prev

Underestimating Leadership?

“I suppose leadership at one time meant muscles; but today it means getting along with people.”
-Mohandas K. Gandhi

 

Yesterday, the ratings agency Standard & Poor’s downgraded their view of U.S. government debt from “AAA” stable to “AAA” negative for the first time since the attack on Pearl Harbor.  The implication of this new rating is that there is now a 33% chance that the S&P downgrades U.S. government debt in the next two years.  To be clear, our view of ratings agencies hasn’t changed—they are lagging indicators at best. 

 

In this instance, though, Standard & Poor’s did provide insight on the current political debate in Washington.  The basis of their call is that they believe it unlikely that the politicians in Washington will come to an agreement on a budget plan that will narrow the deficit over the long term.   This is the point we made in our Q2 Theme call last Friday, so of course we agree.

 

On the Republican side of the debate is the budget proposed by Congressman Paul Ryan from Wisconsin whose key tenets are to cut taxes, cap the size of Medicare and Medicaid, and to dramatically slash discretionary spending.  Conversely, the budget plan presented by President Obama raises taxes on the rich, cuts discretionary spending somewhat, and takes a hatchet to defense spending.  These are meaningfully substantive and philosophical differences with very little common ground as a starting point for negotiation.    

 

The reaction from the Obama Administration to the rating change from Standard & Poor’s was interesting.  The White House effectively dismissed the action, while the Treasury Department doubled down on the politicians in Washington.  In fact, according to Assistant Treasury Secretary Mary Miller, Standard & Poor’s revised outlook “underestimates” the nation’s leadership.  I’m not sure exactly what Ms. Miller thinks is being underestimated about the politicians in Washington, but fair enough.

 

I used the quote above from Ghandi to underscore the core of leadership, which is getting things done in conjunction with your perceived adversaries.  Unfortunately, many of our perceived leaders have failed the nation on this front in the last week.  President Obama failed us by turning a prime time speech about his deficit reduction plan into a campaign speech that alienated Republicans, including Congressman Paul Ryan who was stoically watching the speech live.  While Tea Party leader, and Presidential hopeful, Congressperson Michelle Bachman, failed us by once again bringing up the tired old questions about President Obama’s place of birth last weekend, rather than focusing on the critical deficit issues facing the nation.

 

If Standard & Poor’s action yesterday did anything, it brought the lack of political leadership to solve the deficit issue completely into the mainstream.  Not surprisingly, stock market operators cast their votes appropriately.  While the SP500 closed above our TREND line of 1,302, it did so barely at 1,305 and it is still trading below the TRADE line of 1,319.  Volume also confirmed this vote as it accelerated 28.8% on the NYSE week-over-week.  Volatility did the same with the VIX up 11%.

 

From a sector study perspective, financials became the first of the primary SP500 sectors to break down with yesterday’s market action.  On some level, this is likely the early anticipation of the ending of quantitative easing, which removes the politicization of the short end of the yield curve and hurts the lucrative business of borrowing short and lending long.  As we’ve posted below in The Chart of the Day, the spread between 2s and 10s is at a near all-time high in spread.  (As a way to play this reversion to the mean, we are long the etf FLAT in the Hedgeye Virtual Portfolio, which is a Treasury curve flattener position.)

 

Our Financials Sector Head Josh Steiner also provided some color as a rationale for yesterday’s quantitative breakdown in the sector:

 

“Mortgage-related costs are on the rise and managements are being more open about the accelerating deterioration of fundamentals in that business. Bank of America stated on their call that multiple charges taken in the quarter were tied to ongoing home price deterioration. MSR write-downs at other banks are an additional indication of ongoing deterioration in that business, as JPMorgan highlighted with their $1.1 billion write-down.

 

While most companies are beating on the bottom line it is largely being driven by credit-related improvement, but this is illusory. Most of that credit improvement comes from reserve release, specifically in the credit card business. For instance, JPMorgan’s card services provision was $226 million in 1Q11 as compared with $1.6 billion in 3Q10. One might assume that credit losses had fallen to $226 million, but in reality net charge-offs were $2.2billion in 1Q11. In other words, the company released $2 billion in reserves (defined as the difference between losses and provisions).

 

This reserve releasing has been substantially propping up earnings for the last several quarters, but will be coming to an end in the next few quarters as delinquencies in that business are nearing their trough.

 

The catch? The banks have been using reserve release from their card operations to offset growing pressure and recurring “one-time” charges in their mortgage business. Reserve release in cards will end in the next few quarters but mortgage-related weakness will persist for much longer.

 

Bigger picture, the industry continues to face an environment of little to no loan growth, rising margin pressure, falling non-interest income and, in 2Q11, significantly rising FDIC deposit insurance premiums for most of the large banks. From a macro standpoint, the start of the Consumer Financial Protection Bureau on July 1, 2011 will coincide with the end of QE2 on June 30, 2011, both of which are likely to be incremental headwinds for the sector.”

 

Needless to say, Josh isn’t overestimating the future stock performance leadership of the financial sector. 

Broadly, we will see this week which bell weather companies will lead, follow, or get out of the way as earnings seasons kicks off in full force.  Today, Goldman (this morning), Intel, IBM, and Yahoo all report earnings.

 

One last leadership quote today from the venerable Nobel Laureate Paul Krugman, who said this about the Standard & Poor’s ratings change:

 

“That said, it’s worth remembering that S&P downgraded Japan in 2002… Japanese bonds became known as the “trade of death”, because people kept betting on an interest rate rise, and it kept not happening. So, no big deal.”

 

So according to Dr. Krugman, emulating Japanese fiscal and monetary policy is no “big deal”.  I’m no Nobel laureate and my PH.D is from the School of Hard Knocks, but even I know that becoming Japanese economically IS a big deal. 

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Managing Director

 

Underestimating Leadership? - Chart of the Day

 

Underestimating Leadership? - Virtual Portfolio


Tipping Point

This note was originally published at 8am on April 14, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“There’s an invisible tipping point – when we get there, it’s far too late.”

-Seth Klarman

 

Seth Klarman founded the Baupost Group in 1982 and runs north of $22B.  He’s done a better job than most managing risk out there over the course of the last 30 years – one of the hallmarks of his risk management strategy is doing nothing.

 

“I’m convinced, and have done this over the years, to invest in cash when there is nothing else out there that excites me. Cash is risky too, but less risky than making an overpriced investment.”

 

I pulled these two quotes from a Klarman transcript that was making the rounds in recent weeks. One of our sharpest clients sent it to me after a dinner I hosted in NYC where we had a lively Portfolio Manager debate about the only question that matters to the institutional investment community right now – when does the Fed’s music stop?

 

Whether it was in a New York restaurant or the meetings I’ll be doing in Boston today, I’ll be having the same discussion. Sophisticated investors get that this won’t end well for America – the only thing between now and “when we get there” is daily performance.

 

That only thing is a pretty big thing. The institutionalization of our industry has put short-term performance chasing in the hot-box of misunderstood market tail risks that remain. It’s omnipresent. It’s invisible – but it’s there. And after the next market crisis, you’ll be able to see it very clearly.

 

Presidents Bush and Obama don’t get how globally interconnected markets work. Neither do the Treasury Secretaries and Fed Heads that have advised them. When the entire game is all about gaming the game, sometimes the government guys who are being gamed forget that…

 

Now some people who think Hank Paulson and Timmy Geithner are “smart” will take issue with that – and that’s fine. Most of these people have never traded a market in their life – and if they did, they’d know that being smart doesn’t give you a birthright to being right.

 

This is where I think both the President of the United States and whoever is left in terms of his economic advisors have made some grave mistakes in the last few weeks. Market risk is all about expectations. They have set up both the catalysts and the fundamentals for a US Dollar crash.

 

Crash? Yes, Mr. President, get all the “smart” central planners of your economic universe to unite in Washington – and ask them what happens to a market and an economy when that country’s currency crashes. Oh, wait – the rest of the world is already trading ahead of you on this. As the US Dollar was crashing in Q2 of 2008, the petro priced in dollars went to $150/barrel. Then US Consumption crashed. Then Paulson puked.

 

Is the US Dollar going to retest those lows? Does the President want to experiment with that? Does the bubble in Big Government Intervention need a US currency crisis to get out?

 

Here are the market’s expectations and calendar catalysts:

  1. May 16 – thanks to the market expectation genius of Geithner, that’s the date he gave the world on US debt default
  2. June – last night President Obama outlined “June” as his “deficit deadline”
  3. July 1 – The Bernank is out of bullets (end of Quantitative Guessing II)

Nice. Since all of these professional politicians want to go grandma and children on me now every time they talk about America’s spending future, who in the high-schools of central planning decided to put all of our moms and kids on the trolley tracks for both the biggest monetary and fiscal policy showdowns in US financial history in the same 6 weeks?

 

You can say what you want about the politics of it all. You can say to yourself that The Inflation born out of burning our currency at the stake isn’t there. You can say whatever you damn well please. But the market price says all you need to know right now – it doesn’t lie like our politicians do.

 

Fed fans, don’t worry. These guys are on it. One of the cheerleaders of Big Government Intervention and easy money, St Louis Fed Head James Bullard, had this to say last night on the risk management matter of the June date that he helped impose as a market expectation:

 

“This is very much a live debate within the Federal Reserve. There is a lot of uncertainty about the optimal way to proceed as we haven’t been in that situation.”

 

Awesome. We’ve never done this before so we have no idea how it ends – so we’re talking about that “live” now because it’s almost May.

 

Sleep tight everyone.

 

My immediate-term support and resistance lines for the SP500 are now 1310 and 1327, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Tipping Point - Chart of the Day

 

Tipping Point - Virtual Portfolio


Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.

THE M3: SMOKING BILL DONE; MGM MACAU IPO; AERL

The Macau Metro Monitor, April 19, 2011

 

 

LEGISLATURE APPROVES SMOKING BILL Macau Daily Times

As expected, the tobacco bill passed the final reading.  Ng Kuok Cheong, Au Kam San, Chan Wai Chi, José Pereira Coutinho, Ho Ion Sang voted against the partial smoking ban in casinos.  They believed that casinos should be subject to a complete smoking ban.  The smoking law will be enacted on January 1, 2012, while casinos will be required to build a smoking area with a size not larger than 50% of total public area by January 1, 2013.

 

MGM MACAU CLOSER TO HONG KONG LISTING: REPORT macaubusiness.com

According to The Standard, MGM Macau's listing hearing is scheduled for April 28.

 

AERL TO OPERATE VIP ROOM AT GALAXY MACAU macaubusiness.com 

Asia Entertainment & Resources Ltd. will operate a VIP room with 12 tables at Galaxy Macau on May 15.  AERL already operates three VIP rooms in Macau, at MGM Macau, StarWorld and The Venetian.


Shorting Greenbacks

This note was originally published April 18, 2011 at 14:07 in Macro

Position: We shorted the USD today via the etf UUP.

 

Call us lucky or good, but we’ve had a pretty good run trading the U.S. dollar in the Virtual Portfolio.  Prior to our initiation of another short position in the UUP earlier today (the etf for the U.S. dollar index), we were 19 for 19 in trading the dollar.  In our Q2 theme presentation this past Friday, we outlined the negative case for the dollar over the coming months.  Today, we got our price. 

 

The first, and likely most important factor when contemplating the dollar, is simply the calendar.  Over the course of the next two months, we have a series of catalysts that are all set up to be negative for the U.S. dollar. These are as follows:

 

  1. May 16th – Treasury Secretary Geithner gave this as the date that the debt ceiling needs to be extended by to keep the government operating;
  2. June – In his deficit speech last week, President Obama outlined this as the time frame in which he wants to have the deficit debate finalized; and
  3. July 1st  – Not only is this Canada Day, but it is also the end of Quantitative Easing II. 

 

Notwithstanding the 1% intraday increase in the UUP, which really does nothing more than give us a price from which to reenter on the short side, the calendar events above provide ample opportunity for the global investment community to vote negatively against U.S. fiscal and monetary policy.

 

Longer term, we have grave concern over the federal government to reach any  workable solution on the deficit.  The inability to reach a real  solution means that we are likely faced with more stop gap solutions ahead of the election next fall.   The reality of these stop gap bills, versus real structural reform, is that they are typically more fiction than fact.  As the Washington Post reported late last week, based on analysis from Congressional Budget Office (CBO):

 

“A federal budget compromise that was hailed as historic for proposing to cut about $38 billion would reduce federal spending by only $352 million this fiscal year, less than 1 percent of the bill’s advertised amount, according to the Congressional Budget Office.”

 

Given the wide divergence between President Obama’s budget and the one proposed by Congressman Ryan, it is increasingly unlikely that a real solution is reached before the 2012 elections.  Ratings agency Standard & Poor’s, in an attempt to overcome their status as a lagging indicator, downgraded the outlook for U.S. debt earlier today primarily based on this likely political impasse.  If no compromise on a deficit reduction bill is reached, the outlook is exceedingly ugly for the U.S. deficit.  According to CBO estimates, which are rosy in terms of certain economic assumptions, the United States is on course for more than $8 trillion in deficit spending over the next decade. This is not positive for the U.S. dollar.

 

The other key factor for the U.S. dollar is interest rates, and interest rate expectations.  Globally, interest rates are going up, while domestically it is becoming increasingly likely that the Federal Reserve will not hike rates until the end of the calendar year, if not later into 2012.   The ECB hiked its benchmark rate by 0.25% on April 7th and has signaled its intention to hike further.  Conversely, while the U.S. Federal Reserve may not extend its policy of Quantitative Easing come July 1st, it does seem unlikely that the Federal Reserve will raise rates.  The implication of this is that the New Carry Trade of borrowing lower yielding U.S. dollars and buying higher yielding Euros is set to continue.

 

Our levels on the U.S. dollar are attached below.

 

Daryl G. Jones
Managing Director

 

Shorting Greenbacks - 1


Shorting Greenbacks

Position: We shorted the USD today via the etf UUP.

 

Call us lucky or good, but we’ve had a pretty good run trading the U.S. dollar in the Virtual Portfolio.  Prior to our initiation of another short position in the UUP earlier today (the etf for the U.S. dollar index), we were 19 for 19 in trading the dollar.  In our Q2 theme presentation this past Friday, we outlined the negative case for the dollar over the coming months.  Today, we got our price. 

 

The first, and likely most important factor when contemplating the dollar, is simply the calendar.  Over the course of the next two months, we have a series of catalysts that are all set up to be negative for the U.S. dollar. These are as follows:

  1. May 16th – Treasury Secretary Geithner gave this as the date that the debt ceiling needs to be extended by to keep the government operating;
  2. June – In his deficit speech last week, President Obama outlined this as the time frame in which he wants to have the deficit debate finalized; and
  3. July 1st  – Not only is this Canada Day, but it is also the end of Quantitative Easing II. 

Notwithstanding the 1% intraday increase in the UUP, which really does nothing more than give us a price from which to reenter on the short side, the calendar events above provide ample opportunity for the global investment community to vote negatively against U.S. fiscal and monetary policy.

 

Longer term, we have grave concern over the federal government to reach any  workable solution on the deficit.  The inability to reach a real  solution means that we are likely faced with more stop gap solutions ahead of the election next fall.   The reality of these stop gap bills, versus real structural reform, is that they are typically more fiction than fact.  As the Washington Post reported late last week, based on analysis from Congressional Budget Office (CBO):

 

“A federal budget compromise that was hailed as historic for proposing to cut about $38 billion would reduce federal spending by only $352 million this fiscal year, less than 1 percent of the bill’s advertised amount, according to the Congressional Budget Office.”

 

Given the wide divergence between President Obama’s budget and the one proposed by Congressman Ryan, it is increasingly unlikely that a real solution is reached before the 2012 elections.  Ratings agency Standard & Poor’s, in an attempt to overcome their status as a lagging indicator, downgraded the outlook for U.S. debt earlier today primarily based on this likely political impasse.  If no compromise on a deficit reduction bill is reached, the outlook is exceedingly ugly for the U.S. deficit.  According to CBO estimates, which are rosy in terms of certain economic assumptions, the United States is on course for more than $8 trillion in deficit spending over the next decade. This is not positive for the U.S. dollar.

 

The other key factor for the U.S. dollar is interest rates, and interest rate expectations.  Globally, interest rates are going up, while domestically it is becoming increasingly likely that the Federal Reserve will not hike rates until the end of the calendar year, if not later into 2012.   The ECB hiked its benchmark rate by 0.25% on April 7th and has signaled its intention to hike further.  Conversely, while the U.S. Federal Reserve may not extend its policy of Quantitative Easing come July 1st, it does seem unlikely that the Federal Reserve will raise rates.  The implication of this is that the New Carry Trade of borrowing lower yielding U.S. dollars and buying higher yielding Euros is set to continue.

 

Our levels on the U.S. dollar are attached below.

 

Daryl G. Jones
Managing Director

 

Shorting Greenbacks - 1


investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

next