The Queen Mary Is Turning

“Future shock is the shattering stress and disorientation that we induce in individuals by subjecting them to too much change in too short a time. ”
-Alvin Toffler

So the US Government issues its “stress test” guidelines and everyone scrambles to trade the US futures on what they think this means. This isn’t complicated folks. This is called risk management. And the amateur kind, at best…

Putting the banks through the paces of 2 economic scenarios is what they are calling a “stress test.” While it’s both embarrassing and sad that most of these bankers didn’t use credible scenario analysis prior to the meltdown of our Financial System, I suppose ranting about that will be next to useless this morning. I think everyone gets that at this point – bankers and their levered long prop traders don’t do risk management.

The worst part about this “stress test” is that it’s based on government forecasts. Now that everyone in the Fed and Treasury didn’t proactively prepare for today’s current economic scenario, America’s banks are going to manage their business and capital structure around the forecasts of those same revisionist historians? C’mon Man…

President Obama is going to unveil his first budget this morning. Within it, he is going to remind Americans that the US deficit for 2009 will be in the area code of $1.75T. That’s “T” for TRILLION.

Losing “Ts” is bad. We don’t need a “stress test” to tell us that. All this tells us is that when it comes to US Government sponsored risk management – there was none. Maybe we need a stiff club to the forehead to remind us that crushing America’s balance sheet has an implication for US Treasuries. Boy did we get one last night! For the last few months, I have been worrying about the US Treasury Bond market shaking. Now it’s breaking…

Shaking should make a risk manager worry – breaking should make him move. Who is running the scenario analysis on this side of the risk management ledger? Timmy Geithner?

Yesterday, 2-year Treasuries got hammered and now the yield on those Treasuries is breaking out to the upside as a result. My “stress test” reveals that a 2-year yield anywhere north of +0.97% moves the bonds that trade on those yields into a negative intermediate “Trend.” When Trends break out or break down in global macro, you better be running some serious in house scenario analysis. Tail risk is real when this happens – and as my American Idol, Tim Russert, would have said, “This is BIG.”

Yields on 2-year Treasuries are busting out to the upside this morning to +1.09%. This interest rate is now comfortably above what I call Trend line resistance. If you pull up a 3-year chart on this you will see what I have been calling for since our 2009 Investment Themes Outlook call, “The Queen Mary Turning”…

What’s that? Just like a “stress test”, it’s not complicated – it’s when a massive long term Trend in global macro starts to change its long term direction, making its turn in the oceans of global macro asset allocation – once this momentum factor builds up enough steam, it’s almost impossible to stop.

So what are the implications? Well, the most important is that this signals that American cost of capital is going to start going up. After cost of capital goes to zero, you can imagine how that scenario analysis isn’t trivial. As cost of capital increases alongside access to it tightening, guess what you get? The mother load of bankruptcy cycles…

I am still short Blackstone, primarily because this is the 25-year Trend that has made them, and many other cheap leverage lovers, look genius. Not all Private Equity is managed the same and, to be clear, I think there will be some huge winners in Private Equity land who take advantage of this generational fallout. But the Private Equity that is over-geared right here and now into the Queen Mary’s turn, watch out – massive iceberg cometh…

There are two obvious ways out of this stressful situation: 1. You can blow up the Queen Mary (Bernanke levering his brains out buying Treasuries) or 2. Beg for someone else to buy them (China).

Blowing up the natural forces of free markets doesn’t end well. That’s what this Keynesian gong show we have had over the course of the last 12 months has hopefully taught us all. And begging just isn’t cool. It’s un-American.

Now never rule out the “nevers”, particularly when running real risk management models. Our government has proven to attempt to socialize the losses of financial engineers here at every turn. However, if we assume under one scenario analysis at least, that increasing the cost of American capital is going to morph into a long term Trend, what do we do? Buy more bonds? Uh, no…

The US Treasury market is one of the few (other than gold) bubble markets that has yet to pop…

The Chinese announced this morning that they are going to issue 200B Yuan in 3-year bonds ($29B in USD), and international bond issuance is starting to really take on a life of its own all of a sudden (in Indonesia they issued $4.5B worth of 5 and 10-year bonds last night).

Yes, the rest of the world is allowed to print moneys, just like we have…

No, the long term implications for all of this are not part of Timmy Geithner’s “stress test” of the US Financial system.

This is scary. I have moved back to 76% cash in our Asset Allocation Model as a result.

My immediate term downside target for the SP500 is 730 (4.5% lower), and immediate term resistance is at 785 (2.5% higher). I sold my long positions in QQQQ and SPY yesterday, dropping my Asset Allocation in US Equities to 12% from the 29% I was carrying into the open on Tuesday. I covered my short position in gold yesterday, and sold my long position in oil – both were profitable decisions, as I think will be managing legitimate “stress tests” in your portfolios, rather than government sponsored ones.

Be careful out there,
KM

The Queen Mary Is Turning - etfs022609