Random Illusions

“Make it less random to make it feel more random.”

-Steve Jobs


That’s not a quote to explain why Greek stocks can move up +10.2% this morning (after having crashed -48% since February). That’s what Steve Jobs said about getting the “shuffle” feature right for your iPod.


Dan Gardner (author of “Future Babble – Why Expert Predictions Fail and Why We Believe Them Anyway”) used this Apple analogy to hammer home his point about what psychologists call “the illusion of control.”


“People are particularly disinclined to see randomness as the explanation for an outcome when their own actions are involved. Gamblers rolling dice tend to concentrate and throw harder for higher numbers, softer for lower.” (Future Babble, page 75)


This, of course, is ridiculous. But only the ridiculous can explain much of the “expert” storytelling in our profession.


Last week, I kicked off Monday’s Early Look with a note titled “Uncertainty and Non-Linearity” and I had a tremendous amount of feedback from clients (thank you) on the concept of embracing Uncertainty in both our lives and risk management processes. This morning the process has not changed. My positioning has.


With plenty of asset classes on sale throughout different parts of the week, I was able to put 9% of our 70% Cash position to work by buying Corporate Bonds (LQD), Silver (SLV), and taking up our US Equity exposure from 0% to 3%.


I know, call me a wild and horned up bull.


Here’s how the Hedgeye Asset Allocation Model looks this morning (8 positions):

  1. Cash = 61% (down from 70% last Monday)
  2. Fixed Income = 21% (Corporate Bonds, Long-term Treasuries, and a US Treasury Flattener – LQD, TLT, FLAT)
  3. International Equities = 6% (China and S&P International Dividend ETF – CAF and DWX)
  4. International Currencies = 6% (Canadian Dollar – FXC)
  5. Commodities = 3% (Silver – SLV)
  6. US Equities = 3% (Utilities – XLU)

People always ask me what would get me to change my “market view.” I then have to ask them what market they are asking about. I am a Global Macro man who works with a 40 person team across countries, currencies, commodities, etc, so the answer isn’t as random as where the Dow is going next.


The answer actually gets down to last price. Prices Rule in my multi-factor, multi-duration, Global Macro risk management model. To put that more simply – as prices, volumes, and volatilities change, I do.


A lot of people do not deal with managing risk that way. Some are absolutely certain that God endowed them with a super special ability to think about “valuation” better than you or I can. Some think that markets owe them a “rate of return above the risk free rate.” Some actually don’t put much thought into it at all and just buy all dips.


Across asset classes, here’s what my core 3 factor model (PRICE/VOLUME/VOLATILITY)  said the market was saying week-over-week:

  1. US DOLLAR INDEX = DOWN -0.3% week-over-week and down for the 2nd consecutive week, reminding us that there is no strong US Dollar policy that the Globally Interconnected Marketplace actually believes. If I have written this 100x since 2007, I have written it 1000x - devaluation is not the best path to long-term economic prosperity. It perpetuates short-term inflations.
  2. CANADIAN DOLLAR = UP +2% week-over-week and proving itself where both US Congress and Les Eurocrats can’t (political solidarity). Canada is being led toward a majority that the Globally Interconnected Currency Market can attempt to trust.
  3. EURO = FLAT week-over-week as the Europeans do nothing to change the world’s view that they have no political union that can be believed in. The ever so important vote on the EFSF (European Financial Stability Facility) is up next (late September).
  4. COMMODITIES (CRB Index) = UP another +1.8% week-over-week and holding above both its long-term TAIL and immediate-term TRADE lines of support. This is the Stag in Stagflation that is associated with a debauched US Dollar policy.
  5. OIL = UP +3.8% week-over-week outperforming overall commodity inflation by more than a 2:1 ratio. Getting the stock market up by getting the energy stocks up also gets consumers a nice tax at the pump for Labor Day weekend.
  6. COPPER = UP +2.7% week-over-week to $4.11/lb but not enough to get Dr. Copper back above either its long-term TAIL or immediate-term TRADE lines of resistance (both are converging around $4.17/lb). Copper trading sustainably above $4.21/lb would be one of the key leading indicators that would change my Global Growth Slowing research view.
  7. GOLD = DOWN -3% week-over-week after making all-time weekly closing highs for almost every week of Q3 2011 before that. If you shorted Gold last week, you feel shame this morning. We are long Silver as we think it has less hedge fund risk right here and now than Gold does. Gold and Silver will continue to outperform when real-interest rates are negative.
  8. VOLATILITY (VIX) = DOWN -17% week-over-week and while it’s not conventionally considered an asset class, I don’t see why it shouldn’t be given that the Fed, ECB, and BOJ (Fiat Fools): A) shorten economic cycles and B) amplify market volatility.
  9. US TREASURIES = FLAT on the short end and DOWN on the long end last week as long-term Treasury bonds were immediate-term TRADE overbought in the week prior. Nothing has changed the Treasury Bond Market’s view from an absolute yield pricing perspective. For me to change, I’d need to see greater than 0.28% and 2.49% on 2-year and 10-year yields, respectively.
  10. US TREASURY YIELD SPREAD = UP 13 basis points week-over-week as the long-end of the Treasury curve rallied (10-year went from its YTD low of 2.06% to 2.19% by Friday). We continue to see the intermediate-term TREND of Yield Curve COMPRESSION as one of the most important leading indicators of both US Growth Slowing.

All the while, US stock market bulls had a wonderful week with the SP500 closing up +4.7% (up for its 1stweek in the last 5). But, Prices Rule, and while I moved off of the ZERO bound last week (asset allocation to US Equities = 3%), that certainly doesn’t make me a bull on either an intermediate-term TREND or long-term  TAIL duration. I’d need to see an SP500 close above 1263 for that.


“For humans, inventing stories that make the world sensible and orderly is as natural as breathing. That capacity serves us well, for the most part, but when we are faced with something that isn’t sensible and orderly, it’s a problem” (Future Babble, page 81). That’s why I’ll stick with my own storytelling that both accepts Uncertainty and that the market’s last price makes perfect sense.


My immediate-term TRADE ranges of support and resistance for Gold, Oil, and the SP500 are now $1, $81.35-88.58, and 1154-1191, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Random Illusions - Chart of the Day


Random Illusions - Virtual Portfolio

The Quitting Time

This note was originally published at 8am on August 24, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“If you must play, decide upon three things at the start: the rules of the game, the stakes, and the quitting time.”

-Chinese Proverb


While it’s both sad and pathetic to watch our said “free market” system come to this, the entire asset management world is being dared to bet on either black or red going into Ben Bernanke’s “event” in Jackson Hole, Wyoming on Friday.


If you must play (going to 70% Cash this week, we have decided not to), you should have already decided on 3 things:


1.   RULES: seeing that Japan, Europe, and the US effectively change the rules as we go, this is a tough one! If you have inside information on what Bernanke is going to say, enjoy that and some orange jump suit risk out on your life’s tail.


2.   STAKES:

A)   bet BLACK on Bernanke and the elixir of another short-term stock market inflation is yours

B)   bet RED on no QG3 (Quantitative Guessing III) and there’s a high probability that your P&L doesn’t blow up in 2011


3.   QUITTING TIME: don’t bet at all – go to cash and/or tighten up your net exposure like we have (10 LONGS, 10 SHORTS)


I’m not a big fan of blowing up. When I started in the hedge fund business, my first 3 years (2000, 2001, and 2002) were down markets. Not losing money was the name of the game. Since 2008, I haven’t had other people’s money on the pass-line (betting rules are different when the money isn’t yours). I’ve been “all-in” with my own money. Not interested in rolling the bones, Benny – sorry, “bro.”


This is what the ZERO Percent Interest Rate Policy has done to this gargantuan game of Globally Interconnected Risk. Big Government Intervention is designed to debauch your currency and dare you to bet on the stock market. That’s a dumb long-term strategy. Period.


In the past, we’ve also called this 3D-Risk – ZERO percent cost of “risk free” capital does 3 things:

  1. DARES investors to chase “yield” (stocks over zero percent “risk free” bonds)
  2. DISGUISES financial risk (think Bank of America’s net interest margins and liquidity gap – both in big trouble)
  3. DELAYS balance sheet restructuring (uh, got some Greek or Italian banking sausage?)

So… for me at least, the next 3 days will remain The Quitting Time – and I’m totally cool with that. Call me whatever you want to call me in the meantime. It took me a long time and a lot of mistakes to come to grips with this, but doing nothing with my hard earned capital is sometimes the best decision to make.


Back to the Global Macro Grind


On this day in 2006, the planet Pluto was downgraded by the powers that be in Astronomy to “dwarf planet.” While I’m not an astrology expert, I think that math and physics had something to do with the downgrade. Fancy that.


Shockingly, 5 years later, Japan is getting downgraded this morning from land of Keynesian Nod to something less than getting the nod. On the “news” that Japan is an economic disaster, the Nikkei crashed again (down -20.4% since February 2011) for the umpteenth time since Paul Krugman and the Princeton boys told the Japanese to “PRINT LOTS OF MONEY.”




But have no fear, the aliens are here…


On Fareed Zakaria’s GPS a few weeks ago, CNN teased that they were going to “explore the most important topic (the economy) with the most important voices” (Zakaria was interviewing Krugman). And I couldn’t make this up if it tried, but the venerable Keynesian of Nobel’s Social Study Experiment said:


“If we discovered that, you know, space aliens were planning to attack and we needed a massive buildup to counter the space alien threat and really inflation and budget deficits took secondary place to that, this slump would be over in 18 months…”


You know, space aliens, Ben… We need to be thinking cowboys and space aliens down there in Jackson Hole!


God help us. The Quitting Time with failed Keynesian policies is here.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1809-1901, $81.28-89.28, and 1108-1165, respectively. Yesterday was just another Japanese-like rally to lower long-term highs in US Equities. If people are seriously betting on Bernanke BLACK on Friday, I’ll tell you that this Canadian is in Cash and won’t be surprised whatsoever to see those expectations crash.


Best of luck out there today and a special prayer goes out to my brother Ryan and his beautiful family,



Keith R. McCullough
Chief Executive Officer


The Quitting Time - Chart of the Day


The Quitting Time - Virtual Portfolio


Great July airport data but if US consumption of luxury goods is slowing, the Strip’s high-end domestic play could be under pressure.



July was likely a strong month on the Strip per the McCarran Airport data released late last week.  Management commentary from MGM, WYNN, and LVS seems to confirm the strength.  However, we are a little worried about the prospects for high-end domestic play which represents about 20% of Strip table drop.


The Hedgeye Retail team believes that US luxury good sales have been slowing in the past couple of weeks.  While we don’t yet have hard correlations to back this up, if high-end retail consumers are cutting back, it stands to reason that high-end gamblers may be doing the same.  Table game revenue has been carrying the ball for some time on the LV Strip while high margin slots have yet to show a consistent resurgence.  We doubt that slot revenue will improve dramatically over the near term given the macro environment so without the domestic high-end, baccarat may be the only potential growth driver.  Overall gaming revenues could be under pressure the rest of the year.




Meanwhile, the McCarran Airport July passenger traffic data showed 4.9% YoY growth against a -1.1% comp.  This is the third consecutive month that the number of enplaned/deplaned passengers at McCarran have grown 5% YoY.  For each of the past two months, Strip revenues have soared 30% YoY.   According to our predictive model, for July, Strip gaming revenues growth should moderate to around 10%, assuming positive auto traffic, normal hold %, flat slot handle per visitor, and positive table drop per visitor.  Last July, the Strip reported flat gaming revenues so the comp is still relatively easy.  But starting with August’s comp (+21%), Vegas will be matched up with three straight positive YoY comps. 





Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.47%
  • SHORT SIGNALS 78.68%




TODAY’S S&P 500 SET-UP - August 29, 2011


Last week we took our cash position from 70% to 61%, buying Silver, Corporate Bonds, and some US Equity Exposure (XLU).  As we look at today’s set up for the S&P 500, the range is 37 points or -1.94% downside to 1154 and 1.21% upside to 1191.











  • ADVANCE/DECLINE LINE: +2029 (+3616)  
  • VOLUME: NYSE 1119.40 (-7.43%)
  • VIX:  35.59 -10.49% YTD PERFORMANCE: +100.51%
  • SPX PUT/CALL RATIO: 1.65 from 1.72 -4.37%



FIXED INCOME: US Treasury yields on 3mth paper are negative this morning! -0.01% - retirees, now you pay the

government to hold your cash

  • TED SPREAD: 32.79
  • 3-MONTH T-BILL YIELD: 0.01%
  • 10-Year: 2.19 from 2.23    
  • YIELD CURVE: 1.99 from 2.01

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30 a.m.: Personal income, est. 0.3%, prior 0.1%
  • 8:30 a.m.: Personal spending, est. 0.5%, prior (-0.2%)
  • 10 a.m.: Pending home sales, est. (M/m) (-0.9%), prior 2.4%
  • 10:30 a.m.: Dallas Fed, est. (-8.5%), prior (-2.0%)
  • 11 a.m.: Export inspections: corn, soybeans, wheat
  • 11:30 a.m.: U.S. to sell $29b 3-mo., $27b 6-mo. bills
  • 4 p.m.: Crop conditions



  • Monsanto's bug-resistant corn isn't anymore - WSJ
  • Finance Minister Yoshihiko Noda elected new Prime Minister of Japan - Nikkei
  • Some German banks, agencies have yet to decide if they will join bond swap to help Greece - FT


  • COMMODITIES: Gold is a raging bull off last week's freakout lows, busting through Hedgeye's TRADE line of resist ($1809) this morning.
  • Our TRADE and TREND lines in Gold and Silver have held and both look like raging bulls here this morning. With Bernanke not defending the US Dollar, to a degree this is a repudiation of Keynesian economics but more so a function of real-interest rates being negative. US 3 month treasury yields are literally NEGATIVE this morn at -0.01%!





  • Sino-Forest CEO Resigns Amid Investigation, Share Suspension
  • Gold Drops as Bernanke Says Growth Intact, Offers No Stimulus
  • Cleanup Under Way to Restore Power to 6 Million Cut by Irene
  • Texas Dust Bowl Drives Cotton Rally as Rick Perry Prays for Rain
  • Hedge Funds Turn Gas Bears After Five Months: Energy Markets
  • Funds Boost Bullish Agriculture Bets as Yields May Slump
  • India’s Grain Glut Shows Need to Allow Exports: Chart of the Day
  • Oil Trades Near Three-Day High; Gasoline Drops as Irene Passes
  • Rice May Rally 22% as Thai Buying Raises Cost, Cuts Exports
  • High Rare-Earth Prices Force Hitachi, Toyota to Find Alternative
  • Rusal Seeks to Complete Debt Refinancing Talks in Four Weeks
  • World Growth to Be Sluggish to 2015, CEBR Says, Cutting Forecast
  • Copper Gains in China as Bernanke Says Economic Recovery Intact
  • Corn, Soybeans May Rise as Dry U.S. Weather Eroding Crop Outlook
  • Rubber Demand Seen ‘Sluggish’ as Economic Recovery Stalls
  • Soybeans Advance to Six-Month High on Declining U.S. Yields
  • U.S. Fuel Pipeline, Terminal Operators Report Outages, Flooding






  • EUROSQUEEZE – Greece up +9.2% this morning and Cyprus +18.1%; perfectly normal price action – and I guess Bernank and Trichet call this le “price stability”; Greece and Cyprus were the 2 worst performing stock markets in the world prior to this move at -37.8% and -59.1% YTD, respectively.
  • We covered our only European short we had left last week (Italy); we have no European longs (stocks, bonds, or FX)




  • ASIA: very mixed overnight with China/Indonesia/Philippines down and Korea/India/Singapore up.








Howard Penney

Managing Director

Fed in a Box


Here’s a note from our Macro team on why any form of incremental easing – if it comes at all – will be a 2012 event.


Conclusion: As we anticipated, Chairman Bernanke did not provide an indication that incremental easing is coming in the short term today in his speech in Jackson Hole. Our view is that if it comes, it is likely a 2012 event.


The most focused-on stock market event of the week in Jackson Hole, Wyoming has turned out to be largely a non-event. The text of Chairman Bernanke’s speech was circulated prior to him giving the speech at 10am eastern this morning. We spent time parsing through his comments and there was really no change from his prior public comments. Specifically, Bernanke stated the following this morning about policy duration:


“In particular, in the statement following our meeting earlier this month, we indicated that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. That is, in what the Committee judges to be the most likely scenarios for resource utilization and inflation in the medium term, the target for the federal funds rate would be held at its current low levels for at least two more years.”


Chairman Bernanke went on to say that while the Federal Reserve is willing to “employ its tools as appropriate to promote a stronger economic recovery in a context of price stability”, he stopped short of indicating what form incremental stimulus would take and on what time frame. Thus, the great QE3 waiting game continues.


Our view of incremental easing remains that the Federal Reserve will be in a proverbial box in terms of incremental easing until at least the end of 2011, if not well into 2012. The primary reason for this is simply that the data will not support further easing.


In the chart below, we graph all-items CPI going back three years and highlight when QE1 was announced and then implemented and also highlight when QE2 was hinted and then implemented. The key takeaway is that inflation was running at much lower levels, largely below 1%, when the first two rounds of quantitative easing were implemented. Currently, this measure of inflation is north of 3% and set to remain at that level through the next couple of quarters based our models.


 Fed in a Box - macro chart 1 8 27 11


Just as pertinent to Fed decision making is employment data. As the chart below outlines, in the prior two periods of quantitative easing, monthly non-farm payrolls witnessed a substantial and sustained decline of at least three months. As of now, monthly non-farm payrolls are still positive, albeit marginally and the last three months, ending in July, have averaged additions of only 72K. This is a substantial decline from the prior three months, which averaged 215K additions. Nonetheless, history suggests that we would need to see negative payrolls for a sustained period prior to incremental easing being implemented.


 Fed in a Box - macro chart2 8 27 11


Stepping back, the majority of Bernanke’s speech today related to the theme of the actual conference, which is the outlook for the longer term prospects for the U.S. economy. Bernanke spent a good portion of the speech addressing his perspective on both the positives and negatives relating to long term economic growth of the United States. The one area which he flagged as an impediment to the economic prospects was fiscal policy. To quote the Chairman:


“. . . the country would be well served by a better process for making fiscal decisions. The negotiations that took place over the summer disrupted financial markets and probably the economy as well, and similar events in the future could, over time, seriously jeopardize the willingness of investors around the world to hold U.S. financial assets or to make direct investments in job-creating U.S. businesses.”


In part, the negotiations around the debt ceiling have been an issue, but, if anything, they characterize a short term impediment. Longer term is the actual issue of structural deficits and debt. While we aren’t necessarily surprised, it would have been valuable to have Bernanke address these issues head on for what they are: long term impediments to U.S. growth. We have oft quoted Reinhart and Rogoff’s data from, “This Time is Different”, which clearly shows that as nation’s debt-to-GDP accelerates beyond 90%, its future growth slows. In the last chart below, we show this graphically for the Japanese economy.


 Fed in a Box - macro chart 3 8 27 11


My colleague Darius Dale wrote a note earlier today discussing monetary policy of Australia. In the note, he quoted Bank of Australia Governor Glenn Stevens who recently noted:


“In terms of macroeconomic ammunition, there would be not that many countries who could say they had more than us in the event of a really big episode.”


We are obviously not big fans of government intervention, but one key risk to consider in a more dire economic scenario, is that the Federal Reserve, unlike Australian counterpart, is largely out of ammo.


Daryl G. Jones

Director of Research


The Week Ahead

The Economic Data calendar for the week of the 29th of August through the 2nd of September is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - llac1

The Week Ahead - llac2



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