Your Problem

“The dollar is our currency, but it’s your problem.”

-John Connally


That’s an interesting way to look at the world’s reserve currency; particularly if you’re the United States Treasury Secretary. That’s where John Connally Jr. found himself for a very short period of time (1). Hedgeye economic history does not remember him or Richard Nixon’s political strategy to devalue the dollar well.


In the end, I don’t think history will remember US Treasury Secretaries Hank Paulson or Tim Geithner well either. At least not when considering them alongside this critical score. All pleasantries associated with how they say they saved us from the crisis they helped create aside, the price in the US Dollar Index chart doesn’t lie; professional politicians absolving themselves from it as an accountability metric do.


Storytellers like Paulson and Geithner would have you believe that the US Dollar’s shining moments come to Bear (pardon the pun) when the world is flying for “safety.” And while it is true that if you burn the credibility of your country’s currency to a low enough level that it will eventually bounce (2008), amidst fear enveloping world markets last week the US Dollar went no bid…


Last week, the US Dollar Index was down another -1.38% week-over-week, closing at a fresh 2011 YTD low of $75.72.


For those of you keeping score:

  1. The USD is down for 9 of the last 12 weeks as the USA printed its highest monthly deficit on record in February ($223B)
  2. The USD has lost -7% of its value since the 1st week of January when it became clear that mid-term election promises would be broken
  3. The USD is down -11% since Geithner took office as the 75th United States Secretary of the Treasury

So, if the idea is to try what the French (1950s), British (1960s) or Japanese (1990s) have already tried – devalue your way to prosperity – it looks like Timmy is right on plan.


You don’t need to watch Charles Ferguson’s documentary Inside Job (2010) to understand the basic concept here. We’ve berated this point for 3 years and now you have socially transcending technologies (YouTube) making what drives The Keynesian Kingdom easy to see.


As of this morning’s latest viewership readings, here’s another way to look at the score:

  1. “Quantitative Easing Explained” (The Bernank) = 4,371, 553 views (
  2. “Every Breath You Take” (Columbia Business School) = 1,725,495 views (

So, The People get it. They trust the US Government on financial matters as little as they ever have (that’s saying a lot). They know that US Dollar Debauchery = The Inflation.


But does Wall Street get it? We think it’s starting to. We can see it in the math.


Consider the following 6-week correlations:

  1. USD vs WTI Crude Oil = -0.88
  2. USD vs CRB Commodities Index = -0.75
  3. USD vs SP500 = +0.58

In summary, what these correlations have been telling you for the last 6 weeks is that Burning The Buck is driving The Inflation UP and the US stock market DOWN. This is interesting, but not surprising … particularly if you believe that the causality behind this correlation is primarily Big Government Intervention (deficit spending and dollar devaluation).


Since the US Dollar and stocks are developing a POSITIVE correlation now (like they did in Q2/Q3 of 2008), and the US Dollar and Commodity prices continue to have very high NEGATIVE correlations (like they did in Q2/Q3 of 2008), what should we be proactively managing risk towards?


Well, I think the scenario analysis is pretty straightforward:


1.       US Dollar DOWN from here

= immediate-term TRADE upside in the price of oil to $107/barrel; intermediate-term TREND upside to $109/barrel (+7%)

= immediate-term TRADE upside in Commodities (CRB Index) to 365; intermediate-term TREND upside to 373 (+6%)

= immediate-term TRADE downside in SP500 to 1251; intermediate-term TREND downside to 1231 (-4%)


2.       US Dollar UP from here

= immediate-term TRADE downside in WTI Crude Oil to $96/barrel; intermediate term TREND downside to $91/barrel (-11%)

= immediate term TRADE downside in Commodities (CRB Index) to 348; intermediate term TREND downside to 333 (-5%)

= immediate term TRADE upside in SP500 to 1312; intermediate-term TREND upside to 1352 (+6%)


I also think that The Keynesian Kingdom of stock market cheerleaders should see this as a short-term solution. The best way to DEFLATE The Inflation and have guys like me get bullish on another US stock market rally is to have a Strong US Dollar policy.


As for the US deficit and debt problems that stand in the way of having the international investment community trust American politicians and the US currency again – well, Mr. President, I guess it’s your problem.


My immediate-term support and resistance lines for the SP500 are now 1276 and 1292, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Your Problem - Chart of the Day


Your Problem - Virtual Portfolio


Notable news items from the last few days and price action from Friday’s trading session.

  • SBUX raised its prices for grocery packaged coffee by 12% on Friday.   The increase impacts both Starbucks and Seattle’s Best Coffee brands and is the company’s first price increase on grocery packaged coffee since March 2008.  The increase was, of course, due to still climbing coffee commodity prices.
  • PEET gained 3.8% on strong volume on Friday.  CHUX, MSSR, RRGB, and BOBE also traded up on high volume versus their respective 30 day average volumes.   SBUX, MCD, and AFCE declined on accelerating volume.
  • Wheat stockpiles shrinking the most in 14 years suggests that prices will rebound from their recent slump.  According to a Bloomberg survey of 22 analysts, the grain will average $8 per bushel on the Chicago Board of Trade in the second quarter, an 8.9% gain on the $7.345 at which it traded today.
  • Corn and soybeans may rise for a second straight week on speculation that wet, cold weather will delay planting and reduce yield prospects in the U.S. while rain threatens oilseeds ready for harvest in Brazil.
  • Beef prices could be supported by a rise in demand from Japan, according to a Barron’s article citing an analyst from D.A. Davidson that stated that Smithfield Foods (SFD) has seen demand in Japan increase over the past week.  According to the note, the meat producer, along with companies like Tyson Foods (TSN), “could see even higher demand if Japanese citizens begin to worry about the safety of their food in the wake of radiation exposure.”




Howard Penney

Managing Director


TODAY’S S&P 500 SET-UP - March 21, 2011

Looking at day three of what we called the "Short Covering Opportunity;" we are seeing rallies across the board to lower-highs.  As we look at today’s set up for the S&P 500, the range is 16 points or -0.25% downside to 1276 and 1.00% upside to 1292.



As of the close yesterday we have 0 of 9 sectors positive on TRADE and 4 of 9 sectors positive on TREND. 

  • One day: Dow +0.71%, S&P +0.43%, Nasdaq +0.29%, Russell +1.16%
  • Month-to-date: Dow (3.01%), S&P (3.62%), Nasdaq (4.98%), Russell (3.50%)
  • Quarter/Year-to-date: Dow +2.43%, S&P +1.72%, Nasdaq (0.35%), Russell +1.40%
  • Sector Performance: - Financials +1.12%, Industrials +0.19%, Consumer Staples +0.24%, Healthcare +0.00%, Materials +0.16%, Utilities (0.48%), Tech (0.16%), Consumer Discretionary (0.40%), and Energy (0.80%)


  • ADVANCE/DECLINE LINE: 1315 (-86)  
  • VOLUME: NYSE 1906.76 (+83.92%)
  • VIX:  24.44 -7.32% YTD PERFORMANCE: +37.69%
  • SPX PUT/CALL RATIO: 2.02 from 2.17 (-6.70%)


Treasuries were weaker of Friday.

  • TED SPREAD: 24.71 +0.203 (0.828%)
  • 3-MONTH T-BILL YIELD: 0.07% -0.01%
  • 10-Year: 3.28 from 3.25
  • YIELD CURVE: 2.67 from 2.65


  • 8:30 a.m.: Chicago Fed Nat Activity Index, prior (-0.16)
  • 10 a.m.: Existing home sales, est. change M/m (-4.7%), prior 2.7%
  • 11 a.m.: Export inspections (corn, soybeans, wheat)
  • 11:30 a.m.: U.S. to sell $32b 3-mo., $30b 6-mo. bills


  • Nuclear Regulatory Commission meets to discuss Japan, U.S.; IAEA board holds meeting to discuss Japan
  • Japanese atomic crisis fears ease as spent-fuel pools cool and workers continue to repair damaged reactors, reconnect power
  • Buffett says South Korea ‘hunting ground’ for acquisitions
  • Google says Chinese government is blocking its Gmail service
  • Deutsche Telekom spoke to 5 different parties before agreeing to $39b wirelss unit sale to AT&T, Deutsche CFO


  • CRB: 351.15 +0.71% YTD: +5.51%  
  • Oil: 101.07 -0.35%; YTD: +11.12% (trading +2.12% in the AM)
  • COPPER: 433.90 -0.12%; YTD: -1.93% (trading +0.51% in the AM)  
  • GOLD: 1,417.21 +0.97%; YTD: +0.62% (trading +0.77% in the AM)  


  • Wheat Seen Rebounding 11% as Global Stockpiles Decline the Most Since 2007
  • Commodities Gain for Fourth Day as Oil, Gold Buoyed by Middle East Turmoil
  • Copper Rises on Speculation Japan Rebuilding Will Stoke Demand; Tin Gains
  • Gold Advances as Allies Attack Libyan Targets, Driving Energy Costs Higher
  • Palladium, Platinum the Metals Most Reliant on Japan Demand: Chart of Day
  • Wheat Advances for a Third Day as Investors Boost Bets, Crude Oil Climbs
  • Cocoa May Rally 26% on Stochastic Chart, Country Says: Technical Analysis
  • Asian Stores, Restaurants Drop Food From Japan on Concern Over Radiation
  • Oil Rises as Allied Forces Strike Libya, Turmoil Escalates in Middle East
  • Libya Intervention Risks Prolonged Oilfield Shutdowns, Qaddafi Reprisals
  • Soybean Oil Imports by China Drop to Lowest in Eight Months on Price Curbs


  • EURO: 1.4182 +1.23% (trading -0.11%% in the AM)
  • DOLLAR: 75.718 -0.42% (trading -0.12% in the AM) 


Generally, European markets are trading higher for the third day, with the Telecom sector higher on the AT&T deal.  Eastern Europe continues to outperform with Kazakhstan, Ukraine and Hungary leading the way.


No MACRO data point on the calendar today

  • United Kingdom: +1.13%
  • Germany: +1.87%
  • France: +1.74%
  • Spain: +1.70%
  • Greece +1.63%
  • Italy: +0.86%


Most Asian market traded higher, with the exception of India and Pakistan down -0.22% and 2.06%, respectively.  The markets benefited from Prime Minister Naoto Kan saying he sees the light at the end of the tunnel for Japan’s crisis.

  • Japan: Closed
  • Hang Seng: +1.73%
  • China: +0.08%
  • India: -0.22%
  • Taiwan: +0.87%
  • South Korea +1.13%
  • Australia +0.35%

Howard Penney

Managing Director



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Eye on Macro – Obviously Obvious


"Things always become obvious after the fact.”


- Nassim Taleb


Cygnus Atratus, or the Black Swan, hit us three times in the past week with the combination of an earthquake, tsunami, and nuclear disaster in Japan.  Nassim Taleb popularized this term after writing a book titled “The Black Swan,” which analyzed the misconception of investment risk.  His conclusion was that the highly improbable is much more probable than standard measures of risk suggest. 


Alongside the disaster in Japan, Obviously Obvious continues to prevail globally as tensions accelerate in the Middle East with the recently imposed no-fly zone in Libya; deficits increase and consumer confidence wanes in the United States; and sovereign debt issues continue to rear their ugly heads in Europe.



With the SP500 down for 3 of the last 4 weeks and the peak-to-trough correction being -6.5%, the call-out this week is more of a question. Was that it, or is volatility in US Equities signaling that there is more downside to come? With Global Growth Slowing and the VIX in what we call a Bullish Formation (bullish TRADE, TREND, and TAIL), we definitely need to see a re-test of the SP500’s 1256 close for an answer.



Bullish on Chinese Equities and/or US Treasuries? We’ve been bearish on Chinese Equities for well over a year now and have been working our Q1 Global Macro Theme of “Trashing Treasuries” since Q4, so we get the bear cases in both. But can we be mentally flexible enough to make the turn on either? Early signals in our quantitative setups are telling us that it’s time to focus our work on the long side of both.




Longs – China (via CAF); Healthcare (via XLV); CORN (via CORN); GOLD (via GLD); Canadian Loonie (via FXC); Energy Producers (via XLE); Chinese Yuan (via CYB); Yield Curve Flattener (via FLAT)


Shorts – Spain (via EWP); Italy (via EWI); Industrials (via XLI); Homebuilders (via XLB); Treasuries (via SHY); Transports (via IYT)



  • US Deficit – Expenses ran up +5% year-over-year in February to their highest level ever.


  • US Home Prices – 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.


  • 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 Japanese stock market lost -17% of its value in 2 trading days (biggest drop since 1987). If you go back to Feb. 14th, the week that fund flows into “Developed” Equity Markets peaked, the Nikkei is down -20.7%.


  • In 18 years of Keynesian experimentation, from 1992 to 2010, Japan had on average +0.85% year-over-year GDP growth.  Over the same period, the Nikkei 225 returned -55%.


  • After the January 17, 1995 Kobe earthquake, Japanese equities lost (-24.7%) before bottoming out nearly six months later on July 3. The Nikkei 225 did not break even until nearly 11 months later on December 7 of that year.


  • 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.


  • The EU Summit on Competitiveness agreed that the temporary European Financial Stability Facility (EFSF) will be able to access its full funding (from the member states) of €440 Billion, versus the approximately €250 Billion previously available; funding for the permanent bailout fund, the European Stability Mechanism, starting mid-2013, is pegged at €500 Billion.


  • 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.


  • 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.


  • 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.


  • The ZEW reported a month-over-month decline in its German Economic Sentiment survey, a 6-month forward-looking assessment, registering 14.1 in March versus 15.7 in February.


  • Chancellor Angela Merkel’s has decided to shut-down 7 of the country’s aging nuclear reactors for 3 months pending a safety review in light of the events in Japan. The Swiss followed the Germans saying they will suspend the regulatory process for 3 nuclear power stations because safety remained the first priority.


  • Portugal faces a hefty schedule of debt (principal + interest) that comes due in the months of March, April, and June (or ~ €16.1 Billion), accounting for nearly two thirds of its debt obligations for 2011 (or ~ €25.4 Billion).  So far the country has sold ~ €7 Billion in bonds of its €20 Billion target this year.


  • 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.


  • Both the Swiss National Bank (SNB) and Norway’s Central Bank (Norges Bank) kept their main interest rates on hold, at 0.25% and 2.00% respectively. Both decisions are represented of the recent pause in global economic sentiment. Trichet may well elect to push out a rate hike decision, despite his latest hawkish stance.


  • Oil has a long term inverse correlation to the U.S. dollar, which for WTI is (-0.78) over the past three years. This has become more pronounced in the last six weeks.  In the prior six weeks, WTI’s correlation is (-0.88) and Brent’s correlation is (-0.86) to the U.S. dollar.

The Week Ahead

The Economic Data calendar for the week of the 21st of March through the 25th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - cal1

The Week Ahead - cal2

Japanese Yen: Be Careful What You Wish For, Consensus...

Conclusion: History shows us that G7 intervention to weaken the yen has resulted in a significant uptick in inflation within Japan. In fact, if the G7’s plan to weaken the yen is “successful”, we expect the inflationary impact to be even greater this time around, particularly given Japan’s current staggering sovereign debt load and easy monetary policy.


Positions (TREND duration): Bullish on the yen and bearish on equities; OR bearish on the yen and JGBs. Getting ahead of the whims of central planners will be key to isolating the winning strategy here.


After just over a decade of inactivity on a collective scale, the G7 jointly intervened in the global currency market to help the ailing Japanese economy by weakening the yen, which is down nearly (-2.3%) on the day. In addition to today’s centrally-planned intervention, the G7 promised additional support as needed:


“We will monitor exchange markets closely and will cooperate as appropriate.”


In spite of yet another round of Almighty Central Planning perpetuating unprecedented volatility in yet another market, we remain positive on the yen over the intermediate-term TREND for now. That could change. While today’s intervention may have cooled off the speculative bid for yen appreciation (net yen shorts of Japanese households dropped -30% day/day), the fundamentals – repatriation and compressing interest rate differentials leading to unwinding of carry trades – remain supportive.


The expected acceleration in JGB issuance in the wake of this crisis (which, coincidentally, pushes Japan’s sovereign debt load above one QUADRILLION yen) has to be financed somehow, which is one of the supportive factors for the repatriation case (in addition to risk aversion and the need to finance rebuilding efforts).


Of course, the Bank of Japan could continue to provide “powerful” and “massive” stimulus, as pledged by BOJ governor Masaaki Shirakawa. They are currently already monetizing JGB debt at a rate of ¥21.6 TRILLION ($267.2B) yen annually, so what’s another ¥10-20 TRILLION yen in perpetual debt monetization?


The last time the world’s Almighty Central Planners decided to collectively intervene to weaken the yen as on August 15, 1995 (about a half a year after the Kobe earthquake). The yen went on to weaken (-29%) over the next three years until a reversal of that intervention scheme on June 17, 1998 sent the yen sharply in the other direction.


As with any Fiat Foolery throughout the course of history, the resultant yen weakness was accompanied by unintended consequences, as the deliberate currency devaluation resulted in a sharp spike in reported inflation on the island economy. As always, there are two sides to every trade.


The chart below shows YoY growth in Japanese Import Prices swung +1,860bps in the year following the initial intervention (July ’95: -3.5% YoY vs. July ’96: +15.1% YoY). In the 18 months beginning in Jan ’96, Japanese Import Price growth averaged +10.4% YoY. Eventually, these higher input costs manifested their way into reported inflation throughout the Japanese economy, with Japan’s Nationwide CPI peaking at +2.5% YoY in Oct ’97 vs. a deflationary (-0.6%) YoY just two years prior – a +310bps swing.


Japanese Yen: Be Careful What You Wish For, Consensus... - 1


This history lesson begs the following questions with regard to the current round of intervention:


Can the Japanese government’s stained finances handle backup in interest rates? Debt Service already consumes ~45% of the central government’s revenue.


Japanese Yen: Be Careful What You Wish For, Consensus... - 2


Can the Japanese consumer, after many years of price and wage deflation handle higher prices?


Japanese Yen: Be Careful What You Wish For, Consensus... - 3


Can Japan, which will need to procure raw materials from abroad to rebuild in the wake of the current disaster, afford an acceleration of imported inflation brought on by currency weakness?


Japanese Yen: Be Careful What You Wish For, Consensus... - 4


Can Japanese economy handle higher inflation, period? We don’t think so. This is why we stand counter to the current sell-side storytelling about “accelerated growth driven by construction and yen weakness”. The playbook for where Japan may be headed as a result of this current round of Big Government Intervention has a lot more factors than consensus’ simple two-factor, “buy the dip” model.


In fact, BOJ governor Shirakawa agrees, saying today that the government wants to avoid abruptly weakening the yen because it may bring about a back up in JGB yields. “That’s naturally the biggest fear for the government”, he says.


A worthy fear indeed.


Darius Dale


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