• It's Coming...

    MARKET EDGES

    Identify global risks and opportunities with essential macro intel using Hedgeye’s Market Edges.

"Gentlemen Prefer Bonds"
-Andrew Mellon
 
With all due respect to Mr. Mellon's legacy of philanthropy, I'll continue to take the other side of that "safety" trade in 2009. I'm not lending my money to the US government and US Corporates. They have resorted to begging for the world to buy into that old saying... it is un-American, and quite sad altogether.
 
Both US corporate bonds and now US Treasury bonds have gone from shaking in my macro model to breaking. For some time now, I've expressed our short thesis on what Wall Street storytellers call "corporate high yield" (it is actually junk) via a short position in the LQD (corporate bond ETF). I am also short shorter-duration US Treasuries (1-3 year bonds) via the SHY exchange traded fund. While plenty of gentlemen are still long these bonds, they aren't working out for them like they have forever.
 
Today, the US government will issue another staggering $34B worth of 3-year Treasuries. This is the other side of Paulson and Geithner's free money program - it doesn't come out of thin air. As the said leaders of this country continue to socialize Wall Street's losses with debt issuance, bonds are breaking down, and yields are breaking out.
 
As yields breakout from their longstanding low cost of capital Trend line, over-geared business models start to Shake and Break. While it has the same ring to it, do not mistake this for Will Farrell's "Shake and Bake" move in 'Talladega Nights' - this isn't a go to move for those addicted to leverage! This is more like a leading indicator for their investment vehicles getting wrecked.
 
As cost of global capital continues to accelerate and the access to it continues to tighten, you end up with a marked-to-market value of equity that is lower than what it was before. Whether that equity is "Private" or GE's, it doesn't matter - returns go down on said "equity" when your financing costs go up.
 
No, this isn't that complicated to understand, but it's very difficult for those who lust for leverage to explain. For the last 25 years, the cost of capital in America was conveniently politicized (decreased) at every sniff of an economic growth yellow flag. The go to "Shake and Bake" move by many executives was simply to step on the gas, raise more equity, and pile it on top of losing positions, and/or sell it high to some other poor soul at a private equity shop who didn't do global macro who was perfectly willing to earn a fee to do the same...
 
Ask the folks in the fur coats up in Iceland how this scheme ends. When the debt burden starts to Shake and Break, it's over. Iceland's stock market is obviously a gong show that comes into focus from time to time. Yesterday, it crashed for another -15% down move. These Icelandic guys once fancied themselves as capitalists, like the old American kind who are watching West Texas crude oil breakout of its base alongside these higher interest rates (we're long Oil)... but make no mistake, there is nothing that focuses the mind like a good ole fashioned hanging used to in the wild West ... Shake and Break anyone?
 
The worst part about the Shaking and Breaking in the Treasury market is that we have an incompetent team running the US Treasury (or is there anyone on the team - they can't seem to find Timmy any teammates). No wonder why the deer in headlights (Timmy Geithner) has only found one US market savant to support him (Jimmy Cramer).
 
I wrote an Early Look called "Jimmy and Timmy" a few weeks back, and poor Cramer felt obliged to bust out his Shake and Bake move of an op-Ed in the New York Times - for those of you who'd like to hold Jimmy accountable, I am sure you can find a reprint of that wonderful piece of whatever that was...
 
The New Reality is this: The New York Times ran a headline article on the US Dollar's strength yesterday, and that was equally as relevant, from a contrarian's perspective, as Cramer getting air time on making a macro call - when these things happen, in unison, at a bare minimum, get out of the way.
 
As the US Treasury market continues to break down, the US Dollar (and support for Timmy) will wane. This is good. As the US Dollar strength loses its momentum, US stocks should continue to lose their downward price momentum - on the margin, this is one more reason why stocks are looking to put in an immediate term bottom here.
 
To be clear, this is a Trading bottom. Especially in raging bear markets, bottoms are processes, not points. As the US stock market's volume readings continue to decline, and volatility (VIX) continues to dampen, we're getting closer to that Shake and Bake move called the short squeeze.
 
Immediate term price momentum in the US Dollar index will break at the 88.53 line. We have tested and tried the 89.00 US$ Index level on 3 separate occasions in 2009 - a third failure to break-out of that sound barrier will force people to look at this through our cross asset class lenses...
 
My immediate term upside target in the SP500 is 711. If we close above that line in the face of a US Dollar finally being de-valued (and you're short this market), my advice would be to make sure you have your chin strap done up. Above that line, the short seller of US equities is going to Shake and Break.
 
Gentlemen, start your engines...



LONG ETFS

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.

USO - Oil Fund- We bought oil on Friday (3/6) with the US dollar breaking down and the S&P500 rallying to the upside. With declining contango in the futures curve and evidence that OPEC cuts are beginning to work, we believe the oil trade may have fundamental legs from this level.
QQQQ - PowerShares NASDAQ 100 - We bought QQQQ on a down day on 3/2 and again on Friday of last week.

SPY - SPDR S&P500- We bought the etf a smidgen early, yet the market indicated close to three standard deviation oversold.

CAF - Morgan Stanley China fund - The Shanghai Stock Exchange is up +18.5% 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 on a down day. 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

LQD -iShares Corporate Bonds- Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back. Moody's estimates US corporate bond default rates to climb to 15.1% in 2009, up from a previous 2009 estimate of 10.4%.

SHY -iShares 1-3 Year Treasury Bonds- On 2/26 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 $1.2688. The USD is down versus the Yen at 98.3480 and down versus the Pound at $1.3834 as of 6am today.