The Good News

"I'll study and get ready, and then the chance will come."
-Abraham Lincoln


After a statistically significant weather aberration here in the North East, it's a little chilly here in the New Haven office this morning. However, in preparation to write this note I am warming up to the idea of getting invested again in America.


No, I'm not interested in investing in them bubbly US Treasuries that everyone from China to Japan is chalk full of (Mr. Buffett, thank you for having our back on that bond bubble call in your annual letter). And no, I'm definitely not getting into them butter fly wing nut derivative things that the sell side taped together and slapped a ticker on either. I'm thinking plain vanilla US stocks, for a "Trade"...

Do not mistake this call as a "Trend" - the intermediate Trend in the US market will likely remain a bearish one for a long time now... but everything in markets has a time and a price. Now is the time to be buying American again, for a Trade.

The US stock market is seeing its lowest prices since 1996 (down -22.5% for 2009 to-date), taking those who "invested for the long run" in October of 2007 down -55% from being walked off the Investment Banking Inc. cliff of the willfully blind. The prices I am seeing are definitely compelling - if you can't at least cover shorts here, I don't know when you'll ever be able to.

Why is it that most institutional investors love to buy everything on sale in this country other than stocks? I'd like to say that I do not know... but anyone who has spent more than a year in this business knows... it's sad and its silly, but its true - the art of managing money is having money to manage - and if you can outperform whatever benchmark your marketing department has established for you, heck... just tone it down and start buying after the brave soul next to you does.

I took our cash position down from 76% to 68% yesterday. I took my Asset Allocation to US Equities back up to 17% (I was at 9% at month end) and, to be clear, I am buying American for a Trade. Trade? Yes, my name is Keith McCullough - I am a risk manager, and I trade.

When you are locked under the dominating intermediate "Trend" (3 months or more) of a bear market, pretty much the only time you can really make money is by buying things when no one else is ALLOWED to. For all of the preaching that I do on proactively managing the risk associated with your factor exposures, the reality is that a lot of people out there still manage money based on the reactive relative performance model of chasing price. Price momentum is a one factor model - and it's not that complicated to predict.

I use a multi-factor risk management model that has 27 macro inputs. The factors run across asset classes and geographies. The factors are dynamic. As prices change, I do. This is not Keynesian. This is simply the only way I can attempt to remove emotion, and remain objective.

Do I make mistakes? Of course I do. I wouldn't be down -1.7% (I was down -0.1% yesterday) in our Asset Allocation Portfolio for 2009 to-date if I didn't. But when it comes to the big macro moves, I rarely get caught with my pants down as those massive tides roll out.

As of yesterday's close, my macro model has immediate term "Trade" downside in the SP500 and Nasdaq of less than 1% versus immediate term upside of +8%. That's the best risk reward scenario I have seen in terms of the US market's prices since November the 20th, 2008. Are things nasty out there? You bet your Madoff they are - this -22.5% down move to start 2009 is only rivaled by the years of 1933 and 1938 in terms of the expediency of the decline.

The savings rate in this country just shot up yesterday to 5%. The US savings rate was almost -800 basis points lower in Q3 of 2005 (at -2.7%, Americans had a NEGATIVE savings rate). On its own, this has been a massively relevant drag on consumer spending in America (close to $900B from the peak of negative US savings to now). Given that consumer spending represents almost 70% of American GDP, the slowdown that has been marked to market in your stock portfolios is very much a fundamental one. The good news here is that this is no longer new news...

There are two things that really matter to an American's economic confidence interval: the value of their homes and price of their portfolios. My Partner, Howard Penney, has done some great work on US housing prices as of late, and without belaboring the analysis that we have written on to support this (see macro portal at www.researchedgellc.com), our main conclusion here that matters when it comes to the values of US homes is that they will start to decline at a lesser rate come Q2 of this year. The good news here is that no one agrees with us that this will be new news...

If house prices begin to stabilize, and the US stock market starts to decline at a lesser rate... that will be very good news. In the meantime, study the people around you... "get ready... and then your chance will come." Buy low.

Best of luck out there today.


CURRENT ETF ALLOCATION

LONG ETFS

  • QQQQ - PowerShares NASDAQ 100 - We bought QQQQ on a down day yesterday. The Nasdaq closed down 54.99 points yesterday, or -3.99%, to 1,322.85.

  • EWA - iShares Australia-EWA has a nice dividend yield of 7.54% on the trailing 12-months.  With interest rates at 3.25% (further room to stimulate) and a $26.5BN stimulus package in place, plus a commodity based economy with proximity to China's H1 reacceleration, there are a lot of ways to win being long Australia.

  • SPY - SPDR S&P500- We bought the etf perhaps a smidgen early with the S&P500 at 715, yet will take it at a discount.  The market is also close to 3 standard deviations oversold.

  • CAF - Morgan Stanley China fund - The Shanghai Stock Exchange is up +14.95% for 2009 to-date. We're long China as a growth story, especially relative to other large economies. We believe the country's domestic appetite for raw materials will continue throughout 2009 as the country re-flates. From the initial stimulus package to cutting taxes, the Chinese have shown leadership and a proactive response to the credit crisis.

  • GLD - SPDR Gold- We bought gold last Thursday with the S&P500 in the red and gold down. We believe gold will re-find its bullish trend.

  • TIP - iShares TIPS- The U.S. government will have to continue to sell Treasuries at record levels to fund domestic stimulus programs. The Chinese will continue to be the largest buyer of U.S. Treasuries, albeit at a price.  The implication being that terms will have to be more compelling for foreign funders of U.S. debt, which is why long term rates are trending upwards. This is negative for both Treasuries and corporate bonds.

  • DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.

  • VYM - Vanguard High Dividend Yield -VYM yields a healthy 4.31%, and tracks the FTSE/High Dividend Yield Index which is a benchmark of stocks issued by US companies that pay dividends that are higher than average.
SHORT ETFS
  • SHY -iShares 1-3 Year Treasury Bonds- On Thursday of last week we witnessed 2-Year Treasuries climb 10 bps to 1.09%. Anywhere north of +0.97% moves the bonds that trade on those yields into a negative intermediate "Trend." If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yield is inversely correlated to bond price, so the rising yield is bearish for Treasuries.

  • UUP - U.S. Dollar Index - We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. The Euro is up versus the USD at $1.2632. The USD is up versus the Yen at 97.6740 and down versus the Pound at $1.4055 as of 6am today