Kangaroo Markets

This note was originally published at 8am on May 12, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“I’ve worked with dogs before and they’ll sit and they’ll roll over.  With kangaroos, you say sit and they start boxing with you, they’re nuts.”

-Jerry O’Connell


Keith is out on some family business today, but I think he would, after the last 24+ hours of global market trading, agree with the titled of this note: Kangaroo Markets.  As creative as I can be at times, I have to give credit for the origin of the title to its rightful owners, the Aussies. 


In another capital markets sign of the topping of the global economic cycle, it seems Kangaroo Bond sales surged to a record A$37.3 billion last year and are on track to nearly match that total this year.  As a prominent Australian fixed income manager recently said to the financial press, “I expect more financial kangaroo sales.”  Indeed, and we expect more kangaroo markets, which is to say markets that are “nuts”.  Now, of course, markets can’t really be nuts, but Centrally Planned Price Volatility can certainly make those of us who trade them nuts.


Yesterday’s market action likely didn’t reward many.  The dollar index rallied hard, so commodities were taken out to the woodshed and U.S. equities were down -1% or so with the small cap Russell 2000 leading the way to the downside at -1.8%.  The pundits are calling this the “risk off” trade.  I’m not sure risk is really ever off, but it is a convenient way of explaining that many investors got caught leaning way too hard into consensus.  Or, perhaps, all the Hedgies at the SALT conference just aren’t trading this week…


The other important event yesterday related to the investment management industry was that Raj Rajaratnam, head of Galleon Management, was found guilty on all 14 counts of fraud and conspiracy.  Personally, I don’t have a lot of knowledge about the case, but I can tell you this, Raj’s lawyer certainly thought he was in a Kangaroo Court as he announced immediately after the verdict that they intended to appeal to the Second Circuit.


To the extent that this was actually a catalyst for the market yesterday, there is another catalyst in the pipeline on this front, which is the trial of Zvi Goffer, more commonly known in technology insider trading circles as Octopussy, who according to the accusations and this chart from the WSJ ( was purportedly in the middle of a web of inside information.  Personally, I just think he had a terrible nickname.


The bigger question, of course, is what does this all mean for the investment management industry?  Luckily, despite the headlines, most actors in the investment management industry are ethical and have legal processes, so the prevalence of cheating is likely much less than the headlines would currently suggest. 


In an unusual move, before we even had paying clients at Hedgeye we brought on board our compliance officer, Rabbi Moshe Silver, a Wall Street veteran of over 25 years.  Prior to joining Hedgeye, Moshe worked with Keith at the Carlyle-Blue Wave hedge fund, where he was director of compliance.  When Moshe came on board he recommended we introduce ourselves and our unique business model to our regulators – another unusual move, but in this day and age of increased scrutiny, we thought it was appropriate. 


Moshe’s contributions have expanded to sharing his unique – and occasionally hilarious – insights into the world of regulation, un-regulation, and the shadowy places where Wall Street and the Real World meet.  His thoughts appear in a weekly column that is a must-read for many of our clients.  Needless to say, Moshe hasn’t been effective at limiting our use of hockey references, but we’re glad he’s got our back as he oversees our research and communications to ensure that compliance always comes first.


If there is any potential market impact of more insider trading trials and investigations, it is perhaps to accelerate Centrally Planned Price Volatility.  We've highlighted this last point in the chart below.   Over the course of the past decade when interests rates have been taken to abnormally low levels, such as in the 2002 – 2003 period and in the 2008 – current period, price volatility increases, as emphasized by the VIX stepping up to a new level.


In theory, this makes sense.  Aside from attempting to artificial co-opt the natural business cycle, the other impact of our Central Planners taking interest rates to abnormal levels for extended periods is to force investors to speculatively chase return.  Practically, what does that mean? As an example, it means bidding oil up into the $100+ level when global growth is slowing and global oil inventory is building.  This works, of course, until it doesn’t and then the trade gets unwound, as we are seeing again this morning with the commodity complex down across the board and silver leading the way, down a cool -8.5%.  (But wait, silver’s an industrial metal! Or is it?)


Underscoring the heightened commodity and equity market volatility we are seeing is currency volatility.  This is a function of both the Central Planners at the Federal Reserve, but also the Fiat Fools in Washington, who are currently playing politics with the fiscal future of the United States on the debt ceiling debate.  For a comprehensive review of our thoughts on the debt ceiling debate, please see the note written by my colleague Darius Dale yesterday, titled “Fear Mongering Meets Brinksmanship: A Comprehensive Guide to Navigating the Debt Ceiling Debate.”


Be it the moniker Octupussy, or the Fiat Fools in Washington, some days all of this just seems a little childish, so with that we’ll end with a nursery rhyme:


“Jump, jump, jump goes the big Kangaroo,

I thought there was one, but I see there are two.”




Keep your head up and stick on the ice,


Daryl G. Jones

Managing Director


Kangaroo Markets - Chart of the Day


Kangaroo Markets - Virtual Portfolio


TODAY’S S&P 500 SET-UP - May 17 2011


As we look at today’s set up for the S&P 500, the range is 9 points or -0.19% downside to 1327 and 0.49% upside to 1336.





THE HEDGEYE DAILY OUTLOOK - daily sector view





  • ADVANCE/DECLINE LINE: -1607 (+252)  
  • VOLUME: NYSE 907.30 (+0.99%)
  • VIX:  18.24 +6.85% YTD PERFORMANCE: +2.76%
  • SPX PUT/CALL RATIO: 1.88 from 1.81 (+3.76%)



  • TED SPREAD: 24.02
  • 3-MONTH T-BILL YIELD: 0.04% +0.01%
  • 10-Year: 3.15 from 3.18
  • YIELD CURVE: 2.61 from 2.61 



  • 8:30 a.m.: Housing starts, est. 569k, up 3.6%; prior 549k, up 0.8%
  • 8:30 a.m.: Building permits, est. 590k, up 0.9%, prior 594k, up 11.2%
  • 9:15 a.m.: Industrial production, up 0.4%, prior up 0.8%
  • 9:15 a.m.: Capacity utilization, est. 77.6%, prior 77.4%
  • 11:30 a.m.: U.S. to sell $28b in 4-week bills
  • 4:30 p.m.: API inventories  


  • WSJ notes that Department of Justice is stepping up its merger opposition
  • Luxembourg PM Jean-Claude Juncker raises issue of 'reprofiling' of Greek debt for first time - Bloomberg
  • Goldman, BofA and Morgan Stanley to meet with N.Y. Attorney General Eric Schneiderman as part of an investigation into mortgage securitization
  • Greece may delay payments under EU proposal to extend $156 bailout
  • International finance ministers discuss IMF managing director successorship after Strauss-Kahn arrest



THE HEDGEYE DAILY OUTLOOK - daily commodity view



  • Global Food Prices Extending Gains Set to Raise Costs for Tyson, Kellogg
  • Crude Recovers in New York as European Ministers Endorse Aid to Portugal
  • Copper Rises for Fourth Day Before U.S. Housing-Starts, Production Reports
  • Gold Climbs as Physical Purchases, European Debt Concern Increase Demand
  • Corn Advances for Fourth Day as Wet Weather Delays Spring Planting in U.S.
  • Sugar Rises for Fourth Day on Speculation Surplus May Shrink; Coffee Gains
  • Wheat Damage Claims on Dry Weather May Signal Worse Harvest Than Forecast
  • Mississippi River Diversion Greatly Reduces Threat to Cities, Refineries
  • Cotton Moving Average Signals 21% Drop, Infinity Says: Technical Analysis
  • Soros Sheds Gold ETPs as Paulson Keeps Bet on Bullion Extending Record Run
  • Xstrata Record Profit Seen as Coal Cargoes Gain Amid Rout: Freight Markets
  • Petrobras Yield Gap Over Sovereign Debt Is a Buy Indication: Brazil Credit
  • Fonterra’s New Zealand Milk Production May Reach Record After Mild Autumn
  • Australia Canola Output May Reach Decade High, Matching Record, Group Says




THE HEDGEYE DAILY OUTLOOK - daily currency view



  • European equity markets trade mixed to lower
  • Germany May ZEW 91.5 vs consensus 87.5 and prior 87.1; Germany May ZEW economic sentiment +3.1 vs consensus +5.0 and prior +7.6
  • UK Apr RPI +5.2% y/y vs consensus +5.2% and prior +5.3%; UK Apr RPI +0.8% m/m vs consensus +0.8% and prior +0.5%
  • UK Apr CPI +4.5% y/y vs consensus +4.2% and prior +4.0%; UK Apr CPI +1.0% m/m vs consensus +0.7% and prior +0.3%





  • Thailand was closed for Visakha Bucha Day
  • Singapore was closed for Vesak Day
  • Indonesia was closed for Waisak.
  • Asian markets were mixed to unchanged on the day.








Howard Penney

Managing Director

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Whys and Wherefores

“Faith is an island in the setting sun, but proof is the bottom line for everyone.”

-Paul Simon


My wife Laura and I had a wonderful time at a fundraiser in Greenwich, CT last night. Our good friends were raising money for The Bowery Mission. Founded by Albert Gleason Ruliffson in 1879, it was one of the first missions established for the homeless in America.


The United States of America is one of the most generous lands that our world has ever known. If you give Americans an opportunity to give, they often will. If you give them a chance to lead, many of them do so by example. There is a faith in this country that cannot be centrally planned out of our hearts.


Faith, accountability, and trust. While these principles may not always resonate intuitively with being “bearish” about a market price, there’s an important investment point to be made here. You have to be able to separate your patriotism, religion, and confirmation biases from the daily risk management discipline that will separate you from the flock. You either have faith in your process, or you don’t.


In his morning tweet, the Dalai Lama complimented this point by reminding us that, “reliable and genuine discipline comes not from repression, but from an understanding of all the whys and wherefores of our actions.”


The Whys and Wherefores of what gets you to buy, sell, and hold; the Whys and Wherefores of what gets you to trust, love, and give; the Whys and Wherefores of what it is that gets you out of bed every morning to do what it is that you do…


It’s all there.


No matter what we do in this profession. No matter where we go in this life. The answers to these questions define and shape not only our individual character, but our collective culture.


Back to the Global Macro Grind


Having authored the Global Macro theme of Growth Slowing As Inflation Accelerates, I know exactly why it is that I have been taking down my gross exposure and tightening my net exposure (longs minus shorts) for the last 3 weeks.


Last week I sold all of our Oil. This week I sold all of our Gold. We now have a zero percent allocation to Commodities in the Hedgeye Asset Allocation Model.


We’ve written and talked about the similarities between the US Currency Crashing to lower-lows in Q2 of 2008 and 2011 for enough time now that you know that I will not move away from my risk management discipline of respecting The Correlation Risk between US Dollars and everything that’s highly correlated to them.


If you are a Risk Manager, the month of May has reminded you of the following realities associated with a US Dollar arresting its decline (USD Index TRADE line of $74.41 resistance is now immediate-term support – do not be short the USD here):

  1. Stocks stop going up
  2. Commodities stop going up
  3. US Treasuries stop going down

For us, this is good. In terms of how I am positioned in May, that is.

  1. US and International Equity Exposure = 9%
  2. Commodities Exposure = 0%
  3. US Treasury Exposure = 15%

The Whys and Wherefores as to what got me into these positions are reconciled every day with the same repeatable mechanism that got us to make our US crash call of 2008 and the “May Showers” correction call that we made in April of 2010. Whether I am grumpy or glad, our research and risk management process stays the course.


Are the inverse correlations associated with US Dollar moves going to hold forever? Of course not – correlation risk is never perpetual. Could they matter for far longer than the biggest net long position in hedge fund history can be rationally unwound? Mr. Macro Market is going to have to tell us the answer to that – and, in the meantime, I have plenty of time to buy things back.


Why and Wherefore should I have faith in this process?


Because when it works for me, I know why – and when it doesn’t, I understand wherefore I should evolve it.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1, $93.67-$100.12, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Whys and Wherefores - Chart of the Day


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Time to Press?: Revisiting Japan from a Secular Perspective

Conclusion: The fierce grip of sovereign debt on Japan’s Jugular just got a little bit tighter. Below we explore the limited options Japan has to keep its government functioning and economy afloat in this fiscal year and beyond. Further, we use Japan's current situation as an example to highlight some of the many perils of ZIRP.


Position: Still bearish on Japanese equities for the intermediate-term TREND and long-term TAIL. Bullish on the Japanese yen for the intermediate-term TREND as our Q2 Macro Theme of Deflating the Inflation continues to percolate in the global marketplace.


Much like the US, Japan remains in a state of unmitigated disaster from a political leadership standpoint. Just two months following the greatest natural disasters in the country’s history Japanese bureaucrats have regressed to their longstanding ways of finger pointing and fear mongering on the job. Both opposition-led as well as internal calls for the resignation of current prime minister Naoto Kan have trumped the desire to pass financing legislation for the recently enacted ¥92.4T FY11 budget (which began on April 1st, 2011).


Net of the world’s second-finest political posturing (you know which country is in first place), the Diet essentially has two feasible options to finance the current budget: raise taxes or Pile [more] Debt Upon Debt – especially considering the recently enacted ¥4T supplementary relief budget is being financed in part by ¥1.5T in savings from just about all the cuts the DPJ was willing to stomach from the FY11 budget (additional packages summing ~¥21T will have to be financed with additional debt sales, however).


On the debt issue, the LDP continues to stand behind its refusal to approve legislation to sell the necessary amount of bonds which would stand to cover roughly 48% of the ¥92.4T FY11 budget. With GDP growth likely to come in quite soft for the first 1-2 quarters of FY11 due to the impact from the recent crises, it’s likely that Japan will be forced to issue additional deficit financing bonds along the way as tax receipts trail initial projections of ¥40.9T.


To this point, the BOJ has recently downgraded its domestic GDP forecast (-100bps) to 0.6% for the fiscal year ending March 31, 2012 due to the prolonged impact of supply constraints resulting from the disasters. Even without factoring in any mid-year supplementary JGB issuance, Japan is likely to finish FY11 with its Debt/GDP ratio at a whopping 212.4% – far and away the highest in the developed world and well past the Rubicon of 90% whereby sovereign debt burdens begin to structurally impair economic growth. As we have shown throughout our long-term work on Japan via our Japan’s Jugular thesis, the JGB market is setup to endure a major supply/demand imbalance as the population continues to age aggressively causing the Household Savings Rate to turn negative over the next decade or so. Furthermore, Japanese pension funds will have a hard time meeting the coming wall of payouts so long as they continue to devote a large percentage of their assets to low-yielding JGBs (another way ZIRP hurts economies in the long run).


Time to Press?: Revisiting Japan from a Secular Perspective - 1


On increasing taxes, Kan is considering raising the national consumption tax from 5% to 8% for three years starting in 2012, though his party maintains a reluctant stance considering the last consumption tax hike back in 1997 sent the economy into a recession. The LDP along with both the Economy and Fiscal Policy Minister (Kaoru Yosano) and the Financial Services Minister (Hakuo Yanagisawa) don’t think a +300bps hike is enough, calling for an increase to beyond 10% (more than double the current rate).


 As recently as last month, 38% of Japanese voters approved of higher taxes to finance the rebuilding effort, according to the Nikkei newspaper. It remains to be seen whether or not they approve of structurally higher tax rates to finance deficits that now appear locked in above 10% of GDP in perpetuity (10.7% in FY11) as Japan’s ageing population commands more and more public spending on welfare in the coming years.


Time to Press?: Revisiting Japan from a Secular Perspective - 2


We do, however, have clarity on the impact of higher taxes in Japan – depressed growth rates. With all the emphasis on Japan’s Export and Manufacturing numbers, it’s easy to forget that Private Consumption accounts for 57% of GDP on the island economy (vs. 5% for Net Exports). Given this setup, it isn’t a stretch to say that, over the long-term TAIL, as the Japanese consumer goes so goes Japan. With Overall Household Spending trending negative on a YoY basis since October (coincidentally when we introduced our Japan’s Jugular thesis), we remain skeptical of the ability of the Japanese consumer to absorb higher prices after ten-plus years of deflation and stagnant wage growth.


Time to Press?: Revisiting Japan from a Secular Perspective - 3


Time to Press?: Revisiting Japan from a Secular Perspective - 4


As such, we remain bearish on the long-term TAIL of Japanese economic growth as the confluence of Japan’s suffocating sovereign debt burden or higher taxes depress consumption and limit investment for the foreseeable future. For this reason, we remain bearish on Japanese equities for the long-term TAIL. Reconstruction garbage aside, earnings forecasts for FY12 and beyond will prove much too high given Japan’s long-term growth potential (or lack thereof). To the former point, we remain disheartened by some of the actors within our industry when we come across data points like these: 

  • According to the latest Bloomberg Global Poll, 15% of Global Investors said Japan gave investor the best opportunity among global equity markets over the next 12 months in May, up from 8% in January. Incidentally, 15% was the highest reading in seven such polls dating back to October 2009.
  • Supporting this uptick in sentiment is the belief that Japan experiences an uptick in economic growth in the wake of the recent crises: “The Japanese equity market is largely discounting the reconstruction story… We expect the Japanese economy to have an uptick in activity within the next six to 12 months as reconstruction spending rises.” – Manoj Wanzare Senior PM at Plato Investment Management in Sydney, Australia. 

As we continue to maintain, REPLACING what was LOST due to EARTHQUAKES, TSUNAMIS, and a pending NUCLEAR MELTDOWN certainly doesn’t fall within our definition of ECONOMIC GROWTH. At the bare minimum, it’s not the kind of economic growth we think rational investors would be willing to pay for. The Japanese agree, with Consumer Confidence plunging 5.5 points in April to a two-year low of 33.1. We contend the current batch of bullish bets on Japanese equities are nothing more than another manifestation of The Bernank’s Dare to Chase Yield by marking the risk-free RoR to model via ZIRP. It’s amazing to see the kind of storytelling investors come up with when they are forced to chase returns due to their inability to earn a competitive yield on sensible investments.


Time to Press?: Revisiting Japan from a Secular Perspective - 5


Perhaps they are bullish on Japanese stocks for another reason – additional easing out of the BOJ. As we have seen throughout Japan’s history and even with the US’s own recent history of QE1 and QE2, central bank easing has a powerful way of inflating asset prices, particularly those of the stock market. It would seem that international investors are positioning themselves to take advantage of any potential easing of financial conditions made possible by the BOJ reacting to what are likely to be incredibly depressed economic growth rates over the intermediate-term. In the two weeks following the initial temblor, the BOJ added ¥40T of additional liquidity to the financial system and it certainly wouldn’t be a stretch to see them go at it again, given their long history of being Indefinitely Dovish.


Not so fast, we contend. BOJ governor Masaaki Shirakawa has repeatedly rejected desperate pleas for additional easing from his own board members, Japanese bureaucrats, and Japanese investors alike. Citing academic doctrines taught to him by Milton Friedman himself, Shirakawa has become increasingly concerned with the propensity of Japan’s repeated monetary accommodation to spur rampant inflation and fuel asset bubbles (we are too). As such, he’s overseen a (-10%) reduction in the size of the BOJ’s balance sheet since the March 11 earthquake as well as rejecting political calls for outright JGB monetization, saying Japan’s current slowdown is attributable to supply-side pressures – something that Shirakawa contends cannot be remedied by additional easing.


In late March, the now marginally hawkish Shirakawa had this to say about embarking on a large scale effort to underwrite JGB issuance on the primary market:


“If a central bank starts to underwrite government bonds, there may be no problems at first, but it would lead to a limitless expansion of currency issuance, spur sharp inflation and yield a big blow to people’s lives and the economy, as has happened in the past.”


To his point, in the last round of outright JGB monetization which occurred during the Great Depression era, Japan’s CPI and PPI eventually peaked at YoY growth rates north of +40% and Real GDP growth slowed sequentially for nearly 15 years. We believe Shirakawa is correct in highlighting this risk to further dovishness out of the BOJ. The last thing the Japanese government wants to deal with is a structural re-pricing of JGB yields (higher). Currently, Debt Service eats up 44.8% of Japan’s combined Tax and Fee Revenue.


Time to Press?: Revisiting Japan from a Secular Perspective - 6


Time to Press?: Revisiting Japan from a Secular Perspective - 7


As such, Shirakawa has been surprisingly hawkish on the margin in recent weeks, likely augmenting recent gains in the yen (up +5.9% since it bottomed on April 6). As the yen strengthens, we expect more carry trades to be forcefully unwound, potentially driving up the USD which would support additional weakness in the commodity complex. Obviously, we wouldn’t anoint the traditionally dovish BOJ as the key catalyst behind a bullish intermediate-term bet on the yen; as such, we’ll continue to rely on our call for Global Growth Slowing to continue to get priced into global bond markets and compress global interest rate differentials relative to short-term Japanese swap rates (bullish for the yen). Certainly intervention out of global Central Planners remains the predominant risk to being long here – a risk we very much welcome (better entry price).


Japandora’s Box


No matter how you slice it, Japan is in a box from both a political and economic perspective. It can’t organically grow fast enough to offset the growth of its sovereign debt burden, yet it can’t ease enough to artificially grow without risking a backup in JGB yields in the face of a structural decline in JGB demand. For years, investors have been predicting the fall of the Japanese economy, only to watch it resiliently tread water year after year. Could now, however, finally be the time long-term Japan bears start to get validated?


As we called out just days after the first quake hit, the most important take away from the recent string of disasters  wasn’t blindly going along for a brief, reconstruction-fueled relief rally; rather it was Japan’s fiscal and political ineptitude being exposed on a global scale for the first time in many years. As Japan is pushed closer to the Keynesian Endgame as a result of the associated costs with said reconstruction efforts, we expect the world to start paying attention. As we are finding out with Greece currently, earnings don’t matter when an economy is imploding. Japan will have its turn in the long-term cycle we’ve appropriately named the Sovereign Debt Dichotomy before this dance is over.


The fierce grip of sovereign debt on Japan’s Jugular just got a little bit tighter. Perhaps that explains why Japanese equities remain broken from a TRADE and TREND perspective.


Darius Dale



Time to Press?: Revisiting Japan from a Secular Perspective - 8


It appears that every manufacturer survey out of late indicate more downward pressure on profit margins as producers are still having some difficulty passing “inflation costs” thru the supply chain. 


As a result, we continue to believe that EPS expectations embedded in S&P 500 (which is a lagging indicator) are too high; inflation slows growth, raises the cost of goods sold and lowers margins.  The resulting stagflation implies a lower multiple for the S&P 500.  As the chart below shows, expectations are past all-time highs in terms of EPS forward twelve-month earnings and actual earnings are also at peak levels.  While expectations are pressing higher and higher (the red line below shows the Street’s expectations roaring higher and higher), actual earnings have been lagging higher but – as I stressed earlier – earnings are cyclical lagging indicators.  They were in early 2009 when Hedgeye’s market-view was bullish and they remain so today.  Inflation, and its impact on earnings, cost of sales, and multiples, is the factor to watch at this juncture. 





The evidence of this was made clear in today’s Empire Manufacturing Index.  The report showed that prices paid (highest level since mid-2008 and the second highest ever) for inputs rose by a “median 5%” over the past 12 months, with manufacturers only planning to raise their own prices by a “median 4%.”  And that’s assuming they can get away with it!





As the economic recovery has progressed, and the easy-money policy in Washington has been unrelenting, the rise of cost pressures has been inevitable and manufacturers are feeling that pressure in the supply chain.  This time around it is occurring at a time when consumer confidence is stagnating and improvements in the labor markets are slowing.  Further complicating things is the inventories index which climbed to 10.8, its highest level in a year.   


On the positive side, the survey revealed that managers were more upbeat about the future and the hiring index climbed to the second-highest level on record.  This consistent with a number of consumer confidence readings we see that points to “future expectations” being well ahead of the reality of the “current conditions.”  However, expectations have been outstripping current conditions for some time now. 


Howard Penney

Managing Director

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