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:
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:
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,
Keith R. McCullough
Chief Executive Officer
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.
Conclusion: We’re seeing some notable divergences within the flurry of economic data coming out of Asia over the past few days, all of which are analyzed in the callouts below. In addition, we update our intermediate-term outlooks for each major Asian economy, as well as how to play our views across asset classes.
Perhaps the most bullish data point we’ve seen out of China recently was today’s positive inflection in Manufacturing PMI, which accelerated sequentially in March to 53.4 vs. 52.2 in Feb. The report also showed that Input Prices ticked down in March, and, while still elevated, this is positive on the margin and rewarding of Chinese efforts to rein in inflation over the intermediate term.
Analyzing consensus’ recent moves, we see that an interest rate hike is expected in 2Q and more signs of the sell-side getting positive on China. We remain long Chinese equities as inflationary headwinds have become consensus and no longer carry the same level risk they did when we first called this out back in January 2010. Further, we think the Chinese economy has entered a bottoming process and is poised to reaccelerate over the intermediate term.
The release of the March Manufacturing PMI data confirmed that the recent natural disaster had a pronounced effect on the Japanese economy, ticking down to 46.4 vs. 52.9. With only 5% of the average number of replies (indicating a natural survivor bias), the extent of the quake/tsunami’s impact might have been understated and we expect further near term weakness in Japanese economic data. History and our quantitative models continue to support our view that it’s much too soon to get long the Japanese recovery trade.
Keep an eye on the BOJ; they will be growing pressure to monetize government debt in the coming weeks and are already hinting at an unprecedentedly large lending facility to prevent a wave of bankruptcies from sweeping the nation. Both history and empirical studies suggest this will ultimately end up in perpetuating structural inflation – an outcome that will be equally negative for the Japanese economy as it will be for the Japanese government and its bond holders. This remains a major TAIL risk for the global economy.
The latest weekly inflation report was essentially a wash on a wk/wk basis; prices still remain up double digits on a YoY basis, defying government efforts to cool the economy with the recent rate hikes. Credit growth continues unabated and, as we pointed out in a previous note, the subsidy and tax increases in the upcoming budget will be accretive to current inflationary pressures.
While the RBI continues to ratchet up its typically wildly inaccurate inflation projections, consensus has started calling on the bank to do more to slow the rate of price increases. Inflation is likely to remain a significant headwind for the Indian economy over the intermediate-term TREND, and the RBI’s poor response imposes significant risk of it needing to implement ultra-aggressive tightening measures in the latter half of this year.
The bulk of Korean economic data continues to go the wrong way, with the notable exception of today’s positive trade report. March Export growth accelerated and the 1Q Trade Balance widened on a YoY basis, which is accretive to Korea’s GDP growth. What’s dilutive to growth is accelerating inflation, which quickened to +4.7% YoY in March.
As we called out in November, Korea’s negative real interest rates continue to fuel inflationary pressure, which is only mitigated by recent strength in the won. That said, we think Korea’s relative passiveness in addressing the country’s growing inflation concerns increase the risk of the Korean central bank having to slam on the breaks later in the year. That’s a big negative, particularly given that PMIs (both Manufacturing and Non-Manufacturing) and Industrial Production were all going the wrong direction in the Feb-March period.
Despite all of this, the Kopsi Index has ripped to the upside and is now bullish from a TRADE & TREND perspective. We think the fund flows have rotated on the margin to Korea from Japan, as investors anticipate Korea picking up what used to be Japanese production and export orders. There’s a great deal or risk speculating on Korean equities at current prices, particularly given the trajectory of its domestic growth, as well as global growth (both are sloping down).
The story here is undoubtedly the Aussie dollar, which continues to rip alongside rising commodity prices and rising expectations for the Chinese economy (Australia’s largest export market). It doesn’t hurt that Australia will eventually be called upon to ship larger amounts of materials to its second-largest export market (Japan). Australia’s terms of trade haven’t been higher since the 1950’s, according to the Austrian government, and those very terms look to continue onward and upward over the intermediate term.
That said, we do see a few major risks to chasing the Aussie dollar beyond its current all-time highs: 1) Dr. Copper isn’t confirming a reacceleration in Chinese or global growth; 2) Australia’s near-term trade data stands to roll over alongside its manufacturing data (PMI rolled over in March); and 3) Glenn Stevens and the RBA stand ready to actually cut rates if the global economy falters over the next 3-6 months – which we anticipate. Needless to say, there is a definite air-pocket under the Aussie dollar and any reversal of price momentum carries significant downside risk in our model.
As an aside, the global FX market might be sniffing out a potentially lucrative opportunity for Aussie-based purchases of US Treasuries on a rolling-hedged basis. We urge caution here, as it remains to be seen whether the US Treasury market can withstand the end of QE2 and the upcoming debt ceiling debate. Stay tuned.
We’re getting more constructive on both the Indonesian economy and equity market here, aided by decelerating inflation (March CPI slowed to +6.7% YoY), which is boosting Consumer Confidence (107.1 in March vs. 106.4 in February). A widening Trade Balance further augments the case for Indonesian GDP growth coming in above consensus expectations. We continue to be bullish on the Indonesian rupiah and the currency’s recent strength limits the central bank’s need to continue hiking rates, though we do think they will continue to be hawkish over the near-to-intermediate term.
Hong Kong economic data continues to go the wrong way in February: CPI accelerated to a 30-month high, Trade Balance contracted, Money Supply (M2) growth slowed, Retail Sales growth decelerated, and the Government’s Budget Balance deteriorated. Despite this, the Hang Seng Index looks like it wants to go along for the ride and join China on a bullish breakout. Aided by the yuan appreciation story and its own inflationary headwinds, we remain bullish on the Hong Kong dollar.
CPI on both a Headline and Core basis ticked up in March to +3.1% YoY and +1.6% YoY, respectively, and we think the subsidies currently being handed out by the government in advance of this year’s elections (“buying” votes) will only add to the current inflationary pressure over the intermediate term. We remain bullish on Thai interest rates/bearish on Thai local currency bonds.
Thai equities are now bullish from an intermediate-term TREND perspective – a sign that growth expectations are reaccelerating and a leading indicator that the upcoming elections are likely to go off without any major hitches. Given the scope of last year’s political protests, we find such expectations to be hopeful at best. Last, but certainly not least, there is a lot of mean reversion risk in owning Thai equities right here and now – particularly given the amount geopolitical risk that could flare up any given moment. In addition, inflation looks poised to break out to the upside over the intermediate-term.
We’ve remained bullish on the Singapore dollar since last July on the strength of robust growth and accelerating inflation. Now, both factors are starting to go the wrong way for the currency. Industrial Production growth slowed in Feb to +4.8% YoY vs. +11% YoY in Jan. Non-Oil Export growth slowed measurably in Feb to +7.8% YoY vs. +20.7% YoY in Jan. CPI decelerated for the first time since October in Feb to +5% YoY vs. +5.5% in Jan.
While it appears the strong currency (+10.8% over the past 12 months) is starting to weigh on exports, we can’t help but point out its positive impact on the Singapore consumer: Retail Sales growth (ex-Auto) accelerated in Feb to +15.6% YoY in Jan and we look for that trend to continue with unemployment hovering near a two-year low. Further, PMI data continues to look healthy, accelerating in all but one subcomponent in Feb. Despite this economic health, we remain cautious on Singaporean equities, as their export and manufacturing growth looks to suffer from Japanese supply constrains, as well as a slowdown in US and European consumer demand.
POSITION: Short SPY
I’ve decided to come out of retirement. Short selling is too much fun.
The risk management setup here is getting as interesting as it was on Valentine’s day. We’ve effectively seen a -6.5% correction all but recovered on low-volume, slowed fund-flows, and an almost complete collapse in volatility.
Top-down, our view remains that market expectations that hang in the balance of what a few humbled men in the Keynesian Kingdom do next are going to perpetuate Price Volatility. We can’t get upset about that – we just need to deal with it – and one of the most obvious ways to capitalize on that is to manage risk around the inverse correlation between the SP500 and the VIX.
The VIX has a ton of immediate-term TRADE support between 16.36 and it’s long term TAIL level of support at 15.29. So the highest probability risk management decision I can make from here is to sit tight and Wait & Watch for that volatility zone to be realized on the downside as 1 is tested on the upside. We’re inching closer to these key zones today.
Inasmuch as it was a great call to cover most of our short positions at SP/VIX 29.40, it’s been a bad call coming back to the short side too early. I think I’ve thought about the setup better than I’ve executed on it – and, again, that doesn’t make my being short the SPY here right – but it does provide a healthy reminder that the discipline of patience is what will really drive performance in Q2 of 2011. The next few months will not be for the faint of heart.
Cover low, short high – and stay transparent, my friends.
Keith R. McCullough
Chief Executive Officer
R3: REQUIRED RETAIL READING
April 1, 2011
OUR TAKE ON OVERNIGHT NEWS
Japanese Retailers Down Double-Digits in March - Uniqlo, Isetan Mitsukoshi and Takashimaya reported Friday double-digit drops in March sales, providing the latest indications of how much Japanese consumers are holding back in the immediate aftermath of the earthquake and tsunami disaster. Uniqlo’s corporate parent Fast Retailing said that same-store sales at the fast-fashion chain slid 10.5 percent last month. The comp figures refer exclusively to Uniqlo’s Japan operations. Isetan Mitsukoshi said preliminary March sales at its nine Isetan stores dropped 28.4 percent and those at its 14 Mitsukoshi stores fell 22.8 percent. Similarly, Takashimaya said sales at its 14 stores in Japan slid 17.3 percent in March. J.Front Retailing, which operates 21 Daimaru and Matsuzakaya department stores, said March sales dropped 9.6 percent. Matsuzakaya branches in the Tokyo neighborhoods of Ueno and Ginza saw their sales drop 29.6 percent and 28.9 percent respectively. <WWD>
Hedgeye Retail’s Take: Uniqlo is actually fairing surprisingly well given the circumstances and the fact that 2/3 of the month’s sales were post quake.
Hermes in Discussions to Sell 45% Stake in Jean-Paul Gaultier - Hermes International (RMS) SCA, the French maker of Birkin and Kelly bags, is in talks to sell its stake in the Jean-Paul Gaultier fashion house less than a year after the designer relinquished his role at the luxury-goods maker. Hermes received “an expression of interest from potential buyers” of the 45 percent holding, the Paris-based company said today in a statement, without elaborating. PPR SA is one candidate that may study the sale of the stake, French daily Les Echos said today, without citing anyone. Gaultier stepped down last year as the artistic director of Hermes’s women’s ready-to-wear unit after seven years in the role and was replaced by Christophe Lemaire. The designer has had a relationship with Hermes since 1999, when the company bought a 35 percent stake in his fashion house for $23 million. The stake was later raised. <Bloomberg>
Hedgeye Retail’s Take: Following the death of former Hermes’ Chairman Jean-Louis Dumas who recruited Gaultier last summer, the designer’s relationship with the firm has been tenuous. First he lost his position and now the brand is looking to sell its stake in the fashion house completely.
Google Updates its Site Search Tool for e-retailers - Google Inc. this week updated its site search tool, giving retailers the ability to show consumers local product inventories and more flexibility in setting online promotions. With the launch of Google Commerce Search 3.0, the search engine also says it will test a product recommendation feature that retailers can install on their e-commerce sites. This release builds on the last update to Commerce Search, released in June, and includes a tool similar to Google’s Instant Search. Google introduced that feature to its search in September, enabling consumers to see search results on the page as they type search queries. The Commerce Search update enables shoppers using a retailer’s site search feature to see more product information with every keystroke. <InternetRetailer>
Hedgeye Retail’s Take: Another tool from the dominant search provider. Innovation will remain key to Google’s ability to maintain its steady 65% share of the search market.
New Balance Signs Kevin Youkilis - Boston-based New Balance announced Wednesday it has signed hometown third baseman Kevin Youkilis to a multi-year endorsement deal. New Balance will be the Red Sox player’s official on-field footwear brand, as well as provide shoes and apparel outside of the game. This season, Youkilis will wear a special makeup of the New Balance 1103 baseball spike. The athletic company also will sponsor Youkilis’ charity, Youk’s Kids, which supports existing community-based children's charities and medical research programs in New England. And New Balance will support a new Athletes for Heroes program, providing financial support for children who have lost a parent or have a parent who has been severely injured in military service.<WWD>
Hedgeye Retail’s Take: Great fit for the Boston-based brand, which up to now hasn’t allocated any money towards athletic endorsements. Do we expect a flurry of new signings – no, but the move reminds consumers NB is still in the game.
Magazines Eye E-Tailing - Vogue and Elle have long influenced what clothes and handbags image-conscious consumers buy. Now, in a bid to reverse flagging sales and stay relevant, fashion magazines may sell the products they feature in their articles. As Apple Inc. iPad and other mobile devices change the way people stay informed and shop, e-commerce is creeping onto editorial agendas. Fashion magazines that have gone as far as to add links on their websites to online vendors such as Yoox SpA, may integrate the reading and buying experience, a move that would transform the likes of Vogue and Elle from just trendsetters into virtual shopkeepers. “Gone are the days when consumers want to flip through the back of a magazine to find an index,” said Shannon Edwards, European director of online shopping portal ShopStyle. Combining retail and editorial “is natural from an economic standpoint and natural from a consumer standpoint.” <Bloomberg>
Hedgeye Retail’s Take: The only surprise here is that it’s taken this long.
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