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Patient Silence - asset allocation012209

“Silence is a true friend who never betrays”
-Confucius

As was so often the case, Confucius boiled things down to the deep simplicity associated with making sense of this world. At the end of the day, that is the basis for chaos theory – when you have multi-factor models colliding within a dynamic system, simple patterns govern outputs. That’s most certainly an investment thought that I have applied to my global macro model over the course of the years. Sometimes waiting in silence is the best decision you can make.

Unfortunately, for me at least, I have to make some level of noise with this Early Look note, every day. As I was driving up to Boston last night, reflecting upon the short squeeze rally that perpetuated itself into an up +4.4% day for the SP500, I couldn’t stop thinking about how the Street’s narrative would shift from the prior day’s swoon.

The reality is that the rally wasn’t about Obama – it was about the US Financials having a +15% day. Yes, they were up less than they were down the day prior. Yes, at -27% for the year to date, they have still crashed in 2009. But this reminds the Depressionistas out there that bear market bounces can quite often be more powerful than those in bull markets. Our models must always respect that every ticker has both timing and price to consider. Buy low, sell high.

Tim Geithner’s hearing yesterday reminds us that the US Financial system has already been politicized. This is not new, but never underestimate the impact of socialist policy on a capitalist’s mental model. Nationalization and Socialization are bad – by late 1935, the US stock market started to figure this out, and the FDR love-fest ended badly. America crashed again, and you all know the rest of the story…

When we reference FDR, we are referencing a political climate – that’s it. In a situation like the US finds herself today, the only factor that remains is effectively hope. While hope is what we all aspire our children to embody, it is not an investment process. That, of course, does not mean it governs the emotions and minds of many market participants. That, fully loaded, is the only other explanation that I can give you as to why the US Financials can crash -17% one day and recover +16% on the next. Everything has a time and a price. Waiting in silence, is not a process that the market as a whole tends to abide by.

China’s silence in releasing their economic statistics for Q4 has finally ended. Did the numbers rollover sequentially? You bet your Madoff they did! Does anyone legitimately think that the -70% peak to trough decline in the Chinese stock market wasn’t discounting some level of a slowdown? Hopefully not… but again, that doesn’t mean people don’t hope to believe whatever it is that they need to.

China’s GDP for Q4 came in at +6.8% year over year growth, which is down significantly from the double digit growth rate that the bearers of the “I love Chindia” 2007 thesis levered themselves up long with. This was the worst quarterly print in 7 years and implies that China’s GDP ended up being 9% in 2008. Why wasn’t it 8.9 or 9.1 percent? Well, it’s because the Chinese make up numbers, a lot like some Americans did. Get over it.

So why was the Chinese stock market up another +1% on this “news”? If the apocalypse cometh, at 2,004 why is the Shanghai Stock Exchange +10% since December 31st?  These are simple questions, with a simple answer. Stock markets are stealth leading indicators of future events, not trailing ones.

China could conceivably accelerate GDP growth sequentially in Q4. I don’t have to make that call yet – their stock market is doing it for me. No, not everything Asia is China, so don’t straight line that bullish thought across the expanse of the economic region. I am still amazed when I drive into work that the US media says “Asia was up or down XXX” and all they are referencing is what the Nikkei did in Japan. Hello, McFly – watching Japan and not China in 2009 is the equivalent of the horse and buggy whip operators of Britain’s last great century not paying attention to that emerging economic situation called the United States of America.

So far in 2009, I have been short Korea, India, and Japan against my 6% allocation to China (see our Asset Allocation Model at www.researchedgellc.com). Being short Japan has been a thesis I have been aggravating the “value buyer” of Japan with for a year, so I won’t rehash that or the India part of “Chindia” – that joke is getting stale.

In sharp contrast to China, where 2009 GDP will outpace year over year inflation growth, both Korea and India are going to likely see inflation outrun their GDP growth rates in 2009. That’s an economic cocktail that even the bravest of bailout socialistas won’t be able to swallow. The Korean Development Institute said this morning that they think Korean exports are running down something on the order of -30% in the first 20 days of the month. That’s bad!

The nationalization of a capitalistic systems is bad too – but that doesn’t mean they can’t bounce. Ireland, which move to nationalize banks and saw their stock market lose -20% in less than 10 days as a result, is trading up +4.7% overseas this morning for example. Everything has a time and a price. So do patience and silence.

I have taken my US Cash position up to 65%. On balance, that’s definitely not a bullish signal. For the immediate term “Trade”, I see -5% downside to the SP500’s closing price of 840, and +2% up.

Best of luck out there today.

Patient Silence - etfs012209