Volatility preserves capital. Alongside Price Volatility (VIX) putting on a +28.8% move to the upside since the US stock market topped on February 18th, some other crystal clear risk management signals have reminded people that they are still there:

  1. Growth expectations (measured in US stock prices or UST bond yields) are finally coming down
  2. Risk spreads (CDS, TED Spread, Sovereigns) are widening
  3. International stock markets are deflating (36 of the top 60 countries in our Global League Table are DOWN for the YTD)

Now I suppose that we can all celebrate Big Central Planning this morning as the Greek stock market moves up another +3% making it the world’s best performer for the YTD. Or maybe not…


What goes up, must have gone down a lot. That’s what happens to market prices that aren’t exactly as free as they used to be.


My immediate-term support and resistance levels for WTI crude oil are now $98.55 and $103.31, respectively. My immediate-term support and resistance lines for the SP500 are 1292 and 1313, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Economic Fallacies - Chart of the Day


Economic Fallacies - Virtual Portfolio


TODAY’S S&P 500 SET-UP - March 14, 2011

As Hedgeye’s CEO, Keith McCullough, said today “Some of the dysfunctional European equity markets are celebrating fiat socialism this morning with a perfect can kicking of Greek and Spanish liabilities into the long term back of the net.”   As we look at today’s set up for the S&P 500, the range is 21 points or -0.94% downside to 1292 and 0.67% upside to 1313.



  • 8:30 a.m.: NOPA Oil Stocks/Soybeans
  • 8:30 a.m.: Export Inspections (corn, soybean, wheat)
  • 11:30 a.m.: U.S. to sell $62b 3-mo. bills, $30b 6-mo. bills


  • Hewlett-Packard CEO Leo Apotheker is set to unveil strategic direction for company
  • Retailers sell out of iPad 2 within hours - FT
  • SEC is weighing an enforcement action against Fannie Mae and Freddie Mac - WSJ
  • Facebook plans to test Groupon-inspired service
  • India’s Oil & Natural Gas Corp. lost bid to buy Exxon Mobil Corp.’s 25% stake in an Angolan oil field, two people with knowledge of the matter say
  •  Berkshire Hathaway is to buy Lubrizol for about $9.7b.


As of the close yesterday we have 3 of 9 sectors positive on TRADE and 8 of 9 sectors positive on TREND.  The 3 Sectors that remain bullish on both TRADE and TREND durations are all low beta defensive sectors:

  • Healthcare (XLV)
  • Utilities (XLU)
  • Consumer Staples (XLP)
  • One day: Dow +0.50%, S&P +0.71%, Nasdaq +0.54%, Russell +0.41%
  • Month-to-date: Dow (1.49%), S&P (1.73%), Nasdaq (2.40%), Russell (2.50%)
  • Quarter/Year-to-date: Dow +4.03%, S&P +3.71%, Nasdaq +2.36%, Russell +2.45%
  • Sector Performance: - Energy +1.73%, Materials +1.49%, Industrials +1.17%, Financials +0.67%, Tech +0.39%, Consumer Discretionary +0.62%, Utilities +0.22%, Healthcare +0.33%, Consumer Staples (0.07%).


  • ADVANCE/DECLINE LINE: 804 (+2922)  
  • VOLUME: NYSE 919.93 (-17.87%)
  • VIX:  20.08 -8.23% YTD PERFORMANCE: +13.13%
  • SPX PUT/CALL RATIO: 2.08 from 1.35 (+53.41%)


On Friday, treasuries were notably weaker on selloff pressures following the Japan earthquake.

  • TED SPREAD: 23.95 -0.101 (-0.422%)
  • 3-MONTH T-BILL YIELD: 0.08%
  • 10-Year: 3.40 from 3.37
  • YIELD CURVE: 2.76 from 2.81


  • CRB: 351.88 +0.71% YTD: +5.73%  
  • Oil: 101.16 -1.50%; YTD: +6.69% (trading -1.93% in the AM)
  • COPPER: 420.75 +0.24%; YTD: -6.06% (trading -0.70% in the AM)  
  • GOLD: 1,420.18 +0.88%; YTD: +0.38% (trading +0.22% in the AM)  


  • Rubber Slumps 13% as Tokyo Exchange Widens Limit on Drop in Japan Demand
  • Milk Seen Plunging 14% as Costliest Cheese in Quarter Century Curbs Demand
  • Oil Falls to Two-Week Low in New York as Japanese Quake May Limit Demand
  • Gold Gains for Second Day on Japanese Quake, Libyan Unrest; Platinum Drops
  • Wheat Falls to $7.1525 a Bushel in Chicago, Erasing Advance; Corn Slides
  • Copper Fluctuates Amid Concern Japanese Industrial-Metals Demand May Slow
  • Coffee Falls on Speculation Robusta Supplies Will Be Ample; Cocoa Rises
  • Palm Oil Declines as Japan Quake Triggers Sell-off in Crude Oil, Equities
  • Japan Asks Industry Body to Release Corn From Reserves After Earthquake
  • Corn, Soybeans May Rise as Price Drop Boosts Demand, According to Survey
  • South Korean Steel Mills, Refiners, Automakers Gain on Japan Earthquake
  • Philippines May Raise $4.6 Billion to Help Fund Building of Roads, Rail


  • EURO: 1.3903 +0.60% (trading +0.45% in the AM)
  • DOLLAR: 77.776 -0.65% (trading -0.33% in the AM) 


  • FTSE 100: 0.02%; DAX: (0.64%); CAC 40: (0.10%)
  • European markets generally trade lower from the continuing fall out from the Japanese earthquake.
  • Peripheral markets are broadly higher; Greece up 4%, and Greek banks in particular up over +7%.  The banks got a boost from the agreement to reduce the interest paid on it's bailout package.
  • There was no such agreement announced for Ireland up 0.06%.
  •  Euro-Area Industrial Production Increased, Led by Germany January output +0.3% M/m, est +0.3%; January. output +6.6% Y/y, est. 6.5%
  • The largest categories of growth were intermediate goods (+2.5%) and durable consumer goods (+2.5%). The decline in the production of capital goods (-0.3%), if continued, would suggest that drivers of growth are shifting to consumer spending from investment spending, though a one-month does not make a trend.


  • Nikkei (6.2%); Hang Seng +0.4%; Shanghai Composite +0.1%
  • In the wake of the earthquake, Japan plunged today, but other Asian markets were mixed.  Japan’s central bank doubled its asset-buying scheme to ¥10T and offered to pump ¥15T into the banking system.
  • Hong Kong rose on infrastructure issues, but volume was light as some people waited for more information from Japan.
  • China finished flat.  
  • Mining shares fell on worries that Japan’s earthquake will cut demand for raw materials, leading Australia down.
  • Japan revised January industrial output +1.3% m/m vs preliminary +2.4%. January capacity utilization index +3.6% m/m.

Howard Penney

Managing Director



Eye On Macro – Risk On

“Get the habit of analysis - analysis will in time enable synthesis to become your habit of mind.”

                              -Frank Lloyd Wright


Conclusion: Below we’ve highlighted some key excerpts from our last week of research notes and global economic data synthesis.  If the data is telling us anything, it is that risk is back on. (Not that it was ever truly off.)  In Europe, both sovereign and bank debt CDS spreads continue to flash warning signs as yields and CDS spreads are widening.  In Asia, we are getting continued evidence of inflation (Chinese CPI +4.9%) and growth slowing (Japan revised Q4 GDP lower to -1.3%).  Finally in the U.S., we are getting more evidence of the consumer getting squeezed due to declining home prices (Corelogic had national home prices down -5.5% in January) and accelerating gasoline costs.


Long Macro Positions


Longs oil via etf OIL; Long grains via etf JJG; Long corn via etf CORN; Long gold via etf GOLD; Long Canadian Loonie vie etf FXC; Long Germany via etf EWG; Long Chinese Yuan via etf CYB; Long yield curve flattening via etf FLAT; Long healthcare via etf XLV; Long energy producers via XLE


Short Macro Positions


Short Spain via etf EWP; Short the U.S. Dollar via UUP; Short industrials via XLI; Short homebuilders via XHB; Short treasuries via SHY; Short emerging markets via EEM


Key Research Excerpts


“Up until last week, it can be strongly argued that the dollar’s decline has been aided by a confluence of dovish US monetary policy (QE2) and incredibly lax fiscal policy (the CBO revised up the US federal budget deficit by +46% through FY13).”


“We know QE2 is ending in three months; will the Fed be tempted to step on the gas pedal some more? Reasonably strong US GDP growth forecasts of around +3.5% for 2H11 suggest that QE3 is not consensus – yet.”


“Corn is facing a serious supply shortage in the year 2010-2011 as corn output is estimated at 814.3 million tons while corn demand will flirt with 836 million tons. According to a Feb. 9th USDA estimate, approximately 43% (4.95B out of the 11.6B bushels) of corn demand in the US is for ethanol use.  This only adds to gasoline costs as gasoline is comprised of 10% ethanol.”


“The average U.S. household will spend about $700 more for gasoline in 2011 than it spent last year, bringing total motor fuel expenses up 28 percent to $3,235, based on an annual pump price of $3.61.”


“According to the latest American Pulse™ Survey of 5,224 respondents, 80.3% of registered voters agree that the increase in gas prices is one of the worst problems affecting the United States. The survey asked respondents to list the worst problems currently affecting the United States, and registered voters mentioned in order of frequency: unemployment (80.4%), rising gas prices (80.3%), weak economy (70.6%), national debt (69.4%) and rising food prices (61.9%).”


“The Bloomberg Consumer Comfort Index dropped to minus 44.5 last week from the prior week’s minus 39.7, which was close to the highest in almost three years.” 


“The unemployment rate was a surprise at 8.9%, but it is likely an aberration as more discouraged workers than previous months did not enter the labor force.”


“We have been looking for claims in the 375-400k range as the level that can begin to bring unemployment down.  If this level is held, we expect to see unemployment improve.  That said, it is worth highlighting an important caveat. This recession has been different in that it has pushed the labor force participation rate down by ~200 bps, which has had a correspondingly positive improvement on the unemployment rate. In other words, the unemployment rate isn't really 8.9%, it's 10.9%. So when we say that claims of 375-400k will bring down the unemployment rate, we are actually referring to the 10.9% actual rate as opposed to the 8.9% reported rate.”


“Despite a surge in personal income growth, real spending declined in January. Real personal consumption expenditures slipped by 0.1%, marking the first decline since April 2010. Nominal spending rose by 0.2%, which was about half of the average pace from the previous six months.”


“If you've been wondering when home prices in the U.S. would officially double-dip, your wait is over.  Corelogic reported the Home Price Index for January hit 134.94, the lowest value since 2003.  On a YoY basis, the index fell -5.7%, an acceleration from December's pace of -4.7% YoY (upwardly revised from -5.5%).  Looking at sequential changes, the story is similar. The Index fell -2.5% MoM in January, the largest sequential decline since February of 2009.” 


“According to estimates from the Congressional Budget Office (CBO), the Federal budget deficit for February was $223BN which is an increase of about 1% from February 2010. Revenues actually grew year-over-year by 3%, which is marginally positive.  This is also the 10th straight month of year-over-year revenue increases.  On the flip side, and despite all of spending cut rhetoric, expenditures were up 5% from February 2010.”


“Our Risk Monitor for European banks shows a widening for the Greek banks week-over-week, bucking the trend of tightening across most European banks: tightening for 31 of the 39 reference entities and widening for 8.”


“One small reason Europe needs to raise interest rates is the fact that European gasoline prices are at an all time record of $8.632 per gallon.”


“Currently, the European Financial Stability Facility (EFSF) is funded with €750 Billion, composed of €440 Billion from the 16 Eurozone members; €250 from the IMF; and €60 Billion from European Commission. One pressing issue is that the entire €440 Billion is not all liquid, for guarantees against the money are needed to retain its AAA rating, which effectively leaves only €250 Billion for access. Many argue that should a country far greater than Greece or Ireland need a bailout, say a Spain or Italy, the funds are inadequate.”


“Japan revised its Q4 GDP estimate LOWER again to -1.3% (don’t forget that the US has done the same with Q4 GDP, twice).”


“China reported a huge sequential slowdown in Exports for February at +2.4% (lowest level of demand since early 2009).”


“South Korea raised interest rates to 3% (2nd rate hike for 2011 YTD with the #1 reason being inflation).”



Daryl G. Jones
Managing Director

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Update on Japan

Below are some observations on Japan from Michael Blum, Hedgeye's COO, who is based in Singapore.


"It is 5:45am here in Singapore. We are watching NHK World, the Japanese National Public Broadcasting Organization’s English language channel. The pictures we see are much worse than what is being shown on CNN International, Fox News or the BBC.


All night, we have listened to evacuation notices by the Japanese government trying to reach people in all of the northern provinces and warning them of after-shocks and, most seriously, additional Tsunamis. These evacuation notices have been posted in Japanese, Mandarin, Portuguese and English.


Massive amounts of land are still under water as the Land of the Rising Sun welcomes this day. Total devastation. We see fires of the most unimaginable scale beyond what has been shown on western television in the last 15 hours.


The damage and casualties will be beyond what can be imagined and comprehended by our simple minds."


Michael Blum

Chief Operating Officer

The Week Ahead

The Economic Data calendar for the week of the 14th of March through the 18th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - cal1

The Week Ahead - cal2

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