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OLD DOGS

This note was originally published at 8am on January 04, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“New Year's Day is every man's birthday.”

-Charles Lamb

 

For Wall Street, and many people around the world, the New Year is a big deal.  The New Year offers a chance to leave behind the past and focus on our goals going forward.  While every new day, technically, offers us the same opportunity, no other time of year inspires the same level of introspection and resolution as early January. 

 

After the excesses of the Holiday season, such a mood can seem particularly apropos.  Along those lines, in Christian tradition, the Tuesday before Ash Wednesday and the beginning of the Lenten season is typically an indulgent time.  Whether this day is referred to as Mardi Gras in New Orleans or Pancake Tuesday in London, the idea is generally the same: enjoy this day before Lent begins – a time of soul searching and repentance.

 

While some may ridicule others for using New Year’s or Lent as catalysts for self-improvement, the fact is that every year occasions such as this offer valuable reminders for people not to live an unexamined life, a life that Socrates would say is not worth living.  Are you convinced that Wall Street follows a similar process of self-examination and reflection?  Have the Old Wall Street follies of times past been faced up to following hours of soul-searching?  Or is Old Wall Street simply unwilling or unable to learn new tricks?

 

One trick that these Old Dogs love to perform is year-end S&P 500 targets and targets for U.S. GDP growth.  We wake up every morning trying to embody our vision of what Wall Street 2.0 is all about.  Taking pot shots at numbers (made up in the case of GDP) a year out is not what we do because it is not helpful for our clients, which is our number one priority.  We focus on shorter durations based on scenarios, probabilities and ranges.  In doing this, we offer our clients more than just a “target”; over time they develop an understanding of our process and incorporate it into their own.  So, before anyone else asks: we don’t do full year targets – let the Old Dogs perform Old Tricks. 

 

One of the classic Old Dogs doing the same Old Trick is Byron Wien of the Blackstone group with his 10 surprises.  The inception of 10 surprises for the New Year came nearly three decades ago.  Right on time, Bloomberg reported the 2012 predictions despite a less-than-stellar showing from Wien in his 2011 predictions (S&P 1500, Real GDP growth of 5%).  While we did not make similar predictions, we were early in stating our view that U.S. growth would slow in 2011 – at a time when consensus was calling for accelerating growth.

 

One of his 10 surprises of 2012 might not have made it to January 4th; “Spain/Ireland will strengthen finances in 2012.” Well unfortunately today the new Spanish government has warned the 2011 deficit could top 8% of gross domestic product, versus a target of 6%. In addition, Spanish Prime Minister Mariano Rajoy’s is considering applying for loans from the European Union’s rescue fund and the International Monetary Fund to finance the restructuring of the ailing banks. There are 361 more days to go, but that particular “surprise” is one that I think seems unlikely to win Wien any plaudits in a year’s time. 

 

What are the implications for GDP growth if Byron’s prediction that the “yield on the 10-year Treasury will go to 4%?”  Unfortunately, the Old Dogs of Washington continue performing their same old tricks coming into the New Year!  According to the U.S. Treasury, America ended 2011 with debt at an all time record $15.2T, with the implications being now the U.S. debt-to-GDP ratio is over 100%.  The USA cannot afford to pay a 4% yield; the implications to the debt and deficits are staggering not to mention it will stifle US GDP growth.  Furthermore, Wien’s prediction is based on China shifting investment from bonds into hard assets and raw materials.   Given that the country holds roughly $1.5 Trillion in American government debt, an investment so great that there is little else China can do but continue to support the value of Treasury bonds.

 

We like to say that Hedgeye is redefining how the investment community operates and we are defining Wall Street 2.0.  Thus, it is not surprising that we continue to get questions from clients asking us to conform to the old mentality of year end predictions.  Clearly, our goals are going to take time to achieve but we are heartened by the feedback we have received from our hard-won clients at this early stage.  In our view, any parties claiming to be able to accurately forecast, rather than guess, Real GDP growth a year out is not being entirely honest.  

 

Rather than waste people’s time with Old Tricks, we prefer to offer up themes quarterly that are relevant to the investing landscape that is in front of you.  Our 1Q12 MACRO Themes call will be held on January 13th, 2012.  We will be sending out details of the themes in due course, but avid readers of the Early Look will know our view on “King Dollar” and the implications for consumption in the USA.  Bernanke staying out of the way and allowing the Greenback to appreciate has boosted the U.S. Consumer and the Macro Team will be sharing its thoughts on this trend in 2012 a week from Friday.  Our immediate-term support and resistance ranges for Gold, Oil (brent), EUR/USD, Shanghai Composite, France’s CAC40, and the SP500 are now $1591-1641, $111.26-112.13, $1.29-1.31, 2157-2219, 3149-3276, and 1267-1285, respectively.

 

Function in Disaster; Finish in style

 

 

Howard Penney
Managing Director

 

OLD DOGS - Chart of the Day

 

OLD DOGS - Virtual Portfolio



It's About Time

“It’s about time something good like this happened.”

-Drew Brees

 

It’s about time we started seeing a Strong Dollar equate to Stronger US Employment. It’s about time we can be long both the US Dollar and some US stocks. It’s about time that both of these positions started winning at the same time.

 

It’s Tebow Time!

 

I just loved watching the quarterbacks of the New Orleans Saints and Denver Broncos (Drew Brees and Tim Tebow) do what they do this weekend (win). It’s the best part about living in this country – it always has been. It’s a place where anyone can accomplish anything, provided that the fields of competition are both fair and free.

 

Back to the Global Macro Grind

 

Last week was awesome. So far, this morning is double-awesome. Why? Because we’re winning. And I have no shame in saying that I absolutely and positively love that too!

 

Last week’s positioning (long the US Dollar and US Consumption) registered the following score:

  1. US Dollar Index up another +1.3% week-over-week to $81.25 (a fresh 11 month high)
  2. US Consumer Discretionary Stocks (XLY) up another +2.6% week-over-week (a fresh 11 month high)
  3. US Stock Market Volatility (VIX) dropped another -12% week-over-week to 20.63 (a fresh 6 month low)

While I have the pom-poms out, we’re also long Chinese Stocks – and they just had their biggest up move in 3-months overnight, closing +2.9% to 2225 on the Shanghai Composite Index.

 

It’s About Time!

 

Can we get confident in something we trust and believe in? Big time. While people on the Old Wall might want to label me like they label just about everything else (on a lag), they’re not going to be able to change me. I can get as confident as any Captain in this game when the momentum is there for the right reasons.

 

Positive momentum, like winning, is contagious.

 

Some people in this country want to get paid to win even when they lose. That’s just ridiculous – and Americans will have no more of it. There is no free lunch in this economy. There is a cost to re-build confidence. We call it Deflating The Inflation.

 

Think about this in terms of where the primary driver of Global Inflation (a debauched US Dollar) has been versus where the US Dollar’s Correlation Risk is starting to go (away). Here are the latest correlations between the USD and the SP500:

  1. 30-day = +0.11
  2. 90-day = +0.06
  3. 3-year = -0.66

In other words, the combined fiscal and monetary policies to inflate via US Dollar DOWN were tested and tried for 3 years – and they did not work. What’s working, as it always has in the long-run, is a Stronger Currency Inspiring Consumption and Confidence.

 

I’m going to keep beating this American Bronco Drum until it starts losing, because the alternative just puts me in a bad mood. John Maynard Keynes was in a pretty bad mood come 1932. If your economic theories, politics, and personal accounts completely failed, you would be too.

 

As Nicholas Wapshott explains at the beginning of Chapter 9 in “Keynes Hayek”, come 1, “for all his phrase making and eloquence urging government to instigate public works to cure unemployment… in the aftermath of ‘A Treatise on Money’, Keynes was suffering for a distinct lack of influence in high places.” (page 123)

 

Like a bad Coach who preaches a style of play that ultimately results in failure, The People of Britain and America effectively fired Keynes in the early 1930s – and they should have. That’s why Keynes was forced to re-invent himself with a new “theory” – the General Theory (more on how that idea was re-built later).

 

Back to the now and how to Proactively Prepare our portfolios for tomorrow’s games…

 

If we build upon this country’s latest economic victories and simply keep the Big Government Interventionists (Geithner and Bernanke) out of the way for another 3 months, we really can see US economic growth re-accelerating from its bottom in Q1 of 2012.

 

We’ll go through this on our Global Macro Themes conference call on Wednesday (email ), and that’s where we’ll take the time to show you the Macro Math behind how an arrest of our 1-year old Growth Slowing theme would work. But it’s critical to remind you that this is a US economic scenario that can quickly be unwound by none other than the US Government itself.

 

In our most bullish US Economic Scenario we can get to +2.2-2.8% US GDP Growth for 2012 (which would put us higher than the Bloomberg consensus of 2.1%). But we, unlike the consensus process that’s broken in generating these consensus estimates, do not make annual forecasts and set them in stone. We change as the probabilities, math, and scenarios of the game do.

 

With that bullish scenario in mind though, I think we can all raise a glass to the real-time winners in this country (Brees, Tebow, US Dollar, etc). For now at least, It’s About Time!

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, US Dollar Index, and the SP500 are now $1, $111.89-115.21, $1.26-1.29, $80.31-81.32, and 1, respectively.

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

It's About Time - Chart of the Day

 

It's About Time - Virtual Portfolio


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Weekly Asia Risk Monitor: Growth Slows at a Slower Rate

Conclusion: While nothing to get excited about from an absolute perspective, the month of DEC was positive, on the margin, for Asian economic data. We look for this trend to continue as growth slows at a slower pace throughout the region over the intermediate term.

 

PRICES RULE

  • Equities: Asian equity markets closed up +0.9% wk/wk on a median basis… China and Vietnam were notable underperformers, down -1.6% and -4.2%, respectively.
  • FX: Asian currencies were unchanged wk/wk on a median basis vs. the USD… Indonesia’s rupiah underperformed, down -1.1%... India’s rupee is down -14% vs. the USD over the last 12 months, which compares to a median -0.6% decline for the rest of the region.
  • Sovereign Debt: Asian sovereign debt markets were relatively quiet wk/wk, with no outsized moves in either direction other than the -28bps compression in Indian 10yr yields.
  • Sovereign CDS: Asian 5yr sovereign CDS markets were also quiet wk/wk, narrowing -1.4% on a median percentage basis... Japanese swaps posted the only positive divergence, widening +4.7% or +7bps.
  • O/S Interest Rate Swaps: Asian 1yr swap rates broadly increased wk/wk, closing up +1.4% on a median percentage basis… Indonesia was a notable outlier, falling -10.6% or -65bps; this dramatic easing speculation rhymes with what we saw in the FX market… Indian swap rates are pricing in -77bps of cuts over the next year.
  • O/N Interbank Rates: Asian interbank rates were particularly mixed wk/wk, despite holding flat on a median basis. Australia (-20bps/-4.4%), China (+59bps/+17.4%), Hong Kong (-24bps/-61.3%), and India (+25bps/+2.9%) highlight the intra-regional divergence.

Full performance tables can be found at the conclusion of this note.

 

CHARTS OF THE WEEK

While nothing to get excited about from an absolute perspective, the month of DEC was positive, on the margin, for Asian economic data. We look for this trend to continue as growth slows at a slower pace throughout the region over the intermediate term.

 

Weekly Asia Risk Monitor: Growth Slows at a Slower Rate - 1

 

Weekly Asia Risk Monitor: Growth Slows at a Slower Rate - 2

 

Weekly Asia Risk Monitor: Growth Slows at a Slower Rate - 3

 

KEY CALLOUTS

Growth Slowing:

  • China: Premier Wen Jiabao lent credence to our analysis which suggests Chinese continues to slow in 1Q by saying, “Business conditions may be relatively difficult this quarter.” He also said that “monetary policy will be fine-tuned as needed.” We interpret the combination of these two phrases to mean that no major changes to monetary policy should be expected in 1Q b/c Chinese policymakers are unlikely to be surprised by an incremental slowing of growth in the near-term.
  • China: Business Climate and Entrepreneur Confidence Indexes both ticked down in 4Q to 128.2 and 122, respectively.
  • India: Export growth slowed in NOV to +3.9% YoY from +10.8% prior.
  • South Korea: Manufacturing PMI slowed in DEC to 46.4 vs. 47.1 prior. Moreover, Export growth slowed slightly in DEC to +12.5% YoY from +12.7% prior.
  • Singapore: Real GDP growth slowed in 4Q to +3.6% YoY from +5.9% prior; QoQ SAAR growth also slowed: -4.9% vs. +1.5% prior.
  • Indonesia: Export growth slowed in NOV to +8.3% YoY from +17.8% prior.

Growth Slowing’s Bottom:

  • China: Manufacturing and Services PMIs ticked up in DEC to 50.3 and 56, respectively. The sub-indexes for New Orders, New Export Orders, and Order Backlog all increased MoM as well.
  • Hong Kong: Manufacturing PMI ticked up in DEC to 49.7 from 48.7 prior.
  • Taiwan: Manufacturing PMI ticked up in DEC to 47.1 from 43.9 prior.
  • India: Both Manufacturing and Services PMIs ticked up in DEC to 54.2 from 51 and 53.2, respectively.
  • Singapore: Manufacturing PMI ticked up in DEC to 49.5 from 48.7 prior. 
  • Indonesia: Consumer Confidence ticked up in DEC to 116.6 from 114.3 prior.
  • Australia: Manufacturing and Services PMIs ticked up in DEC to 50.2 and 49, respectively.

Deflating the Inflation II:

  • Taiwan: WPI slowed in DEC to +4.3% YoY from +5.3% prior.
  • India: Inflation readings continue their downtrend in the week ended 12/24: Food Inflation slowed to -3.4% YoY; Primary Articles Inflation slowed to +0.1% YoY. Energy Inflation, which tracks the benchmark Wholesale Price Index far more tightly than the other two indexes, actually accelerated to +14.6% as crude prices remain elevated amid geopolitical tension.
  • Indonesia: CPI and Core CPI slowed in DEC to +3.8% YoY and +4.3% YoY, respectively.
  • Thailand: CPI and Core CPI slowed in DEC to +3.5% YoY and +2.7% YoY, respectively.
  • Philippines: CPI and Core CPI slowed in DEC to +4.2% YoY and +3.4% YoY, respectively.

King Dollar:

  • India: Subir Gokarn, deputy governor of the Reserve Bank of India, said flat-out: “The monetary cycle has peaked.” While not at all a surprise, we do think his additional commentary confirms our view that the RBI is in a box as it relates to monetary policy: “The RBI is very concerned about the impact of rupee depreciation on inflation… The central bank remains more comfortable using open-market operations to inject liquidity for now, because cutting the cash reserve ratio would send a premature signal that the monetary policy stance has changed.” To that tune, Indian banks are taking advantage of RBI liquidity at an accelerating rate, borrowing an average of $22 billion a day from the central bank in DEC (up from $17.5 billion in NOV). We remain the bears on the Indian rupee, which has fallen -16.4% vs. the USD from its cycle peak in early AUG.

Counterpoints:

  • Taiwan: CPI accelerated in DEC to +2% YoY from +1% prior.

Other:

  • China: As it relates to what’s going to drive Chinese growth on the margin in 2012, Chinese Commerce Minister Chen Deming said that, “China will roll out measures to boost consumption this year.” This rhymes with Premier Jiabao’s commentary from earlier in the week: “China will continue to focus on rebalancing growth, restructuring the economy and increasing consumer and investment demand to support the real economy.” Deming continues: “The ministry will encourage companies to invest and make acquisitions overseas. China will also increase imports of energy products, raw materials, technologically advanced equipment, key components, and consumption goods this year.”
  • China: China’s aforementioned top-down 2012 strategy outlook is consistent with persistent, central bank-induced CNY strength (just off an 18yr high vs. the USD); as such, we’ve seen reduced hedging activity in recent weeks: 1yr USD/CNY forwards are now trading at a -0.4% discount to the spot rate – up from -1.3% on 12/29. The offshore USD/CNY rate is now trading at a [slight] premium to the onshore rate for the first time since mid-SEP.
  • China: Attempting to skirt a cash crunch ahead of Lunar New Year and the peak month for credit extension (JAN), the PBOC injected the most liquidity into the Chinese banking system this week as it has in eight weeks ($8.1B). Little-by-little, Chinese policymakers are doing what they can to engineer a soft landing, though we continue to believe they need more clarity on the inflation front (i.e. what Bernanke/Dudley/Evans are going to do next) in order to justify a major inflection.
  • Japan: Japan, which needs to rollover $3 trillion in maturing sovereign debt this year (on top of another $566 billion in new issuance), has to refinance 31.2% of its outstanding sovereign debt load in 2012. That, combined with repeated warnings for incremental downgrade(s) – which may trigger ~$80 billion in Japanese bank capital raises – suggest that 2012 may be the year Japan has a sovereign credit event. Our thorough analysis of the JGB market suggests otherwise, but it is an intermediate-term tail risk we are monitoring. Prime Minister Yoshihiko Noda has recently vowed to overhaul the nation’s tax and social security systems and legislation proposing to double the 5% consumption tax in a few years is currently being debated in the Diet. Its passage may be critical to maintaining investor confidence in this market.
  • Taiwan: Ahead of the JAN 14 presidential election, both of the leading candidates pledged to introduce capital gains taxes on transactions of properties to curb speculative buying. Look for the measure(s) to weigh on Taiwan’s real estate market going forward. Prices, which have doubled since 2000, are just shy of record levels.
  • Thailand: In a classic show of fiscal and monetary prudence, Thai policymakers debated and ultimately resisted the urge to monetize $35 billion of legacy sovereign debt accrued from bank bailouts following the 1997 Asian Financial Crisis. Instead, they will protect the handshake of their currency by charging commercial lenders fees and drawing on central bank profits, if any.

Darius Dale

Senior Analyst

 

Weekly Asia Risk Monitor: Growth Slows at a Slower Rate - 4

 

Weekly Asia Risk Monitor: Growth Slows at a Slower Rate - 5

 

Weekly Asia Risk Monitor: Growth Slows at a Slower Rate - 6

 

Weekly Asia Risk Monitor: Growth Slows at a Slower Rate - 7

 

Weekly Asia Risk Monitor: Growth Slows at a Slower Rate - 8

 

Weekly Asia Risk Monitor: Growth Slows at a Slower Rate - 9

 

Weekly Asia Risk Monitor: Growth Slows at a Slower Rate - 10

 

Weekly Asia Risk Monitor: Growth Slows at a Slower Rate - 11


The Topping Process Part II: Selling TLT Trade Update

Conclusion: From a fundamental perspective, the Treasury bond market offers limited upside.

 

Position: Closed our long position in the long-end of the U.S. Treasury bond market (TLT).

 

Concurrent with our recent sale of the Treasury curve flattener (FLAT), we’ve decided to also part ways with the long bond by selling our iShares Barclays 20yr-plus Treasury Bond Fund (TLT). Simply put, we think the topping process is underway in both securities, meaning that there is a meaningful amount of asymmetry to the downside from a risk/reward perspective.

 

From a fundamental perspective, the Treasury bond market offers limited upside – especially given our call for the slope of U.S. economic growth to bottom out in 1Q. Moreover, we think our dovish intermediate-term outlook for inflation is largely priced into the long end of the Treasury yield curve. Recall that in late 2010, long-maturity Treasury yields ripped ahead of the 1Q11 jump in reported inflation. A similar lead time in this cycle supports our view that lower-highs in CPI over the intermediate term is largely priced in at current yield levels.

 

The Topping Process Part II: Selling TLT Trade Update - 1

 

Using 10yr yields as a proxy, a quantitative breakout above TREND resistance at 2.03% would be incremental confirmation of the intermediate-term growth scenario we have laid out in recent months. That would likely coincide with a breakdown of the TLT ETF through TREND support at $117.07. In the event we receive the aforementioned quantitative signals in the coming weeks, our next step(s) would be to consider a Treasury curve steepener and/or shorting long bonds. 

 

For now, we are content to wait and watch.

 

Darius Dale

Senior Analyst

 

The Topping Process Part II: Selling TLT Trade Update - 2

 

The Topping Process Part II: Selling TLT Trade Update - 3


The Week Ahead

The Economic Data calendar for the week of the 9th of January through the 13th 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. calendar

The Week Ahead - 2. calendar


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