Serving The End

This note was originally published at 8am on May 23, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The most effective way of making everybody serve the single system of ends toward which the social plan is directed is to make everyone believe in those ends.”

-F.A. Hayek


That’s the first sentence of Chapter 11 titled “The End Of Truth” in F.A. Hayek’s “The Road To Serfdom” (page 171). “And the most efficient technique to this end is to use old words but change their meaning.” (page 174)


As they did in using the old techniques of dollar devaluation and debt monetization in the 1970s, messiahs of the Keynesian Kingdom continue to shop us their central planning policies. But that doesn’t mean that the rest of us have to follow.


Whether it’s the center-right Popular Party crushing Zapatero’s Socialist party in Spain this weekend or watching America’s political class go after Paul Ryan for having a spine on debt/deficit reform – no matter where you go out there this morning, there they are – The People.


The People get the storytelling. The People know when someone is lying to them. The People will protect their capital against the bureaucrats.


In the last 4 weeks, I have protected my family’s hard earned capital by moving to a 61% position in Cash. Since we do in fact keep score at Hedgeye every day, you’ve seen me hold myself accountable to these asset allocation decisions in real-time. I moved to a ZERO percent allocation to US Equities last Thursday as people were bucking up to get Linked-In.


This is not to say that I haven’t made my fair share of mistakes in 2011. Neither is it to suggest that I won’t buy back some US Equity exposure if I see my intermediate-term TREND line of support hold (SP500 = 1321). This is simply a reminder that I have an outstanding research team here in New Haven, CT that’s had an outside of consensus view in 2011 – and we’re sticking to it:

  1. Q1 2011 – Growth Slowing As Inflation Accelerates
  2. Q2 2011 – Deflating The Inflation

These two research views did not support chasing Equity or Commodity prices into their respective 2-year highs in April. As Global Macro Risk Managers, we are tasked with getting the slope of A) Growth and B) Inflation right. If we can do that, we take out a lot of risk.


In terms of what that means in the Hedgeye Asset Allocation Model, here are the moves I made week-over-week:

  1. Cash = 61% (down from 52% last week and 34% at the end of April)
  2. International Currencies = 18% (Chinese Yuan – CYB)
  3. Fixed Income = 18% (Long-Term Treasuries and US Treasury Flattener – TLT and FLAT)
  4. International Equities = 3% (Germany  - EWG)
  5. US Equities = 0%
  6. Commodities = 0%

Of course, anytime I move to a ZERO percent asset allocation to anything, I get a lot of questions. Most of the questions surround how much conviction we have that The Bernank isn’t going to stop gravity.


With gravity being Growth Slowing


What’s most interesting (but least surprising) about recent week-over-week moves is that the US Dollar Index continues to drive The Correlation Risk in asset prices. Typically, DOWN DOLLAR would equate to big “REFLATION” trades in everything US Equities. Not so much last week. After “REFLATION” becomes The Inflation – don’t forget that Deflating The Inflation comes next!


My longest of long-term base cases about Fiat Fool policy is that:


A)     It shortens economic cycles

B)      It amplifies market volatility


Therefore, it stands to reason that once you have debased your currency (3 weeks ago, the US Dollar was down -17% since Obama/Geithner took over in 2009) the stock market pops turn into drops.


And from what I can tell, all this popping and dropping is making The People tired…


After a 2-week +3.8% pop, last week’s US Dollar Index move was only down -0.2% to $75.65. Here’s what everything else did:

  1. SP500 = DOWN -0.3%
  2. Russell 2000 = DOWN -0.7%
  3. Euro = FLAT at $1.41
  4. CRB Commodities Index = UP +0.9%
  5. WTI Crude Oil = UP +0.5%
  6. Gold = UP +1.0%
  7. Copper = UP +3.5%
  8. Volatility (VIX) = UP +2.1%
  9. 2-year UST Yield = DOWN -3.7%
  10. 30-year UST Yield = DOWN -0.2%

So what does our Chaos Theory model tell us about these moves? What’s the deep simplicity of Mr. Macro Market’s messaging?

  1. GROWTH - Growth Slowing (stocks and UST bond yields falling for 3 consecutive weeks in unison)
  2. INFLATION - Deflating The Inflation (commodities are bouncing to lower-highs on low conviction rallies)

How does this all end? Well, if it means that we’re going to sustain anything that remotely resembles The Stagflation of the 1970s, that’s really bad for the market multiple you’ll pay for peak-cycle earnings (in 1974 the SP500 traded to 7x). As to how the storytellers will be Serving The End, like Europe’s proverbial pigs, we’re not sure this decade’s version of the Keynesians will fly.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1504-1518, $95.58-$101.13, and 1321-1340, respectively.


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


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