"Learning without thought is labor lost."
-Confucius
If there is one thing that we think about most here every morning at Research Edge, it's thinking about what we haven't thought about. We trust the process that real-time marked-to-market prices are leading indicators. As prices change, we force ourselves to ask the questions that need to be asked.
Unless they are "marked-to-model", prices in this business don't lie - people do. Sometimes real-time prices can actually tell you that someone either has inside information, or thinks that they do. That isn't the New Reality; the game has always been played this way. However, today's prices are as interconnected across geographies and asset classes as they have ever been. With every new data set of prices, there are macro signals that reveal themselves as having a dominating impact on your portfolio.
As market prices change, the patterns of behavior associated with those changing prices become more or less predictable, within a few standard deviations, on an immediate term basis. As Howard Penney pointed out in Friday's Early Look, one of the most dominant factors in Global Macro in 2009 has been the inverse correlation between the price of the US Dollar Index and US Equities.
As unpatriotic as it has sounded, our recommended investment solution to the US Financial System's crisis has been to "Break The Buck." No, this is not a long term solution. This, like many others that have been tested and tried, is an intermediate term one. Until proven otherwise, it has been one of the few solutions that has worked in 2009. The problem is that it has only worked for 2 separate weeks of this new year!
Last week the US Dollar posted its first week over week decline since the week of February 2nd. In the face of the US Dollar Index dropping -1.4%, the SP500 squeezed the consensus short selling community for a hefty +10.7% move. For the week of 2/2/09, the US$ was down -0.66%, and that was the last week of consequence that the US stock market shot higher, with the SP500 melting up +5.2% in that same week.
This morning, the US Dollar is breaking down further to 86.94, and looky here... the SP500 Futures are indicated UP! There is no irony in this relationship folks. The beauty of being price dependent is that we don't have to get emotional about this or endure some academic and qualitative debate. The New Reality of 2009 is that the only way to get the US stock market to "re-flate" is by breaking the buck's upward price momentum.
This certainly doesn't rhyme with the US government's West Wing consensus, which is all of a sudden choke full of Keynesian Big Government Interventionists. This is much more old school Irving Fisher type pin action, playing out almost to his textbook's form. But where is there room in the Big Rubin ego of one Larry Summers to wrap his head around this? Does Big Leverage Rubinite Junior, Timmy Geithner, understand what's going on here? Is he ALLOWED to learn without thinking?
These are all very critical questions that I hope President Obama inspires his team to ask - what is his economic team NOT thinking about? This objective thinking process was certainly part of Obama's campaign promise, but the man is definitely under fire now to show the country that his inclusive management process includes allowing his financial advisors to learn as they think.
Hope, of course, much like "marked-to-model" investment banking accounting, is not a credible investment process. After listening to both Summers and Christina Romer (Obama financial advisor) on the Sunday morning talk shows yesterday, I was reminded of as much and altogether happy that I took last week's US market strength as an opportunity to book gains. From an Asset Allocation standpoint, I am now back into my crouch, preparing for the US market's next big move.
This morning's US Futures indicate a higher open, but the big move in this market is behind us now. I was in the game on the long side in anticipation of a vicious Bear market TRADE. I have chosen NOT to keep a TRADE a trade in this business enough times to remind me that I shouldn't break my self-imposed rule. Keep a TRADE a trade.
The US Dollar is now broken from an immediate term TRADE perspective. That line of support now becomes resistance at 87.30, and we can breakout above it as fast as we broke down through it. From an intermediate term TREND perspective, the buck has tremendous support down at 85.24. Until that line is broken alongside the US government's long standing and dogmatic "strong Dollar" policy, I don't see the return of a bull market in US stocks any time soon.
My immediate term upside target for the SP500 is now 768. A close above that line would put this market in a bullish immediate term TRADE position. If we continue to close below that line, I'll proactively predict the SP500 has -6% downside from Friday's close to 711.
As prices change, I will. Prices Rule.
Best of luck out there this week,
KM
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.
CAF - Morgan Stanley China fund - The Shanghai Stock Exchange is up +18.2% 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%.
SHORT ETFS
DIA -Diamonds Trust-We re-shorted the DJIA on Friday (3/13) on an up move as we believe on a Trade basis, the risk / reward for the market favors the downside.
EWW - iShares Mexico- We're short Mexico due in part to the country's dependence on export revenues from one monopolistic oil company, PEMEX. Mexican oil exports contribute significantly to the country's total export revenue and PEMEX pays a sizable percentage of taxes and royalties to the federal government's budget. This relationship is unstable due to the volatility of oil prices, the inability of PEMEX to pay down its debt, and the fact that PEMEX's crude oil production has been in decline since 2004 and is down 10% YTD. Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.
IFN -The India Fund- We have had a consistently negative bias on Indian equities since we launched the firm early last year. We believe the growth story of "Chindia" is dead. We contest that the Indian population, grappling with rampant poverty, a class divide, and poor health and education services, will not be able to sustain internal consumption levels sufficient to meet targeted growth level. Other negative trends we've followed include: the reversal of foreign investment, the decrease in equity issuance, and a massive national deficit. Trade data for February paints a grim picture with exports declining by 15.87% Y/Y and imports sliding by 18.22%.
XLP -SPDR Consumer Staples- 2nd best performing sector on Friday, yet is broken on a trade and trend duration.
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 $1.2972. The USD is up versus the Yen at 98.2400 and down versus the Pound at $1.4173 as of 6am today.