Incredibly Hobbled

This note was originally published at 8am on December 08, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

 “I can believe anything, provided it is quite incredible.

-Oscar Wilde 


Heading into tomorrow’s highly anticipated two-day EU Summit, Wilde’s pithy quote reminds us that Eurocrats have a tall order to impress the market with policy that will revert the direction of Europe’s 19 month-old sovereign debt and banking crisis. Below we caution that tomorrow’s results will likely disappoint investors’ expectations. Why?


If we’re right that the focus of tomorrow’s resolutions are largely centered on the topic of a fiscal union, either for the EU’s 27 countries or the Eurozone’s 17, we don’t think that the creation of another (likely bureaucratic) organization to monitor and impose budget restrictions will be the “bazooka” around which markets will see a sustained rally. Over the last decade we’ve seen the utter inefficiency of a somewhat similar program in the EU’s Stability and Growth Pact—a budget agreement issued in 1997 that limited member states to public debt (as a % of GDP) to 60% and deficit to 3%— as the majority of countries (including Germany) breached its mandates. 


Further, beyond how a “hands-on” Fiscal Union 2.0 is going to make up for the shortcomings of the Stability and Growth Pact, it’s unclear how Eurocrats will address the pressing question:  if peripheral European countries can’t grow and can’t fund themselves with rising credit spreads, and therefore can’t balance their budgets no matter how much austerity is delivered; aren’t allowed to default (Greece); and can’t individually adjust monetary policy, 1.) how do weak states get out of this vortex? and 2.) what’s the benefit to weaker states to be bound in the Eurozone?


If we take the view that major Eurocrat actors (including Merkel, Sarkozy, and Draghi) strive to preserve the fabric of the Eurozone, we believe Eurocrats largely have their hands tied as they don’t have the facilities (firepower) to adequately answer the questions above.  We estimate that European banks and the sovereigns need a funding facility to the tune of $2 to 3 Trillion (or $1.25 to 1.75T to recapitalize banks and $0.75 to 1.25T to fund future sovereign deficits) to address bailout and funding assistance needs.


Key factors that will continue to challenge issuing a “bazooka”:

1.)    The ECB, unlike the Fed, cannot print money to leverage/expand the EFSF

2.)    Merkel and ECB stand against the issuance of Eurobonds

3.)    We don’t see it in China’s interest to run in with a blank check to “save” Europe

4.)    The current EFSF has a mere €250 Billion left to address sovereign and banking concerns

5.)    The IMF only has €385 Billion in lending capabilities

6.)    Fiscal Union 2.0 will require treaty changes and a united voices across at least 17 countries


Should we not get any positive discussion on points 1-3 on Friday, which we think is highly likely, we do not expect capital markets or the EUR-USD to lift into a sustained rally (see chart below of our EUR-USD levels; we’d short any rally around $1.36 and don’t see a next material line of support until the previous low of $1.19).  It’s more probable that the ECB reiterates its ardent position that its sole mandate is price stability; Merkel says she is unwilling to see German funding costs rise; and the “value” of assets on the chopping block for the Chinese is unclear.


Under such a scenario, particularly in which there’s no talk or action specific to ECB backstop involvement or the issuance of Eurobonds, we’d expect the ECB’s secondary bond purchasing program, the Securities Market Program (SMP), to take on a larger role to fill waning demand for PIIGS paper. For context, last week the SMP bought €3.7 Billion versus €8.6 Billion in the previous week to take its total since May 2010 to €207 Billion.


Ultimately, we think this leaves the region in a tenuous position. First, the SMP is intended to only be a “temporary” program. Second, it will force the SMP to take on a much larger role to meet the demand of PIIGS issuance, or put an artificial bid that alone may not drive down sovereign yields.


More Risks on the Horizon Without ECB Support

While we view the actions of ratings agencies as lagging indicators, Monday’s move by Standard & Poor’s to place the ratings of 15 Eurozone nations on CreditWatch negative and Tuesday’s announcement that the EFSF’s AAA rating is being placed on CreditWatch negative adds one more bee in the Eurocrats’ bonnet ahead of Friday.  S&P said that ratings could be cut up to one notch for Austria, Belgium, Finland, Germany, Netherlands, Luxembourg – and by up to two notches for everyone else (France, Italy, Spain, Portugal, Ireland, Slovakia, Slovenia, Estonia, and Malta.)  (Note: Greece was spared, and Cyprus remains on negative watch.)


While S&P said it would review the ratings following the Summit, the warning portends negatively for the EFSF, a facility that is built around its AAA status. Should downgrades come to Germany and France, its main contributors at 28% and 22%, respectively, we’d expect funding costs to rise, which negates the very purpose of this facility, and once again (negatively) refocuses the eye on the undercapitalized programs to fund imbalanced sovereigns and banks. 


Expect insolvent banks in this environment to struggle to raise money on the secondary market. This will elevate risk as sovereigns are now less capable to back their struggling banks, and the EFSF is far undercapitalized. Here we think French and German banks will be critical to watch. Along those lines, the European Banking Authority will publish updated stress tests at 12pm EST today to review how much capital lenders should raise to absorb losses from Eurozone bonds. We’ll reiterate that if countries truly mark their sovereign holdings to market, we think the capital raise will need to be substantially larger than the Q2 published result of €106 Billion to reach a 9% core Tier 1 capital by mid-2012.


German Chancellor Angela Merkel said to her Parliament on Dec. 2, 2011: "Resolving the sovereign debt crisis is a process, and this process will take years." If Europe’s currency union is here to stay, beware of the lofty expectation that Friday will bring quick-fixes to years of fiscal and banking imbalances and excesses, as well as cultural differences that divert priorities as Europe will once again need to find a united voice on fiscal union.


Unfortunately, should Friday’s Summit come up short of expectations, there’s nothing currently on the calendar in terms of summits or major catalysts into year-end around which markets could get behind.  


Hobble on.


Matthew Hedrick

Senior Analyst


Incredibly Hobbled - EL EUR


Incredibly Hobbled - VP 12.8


TODAY’S S&P 500 SET-UP – December 13, 2011


KM notes from this AM - Our call yesterday for a Short Covering Opportunity only remains relevant from the level we made it at – manage your risk on green today.  I’m long SPY and holding my longest net long position of Nov/Dec. I doubt I overstay my welcome.  As we look at today’s set up for the S&P 500, the range is 16 points or -0.36% downside to 1232 and 0.93% upside to 1248. 




Yesterday our immediate-term TRADE line of support for the SP500 (1232) holding intraday, KM took the asset allocation to US Equities up to 12% today. We’re also long Healthcare (XLV) and Consumer Discretionary (XLY) as both Sectors (1) remain bullish on both TRADE and TREND durations and (2) are supported by our fundamental Global Macro research view of King Dollar. Strong Dollar = Strong US Consumption.


We’ve stopped hoping that central planners and their Keynesian sources understand this basic point about a country’s currency and her purchasing power. The political economy is not the real-time economy – and hope is not a risk management process.  The 2 worst Sectors to be long under our bullish US Dollar theme remain Financials (-19.8% YTD) and Basic Materials (-13.3% YTD).




THE HEDGEYE DAILY OUTLOOK - daily sector view


THE HEDGEYE DAILY OUTLOOK - global performance



  • ADVANCE/DECLINE LINE:  -1867 (-4017) 
  • VOLUME: NYSE 779.79 (-5.06%)
  • VIX:  25.67 -2.69% YTD PERFORMANCE: +44.62%
  • SPX PUT/CALL RATIO: 1.66 from 1.61 (+3.07%)



  • TED SPREAD: 53.84
  • 3-MONTH T-BILL YIELD: 0.01%
  • 10-Year: 2.03 from 2.07   
  • YIELD CURVE: 1.79 from 1.85


GLOBAL MACRO DATA POINTS (Bloomberg Estimates):

  • 7:30am: NFIB Small Business, est. 91.5, (prior 90.2)
  • 7:45am/8:55am: ICSC/Redbook weekly retail sales
  • 8:30am: Retail Sales, est. 0.6%, (prior 0.5%)
  • 10am: IBD/TIPP economic optimism, est. 42.3, (prior 40.6)
  • 10am: JOLTS job openings: (prior 3354)
  • 10am.: Business inventories: est. 0.8% (prior 0.0%)
  • 11:30am: U.S. to sell $35b 4-wk bills, $25b 52-wk bills
  • 1pm: U.S. to sell $21b 10-yr notes reopening
  • 2:15pm: FOMC Rate decision, est. 0.25%
  • France Nov final CPI (EU harmonized) +2.7% y/y vs consensus +2.5%
  • UK Nov - CPI +4.8% y/y vs consensus +4.8%, prior +5.0%; RPI +5.2% y/y vs consensus +5.1%, prior +5.4%
  • Germany ZEW Survey Current Situation (Dec); actual +26.8%; consensus +30
  • Germany ZEW Economic Sentiment (Dec); actual (53.8); consensus (55.3)


  • Fed holds policy meeting today amid speculation officials will maintain pledge to keep borrowing costs near record low
  • Former MF Global CEO Jon Corzine appears before Congress again; CFO Henri Steenkamp and Bradley Abelow, president and COO, said they didn’t know what happened to as much as $1.2b in missing client funds, in testimony prepared for today’s hearing
  • House expected to vote today on package that extends employee payroll tax cut for one year
  • Secretary of State Clinton meets with UAE Foreign Minister Abdallah bin Zayed, then holds bilateral meeting with Bosnia and Herzegovina President Zeljko Komsic




COMMODITIES – last Thursday we took the my asset allocation to commodities back down to 0% after the ECB press conf as I thought the EUR/USD was going to unwind again – get that USD direction right and you get Commodities right – Oil, Copper, Corn, etc all have broken TAILS and Gold continues to break down this morning (new Gold range = 1 with TREND resistance = 1743)

  • Sino-Forest May Default as It Will Miss Earnings Deadline
  • Laborer-Turned-Billionaire Tinkler Plans More Coal M&A
  • Death of Gold Bull Market Seen by Gartman After Selling Metal
  • China’s 150 Million Electric Bikes Bolstering Lead: Commodities
  • Gold May Fall a 2nd Day in London as Dollar Strength Cuts Demand
  • Oil Trades Near Two-Week Low as Downgrade Risk Weighs on Outlook
  • World Fuel Seen Riding Shipping Bankruptcy to 12% Gain: Freight
  • Gold Imports by India May Decline as Rupee Plunges to Record
  • Rio Allowed to Maintain Ivanhoe Stake, Arbitrator Decides
  • Freeport Indonesia Workers Expect Deal to End 3-Month Strike
  • China’s Gold Imports From Hong Kong Surge 51% on Haven Demand
  • OceanaGold Seeks Acquisitions to Boost Output, Wilkes Says
  • Copper Drops for Second Day on European Debt-Crisis Concern
  • Vale Pays $1.1 Billion to Increase Fertilizer Unit Stake
  • Palm Oil Production in Malaysia Declines to Seven-Month Low
  • Wheat Gains as Traders Speculate Farmers May Switch From Corn
  • Saudi Oil Minister Says He’s Happy With Current OPEC Output
  • Aluminum Surplus May Narrow 12% as Asian Consumption Expands


THE HEDGEYE DAILY OUTLOOK - daily commodity view





THE HEDGEYE DAILY OUTLOOK - daily currency view





European Data – first morning in what seems like forever (10 months) where my entire data run on Europe was not a another sequential deterioration – better than toxic is still awful, but German ZEW up for the 1st time in 10mths to -53.8 (vs -55.2) and the UK inflation print stopped going up (+4.8% NOV vs +5.0% OCT). European Stagflation remains.


THE HEDGEYE DAILY OUTLOOK - euro performance





CHINA – certified train wreck in Chinese stocks didn’t stop overnight with the Shanghai Comp down another -1.9% to -19.9% YTD finally moving it to an immediate-term TRADE oversold signal in my model. Chinese Exports to Italy in NOV down -23% y/y!


THE HEDGEYE DAILY OUTLOOK - asia performance




  • Tunisia After Revolt Can Alter E-Mails With Big Brother Software
  • Egyptians Seek Dollars as Devaluation Concern Grows: Arab Credit
  • Security Council Urged to Act as UN Raises Syria Death Toll
  • IEA Cuts 2012 Demand for OPEC Oil as Global Consumption Slows
  • Iraq Can Lead the Arab World If It Gets Oil Policy Right: View
  • Pakistan Sukuk Drought Spurs Demand From Banks: Islamic Finance
  • Iran to Hold Military Drill for Closing Hormuz Strait, Fars Says
  • Saudi Oil Minister Says He’s Happy With Current OPEC Output
  • Iran Sees Oil Prices Falling in 2012 If OPEC Doesn’t Curb Output
  • U.A.E.’s New Company Law May Struggle to Prompt IPOs Amid Slump
  • Drake & Scull Wins 142 Million Dirhams Contract in Egypt
  • Petrofac to Beat Oil Services Profit Target With 20% Growth
  • BP Plans to Produce First Natural Gas in Oman by 2016
  • Saudi Arabia, Pakistan, Emirates, Selangor: Islamic Bond Alert
  • BP to Spend $1b by 2012 on Omani Tight Gas Appraisal, Evans Says
  • Emirates, Qatar Banks Interested in Turkey, Hurriyet Reports
  • U.S. Violation of Iran Airspace Was Clear, Mehmanparast Says
  • Saudi Arabia’s Al-Naimi Says He’s Happy With Current OPEC Output
  • Obama Says U.S. Has Asked for Iran to Return Downed Drone

THE HEDGEYE DAILY OUTLOOK - asia performance



The Hedgeye Macro Team

Howard Penney

Managing Director



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Time and Price

“The only reason for time is so that everything doesn’t happen at once.”

-Albert Einstein


Intraday yesterday we made another “Short Covering Opportunity” call. It was no different than any of the other short covering calls we’ve made in 2011 (August 8th, September 12th, October 4th). It’s what we do. Timing matters.


Immediately after making the call our Sales Desk and tweet-machines lit up like a Christmas tree with questions that weren’t all the same – but they certainly rhymed: “but what’s changed”… “why here”… “what’s the catalyst”… etc.


The summary answer to all of the questions is that nothing in our risk management process changed – time and price did. With a long SP500 (SPY) position, a 12% asset allocation to US Equities, and 10 LONGS vs 4 SHORTS in the Hedgeye Portfolio, this is the most bullish position I have taken in all of November-December (that’s a good thing – the SP500 is down for both months).


Back to the Global Macro Grind


If you go all the way back to a week ago today, our Senior Analyst of European research, Matt Hedrick, and I were making an explicit call to short Global Equities and Commodities into the EU Summit. Long live King Dollar (UUP) versus the Euro (FXE) was implied.


On two separate occasions (last Tuesday and Wednesday) you had an opportunity to sell SP-1268. Maybe you didn’t top tick it, but hopefully you cut your gross and net exposures up there because I can assure you that in the world of your own money, a -3% drawdown of your capital (from 1268 to yesterday’s lows of 1229) matters.


Now some people throw their arms up in the air and say, ‘well, I can’t manage that type of a move’ or ‘I’m too big to make those types of decisions that quickly’ – and I hear and respect where they are coming from. But that doesn’t mean that other people can’t.


Yes We Can.


Managing your gross and net exposure within a band of 300 basis points of risk (3%) is very achievable if A) you have a Global Macro research process and B) you have the catalysts right.


Sometimes catalysts like the EU Summit are scheduled events. Sometimes the catalyst is simply time and price. You need a process to absorb both.


Why did I buy the SP500 (SPY) yesterday?

  1. My immediate-term TRADE line of SP500 support (1232) held
  2. My immediate-term TRADE line of VIX resistance (27.78) held
  3. My immediate-term range of risk collapsed to 37 SP500 points wide (vs 77 on the day prior)

Those first two points are easy to understand. US Equities (SPY) and Volatility (VIX) are inversely correlated on the order of -0.7 right now and of the many factoring relationships in our model, that’s one of the most important ones to consider.


Volatility is also one of the most misunderstood risk factors in all of portfolio construction. In many instances it’s a coincident to lagging indicator – in some instances it’s a leading indicator. That’s why it drives people nuts. That’s why I have built a model to front-run my own volatility signals.


Front-running? Bad word – if you run a brokerage like Corzine did. Good idea if you want to get ahead of the robots that are making decisions in real-time. If you didn’t know that they chase beta, now you know.


Most of you who have dialed into our Morning Call (every morning at 830AM EST – ask for access) know that I front-run my Volatility range using a ‘range of risk’ model that calculates the probability of the next move in both volatility and price.


What does that mean?

  1. If my range is compressing (ie from 77 points wide to 37 points), the implied risk of the range is going down (= BUY)
  2. If my range is widening (ie from 37 points wide 145 points wide where it was last Tuesday), implied risk goes up (= SELL)

To be clear, my ‘range’ signal is one of the many signals I consider before making any exposure, asset allocation, or position decision. Remember, Multi-Factor and Multi-Duration is how we roll.


Not unlike seeing a play develop on the ice, time and patterns are omnipresent. As opposed to the time and space a hockey player needs to consider in making a short-term decision, solving for time and price risk in markets is what can make for a longer-term career.


My immediate-term support and resistance ranges for Gold (bearish TRADE and TREND), Brent Oil (Bearish TRADE, TREND, and TAIL), and the SP500 (bullish TRADE; bearish TAIL) are now $1, $107.12-109.29, and 1. On a move back towards 1248, I’ll likely do the opposite of what I did yesterday. Time and price pending.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Time and Price - Chart of the Day


Time and Price - Virtual Portfolio

A Look Under the Hood at Asia’s Trade Data and Capital Flows

Conclusion: A rigorous analysis of the recent trade data coming out of Asia, as well as a quantification of the region’s capital exposures by source grant us conviction in the following two viewpoints: 1) global growth is still slowing; and 2) Asian currencies remain at risk of further declines.


China’s Nasty Trade Data

Over the weekend, China put up another sour trade report (Nov) which was highlighted by growth in exports slowing to +13.8% YoY vs. +15.9% in the month prior. Excluding the Feb ’09 Lunar New Year distortion, the +13.8% yearly gain is the lowest rate of growth since Dec ’09. Underneath the hood, we saw exports to the E.U. slow to +5% YoY vs. +7.5% prior and greater than +22% as recently as Aug. The weak E.U. figure compares to growth in China’s exports to the U.S. accelerating to +17.2% YoY in Nov vs. +13.9% prior. China’s exports to Germany fell -1.6% YoY in Nov; exports to Italy from China fell -23% YoY in Nov.


A Look Under the Hood at Asia’s Trade Data and Capital Flows - 1


While we don’t buy the U.S. is going to decouple completely from the interconnected risks associated with the global economy, it is clear that Europe’s Sovereign Debt Dichotomy and banking crisis are having a disproportionately ill effect on European demand relative to the world’s other principle economic bloc. This is in-line with our intermediate-term outlooks for both regions and fundamental positioning: 

  • King Dollar: Bullish on the USD;
  • Deflating the Inflation: Bullish on select U.S. consumption names and sectors (XLY, XLV);
  • European Stagflation: Bearish on France, bearish on the Euro; 

Both data and quantitative setups continue to strongly support our views here.


Asian Trade Data Portends Negatively For E.U., Global Growth

Taking a step back from China specifically, we see that Asian trade data is sending some bearish signals as it relates to the slope of global demand. We’ve taken the liberty to create a proprietary index that captures the slope of Asia’s aggregate export and import growth. The index is a weighted average of the following countries’ export and import statistics: China, Japan, Hong Kong, South Korea, Singapore, Thailand, Taiwan, India, Indonesia, Malaysia, Philippines and Vietnam.


Using this index, we see that Asian export growth slowed to +7.9% YoY in Nov vs. +12.8% in the month prior. The +7.9% YoY growth rate is the slowest pace since Nov ’09 and the first breakdown into single digit growth since Oct ’08. Asian import growth actually accelerated in Nov to +19.6% YoY vs. +18.3% in the month prior.


A Look Under the Hood at Asia’s Trade Data and Capital Flows - 2


A Look Under the Hood at Asia’s Trade Data and Capital Flows - 3


As we have concluded in prior notes, “If the velocity of Asia’s production and shipment of goods is slowing, then Western demand for those goods is also slowing. Expect to see this slowdown in Asian manufacturing and exports show up in headline growth statistics throughout the developed world on a lag.”


Covering AYT Trade Update

The aforementioned acceleration in Asian import growth in the month of Nov can be attributed to further weakness in Asian currencies and resilience in global raw materials and energy prices. Asian central banks, which have started or are in the process of starting monetary easing cycles are seeing the result of the rapid decline in their exchange rates (vs. the USD) show up in marked-to-market import and consumer price inflation.


A Look Under the Hood at Asia’s Trade Data and Capital Flows - 4


While Keith used today’s weakness to cover our short position in a basket of emerging Asian currencies in the Virtual Portfolio this afternoon, the immediate-term bearish thesis is still very much intact: 

  • Slowing growth and peaking/slowing inflation will force Asian policymakers into a cycle of monetary and [potentially] fiscal easing;
  • Waning demand for Asian goods and services in key export markets (particularly E.U.) will reduce demand Asian currencies on the international foreign exchange market; and
  • A slowing of inflows or outright repatriations of capital from the region will also weigh on Asian currencies. 

A Look Under the Hood at Asia’s Trade Data and Capital Flows - 5


A Look at Asian Capital Flows

To the latter point above, Asia is highly reliant on E.U. capital to finance its growth, meaning that a continuation or deepening of Europe’s banking crisis should continue to weigh on Asian capital inflows. European banks finance a larger share of Asian domestic credit relative to their U.S. counterparts in each of the 11 countries we have data for; declining trade financing throughout the region remains an acute risk as a result. From a portfolio investment perspective, agents within the European Union provide roughly 2/3rds to 3/4ths the capital U.S. agents supply to the region. 


A Look Under the Hood at Asia’s Trade Data and Capital Flows - 6


A Look Under the Hood at Asia’s Trade Data and Capital Flows - 7


All told, a rigorous analysis of the recent trade data coming out of Asia, as well as a quantification of the region’s capital exposures by source grant us conviction in the following two viewpoints: 1) global growth is still slowing; and 2) Asian currencies remain at risk of further declines.


Economic gravity is weighing on Asia.


Darius Dale

Senior Analyst


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