“The bureaucrats do not understand the quasi-automatic system of the market.”
If you are bullish on Big Government Bureaucrats intervening in free markets, this morning is going to put a gigantic smile on your face. Overnight, the overlords of the G-7 intervened in currency markets in a way like they haven’t in over a decade – Central Planners of the world unite!
To be crystal clear on my view of the US Equity market, in the last 48 hours I have called it a Short Covering Opportunity. That’s a lot different than saying “buy-de-dip” or “buy-the-crash.” I do not want any part of being grossly exposed to riding these Bureaucrat Bulls or the Japanese Government pushing their debt over the QUADRILLION mark this morning (that’s ¥1,010,000,000,000,000).
The aforementioned quote comes from page 109 of Henry Hazlitt’s classic risk management book “Economics In One Lesson.” I’ve cited Hazlitt in 3 of our 5 Early Look notes this week because I think we need to get back to basics. Hazlitt wrote this book in 1946 and I suggest the talking heads of the Keynesian Kingdom take the time to read it. It’s time to get out of your textbooks boys and wake up to how bid-ask spreads work in the real world.
Not only do bureaucrats in the G-7 like US Treasury Secretary Geithner not get how Global Macro markets have become increasingly interconnected since 1946, they Perpetuate The Price Volatility in global markets by intervening in them.
“… they are always disturbed by it… they are always trying to improve it or correct it, usually in the interests of some wailing pressure group.”
-Henry Hazlitt (1946)
Now I don’t think it’s fair to lop everyone who has been bullish on Global Equity markets since the beginning of the year into a big bucket of being bullish on bureaucrats. I’m pretty sure most of our clients wouldn’t let a government person touch the P&L of their assets under management with a ten-foot Madoff pole. But they do try to front-run what these central planners are going to try next – that’s smart.
What’s not smart is being Timmy… sitting there in Washington’s “markets room” not thinking he is being gamed…
The problem with this global game of Gaming The Government is that it super-imposes massive correlation-risk into our markets. There is no greater impact a Fiat Fool in DC can have on global currency, commodity, and equity markets than by intervening in some way, shape, or form in the US Dollar. Almost everything that matters trades either in US Dollars or relative to a basket of US Dollars – both are burning.
Rather than confusing Geithner’s political skills with market ignorance, let’s run through some correlation math for his “markets” guys:
Don’t worry Timmy, I’m not geek-ing out on you and diving deep into the tapestry of my multi-factor, multi-duration, model that’s built on the principles of Chaos and Complexity Theory. I’m keeping this point very simple so that the next time you look into the camera under oath you can improve upon your storytelling performance. The Chinese are watching.
If The Bernank absolves himself from all accountability pertaining to America’s Burning Buck, and Timmy wouldn’t know a strong US Dollar policy if it smacked him upside the head like a Chinese 50bps rate hike this morning, who on God’s good centrally planned earth is going to get this right?
Suffice it to say, I think you could win the Presidency of the United States of America by explaining that burning our currency at the stake and perpetually intervening in our markets is bad – very bad – for the long term prosperity of the American people.
That’s all I have to say about that…
What am I going to do about this frightening level of blind faith in Big Government Intervention this morning? I’m going to sell and raise my asset allocation to CASH again. I have no patience for this. I don’t trust these people. And I refuse to put my family and firm in the palm of their centrally planned hands.
Like I said, there are still plenty a stock market bull that is not a Bureaucrat Bull, and the bears are chasing them down too. For 2011 YTD, the average and median percentage change in the 65 global equity markets and nine S&P sectors we track has been (-1.3%) and (-1.1%), respectively. Only 38% of countries currently register a positive gain. I know – “bull market”…
What would get me bullish on US Equities?
And, yes, I get it. That’s what I want for me. And the market doesn’t care about me. So while the Keynesian Kingdom of 1970s ghosts past move towards planning for Quantitative Guessing Part III, the best I can do is trade these markets with the Price Volatility these bureaucrats perpetuate.
My immediate-term support and resistance lines for WTI crude oil are $96.92 and $103.01, respectively. My immediate-term support and resistance lines for the SP500 are now 1254 and 1295, respectively.
Have a great weekend and best of luck out there today,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on March 15, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“The world is full of so-called economists who are full of schemes for getting something for nothing.”
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:
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.
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.
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
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TODAY’S S&P 500 SET-UP - March 18, 2011
Big Keynesian Intervention overnight from the G7 – Central Planners of the world unite! This is only going to perpetuate Price Volatility across asset classes as what’s happening in USD/FX markets remains the fulcrum for most of the massive correlation risk were trading in equities and commodities in particular. As we look at today’s set up for the S&P 500, the range is 41 points or -1.55% downside to 1254 and 1.67% upside to 1295.
As of the close yesterday we have 1of 9 sectors positive on TRADE and 3 of 9 sectors positive on TREND. Energy is the only sector that is positive on both TRADE and TREND.
CREDIT/ECONOMIC MARKET LOOK:
Treasuries gave back some of their recent gains with dampened flight-to-quality.
MACRO DATA POINTS:
WHAT TO WATCH:
COMMODITY HEADLINES FROM BLOOMBERG:
Generally, European markets are trading higher for the second day. Eastern Europe continues to outperform with Kazakhstan, Estonia and Latvia leading the way. Spain and Greece are underperforming.
U.K. consumer confidence fell to a record low in February. The index dropped 10 points to 38, the lowest since records began in 2004.
Germany Feb PPI +6.4% y/y vs consensus +6.3% and prior +5.7%
Most Asian market traded higher, with the exception of India and Pakistan down -1.49% and 2.03%, respectively.
The Reserve Bank of India raised its inflation forecast for the second time since late January and increased interest rates by 0.25% to 6.75% (the eighth move in a year).
China raised banks’ reserve requirements for the third time this year.
You might not see inflation Ben, but Nike does. There will be ‘ticker shock’ on the event, of course. But the alignment of the story over the course of the next 18 months is one of the best in Consumer. Entry points take center stage.
Let’s get a very important point out of the way real fast… First and foremost – like it or not – Nike’s key takeaway by Mr. Market will be from a Macro Trader/PM vantage point. They could care less about LeBron, NikeID, the new China logistics center, and even positive Futures trends. They’re going to spank the stock margins. There are a few Nike-specific items that added to the miss (more on that later), but a PM won’t know or care. The fact is, here’s a Consumer bellwether that’s seeing the long-awaited cost inflation. If it’s going to impact Nike, then what about the average-quality companies out there? What about the junk??? Guess what Bernanke? You might not see inflation, but Nike does.
Adding to the bear case is that inventories came in hot (+18% on 7% sales growth). A miss with lower margins and high inventories is usually the kiss of death for anyone in the supply chain – and especially should be this year. Good luck to any perma-bull trying to defend that sort of trend in this tape.
But what’s keeping Nike fundamentally grinding forward is the fact – and it is a fact – that its Futures remain very solid. Orders were up a strong 11% in the US – still double digit despite hitting a point where last years’ compares get tough. 2-yr futures accelerated sequentially from 6 to 7.5% in North America.
Emerging markets accelerated (32.5% 2 yr!). China accelerated as well to a mid teens rate, which is nice to see given that it was a concern of ours coming out of 2Q. Basically…they’re doing everything they said they were going to do. The category realignment is absolutely working and they’re growing in all the right places – apparel, in particular.
As it relates to growth, management’s tone was so dang optimistic on the call that even someone like me (who has high growth expectations and knows the company a bit better than the average guy) did a double-take. For a conservative CFO like Don Blair to feel good enough to step up and say that he’s comfortable with the high end of long term plan of ‘high-single-digit’ growth for the next 5-quarters is pretty big, and that’s an understatement.
One thing I’ve always accused Nike of is not being aggressive enough when times are tough in turning the screws to its competition. I think that they are FINALLY doing this. Not by price – that’s not their style. But with product innovation and special programs throughout regions and channel partners. To do this, however, you’ve got to have the inventory – especially when we are coming off such tight inventories over the past two years. The best companies are the ones that will grow. To grow, you need inventory. It’s as simple as that.
So we’ve got a miss and high inventories. But the hardest quarter for Nike is the one that the company just guided for (4Q – w 300bp decline in GM%). Then what? We anniversary excess airfreight costs in the Aug qtr, then we get the benefit of price increases and better utilization on new Asian capacity – which meaningfully eases COGS pressure. Then we cruise right on in to the Olympics – expectations for which will start to build before Nike’s 2Q12 (Nov 11). And by the way, anyone want to find me a time period where Nike disappointed two quarters in a row?
In Consumer Discretionary, it’s not too easy to find places to hide. Some of us have the opportunity to avoid the space – or even short it. But if you’re looking for quality growth in Consumer, there’s not much to hang your hat on.
We can beat the company up all day for freight costs, oil, growth spending and inventories. But the reality is that…
a) The long-term call is completely in-tact here. $20bn company goes to $30bn over 5 years.
b) The intermediate-term call looks good: Nike-led athletic cycle takes through the Olympics in Summer 2012.
c) Near-Term: There are definitely question marks. Be smart about entry points – but we definitely think they should be entry – not exit. Something to definitely keep on your screen Friday is $78.14, which is Keith’s Long-Term TAIL line of support.
We’re looking at $5 in earnings in FY12(May) and $5.75 a year after. Will the stock make you rich here? Probably not. But for a GARP name where the underlying story is very good, the company is taking share, and the balance sheet is like iron ($9.25 per share in cash) we think this is a pretty good spot to be.
Conclusion: In the report below, we analyze clues embedded in the price action across asset classes and key global markets for hints as to what Global Macro trading could look like over the intermediate-term TREND.
While the consensus outlook for risk (be it “on/off”) hinges on the latest update from the grave situation at Japan’s Fukushima Dai-Ichi nuclear power plant, we thought we’d take the opportunity to: a) reiterate our belief that risk is always “on”; and b) provide some clues as to what the Global Macro trading environment may look like over the intermediate-term TREND with a bevy of ideas on how to play it across asset classes.
This is in no way an attempt to make a “call” the chaos that is Global Macro risk. Rather, it is our best attempt to analyze the market data provided in the near-week since the current series of tragic events began in Japan in an attempt to offer some clues as to what the major moves will be across the asset allocation spectrum. Understanding that prices often lead fundamentals, we attempt to get you ahead of the storytelling that may be coming down the pike over the next 3-6 months.
In the essence of keeping this report tight, we’ll get right to it by addressing each asset class individually. As always, we encourage you reach out to us if you have any follow up questions or would like to discuss a topic(s) further.
Since the close of 3/10, the average and median percentage change in the 65 global equity markets and nine S&P sectors we track has been (-1.7%) and (-1.6%), respectively. Only 13 of them currently register a positive gain.
Excluding Japan’s Nikkei 225, which is down (-14.1%), the leader board is bookended by countries like Germany’s Dax (-5.8%), Hong Kong’s Hang Seng (-5.6%), and Switzerland’s Market Index (-5.2%) on the losing end and Greece’s Athex (+4.9%), Venezuela’s Stock Market Index (+3.3%), and the XLE (+2.9%) sit atop the winning end. Without reading too much into it, it seems that the “bailout trade” (Greece) and “inflation trade” (Venezuela, XLE, Hong Kong) are still intact. Interestingly, we see currency strength is hurting the more export-oriented countries of Germany (Euro +1.6% vs. USD) and Switzerland (Franc +3.7% vs. USD).
Perhaps even more so than before, keeping an eye on FX volatility will be integral to managing exposure to certain equity markets. For example, Brazil’s Bovespa has appreciated modestly (+0.3%) on its positive exposure to the anticipated increase in the prices of basic materials needed for Japan’s recovery and crude oil via Petrobras. We do caution, however, that this story may be a trap, as further weakness in the real (-1% vs. USD) via Japanese repatriation (Japan is the largest source of foreign demand for Brazilian local bonds) may give the Brazilian central bank the headroom it needs to accelerate rate hikes.
Elsewhere, we expect a further yen strength to weigh on Japanese equity prices; the current sell-side recommendations to buy this dip on “valuation” and “rebuilding” are ill-timed at best, reckless at worst. We don’t subscribe to the Keynesian school of investing which largely follows the “broken window economic theory” followed by a fix of Big Government Intervention and we don’t subscribe to the sell-side’s strategy of using the current crisis in Japan as a “catalyst for growth” and a reason to buy Japanese equities right here.
All told, we made the intermediate-term TREND research call on Global Stagflation in early November and, irrespective of the situation in Japan, this major risk to both corporate margins and equity valuation multiples hasn’t gone away. If anything, the tragic events in the world’s third-largest economy support this Macro backdrop. That said, we do expect Asian equity markets to bottom first and have been watching Chinese stocks with a bullish eye for the past several weeks.
With the exception of Natural Gas (+8.6%), Coal (+5%), and Copper (+3.5%) – all of which benefit from current anti-nuclear power sentiment and the Japanese recovery story – commodity prices have been largely soft since last week’s incident. There’s been particular weakness in agricultural commodities; we posit that investors have aggressively “de-risked” their portfolios by slashing their speculative exposure to Oats (-5.9%), Corn (-5.3%), Cotton (-4.4%), Cocoa (-4.7%), and Wheat (-4.1%).
While the situation in Japan is definitely something to pay attention to as it relates to consensus’ risk appetite in the near term, over the intermediate term, we don’t see any change in the fundamentals of the most dominant of the many factors supporting elevated commodity prices – US Dollar weakness (-1.7%). In fact, the our expectation of continued Japanese repatriation and further unwinding of yen carry trades supports further JPYUSD strength, which, in turn, is a bearish factor for the US Dollar Index (yen = 13.6% of the basket).
After a (+5.2%) up move since in the earthquake and ensuring tsunami first hit Japan, it’s obvious that the Japanese yen is “stealing the show” here. As far as the fundamentals are concerned, we see two reasons for continued yen strength over the intermediate-term: 1) repatriation by Japanese households and corporations to help finance the rebuilding effort (Japan’s net foreign assets total roughly 56% of GDP); and unwinding of yen carry trades, as short-end interest rate differentials relative to Japanese sovereigns continue to compress across the board.
Of course, we don’t expect the yen to continue appreciating in a straight line and since touching a post-war high of 76.36 in intraday trading overnight, it’s come in to around 78.98 – still a post-war high, nonetheless. Further, we feel much of the current yen strength is actually being driven by investors getting ahead of the aforementioned fundamentals. Given that the speculative bid may be priced in at current levels, we’d expect the yen to continue a gradual appreciation over the intermediate-term TREND.
As always, the risk of Japanese officials intervening in financial markets looms large and we can all but count on their intervention in the FX market in the near future. As we saw late last year, however, their attempts will likely prove futile in reversing the trend of the global currency market. They will, however, succeed in perpetuating the heightened volatility that accompanies Big Government Intervention. The current two-year high on implied volatility for the dollar-yen lends credence to this stance.
Elsewhere in the FX market, the Aussie dollar (-2% vs. USD) and Brazilian real (-1% vs. USD) are two currencies that look particularly vulnerable given the aforementioned Global Macro backdrop. The Aussie looks vulnerable because the market could increasingly start to bake in interest rate cuts if Australian growth falters in any way from slowing growth in its three largest export markets: China (#1), Japan (#2), and Korea (#3). In fact, the market is increasingly sniffing this out, as analysis of swaps trading suggest investors are betting there is a 27% chance the RBA cuts the cash rate by (-25bps) – up from 22% yesterday.
Even though we’re looking to get ahead of the bottoming in Chinese growth and increasingly like Chinese equities, the fact of the matter is that consensus is still far too bullish on Chinese growth, which we expect to slow. And understanding that Australian (or any) central bank action will lag the reported data, the Aussie dollar may be a victim of consternation for quite some time.
Lastly, we continue to remain bullish on the Canadian dollar, insofar as crude oil continues to trade in a bullish quantitative formation on all three of our core investment durations. We remain bearish on the US dollar’s intermediate-term TREND and long-term TAIL; as Japan’s Keynesian Debt & Deficit Crisis gets exposed to the world via this tragic event, we expect the focus of the global currency market will turn to similarly-positioned countries. Though the EU continues to have its issues, we still like EURUSD understanding the following factors:
With regard to fixed income, there are two things we’re acutely focused on: QE3 and inflation. Our current bullish stance on crude oil and gold and bearish view of the US dollar implies we expect inflation to continue to remain a headwind over the intermediate-term TREND. That’s bad for bonds.
What’s good for bonds is a rotation out of risk assets like equities over the intermediate term, particularly as consensus forecasts start to come in toward our bearish view on the slope of global growth. That doesn’t make us bullish on bonds, but we could foresee a scenario whereby they continue to get bid up like they have in the wake of the incident in Japan.
Looking at the US Treasury curve specifically, we see that 2’s, 10’s, and 30-year yields continue to trade below what used to be their TREND lines of support. Whether or not this bullish bid is forecasting another round of Quantitative Guessing remains to be seen. Both Bernanke and Dudley have recently stated that the Fed has no intentions at the current time to increase the asset purchases beyond June or the $600B target. By removing phrases like “the recovery is disappointingly slow”, “tight credit”, “modest income growth”, and “lower housing wealth” from their latest statement, the Fed sent a signal to market participants that the US economy is indeed in a better place in their eyes and that no further easing would be required. At the bare minimum, however, as long as Treasuries continue to have a bullish TREND-line bid, QE3 remains a possibility in our model.
All told, the events in Japan have created much consternation in global financial markets and the large amount of news coverage dedicated to this crisis has masked some global economic fundamentals – both positive and negative. Given, we continue to urge investors to acutely focus on all risks, not just those surrounding the Japanese reactors.
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