Salvaging The Wreck

“The world will seek the greatest possible salvage out of the wreck.”

-Irving Fisher, 1918


That’s a famous Irving Fisher quote Silvia Nasar uses to introduce Act II “Fear” in her wonderfully written economic history book – Grand Pursuit.  She starts the Act with a chapter titled “War of the Worlds” where a young John Maynard Keynes obtained a critical WWI post at the British Treasury where he became the “go to-official for inter-Allied (read American) loans.”


“The Treasury’s task was not to only achieve “maximum slaughter for minimum expense” but also to finance the war without debauching the world’s safest currency or jeopardizing Britain’s supremacy as the world’s banker.” (page 198)


This week, as Keynesian bailout politicians attempt to make history through another currency debauchery, I thought I’d use the pre and post WWI period as a reminder of how The People used to think about a currency’s credibility and purchasing power.


After the Treaty of Versaille (1919) when the Germans, Austrians, and Hungarians were saddled with reparations debt, money printing became their only option – a political Policy To Inflate (sound familiar?). The economic stagflation (then hyperinflation) that ensued throughout Europe during the 1920s may rarely be discussed by Ben Bernanke and Tim Geithner, but it will never be forgotten.


As stock market futures hope for European resolve this morning, do not forget what the Germans will never forget. Hope is not a risk management process.


Back to the Global Macro Grind


After the worst Thanksgiving week for stocks since 1932, followed by one of the best weeks for stocks in the last 3 years, this week’s “full employment and price stability” Act III by central planners should be exhilarating.


Here’s how the Global Macro calendar of catalysts looks so far:

  1. Monday: US Federal Reserve President from Chicago, Charles Evans, will speak on his short-term politicking for QE3
  2. Tuesday: my brother Ryan’s birthday
  3. Wednesday: whispers of the ECB Rate Cut decision (Thursday) should be all over the tape, weakening the Euro (again)
  4. Thursday: The Chinese report all of their economic data for November (should be weak, sequentially, across the board)
  5. Thursday/Friday: The EU Summit where central planners will struggle to explain who, precisely, is going to backstop more bailouts

To review hope/expectations: there is hope of a $100-200B bank bailout fund from the IMF that is effectively backstopped by Americans more so than it would be Germans (USA’s IMF quota is 17% and Germany’s 6%). There’s also hope that we see an Italian Job by Super Mario Draghi to backstop the EFSF bailout facility by the ECB.


Hope is not a…


Right, right, Keith. But the futures are up, so how are we supposed to chase and/or beat beta when we don’t know what these European central planners are going to do?


Good question.


As most of you know, this Globally Interconnected Game of Risk is changing. In Hedge Fund Industry 1.0 some of us could “get the call” on a big market catalyst like this, whereas today Wall Street 2.0 is struggling with a flatter playing field of who gets to know what and when.


Rather than looking for some Orange Jumpsuit Risk, I look to the currency and bond market Correlation Signals before I look to equity markets. Why? Primarily because both FX levels and bond yields have had it right for the better part of 2011.


Effectively, currencies and bond yields have been front-running stocks.

  1. FX: the EUR/USD’s TRADE and TAIL lines of resistance are $1.36 and $1.40, respectively.
  2. BONDS: the UST and European 10-year yield TRADE and TREND lines continue to confirm the same I see in the EUR/USD FX pair.

For US Treasury yields to signal that Growth Slowing is no longer going to be perpetuated by Piling-Debt-Upon-Debt, I’d need to see 10 and 30-year UST yields trade, sustainably, north of 2.12% and 3.22%, respectively.


For European Sovereign Bond yields to signal that we’re all free and clear from European bank insolvency on the order of magnitude that the likes of Lehman have never seen, I’d need to see Italian bond yields trade, sustainably south of 6%.


Salvaging The Wreck is going to take a very long-time. The greatest possible salvation we can all hope for this week is that stock markets don’t run-up too high ahead of another failed expectation on Friday.


My immediate-term support and resistance ranges for Gold, Brent Oil, France (CAC40), Italy (MIB Index), EUR/USD, and the SP500 are now $1, $109.34-111.89, 3074-3303, 149, $1.32-1.35, and 1, respectively.


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


Salvaging The Wreck - Chart of the Day


Salvaging The Wreck - Virtual Portfolio

Weekly Asia Risk Monitor: China and the Rest of Asia Have Not RSVP’ed

Conclusion: While our central planners may have ignited a short-term beta chase across Global Macro markets, our analysis of the economic fundamentals out of Asia suggest there is more downside to come for the global economy.


Shorting AYT – Trade Update: This afternoon, Keith shorted the Barclays GEMS Asia 8 ETN (AYT) in our Virtual Portfolio – a security we’ve managed risk on the short side of over the past couple of months. To refresh, the thesis is as follows: slowing growth and peaking/decelerating inflation will lead to a broad-based monetary easing cycle across the region. Refer to the following notes for more in-depth analysis:

Our proprietary quantitative levels are included among the charts below.



Asian equity markets had a strong week, closing up +5.2% wk/wk on a median basis. Gains were led by South Korea and Hong Kong, up +7.9% and +7.6%, respectively. China was the only market to close down, falling -0.8% wk/wk. We interpret this dramatic negative divergence as signal to investors that near-term expectations of broad-based monetary policy easing in China need to be dramatically tempered.


Asian currencies also showed similar strength this week, closing up +2% wk/wk vs. the USD on a median basis, led by the Aussie and Kiwi dollars (up +5.3% and +5.1%, respectively).  Every single Asian currency we monitor (15 in total) finished the week flat-or-down over the last month vs. the USD.


Asian sovereign debt yields broadly declined on the week, driven by a mixture of higher risk appetite and slowing growth. China, India, Indonesia, and Thailand saw the greatest wk/wk declines across the curve (2yr: -22bps, -28bps, -16bps, and -16bps, respectively; 10yr: -14bps, -15bps, -66bps, and -13bps, respectively). Australia, whose bond market has been well ahead of the global growth slowdown, saw their yields back up +18bps wk/wk on the 2yr and +15bps wk/wk on the 10yr.


As it relates to monetary easing speculation, Chinese 1yr O/S interest rate swaps continue to support expectations for pending Chinese rate/RRR cuts: -25bps tighter wk/wk; -75bps below the benchmark deposit rate.  That said, however, our stance continues to be one of patience – it likely won’t pay to get broadly bullish at the start of China’s easing cycle, using 2008 as an admittedly imperfect proxy for the current Global Macro environment.


The credit default swaps markets signaled a broad-based improvement in the perception of creditworthiness of Asian sovereign borrowers. 5yr CDS contracts tightened -14.1% wk/wk on a median percentage basis. China – whose swaps have widened nearly +100% in the YTD on growing concerns surrounding its banking system – saw its contracts tighten -27bps/-16.3% wk/wk.




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Growth Slowing:

  • Chinese manufacturing PMI slowed in Nov to 49 from 50.4 prior – the first sub-50 reading since Feb ’09. Looking under the hood of the China Federation of Logistics and Purchasing index, we saw that the forward-looking subcomponents all declined MoM as well: new orders (45.6 vs. 48.6) and backlog of orders (45.2 vs. 46). HSBC’s unofficial PMI index also confirmed this weakness in China’s manufacturing sector, falling to 47.7 vs. 51.0.
  • The lone bright spot in China’s Nov PMI report(s) was that the input price sub-index declined to the lowest level since Jan ’09 (44.4 vs. 46.2). Ahead of this decline in inflationary pressures (and economic growth), China cut bank reserve requirements -50bps to 21% for major banks starting 12/5. China continues to “fine tune” its monetary policy, but key policymakers continue to speak out against consensus expectations for a broad, near-term easing cycle. Per Xia Bin, a member of the PBOC’s monetary policy committee: “China’s policy fine-tuning doesn’t mean credit controls will be loosened and people shouldn’t hope for a reversal of curbs on the property market” (i.e. the main driver of Chinese economic growth). He continues: “High investment growth before the financial crisis can’t be sustained because it has led to property bubbles and huge latent risks in local government financing vehicles. Under such circumstances, we must maintain a relatively tight stance on credit.” Translation: Chinese demand will continue to slow over the intermediate term as the central bank and State Council maintain a largely-prudent policy stance.
  • Outside of China’s weak manufacturing PMI report, we also saw quite a few other nasty Nov PMI readings throughout Asia from either a marginal or absolute perspective: Japan (49.1 vs. 50.6 prior); India (51 vs. 52 prior); Korea (47.1 vs. 48 prior); Taiwan (43.9 vs. 43.7 prior); and Australia (47.8 vs. 47.4 prior). Taken in aggregate, it’s easy to see that manufacturing is broadly contracting in Asia at a largely-accelerating rate.
  • According to data from Clarkson Securities Ltd., a unit of the world’s largest shipbroker, shipping rates from China to the E.U. have fallen -39% since the end of August – more than double the -18% decline in China-to-U.S. shipping rates. As we’ve been calling for, growth in the world’s largest economic bloc continues to slow precipitously.
  • Hong Kong’s M3 money supply growth slowed again in Oct to -3.8% YoY vs. -0.4%. Why do we care about the supply of money in Hong Kong? Because its sustained drop into negative territory was a stealth leading indicator of deteriorating global economic conditions in 2Q08.
  • Japan’s unemployment rate backed up to 4.5% in Oct from 4.1% prior – a meaningful increase, given that the labor force is hovering down around 1989 levels due to population decline.
  • Indian real GDP growth slowed again in 3Q to +6.9% YoY vs. +7.7% prior – the lowest rate of growth in India since 2Q09. Moreover, Finance Minister Pranab Mukherjee’s latest commentary confirms exactly what we’ve been saying about India for several quarters now: “The Indian government has limited scope for a boost in spending to create demand and spur growth… When the adverse impact of the 2008 crisis was felt in the economy, we could generate domestic demand through a stimulus package. I am not in a position to provide that kind of fiscal stimulus [today].”
  • South Korean industrial production and service industry output growth slowed in Oct to +6.2% YoY (vs. +6.9% prior) and +3.5% YoY (vs. +3.2% prior), respectively. The marked-to-market slowing of Korean economic growth has the Bank of Korean considering lowering its economic growth forecasts for both 2011 and 2012: “Our economy will be less than our expectation… Global economic growth is now showing a kind of downward risk so in the sense, maybe the Korean economy is a little bit downward as well.” – Lee Jong Kyu, deputy director-general at the Economic Research Institute at the Bank of Korea. Any lowering of their forecasts is likely to tilt the balance of risks towards preserving economic growth, auguring well for future monetary easing in Korea.
  • Asian export growth continues to slow: India (+10.8% YoY in Oct vs. +36.4% prior); Indonesia (+16.7% YoY in Oct vs. +44% prior); and Thailand (-0.1% YoY in Oct vs. +18.4% prior) all showcased declining overseas demand for their products.
  • Got Confidence?: Bank Indonesia’s consumer confidence index ticked down in Nov to 114.3 vs. 116.2, while Thailand’s business sentiment index fell in Oct to 36.7 vs. 48.5 prior.

Deflating the Inflation:

  • Indonesian CPI slowed in Nov to +4.2% YoY vs. +4.4% prior. Core CPI held at a +4.4% YoY rate, however.

Sticky Stagflation:

  • South Korean CPI accelerated to +4.2% YoY vs. +3.6% prior. Core CPI accelerated as well: +3.5% YoY vs. +3.2% prior.
  • Thai CPI, both headline and core, came in flat in Nov at +4.2% YoY and +2.9% YoY, respectively.

Eurocrat Bazooka:

  • We continue to hammer away on our view that Asia will not be there in size to help lever the EFSF or some other form of E.U. bailout. Zhu Guangyao, China’s Vice Foreign Minister in charge of European affairs, had this to say regarding the use of China’s $3.2 trillion in FX reserves: “China can’t use its $3.2 trillion in foreign exchange reserves to rescue European nations… Foreign reserves are not revenues. China can’t use its reserves to fund poverty alleviation at home or to bail out foreign countries… Now is not the time for China to have a contingency plan in the event a euro zone country defaults on its debts or exits from the 17-nation single currency. The government has already done its part to help Europe, which has the wisdom and strong economic fundamentals to solve its sovereign debt crisis.”

King Dollar:

  • China’s confirmed entry into a monetary easing cycle is weighing on expectations of yuan appreciation; 1yr USD/CNY non-deliverable forwards are now trading at a -0.3% discount to spot prices. The specter of less yuan appreciation is, in turn, weighing on the dim sum bond market, where the average issue has fallen -2% in the YTD, according the HSBC indexes. It is also driving increased investor scrutiny over the quality of the issues in a market where over 60% of the non-financial issues have no leverage limits. As we like to say, nothing focuses the mind like an ole’ hanging.
  • Thailand, which, admittedly, is feeling the ill-effects of nationwide flooding, reduced its benchmark interest rate by -25bps to 3.25%.
  • Demand for mortgages in Australia hit another all-time low growth rate in Oct to +5.7% YoY vs. +5.8% prior. We remain long-term bears on Australia’s housing market and see this as a structural headwind to both Australian interest rates and the Aussie dollar.


  • Japanese retail sales and overall household spending growth accelerated in Oct to +1.9% YoY (from -1.1% prior) and -0.4% YoY (from -1.9% prior), respectively. As well, the country’s industrial production growth accelerated in Oct to +0.4% YoY vs. -3.3% prior. Construction orders and housing starts (earthquake/tsunami reconstruction) also accelerated in the world’s third-largest economy. Still the mere threat of slowing growth from current low levels of economic activity has driven policymakers to plan an unprecedented (post-WWII) fourth “extra budget” (i.e. stimulus package) in the current fiscal year to help support growth. Small in size (only $26 billion), it sends a large message to the international community that this country continues to be unable to grow w/o the help of deficit spending and sovereign debt buildup.


  • As China enters into the thralls of its economic slowdown, we’re seeing falling growth expectations impact corporate credit spreads in the mainland. The premium investors demand to hold securities rated AA or below over AAA-rated securities has widened to 433bps – the widest since Dec ’08.
  • Japan’s AAA status has been put of negative watch by a domestic ratings agency, shining light on what we’ve been saying for over a year: Japan’s eroding domestic savings tailwind and perpetual kicking of the can down the road away from cutting spending and raising taxes is a long-term headwind for JGBs. In conjunction with the ratings news, Japan’s bid-to-cover ratio on a 10yr issue declined to 2.47x – the lowest since Dec ’10. All told, we think investors are misinterpreting the [marginal] back-up in JGB yields and decline in demand as a credit event, but, in reality, it’s likely more a function of updated global growth/inflation expectations when analyzed with a globally-interconnected lens. This week’s global beta chase was simply not supportive of JGB or JPY demand.

Darius Dale



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Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%

The Week Ahead

The Economic Data calendar for the week of the 5th of December through the 9th 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. cal

The Week Ahead - 2. cal

Weekly Latin America Risk Monitor: All Eyes On Brazil

Conclusion: Alongside China, Brazil is one of the key global economies that led 2011’s global growth slowdown. Supported by aggressive policy, we expect the country to lead on the way up if/when the global economic cycle turns.



Through yesterday’s close, Latin American equity markets have had a phenomenal week, closing up +5.8% in the week-to-date on a median basis. Gains were led by the higher-beta Argentina, which closed yesterday up +7.5% in the week-to-date. We remain negative here, and do not see their capital flight headwinds/currency devaluation pressure easing in a meaningful way over the intermediate term. Brazil, a market we are getting increasingly constructive on from a fundamental perspective after having the negative view for over a year, closed up +5.9% in the week-to-date.


There are a couple of monster moves to report across Latin American FX markets. Brazil’s real finally stopped going down on the back of monetary easing, closing up +5% vs. the USD in the week-to-date. Mexico’s peso also had a great week vs. the USD, closing up +4.5% in the week-to-date on the heels of central bank holding rates and announcing measures to strengthen the currency. We think the latter will eventually lead to easing in the former and remain fundamentally negative here. The -15bps week-to-date drop in Mexico’s 1yr O/S interest rate swap rates lend credence to our view.


Slowing growth continues to get imputed into Latin American sovereign debt markets, though at varying levels of duration risk due where each country is in the context of its own economic cycle. Brazil, which has led regional and global growth lower in the YTD, saw its 2yr yields fall -24bps in the week-to-date. Even after this week’s rate cut, Brazil’s 1yr O/S interest rate swaps market remains 90bps below the benchmark Selic rate – an indicator of expectations for further easing. Mexico, which has held up alongside a “resilient” U.S. economy saw its 10yr yields fall -46bps in the week-to-date as international capital continues to view Mexican sovereign debt as a “levered play on the U.S. economy” (per one bond fund manager). We expect this short-term move to reverse; Mexico’s 10yr yield has an -0.95% inverse correlation to the MXN/USD sport price.


No surprise here, given the week-to-date rally in global beta, but Latin American 5yr CDS markets closed down -13.1% on a median percentage basis. Argentina, a country with a deteriorating credit profile, underperformed, narrowing only -91bps or only -8.4% in the week-to-date.




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Growth Slowing:

  • Brazilian industrial production growth slowed in Oct to -2.2% YoY vs. -1.6% prior.
  • Credit growth continued to slow in Brazil, falling in Oct to +18.4% YoY vs. +19.7% prior. In an effort to ward off a more material deceleration in domestic liquidity, the monetary policy council will delay the implementation of accounting rules that would have been rather punitive to Brazilian financials in the near term, including having to fully book loan portfolios as a profit at the time of sale. This accounting change would have forced them to record a string of losses stemming from prepaid loans. Additionally, the central bank is considering increasing the limit larger banks can uses to buy loan books in an effort to increase liquidity for smaller lenders (currently at 36% of reserves on time deposits).
  • Brazil’s domestic growth situation must be rather dire; either that or Brazilian policymakers are far too aggressive with recent measures – which may show up in 2012 inflation readings. We think it’s a little bit of both… Their latest stimulus efforts include reducing a variety of taxes throughout the real and financial economies. The IOF taxes on foreign equity purchases and corporate infrastructure debt have both been reduced to 0%; the IOF tax on consumer credit has been reduced by -50bps to 2.5%; and sales taxes on consumer appliances and food staples have been cut by an estimated R$1 billion. If Rouseff’s government finds a way to enact meaningful austerity (vs. the usual accounting gimmicks) in the coming months, Brazil’s 2012 economic outlook should appear rather bright.
  • Chile’s Oct economic data was quite bad, on the margin: industrial production growth slowed (-0.8% YoY vs. +5.2% prior); industrial sales growth slowed (-0.6% YoY vs. +1.1% prior); and retail sales growth slowed a full -100bps to +8.6% YoY. One bright spot was the unemployment rate, which saw a -20bps MoM decline to 7.2%.

Deflating the Inflation:

  • Brazilian CPI, as measured by the unofficial IGP-M series, slowed in Nov to +6% YoY from +7% YoY prior. This deceleration is supportive of our dovish intermediate-term outlook for Brazilian inflation, as the IGP-M series has led the benchmark IPCA series by an average of 5.2 months over the last ten years.

Sticky Stagflation:

  • Peruvian CPI accelerated in Nov to +4.6% YoY vs. +4.2% prior.

King Dollar:

  • Brazil’s central bank lowered its benchmark Selic rate by another -50bps, in-line with the recent pace of cuts (now at -150bps in the current easing cycle). Their commentary was unchanged meeting-to-meeting, suggesting to us that they intend to keep cutting at a “moderate” rate.
  • As the U.S. dollar continues to make a series of higher intermediate-term highs and lows, we’ve seen it materially erode EM corporate earnings and the market for issuing international debt, as well as increasing dollar funding costs for such borrowers. The latest data out of Brazil, whose international junk bond issuance calendar has been dark since July 7, saw HY/HG credit spreads widen to 565bps – the largest premium since April ’09 and up from a much-tighter 216bps in early July. Our models have Brazilian GDP growth bottoming in the 4Q/1Q range, so we expect to see additional deterioration in Brazil’s HY credit market over the near term.
  • Mexico, whose currency (the peso) has declined the most in LatAm vs. the USD over the past six months (-13.9%), saw its central bank announce measures to support the peso through U.S. dollar auctions. In the short term, this announcement is bullish for the currency at face value, but looking through to forward implications, this sets the MXN up to extend declines as it gives the central bank room to eventually cut its benchmark interest rate from the current all-time low of 4.5%, after holding at that level today. Recall that last week both JPMorgan and Credit Suisse recanted forecasts for Banxico to cut rates as a function of the dramatic decline in the peso, which has the potential to negatively impact Mexico’s domestic intermediate-term inflation outlook.
  • The recent spate of aggressive intervention out of Argentine policymakers (designed to stem capital flight) has had some negative consequences to-date: consumer confidence ticked down in Nov to 56.7 vs. 57.7 prior; yields on Argentine bank bonds are rising 4-10x their LatAm peers after restrictions on FX purchases forced depositors to withdraw dollar depots from the country’s banking system; and insurers and other investors are fast selling the country’s dollar bonds after being forced boost local investments. Argentina’s 2012 securities declined -7.3% last week vs. +5.8% for JPMorgan’s broad EM dollar bond index. The latest data (through 3Q) shows the pace of capital flight has accelerated to a single-quarter record of $8.4 billion, upping the YTD total to $18 billion (+100% YoY!).

Eurocrat Bazooka:

  • Santander is planning to sell a ~10% stake in its Brazilian unit, Banco Santander Brasil SA, and another 7.8% stake in Banco Santander Chile SA as the struggling Spanish bank looks to artificially strengthen its capital ratios by selling what it can vs. liquidating what it should (i.e. Spanish sovereign debt).


  • Brazil’s FGV consumer confidence index ticked up in Nov to 119 vs. 115.2 – a four-month high. Brazil’s unemployment rate ticked down to 5.8% – an all-time low for the month of Oct.
  • Still slowing, but at a slower rate: Brazil’s manufacturing PMI ticked up in Nov to 48.7 vs. 46.5 prior.
  • Mexican real GDP growth accelerated in 3Q to +4.5% YoY vs. +3.2% prior, aided by a resilient consumer (retail sales growth accelerated in Sept to +4.7% YoY vs. +2.7% prior). The strength was followed by a dramatic improvement in the unemployment rate in Oct to 5% vs. 5.7% prior.
  • In an effort to combat a recent uptick in inflation, Colombia’s central bank hiked its benchmark interest rate to 4.75% - the first LatAm country to do so since July.


  • Brazil’s domestic fund flow situation anchors well with our intermediate-term outlook for the country (continued slowing growth and inflation), as fixed-income funds received another R$2.8 billion in Oct, which drove the YTD inflows up to a 4yr-high of R$67 billion. The central bank wound up cutting the benchmark Selic rate -500bps from the following year’s peak of 13.75%, making the pre-2008 fund-flow move a profitable bet for a great many of Brazil’s domestic money managers. If their trip back to the ol’ well is successful this time around, it may be the result of a dramatic deterioration in global economic conditions.
  • In what may be his last year as President of Venezuela, Hugo Chavez just recently signed into law regulation that will allow his government to set price caps on as many as 15,000 products. The cost of 18 basic goods including soap, toothpaste, and diapers will be immediately frozen. This new measure is on top of existing legislation that regulates the price of 100 foodstuffs – a law that has been viewed by many as a culprit behind persistent shortages of key items. Vice President Elias Jaua had this to say upon the announcement: “This idea of an invisible hand of the market that generates an equilibrium between supply and demand is a lie... [This is] a system in which the capitalists won’t have any way of fooling and defrauding us. The only ones who should fear the law are the speculators who have become accustomed to robbing the Venezuelan people.” On that cheery note, have a great weekend.

Darius Dale



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