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“What is defeat? Nothing but education; nothing but the first steps to something better.”
-Wendell Phillips
 
Pittsburgh Steelers linebacker, James Harrison, had to learn defeat before he found his Super Bowl victory last night. The NFL’s Defensive Player of the Year was cut by the Steelers on three separate occasions and, at one point, almost went back to being a bus driver.
 
How sweet victory was for this 242 pound linebacker after running back the longest interception in Superbowl history. As Harrison was lying exhausted on his back in the end zone John Madden’s comment summed it up – “no matter what this replay reveals, you gotta give this guy a touchdown.”
 
To truly appreciate victory, one has to be educated by defeat. The US stock market was reminded of as much this past month. In the end, it was actually the worst January ever. Yes, ever, is a long time. The Steelers record setting 6th Superbowl victory comes on the heels of a record setting SP500 performance for January of down -8.6%. This miserable defeat was actually a good margin past the prior record of -7.7% in January of 1970.
 
Interestingly, on a peak to trough of the month basis, the SP500 dropped from 934 on January 6th to 805 on the 20th – that was a -13.8% smashing… then it rallied +8.5% straight up and into a recklessly CNBC instigated “bad bank bailout” lower high of 874 (which we sold into and took our cash position to 82%), before being clobbered by the reality of a broken quantitative “Trend” – make no mistake, this tape remains fundamentally and quantitatively broken. That’s why I moved our Asset Allocation model to 86% cash on Friday.
 
Our Hedgeye Asset Allocation model finished down -1.74% for the month (no stocks, just ETFs). While I am sure that wasn’t the worst performance in the league, I am not pleased with it. No excuses – we move forward into February. In order to proactively look forward, I always take the time to look back. Looking back at January a few very important “Trends” (intermediate term) re-established themselves.
 
For the US stock market, the most negative Trend that re-emerged in January was the strengthening of the US Dollar. The greenback “re-flated” to the tune of almost +6%, and in terms of historical monthly moves go, that was a big one. As we shift into an Illiquidity Crisis from the Liquidity Crisis of October/November, US cash is asserting itself as king. Those who own both the liquidity and duration associated with their investments are winning. Those who are levered up long and illiquid are losing.
 
For global equities, there are positives and negatives emerging out of The New Reality that all equity markets no longer auto-correlate. This is also a function of the Illiquidity Crisis, and you can see this in terms of how global equity markets traded again overnight. China, which re-opened post the Chinese New Year break, closed up another +1% last night, taking the Shanghai Stock Exchange to 2,011, and +10.5% for 2009 to date. Meanwhile, stocks in India got smoked, closing down another -3.8% on the session, taking their year to date losses to -6%. “Chindia” does not exist. China owns liquidity – India does not.
 
In the game of geopolitics, “Putin Power” is also losing its liquidity. The Russian Trading System is getting pulverized again right now, trading down another -5% this morning in the face of a domestic currency crisis. Russia is the only major economy whose stock market is trading below the October lows, and it’s trading a good clip below it at that (-7.5%). Without petrodollars, Putin’s liquidity goes away.
 
European stock markets continue to swoon as their Illiquidity Crisis continues to manifest. Nine out of the top ten credit default swap moves in 2009 (at the country level) are European countries for a reason. Spain is #3 on that list, behind Ireland and Belgium, and Spanish stocks are getting whacked for another -3% down move so far to kick off the week. To speculators formerly known as Spanish bulls, wasn’t levering up your economy fun? Leverage works both ways folks…
 
Not all markets in global equities are going down. Alongside this impressive Chinese move, the Brazilian stock market (which we are long in the Asset Allocation portfolio via EWZ), is up +4.5% for 2009 to date. On Friday with the SP500 down another -2.3%, Brazil outperformed again, flashing a positive divergence and losing only 83 basis points on the day. Brazil has an organic domestic growth engine that seems to be pushing forward, without using excess leverage. Imagine that…
 
Back to the USA, importantly, we are seeing a very welcomed steepening of the yield curve. This morning’s spread between 10 and 2 year US Treasury yields has widened once again to +191 basis points. This is a very positive development for those who are liquid (borrow short, lend long), and a dangerous one for anyone locked in that Illiquidity trade that Barron’s gave us the knucks with on this weekend’s cover (private equity “Ka-boom”).
 
As cost of capital on the long end of the curve continues to rise, and access to capital continues to tighten (for those who were addicted to borrowing it), look for more winners and losers to emerge. The defeat that you’re seeing out there in this interconnected global marketplace is real, and it will be a long long time before some of these leverage only compensation structures are allowed to return to prime time.
 
While hope is not an investment process, at this stage of the game I can only hope that Americans have been educated by all of this – after another crushing month in our stock market, “education is nothing but the first steps to something better.”
 
Best of luck out there this week.

 

Education - etfs020209