"Alcohol is the anesthesia by which we endure the operation of life."
-George Bernard Shaw
Keith is New York today for meetings and to co-host Squawk on the Street at 10am eastern, so I’ve been handed the keyboard on the Early Look. I actually have the pleasure of writing this missive from my vacation in Mexico (Cancun to be exact), so unlike many of you stock market operators who have had to endure the manic volatility over the last couple of days, I´ve been enjoying the sun, beach, and, dare I say, a few nips of that old magic agave elixir . . . tequila!
To be sure, this has been a year in which the consumption of alcohol has gone up in proximity to many of the world´s financial districts. Although I certainly would not condone overconsumption, to Shaw´s point above, a few drinks does, at times, provide an appropriate release and if there was ever a year in which a suspension of reality was needed, it may be 2011.
Yesterday, the SP500 closed up almost 3% at 1,241. Interestingly, that is about 5 S&P points below the price at which November closed, 1,246. So, despite the massive squeeze the SP500 is still down roughly 40 basis points on the month. So far, at least, Santa Claus has not delivered.
Although the stock market will likely not end the end the year with a meaningful decline, at least not in the U.S., underperformance has been rampant at many mutual funds and hedge funds. To those that have generated positive performance and alpha this year, Hedgeye salutes you as it has not been easy.
Roughly a year ago, Fortune asked us for our perspective on 2011, so I wrote an article on December 31stwhich outlined our key thoughts with the following summary:
“When contemplating the outlook for the upcoming year, the best place to start is consensus expectations. Currently, according to a Bloomberg survey of the strategists from 11 of the largest brokerage firms in the United States, the mean consensus target for the S&P 500 by year end 2011 is roughly 10% above current levels. Further, every single strategist is expecting a positive performance out of the index in 2011.
Suffice it to say, Hedgeye is decidedly non-consensus heading into 2011.
As it stands, we see a trinity of negative fundamental macro clouds on the horizon that have yet to be properly discounted by the market, and which are poised to cast a potentially long shadow over domestic equities heading into next year. The three key risks we see to these lofty consensus expectations heading into 2011 are: global growth slowing, inflation accelerating, and interconnected risk heightening.”
(The article in its entirety can be found here: http://finance.fortune.cnn.com/2010/12/31/a-new-year-brings-new-economic-headwinds/ )
Interestingly, interconnected risk has become the most noteworthy of the three risks we flagged at the end of last year. The most relevant evidence of this is probably a recent statistic emphasized by Jim Grant. According to his analysis, in the entire history of the SP500, going back to 1957, there has never been a day when all 500 stocks rose or fell. There have, though, been 11 days when over 490 stocks moved in the same direction and 6 of those have occurred since July 2011. Still think government intervention has no impact on your portfolios?
At times, our outlook for 2011 looked really wrong. In fact, by April 29th2011 the SP500 was up 8.4% for the year and on track for a 25%+ gain on an annualized basis, which, of course, would have made our outlook not just wrong, but dead wrong. As for those of you who have followed us closely for the past few years, we are anything if not convicted in our research. In 2011, it paid to have conviction on that macro process.
Related to the game in front of us, the short term question is what to do with yesterday's massive squeeze. The key drivers of the squeeze were both a better than expected new housing data point in the U.S. and the newest panacea from Europe (or is it the newest acronym?), the ECB’s LTRO facility. On the first point, housing starts were up 9.3% sequentially to 685K on an annualized basis, but this was driven by a 25% growth in multifamily starts (single family starts have been flat since the expiration of the second tax credit in April 2010 and remain well off prior cycle peaks of 2.27MM on an annualized basis). As it relates to Europe, Italian 10-year yields are up at 6.85% this morning, which suggests we may be shortly awaiting the next European panacea to keep the equity rally going. (Incidentally, Greek 10-year yields are north of 35%.)
Unlike Taiwan equities which posted a 4.56% gain overnight, that market’s biggest gain in 2.5 years, on the back of the government saying it will let its National Stabilization Fund buy equities to support domestic markets, China closed down 1.2% and is now down 22% on the year. The Chinese, it seems, are less excited by the continued path of structurally impaired growth as insinuated by the 498 billion Euros to be lent from the ECB to the European banking system.
As for our moves yesterday, Keith bought back long term Treasuries (TLT) and shorted oil (BNO) as the SP500 remains Bearish from a TAIL perspective with a range of 1,207 and 1,270. As for me, I’m headed back to the beach to enjoy a few more margaritas before my vacation ends, but rest assured I will be risk managing my consumption. For as Seneca once said:
“Drunkness is nothing but voluntary madness.”
Happy holidays to you and your loved ones,
Daryl G. Jones
Director of Research
TODAY’S S&P 500 SET-UP – December 21, 2011
Another debt laden central plan, another short covering rally – Joy to the Levered World.
As we look at today’s set up for the S&P 500, the range is 24 points or -1.15% downside to 1193 and 0.78% upside to 1251.
SECTOR AND GLOBAL PERFORMANCE
So my TREND line of 1207 support holds and zoom! Everything that was a down December of -3.3% to-date (24hrs ago) is fixed. Just like that – presto. Perfectly manageable, provided that you can change your entire positioning in 1 hour of trading.
The new range for the S&P 500 (1 - TAIL) and my call remains that you’ll push the low end of that range on Dollar up moves and the high-end on Dollar down. With the immediate-term TRADE correlation (inverse) between SP500 and USD = -0.88 and for EuroStoxx vs USD its -0.97.
We are long Consumer Discretionary (XLY) as I think the USD down day today is more of a counter-TREND move than the bigger picture one that continues to develop. Strong Dollar = Strong Consumption (new YTD highs today in our big cap Consumer favorites – WMT and SBUX), and a much more sustainable economic and risk mgt environment than what you’re attempting to deal with as central planners attempt to “smooth” the price/volatility cycle.
SENTIMENT – the best thing about not running money is I get much better feedback on how people are really positioned. While its fashionable to say “everyone is bearish”, as of DEC the data no longer supports that qualitative claim (VIX anywhere in the area code of 21-23 is a very complacent signal and the II Bullish/Bearish Survey Spread just popped right back up to a 3mth high (to the Bull side) of +1800bps wide (last registered Dec 7th, before we swooned, again)
- ADVANCE/DECLINE LINE: 2135 (+4057)
- VOLUME: NYSE 947.03 (+22.25%)
- VIX: 23.22 -6.82% YTD PERFORMANCE: +30.82%
- SPX PUT/CALL RATIO: 1.25 from 1.60 (-22.10%)
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: 57.12
- 3-MONTH T-BILL YIELD: 0.01%
- 10-Year: 1.94 from 1.82
- YIELD CURVE: 1.68 from 1.58
GLOBAL MACRO DATA POINTS (Bloomberg Estimates):
- US MBA Mortgage purchase applications index (4.9%) in 16-Dec week; total market index (2.6%) compares to (8.2%) and +4.1%, respectively, in the prior week; refi index (1.6%) vs. +9.3%
- 10am: Existing home sales, Nov., est. up 2.2% to 5.05m
- 10:30am: DoE inventories
- 1pm: U.S. to sell $29b 7-yr notes
WHAT TO WATCH:
- Bank of America said close to settling a Justice Dept. probe into whether its Countrywide unit violated fair-lending practices
- Fed’s plan to boost supervision for U.S. banks stopped short of setting minimum liquidity levels, delayed decisions on risk-based capital and leverage until intl. regulators weigh in
- House, Senate remain deadlocked on extending unemployment benefits
- Bullish sentiment increases to 48.4% from 45.3% in the latest US Investor's Intelligence poll
- Sinopec's buying spree has wide-ranging effects - WSJ
- Switzerland and the United States are " reasonably close" to foster a tax agreement in order to end tax evasion using Swiss accounts – Swissinfo
- Hackers in China got access to all of US Chamber of Commerce's information – WSJ
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Nordic Shipping Banks Beat UniCredit Amid Overcapacity: Freight
- Record Coal Deals Whittle Targets as Prices Climb: Commodities
- Gold Extends Climb on Global Recovery Speculation, Weaker Dollar
- Oil Climbs a Third Day on U.S. Economy, Shrinking Crude Supplies
- Emerging Stocks to Drop on Commodities Risk: Technical Analysis
- Hedge-Fund Refuge Sought by Traders Amid Bank Cuts: Commodities
- Copper Climbs on Chinese Pledge to Support Exports, Trade Data
- Container-Shipping May Rise in 2012 After Alliances, Platou Says
- Corn, Wheat Decline on Forecast of Rains Easing Stress on Crops
- Temasek Buys Mosaic Shares to Become Largest Shareholder
- New Gold May Top 1 Million Ounces in Six Years, Oliphant Says
- Oil Climbs a Third Day on U.S. Economy, Shrinking Crude Supplies
- China Refined Copper Imports Rise to 29-Month High on Prices
- Palm Oil Gains on Concern Supplies May Drop as Production Slows
- Metal Thieves Thought to Have Taken London Sculpture, FT Says
- Gold Gains as Euro Advances on IMF Pledge, German Confidence
- India May Allow More Sugar Exports After Mills Fill Quota
LTRO – genius. brilliant. Right, right – for another short-term TRADE squeeze but piling another 498B Euros (monster #) in LTRO leverage onto this sick puppy is like lathering up tricky Dick Fuld a month before the blowup. This has both the DAX and CAC getting squeezed right back above TRADE lines of support (5809 and 3062, respectively) and I would not be short European Equities or the Euro here. EUR/USD mini breakout line = 1.31; waiting on 1.33 to re-short.
CHINA – apparently the Chinese didn’t get the Institutional AM short covering memo (short red; chase green) – China looked more like Oracle’s guidance last night, losing another -1.2%, still in freefall at -22% YTD (Shanghai Comp). Remember, adding more leverage to the system structurally impairs Global Growth.
MIDDLE EAST (HEADLINES FROM BLOOMBERG)
- Goldman Sachs Sukuk Row May Dent Industry Lure: Islamic Finance
- U.S. Joins EU Pressing to Cut Iran Oil Sales Over Nuclear Effort
- Troops Are Gone but Iraq War Is Not ‘Over’: Meghan L. O’Sullivan
- Aldar Won’t Delist Shares From Abu Dhabi, Deputy CEO Says
- Almarai Acquires Argentina’s Fondomonte for $83 Million
- Aldar of U.A.E. Drops to Record Amid Delisting Bets; Yield Falls
- US Military 'Ready to Engage in a Conflict With Iran'
- Lebanon Deposit, Loan Growth Slow on Syria Unrest: Arab Credit
- BPCL Said to Plan Paying Iran for Crude Via Rivals’ Accounts
- Qatari Group to Acquire 90% of Dexia BIL in $950 Million Deal
- Dexia break-up quickens with Qatari deal
- Oil Climbs Second Day on Gain in Housing Starts, Iran Concern
- Genel in Talks With Longford Over Iraq Oilfield Stake Purchase
- Record Oil-to-Natural Gas Ratio Reshapes Chemicals: 2012 Outlook
- Drydocks World Sees $2.2 Billion Debt Restructuring in March
- Hayward’s Genel in Talks to Buy Further Stake in Iraq Field: Sky
- Etihad Signs $1 Billion Technology Deal With Sabre Airline
- National Marine Dredging to Buy Emarat Europe Fast Building
The Hedgeye Macro Team
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“Economics is too important to leave to the economists.”
– Steve Keen
I graduated with a degree in Economics from Princeton University; looking back at old textbooks and syllabi, and listening to former professors debate current economic issues, I can’t help but feel like I “dropped a hundred and fifty grand on an education [I] could’ve gotten for a dollar fifty in late charges from the public library,” to quote one of my favorite movies, Good Will Hunting. [I fully expect an angry call from my parents today.]
But it seems that I’m not alone. Last month, seventy freshmen at Harvard walked out of Gregory Mankiw’s introductory Economics 10 lecture; they wrote to the well-known economist that his course “espouses a specific – and limited – view of economics that we believe perpetuates problematic and inefficient systems of economic inequality in our society today.” And that, “As your class does not include primary sources and rarely features articles from academic journals, we have very little access to alternative approaches to economics.”
The quote that prologues this note is from Post-Keynesian economist Steve Keen’s book Debunking Economics. If you’ve never heard of him it’s because he doesn’t write for the New York Times or dine in Davos, though in 2010 he did win the Revere Award for Economics for being “the economist who first and most cogently warned the world of the coming Global Financial Crisis.”
He is a harsh critic of mainstream economists; while Keen warned as early as 2001 that “economic theory has been complicit in encouraging America’s investing public to once again delude itself into a crisis,” neoclassicists like Greenspan, Bernanke, and Geithner were our economic leaders that empowered the private sector to lever up to an unsustainable level (private sector debt to GDP of 300%), gave no warning of imminent danger, and today fail to apply appropriate policies to lift us out of the recession because they don’t understand what caused it.
Like those Harvard freshman, Keen isn’t afraid to say that today’s Emperors of Economics aren’t wearing any clothes. Hedgeye says it every day.
The economists that make the world’s crucial monetary policy decisions are the same economists that I listened to in lecture halls and authored my textbooks. While superficially appealing, their theories lack empirical evidence, are riddled with internal inconsistencies, and are based upon tenuous assumptions. Specifically, their models are built on downward sloping demand curves, upward sloping supply curves, perfect competition, rational consumers, benevolent dictators, and general equilibrium; there is no dynamic analysis, no consideration of disequilibrium, and no role of private sector debt.
What real-world, market economy adheres to the principles defined by our leading economists?
There isn’t one. That’s why Milton Friedman argued that a theory cannot be judged by its assumptions, but only by the accuracy of its predictions. But that defense doesn’t hold up so well after every neoclassical economist failed to predict the financial crisis and ensuing recession. In fact, in August 2008, Olivier Blanchard, professor at MIT and now chief economist at the IMF plainly stated that, “The state of macro is good.” Somehow, even when groupthink’s policy resulted in turmoil the world over, economic leaders failed to judge modes of economic thought by the accuracy of their predictions. As a result, the same actors – Geithner, Bernanke et al. – remain in systemically-important roles even after being proved wrong pre and post 2008.
As Keen puts it, neoclassical economists are “wedded to the belief that capitalism is inherently stable. They cannot bring themselves to consider the alternative perspective that capitalism is inherently unstable, and that the financial sector causes its most severe breakdowns.”
Rather than expanding the range of phenomena that economics can explain, the leading edge of neoclassical theory focuses on defending the core beliefs from the attacks of ancillary views. It is truly a Degenerative Science, if economics can be considered a science at all. True sciences expand and evolve: genetics, psychology, quantum mechanics, astronomy; economics defends itself – it is an ideology.
On scientific progress, German physicist Max Planck said that, “Science advances one funeral at a time,” and Keen concurs: “You cannot persuade people who believe a mythical vision of reality and their whole lives are dedicated to believing that way.”
As it pertains to the leadership of our globally-interconnected economy, we’re more optimistic. The American people’s frustration demands a faster rate of change than “one funeral at a time.” Whereas academic economists move at a glacial pace (if they are moving at all), the people are unafraid of change – they will fold a losing hand. Public opinion polls have shown for some time the dissatisfaction of the American people with Bernanke’s performance, for instance.
Americans want to stop playing with perennial losers, while potential winners are left on the bench.
Including concepts from complexity theory, evolutionary economics, Austrian economics, Post-Keynesian economics, and other alternative economic schools – all shunned by today’s monetary and fiscal policy leaders – would be a positive change on the margin. What we need is an economic theory that is more relevant to a modern capitalist economy – one that embraces uncertainty and disequilibrium, is grounded upon realistic assumptions, is judged by the accuracy of its predictions, and where debt and money are implicit, important factors.
Like Wall Street 1.0, Economics 1.0 is broken and has to evolve. Keen aptly states, “If economics is to become less of a religion and more of a science, then the foundations of economics should be torn down and replaced.” We are on the way.
Our immediate-term support and resistance ranges for Gold (bought it on 12/14), Brent Oil (Bearish Formation), and the SP500 are now $1568-1596, $103.23-107.91, and 1206-1228, respectively.
The Macau Metro Monitor, December 21, 2011
CONSUMER PRICE INDEX FOR NOVEMBER 2011 DSEC
Macau CPI for November 2011 increased by 6.65% YoY and 0.39% MoM.
Conclusion: USD strength and the resultant knock-on effects continue to force the hands of international policymakers.
- Equities: Regional equity markets closed down -0.9% wk/wk on a median basis, w/ Venezuela outperforming (up +0.6%) and Argentina underperforming (down -1.3%);
- FX: Latin American currencies are up modestly vs. the USD wk/wk (+0.1%), w/ the Brazilian real outperforming (up +0.8%) and the Chilean peso underperforming (down -0.8%);
- Fixed Income: Regional sovereign debt yields generally backed up across the maturity curve, w/ Brazil gaining +19bps wk/wk on both its 2yr and 9yr issues;
- CDS: 5yr sovereign CDS closed +6.6% wider wk/wk on a median percentage basis, w/ Peru widening the most (+8.4% or +13bps) and Argentina widening the least (+2.2% or +22bps);
- Rates (swaps): 1yr O/S interest rate swaps markets were flat wk/wk on a median percentage basis, bracketed by Mexico (+9bps wider) and Chile (-4bps tighter); and
- Rates (interbank): O/N interbank rates backed up +0.3% wk/wk on a median percentage basis, bracketed by Mexico (+10bps wider) and Argentina (-25bps tighter).
Price tables can be found at the bottom of this note.
CHARTS OF THE WEEK
Growth in Brazil continues to be rather un-“BRIC”-like:
As such, various markets continue to price in additional monetary easing measures out of Brazil’s central bank:
Jumping ship, aggressive financial repression appears to have slowed capital outflows in Argentina – for now:
- Brazil: After publishing a sour 3Q real GDP report, Brazil’s economic activity index (a proxy for GDP) slowed incrementally in Oct to +0.7% YoY vs. +1.3% prior.
- Colombia: Industrial production growth slowed in Oct to +5% YoY vs. +5.2% prior… retail sales growth slowed in Oct to +6.1% YoY vs. +8.1% prior.
- Peru: Real GDP growth slowed in Oct to +5% YoY vs. +5.8% prior.
- Brazil: USD strength continues to force the hands of international policymakers; Brazil’s central bank became the latest country to [re]introduce ‘08/’09-esque measures to protect its currency and the supply of capital flowing into the country. Specifically, the program is structured as a 1-3 month repo that is intended to provide trade financing for Brazil’s exporters. A noteworthy takeaway here is that the central bank may view this as an effective maneuver in the short term to slow the pace of the real’s decline, thus opening the door for further rate cuts. Of course, the derivate of the latter action is indeed a weaker outlook for the currency.
- Brazil: Regarding the slope of Brazilian interest rates, widespread political pressure continues to be applied to the country’s central bank operatives. President Dilma Rousseff had this to say over the weekend: “[Brazil] is ready to use monetary policy to stimulate growth amid a violent global crisis… Developed nations have interest rates close to zero. We have a room for maneuvers that they don’t.” Markets are taking her continued outlook for Brazilian interest rates seriously: 2yr sovereign debt yields, 1yr interest rate swaps, and O/N interbank rates are all trading below the official Selic rate at -54bps, -112bps, and -10bps, respectively.
- Argentina: Financial repression, while successful at slowing the pace of capital flight, continues unabated in Argentina as the gov’t seeks to stave off a crash in the currency. To the former point, the central bank has now become a net buyer of FX reserves as insurers, energy and mining companies repatriate an estimated $2-4 billion into year-end per the government’s directive. Slowing capital flight, which fell to about $1 billion in Nov from $3 billion in Oct, and pressure from central bank president Mercedes Marco Del Pont are combining to drive down the cost of capital in the country (from a mid-Nov peak of 26.1% to 18.8% on the 30-day badlar). As mentioned, these near-term “successes” are not without consequence. Over the long term, we expect the country to experience incremental economic volatility and even higher [unofficial] rates of structural inflation as investors lose confidence in the country altogether and abandon peso-denominated assets. To that point, 1yr USD/ARS NDF contracts are currently pricing in a -20.2% crash from the spot rate over the NTM.
- Chile: Less than a week after holding its benchmark policy rate at 5.25%, Chile’s central bank lowered its 2012 growth and inflation outlook by -50bps and -20bps, respectively, to 4.25%-4.7% and 2.7%, respectively. Their reduced expectations for both metrics paves the way, on the margin, for them to cut rates – an outcome currently being priced into Chile’s 1yr O/S interest rate swaps (trading -90bps below the policy rate).
- Mexico: Who says you need a strong currency to empower domestic consumption? Mexico’s ANTAD same store sales growth ripped to the upside in Nov to +14.6 YoY vs. +5.8% prior, despite the peso falling -9.4% vs. the USD in the YTD through Nov. We don’t expect this divergence to sustain itself and remain the bears on the peso (vs. King Dollar) over the intermediate-term TREND. Mexico’s central bank remains divided on the next step(s) in monetary policy. This indecision is subtly bearish for the peso as heightened volatility forces investors to demand greater premiums to hold risky assets – a premium that is not being adequately provided by the central bank due to their Indefinitely Dovish interest rate policy.
- Peru: Less than six months after winning the Peruvian presidency on the strength of strong populist support, it appears President Ollanta Humala is losing some of his left-most supporters in politics after he recently declared a state of emergency and authorized a military response to quash protests against a $4.8 billion gold mine being developed by Newmont Mining Corp. Two senior officials in his cabinet resigned after voicing support for the demonstrations; he then replaced his cabinet chief with a former military instructor. Former president Alejandro Toledo withdrew his party’s support for Humala in Congress, where Humala’s Gana Peru party only has 47 of 130 seats. Congressional gridlock and lower-highs in presidential approval appear to be in the cards for Peru and its now pro-business president over the intermediate and, potentially, long term. Ironically, it was Humala that led a violent uprising as a rebel solider just over ten years ago.
- Venezuela: Another socialist leopard changing its spots? In an attempt to limit consumer goods supply shortages ahead of next year’s elections, Venezuelan president/dictator Hugo Chavez is forging strategic alliances with private international companies to entice them back to the country’s retail markets. This is a major reversal of his political M.O.; as recently as a few weeks ago, he authorized a dramatic piece of new legislation which would allow the government to impose draconian price caps on thousands of consumer goods. Moreover, since taking office in 1999, Chavez has seized the assets of 1,045 companies and is on the hook for roughly $30 billion in paid and unpaid international legal settlements. While we don’t expect Chavez to soon adopt Adam Smith-style capitalism, we do think this latest round of political short-termism might actually be marginally supportive for the economy struggling with structurally high rates of inflation – if he is to follow though, of course.
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