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America's Last Entitlement

This note was originally published at 8am on April 08, 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 best way to destroy the capitalist system is to debauch the currency.” 

-John Maynard Keynes

 

What’s worse right now, American fiscal or monetary policy? Sadly, that’s a tough call. As the world embraces the idea of a US Government Shutdown this morning (yes, many of us would like to see these people stop what they are doing), even John Maynard Keynes is rolling over in his grave. The US Dollar Index is trading down at fresh YTD lows of $75.14.

 

Let’s take a look at both sides of what drives a country to “debauch the currency” (looking at Europe vs USA, straight up) and the immediate-to-long-term risk management implications for your portfolios:

 

1. Monetary Policy

 

As anyone who has traded a currency market in the last 40 years knows, currencies trade not only on the direction of a country’s monetary policy (hawkish or dovish), but relative to other countries with competing policy views.

 

For the 1st time in 40 years, the Europeans raised interest rates before Americans did yesterday. Notwithstanding the colossal failure of common sense associated with The Bernank opting to starve the American common man with inflation and a zero percent return on his savings account, it’s important to recall that Trichet’s rate hike didn’t come from the zero bound. He was already at 1% and he moved to 1.25%. That’s bullish for Euros versus Dollars.

 

In justifying the interest rate hike, the ex-Finance Minister of France told the world, “You know from our own doctrine that we always do what is necessary to deliver price stability.” In the immediate-term, even for the left-leaning Frenchman, that is pseudo-true. Relative to The Bernank, it’s very true. With the USD down for 11 of the last 15 weeks, Bernanke is perpetuating the highest PRICE VOLATILITY that commodity markets have ever seen.

 

2. Fiscal Policy

 

On a relative basis versus Europe, particularly relative to the United Kingdom, the United States of America isn’t even in the area code of where capital market winds have blown European politicians. Since many European markets can’t mark-their-bonds-to-model like Geithner and Bernanke have attempted to mark US Treasuries, austerity measures have either been imposed by popular vote (UK) or by market vote (Portugal). Both votes count.

 

Many Americans have found rhetorical resolve in calling Europeans “pigs”, and that might feel all good and fine if you’re an American living large on a banking fee or a Washington retainer, but that doesn’t change the reality of what the rest of the world rightly started calling Boehner and Reid this week – donkeys.

 

While the “audacity” of President Obama’s “hope” is clearly not an investment process that global currency markets are long of (to the contrary, the largest short position in US Dollars, ever, implies the world is betting against the 112th Congress in size), an earthshaking culture shock to the Big Government Spending model is the only thing Americans can hope for.

 

3. Long Dollar, Short Euro, Short Commodities?

 

That would be the most contrarian (and least profitable) call you could have made in the first 3 months of 2011. And that’s exactly why you should be asking yourself if The People can govern the government as the US Constitution asks them to. Betting against professional politicians of a centrally planned state is easy – betting against the common sense of the sometimes Forgotten Man (Amity Schlaes) in America is a losers’ long-term bet.

 

I think my defense partner, Daryl Jones, asked the most contrarian question on US Fiscal Policy yesterday that you can ask yourself right now, “Could The Ryan Budget Be The Most Economically Bullish Legislation of Our Lifetimes?” (send us an email if you’d like a copy, sales@hedgeye.com)

 

This isn’t a partisan point. Remember, I am Canadian – and I edit Big Alberta’s work. If a Democrat or a talking monkey were to put a legitimate spending cut bill on the floor we’d be asking the same question. I really don’t care what it takes, or who sponsors it – arresting the Debauchery of the US Dollar has become a national security issue for America’s standard of living.

 

You don’t have to take my word for it on what happens when you burn your currency at the stake. History is littered with examples. This is not the best long-term path to prosperity. If you are a raging Republican or a dogmatic Democrat who has supported Big Government Intervention for the last decade, all you need to do is take the Keynesian Kingdom call on this from John Maynard Keynes himself – “The best way to destroy the capitalist system is to debauch the currency.”

 

If you’re really long The Inflation this morning (LONG: oil, gold, etc; SHORT: dollars, US Treasuries, etc), this idea of combining fiscal and monetary conservatism should scare the hell out of you. When you consider that The Bernank has not only perpetuated unprecedented Price Volatility AND the largest NET-LONG position that the hedge fund industry has EVER had in commodities – you should be afraid, very afraid. I am.

 

But we are all big boys and girls managing risk out here on the Global Macro gridiron, so suck it up, take a deep breath, and pray. Because, at a new all-time record high price for Gold this morning of $1470/oz and $111.56/barrel oil, there’s a new bubble in town – the bubble of America’s Last Entitlement. Cheap money and donkey politicians won’t last forever.

 

My immediate-term support and resistance lines for oil are now $107.16 and $111.59, respectively. My immediate-term support and resistance lines for the SP500 are 1312 and 1343, respectively.

 

Best of luck out there today and have a great weekend,

KM

 

Keith R. McCullough
Chief Executive Officer

 

America's Last Entitlement - Chart of the Day

 

America's Last Entitlement - Virtual Portfolio


CHART OF THE DAY: Beta Chasing Will Eventually Leave a Mark

 

 

CHART OF THE DAY: Beta Chasing Will Eventually Leave a Mark -  chart


THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - April 13, 2011

 

China continues to trade higher, up another +0.96% last night to +8.6% YTD (almost 2x the YTD SP500 return, unadjusted for Burning Bucks) leading what continues to be an improving Asian equity picture (ex-Japan).  As global growth slows, unlevered Chinese growth becomes more valuable.

 

After being bearish/short China in 2010, we’re long now and will focus 1/3 of our Q2 Macro Theme presentation (Friday) on the why.  As we look at today’s set up for the S&P 500, the range is 18 points or -0.32% downside to 1310 and 1.05% upside to 1328.

 

SECTOR AND GLOBAL PERFORMANCE

 

Two more sectors broke trade yesterday; Energy and Technology.  We now have 6 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND.    

 

THE HEDGEYE DAILY OUTLOOK - daily sector view

 

THE HEDGEYE DAILY OUTLOOK - BEST PERFORMING GLOBAL

 

THE HEDGEYE DAILY OUTLOOK - WORST PERFORMING GLOBAL

 

 

EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: -1498 (-318)  
  • VOLUME: NYSE 949.53 (+15.98%)
  • VIX:  17.09 +3.10% YTD PERFORMANCE: -3.72%
  • SPX PUT/CALL RATIO: 1.50 from 1.37 (+9.26%)

 

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD: 23.51
  • 3-MONTH T-BILL YIELD: 0.05%
  • 10-Year: 3.52 from 3.59
  • YIELD CURVE: 2.75 from 2.74 

 

MACRO DATA POINTS:

  • MBA mortgage applications index fell for third week, declining 6.7% week ended April 8 to lowest in 2 months; Refis down 7.7%; Purchases drop 4.7%
  • 8:30 a.m.: Retail Sales, est. 0.5%, prior 1.0%
  • 9 a.m.: IMF releases report on global financial stability
  • 10 a.m.: Business inventories, est. 0.8%, prior 0.9%
  • 10:30 a.m.: DoE inventories
  • 1 p.m.: U.S. to sell $21b 10-year notes reopening
  • 2 p.m.: Fed’s Beige Book
  • 5 p.m.: Fed’s Bullard to speak in St. Louis

 

WHAT TO WATCH:

  • Leonard Green may make bid for BJ’s Wholesale Club today; BJ’s said to ask for opening round proposals this week: N.Y. Post 
  • China’s debt rating may be cut for first time in 12 years after record jump in lending: Fitch.
  • Newsletter writers classified as bears by Investors Intelligence was below 20% for second week in a row. Bullish sentiment declines to 55.4% from 57.3% in the latest US Investor's Intelligence poll
  • EU Commission fines Procter & Gamble and Unilever a total of €315.2M in washing powder cartel case
      

COMMODITY/GROWTH EXPECTATION

 

THE HEDGEYE DAILY OUTLOOK - daily commodity view

 

COMMODITY HEADLINES FROM BLOOMBERG:

  • Sugar Seen Declining as Production in India Set to Climb 5% on Plantings
  • Oil Drops a Third Day in New York as Libyan Rebels Consider Truce Proposal
  • Soybeans Advance as Biggest Drop in a Month Lures Importers; Corn Climbs
  • Copper May Drop for Third Day on Concern About Credit Tightening in China
  • Gold May Rebound From One-Week Low as Japan Concern, Libya Add to Demand
  • Cocoa May Advance on Ivory Coast Disruption; Coffee Climbs, Sugar Drops
  • Equities Trump Gold as Investors' Best Inflation Hedge: Chart of the Day
  • China Cotton Buying Slows for U.S. Sellers, Eastern Trading Co.'s Lea Says
  • Rio Tinto Iron-Ore, Coal, Uranium Production Declines on Australian Floods
  • BHP Isn't Justifying Laggard Woodside's Most Expensive Valuation: Real M&A
  • Rubber Futures Tumble as Toyota Set to Suspend Output at European Plants
  • Cocoa Arrivals Gain 36% From Brazil’s Bahia Region, Thomas Hartmann Says
  • Malaysia Plans Sugar IPO, Postal Sale as State Companies Pledge to Divest  

CURRENCIES

 

THE HEDGEYE DAILY OUTLOOK - daily currency view

 

EUROPEAN MARKETS

  • Industrial production data for the euro area suggests that the economic outlook continues to deteriorate for the region’s weakest countries; EuroZone Feb Industrial Production +7.3% y/y vs consensus +7.8% and prior revised +6.3% from +6.6%; EuroZone Feb Industrial Production +0.4% m/m vs consensus +0.7% and prior revised +0.2% from +0.3%
  • European equity markets trade higher following a positive lead from Asia
  • France Mar CPI ex tobacco +0.8% m/m, prior +0.5%
  • Germany Mar Wholesale Prices +10.9% y/y vs consensus +10.7%, prior +10.8%
  • UK Feb ILO unemployment rate +7.8% vs con +8.0%
  • UK Mar claimant count +0.7k vs con (4.2K)

THE HEDGEYE DAILY OUTLOOK - BEST PERFORMING EURO

 

THE HEDGEYE DAILY OUTLOOK - WORST PERFORMING EURO

 

ASIA PACIFIC MARKTES:

  • Asian markets rose in the afternoon after seeing limited gains in the morning.
  • South Korea and India led the region.
  • Vietnam and Pakistan were outliers on the downside.
  • Japan March CPGI +0.6% m/m, +2.0% y/y.

THE HEDGEYE DAILY OUTLOOK - BEST PERFORMING ASIA

 

THE HEDGEYE DAILY OUTLOOK - WORST PERFORMING ASIA

 

 

MIDDLE EAST

 

THE HEDGEYE DAILY OUTLOOK - MIDEAST PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - levels413

 

 

 

Howard Penney

Managing Director


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Prophecies of a Risk Manager

“One need not be a prophet to be aware of impending dangers.”

-F.A. Hayek

 

With the US stock market down for its 4th consecutive day yesterday I moved to our most invested position of 2011. The Hedgeye Asset Allocation Model now has a 37% position in Cash and the following allocations:

  1. Cash = 37% (down from 52% last week)
  2. International Currencies = 30% (Chinese Yuan, Canadian Dollar, British Pound – CYB, FXC, FXB)
  3. Fixed Income = 12% (Long-term US Treasuries and a US Treasury Flattener – TLT and FLAT)
  4. US Equities = 9% (Dividends and Technology – VIG and XLK)
  5. International Equities = 6% (China – CAF)
  6. Commodities = 6% (Gold – GLD)

This certainly doesn’t imply that I am a raging bull. Neither does it suggest that I am a raging bear. I really don’t think there’s a lot of value in being raging anything when you are tasked with being a Risk Manager.

 

In the past week I’ve moved from a zero percent asset allocation to US Equities to 9%. With virtually every sell-side strategist cutting their US GDP Growth estimates, and the US stock market’s price now down for the month-to-date, expectations for Growth Slowing As Inflation Accelerates are starting to get priced in.

 

JP Morgan’s earnings can be as good today as Alcoa’s were bad yesterday – then Bank of America can have no earnings on Friday. Managing risk in an environment where everyone isn’t a winner on earnings day anymore is going to present tremendous opportunities for the proactively prepared.

 

One of the hallmarks of effective risk management isn’t just having it in you to short and/or sell things when they are up – it’s having a repeatable risk management process to cover and/or buy them when they are down. Some people in this industry will tell you they can’t do that because that’s called “market timing.” And if you saw what some of these people do when under pressure, you should definitely take their word for it on that.

 

I’ve made two “Short Covering Opportunity” calls in 2011.  The first was on March 16th and I made the second one intraday yesterday (send an email to if you’d like our intraday Risk Manager notes). That’s not me pumping my own tires – that’s just me telling you what I did.

 

Short Covering Opportunities in these interconnected times aren’t raging bull calls to action. In this case I see every opportunity for the SP500 to bounce to another lower-long-term-high and lower-immediate-term high up at 1328. Then you start making sales again. If it’s not in your investment mandate to manage risk on a short to intermediate-term basis like this, that’s cool. I don’t have that mandate.

 

If the US stock market sees a breakdown below 1310 and Volatility (VIX) breaks out above $18.03 (intermediate-term TREND line resistance) again, this call to cover shorts and get more invested will likely be a bad one.

 

Why would it be a bad one? Because I made a short-term risk management decision to get longer yesterday in the face of mounting long-term risks. This is what we call Duration Mismatch – and every Risk Manager is hostage to its uncertainties.

 

Notwithstanding that the world’s reserve currency (US Dollar) has gone no bid and appears to be on a crash course to nowhere, here are some of the other major market risks that I called out on Thursday April 7th (before this 4-day correction in US Equities, Commodities, etc.):

  1. Hedge fund net leverage in February 2011 hit its highest level since October 2007 (the last market top)
  2. Hedge fund net-long exposure to Commodities has eclipsed the prior 2007-2008 peak in 2011 (special thanks to The Bernank)
  3. Institutional Investor’s Bullish-to-Bearish weekly survey just tanked to one of its lowest Bearish readings ever

The good and bad news is that all of these factors change in real-time. While it probably felt pretty cool to be levered-long oil and everything that is The Inflation trade last week, it didn’t feel so good yesterday – or the day before that. From their YTD highs last week, the price of oil (WTI) and energy stocks (XLE) are down -5.8% and -5.7%, respectively, in pretty much a straight line. Yes, chasing The Bernank’s Beta can leave a mark.

 

So… after prices fall:

  1. The largest net-long commodities position EVER in the hedge fund community will come down…
  2. The widest spreads ever between Bulls and Bears in the Institutional Investor weekly sentiment survey will come in…

And we’ll all go on in life dealing with the today.

 

Not surprisingly, today’s Bullish-to-Bearish weekly survey saw the spread between Bulls and Bears narrow by 2 points to +38 for the Bulls (down from last week’s +41). And the prophecy of this Risk Manager is that this spread will narrow again next week. At only 16.3% of institutional investors admitting they are Bearish, that number only has one way to go when stocks and commodities come down like they just did – and that’s up.

 

My immediate-term support and resistance levels for oil are now $105.23 and $109.02, respectively. My immediate-term support and resistance levels for the SP500 are 1310 and 1328, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Prophecies of a Risk Manager - Chart of the Day

 

Prophecies of a Risk Manager - Virtual Portfolio


WEEKLY COMMODITY MONITOR: DPZ, PZZA, DRI, CBRL, PNRA

Cheese prices bounced once again after a sustained period of trading down.  The level of inflation in cheese has declined greatly but its rebound over the past week was the most substantial of all the commodities we monitor.  All in all, looking at the table below shows more red than blue in the week-over-week column.  Coffee continues to press higher, now up 94% year-over-year as it gained 2.2% over the past week.  I continue to hold a cautious view of chicken producers (SAFM, TSN and PPC) despite corn’s week-over-week decline.  The commodity surged 14% last week and, I believe, is likely to remain at these elevated levels for some time.  This will likely lend support to protein (feed costs) and wheat (substitution effect) prices.

 

WEEKLY COMMODITY MONITOR: DPZ, PZZA, DRI, CBRL, PNRA - com412

 

Cheese gained 3.2% on the week. As the chart below shows, cheese prices have come down considerably over the past month.  Below, I gain provide some commentary from management teams from their most recent earnings calls with their views on cheese prices and the implications for their businesses.

 

DPZ:

 

"Yeah, so the forward curve and kind of looking at about three different sources right now have cheese actually easing a little bit through the rest of the year. We're at almost $2 right now. And so, our expectation is that we're going to see a little bit of easing, to give you on cheese. We've talked about this in the past, we've got a contract in place that basically reduces the volatility on cheese moves by about a third. So about two thirds of increases or decreases in cheese are passed through to our system.

 

I think the kind of consensus forecast out there right now for cheese are in the $1.70 to $1.75 range. And – you know so what you're looking at is kind of a $0.25 to $0.30 move and I think we've said in the past a $0.40 move in cheese is equal to a point at the store level P&L."

 

PZZA:

 

“We expect the favorable impact of early year sales results to substantially mitigate the unfavorable impact of currently projected commodity cost increases, most notably cheese, throughout the remainder of the year.”

 

DPZ is 95% franchised and, as such, management claims a degree of insulation from commodity costs.  Of course, to the extent that price needs to be taken and royalties slow, the company is not immune from inflation.  The downward move of cheese over the past month will raise hopes that a price increase can be avoided. 

 

WEEKLY COMMODITY MONITOR: DPZ, PZZA, DRI, CBRL, PNRA - cheese 412

 

It’s also worth noting the strong week-over-week move in gas prices.  Demand destruction is coming to the restaurant space this quarter.  Clarence Otis, Darden CEO, said as much on DRI’s most recent conference call.  Companies like CBRL (see post from yesterday), are particularly vulnerable.

 

WEEKLY COMMODITY MONITOR: DPZ, PZZA, DRI, CBRL, PNRA - retail gas 412

 

Wheat prices declined sharply last week as other grains, such as corn and rice, also saw downward price action.  Media reports today suggest that wheat futures tumbled today as a result of speculation that demand will decline for U.S. commodities as the nuclear crisis seems to escalate in Japan.  Some commentators see this decline as incongruous with the underlying dynamics of the wheat market, given the poor crop conditions currently in the U.S., but if a fall-off in demand were to occur, it could provide relief for PNRA.  The company expects wheat costs for 2011 to be roughly flat versus 2010, as the company currently has nearly 75% of its wheat costs locked in for 2011, modestly below the 2010 price.  

 

WEEKLY COMMODITY MONITOR: DPZ, PZZA, DRI, CBRL, PNRA - wheat 412

 

 

Howard Penney

Managing Director


PENN: FIRST OF 3

PENN should be the first of three strong regional gaming earnings releases followed by ASCA and PNK.

 

 

We’ve been positive on the regional gamers for the past month or so and we’re confident that PENN’s Q1 earnings release next week will prove us right, at least on the fundamentals.  March was a good month for regional gaming as evidenced by the state released gaming revenues, all of which, thus far, have proven to be sequential upticks from Q4 and January and February.

 

Our Q1 EBITDA and EPS estimates for PENN of $172 million and $0.42 slightly exceed both company guidance and the Street consensus. Certainly, there are headwinds including high gas prices and unemployment.  However, we expect management will be reasonably constructive about near term trends.  Management rarely exudes bullishness and we don’t expect that they will get expectations too high now either.  Their tone should be nonetheless, positive on the margin.

 


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