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Available Cash

This note was originally published at 8am on November 23, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Desire is proof of the availability.”

-Robert Collier

 

As I grind through the end of Sylvia Nasar’s “Grand Pursuit” this weekend, I’m looking forward to the most talked about book in the high-halls of intellectual hockey-head thought – Dan Kahneman’s recently published “Thinking, Fast and Slow.”

 

I love everything about that title. Being an amateur writer whose first English paper at Yale was deemed “un-grade-able”, I think the punctuation (using a comma) of the title provides a lesson for everyone in this business. Thinking is important – sometimes you need to do it fast. Sometimes you need to do it slow. Risk waits for no one.

 

Thinking back to his prior works in the 1970s (a period Bernanke should familiarize himself with), Kahneman (and Tversky) did a psychological experiment called the “Availability Heuristic” which essentially “operates on the notion that if you can think of it, it must be important.” (Wikipedia)

 

Can you think of anything going on in Europe right now?

 

Of course you can. That’s all the financial media talks and writes about every day. South Park’s Trey Parker must have Blame Europe in the works, right?

 

Right?

 

How many Old Wall Street meetings and/or interviews have you observed in recent months where the person speaking ends what they are saying with the word “right?”

 

Right?

 

That’s the business we are in. Whether people want to admit it or not, groupthink in our economic outlooks, politics, and choice of words is pervasive. Too Big To Think?

 

Back to the Global Macro Grind

 

The reason why Global Equities have been going down since Q1 of 2011 has a lot more to do with Global Growth Slowing than it does anything else. If you got US and Global Growth right at the beginning of 2011, you’re having a good year.

 

This morning’s Global Macro data continues to hammer home the deep simplicity of this fundamental research point:

  1. China’s flash HSBC Producer Manufacturing Index (PMI) dropped again, sequentially, to 48 in NOV vs 51 OCT
  2. Hong Kong’s Consumer Price Inflation (CPI) remained elevated at +5.8% y/y in OCT (inline with SEPT)
  3. Germany’s manufacturing PMI dropped again, sequentially, to 47.9 in NOV vs 49.1 OCT

Oh, that last point is about Europe. Right.

 

Well the inconvenient truth is that Globally Interconnected Macro markets aren’t all about Europe. Asian Growth Slowing and USD Correlation Risk would be 2 of the Top 3 (next to Europe) that any objective global analyst has to be proactively prepared for.

 

Get the US Dollar right, and you’ll get The Correlation Risk right.

 

On our immediate-term TRADE duration, here’s how inversely correlated the US Dollar Index remains to the big stuff moving markets:

  1. SP500 = -0.83
  2. EuroStoxx600 = -0.89
  3. CRB Commodities Index = -0.79
  4. 10-year US Treasury Yield = -0.72

Anyone who trades stocks or commodities gets points 1 through 3, but point 4 is a stealth reminder that the US Bond Market had US Growth Slowing right throughout the entire US Equity and Global Commodity head-fake rallies of October 2011.

 

With the US Dollar strengthening again intraday yesterday, that’s partly why I sold my Gold position and took my allocation to Cash in the Hedgeye Asset Allocation Model back up to 67% from 58% day-over-day.

 

Gold is one of the most over-owned, over-valued, “asset classes” left in Global Macro markets.

 

Right?

 

With Gold’s immediate-term TRADE correlation to the US Dollar becoming more intense (-0.49 last) and the hedge fund community under liquidation pressure again here in November (the industry doesn’t do well when stocks and commodities stop going up), booking a small -3.6% loss in Gold makes me more comfortable than taking a predictably larger one.

 

In the meantime, Available Cash remains King. That’s a 2011 Availability Heuristic you’ll be talking about over Thanksgiving dinner.

 

My immediate-term support and resistance ranges for Gold (bearish TREND resistance = $1724/oz), Brent Oil (Bearish Formation), France (Bearish Formation), Hong Kong (Bearish Formation), and the SP500 (Bearish Formation) are now $1670-1724, $105.67-109.59, 2801-3003, 17801-18556, and 1177-1198, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Available Cash - Chart of the Day

 

Available Cash - Virtual Portfolio


MONDAY MORNING RISK MONITOR: EU BANK SWAPS A SEA OF RED

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* Last week was a sea of red across our risk monitor categories. Most notable were the following:

 

* The TED spread made another new YTD high at 50.3 bps. As a reminder, while this is well below 2008 for structural reasons, the important consideration here isn't the level, but the trend. Higher TED spread prints continue to indicate risk in the banking system is still rising. Until we see a cooling off in the TED spread investors should remain defensively positioned, as the systemic risks have been properly addressed.

 

*Credit default swaps for Eurozone countries were generally wider. German swaps were particularly noteworthy, widening by 15% to 111 bps.

 

*Credit default swaps for European banks widened 16% last week, on average. There is a sharp divergence between the Scandinavian/UK/Swiss banks and the rest of the group.

 

* Short-term Silver Lining: Our macro quantitative model indicates that in the short term (TRADE), there is currently around 2 times more upside than downside in the XLF (5.2% upside vs. 2.5% downside).

 

Financial Risk Monitor Summary (Across 3 Durations):

  • Short-term (WoW): Negative / 0 of 11 improved / 7 out of 11 worsened / 4 of 11 unchanged
  • Intermediate-term (MoM): Negative / 0 of 11 improved / 9 of 11 worsened / 2 of 11 unchanged
  • Long-term (150 DMA): Negative / 1 of 11 improved / 8 of 11 worsened / 2 of 11 unchanged 

MONDAY MORNING RISK MONITOR:  EU BANK SWAPS A SEA OF RED - Summary2

 

1. US Financials CDS Monitor – Bloody. Swaps widened for all 27 major domestic financial company reference entities last week.   

Widened the most vs last week: BAC, PRU, XL

Widened the least vs last week: COF, CB, AGO

Widened the most vs last month: GS, MS, PRU

Widened the least vs last month: MBI, AGO, MMC

 

MONDAY MORNING RISK MONITOR:  EU BANK SWAPS A SEA OF RED - US  cds

 

2. European Financials CDS Monitor – A Sea of Red. Bank swaps were wider in Europe last week for 35 of the 40 reference entities. The average widening was 5.4% and the median widening was 16.1%.  Bank swaps remain below 300 in Norway, Sweden, Switzerland, and the UK.  Across the 29 banks in Austria, Belgium, Denmark, France, Germany, Greece, Italy, Portugal, Russia, Scotland, and Spain, there is only one bank with swaps trading below 300 bps. While no one needs reminding that the systemic risk in the European banking system is extraordinarily high, this morning's data serves as a reminder nonetheless.  

 

MONDAY MORNING RISK MONITOR:  EU BANK SWAPS A SEA OF RED - EURO  cds

 

3. European Sovereign CDS – European sovereign swaps mostly widened last week. German sovereign swaps widened by 15.3% (+15 bps to 111.5) and American swaps by 7.8% (+4 bps to 55.5).

 

MONDAY MORNING RISK MONITOR:  EU BANK SWAPS A SEA OF RED - Sovereign 1

 

MONDAY MORNING RISK MONITOR:  EU BANK SWAPS A SEA OF RED - Sovereign 2

 

4. High Yield (YTM) Monitor – High Yield rates rose 39 bps last week, ending the week at 8.45 versus 8.06 the prior week. 

 MONDAY MORNING RISK MONITOR:  EU BANK SWAPS A SEA OF RED - High Yield

 

5. Leveraged Loan Index Monitor - The Leveraged Loan Index fell 15 points last week, ending at 1572.

 

MONDAY MORNING RISK MONITOR:  EU BANK SWAPS A SEA OF RED - LLI

 

6. TED Spread Monitor – The TED spread rose 1.5 points last week, ending the week at 50.3 this week, a new YTD high.

The TED spread has eclipsed its highs from April/May 2010 and now stands at its highest level since May 2009.  

 

MONDAY MORNING RISK MONITOR:  EU BANK SWAPS A SEA OF RED - TED spread

 

7. Journal of Commerce Commodity Price Index – The JOC index fell 1.4 points, ending the week at -24.16 versus -22.78 the prior week. Negative commodity momentum is reflective of the strong Dollar, which is benefiting from the weak Euro.

 

MONDAY MORNING RISK MONITOR:  EU BANK SWAPS A SEA OF RED - JOC

 

 8. Greek Yield Monitor – The 10-year yield on Greek debt rose on Thursday to 2988 bps, a new all time high, but retreated 1 bp on Friday and ended 168 bps higher over last week at 2987 bps.

 

MONDAY MORNING RISK MONITOR:  EU BANK SWAPS A SEA OF RED - Gr Bonds

 

9. Markit MCDX Index Monitor – Worsening. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 14-V1. Last week spreads widened, ending the week at 193 bps versus 183 bps the prior week.

 

MONDAY MORNING RISK MONITOR:  EU BANK SWAPS A SEA OF RED - MCDX

 

10. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production. Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion. Last week the index fell 88 points, ending the week at 1807 versus 1895 the prior week.

 

MONDAY MORNING RISK MONITOR:  EU BANK SWAPS A SEA OF RED - Baltic Dry

 

11. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure.  Last week the 2-10 spread tightened to 170 bps, 3 bps tighter than a week ago.

 

MONDAY MORNING RISK MONITOR:  EU BANK SWAPS A SEA OF RED - 2 10

 

12. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 5.2% upside to TRADE resistance and 2.5% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR:  EU BANK SWAPS A SEA OF RED - XLF macro quant setup

 

Margin Debt in October


We publish NYSE Margin Debt every month as soon as it’s released. 

 

The chart below shows the S&P 500 overlaid against NYSE margin debt going back to 1997. In this chart both the S&P 500 and margin debt have been inflation adjusted (back to 1990 dollar levels), and we’re showing margin debt levels in standard deviations relative to the mean covering the period 1.

 

While this may sound complicated, the message is really quite simple. First, when margin debt gets to 1.5 standard deviations or greater, as it did this past April, that has historically been a signal of extreme risk in the equity market - the last two times it did this the equity market lost half its value in the ensuing period. We flagged this for the first time back in May of this year. The second point is that margin debt trends tend to exhibit high degrees of autocorrelation. In other words, the last few months’ change in margin debt is the best predictor of the change we’ll see in the next few months. This is important because it means that margin debt, which retraced back to +0.43 standard deviations in September, still has a long way to go. We would need to see it approach -0.5 to -1.0 standard deviations before the trend reversed. There’s plenty of room for short/intermediate term reversals within this broader secular move, as we saw in October’s print of +0.78 standard deviations. But overall, this setup represents an ongoing material headwind for the market.  

 

One limitation of this series is that it is reported on a lag.  The chart shows data through October.

 

MONDAY MORNING RISK MONITOR:  EU BANK SWAPS A SEA OF RED - Margin Debt

 

Joshua Steiner, CFA

 

Allison Kaptur

 

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Dynamic Risk Management

“Schumpeter’s ambition was to replace static with dynamic economic theory.”

-Sylvia Nasar

 

Chapter V of Nasar’s “Grand Pursuit”, Creative Destruction: Schumpeter and Economic Evolution, was my favorite. While I am not sure if it’s politically correct to say that I like to creatively destruct things, I’m not sure I care. I’m not exactly a politically correct kind of a guy.

 

While Joseph Schumpeter ended up becoming a compromised man of government later in life, his early days of collegiate thinking were some of the most formative in all of modern economic theory.

 

Shakespeare wrote that youth is ‘ambition’s ladder.’ Being left to the devices of his own commoner’s experiences (“born in a small factory town” in the Czech Republic, page 171), Schumpeter defined “creative destruction” using common sense.

 

Back to the Global Macro Grind

 

First, in order to contextualize this morning’s sharp squeeze higher across Global Equities, we need to take a step back and remind ourselves of what pricing of risk that we are bouncing from:

  1. US Dollar Index was up another +2.1% to close the week at a fresh Q4 high of $79.69 (up +9.2% from the April low)
  2. EUR/USD was down -2.2% to our immediate-term TRADE oversold line of $1.32
  3. US Stocks (SP500) were down another -4.7% week-over-week to close at a higher-YTD-low of 1158
  4. Italian, German, and French stocks were down -8.3%, -5.3%, and -4.7%, respectively (all crashing and in Bearish Formations)
  5. Asian stocks were down across the board again (Taiwan -6.2%, Australia -4.5%, Hong Kong -4.3%)
  6. CRB Commodities Index (19 commodities) was down another -2.2%
  7. Gold was down another -2.1% (in-line with the weekly US Dollar move up)
  8. Volatility (US Equities) was up another +11% to 34.47 (taking the cumulative rip in Bernanke’s “price stability” since April to +130%!)
  9. Long-term US Treasuries rose again as 10-year yields dropped to 1.96%
  10. Yield Spread (10s minus 2s) compressed by another 4 basis points week-over-week to 169bps wide

Dead cats bounce.

 

That would be a polite way of putting it actually. Last week was the worst week for US stocks during a Thanksgiving week since 1932 (not a good historical reference point, fyi).

 

In a world dominated by Keynesian policy makers perpetuating immediate to intermediate-term price moves in their respective fiat currencies, what we have left is called Correlation Risk.

 

The Correlation Crash (one of our 3 Global Macro Themes for Q4 alongside King Dollar and Eurocrat Bazooka) is born out of what the world’s fiat reserve currency (US Dollar) does relative to everything else.

 

If you get the US Dollar right, you’ll likely get mostly everything else right.

 

To be clear, correlations, like political careers, are not perpetual. So don’t expect this to stay with you for the rest of your born life. Just expect to have to deal with its implications in your portfolio again today.

 

Today’s immediate-term TRADE inverse-correlations to the US Dollar Index are as follows:

  1. US Stocks (SP500) = -0.94%
  2. European Stocks (EuroStoxx) = -0.94%
  3. Commodities (CRB Index) = -0.87%
  4. Bond Yields (UST 10yr) = -0.81%

Now if you are still using a static Marshallian or Keynesian economic model to manage risk, you’re probably not too happy with your 2011. What you should have done in the last 4 years is use this tremendous learning opportunity to evolve your risk management process into a dynamic one – a process that embraces the uncertainty associated with a Globally Interconnected Market’s last price.

 

Today’s uncertainty leads me toward one question – can this EUR/USD bounce extend itself this week so that the following immediate-term TRADE and TREND lines of resistance are overcome:

  1. SP (TREND)
  2. Germany’s DAX 5893 (TREND)
  3. France’s CAC 3089 (TRADE)
  4. Italy’s MIB 15135 (TRADE)
  5. Hang Seng 19443 (TREND)
  6. Shanghai Composite 2449 (TRADE)
  7. Japan’s Nikkei 8601 (TRADE)
  8. Brent Oil $110.61 (TREND)
  9. Gold $1726 (TRADE)
  10. Copper $3.45 (TRADE)
  11. UST 10-year yield 2.12% (TRADE)
  12. EUR/USD $1.37 (TRADE)

I know. Those are a lot of lines and a lot of durations. But that’s the point about Dynamic Risk Management – its construction needs to be multi-factor and multi-duration. And its principles need to adhere to one of the greatest mathematical discoveries since relativity (Chaos Theory).

 

“… just as Darwin had swept aside traditional with evolutionary biology” (Grand Pursuit, page 177), I’m very comfortable climbing Schumpeter’s ladder of creative destruction on Old Wall Street this morning. Change is good.

 

My immediate-term support and resistance ranges for Gold, Brent Oil, France’s CAC40, and the SP500 are now $1, 104.65-109.39, 2, and 1143-1195, respectively.

 

Best of luck out there today,

KM                        

 

Keith R. McCullough
Chief Executive Officer

 

Dynamic Risk Management - Chart of the Day

 

Dynamic Risk Management - Virtual Portfolio


The Week Ahead

The Economic Data calendar for the week of the 28th of November through the 2nd of December is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.

 

The Week Ahead - 1. LA

The Week Ahead - 2. LA


AN: Covering Trade

 

Keith covered AN in the Hedgeye virtual portfolio at $33.98 (please note correction on price) for a nice gain managing risk and trading the range this morning.

 

We continue to be concerned near-term with CapEx having doubled back to levels more in-line with investment prior to AN shrinking to half its size from ’05-’10 and is on pace to increase even higher as a % of sales this year. Returning to prior levels to offset deferred investment will impact FCF and the company’s ability to buy back shares and manage earnings near-term.

 

AN: Covering Trade - AN 11 25 11

 

 


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