“Man is free if he needs to obey no person but solely the laws.”
Kant was an 18th century German philosopher who over-weighted the value of real-life experience versus academic theory. Hayek used Kant’s aforementioned quote in “The Road To Serfdom” to support his point that unchecked government planning and the Rule of Law run counter to each other’s objectives.
“By giving the government unlimited powers, the most arbitrary rule can be made legal; and in this way a democracy may set up the most complete despotism imaginable.” (F.A. Hayek, “The Road To Serfdom”, 1944, page 119).
Since professional politicians gave Hank Paulson the TARP “bazooka” and started begging The Bernank for both “shock & awe” rate cuts to zero (2008), then The Quantitative Guessing (2009-2010), we’ve been waking up every morning trying to manage risk around Fiat Laws.
This morning’s speculation as to what the European Union is going to do with Greece’s $110,000,000,000 lifeline of bailout Euros is no different than the perpetual risk management exercise of Gaming Policy that we engage with here in the US. It’s a sad state of the “free” market union.
The good news is that we can measure the Global Macro risks embedded in the next Big Government Intervention mathematically. If the intermediate-term TREND of US Dollar Debauchery is going to change, the currency market is going to signal that to us in real-time.
Last week’s short squeeze in the US Dollar did exactly what we thought it would do if and when it stopped crashing – it started making everything else start to crash. The Bernank calls this “The Price Stability.”
With the US Dollar closing up +2.6% week-over-week (only it’s 5th up week in the last 19 weeks), here’s what The Correlation Risk looked like:
- Euro = DOWN -3.4%
- CRB Commodities Index = DOWN -8.9%
- WTI Crude Oil = DOWN -14.7%
- Gold = DOWN -4.2%
- Copper = DOWN -4.8%
- Volatility (VIX) = UP +24.7%
No, that’s not a typo on the marked-to-market pricing of The Price Volatility associated with The Bernank pandering to the political winds and keeping “hope” for a 3rd round of rule making (QE3) alive.
Now, for myself, The Price Volatility is cool because I’m trying to prove that Big Government Intervention in our markets does nothing but A) shorten economic cycles and B) amplify market volatility.
For our profession and the economy that we live in, it’s not so cool. Last week’s US jobless claims (474,000 – breaking out to the upside) reflect this. So does the weekly Bloomberg consumer confidence survey coming in at minus -46.1. Volatility crushes confidence.
While there is a lot of partisan fanfare about a “bull market in stocks”, I don’t think I have ever seen so much storytelling go alongside a +6.6% YTD return for the SP500 since I started in this business 13 years ago.
Globally, as of Friday’s closing prices, the big “bull market” in equities isn’t especially bullish looking either. Take a look at the Top 3 Global Equity market performers for 2011 YTD:
- Venezuela = +17.6%
- Hungary = +11.2%
- Romania = +10.0%
Go Chavez and the Keynesian Kingdom?
Notwithstanding The Price Volatility that it’s taken us to get to another lower-long-term high in US Equities (down -14.4% versus it’s October 2007 peak), isn’t it interesting that there are only 3 stock markets in the world with double digit returns for the YTD?
Markets aren’t “free” – at least not like they used to be. And being reminded of that last week is why I took up the Cash position in the Hedgeye Asset Allocation Model on the Bin Laden news. Here are my current asset allocations and positions:
- Cash = 43% (versus 34% last Monday)
- International Currencies = 24% (Chinese Yuan and British Pounds – CYB and FXB)
- Commodities = 12% (Gold and Oil – GLD and OIL)
- Fixed Income = 9% ( US Treasury Flattener – FLAT)
- International Equities = 6% (China – CAF)
- US Equities = 6% (Technology – XLK)
As a reminder, the way I think about asset allocation is the way I think about my own net worth. I’m not saying that’s a perfect methodology for everyone else – I’m just saying it’s the only one I can hold myself accountable to. So after a +98.2% two-year rally in US stocks (where we got bullish in 2009), it shouldn’t be a surprise to see me wait and watch for my spots to get invested again.
We made a call in April of 2010 called “May Showers” that saw The Price Volatility index (VIX) shoot up to 45 by June. Looking ahead at the US political calendar of deficit and debt ceiling debates this June, I’m not especially hurried to be levering myself up alongside my least favorite Fiat Fools either. I’d rather obey my own risk management laws.
My immediate-term support and resistance line for Gold are $1485 and $1521, respectively. Immediate-term support and resistance for oil are $98.63 and $109.11, and my immediate-term support and resistance lines for the SP500 are now 1333 and 1351, respectively.
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on May 04, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“We are willing to accept almost any explanation of the present crisis of our civilization except one.”
That’s an important quote from page 65 of a chapter that Hayek wrote in “The Road To Serfdom” titled, “The Abandoned Road.” As I take a step back and think about what a tremendous opportunity our profession has had to learn about real-time risk management and the interconnectedness of Global Macro markets in the last 3 years, it’s somewhat sad to realize that consensus hasn’t been paid to learn much.
What we get paid to do is chase short-term returns. The Bernank perpetuates this performance pressure by marking the short-term “risk free” rate to model (or the ZERO bound) and, as a result, this gargantuan experiment of starving savers of returns imputes 3D Risk (3 D’s) into markets:
- The Dare – zero percent rates dare you to chase yield across asset classes where you can justify it
- The Delay – zero percent short-term financing for banks delays the financial restructurings that free market prices would impose
- The Disguise – zero percent expectations disguise the interconnected risks associated with carry trading, correlation risk, etc
The Disguise is the one that can really nip a perma-bull in the butt. That’s the one that, allegedly, “no one can see coming.” That’s the one that is being revealed real-time. In terms of making excuses for being willfully blind to it, this time is different because we have a modern day technological innovation in financial market transparency – it’s called Twitter.
Going back to Hayek’s aforementioned point, I think that’s the one thing our professional politicians do not get paid to understand. That would be called accountability. The Disguise in financial markets is The Correlation Risk – and while his original text was addressing a different kind of socialism and Big Government Intervention in 1944, I still think what Hayek goes on to say about explaining our perpetual financial “crisis” is very appropriate:
“… that the present state of the world may be the result of genuine error on our own part… and that the pursuit of some of our most cherished ideals has apparently produced results utterly different from those which we expected.”
With another 78 Billion Bailout Euros being extended to the government of Portugal this morning, Spain seeing unemployment spike to 21.3% (new all-time highs), and Americans staring down $5/gas at the pump with jobless claims re-accelerating, wasn’t that some advice our “independent central bankers” and fiscal spenders should have considered?
Independent research? Should we just never mind silly old school things like the American Constitution or what John Locke wrote On Liberty 80 years before Hayek penned his original counter-points to Keynes? Just buy-the-damn-dips, chase yield, and believe that it’s going to end well this time?
Back to The Correlation Risk and playing the game that’s in front of you…
Given that the US Dollar is the #1 factor we are talking about when we say Global Macro Correlation Risk (say it central planners -“who –ho-wns de Campaigner-in-Chief?”), let’s get a real-time price check on how that looks on our intermediate-term TREND duration (3 months or more):
- Crude Oil = -0.92
- Gold = 0.94
- Silver = -0.94
- Coffee = -0.84
- Pork Bellies = -0.92
- CRB Commodities Index = -0.87
I know, I know – The Bernank calls this commodity stuff that you put in your cars, stomachs, and teeth “transitory”…
How about the intermediate-term TREND inverse-correlations between the US Dollar Index and relatively larger matters like countries?
- USA (SP500) = -0.82
- Brazil = -0.88
- Mexico = -0.82
- Germany = -0.93
- Spain = 0.94
- Russia = -0.85
- China -0.85
- South Korea = -0.90
- Australia = -0.91
How about the obvious, the intermediate-term TREND inverse correlations between the USD spot price and the world’s currencies?
- Euro = -0.99 (not a typo)
- Swiss Franc = -0.96
- British Pounds = -0.95
- Chinese Yuan = -0.92
- Japanese Yen = -0.87
- Singapore Dollar = -0.96
- Aussi Dollar = -0.94
- Brazil’s Real = -0.92
- Canadian Dollar = -0.85
Really? Yes, President Obama – really. This Correlation Risk math checks out from Hawaii to Havana. We get it. Anyone gaming Geithner and The Bernank get it. The Chinese get it.
In the Peoples Bank of China’s Q1 Monetary Policy Statement last night (published on China’s website – not to be politically pandered to on 60 Minutes this Sunday or at a US Federal Reserve Presser), this is what the Chinese had to say about all of the aforementioned real-time prices:
“Stabilizing prices and managing inflation expectations are critical… given the loose monetary policies of major economies and gradual recovery of the global economy, commodity prices and global inflation expectations are rising significantly.”
“Significantly” versus “transitory.” Academic dogma versus independent analysis. Government storytelling versus Correlation Risk. It’s all out there folks. It always has been – and, sadly, when it comes to US policy, so has Hayek’s “Abandoned Road.”
My immediate-term support and resistance lines for Gold are now 1525 and 1565, respectively. For oil I’m at $109.39 and $114.21 – and for the SP500, my immediate-term support and resistance lines are now 1349 and 1373, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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MCD will announce sales numbers for April on Monday, May 9th, before the market open. On the 1Q11 conference call, management indicated April comps were healthy, running at or above the +4.2% rate seen in 1Q11. Therefore, how the different regions of the world performed will be the focus on Monday.
There was a slight calendar shift between the number of weekdays and weekend days in April 2011 versus April 2010. April 2011 had one additional Saturday, and one less Thursday, than April 2010. Easter 2010 and Easter 2011 both fell in April. I would expect a slight, positive calendar shift in April 2011’s result due to the extra Saturday.
For the U.S., March comparable restaurant sales came in above my expectations, and those of the Street, at 3%. I have b I have been bearish on the stock since December and released a Black Book to that effect in January. While March was certainly a blow to my thesis, it by no means has led me to capitulate in my view that 2011 is proving to be a difficult year for the U.S. business overall. I believe that comps will slow during the year due to a declining core business. In addition, a complicated menu borne of management’s aim to offset the decline in the core menu with new menu items, it proving a hindrance for operators seeking to operate efficiently at this time with commodity costs so elevated.
Below I go through my take on what numbers will be received by investors as GOOD, BAD, and NEUTRAL, for MCD comps by region. For comparison purposes, I have adjusted for calendar and trading day impacts.
U.S. - Facing a +3.15% compare (including a calendar shift which impacted results by +0.4% to +0.9%, varying by area of the world):
GOOD: A print above 4% would be received as a good result, implying two-year average trends that were roughly level with those in March. The comparable restaurant sales growth in March, on a calendar-adjusted basis, implied a sequential acceleration in two-year trends of roughly 200 basis points. While I remain bearish on the prospects of MCD “comping the comps” through the summer months when the compares significantly step up in difficulty, I think that April will likely be a stable month for MCD given the easier compare versus March and the strong performance management spoke to during the earnings call. The Bloomberg Consumer Comfort Index trended positive overall during April, albeit peaking mid month and declining thereafter. The decline has continued in May but it is likely, in my view, that April will be a solid month for MCD.
NEUTRAL: A print between 3% and 4% would imply two-year average trends slightly below those seen in March. However, I think it is unlikely that the two-year trend remains quite as robust as it did in the final month of 1Q. While the mid-point of this range is below consensus, it would still be a healthy result for MCD and imply a two-year trend far in excess of the level seen during the malaise of December/January/February.
BAD: A print below 3% would not be received well by the Street as it would imply a sequential deceleration in two-year average trends. In addition, it would likely dampen investor sentiment given that concerns are arising around the pricing strategy that will be required to overcome inflation. If the core business is not robust, it could be perceived that a price increase will adversely impact traffic, which of course is the lifeblood of MCD’s comps.
Europe:- Facing a difficult +5.30% compare (including a calendar shift which impacted results by +0.4% to +0.9%, varying by area of the world):
GOOD: A comparable restaurant sales number of 6% or higher would be received well by the Street as it would represent a sequential acceleration in two-year trends. While this acceleration would be meager, I believe that with the austerity measures being implemented in Europe, MCD maintaining the ~5%+ two-year average trends that have been the norm in 2011 would be a positive. In spite of the austerity measures and cloud uncertainty that remains over Europe’s political/fiscal future, MCD has been performing well in Europe this year and the recent Euro strength may also support confidence somewhat.
NEUTRAL: Between 5% and 6% would imply two-year average trends slightly below those seen in March. While a deceleration is never what investors are hoping for, I think a slight slowdown (~20 basis points) in this case would not raise too many concerns and two-year trends would remain above 5% and well above the trends seen in November and December in Europe.
BAD: Below 5% would imply a significant sequential slowdown in two-year average trends.
APMEA:- Facing a difficult +10.1% compare (including a calendar shift which impacted results by +0.4% to +0.9%, varying by area of the world):
GOOD: Above 2.5% would imply a sequential acceleration in two-year average trends. Inflation has been a concern for consumers in many Asian countries, and countries around the globe for that matter, and I believe an improvement in two-year trends would be received positively.
NEUTRAL: Between 1.5% and 2.5% would imply two-year average trends slightly higher than those seen in March but still well below the average two-year comp over the last 6, 12, or 24 months.
BAD: Below 1.5% would imply two-year average trends roughly in line with, or below, those seen in March which would raise concerns that last month’s poor result could be the start of a longer trend.
Conclusion: Below we flag the potential for a drastic change in the direction of fiscal policy within Singapore. Further, expect the confluence of political consternation, social unrest, and accelerating inflation to weigh on Thai equities over the intermediate-term TREND.
Historic Change on the Way for Singapore?
On April 21, we published a report titled, “Read-Throughs From Singapore’s Upcoming Election”, which outlined the stakes for Singapore’s parliamentary election, currently taking place now through 8:00pm SGT tomorrow night. The largest takeaway was that Singapore is potentially looking at a major inflection point with regard to the direction of fiscal policy, and as such, we expected the ruling People’s Action Party to continue to give in to more populist demands as they try to protect their party’s 52-year stranglehold on the Singaporean government.
Such measures have included spending $6.6B on cash handouts to citizens as a “growth dividend”, upgrading residential real estate, and increasing federal mandates for corporate pension fund contributions. Prime Minister Lee Hsien Loong has even gone as far as to officially apologize for Singapore’s exorbitant and often unavailable housing, promising additional attention to this issue if re-elected.
Judging by the tone on the streets of Singapore and the recent move in the equity market (suddenly broken from a TRADE & TREND perspective), re-election for Loong and his PAP counterparts is as questionable as it has seemingly been in decades. While that is not to say they won’t win with a majority of the ballots once again, we could see a measured reduction in their party’s current 87 parliamentary seats (out of 94 total) due to a record 82 challenges being mounted by opposing lawmakers including members of the growing Worker’s Party and the Singapore Democratic Party.
The strength in the opposition is being driven by a growing discontent among the Singaporean electorate stemming from rising consumer inflation, overcrowding, a general perception that jobs are increasingly harder to come by as a result of the government’s lax immigration policies, as well as a general distaste for what many describe as a “sense of complacency” out of the current government – well deserved complacency we might add.
Singapore’s GDP has grown 41x and its GDP per Capita has growth 45.7x since the PAP took over five-plus decades ago. Even still, there’s a growing sense among Singapore’s youth that the current party in office is out of tune with their interests. To their credit, Singapore’s GINI Coefficient, a measure of income inequality has actually risen over the last decade from 0.44 to 0.48, meaning that Singapore’s world-beating growth rates have yet to fully filter down though the social ranks. Unfortunately for the incumbent party, Singapore’s “rising tide” hasn’t lifted all boats; instead it’s buoyed the yachts of the world’s highest per capita share of millionaires. As such, it doesn’t come as a conceptual surprise to see quotes like these from the Singaporean voters (Source: Bloomberg.com):
- “They keep telling us how they built Singapore… They are really very complacent.” - Alvin Lee, a 25-year-old economics and finance student at Singapore Institute of Management who plans to vote for the opposition.
- “It’s very pressurizing living in Singapore... Everything is so expensive. The government says the economy is doing well but why am I not feeling it?” - housewife Low Bee Kian, 39, who has three children aged 10 to 16.
- “The PAP has served us well over the many years but it’s gotten too high and mighty… I think it’s about time we had more opposition voices.” - Yeo Pei Ming, 56, a vegetable merchant and resident of Aljunied.
With a record number of opposition candidates and a record number of eligible voters (2.21M) – many of whom have grown tired of the status quo – we could potentially see the a major political change take place this weekend in Singapore. Though it is unlikely the PAP will lose their majority in parliament, we could see electoral support for their party erode meaningfully enough to have a measured impact on the direction of fiscal policy in Singapore. Should this outcome occur, we would expect an acceleration in populist legislation (likely bullish for Singaporean consumer names and bearish for Singaporean property developers). We will continue to monitor for such changes, if any, real-time.
Social Unrest on the Horizon in Thailand?
Today, Thai Prime Minister Abhisit Vejjajiva dissolved parliament with the intention of paving the way for an election that may take place anytime within 45-60 days from now (July 26 – June 3). Vejjajiva and his ruling Democrat Party counterparts are looking to win their first popular mandate since 1992, after having been swept into power during the 2007 elections after the former prime minister Thaksin Shinawatra was overthrown in a military coup in 2006 and remains outside of the country avoiding a 2008 prison sentence for the abuse of power.
Now, Shinawatra’s Puea Thai party is “back with a vengeance” and they fully intend to use their widespread popularity – particularly among Thai’s poorer voters – to regain control of the Thai parliament by winning the popular vote as they have done in the previous four elections. If the upcoming election is as emotionally charged and politically polarizing as the 2007 election (which we fully expect), we should continue to see major consternation hang over Thai assets. Since peaking on April 21, Thailand’s SET Index is down in a straight line and is now quantitatively broken from a TRADE perspective. A breakdown through the TREND line would be an ominous leading indicator for the short-term stability of the Thai political economy.
The bear case here would be a return to the style of violent and deadly protests we saw grip the streets of Bangkok roughly one year ago. Careful analysis of the situation reveals that protests of this magnitude (nearly 100 deaths) are actually a probable scenario and that they could potentially exceed last year’s riots in both scope and breadth of violence. The results of recent polls conducted by both of the main opposition parties have each expecting to win a majority of the 500 open seats in the Thai House of Representatives. Even Vejjajiva’s own campaign coordinator concludes that “it’s a very tight race”, saying recently, “One time we are down; one time we are up. We can’t tell.”
The largest takeaway from this polling gridlock is twofold: 1) the Thai electorate is torn and supporters of the Puea Thai (red-shirts) are indeed mobilized; and 2) supporters of either party will be both heartbroken and outraged by what is likely to be a close defeat. Should the Democrats (yellow-shirts) manage to win, we expect the red-shirts to once again take to the streets in protest. On the flip side, should the red-shirts win, we are likely to see a second coup – either military or judicial – as both the armed forces and political elite of Thailand continue to strongly back the current ruling coalition. Such an occurrence is highly likely to result in a second round of protests as red-shirts take to the streets in outrage.
The net result of it all is that we fully expect social instability to increase dramatically within Thailand in the coming months as a result of this election. As a result, we do expect the politicized consternation to hang over the Thai equity market, which augments our current bearish thesis on Thai equities – a thesis supported by slowing economic growth and accelerating inflation.
Perhaps the most tell-tale sign that we’re right on both accounts is the fact that Vejjajiva dissolved parliament a full seven months ahead of schedule, citing a desire to “move the country forward”. On the contrary, we think this is a “CYA” move in an attempt to get ahead of higher rates of inflation on the horizon, which may incrementally sway Thailand’s pooer voters into the arms of the populist Puea Thai party. He’s repeatedly affirmed his official policy priority, which is to “help put money in people’s pockets so that they can cope with rising prices”.
Vejjajiva has certainly put his money where his mouth his and has taken to “buying votes” in the process, recently increasing the minimum wage and pledging a further +25% increase over two years, increasing civil-servant salaries, implementing price controls, extending food and fuel subsidies, offering low-interest loans to taxi drivers, offering low-income energy cost exemptions, and extending social-security coverage for undocumented workers.
While these populist measures are likely to help buy him a number of votes in the upcoming election, we believe the net result of these measures is higher rates of inflation through an increase in aggregate demand by adding cash to the economy. In addition, the anticipated removal of State subsidies on diesel is predicted by the Bank of Thailand to add +100bps to the YoY growth rate of Headline CPI and +50bps to the YoY growth rate of Core CPI (currently at 15 and 30-month highs, respectively). It’ll be interesting to see whether or not the government chooses to continue to subsidize fuel and energy costs by allowing the oil fund to swing into deficit come July. Regardless of whether or not the subsidy is removed, we still foresee Thai inflation up and to the right, and remain positively disposed to the baht on expectations of tighter monetary policy. The direction of fiscal policy (populist), keeps us from being outright bullish on the currency.
All told, we continue to flag the potential for a drastic change in the direction of fiscal policy within Singapore. Further, expect the confluence of political consternation, social unrest, and accelerating inflation to weigh on Thai equities over the intermediate-term TREND.
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