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Misery's Mistake

This note was originally published at 8am on August 16, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“They get to see all of my mistakes.”

-Ray Dalio (The New Yorker, July 25th, 2011)

 

Recent history is marked-to-market. That’s a good thing because it helps us rethink, rework, and learn faster. Modern day multi-media tools from YouTube to Twitter have revolutionized and expedited our quest to find the right sources of alpha. Old Wall Street’s “sources” are either wearing orange jump suits or dying on opacity’s vine.

 

Per the same New Yorker article that I cited yesterday (“The Machine – How Ray Dalio built the world’s richest and strangest hedge fund”, by John Cassidy at The New Yorker), Ray Dalio has a “rule of radical transparency” that has ultimately shaped the risk management culture at Bridgewater Associates.

 

Transparency: I like that word; particularly when someone is practicing it out loud.

 

As a practical matter, I do find it very interesting (but not ironic) to note that two of the most successful Global Macro Risk Managers of our generation  (George Soros and Ray Dalio) both started their firms during the mid-1970s. Soros and Dalio hung up their own shingles in 1973 and 1974, respectfully.

 

What was very unique about the 1970s was that there was this economic reality called The Stagflation. It was man-made by central planners and, ultimately, it ran all of the Keynesians right over. Big Government Interventions that were focused on devaluing the US Dollar perpetuated rising inflation and slowing growth (stagflation).

 

I’m not sure how either Soros or Dalio’s macro models scored The Stagflation then, but this is how Hedgeye scores it now:

  1. Growth Slowing At An Accelerating Rate
  2. Inflation Rising (and remaining) Above The Real Growth Rate
  3. Monetary and Fiscal Policy that perpetuates 1 and 2

The Stagflation: In the US and across most of Western Europe, that’s basically what you have right here and now. In fact, if you take the US Government’s word for it and use the Q1 2011 US GDP number (revised down by 81% to 0.36%), and then “trust” that headline Consumer Price Inflation was 3.3% in Q1 - that’s a ratio of 10:1 of inflation over growth. That’s nasty.

 

Causality? What drives The Stagflation? That’s easy. Keynesian Politicians.

 

This is what Nixon, Carter, Bush II, and Obama all had/have in common. They and their economic “advisors” were/are all Keynesians. And all 4 of their Administrations oversaw horrible employment decades combined with horrifically low Presidential approval ratings.

 

Today, this country doesn’t like The Stagflation any more than it didn’t in the 1970s. Back then, they called it the Misery Index (unemployment + inflation). On this very common sense calculation, the Obama Administration ranks 3rd worst in American history to Nixon and Carter. Not surprisingly, Reagan, Clinton, and Kennedy are the Top 3.

 

Back to the Global Macro Grind

 

Let’s take a ride around the world and take a gander at some stagflation callouts from this week’s Global Macro Economic Data:

  1. JAPAN – reports a down -1.3% GDP number for Q2 2011. Keynesians celebrated that as “better than expected due to the tsunami effects.” Non-Keynesians remind realists that Japan’s GDP was negative for the 6 months before the tsunami!
  2. UNITED KINGDOM – reports an awfully high Consumer Price Inflation (CPI) print for July of +4.4% (versus +4.2% in June); the British (homeland of the Keynesians) are now running 10:1 inflation over GDP growth like the Americans are.
  3. GERMANY – reports a huge sequential slowdown in economic growth for Q2 2011 of +2.8% (cut in half versus Q1 GDP growth of +5.2%). If you didn’t know why German stocks have crashed since May 2011 (down -22%), now you know.

Elsewhere in Global Macro, commodities, currencies, and bond markets continue to signal that Global Growth Slowing remains reality:

  1. CRB COMMODITIES INDEX – closed at 330 yesterday and remains well below Hedgeye’s intermediate-term TREND line of 348
  2. WTIC OIL – trading $86 this morning continues to be broken across all 3 of our risk management durations (TRADE/TREND/TAIL)
  3. DR. COPPER – leads to the downside this morning (down -1.3%) and has now broken its long-term TAIL line of support ($4.10/lb)
  4. EUR/USD – continues to hope and pray to hold above its intermediate-term TREND line of resistance = $1.44
  5. UST YIELDS – 10-year yields remain broken across all 3 of our risk management durations (downside support = 2.06%!)
  6. UST YIELD SPREAD – continues to compress (10s minus 2s = +209 basis points) and is down -25% since Q1 Growth Slowed

But, but…

 

There are no buts. Stocks aren’t “cheap” either. Our 2011 call on US Equities has not been that stocks will get as cheap as they did during The Stagflation of 1974 (7x earnings). But it has been that buying Equities as Growth Slows And Inflation Accelerates is Misery’s Mistake.

 

My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1725-1827, $79.10-91.79, and 1098-1256, respectively. Yesterday I bought Silver (SLV) and sold half of our long China (CAF) position in the Hedgeye Asset Allocation Model, taking my allocation to International Equities down to 6% and keeping my allocation to US and European Equities at 0%.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Misery's Mistake - Chart of the Day

 

Misery's Mistake - Virtual Portfolio



Give It Up

“There’s nobody taking center from me until I give it up.”

-Joe DiMaggio

 

That’s what Joltin’ Joe had to say about Mickey Mantle taking his position in center field for the New York Yankees in 1951. Mantle was the superstar rookie. DiMaggio was the tiring veteran. 1951 would be the last year Joe DiMaggio played center field.

 

That’s another quote from “The Last Boy – Mickey Mantle and The End of America’s Childhood” (Jane Leavy, page 15) and, like I do with every book I read, I dog eared the page, and wrote a personal note to myself beside the quote.

 

I write a lot because I like to think a lot. Writing helps me think. Whether it’s to all of you every morning or to myself in bed with my books every night – it’s just what I love to do.

 

Rather than rip into some tired Old Wall Street brain-trust that doesn’t want us to be successful this morning, I think my humble submission to you today should be a simple one. Be yourself. Play the game that you love. And enjoy what you do.

 

Thirteen years ago when I started in this business, it was my job. Ten years ago, it became a compensation mechanism to make enough money to not have to worry like many hard working and honest people do in this world.

 

Today, it’s not about the money. It’s about building something that I love; building something that’s successful; and building something that lasts.

 

I don’t doubt that Merrill Lynch founder Charles Merrill and Joe DiMaggio were some of the best players of their days. I respect their successes. I love celebrating winners wherever I can find them. But today, Merrill and DiMaggio are dead.

 

Today, Bank of America Merrill Lynch is setting up to fire another 10,000 people (WSJ). Today is a new day. Today is as good a time as any for Old Wall Street to Give It Up.

 

We need to rethink and rework this business. We need new leadership. We need to evolve. Fast. Or it will, once again, be too late.

 

Back to the Global Macro Grind…

 

Global stock markets around the world are crashing. Crash, as we defined it, is a peak-to-trough decline of 20% or more in the price of something that ticks in a short period of time. From Seoul, Korea to Frankfurt, Germany, here’s what’s really going on out there:

  1. KOSPI (Korea) = down -6.2% overnight and down -22% since May
  2. DAX (Germany) = down -3.5% this morning and down -28% since May
  3. CAC (France) = down -2% this morning and down -33% since February
  4. MIB (Italy) = down -2% this morning and down -37% since February
  5. XLF (US Financials) = down another -2% pre-open and down 28% since February
  6. XLI (US Industrials) = down another -1.5% pre-open and down 23% since April

Old Wall Street can blame Europe, blame China, or blame Canada at this point. Reality is that finger pointing is for losers and I, like most of you, am tired of watching it. It’s time for the Captains of American Accountability to step up and take charge. US Growth Slowing is as big a problem as any right now to this globally interconnected marketplace.

 

Need more US-centric leading indicators other than Financials and Industrials crashing?

  1. US CURRENCY – while the US Dollar isn’t crashing to all-time lows (yet), it’s getting pretty darn close. At $74.20 on the US Dollar Index, it’s only 3% away from its all-time lows that were established by 2 conflicted and compromised Federal Reserve Chiefs (Arthur Burns in the 1970s and Ben Bernanke, twice, since 2006).
  2. US TREASURIES – both 2 and 10-year US Treasury Yields are now collapsing/crashing to all-time lows. When compared to 2008 (the levels they just eclipsed on the downside), that’s saying something. And that something is not good.
  3. US JOBS and HOUSING – both sets of numbers yesterday (weekly jobless claims and Existing home sales for July) were bad enough in their own right. The bigger problem is expectations of how bad both jobs and housing numbers are setting up to look in August-September. Yes, these are Hedgeye forecasts – and yes, we have been right on both YTD.

I’m young, and I have plenty of character faults. I get that I have a lot to learn. But I can assure you that I am on it. I love this game. I love this country. And I think my team and I can help be the change we all want to see in our profession.

 

My immediate-term support and resistance ranges for Gold (immediate-term TRADE overbought this morning), Oil (we remain the bear on oil, Goldman the bull), and the SP500 (bearish) are now $1, $79.23-84.42, and 1106-1166, respectively. Our allocation to both US and European Equities in the Hedgeye Asset Allocation Model remains 0%.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Give It Up - Chart of the Day

 

Give It Up - Virtual Portfolio


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CPI: GROCERY BILLS STILL OUT-INFLATING RESTAURANT CHECKS

Inflation in the grocery aisle continues to outstrip price increases at restaurants, the latest CPI data for July indicates.  It seems logical that restaurants may be gaining some benefit in terms of traffic as grocers have moved first (and aggressively) in hiking prices to protect margins.

 

From WMT’s commentary during its 8/16 earnings call, it seems that grocers’ customers are managing their checks quite closely: “While we saw an increase in grocery inflation of approximately 3.5% during the quarter, customers remain under continued pressure and are trading down to lower price points and smaller pack sizes, as well as opting out of discretionary purchases. As a result, we're seeing minimal pass-through of inflation to sales. Food inflation has replaced gasoline price as the most important household expense concern.”  Food inflation, according to WMT, has become the most important household expense concern.

 

The first chart below shows the significant difference between Food at Home CPI and Food Away From Home CPI.  The second chart shows the difference between the year-over-year growth of these respective indices and Core CPI growth.  The spread between Food Away From Home CPI growth and Core CPI growth has been fairly constant over the last few months.  The spread between Food at Home CPI growth and Core CPI growth, however, has been widening as suppliers and, in turn, grocers react to margin pressure. 

 

CPI: GROCERY BILLS STILL OUT-INFLATING RESTAURANT CHECKS - FAH vs FAFH

 

CPI: GROCERY BILLS STILL OUT-INFLATING RESTAURANT CHECKS - FAFH FAH spreads

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


GPS Quick Hit

The table below includes a variance analysis. The blue numbers are consensus numbers as they stand ahead of managment commentary. Overall, no major surprises in the quarter.

 

GPS Quick Hit - GPS top

GPS Quick Hit - GPS bottom

 

GPS Quick Hit - GPS SIGMA

 

GPS Quick Hit - GPS sentiment


PNK: TRADE UPDATE

Booking the gain at 8%

 

 

Keith covered PNK in the Hedgeye virtual portfolio at $11.52, netting a 8% gain on the short trade.  According to Keith's model, TRADE resistance has moved to $12.54, while TREND resistance is at $14.79.  It's great timing considering the release of Louisiana's state gaming revenues, which showed L'Auberge had an explosive July, +17% YoY in revenues.  But we believe the exuberance will be short-lived as regional gaming will have to deal with a difficult macro environment ahead.  We remain bearish on the intermediate-term TREND.  

 

PNK: TRADE UPDATE - PNK


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