"Success depends upon previous preparation, and without such preparation there is sure to be failure."
Regardless of whether we're bullish or bearish, a proactively prepared investment process allows us to manage the risk implied in deflating or reflating asset prices.
Many a wanna be short seller of everything "Depression" has just been reminded that there is massive risk implied on the upside in a Bear market. Risk in markets is omnipresent. The most relevant risks are always embedded in expectations - this, of course, includes the probability for a raging short squeeze.
After one of the most expedited 2-week bear market rallies in the last 113 years, a lot of the early cycle global macro signals that we've been writing about will now become crystal clear. The entire Street is now getting bullish on the call our head of Tech, Rebecca Runkle, had in semiconductors 6 weeks ago; and all of a sudden some of the most fantastic shark biting of the shorts that I have ever seen in my career is happening in the American casual dining names that our head of Restaurants, Howard Penney, has been bullish on since December. Yes, both main Street Americans, and their pet sharks can still strap on the ole feed bag.
Volatility, as measured by the VIX, has been cut by almost 50% in the last 5 months, and assets from West Texas Crude Oil to Russian Equities have re-flated by over +41% in a straight line over the course of the last 5 weeks. Copper and China are racing one another for the lead in 2009 YTD gold medal race - as of this morning, copper is +25% YTD and the Shanghai Stock Exchange Index closed up for the 7th day in a row, taking YTD gains for the Chinese to +28.5%.
The CRB Commodities Index closed at 229 last night - now it's FLAT for the YTD. The Nasdaq, which doesn't have GE or any of the Financials, closed at 1577 yesterday, and is now only down -1.4% for 2009. Market prices are leading indicators - do all of these aforementioned prices give any objective mind reason to believe that we are on the precipice of entering the Great Depression Part Deux? Of course not - that's what the bears of 2008 are still rushing to their publishers to write books about. It's yesterday's news.
We get paid to have our feet on the floor early every morning in order to help you proactively prepare for today and tomorrow. Understanding history, or yesterday, is a critical component of this process. Some people don't like it when I take victory laps - but that's ok, ask my good friend Benoit Morin how passive I was about celebrating Yale Hockey goals in them ole school Yale/Princeton tilts we used to have up here in New Haven - not very!
We approach this game like professional athletes. There is a discipline, passion, and pace at which you need to play the game. Striking the balance between emotion and control is always the greatest challenge. I call it playing on the Research Edge. But in no sport, that I know of at least, does the replay not matter. In what was the horse and buggy whip Wall Street of yesteryear, I guess portfolio managers could get away without issuing the transparency associated with mirrors - but guess what, You Tube is here - those days are over.
Today is a new day, and I'm only as good as my last game - so what's my "call"? Well, like any proactively prepared risk manager, I make most of my moves into the close on the day prior. I've had my head handed to me enough times in this business to finally understand that there is never a mistake in booking large percentage gains. Do I think that everything we are long should continue to re-flate? I sure hope so... why else would I be long something? Does that mean that things can't get overbought? Of course not...
For accountability/transparency purposes, I issued an intraday note to our Macro clients into the close yesterday titled "Shark Bite, Part Deux: SP500 Levels, Refreshed" outlining the following levels of resistance: SP500 TRADE resistance at 817; TREND resistance at 829.
The SP500 closed 60 basis points above that immediate term TRADE 817 line, but 84 basis points below the intermediate term TREND line. More importantly, my support level for the SP500 was all the way down at 770, which is -6.3% lower. Anytime the risk outruns the potential reward like this, I sell.
I raised the Cash position in my Asset Allocation Model from 59% back up to 71% yesterday. I sold my long positions in Russia and Brazil for +15% and +10% gains, respectively, taking my Allocation to International Equities down from 19% to 10%; and I sold down my Allocation to US Equities from 13% back down to 10%.
Call me conservative, or call me names - this is what I do. I manage risk by managing my exposures around price levels using a scenario analysis that is much closer to a market operator's "stress test" than what the US Government is currently trying to sell you on.
The US Government did the proactively predictable yesterday and traded what economist Paul Krugman accurately labeled "Cash for Trash". No, I'm not a Krugman lover, but you know I love a good one liner that's paired up with an objective conclusion - especially when it stirs a bee in the bonnet of the Goldman brain-trust that continues to dominate the West Wing. Larry Summers was really agitated by Krugman's refusal to STAND DOWN - he doesn't like to hear opinions that differ from his own.
Short term "trading" is what it is. I call it risk management. The US Government is as reactive a short term trader of political capital that you'll find in this global marketplace right now - as long as you understand that, and can remove all emotion while managing around your cash position, you can proactively pick off the market's behavioral patterns associated with the new reactive American crackberry culture.
Be careful out there today. After a 21.6% 2-week re-flation, the real-time risk managers understand that this Bear is far from dead.
EWC - iShares Canada-We bought Canada on Friday 3/20 into the selloff. We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's socialist past, and believe next year's Olympics in gold-rich Vancouver should provide a positive catalyst for investors to get long the country.
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.
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.
CAF - Morgan Stanley China fund - The Shanghai Stock Exchange is up +28.4% 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.
DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.
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%.
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-Consumer Staples was the third worst sector yesterday. XLP has a positive TRADE and negative TREND duration.
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.
"Success depends upon previous preparation, and without such preparation there is sure to be failure."