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JCP: Convergence Boosts Conviction

KM re-shorted JCP today. Recall that he covered in advance of storytelling around Ira Sohn today. Apparently, this is not materializing. The margin risk here is meaningful, as it's at the center of the bullseye as the industry margin structure cracks. Check out the $0.12 gap between TRADE and TREND lines. Convergence makes this one of our best shorts.


JCP: Convergence Boosts Conviction - Snag

Ay! Mexico’s Going to Miss

Conclusion: We are inclined to short Mexican equities on rallies in our Virtual Portfolio due to the combination of slowing domestic growth and slowing growth in its key export market (US). Fairly robust growth expectations need to be reset lower on all fronts.


Position: Bearish on Mexican Equities for the intermediate-term TREND.


Up until recently, Mexico has been boring to cover. With an economic cycle that closely tracks the US’s (lagging by about 1Q on average), there really hasn’t been much to talk about since our mid-February update. While not always the case, getting US growth story right will typically lead you to the promised land on Mexico (80% of Mexican exports go to the US in the form of automobiles, appliances, and, of course, crude oil). In fact, over the last 27 months, Mexico’s benchmark IPC Index has traded with a positive correlation of r² = 0.92 to the XLY and a positive correlation of r² = 0.91 to the XLP on a weekly closing price basis.


Ay! Mexico’s Going to Miss - 1


Ay! Mexico’s Going to Miss - 2


Needless to say, as the US consumer goes, so goes Mexico. And given that we authored the call on US Growth Slowing, as well as the Consumption Cannonball thesis, it would make sense for us to have a bearish bias on Mexican stocks – which we do, of course.


While the aforementioned factors are certainly supportive of being short/underweight Mexican equities, there is more to the thesis. As we pointed out in a report yesterday afternoon titled, “Hong Kong is Not Mainland China”, investors can indeed find themselves caught off guard as a result of playing surrogate investments based on trailing correlation studies. So in the essence of managing risk, we’ll quickly dive into the additional reasons that we are bearish on Mexican equities over the intermediate-term TREND.


Growth is Slowing; Expectations Need to Come Down


With the IPC Index down -8.2% YTD and broken from a TRADE & TREND perspective in our quantitative models alongside Mexico’s sovereign bond yields 10Y-2Y spread falling -45bps since peaking in Feb, PRICE is definitively telling us that growth is slowing south of the border. While not at all news to our Hedgeyes, we think many investors and policy makers alike will be surprised to the downside in coming quarters: 

  • Earlier this month, Mexico’s Central Bank raised its 2011 GDP forecast to +4-5% YoY from a previous range of +3.8-4.8% YoY, citing domestic consumption and private investment as reasons for the increase;
  • Last month, Mexico’s Finance Ministry increased its 2011 GDP forecast to +4.3% YoY from a previous forecast of +4% YoY, citing a “strong US growth” leading a rebound in Mexican exports;
  • Last month, the IMF raised its 2011 Mexican GDP forecast to +4.6% YoY from a previous forecast of +4.2% YoY; and
  • In the last three weeks alone, the Bloomberg Consensus forecast for Mexico’s 2011 GDP has shot up from +4% YoY to +4.4%. 

Ay! Mexico’s Going to Miss - 3


It seems everyone is bullish on Mexican growth except us… and the data, of course: 

  • Industrial Production growth slowed in March to +4.2% YoY vs. a prior reading of +5.2%;
  • IMEF Manufacturing Index fell in April to 53.1 vs. a prior reading of 54.1;
  • IMEF New Manufacturing Orders Index fell in April to 55.4 vs. a prior reading of 59.1;
  • Export growth slowed in April to +12.6% YoY vs. a prior reading of +20.1%;
  • Import growth slowed in April to +9.8% YoY vs. a prior reading of +16.3%;
  • Trade Balance growth slowed in April to +$665M YoY vs. +$1.1B;
  • INEGI Consumer Confidence Index ticked down to 89.7 in April vs. a prior reading of 91.7; and
  • INEGI Retail Sales growth slowed in Mar to +1% YoY vs. a prior reading of +2.7%. 

On the “glass half full” side of things, Mexico’s current +3.4% YoY CPI reading is running a near five-year low and Mexico’s Unemployment Rate ticked down to a 27-month low of 4.6% in March. In our opinion, the US rolling over from a top-down perceptive calls into question the sustainability of further improvement in Mexican employment statistics (which are a lagging indicator anyway). Our models don’t produce an overly malignant output for Mexican CPI, but we do think the probability of it bouncing off multi-year lows and surprising our “high” scenario is a risk to consider, given that Mexico’s benchmark policy rate has remained at an all-time low of 4.5% for the last two-plus years.


All told, we are inclined to short Mexican equities on rallies in our Virtual Portfolio due to the combination of slowing domestic growth and slowing growth in its key export market (US). Fairly robust growth expectations need to be reset lower on all fronts.


Darius Dale



Ay! Mexico’s Going to Miss - 4 

Gravity: SP500 Levels, Refreshed

POSITION: no position in SPY


No position could very well change by the end of the day/week. I am predisposed to be short here, but I need to manage that risk. The US stock market has been down for 3 consecutive days and 4 consecutive weeks, so mean reversion is a relevant bullish factor to consider.


What I am doing right here and now (1PM EST) is waiting and watching on a confirmation of a TREND line breakdown in the SP500 (1322). It’s already been confirmed by a broader intermediate-term TREND breakdown in the Russell2000 and many other Global Equity market barometers (Nikkei, Sensex, Hang Seng, FTSE, CAC, IBEX, etc). These breakdowns coincide with Global Growth Slowing.


Under most free market scenarios, a SUPPLY (more stocks for sale), DEMAND (growth slowing), and PRICE (TREND line breakdown) model should suffice. However, Americans have signed off on the 4th factor (The Bernank) and, while that’s sad, it’s still a very relevant risk.


What could the Fiat Fools do to keep this market levitating on low-volume above our intermediate-term TREND line of 1322? That’s easy - blow up the US Dollar. The USD is down today, so stocks are up – barely.


And that’s the longer-term point - defying the laws of SUPPLY/DEMAND/PRICE (or gravity) can only convince people for so long  - and that’s why this market is still bearish on its longest of long-term TAIL durations (resistance = 1377, a lower long-term high)


If gravity takes over (1322 doesn’t hold), 1308 is now your immediate-term downside target of support.



Keith R. McCullough
Chief Executive Officer


Gravity: SP500 Levels, Refreshed - 1

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Intellectual Honesty

This note was originally published at 8am on May 20, 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 think we are very good at intellectual honesty.”

-Seth Klarman


I was flying to Kansas City from Denver last night and an outstanding interview in the Financial Analysts Journal bubbled up to the top of my pile – an interview with one of the world’s most thoughtful Risk Managers, Baupost’s Seth Klarman.


“We actually hire for intellectual honesty. In an interview, we work hard to see whether people can admit mistakes. We hold our people accountable to that standard.” (Klarman, “Ahead Of Print”, 2010 CFA Institute)


Accountability. Honesty. Standards.


That works for me and, from what I can tell, it works for a lot of our clients who understand that there is a difference between running a P&L and running a business. There’s a difference between rigorous research and disciplined risk management too. The best teams in this business do both.


“We have all our own money invested in the firm, and so we are very conservative. We have picked our poison. We would rather underperform in a huge bull market than get clobbered in a really bad bear market.” (Klarman, “Ahead Of Print”, 2010 CFA Institute)


Ownership. Preservation. Conviction.


Those principles work for me too.


“We ask people, what is the biggest mistake you’ve ever made? It’s a very open-ended question because it’s not solely an investment question, although prospective hires often answer it as if it were.” (Klarman, “Ahead Of Print”, 2010 CFA Institute)




Back to the Global Macro Morning Grind


In the face of awful US Economic data yesterday:

  1. CONFIDENCE: Bloomberg Weekly Consumer Comfort Index dropped to a fresh YTD low of -49.4 vs -46.9 last week.
  2. HOUSING: US Existing Home Sales  fell -0.8% for April, dropping from 5.09 million in March (seasonally adjusted annualized) to 5.05 in April.  This is a sharp divergence from the March Pending Home Sales, which increased 5.1% month-over-month.
  3. GDP GROWTH: US Leading Indicators for April were down (0.3%) sequentially vs. +0.7% in March (the sharpest decline in well over a year)

And … with the US Dollar down on the day… the inverse relationship (The Correlation Risk) between Fiat Fool policy and stocks continued to hold (USD down = stocks up). The US stock market was able to hold a +22 basis point gain. With the SP500 closing at 1343, it’s down -1.5% from its April 2011 YTD high, and down -14.2% from its October 2007 all-time high.


You mean, on alarmingly low-volume, the mistakes we’ve all made between late 2007 (where I got bearish too early) and early 2011 (where consensus has been too bullish on US Growth) has only equated to lower immediate-term and long-term highs in US stocks? Yep. This special case of making lower-highs in stocks has been occurring in Japan since 1992. Big Government Intervention has its perks.


No matter where I go this morning, the entire risk management community can see all of my mistakes. My current mistakes are attached at the bottom of every morning’s Early Look (my biggest mistake on the long side is currently Suncor (SU) at -5.3% and, on the short side, Consumer Staples (XLP) at -2.9% against me). My longer term mistakes are all time stamped on our website and on the back of my ankle.


Transparency. Accountability. Trust.


These are principles that plenty of politicians give lip service to. In real-life, they are extremely hard to achieve. I don’t think my firm is there yet, but I do know that the people I have working with me have Intellectual Honesty – and in terms of re-thinking industry standards on independent research, I think we’re well on our way.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are $1480-$1502, $95.16-$100.91, and 1324-1358, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Intellectual Honesty - Chart of the Day


Intellectual Honesty - Virtual Portfolio

CHART OF THE DAY: Distributing The Future


CHART OF THE DAY: Distributing The Future - Chart of the Day

Distributing The Future

“The future is here. It’s just not evenly distributed yet.”

-William Gibson


Speculative-fiction author Bill Gibson is my kind of guy – he’s an American-Canadian. He also likes to make up his own terms for things and put himself out there with contrarian predictions about the future.


I’m currently in the middle of reading “The World In 2050” by Laurence Smith (excellent research read on resource risk, demographic risk, etc). In the very first chapter of the book, Smith gets your attention with the aforementioned Gibson quote and another by Niels Bohr.


Making market “calls”, or proactively managing risk around the edges of this globally interconnected marketplace, isn’t as hard as people crack it up to be. Sure, the daily grind is hard - but the data is there.


The future of Global Macro Risk Management is here.


Getting what people in this business used to call “edge” doesn’t come without orange jump suit risk. Ask The Raj about that. In economic cycles that are being shortened by Fiat Fool policies, the future of Risk Management Edge is going to be grounded in getting TIME and PRICE right.


To do that, in today’s marketplace at least (and this will change), you really need to get The Correlation Risk right.


To get The Correlation Risk right, you need to get the US Dollar right. To get the US Dollar right, you need to get monetary policy right. To get monetary policy right, you have to grind (or buddy up with The Gopher).


If the future was evenly distributed, you wouldn’t be seeing these massive moves in asset classes from quarter-to-quarter. It was only 6 months ago that Hedgeye had a Global Macro Theme called “Trashing Treasuries” (as in short them). Today, one of my highest conviction positions is long the long-bond (TLT). And in 3-6 months, I am sure that will change too.


What if you don’t change? What if you haven’t evolved your risk management process since 2008?


Dagny Taggart probably has a few answers for us all to those questions. My simple one is this – if you don’t evolve the process, you’ll lose. And I don’t mean lose whatever moneys you’ve made. I mean you’ll lose your confidence in making emotionless decisions. You’ll lose the conviction that it takes to change your mind.


So what is my Global Macro Risk Management process flagging this morning?

  1. Vietnam is the first Asian Equity market to crash – down -4% last night and down -20.5% since May 4th
  2. Japan continues to resemble the Big Government Intervention train wreck that bailout beggars in America want our markets to be
  3. Chinese equities have once again broken their intermediate-term TREND line of support (2811 on the Shanghai Composite Index)
  4. Indian stocks were down another -0.7% overnight to -12.8% YTD and remain one of our best Macro short ideas in 2011
  5. South Korean and Australian Equities have moved to bearish TRADE and TREND in our model – nasty signals for Global Growth
  6. Pakistan was up overnight, hooray
  7. European Equities are starting to look as ugly as their socialist policy to keep Greek and Portuguese bond markets ticking
  8. Germany, which we like, doesn’t look good
  9. Sweden, which we like, doesn’t look good
  10. Spanish and Italian Equities have broken their TRADE and TREND lines (this is new – in Q1 they were bullish on both durations)
  11. Russian stocks have broken their intermediate-term TREND line on the RTSI of 1964 – bearish signal for The Petro Dollar markets
  12. The Euro is testing and intermediate-term TREND breakdown of $1.41 TREND line support
  13. The US Dollar has moved to bullish immediate-term TRADE – what was big resistance at $74.41 is now big support
  14. US stocks have been down for 3 consecutive days and 4 consecutive weeks
  15. TREND lines in the SP500 (1321), Nasdaq (2794), and Russell2000 (826) are all broken as of last price
  16. Only 3 Sectors in our S&P Sector Risk Management Model are bullish TRADE and TREND (Healthcare, Utilities, and Staples)
  17. Volatility (VIX) is bullish on 2 of our 3 core durations (TRADE and TAIL), with a big breakout line at 18.04 daring you to buy the dip
  18. US Treasury Bonds look awesome – as in awesome bullish

Awesome is as awesome does. That’s the future. It’s here. And it’s our job to manage risk around it.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1 (bullish), $96.98-100.93 (bearish), and 1311-1321 (bearish), respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Distributing The Future - Chart of the Day


Distributing The Future - Virtual Portfolio

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.