“A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be.”
Late last week Keith and I were in Boston meeting with clients on the eve of the beginning of the Boston / Montreal first round playoff series. While Bostonians and hockey fans around the world are gearing up for the beginning of the NHL playoffs, money managers, as usual, are contemplating portfolio positioning for the upcoming months.
Whether your strategy involves bottom-up company analysis, top-down economic analysis, or a healthy dose of both, the objective is the same: to anticipate where the Investment Puck is going ahead of the competition. To borrow from Mr. Gretzky, good money managers play the market where it is, great money managers play the market where it is going to be.
Currently, from a macro perspective, the primary focus of many money managers is attempting to determine the timing of the next move in monetary policy. Given the high correlation between U.S. monetary policy, the U.S. dollar, and many global asset classes, this is the key area to focus.
To emphasize this point, in the Chart of the Day attached below, we show the correlation of Federal Reserve Treasury Purchases with the CRB index, which highlights the high correlation to loose U.S. monetary policy and inflation of many U.S. dollar-based commodities.
While “fundamental” supply and demand certainly matters, if you are invested in oil, or oil related equities, keep one market quote front and center: the U.S. Dollar Index. Over the past three months, the correlation between the U.S. dollar index and WTI Crude Futures is -0.86, while the correlation between the U.S. Dollar Index and Brent Crude Futures is -0.91. Dollar down continues to equal oil up, and decidedly so.
In our presentation late last month titled, What’s Next For Oil?, we highlighted turmoil in the Middle East as a key factor supporting the price of oil. Indeed, violence in Libya continued to escalate this weekend as the recent U.S. led NATO intervention so far seems largely ineffectual. According to British Prime Minister Cameron this weekend:
“We have to ask ourselves, what more can we do to protect civilian life and to stop Qaddafi’s war machine unleashing such hell on his own people.”
With an unknown outcome Libyan oil production remains well below its full output of 1.8MM barrels per day, which supports oil prices.
On the other side of the ledger for oil, there are mounting bearish supply and demand data points. Specifically, according a recent report from the International Energy Administration, oil consumption grew 2.6% year-over-year in Q1 2011. This was a sequential slowdown from 4.1% year-over-year growth in consumption in Q4 2010. Further, the IEA now expects oil consumption to grow 1.6% year-over-year in all of 2011 versus 3.4% for 2010. In addition, crude oil stocks in the United States grew 0.5% year-over-year, which is near decade highs. With the price of gasoline up 24.6% year-over-year, oil stocks should continue to build.
If you don’t believe the oil market is oversupplied in the short term, take it from the Saudis. This weekend the Saudi Oil Minister said the following in a press conference:
“The market is overbalanced ... Our production in February was 9.125 million barrels per day (bpd), in March it was 8.292 million bpd. In April we don't know yet, probably a little higher than March. The reason I gave you these numbers is to show you that the market is oversupplied."
This morning China increased the reserve ratio for their banks by 50 basis points to 20.5% and pledged there is more to come. So unlike The Bernank who attempts to manage monetary policy via a press conference (according to the top article on Bloomberg this morning), the Chinese continue to proactively combat inflation.
Chinese tightening is incrementally bearish for commodities, to argue different is simply story telling. (Interestingly, the Chinese equity market closed up +23 basis points despite this incremental tightening, which is positive for our long Chinese equity position in the Virtual Portfolio.)
As bearish supply and demand data points continue to mount for oil and other U.S. dollar based global commodities, the increasing focus is on determining the direction of the U.S. dollar, which will be driven by U.S. monetary policy. So, where do we stand on the direction of monetary policy? To some extent, it will depend on the data.
We are quite confident housing has another leg down (email if you are an institutional prospect and want to talk to our Financials Sector Head Josh Steiner about his 100+ page negative thesis on housing). Further, employment is seeing anemic improvement, which is mostly being driven by people leaving the workforce and will not see much improvement with U.S. GDP growth likely to come in lower than expected this year. On both of these key fronts, Chairman Bernanke will have plenty of cover to keep rates low for an “extended period”.
Ironically, government CPI, which is not the best proxy for inflation in our estimation, may actually be the thorn in The Bernank’s side. As we highlighted in our Q2 Theme presentation, CPI compares are set to get very easy in the United States. In fact, June CPI last year was +1.1%, which is really the beginning of the easy comps. Starting this summer it is likely that we see government reported data that looks inflationary and will make it difficult for The Bernank to remain perpetually dovish.
As monetary policy begins to tighten in the U.S. and theoretically strengthen the U.S. dollar, the music will likely stop for the commodity rally in the intermediate term. This will create an investment opportunity of another kind if you are at the Investment Puck. And as famed U.S. Olympic Coach Herb Brooks once said:
“Great moments are born from great opportunities.”
Keep your head up and stick on the ice,
Daryl G. Jones
This note was originally published at 8am on April 13, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“One need not be a prophet to be aware of impending dangers.”
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:
- Cash = 37% (down from 52% last week)
- International Currencies = 30% (Chinese Yuan, Canadian Dollar, British Pound – CYB, FXC, FXB)
- Fixed Income = 12% (Long-term US Treasuries and a US Treasury Flattener – TLT and FLAT)
- US Equities = 9% (Dividends and Technology – VIG and XLK)
- International Equities = 6% (China – CAF)
- 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 email@example.com 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.):
- Hedge fund net leverage in February 2011 hit its highest level since October 2007 (the last market top)
- Hedge fund net-long exposure to Commodities has eclipsed the prior 2007-2008 peak in 2011 (special thanks to The Bernank)
- 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:
- The largest net-long commodities position EVER in the hedge fund community will come down…
- 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,
Keith R. McCullough
Chief Executive Officer
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Q2 KEY MACRO THEMES: FINDING STABILITY AMID HEIGHTENED VOLATILITY
REPLAY PODCAST & SLIDES
Today, April 15, 2011, 11am EDT
Hedgeye's Macro Team, led by CEO Keith McCullough and Managing Director Daryl G. Jones, recently hosted their quarterly themes conference call. The key topics included:
- Year of the Chinese Bull (Bullish on Chinese equities and the Chinese yuan)
- Deflating the Inflation (Inflation Scenario Analysis)
- Indefinitely Dovish (U.S. Interest Rate Scenario Analysis)
If either hyperlink fails to work, please copy & paste it into the URL of your browser.
The Hedgeye Macro Team
Today the Greek government announced that it will issue an additional €26 Billion in austerity measures and sell €50 Billion in state-assets to meet its targets to reduce the country's public debt and deficits. Bottom line: Greece is accelerating its position on the road to the Keynesian Endgame. While the measures announced today may at best quell investor fears over the short run, longer term the government is putting another band-aid over the deep fiscal imbalances that are not being properly accounted for by the government.
So what’s on the chopping block? The Greek Finance Minister put to auction today stakes in the Hellenic Telecommunications Organization (HTO) and Public Power Corp (PPC), estimated to yield €15 billion by 2013 and €50 billion by 2015.
With Greece’s debt estimated to ramp to 159% of GDP in 2012, and expectations to cut the budget deficit from a high of 15.4% of GDP in 2009 to 3% by 2014, as the government works against €13.1 Billion in debt (principal and interest) due in the months of April and May (of the some €42.5B due this year), while the Greek 10YR yield rips to over 13% -- we’d say the country is 1.) going to need a far greater life line and/or solution to restructure its debt, and 2.) rife for some more civil unrest.
In the meantime, be patient and wait for your price on a beautiful Greek island to call your own. Bon weekend!
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