Great Misunderstandings

“To be great is to be misunderstood.”

-Ralph Waldo Emerson


Great short sellers in this game have one thing in common – they know when to cover.


I was taught how to sell short by doing. That’s not to say I’m the greatest short seller since the Count of Monte Cristo either. That’s simply to say that since 1999 I have had a lot of reps.


Like in any other profession, the more you do of something the more you have an opportunity to make mistakes. It’s your mistakes that make you evolve as a Risk Manager – that’s if you choose to let them teach you.


There have been plenty of opportunities for people in this game to evolve since 2008. Evidently, some have chosen not to. According to S&P data, only 167 of over 19,000 “recommendations” by Old Wall Street’s analysts this year have been “sell.” Professionally embarrassing.


We don’t want to embarrass the competition inasmuch as we want to challenge them. We wake up early every morning with fire in our bellies and a passion to be the change we want to see in this business.


Obviously on Washington’s Wall Street there hasn’t been a lot of that going on for the last 9 months – that’s why we do what we do. We want America to start winning again. Every losing streak ends with a win. It’s time to embrace winners.


Back to Short Covering


I’ve written 2 intraday notes in Q3 of 2011 titled “Short Covering Opportunity” (one on August 8th and one yesterday). Yesterday’s call to cover shorts generated as much questioning and feedback as any time I think I have ever made a call to cover shorts since the thralls of early 2009. This is an important sentiment indicator.


Sentiment is one of the hardest things in this game to quantify. I was on multiple client calls yesterday where, ultimately, what very astute investors wanted to know was what I was “hearing” from other clients. My answer to that question is that there is no answer that is of quantifiable relevance. What any of us are “feeling” or “hearing” about markets subjects our performance to Great Misunderstandings.


As I wrote in yesterday’s Early Look, stock market fund “outflows” and “sentiment” will be the final stage for the 2011 Equities bears to navigate. What I meant by that is those who have been too bullish in 2011 will have redemptions (outflows) and forced to sell at immediate-term bottoms. All the while, quantifiable sentiment indicators will show signals of immediate-term TRADE capitulation.


Here are 3 of those:

  1. II Sentiment Survey Spread (Bulls Minus Bears) = dropped to almost a dead heat in the last week (39% Bulls, 38% Bears) and could easily move to the bearish side (more institutional investors admitting they are bearish at the bottom than bullish – it’s called career risk management into year-end) this week and next.
  2. Volatility (VIX) = immediate-term TRADE overbought yesterday at 43 and is now making a lower-high versus the August 8th Short Covering Opportunity high of VIX 48. Unless you think 2008 starts happening this week (it could!), lower-highs are what they are (bearish on the margin for volatility) and I shorted fear yesterday via a short position in the  VXX.
  3. US Stocks vs US Treasury Bonds = flagged one of their widest performance chasing divergences of the year yesterday (stocks down, bonds up) and, critically, both the UST 10-year yield hit my immediate-term downside target of 1.87% intraday at the same time that the US stock market (SP500) tested lower-lows (then stocks recovered to close at a significantly higher-low).

“Significant” is as significant does. If you are using the wrong models and/or sources to help you navigate this beast of Keynesian Economics gone bad, we’d agree that most bulge bracket sell-side desks aren’t going to be helpful at this stage of the game (unless they are making calls to fade their economist/strategist calls as they “cut estimates” at the bottom).


Remember, bottoms are processes, not points. So you need a rigorous and repeatable Global Macro risk management model that has worked in both 2008 and 2011 to know when to cover. Making the turns “off the lows” matters.


Lastly, after you take advantage of Short Covering Opportunities, you need to quickly, but patiently, get yourself back into position on defense. There are no rules against re-shorting things that you covered lower. Neither are there any Keynesian laws (yet) that prevent you from thinking quickly as you patiently pick your spots.


In Steven Pressfield’s “Gates Of FireAn Epic Novel of The Battle of Thermopylae” (I read it on the beach last week to get me fired up for Q4’s Global Macro battle), Pressfield explains the “role of an officer” in Spartan war as follows:


“He was just a man doing his job. A job whose primary attribute was self-restraint and self-composure, not for his own sake, but for those whom he led by his example.” (“Gates Of Fire, page 112)


To be great in this globally interconnected game takes passion, patience, and time. The greatest of misunderstandings is how quickly we need to evolve the risk management process before it becomes our Waterloo.


My immediate-term support and resistance ranges for Gold, Oil, Germany’s DAX, and the SP500 are now $1, $86.03-90.51, 4, and 1141-1174, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Great Misunderstandings - Chart of the Day


Great Misunderstandings - Virtual Portfolio


The Macau Metro Monitor, September 13, 2011




In an official statement, DSSOPT (Land, Public Works and Transport Bureau) said Wynn's request for a land concession was currently being reviewed and the Administration has yet to make a final decision. DSSOPT added that the procedures concerning this request have yet to be fully completed.


Within 15 days of the land grant being published in the govt gazette, Wynn Macau will also pay US$50MM to a Macau company, Tien Chiao Entertainment and Investment, in exchange for it relinquishing rights to the Cotai site, under an agreement disclosed in Wynn Macau's 2009 listing prospectus.





Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Weekly Latin America Risk Monitor


At Hedgeye, we firmly believe risk is always “on”. Latin American financial markets would certainly attest to this contrarian mantra.



Last week was a rough week for Latin American equity investors, with the region’s indices closing down -2.5% wk/wk on average and falling -3% wk/wk on a median basis. Argentina led the way to the downside, plunging -4.1% wk/wk, while Colombia’s -0.3% wk/wk decline outperformed amid a sea of red.


Falling expectations for further monetary tightening and outright speculation for monetary loosening continues to weigh on Latin American FX markets, with our least favorite – the Mexican peso – leading the way to downside (-2.2% wk/wk vs. the USD). Interest rates across Latin America’s sovereign debt markets continued their recent trend of declines – particularly on the short end of the curve, where monetary policy tends to have a more forceful impact. Interestingly, rates on the long-end of Mexico’s sovereign debt curve backed up fairly meaningfully wk/wk. The -3.8% wk/wk decline in Mexico’s IPC Index and the central bank’s own bearish commentary do not suggest that this widening of Mexico’s yield curve should be interpreted as heightened growth expectations, however.


Latin American sovereign CDS broadly widened wk/wk, with Colombia and Peru leading the way on a percentage basis (up +12.9% and +11.4%, respectively). The recent broad-based trend of higher-highs and higher-lows remains intact.


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Weekly Latin America Risk Monitor - 6



Brazil: Brazilian economic data remains flat-out terrible and has been for much of the last 3-4 quarters, yet Brazilian financial markets continue to signal there is more bad data to come (equities, currency, bond yields – all down wk/wk). The most recent spate of Sticky Stagflation on a reported basis came in the form of slowing real GDP growth (+3.1% YoY in 2Q vs. +4.2% prior) and accelerating CPI (+7.2% YoY in Aug – a six year high – vs. +6.9% prior). Even Brazil’s oft-bandied about domestic demand is slowing, with the Aug services PMI reading ticking down to 52.2 (vs. 53.7 prior).


Obviously with the recent rate cut, combating slowing growth remains atop Brazilian policymakers’ collective agenda. In fact, Finance Minister Guido Mantega said that Brazil has a “great deal of room to maneuver” in both monetary and fiscal policy (though he did confirm that officials would prefer not to use the fiscal stimulus – a much-needed sign of fiscal conservatism). Absent a material unwinding of the European banking system, we continue to believe that much of Brazil’s stimulus efforts will come in the form of interest rate cuts, due to mounting political pressure to lower the country’s real interest rate/debt service burden, as well as the simple fact that the Rousseff administration has shown that it has its hands full with containing nominal expenditure growth in the upcoming federal budget.


An interesting callout that we wanted to flag was the rate of DPGE debt being issued by mid-sized Brazilian banks (R$8.5B YTD vs. R$6.3B in all of ’10). The bonds, which are backed by the country’s depoisit insurance fund, have essentially become a source of last-resort funding for Brazilian lenders after the Banco Panamericano scandal all but evaporated the loan portfolio market. Obviously, we’re a long way away from a crisis, but the risk that mid-sized banks in Brazil face heightened liquidity risk in 2012 is an important one to flag, as government incentives for larger banks to buy bonds or loan books from smaller banks get phased out.


Mexico: Mexican economic data continues to support our bearish intermediate-term view of the Mexican peso and Mexican equities: consumer confidence ticked down in Aug to 93.4 (vs. 95.5 prior); manufacturing PMI ticked down in Aug to 51.5 (vs. 50.1 prior); services PMI ticked down in Aug to 52 (vs. 52.5 prior); and CPI slowed in Aug to +3.6% YoY (vs. +3.6% prior) – which is negative for expectations for tighter monetary policy (MXN-bearish). In fact, of the 47 currencies we track, the Mexican peso’s -9.2% decline vs. the USD over the last two months is only bested by the Polish zloty’s -9.5% decline.


Chile: Sticky Stagflation continues to dominate both headlines and headline economic data in Chile. From a headline perspective, the central bank lowered the top end of its 2011 real GDP growth forecast -75bps to +6.25% YoY. Currently growing at an +8.2% pace YTD, their outlook clearly implies a meaningful drop-off in Chilean economic activity in 2H – which is in line with what our models were signaling much earlier in the year and continue to signal. On the inflation front, CPI accelerated in August, supportive of the central bank’s recent statement that it was “too early to cut interest rates”. Elevated rates of reported inflation are likely to continue to keep many central banks in a box and prevent them from easing monetary policy in a proactive manner and Chile is no exception in this regard.


Colombia: Political pressure on Colombia’s central bank to cut interest rates continues to grow and a marginally dovish inflation reading for Aug only amplified those claims (CPI slowed to +3.3% YoY vs. +3.4% prior). President Juan Manuel Santos blatantly asked the central bank to refrain from raising interest rates early last week and subsequently tweeted, “There is no reason to raise rates.” Moreover, he publically stated that he “remains concerned about the strength of the [Colombian] peso” (COP). While Colombia’s 2yr sovereign debt yields have fallen -66bps over the last three months, they remain a regional outlier from a YTD perspective (up +57bps) and this tug-of-war should eventually culminate with the central bank giving in to the President’s demands (our models have Colombian GDP growth slowing in 2H11).


Darius Dale


European Risk Monitor: Blood in the Ring

EUR/USD breaks TREND and TAIL as Greek Concerns Flair


If we were to relate the European Sovereign Debt contagion to a boxing match, Germany (represented as the long-standing heavyweight champion) would be facing-off against numerous competitors in a league that includes the countries of France and the PIIGS, the latter of which collectively belong to the featherweight and welterweight divisions. The obvious mismatch would see Germany handily defeat the PIIGS—blood would spray deep into the 10th row and the sea of German fans would cheer!


Yet now consider that while Germany would happily throw the knock-out punch to see at least its featherweight competition never rise to its feet again (call them Greece, Ireland, and Portugal), Germany has ulterior motives, influence both by its fan club (the German populous and Merkel’s reelection efforts) and the Boxing Commission (think: ECB and Eurocrats from Brussels).


Firstly, Germany intuitively understands that it’s happy to beat up on its competition, but ultimately if it wants to fill the seats (think: export markets) it needs competition week in and week out. Secondly, Germany is being pressured by the Boxing Commission that so long as it doesn’t “finish off” its competition, the Commission will help split the PIIGS’ medical bills (think: bailout packages; SMP bond purchases; and EFSF) to ensure there are future rounds to fight.  


Germany, however, soon realizes that the competition is so mismatched that its weakest competition can hardly stand up straight, let alone see straight to protect (help) itself, and upset with the rising medical costs to “fix” its competition, the share of which is increasingly rising. Further, the game is so mismatched, that Germany fears it will lose not only its fan base who cannot justify the ticket price for such a match, but also that its poor competition will drag down its championship form (GDP).


Germany, the Boxing Commission, and the badly injured adversaries are at an impasse--what should be done?  German fans aren’t returning (Merkel’s popularity tanking); Greece, Ireland, and Portugal are in the ICU; and Spain and Italy need extra doses of morphine to deal with the pain.  The Boxing Commission and Germany are at odds. Germany’s only other competition, France, has caught a nasty cold with whispers of pneumonia. While Germany isn’t willing to let the league disintegrate, it’s also not in the position to continue to pay the lion’s share of the medical bills to fight another week. And so far Boxing Commissioner (Trichet) has yet to indicate that he’s willing to cover the rising medical bills should Germany skirt the bill. 


On the 29th of September the German team will hold a vote to see if they want to continue to pay the medical bills to insure future matches. Heading into the vote, many of the team’s strong voices feel that paying the bills accomplishes little: even with a healthy Greece, Ireland, and Portugal, there’s no competition for Germany. Further, fears percolate that should France be down and out for a long period and Italy and Spain require care, Germany will not be able to fit the bill. The larger question before the team remains: is it a larger risk for Germany to let the league disintegrate and lose its championship form, or continue to support its competition at a heavy cost so it at least has a body to throw punches at in the ring?  The fans seem unwilling to let this decision linger.


The “boxing tale” above presents some of the larger issues regarding European sovereign debt contagion and Germany’s leading position in the issue, all of which have heightened since the German government considered the impact of a Greek sovereign default on its banks over the weekend. While there are numerous moving parts in crafting “solutions” to this contagion issue, including political conflicts and solving for known unknowns on the sovereign and banking sides, what’s clear is that Germany’s vote on the 29th, a change in the ECB’s willingness or unwillingness to provide more fiscal support, and/or market forces may all have significant impact on the direction of this contagion.


We’re not currently invested in Europe via our Hedgeye Portfolio and don’t expect a quick fix to European debt and banking contagion risks and expect to see more downside in European capital markets from here as:

  1. Eurocrats refuse to accept default of member countries
  2. The EU Constitution does not account for measures to let a member country leave the Eurozone
  3. Stronger nations will likely vote against Eurobonds
  4. Countries (like Finland) will demand collateral for funds posted to the EFSF which will pinch the Greek state which doesn’t have the assets to cover the EFSF
  5. There’s no European-wide banking plan to recapitalize/write down peripheral exposure, or simply to let banks fail

Obviously the region’s common currency hangs in the balance. Our immediate term TRADE levels on the EUR-USD cross are $1.36 to $1.39. As Keith has stated recently, from “The Correlation Risk perspective, this cross remains the most important relationship in all of Global Macro. We like to say, “get the EUR/USD pair right and you’ll get a lot of other things right.” Both the TAIL ($1.39) and TREND ($1.43) for the Euro have broken expeditiously here in September.”


As we show in the 3 year chart below, we don’t see any longer term support in the EUR-USD until $1.20. From a calendar perspective, the Germany’s EFSF vote at the end of the month remains a critical catalyst, as does Troika’s report on Greece’s fiscal consolidation measures, the report of which is expected to come out at the end of the month and the findings of which will determine if Greece receives its next tranche of funding of 8B EUR, monies it’s desperately relying on to pay its bills.


European Risk Monitor: Blood in the Ring - 1. monday


European equity indices, especially banking stocks took it on the chin in August and are off to a bad start in September. The heavy weight German DAX is down a full -33% since its early May highs!  The point here is that no country is immune despite how impressive its right hand (balance sheet) is.


Below we include the Weekly Risk Monitor report from our Financials sector head Josh Steiner. It shows in particular the rising risk premium, reflected by CDS spreads, across the sovereigns and banks of Europe. Directly below we refresh our chart of 10YR yields of the periphery.  In particular, Italy has move back to 5.50%, and therefore is flirting closer to the 6% breakout level. Italy’s 54.5B EUR austerity program, which could pass the lower house as soon as this week, is weighing on this yield—both that the package gets passed and the terms are bold enough to arrest the country’s severe debt levels. Whether or not the Chinese come to Europe or Italy's aid (FT rumors today), we’re sure there are no short term fixes to Europe's  debt "crisis", especially if Eurocrats have their way.


European Risk Monitor: Blood in the Ring - 2. monday



European Financials CDS Monitor – Banks swaps also widened in Europe last week.  35 of the 39 swaps were wider and 4 tightened.   The average widening was 5.9%, or 25 bps, and the median widening was 21.3%.  Tightening was concentrated in the Greek banks, where swaps are already trading well over 1,000 bps. 


European Risk Monitor: Blood in the Ring - j1


European Sovereign CDS – European sovereign swaps went parabolic last week.  All the countries we track, with the exception of Ireland, hit a new high as of this morning.  Greek swaps are up 56% WoW as of this morning, rocketing to 3500 bps.  French CDS rose 23% WoW to a new high of 191 bps. 


European Risk Monitor: Blood in the Ring - j2


European Risk Monitor: Blood in the Ring - j3


Matthew Hedrick

Senior Analyst





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