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CHART OF THE DAY: Japan's Long-Term Tail



CHART OF THE DAY: Japan's Long-Term Tail -  chart

Something For Nothing

“The world is full of so-called economists who are full of schemes for getting something for nothing.”

-Henry Hazlitt


Today you’ll hear a lot of excuse making. You’ll see a lot of finger pointing. The easiest thing to do will be huddling in the comfort of crowds that will tell you “nobody saw this coming.” While taking brokerage fees on that kind of advice may be convenient, that’s not a risk management process.


There will be no accountability from the Keynesians who have advised the Japanese to “print lots of money” (Paul Krugman). There will be no causality in the analysis. But there will still be an island economy that has levered itself up with 998 TRILLION Yen in leverage – that risk management compromise and the horror of this natural disaster will be something the Japanese citizenry will have to bear for a long time to come.


Of course our hearts and prayers go out to the Japanese, but we aren’t going to use their crisis as a crutch. It’s time to remind people that chasing US, European, or Japanese stock market returns for the sake of relative performance comes with major event risk. From deficit and debt spending to The Inflation born out of printing money from the heavens, getting Something For Nothing isn’t a perpetual return.


The Japanese stock market has lost -17% of its value in 2 trading days (biggest drop since 1987). If you go back to the week that fund flows into “Developed” Equity Markets peaked (the week of February 14th – see my Early Look titled “The Flows”), the Nikkei is down -20.7%. That’s called a crash.


Like America’s, the Debt/GDP crisis in Japan is obvious. In hopes of getting Something For Nothing, the Big Government Intervention bureaucrats of Japan have already jacked up sovereign debt to 210% of GDP – and that’s not including the projected 15 TRILLION in emergency stimulus they’ve already approved to spend on this disaster.


There comes a point in an economy’s money printing and leverage-cycle that disaster (including war) can no longer be financed with Fiat Fool paper. As we rightful grieve for the Japanese people this morning, this is a major structural consideration that the 112th Congress of the United States of America should consider when politicking about the risk/reward in raising America’s Debt Ceiling.


In the US, we’ve been calling for a 3-6% correction in US Equities since fund flows peaked in mid-February. As of yesterday’s SP500 closing price of 1296, we’ve already registered -3.5% of that. This morning we’ll see our Drawdown Line of 1271 tested on the downside (see my intraday risk management note from yesterday titled “Drawdown: SP500 Levels, Refreshed”).


This is not to take a victory lap. I am long German Equities this morning and I am getting clocked in that position just as cleanly as you’ll get clocked in your long positions. This is a reminder however that having a large asset allocation to CASH is king if you proactively prepare for globally interconnected storms.


Yesterday I raised my allocation to CASH in the Hedgeye Asset Allocation Model to 49% from 43%. I sold down my US Equity allocation from 6% to 3% and I cut my exposure to Commodities from 15% to 12%.  Again, not a victory lap – this is simply what I did.


What a lot of other people did is what they have been doing since US and Japanese Equities broke out to the upside in December – buy-the-dip. They’ll be accountable justifying that strategy with “valuation” this morning inasmuch as I will be to mine. That’s what makes a market.


Without a Global Macro risk management process this morning, I don’t know what price momentum traders are going to do – but I do know what I am going to do – and really, that’s all I care about. So here are my risk management lines and a plan:


1.       ASIA


A)     Japan’s Nikkei225 Index long-term TAIL line of support (10,219) is now broken, so we’re not buying that.

B)      India, South Korea, Indonesia, Thailand, Singapore, etc. have been seeing Growth Slowing As Inflation Accelerates since November, so we’re not buying those either.

C)      China outperformed most of Asia last night and looks most interesting to us on the long side, if only because we have been bearish on that market for the last year and there’s a mean reversion opportunity on the upside. The immediate-term TRADE line of support for the Shanghai Composite of 2851 held.



2.       EUROPE


A)     Germany’s DAX broke its intermediate-term TREND line of support of 7012 this morning – that’s bad and I need to take down exposure to that market no matter how bullish the fundamentals have been for the last year. Fundamentals change.

B)      Britain’s FTSE and France’s CAC also broke their intermediate-term TREND lines of support of 5918 and 3959, respectively this morning. Another way to hedge my long Germany exposure will be to short one of these markets on the next bounce.

C)      Spain (which I am short in the Hedgeye Portfolio) looks worse than the DAX, FTSE, and CAC as it has more price performance chasers long of it with a hope that Piling Debt-Upon-Debt is going to end well. Sorry leverage folks. This time is not different.



3.       USA


A)     SP500, Nasdaq, and Russell2000 all broke their immediate-term TRADE lines of support last week and 7 of 9 S&P Sectors are already broken as well. That’s not going to be new this morning, so don’t let an excuse maker tell you otherwise.

B)      SP500’s critical line of drawdown support = 1271, so watch that line very closely in the coming days. Almost all of Asia and Europe have broken their intermediate-term TREND lines, so the call to “buy-the-dip” would imply that the US “decouples” from Global Growth Slowing, which you know we disagree with. US GDP growth estimates need to come down to where the market is pricing them.

C)      Volatility (VIX) is threatening a long-term TAIL breakout above the 22.03 line this morning. That’s not a line that you get paid to mess with, and I suggest you respect the inverse relationship between the SP500 line of 1271 and VIX 22.03, acutely.


No one in New Haven said there was such a thing as a Big Government free lunch. No one here is going to beg for Something For Nothing this morning either. It’s time to get serious about fiscal and monetary policy. It’s time to strengthen the US Dollar so that we can tone down The Inflation. It’s time for risk management.


My immediate-term support and resistance lines for WTI crude oil are $95.43 and $103.52, respectively. My immediate-term support and resistance lines for the SP500 are 1271 and 1312, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Something For Nothing - t1


Something For Nothing - t2


TODAY’S S&P 500 SET-UP - March 15, 2011

The risk management call out today is to watch the VIX.  The VIX is going to blowout into bullish long term TAIL if it closes > 22.03; that’s not something you want to mess with if it holds.  As we look at today’s set up for the S&P 500, the range is 41 points or -1.96% downside to 1271 and 1.20% upside to 1312.



  • 7:45 a.m.: ICSC/Goldman weekly sales
  • 8:30 a.m.: Empire Manufacturing, est. 16.1, prior 15.43
  • 8:30 a.m.: Import price index, est. 0.9%, prior 1.5%
  • 9 a.m.: Total net TIC flows, est. $37.5b, prior $48.2b
  • 10 a.m.: Geithner testifies at Senate Banking Committee on housing
  • 10 a.m.: NAHB Housing Market Index, est. 17, prior 16
  • 11:30 a.m.: U.S. to sell $40b in 4-week bills
  • 2:15 p.m.: FOMC rate decision


  • Nasdaq OMX is considering making a competing bid for the New York Stock Exchange
  • Monthly charge-offs from Big 6 credit-card companies
  • Microsoft’s Internet Explorer 9 available for download today
  • Qaddafi’s forces advance as rebels request Western airstrikes
  • Clinton meets with European foreign ministers in Paris
  • Google plans to start testing mobile-payment service in stores within 4 months
  • U.S. lawmakers may propose legislation as soon as today to delay proposed debit-card “swipe” fee caps


As of the close yesterday we have 2 of 9 sectors positive on TRADE and 8 of 9 sectors positive on TREND.  The 2 Sectors that remain bullish on both TRADE and TREND durations are all low beta defensive sectors:

  • Healthcare (XLV)
  • Utilities (XLU)


  • One day: Dow (0.43%), S&P (0.60%), Nasdaq (0.54%), Russell (0.58%)
  • Month-to-date: Dow (1.91%), S&P (2.32%), Nasdaq (2.92%), Russell (3.07%)
  • Quarter/Year-to-date: Dow +3.59%, S&P +3.08%, Nasdaq +1.81%, Russell +1.85%
  • Sector Performance: - Utilities (1.32%), Consumer Discretionary (1.23%), Financials (0.91%), Industrials (0.85%), Consumer Staples (0.71%), Healthcare (0.49%), Tech (0.47%), Materials (0.37%), and Energy +0.55%


  • ADVANCE/DECLINE LINE: -1104 (-1098)  
  • VOLUME: NYSE 963.83 (+4.77%)
  • VIX:  21.13 +5.23% YTD PERFORMANCE: +19.04%
  • SPX PUT/CALL RATIO: 1.80 from 2.08 (-13.08%)



Treasuries were stronger with relative strength in the belly.

  • TED SPREAD: 22.58 -0.913 (-3.885%)
  • 3-MONTH T-BILL YIELD: 0.09% +0.01%
  • 10-Year: 3.36 from 3.40  
  • YIELD CURVE: 2.75 from 2.76


  • CRB: 350.61 -0.36% YTD: +5.35%  
  • Oil: 101.19 +0.03%; YTD: +6.46% (trading -2.77% in the AM)
  • COPPER: 418.65 -0.50%; YTD: -7.53% (trading -2.10% in the AM)  
  • GOLD: 1,425.45 +0.37%; YTD: -0.78% (trading -1.30% in the AM)  


  • Commodities Tumble, Led By Oil, Copper as Japanese Quake Threatens Demand
  • Rice Prices May Slide as Global Stockpiles Poised to Reach Nine-Year High
  • Gold Declines as Some Investors Sell to Make Up for Drops by Other Assets
  • Crude Oil Drops as Loss of Demand in Japan Outweighs Middle East Tension
  • Copper in London, Shanghai Declines as Japan Says Radiation Risk Growing
  • Rubber in Tokyo Falls to Four-Month Low as Japan Quake May Derail Demand
  • Uranium Slumps 9.8% as Quake, Tsunami Cause Japan Nuclear Reactor Crisis
  • Shipping Rates Poised to Decline 30% After Two-Week Rally: Freight Markets
  • Cotton Demand Outlook Is `Very Optimistic' on China, India, Olam Predicts
  • Wheat, Corn, Soybeans Tumble as Japan's Kan Sees Further Radiation Danger
  • Copper, Aluminum Futures Trading in China May Climb on Warehousing Change
  • Japanese Earthquake Threatens Prime Minister's $175 Billion Nuclear Dream
  • Posco, SK Innovation Set to Benefit From Earthquake Disruptions in Japan
  • Japan Reduces Wheat Tender Purchase by 76% After Earthquake, Ministry Says


  • EURO: 1.3990 +0.63% (trading -0.81% in the AM)
  • DOLLAR: 77.349 -0.56% (trading +0.84% in the AM) 


  • FTSE 100: (1.84%); DAX: (3.09%); CAC 40: (2.17%)
  • Bell ringer in the major Western European markets with intermediate term TREND line breaks in FTSE, DAX, and CAC
  • Russia holds up best, which is not surprising given that oil is still bullish TRADE, TREND and TAIL
  • German ZEW economic sentiment 14.1, est. 15.9


  • Nikkei (10.6%); Hang Seng (2.9%); Shanghai Composite (1.4%)
  • Nikkei blew through its long term TAIL line of support (10,219)
  • After rising yesterday, energy stocks led declines in China.
  • Australia fell 2.11% in reaction to the news from Japan; uranium miners plunged again on worries about the global prospects for the nuclear industry.
  • Hong Kong lost more than 4% by midday, recovering to close down 2.9%.

Howard Penney

Managing Director



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2012 . . . Can Obama Be Beat?

Conclusion: It’s a long ways out, but President Obama looks more and more formidable heading into 2012.  The key issue is that there does not appear to be a Republican contender. Or at least anyone that is willing to be considered such.


As of yet, no Republican candidate has declared that he or she is running for President in 2012.  While the election is more than a year and a half away, the lack of decisiveness and early declaration may turn out to be an error by those candidates striving for the office.  In contrast, President Obama seems to be gaining momentum in terms of his positive standing among the electorate.


We are big fans of the Intrade markets for politics.  As we’ve witnessed in the past, they are often dead on in their ability to predict electoral outcomes and we saw this in spades with the recent midterm elections, as Intrade came very close to predicting the margin of victory in Congressional elections by the Republicans. 


The futures contract on Intrade for President Obama to win the 2012 Presidential election is currently trading at 62.  This means that if you were to buy the contract, and President Obama wins, your payout would be $38 on every $62 invested.  As outlined in the chart below, this market has trended up since its inception in December of 2010, when the futures contract was trading at 50.


2012 . . . Can Obama Be Beat? - 1


While the Presidential election is still more than a year and half away, this type of data must be disconcerting for Republican strategists, especially combined with some recent polls.  In particular, a recent NBC News / Wall Street Journal poll, with the polling period of 2/24 – 2/28 indicated Obama a +5 versus the generic Republican candidates.


More broadly, while President Obama’s approval ratings are still mired in mediocrity, he has seen some improvement from his worst approval ratings of his Presidency.  Currently, according to the Real Clear Politics Presidential Approval poll aggregate, 47.4% of respondents approve of President Obama and 48.0% disapprove.  While this rating has gone the wrong way over the last few weeks in conjunction with accelerating gasoline costs and a U.S. equity market selloff, it is still well improved from the 51% disapproval rating on September 27, 2010, which was the worst reading of the Obama Presidency.


President Obama’s ratings are far from stellar, but so far they are holding stable despite a major setback for his party in the midterms and only modest economic improvement, especially as measured by employment, in the last year.  A key benefit for Obama appears to be that there is no real frontrunner, or even a declared candidate for the Republicans yet.  In the chart below, we show the poll aggregate for the potential Republican candidates, which validates the lack of a front runner.


2012 . . . Can Obama Be Beat? - 2


In the 2008 Presidential campaign, shortly after the midterms, Presidential candidates began declaring in size.  In fact, between November 2006 and February 2007, Joe Biden, Hilary Clinton, Chris Dodd, John Edwards, Dennis Kucinich, Barack Obama, Bill Richardson, and Tom Vilsack all declared their candidacy.   In the same time period, almost as many Republicans officially declared their candidacy, including Tommy Thompson, Jim Gilmore, Sam Brownback, Mitt Romney, Ron Paul, John McCain, and Rudy Giuliani.


Currently, no Republican has officially declared his or her candidacy.  This is somewhat surprising given the large amount of cash needed to fund a campaign, and the lead time needed to raise that cash.  In addition, there is bully pulpit afforded to an official nominee.  Surprisingly, so far no potential candidate has decided to take advantage of that potential media exposure and establish his or her credentials (and, of course, attack the President).


The other challenge for the Republican Party is that they do not appear to have a strong candidate at the moment.  Currently Obama polls worse against a generic Republican than he does versus any of the perceived front runners.  According to the Real Clear Politics poll aggregates, President Obama leads a generic Republican by 2 points, but leads Huckabee by 5.5 points, Romney by 5.2 points, Ron Paul by 9 points, Gingrich by 14 points, and Palin by 15.2 points.


Clearly, the longer the Republicans wait, the more of an incumbency advantage President Obama will have in the fall of 2012.  As well, even if Republicans were to begin declaring for the Republican candidacy shortly, the other major concern from the polls is that no Republican currently seems viable.


Christie  / Walker 2012… anyone?


Daryl G. Jones

Managing Director

European Risk Monitor: Greek Bank Swaps Anticipated Positive EU Summit

Positions in Europe: Long Germany (EWG); Short Spain (EWP)


Below we include our weekly Risk Monitor for European bank CDS. Greek bank swaps were a noticeable standout week-over-week, tightening in anticipation of a favorable result to this weekend’s EU Summit. In fact, Eurozone leaders agreed to lower Greece’s bailout interest rates of about 5% by 100bps, and extend the repayment period of the loans to 7 1/2 years from 3 years.  Greek PM George Papandreou estimates the moves would save about €6 billion over the life of the loans. [See our note published today titled “The EU’s Extend and Pretend Summit Lean” for our full take on results of the EU Summit on Competitiveness over the weekend.]


Overall, bank swaps in Europe were mostly wider, widening for 32 of the 39 reference entities and tightening for 7 (see chart below).


This morning our CEO Keith McCullough summed up the policy and market implications of the EU Summit as:


“Some of the dysfunctional European equity markets are celebrating fiat socialism this morning w/ a perfect can kicking of Greek and Spanish liabilities into the long term back of the net.  Greece’s stock market is up a full +3% this morning, moving into a clean cut lead as the world’s best performing stock market for the YTD at +15%. The Federal Reserve has taught the ECB well – Central Planners of the world unite in victory.


Over the intermediate to long-term, piling more debt-upon-debt on these types of terms only increases the inevitability of another crash.”


We remain long Germany via the eft EWG in the Hedgeye Virtual Portfolio and shorted Spain via EWP last week (3/11) on a bounce. We think Spain’s banking issues are far from over despite government estimates late last week that the incremental capital needed to recapitalize its lenders is €15.1Billion, less than initial government estimates of €20 Billion in early January 2011. Our models show the EUR-USD trading in a range of $1.37-$1.40 over the immediate term (3 weeks or less).


Matthew Hedrick



European Risk Monitor: Greek Bank Swaps Anticipated Positive EU Summit  - swaps

RL: Quantifying Japan Risk

Our best shot in quantifying Japan gets us to about a $0.43 risk to Fiscal 2012(Mar) EPS. That STILL leaves us a buck above consensus.


We definitely cannot say that the devastation in Japan will not impact Ralph Lauren. There will be logistical disruptions in Japan, which probably don’t matter as much as a dried up tourist market, and what can only be a massive distaste for luxury shopping as Japanese consumers cope with the magnitude of how their Country has changed. We hate to bring this into a stock discussion, but hey… we need to manage risk. It’s what we do.

First of all, let’s focus on some numbers.


Ralph’s overall exposure to Asia is about $850million, with most of that focused on Japan and South Korea. That number sounds colossal when looking up RL’s $5.7bn GAAP revenue base. But remember that RL has wholesale, retail, and licensing revenue streams.

  • Retail is the most pure at about $2.7bn
  • Licensing’s $175mm in GAAP revenue needs to be grossed up by an average royalty rate of 7%, which gets us to global brand value of another $2,500
  • Wholesale sales of $2.8bn needs to be grossed up to a retail equivalent of about $5.5bn

All in, we’re looking at just over $10billion in global Ralph-related sales at retail.


If we conservatively assume that 80% of the existing $850mm business is Japan, Then we’re looking at 6.5% of total global brand sales.


Profitability is below company average.


Management on 3Q call: “As you can imagine, it takes a fair amount of time for us to execute our plans. Japan, South Korea and what I'll call China territories are each at different stages of development for us and it takes time to understand the varying tastes and preferences of our customers throughout this region. We are simultaneously looking for ways to maximize operational efficiencies throughout the region. This is easiest to do with our corporate shared services and creative teams, but we are also exploring synergies with inventory management and merchandising initiatives; again, recognizing there are often substantial differences between countries. We’ve made good progress in Japan in a relatively short period of time and despite extremely unfavorable market conditions, but we're still far away from where we want to be.”


All in, when we stress test the model and assume that JAPANESE REVENUE GOES AWAY,  we get to $0.33-$0.43 per share.


There are other factors to consider, including the shared services factor as it relates to implementation and integration of the Chinese and South Korean businesses. Could we see extra costs? Yes. Pushed back by 1-2 quarters? Yep.


But that would take our Fiscal 2012(Mar) estimate down to about $7.40-$7.50. Yes, that's STILL a buck above consensus.



Brian McGough

Managing Director






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