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This note was originally published March 30, 2011 at 07:59 in  

“Disaster was caused by errors committed by the leaders at the front.”

-George McClellan, 1861

I’m in the middle of reading an outstanding US history book that one of our star analysts, Allison Kaptur, recommended: “Team of Rivals – The Political Genius of Abraham Lincoln”, by Doris Kearns Goodwin.

The aforementioned quote comes from Chapter 14 which is titled “I Do Not Intend To Be Sacrificed.” As I was reading it last night, I couldn’t help but think about the parallels between America’s political leadership, then and now…

McClellan was a Major General in the American Civil War who served a very short term as Lincoln’s General-In-Chief of the Union Army (from November 1861-1862), before ultimately falling on his own sword of accountability.

Whether on the ice of athletic competition or in the arena of professional asset management, I’ve seen plenty of McClellans in my day. Their biggest problem is one of perception. However talented and resume’d up they may be, they don’t quite get what it means to lead people – by example.

Consider the following contrast between McClellan’s public representation of himself: “You have no idea how the men brighten up, when I go among them.” (“Team of Rivals”, page 378)…

And how he behaved when he thought no one was looking: “The whole thing took place 40 miles from here without my orders or knowledge… it was entirely unauthorized by me and I am in no manner responsible for it.” (“Team of Rivals”, page 383)…

It’s both sad and pathetic to think that the said leaders of this world, both then and now, think that they can fool history into believing not only the facts, but their intentions in representing their version of the “truth.”

McClellan’s finger pointing and excuse making came on the heels of a big mistake he made that led to a Union loss at Ball’s Bluff. This wasn’t a one-off event. To the contrary, if you follow a man’s behavior long enough – the leadership methods he employs, the decisions he makes, and the reactions he has to wins/losses – you’ll figure him out. That’s the point, in principle, that I want to make this morning about risk management.

Back to the Global Macro Grind

I’m certainly not suggesting I don’t make mistakes. But I’ll be one of the last guys who goes to war with you who will be accused of being gutless. And no, that doesn’t mean I’m the prettiest player in this game – neither the most polite. It just means my friends call me Mucker.

We’ve created a culture here at Hedgeye that resembles that of the 4-wall dressing room we fostered at the Yale Whale in 1995. We are accountable to our performance in real-time. Everyone faces each other. There is nowhere to hide.

No matter where you go this morning, there it is – the score. As we push into both month and quarter end, however “light the volume” has been for the last week in Global Equity market trading – the price performance has been up into the right. Thankfully, I’ve drawn down my cash position in the Hedgeye Asset Allocation Model by 18% (to 43% from 61%) in the last 6 weeks.

While I made the right “Short Covering Opportunity” call on March 16th, I’ve made the wrong call in not holding the line on a very net long position (16 LONGS and 4 SHORTS in the Hedgeye Portfolio) until the very end of the month. That would have made our navigation of the last 2 weeks of Q1 2011 perfect – and perfect we are not.

We do have a risk management process however. That’s what guides us in asking questions as to where we could be right or wrong next. The #1 question on my mind right now is can we see a DEFLATION of The Inflation?

On that score, there are two scenarios I see playing out – they are both US Dollar based:

  1. US Dollar UP  - through an end to the unaccountable outcomes of QG1 and QG2 (The Bernank Perpetuating The Inflation), I think this would relieve a huge consumption tax on the American people. With 72% of US GDP being tied to Consumption, we have to get this right.
  2. US Dollar DOWN - through a continued Debauchery of the Dollar, Americans will face either a currency or bond market crisis (or both). This will be a massive headwind for all US capital markets (currency, stocks, and bonds) as it was in the 1970s.

On the short side of US Equities, I’m not brave enough to fight a bullish breakout in the US Dollar again. Been there, tried that in December of 2010. And I don’t think those who have been as bearish as we have on US stocks since Valentine’s Day should be testing bravery-to-the-death on that front (if we see it again) either.

As is always the case when fighting the proverbial Fed War, our risk management process defers to the highest probabilities embedded in the math. That is, in the correlation risks we see developing between our most heavily weighted Global Macro Factor (US Dollar Index) and everything else.

As of the last 6 weeks, it’s critical to note that the long standing 2-year inverse correlation between the USD and the SP500 has changed (DOWN Dollar = The Reflation trade). Whether you look at it on a 3 week or a 6 week duration, this is the latest math:

  1. 3-week TRADE: USD versus SP500 = +0.29
  2. 6-week TREND: USD versus SP500 = +0.67

Don’t fight the truth. Embrace it. This means that our ultimate strategy for the President of the United States holds true where it matters most. On the battlefield of American currency.

Dear Mr. President, if you strengthen the US Dollar, you will DEFLATE The Inflation – and stocks will go up. Alternatively, if your General-in-Chief of the US Federal Reserve continues to point fingers at everyone in this global market system other than at himself, your currency will burn and your citizenry will lose confidence in whatever confidence they have left in our Leaders At The Front.

My immediate-term TRADE lines of support and resistance for WTI Crude Oil are $104.09 and $108.03, respectively. My immediate-term TRADE lines of support and resistance for the SP500 are 1306 and 1328, respectively.

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer

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