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Short Covering Opportunity

“It isn’t as important to buy as cheap as possible as it is to buy at the right time.”

-Jesse Livermore

 

Having been a market practitioner for the last 12 years, I’ve come to respect that a Risk Manager needs to be as well versed in the tactical thinking of a Jesse Livermore (“Reminiscences of a Stock Market Operator”) as the libertarian theorizing of a Bastiat (read “The Law”, 1850).

 

Valuation isn’t a catalyst. Price momentum is. When the slope of price momentum changes to the bearish side, valuation becomes a trap. When price momentum is bullish, it justifies the best storytelling in the world.

 

I’m not so much interested in being a valuation-guy, a perma-bull, or a perma-bear. Been there, tried all three. I’m interested in being right. Livermore taught me the same – “There is only one side of the market and it is not the bull side or the bear side, but the right side.”

 

Whether you are on the buy-side or the sell-side, I’ll assume your goal is also to be on the Right Side. That’s how you get paid. Sure, we all have different durations and risk tolerances in being exposed to our respective investment decisions. But the market doesn’t care about how we think about these things individually. The market waits for no one.

 

This is why I am trying my best to evolve my Multi-Factor Global Risk Management Model so that it is Duration Agnostic. That’s where the concept of our TRADE/TREND/TAIL framework was born. And the mathematical principles of interconnectedness embedded in Chaos Theory support it.

 

As a reminder, here’s how we think about TRADE/TREND/TAIL durations:

  1. TRADE = the immediate-term (as in 3-weeks or less, which I’ll get to in a minute in terms of seeing a Short Covering Opportunity)
  2. TREND = the intermediate-term (3-months or more, which is how we think about companies and countries sequentially)
  3. TAIL = the long-term (3-years or less, which is how we think about our key Global Macro Themes like “Housing Headwinds”)

Of course, some of you invest beyond what I am defining as the TAIL. I do too. When I invested 1/3 of my net wealth to create Hedgeye Risk Management, I considered that a fairly long-term and concentrated investment idea.

 

But when it comes to managing Global Macro market risk in an environment of Heightening Price Volatility (which is what these Fiat Fool central planners from the US Federal Reserve to the Bank of Japan are perpetuating via their unprecedented money printing experiments), I think you need to acutely manage the shorter-term duration risk - the TRADE and TREND.

 

So that’s how we think about it and this is what I did about it yesterday in the Hedgeye Portfolio:

  1. Covered short position in SPAIN (EWP)
  2. Covered short position in EMERGING MARKETS (EEM)
  3. Covered short position in WALMART (WMT)
  4. Covered short position in INDUSTRIALS (XLI)
  5. Bought long positions in HEALTHCARE (XLV)
  6. Added to long position in GERMANY (EWG)

Overweighting one of the key risk management relationships we’ve been working with in calling for this 6.5% correction (the inverse relationship between the SP500 and the VIX), yesterday I finally registered a signal that I considered an explicit Short Covering Opportunity.

  1. The SP500 is immediate-term TRADE oversold (3.0 standard deviation move)
  2. The VIX is immediate-term TRADE overbought (3.5 standard deviation move)

Now there is a difference between what The Street and a bullishly-bias media amusingly label a “buying opportunity” and what Risk Managers recognize as a Short Covering Opportunity.

 

A Short Covering Opportunity is reserved for those Risk Managers who had the sobriety to short things before they started going down. A “buying opportunity” is a decision to deploy cash and expand you gross exposure to the market. 

 

I did both yesterday (you are allowed to do both):

  1. Hedgeye Portfolio (a proxy for my net exposure to the market): I moved to 16 LONGS and 4 SHORTS, by covering shorts
  2. Hedgeye Asset Allocation (a proxy for my gross exposure): I moved to 43% CASH yesterday, down from 46% the day prior

Again, I fully respect and understand that how I am expressing my risk management views may not be found in a Yale economics textbook on portfolio theory. I am trying to evolve the risk management process and show the financial services community that there is a transparent and accountable way that a firm can both originate ideas and manage risk, without being on the other side of our clients’ trades.

 

I also fully understand (but do not fully respect) the marketing message behind being “fully invested.” Sure, there will be a time for that (Q2 of 2009), but not when our fundamental Global Macro research is proactively calling for Global Growth Slowing As Global Inflation Accelerates. When the winds of price momentum blow from bullish to bearish, that’s called being fully exposed.

 

I’m not trying to take a “victory lap” this morning. I am deeply interested in trying to explain what we are doing here and why. I don’t think it’s credible for the said savants of Wall Street “strategy” to keep missing huge draw-downs in global markets like they have for the last decade. Instead of whining about it, we are passionately pursuing a better way.

 

My immediate term support and resistance lines for WTI crude oil are now $97.02 and $102.60, respectively, and I took our asset allocation to oil up to 6% on Monday from 3%. My immediate term support and resistance lines for the SP500 are 1256 and 1274, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Short Covering Opportunity - Chart of the Day

 

Short Covering Opportunity - Virtual Portfolio


THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - March 17, 2011

 

We made a "short term bottom" call into the close yesterday, and this morning’s action in global equity, commodity, and currency markets confirms the same. Every market gets immediate-term TRADE overbought and oversold.  As we look at today’s set up for the S&P 500, the range is 18 points or -0.07% downside to 1256 and 1.36% upside to 1274 (with upside to 1307 on a close  > 1274).

 

PERFORMANCE:


As of the close yesterday we have 0 of 9 sectors positive on TRADE and 2 of 9 sectors positive on TREND - Energy and Health-care. 

  • One day: Dow (2.04%), S&P (1.95%), Nasdaq (1.89%), Russell 2000 (1.19%)
  • Month-to-date: Dow (5.01%), S&P (5.30%), Nasdaq (5.95%), Russell (5.05%)
  • Quarter/Year-to-date: Dow +0.31%, S&P (0.06%), Nasdaq (1.36%), Russell (0.22%)
  • Sector Performance: - Tech (2.44%), Industrials (1.86%), Materials (2.01%), Financials (1.85%), Energy (1.60%), Healthcare (1.74%), Consumer Disc (1.70%), Utilities (1.57%), Consumer Spls (1.43%)

EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: -1636 (+106)  
  • VOLUME: NYSE 1460.96 (+13.43%)
  • VIX:  29.40 +20.89% YTD PERFORMANCE: +65.63%
  • SPX PUT/CALL RATIO: 2.52 from 1.69 (+48.45%)

CREDIT/ECONOMIC MARKET LOOK:

 

Treasuries were underpinned by a pickup in flight-to-quality buying.

  • TED SPREAD: 22.58 0.101 (0.451%)
  • 3-MONTH T-BILL YIELD: 0.10% +0.01%
  • 10-Year: 3.22 from 3.33
  • YIELD CURVE: 2.64 from 2.70

MACRO DATA POINTS:

  • 8:30 a.m.: Consumer Price Index, est. 0.4%, prior 0.4%
  • 8:30 a.m.: Net export sales, commodities
  • 8:30 a.m.: Jobless claims, est. 388k, prior 397k
  • 9:15 a.m.: Industrial production, est. 0.6%, prior (-0.1%)
  • 9:15 a.m.: Capacity production
  • 9:45 a.m.: Bloomberg Consumer Comfort, prior 44.5
  • 10 a.m.: Leading indicators, est. 0.9%, prior 0.1%
  • 10 a.m.: Philly Fed, est. 28.8, prior 35.9
  • 10:30 a.m.: EIA Natural Gas
  • 3 p.m.: Geithner attends FSOC meeting

WHAT TO WATCH:

  • U.S. nationals urged to leave Japan amid growing fears of nuclear meltdown
  • Obama administration indicates it will vote at the United Nations tomorrow to authorize military actions and no-fly zone in Libya
  • U.S. House Republicans vote to cancel $1b in housing aid
  • Moody’s keeps negative outlook on U.S. states and local government bonds
  • Senate is expected to vote on three-week budget resolution 

COMMODITY/GROWTH EXPECTATION:

  • CRB: 338.17 flat YTD: +1.61%  
  • Oil: 97.98 +0.82%; YTD: +6.85% (trading +1.43% in the AM)
  • COPPER: 419.75 +1.46%; YTD: -4.08% (trading +1.57% in the AM)  
  • GOLD: 1,396.95 +0.16%; YTD: -1.16% (trading +0.37% in the AM)  

COMMODITY HEADLINES FROM BLOOMBERG:

  • Soaked Midwest Soil Boosts Flood Risk for U.S. Wheat Crops, Sandbag Cities
  • Beef, Pork Production in Japan’s Eastern Region Disrupted, Ministry Says
  • Thailand, Indonesia, Malaysia May Delay Rubber Shipments, Consortium Says
  • Oil Leads Commodity Advance for Second Day, Reversing Earlier Decline
  • Gold May Advance as Japanese Crisis, Turbulence in Middle East Spur Demand
  • Dry Weather May Hurt Coffee Production in Vietnam, Bolstering World Prices
  • Copper May Rise in London on Prospects for Japan Rebuilding: LME Preview
  • Glencore Loses $3.6 Billion as Mining Stocks Decline, Threatening IPO Plan
  • Japan Quake May Mean U.S. Heating Oil Price Tops Gasoline: Energy Markets
  • U.S. Feedlots Buy Fewer Cattle as Feed Costs Increase, According to Survey
  • Corn, Wheat Advance as 9.5% Price Decline Attracts Importers, Investors
  • Palm Oil Futures Decline for Second Day on Expectation Supplies to Expand

CURRENCIES:

  • EURO: 1.3889 -0.63% (trading +1.04%% in the AM)
  • DOLLAR: 76.681 +0.46% (trading -1.02%% in the AM) 

EUROPEAN MARKETS:


No major MACRO data points were released today.  Generally, European markets are trading higher.  Austria and Ireland are the two best performing markets up over 1%.  Iceland is the worst performing market down -1.30%.

  • United Kingdom: +0.54%
  • Germany: +0.61%
  • France: +0.74%
  • Spain: +0.66%
  • Italy: +0.55%
  • Greece: +0.01%

ASIAN MARKTES:


Most Asian market traded lower, with the exception of South Korea up +0.05%. The worst performing market was the Philippines trading -1.57%.

  • Japan: -1.44%
  • Hang Seng: -1.83%
  • China: -1.14%
  •  India: -1.14%
  • Taiwan: -0.50%

Howard Penney

Managing Director

 

THE HEDGEYE DAILY OUTLOOK - setup



Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.64%
  • SHORT SIGNALS 78.61%

Short Covering Opportunity

Looking at one of the key risk management relationships we’ve been working with in calling for this 6% correction (the inverse relationship between the SP500 and the VIX), we’re at a spot here today that I would consider a Short Covering Opportunity. 

  1. The SP500 is immediate-term TRADE oversold
  2. The VIX is immediate-term TRADE overbought 

That should not be mistaken for a “buying opportunity” on the long side. At least not in terms of ramping gross long exposure aggressively. Not yet. What I see for the immediate-term TRADE is a Short Covering Opportunity in oversold positions (book gains) and a modest asset allocation to US and German Equities.

 

In the Hedgeye Portfolio these are the moves I’ve made into the market close: 

  1. Covered short position in SPAIN (EWP)
  2. Covered short position in EMERGING MARKETS (EEM)
  3. Covered short position in WALMART (WMT)
  4. Covered short position in INDUSTRIALS (XLI)
  5. Bought long positions in HEALTHCARE (XLV)
  6. Added to long position in GERMANY (EWG) 

Let me know if you have any questions. All of these moves tick live with time stamps on our site at Hedgeye.com.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Short Covering Opportunity - 1


THE VIX REVISITED

Yesterday, in the Hedgeye Daily Outlook, our risk management call out was to watch the VIX.  In it, I advised that “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.”  Since the close on Monday, the VIX is up 23.3%, trading comfortable above 22.03.

 

Looking the chart below, it is clear that the VIX could still go a lot higher from here.  Last year, during the peak of the Sovereign debt crisis, the VIX traded at 45.79.  The average of the peak VIX levels during the past 6 major crises that impacted global financial markets comes to approximately 50, which would represent 48% upside from here.

 

As we always say, risk is always on.  Clearly, events in Japan are tragic and deeply saddening.  However, the systemic risks in Japan from an investment perspective remain: demographic headwinds and staggering government debt being the most prevalent.  These risks will not go away and, if anything, the unfortunate severity of the earthquake, tsunami, and ensuing (and continuing) radiation crisis will likely increase uncertainty and heighten concerns about economic growth from here.  Furthermore, the government’s handling of the crisis is being heavily criticized, as is evident by the trend on twitter from Japanese people ordering Prime Minister Kan to wake up: #han_okiro.  Tellingly, yesterday, some users were switching to #kan_netero, meaning “Kan, stay in bed”.

 

The media is currently focused on Japan.  As is tradition, mainstream media likes to focus on one thing at a time.  As events in Japan continue to captivate viewers of the most prevalent news sources, the unrest in the Middle East continues.  The uncertainty that this wave of political agitation can bring to global markets, particularly those most closely tied to oil, is likely to cause significant volatility if regimes continue to fall.  Footage of unarmed civilians being shot at point blank range by Bahraini military forces speaks to the gravity of the situation in Bahrain at present.

 

Another small island country, Ireland, is also worth monitoring from a risk management perspective.  A tiny economy by comparison to the larger EU, Ireland’s economy is heavily burdened by a debt-laden financial sector that was 100% guaranteed by the country’s last government.  At present, the new Irish Taoiseach, or Prime Minister, is refusing to budge on EU demands to raise its corporate tax rate from its current level of 12.5% towards the European average of 23%.  As a result, Ireland is being denied its request for a reduction in the interest rate on its bailout loan from the EU/IMF.   Given the contentious nature of this issue, and the fact that a failure to reach resolution could spur contagion in the Euro zone, it is worth monitoring closely.  Our Macro conviction is that the EU is likely to kick the can down the road as debt ratios go higher and higher.  Markets applauded the European debt crisis package on Monday, to a degree, but Ireland is systemically important part of Europe’s sovereign debt conundrum and the situation could deteriorate if the current impasse between Dublin and Brussels persists.

 

Clearly, risk is always “on”, whether or not the media is focused on them at this particular moment.  The recent downgrades of Portugal and Spain by Moody’s remind us of this.  As the current crisis in Japan intensifies, questions mount as to whether or not the FED suggested yesterday that QE3 will not be needed, inflation accelerates, global growth slows (downward GDP revisions),  and the Euro-zone debt crisis looms large in the background, a melt up in volatility could be just around the corner.

 

The VIX is immediate-term overbought.  Over the intermediate term, we have the range for the VIX getting as high as $35 or $40.

 

Howard Penney

Managing Director

 

THE VIX REVISITED - shawshank


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

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