"You don't need a weather man / to know which way the wind blows."
Bob Dylan
An Inversion is the act of changing or being changed from one position, direction, or course to the opposite. In the art of using the breath to control the mind and body; the practice of Inversion allows for maximum brain stimulation.
The brain is responsible for processing all information we gather over our life time and blockages of blood flow to the brain can sometimes result in lack of clarity or something even worse. The inversion combats the lack of clarity by forcibly flushing old blood out of the brain cells, replacing it with freshly oxygenated, nutrient rich blood coming directly from its source, the heart.
Yesterday, Bernanke performed the economic equivalent of an inversion. It is very clear now where we are going, the Chairman put the US $ on its head giving some clarity to where we are headed.
At any given time at Research Edge we are managing multiple themes to help understand and invest in the global MACRO world. Of all the themes we are currently writing about none is more significant in the 2009 GLOBAL MACRO environment than the inverse correlation between the price of the US Dollar Index and US Equities. We call it "Breaking the Buck."
Our "Break the Buck" theme was made clear last week when the US Dollar posted its first week over week decline since the week of February 2, 2009. In the face of the US Dollar Index dropping -1.4%, the S&P500 powered ahead for a 10.7% move. The only other time this happened in 2009 was the week of February 2nd. In that week the US$ was down -0.66%, and it was also the last week the S&P 500 had positive performance of consequence, with the S&P 500 improving 5.2%. I don't need to repeat what happened yesterday.
In short, the consequences of Chairman Bernanke's actions and that of a weak US$ will inflate assets domestically and make US$ denominated debt more attractive to foreign buyers. The re-flating of US assets will help appease the Chinese, bolster the US housing market and shed a light at the end of the tunnel on the 14-month U.S. recession, which we have been calling the "Great Recession"!
"Breaking the Buck" has positive implications for anther consumer related theme we have written about - M E G A. If consumers can regain confidence that their Assets (A = 401k and home prices) will stop declining the world will be a better place.
At this point I know what you are thinking. No, this is not a long term solution! Re-flating assets has been tested and tried, and is an intermediate term solution. We will need to deal with the consequences down the road and yes, it ultimately could end badly. Right now, we remain short the US$!
As Chairman Bernanke is "Breaking the Buck," several other factors are starting to turn positive for the market. First, yesterday's move in the S&P 500 makes seven of the nine sectors bullish on TRADE and only one sector bullish on TREND; Technology (XLK).
The two sectors that are not bullish on TRADE (Healthcare and Utilities) appear to be are going nowhere; however, Consumer Staples (XLP) was the only sector to close down yesterday. Second, the VIX is broken on both durations; TREND and TRADE. Over the next week, we see the VIX breaking down through the 40 line, headed to 37.33. Third, volume was massive yesterday, up +47% day-to-day; the biggest volume day of 2009. In the MACRO models, the surge in volume is very bullish, highlighting conviction and is a signal that confirms the price move above our critical SHARK line. Along with volume, breadth (advance/decline line) continues to expand, as Industrials (XLI) joined the sectors in a positive TRADE. Yesterday, we covered our short on the XLI.
Lastly, the M&A cycle which started in Healthcare has now moved rather convincingly to technology. We think the Technology M&A cycle is just beginning and two ways to play it are by owning Yahoo! (YHOO) and Monster Worldwide ( MWW).
As we wrote about on March 10th, to gain Alpha in the current environment, you need to beta shift away from the "safety play." Over the past month, the top three performing sectors are the XLF (Financials), XLY (Consumer Discretionary) and the XLK (Technology). The corresponding beta on those three sectors is 1.8, 1.4 and 1.1, respectively. Yesterday, with a beta of 0.64, the XLP (Consumer Staples) showed a massive negative divergence. Driving incremental performance in the high beta sectors are numerous examples where fundamentally, things are looking less bad in 1Q09 from 4Q08. We continue to like early cycle Technology, Consumer Discretionary and Gaming stocks.
Function is disaster; finish in style.
Howard Penney
LONG ETFS
RSX - Market Vectors Russia-The Russian macro fundamentals line up with our quantitative view on a TREND duration. Oil has benefited from the breakdown of the USD, which has buoyed the commodity levered economy. We're seeing the Ruble stabilize and are bullish Russia's decision to mark prices to market, which has allowed it to purge its ills earlier in the financial crisis cycle. Russia recognizes the important of THE client, China, and its oil agreement in February with China in return for a loan of $25 Billion will help recapitalize two of the country's important energy suppliers.
DJP - iPath Dow Jones-AIG Commodity -With the USD breaking down we want to be long commodity re-flation. DJP broadens our asset class allocation beyond oil and gold.
XLK - SPDR Technology-Technology looks positive on a TRADE and TREND basis. Fundamentally, the sector has shown signs of stabilization over the last several weeks. Semiconductor stocks, which are early cycle, have provided numerous positive data points on the back of destocking in the channel and overall end demand appears to be stabilizing. Software earnings from ADBE and ORCL were less than toxic this week and point to a "less bad" environment. As the world stabilizes, M&A should pick up given cash rich balance sheets in this sector and an IBM/JAVA transaction may well prove the catalyst to get things going.
EWZ - iShares Brazil- The Bovespa is up 6.9% YTD. President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt -leading to an investment grade credit rating. Brazil cut its benchmark interest rate 150bps to 11.25% on 3/11 and will likely cut again next month to spur growth. Brazil is a major producer of commodities. We believe the country's profile matches up well with our re-flation theme: as the USD breaks down global equities and commodity prices will inflate.
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 +24.4% 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
EWJ - iShares Japan - Into the strength associated with the recent market squeeze, we re-shorted the Japanese equity market rally via EWJ. This is a tactical short; we expect the market there to pull back when reality sinks in over the coming weeks. Japan has experienced major GDP contraction-it dropped 3.2% in Q4 '08 on a quarterly basis, and we see no catalyst for growth to return this year. We believe the BOJ's recent program to provide $10 Billion in loans to repair banks' capital ratios and a plan to combat rising yields by buying treasuries are at best a "band aid".
EWU - iShares UK -The UK economy is in its deepest recession since WWII. We're bearish on the country because of a number of macro factors. From a monetary standpoint we believe the Central Bank has done "too little too late" to manage the interest rate and now it is running out of room to cut. The benchmark currently stands at 0.50% after a 50bps reduction on 3/5. While the Central Bank is printing money and buying government Treasuries to help capitalize its increasingly nationalized banks, the country has a considerable ways to go in the face of severe deflation. Unemployment is on the rise, housing prices continue to fall, and the trade deficit continues to steepen month-over-month, which will hurt the export-dependent economy.
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- It performed terribly yesterday, closing down as a sector despite the market melt-up.
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 $1.3496. The USD is down versus the Yen at 95.7400 and down versus the Pound at $1.4291 as of 6am today