Politics, Process and People

Politics, Process and People - asset allocation011309

“There’s been a breakdown between the conduct of politics and the people”
-Yoshimi Watanabe, last night…

Japanese Cabinet Minister, Watanabe, walked out on his political position last night and called for the resignation of Japan’s latest token Prime Minister, Taro Aso. Since Koizumi stepped down, Japan basically changes their said “leader” every 9 months, so it wouldn’t surprise me whatsoever if Aso eventually resigns – what does surprise me, however, is this loud and public ‘You Tubing’ of Japan’s long held (and accepted) bureaucratic order. It’s about time – well done Mr. Watanabe, well done!

Japan’s stock market is one that I have asked you to avoid like the bubonic plague for the better part of, well… since I started writing these notes – so I trust that you have. As Marty Whitman would say, “a bargain that remains a bargain… is no bargain.”

Japanese stocks got hammered last night closing the session down -4.8% on decent volume. That was the worst performing market in Asia, and it should be. Japan’s yield curve has been flat for a decade – they have inspired ZERO foreign investment as a result. When you pay out ZERO returns, that’s what you get – the American political machine better not forget that as it locks arms with the beggars of the politico and trudges along the lows of a global socialist bailout program. When there is a “breakdown between the conduct of politics and the people,” the people in America always win. Americans are taking their country back from the bankers right now. Thankfully, this long overdue process is in motion.

All three of the American indices that I called out yesterday broke down and closed below my support levels. Make no mistake, this is bearish. Now those support levels become my resistance levels – unless we can close above them, you are best served to be making sales on up days.

Do I like getting smacked around out there in the marketplace? No. The risk/reward in my macro model’s math played to the bullish side yesterday, and it still does this morning… just from a lower price. As prices change, expectations do. The Obama inauguration catalyst that I have been highlighting, bullishly, for the last month, is what it is – a month into my ranting about it. Could the US market’s +16% rally from its November lows have already discounted the positivity associated with Obama’s new leadership in The New Reality? Maybe – as the math changes, I will.

From yesterday’s close of SP500 870, I see a risk/reward in buying the SPY’s (SP500 etf) at -1% risk for +3% reward. That’s why I bought SPY into the close yesterday in our virtual Portfolio (see ). Every decision in markets has a time and price. If I allow my mind to be infiltrated with the negative thoughts of giving away a goal, I will never have the clarity needed to get back in the faceoff circle expecting to win the next puck back. That’s just how this game goes – if you let your mistakes eat you up inside, they will.

The following levels of resistance in the SP500, Nasdaq, and Russell 2000 need to be overcome for our “Obamerica” and “MEGA US Consumer Squeeze” rally to continue to make higher 3-month cycle highs and higher lows: SP500 889, Nasdaq 1554, and Russell 477.

If those levels are overcome, and the US emotional index (VIX) can keep a lid on itself under the 54.35 line, the US stock market is going to go up as fast in the next week as it has dropped in the last one. Since I asked you to make sales at 941 SP500 last week, don’t forget the math – the SP500 has effectively dropped -7.5% in a straight line, inspiring the “Great Depression” friends of my bear clawing past to re-populate their mugs all over your local manic media TV channel. Everything has a time and a price. All of the other noise that occurs in between timing and pricing is what it is – revisionist history.

Other than the Pandit Bandit compromising whatever credibility he had left yesterday, what was it that had people run for the global equity exits? I can give you a laundry list of things – surely, this too is revisionist history by virtue of it being yesterday’s news – but here’s what gets the red marker in my notebook this morning:

1.      Asian stock markets have broken short term momentum support

2.      Asian currencies (ex-Japan) are going down in concert

3.      European stock markets broke short term support

4.      Russia came back from their holidays, and devalued both the ruble and the RTSI exchange

5.      Middle Eastern conflict has passed through its apex of Israeli attacks (they need oil to go up, not down)

6.      Brazil had a -5.2% correction yesterday, after seeing a +40% move to the upside

7.      Commodities (CRB) were down -3.9% yesterday, underperforming equities

8.      Oil prices have lost -25% in 6 days

9.      The US Dollar has strengthened from its lows, weakening everything “re-flation”

I’m stopping with 9 contributing factors that I have interpreted as negative. There are plenty more that I will touch on during our daily “Macro” client call at 830AM. I don’t wake up every morning looking for data points to support my “call”. I strap on the accountability pants and call the river cards on the table as they lay. The facts don’t lie, people do… and I for one, am not going to stand up this morning and be proud of losing yesterday.

Today is a new day, and not losing your money remains the objective. Start clean and don’t start selling the lows into the market’s opening weakness. We are one day closer to the Obama catalyst. We have $36/oil, zero percent interest rates, the narrowest TED spread we have had in months, and an arguably a deserved “Bush Bottom” (see yesterday’s intraday Macro post at  for that note) as a result of “a breakdown between the conduct of” American politics…  “and the people.”

Best of luck out there today.

Politics, Process and People - etfs011309

Charting The Street's Emotions

Inclusive of today’s -1.5% intraday SP500 selloff, we are a long way from anything in the area code of the quantified anxieties associated with the October/November freak-out. Below is one measure of that reality – the Volatility Index (VIX).

Today the VIX is up another +3.8% at $44.43. While this is up +20% from where I was calling this out last week as oversold, I wrote that we could see a “full +27%” run-up in the VIX and nothing will have changed this fundamentally bullish “Trend” of Volatility breaking down. On the margin, this continues to back my case that the US stock market has seen its 3-month cycle low. The SP500 should continue to make higher lows and the VIX lower 3-month cycle highs.

The chart shows two lines:
1. An immediate term overbought line for the VIX at 48.59 (dotted red)
2. An intermediate overhead resistance “Trend” line for the VIX up at 54.33.

If these lines hold, alongside a narrowing TED spread (3mth LIBOR minus 3 mth US Treasuries), we will continue to see a more palatable environment to not have our hard earned dollars locked up in our ZERO interest bearing savings accounts.

Keith R. McCullough
CEO & Chief Investment Officer

Eye On India: This Isn't China!

MACRO: ASIA -Indian Industrial Production

Although the November numbers look bullish on the margin, we think it is a head fake…

India’s industrial production numbers came in at 2.4% for November, unexpectedly stronger, sequentially, after October’s -0.34% decline. This positive data point was not enough to stem the tide of post -Satyam selling as Sensex sold off by another -3.2% on the heels of a -1.88% decline in Friday’s session. The cumulative decline in India’s stock market has been approximately -12% in less than a week.

This production data looks positive on the margin. From an industrial manufacturing standpoint, India should have a few things going for it now… in Theory:

• Cheap Labor and good engineering schools
• Lower basic material prices globally
• Strategic geographic location
• Sharply decreased maritime shipping costs
Whereas the Services sector is being held hostage by declining demand in the US and Europe, and the problems facing the agricultural sector are too involved to touch on here, the Industrial portion of the subcontinent’s economy should be able to retain a relatively competitive stance in pursuit of what demand remains. It probably won’t.

India’s union biased employment laws and socialist governmental policies will make it difficult for producers to capitalize on the vast sea of cheap skilled and unskilled labor around them effectively. Additionally, the obese overlapping state, local and national governmental bureaucracies have made it virtually impossible to create new industrial facilities –with years’ worth of legal wrangling required to build new factories and badly needed new ports.

We have been negatively biased regarding India since I started at Research edge, which was the day we opened our door. We continue to believe that the deep structural flaws in the Indian economy outweigh the massive potential that lies there.

Andrew Barber

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Golden Eye: Buying More Gold Today

The last time/price we sold out of our long position in GLD (Gold’s etf) was 12/29 at $86.66. The only fundamental facts that have changed since that date play in gold’s bullish favor.

As the entire free world devalues their respective currencies (at $31.12 per USD, the Russian ruble dropped to a 6yr low this morning, putting it down -25% since the price of oil peaked in July/August of last year) in order to stoke export growth and re-flation, gold continues to look attractive. Today I am taking Gold to 6% of my Asset Allocation model, up from 3% prior.

See the chart below for my buying range in the GLD etf (in green): in terms of physical gold, this green range is the equivalent of $812-$838/oz. I’d sell some up at $891/oz (dotted red line).

Keith R. McCullough
CEO & Chief Investment Officer

MCD – Adding complexity to the system

The NY Times ran an article over the weekend that highlights MCD’s recent success against the backdrop of both a struggling economy and restaurant industry. Specifically, the article points out that the company has delivered 55 consecutive months of global same-store sales growth and that MCD shares increased nearly 6% in 2008 when the stock market lost a third of its value. The article attributes much of MCD’s outperformance to the company’s turnaround efforts which began in 2003 and focused around the then CEO James Cantalupo’s “Plan To Win.” This plan shifted the company’s strategy and focused largely on improving in-store operations and growing same-store sales performance rather than relying on aggressive, new unit growth to drive sales. It was a back-to-basics strategy that worked to improve the customer’s experience by refreshing MCD’s existing store base and by upgrading the quality of the food being offered.

Prior to this turnaround period, the article reported that “McDonald’s was struggling to find its identity amid a flurry of new competitors and changing consumer tastes. The company careened from one failed idea to another. It tried to keep pace by offering pizza, toasted deli sandwiches and the Arch Deluxe, a heavily advertised new burger that flopped. It bought into non-burger franchises like Chipotle and Boston Market. It also tinkered with its menu, no longer toasting the buns, switching pickles and changing the special sauce on Big Macs. None of it worked.”

The WSJ ran an article in mid December about the best CEOs of 2008 and included MCD’s CEO Jim Skinner among its list. This article also pointed out that the company’s success stems from the fact that it “has done a terrific job of improving what it does at its existing locations, improving the food, improving service, expanding the menu, expanding hours. They've stuck to their knitting and made their existing stuff better and it's paid off."

I would agree with the conclusions of both of these articles that MCD has improved its performance by focusing on initiatives within its four walls, which resulted in higher returns. The company had lost its focus on what made it great by failing to execute on a store-level basis as it tried to expand its menu and store base in every direction. This misdirected growth and subsequent return to basics strategy which has enabled MCD to outperform formed the basis of what I like to call sustainability or “Shrink to Grow.” SBUX is undergoing a similar turnaround now as it closes underperforming stores and refocuses on the customer’s in-store experience.

I would argue that MCD’s current specialty coffee launch is a shift away from the basics and will prove to be a distraction for the company. The specialty coffee program is the most expensive new product initiative in the history of the company, costing the company about $100,000 per restaurant to implement in the U.S., as MCD has to revamp its current drive-thru configuration to accommodate the beverage equipment. I don’t think the beverage strategy will drive the top-line numbers that most are expecting. At the same time, it will increase the complexity of the system.

Bush's Bottom?

George W. Bush just finished giving his final Q&A to Washington's finest revisionist historians. It was as colorful an interchange as we have seen in quite some time.

While it's hard to find a case whereby Bush's approval rating as President of the United States drops further (there's only 1 week left!), I never say never...

While watching the man's confidence in the manic media's myopia drop at the same expedited pace that crude oil is today, I can't help but wonder what a Bush bottom will look like, in hindsight, weeks and months from this day...

Some bottoms start with the end, after all...

I am long SPY, looking forward to the Thursday/Friday US PPI and CPI deflation reports.

Keith R. McCullough
CEO & Chief Investment Officer