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Economic Fallacies

This note was originally published at 8am on March 14, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“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,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Economic Fallacies - Chart of the Day

 

Economic Fallacies - Virtual Portfolio


ROLLING JOBLESS CLAIMS FALL TO NEW YTD LOW

Initial Claims Fall 10k

The headline initial claims number fell 10k WoW to 385k (12k before a 2k downward revision to last week’s data).  Rolling claims fell 7k to 384.5k. On a non-seasonally-adjusted basis, reported claims fell 34k WoW.  

 

We have been looking for claims in the 375-400k range as the level that can begin to bring unemployment down. We have now had three weeks inside of this range. If this level continues to hold, 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 start to bring down the unemployment rate, we are actually referring to the 10.9% actual rate as opposed to the 8.9% reported rate.

 

ROLLING JOBLESS CLAIMS FALL TO NEW YTD LOW - rolling

 

ROLLING JOBLESS CLAIMS FALL TO NEW YTD LOW - raw

 

ROLLING JOBLESS CLAIMS FALL TO NEW YTD LOW - NSA

 

One of our astute clients pointed out the relationship between the S&P and initial claims shown below.  We show the two series in the following chart, with initial claims inverted on the left axis.

 

ROLLING JOBLESS CLAIMS FALL TO NEW YTD LOW - S P

 

Yield Curve Tightens 12 bps

We chart the 2-10 spread as a proxy for NIM. Thus far the spread in 1Q is tracking 41 bps wider than 4Q.  The current level of 264 bps is slightly tighter than last week (278 bps).

 

ROLLING JOBLESS CLAIMS FALL TO NEW YTD LOW - spreads

 

ROLLING JOBLESS CLAIMS FALL TO NEW YTD LOW - spreads QoQ

 

Financial Subsector Performance

The table below shows the stock performance of each Financial subsector over four durations. 

 

ROLLING JOBLESS CLAIMS FALL TO NEW YTD LOW - subsector perf

 

Joshua Steiner, CFA

 

Allison Kaptur


TALES OF THE TAPE: MRT, PEET, MCD, PZZA, SBUX, WEN

Notable news items and price action over the past twenty-four hours.

  • MRT share prices gained 11.8% on accelerating volume following news that the company is for sale.
  • PEET also gained on accelerating volume as headlines continue to point to a possible acquisition of the company by Starbucks.
  • MCD named Cyril Pamaphosa as developmental licensee for South Africa and will be responsible for the operation of McDonald’s restaurants in South Africa, according to a statement from the company.
  • PZZA, SBUX, MCD, and WEN all declined on accelerating volume.
  • Corn and wheat climbed for the first time in three days on signs that a price slump prompted by the tragic events in Japan is spurring demand from importers.

TALES OF THE TAPE: MRT, PEET, MCD, PZZA, SBUX, WEN - stocks 317

 

Howard Penney

Managing Director


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THE M3: ADELSON UPSET ON JACOBS CASE; VENETIAN NOT IN HENGQIN; MACAU-HK-ZHUHAI BRIDGE; PACKAGE DATA

The Macau Metro Monitor, March 17, 2011

 

 

ADELSON DUBS JACOBS ALLEGATIONS AS "LIES AND FABRICATIONS" macaubusiness.com

In his first comments on the Jacobs case, CEO Adelson said, “While I have largely stayed silent on the matter to this point, the recycling of his allegations must be addressed.  We have a substantial list of reasons why Steve Jacobs was fired for cause and interestingly he has not refuted a single one of them.  Instead, he has attempted to explain his termination by using outright lies and fabrications which seem to have their origins in delusion.”

 

VENETIAN SAYS INVESTING IN HENGQIN NOT THE RIGHT TIME Macau Daily News

According to the President and COO of the Venetian Macao, Edward Tracy, Venetian will initiate many large‐scale projects in the future 5 to 6 years.  However, Hengqin is not in the company's interest at this time.

 

HONG KONG-ZHUHAI-MACAU BRIDGE FINANCING SEALED IFR Asia

The long-awaited financing to back the construction of the Hong Kong-Zhuhai-Macau Bridge has been closed as a RMB 29.39BN onshore deal with seven banks joining.

 

PACKAGE TOURS AND HOTEL OCCUPANCY RATE FOR JANUARY 2011 DSEC

Visitor arrivals in package tours decreased by 3.7% YoY to 442,061 in January 2011. Visitors from Mainland China (316,362), Japan (22,224) and Hong Kong (17,522) decreased by 3.8%, 6.5% and 15.1%; however, visitors from Republic of Korea (24,050) and Taiwan (23,961) increased by 85.6% and 4.5% respectively.


CHART OF THE DAY: Quantitative Set-up :: US Equities

 

 

CHART OF THE DAY: Quantitative Set-up :: US Equities -  chart


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


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