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Perpetually Reverting

This note was originally published at 8am on January 19, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The only thing that’s gone up for the last 12 years is my weight.”

-Keith McCullough


Two nights ago Keith and I hosted a dinner for a number of our subscribers at the beautiful Patroon restaurant in midtown Manhattan.   Keith’s quote above was in reference to asset classes generally.  Now, truth be told, Keith and I snuck away to play noon hour hockey earlier this week and he’s actually staying in pretty good shape.  Nonetheless, his analogy was an apt one.  Asset class returns are not perpetual, nor are global macro investment views.


On the latter point, the big surprise we heard at the dinner and feedback from our Q1 Themes call last week is the shock that we are getting more constructive on equities and the U.S. economy.  Yes, we are less bearish.  Not raging bulls, per se, but on the margin less bearish.  As a result we’ve upped the equity allocation in our asset allocation model to its highest level since mid-September ’11.  So, what’s driving our more constructive outlook?


First, we believe the rally in the U.S. dollar will continue to gain momentum.  The strength in the dollar is likely to be driven by a fiscal outlook in the United States that is improving, on the margin, due to automatic budget cuts via sequestration and the winding down of the Iraq war.  In addition, both political parties have signaled, at least rhetorically, the importance of getting government spending under control, an issue that will be front and center in the 2012 election, and will likely lead to further budget cuts, or the perception of such.


The other key tailwind for the U.S. dollar is monetary policy.  Since the financial crisis in 2008, the United States has led the world in accommodative monetary policy.  This is changing and will continue to change.  We believe the Fed is in a box related to its ability to implement additional quantitative easing due to an improving employment and economic growth situation.  Conversely, central banks globally have plenty of room to ease, which naturally narrows the differential between U.S. interest rates and global rates.  The most recent example of this is from China, where this morning reports suggest Chinese officials are weighing plans to relax capital requirements for the major Chinese banks.  Add to this Brazil, which cut interest rates by 50 basis points overnight and the Philippines, which cut rates for the first time since 2009. 


The primary benefit of a strong dollar is that it boosts the purchasing power of the U.S. consumer by deflating those commodities that are priced in U.S. dollars and by making global goods cheaper on a relative basis.   This is important when considering the outlook for GDP since 71% of U.S. GDP is driven by consumption.  Conversely, Eurozone government spending is almost 50% of GDP, which makes the outlook for European growth relatively bleak in comparison given the dramatic austerity being implemented in 2012.  (Incidentally, a weak European economy and euro are also positive for the U.S. dollar.)


Last year at this time, consensus U.S. GDP estimates for 2011 were at 3.2% and came down steadily all year.  It is likely that full year 2011 U.S. GDP comes in at, or under, 2%, which implies an almost 38% miss by the consensus Wall Street prognosticators.   Call it process or luck, but we started last year with a much more pessimistic view of economic growth.  Thus, for most of last year we were underweight equities and overweight fixed income, with a focus on FLAT and TLT.


This year the scenario is basically reversed.  U.S. GDP consensus growth estimates are now just above 2% for 2012.  Our models suggest a reasonable high end range of GDP growth in the U.S. could be 2.8%.  This is almost 40% above the consensus number and an economic scenario in which growth is accelerating versus last year.  Not surprisingly then, we have exited our fixed-income positions and have a much higher allocation to equities, both U.S. and global.


Currently, one of our key global equity positions is long Chinese equities via the closed end fund CAF.  As of this morning, the position has already returned more than 15% for us in the Virtual Portfolio.  Are we surprised? Well, perhaps by the rapid price appreciation, but it was a game of expectations in China.  The Chinese bears have been perpetuating an end of the world scenario for China and the Chinese benchmark equity index was down more than -20% last year.  Thus, when economic growth from China came in better than bad a couple of days ago at +8.9%, Chinese equities reacted favorably.  This is not dissimilar to the economic setup we see in the United States.


In the Chart of the Day today we’ve highlighted gold versus the U.S. dollar going back twelve years.  The key take away from the chart is that bull markets in gold have been perpetuated by bear markets in the U.S. dollar.  After gold has gone straight up for the last decade plus, it might not seem to be a contrarian call to suggest there is bubble in gold and it is potentially primed for a potential major correction, but there is major complacency related to gold.  Unfortunately for the gold bugs, nothing goes up forever, not even gold.  But if you don’t believe us, ask India, the world’s largest consumer of gold, who is set to import 54% less gold in Q4 2011 on a year-over-year basis.


If there is one truism of investing, it is that prices revert to the mean.  As Jeremy Grantham once said:


“I got wiped out personally in 1968, which was the last really crazy, silly stock market before the Internet era….After 1968, I became a great reader of history books. I was shocked and horrified to discover that I had just learned a lesson that was freely available all the way back to the South Sea Bubble.”


No asset class goes up, or down, in perpetuity.


Our immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, US Dollar Index, Shanghai Composite, and the SP500 are now $1636-1675, $109.02-111.91, $1.26-1.29, $80.31-81.61, 2220-2354, and 1290-1310, respectively.


Keep your head up and your stick on the ice,


Daryl G. Jones

Director of Research


Perpetually Reverting - Chart of the Day


Perpetually Reverting - Virtual Portfolio

Natural Laziness

“Laziness is built deep into our nature.”

-Daniel Kahneman


Chapters 2 and 3 in Dan Kahneman’s “Thinking, Fast and Slow” are linked by laziness. I loved it – the author really forces you to ask yourself if you really know what you don’t know.


“Highly intelligent individuals need less effort to solve the same problems, as indicated by both pupil size and brain activity. A general “law of least effort” applies to cognitive as well as physical exertion. The law asserts that if there are several ways of achieving the same goal, people will eventually gravitate to the least demanding course of action.” (page 35)


Most people in our profession are, from an academic achievement perspective, considered “highly intelligent.” Odds are that if you are a Buy-Sider paying a Sell-Side desk a commission, the Sell-Sider might even call you “really smart.”


Really? How really smart is smart? Collectively, the Old Wall’s Consensus on Global Macro risk management issues hasn’t been smart for the last 3-5 years. It’s been lazy.


Let’s take, for instance, this newly wedded concept the Street has to “Risk On” versus “Risk Off.” The entire premise of that idea is just lazy. While it may provide a framework for people to talk about risk with the least demanding course of thought or action, it doesn’t change the fact that risk is always on.


Back to the Global Macro Grind


Risk also works both ways. The #1 risk we have been beating on so far in 2012 is not Greece. It’s Global Growth. And the “risk” on Growth Expectations is to the upside.


Unless you’ve been living under a rock for the last 3 years, you’re aware the Greeks have more issues than Time Magazine. Last year alone, the Greek stock market crashed by another -51.9%. This morning, Greece is down -2.5% (and the manic media can’t find anything else to talk about but Romney’s taxes), but that doesn’t mean that the rest of the globally interconnected world ceases to exist.


Here’s how we think about the Natural Laziness of getting lulled into yesterday’s news: Market Prices Rule.


What I mean by that is that if you look at what the construct of real-time market price, volume, and volatility signals are telling you within a time horizon that’s Duration Agnostic, you can up the probability of not getting caught off-sides by consensus.


Across all 3 risk management durations in our model (TRADE/TREND/TAIL), here’s how Greece’s General Share Index looks:

  1. Immediate-term TRADE support = 669 (bullish breakout)
  2. Intermediate-term TREND support = 708 (bullish and holding that new support)
  3. Long-term TAIL resistance = 1109 (bearish)

Ok. Makes sense right? But maybe it only does because I just gave you a short-cut to think about risk within the context of the short, intermediate, and long terms. Is that good enough? Do you have an alternative process that’s better? How can we evolve it?


These are all questions that I encourage my team to push me on each and every day. Question the premise of the assumptions, particularly when our investment positioning is wrong. The market always knows something.


For now, only people who are short Greek stocks in 2012 can assure you of what the wrong position has been. Inclusive of today’s -2.5% selloff, Greece is still up +6.5% for 2012 YTD, beating the SP500 by 1.8% (1316). Who would have thunk?


In other globally interconnected news, Japan popped right back onto our risk management radar this morning with the following:

  1. Japan will not meet its top-line (GDP Growth) goals, again
  2. Japan will not meet its bottom-line (deficit) goals, again
  3. Japan is becoming increasingly annoyed with their failed Keynesian Experiment

How’s that money printing + fiscal “stimulus” model treating the old boy network in Tokyo?


Now if Japan didn’t have to roll over 31% of its debt in 2012, we might brush off what’s happening in one of the world’s Top 3 economies like Newt is trying to side-step his Freddie Mac compensation. But, we’re not dumb enough on the math to try that yet. We’re talking about rolling over 231 TRILLION Yens in debt ($3T USDs). Even by Fiat Fool standards, that’s a lot of Yens!


Relative to the US Dollar, the Japanese Yen, naturally, is down this morning on that “news.” As to why the Old Wall’s Consensus didn’t list a Japanese Sovereign Debt Crisis as part of their 2012 “biggest surprises”, we’ll just have to chalk that up to Natural Laziness too.


My immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, US Dollar Index, Nikkei225, and the SP500 are now $1, $109.31-111.26, $, $79.63-80.44, 8, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Natural Laziness - 1. Athex


Natural Laziness - 1. VP Heut

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2012 Tail Risk: Shorting EWJ Trade Update

Conclusion: The Japanese sovereign debt markets are beginning to look stressed, as noted by CDS that have widened (particularly versus the rest of Asia), as the re-financing needs of the Japanese government accelerate in 2012.  As such, we believe the massive issuance on the horizon for Japan sovereign debt will continue to limit economic growth, over the TAIL, which is negative for Japanese equities.


Position: Short Japanese equities (EWJ)


Earlier today, Keith shorted Japanese equities in our Virtual Portfolio. Adding this risk exposure is a continuation of our long-term bearish research thesis on Japan (Japan’s Jugular), which we published a presentation on in 4Q10.


In addition to that work, we’ve published detailed analysis of the puts and takes of Japan’s banking system and its exposure to JGB risk – which is on the table in a major way in 2012, as the economy has to roll over 30.9% of its QUADRILLION-plus yen sovereign debt balance via redemptions and new issuance this year. To the later point, new issuance is expected to cover 49% of all expenditures – a record high.


Thoughtful analysis of the aforementioned puts and takes has kept out of the way of the short side of the JGB/JPY markets, unlike other notable Japan bears. That said, our propriety analysis suggests that the Japanese banking system may be on the hook for over $80B in capital raises should Japan be downgraded to an A+ equivalent by two of the ratings agencies (using Basel II standards). Currently, both Fitch and Standard & Poor’s ascribe a negative outlook to the country’s LT sovereign debt. This potential headwind may erode what is the main structural demand tailwind for the JGB market (surplus liquidity in the banking system).


Ironically, our models have Japanese real GDP growth accelerating through 2Q12E, as the country comps up against one of the worst natural disasters in modern history. We think being long Japan for that trade is the kind of investment that can sucker in those that fail to do enough of the background work.  As such, we are taking the other side of this obvious (and consensus) tailwind and are electing to trade Japanese sovereign debt tail risk with a bearish bias for now.


As always, we are happy to follow up with further analysis. Email us if you’d like to start a dialogue on the subject.


Darius Dale

Senior Analyst


2012 Tail Risk: Shorting EWJ Trade Update - 1


Dr.Copper: Chinese Imports Reach an All Time High

Conclusion:  Chinese copper imports were up 78% y-o-y in December reaching a new high for monthly imports.  We think this is an important and supportive data point of Chinese growth bottoming and supportive of our long Chinese thesis.


Positions: Long China via the etf CAF


Copper is often jokingly referred to as Dr. Copper with the insinuation being that copper has a Ph.D. in economics given its sensitivity to economic demand.  Globally, copper use is broken down into the following categories of end market demand: electrical wires (60%), roofing and plumbing (20%), industrial machinery (15%), and other alloys (5%).  As such, demand for copper is very economically sensitive and is often a leading indicator for economic growth, so the commodity’s nickname is fitting.


In the commodity markets, marginal increases or decreases in demand can be critical in determining price.  One of our key Q1 2012 themes is Growth Slowing’s Bottom, which implies that economic growth is bottoming.  The next phase, of course, is economic expansion, which will lead to increasing demand for commodities, such as copper.  Interestingly, the most recent data from China on copper imports suggests that the Chinese may be beginning to prepare for accelerating growth, or at the least that the Chinese do not anticipate a slow down.


In the chart below, we’ve outlined copper imports in China going back to January 2008, which highlights that copper imports have been accelerating for seven straight months.  Importantly, copper imports reached an all-time high for monthly imports in December 2011, up an astounding +78% y-o-y, to 406,937 metric tons.  This acceleration in demand is particularly noteworthy in that Chinese imports were down in both 2010 and 2011, -8.4% and -3.0%, respectively.  Thus, the December copper import data appears to be signaling that the demand profile for Chinese demand is improving.


Dr.Copper: Chinese Imports Reach an All Time High - 1


The pickup in Chinese demand for refined copper comes at the same time as both GDP growth and industrial production have also provided support for our Growth Slowing’s Bottom theme and long Chinese equities position.  Recall, China’s real GDP grew at +8.9% in Q4 2011 versus an expectation of +8.7% and industrial production grew +12.8% in December versus a forecast of +12.3%.   Even though copper inventories in China are at a nine month high, the Chinese are clearly betting that demand for copper is poised to accelerate, so they are attempting to buy ahead of an increase in the price of copper.


In the global copper supply and demand model, Chinese growth and demand are the primary input.  Depending on whose estimates we use or believe, Chinese is approaching anywhere between 40% and 50% of global copper production, the vast majority of which is imported from abroad.  So, as Chinese growth shifts on the margin, it’s obviously very influential to the price of copper.


In the chart below, we’ve highlighted our current quantitative levels on copper, which highlight that copper has gone bullish TREND driven by the dynamics outlined above.   It is important to note, though, that copper remains below its TAIL line of resistance at $3.98 per pound.  To get incrementally bullish on copper, we will need to see it breakout above its TAIL line.


Dr.Copper: Chinese Imports Reach an All Time High - 2


From a relative price perspective, we also took a look at the gold / copper ratio going back more than twenty years.  Based on this ratio, and as the chart below shows, copper is near its cheapest level as priced in gold.  Currently, one ounce of gold can buy 440 pounds of copper. This is more than one standard deviation above the twenty year average of 349, and it is 148% above the low for that period.


Dr.Copper: Chinese Imports Reach an All Time High - 3


 It is also noteworthy to highlight that the world’s largest importer of gold is India, who is expected to import 54% less gold in Q4 2011 than in Q4 2010. This is obviously in stark contrast to the growing demand from the largest importer for copper, China.  At least partially, this is a function of copper prices being down -20.1% last year and much cheaper and gold being up +10.1% and being more expensive.  If there is one repeatable pattern in investing, it is reversion to the mean.


Daryl G. Jones

Director of Research

Weekly Latin America Risk Monitor: All Eyes on Brazil Part II + A King Dollar Update

Conclusion: The Brazilian economy remains in the sweet spot for equity investments and we continue to hold a bullish bias towards Brazilian equities for the intermediate term. Elsewhere, the fundamentals continue to suggest that King Dollar will appreciate versus LatAm currencies over the intermediate term TREND.


No Virtual Portfolio positions in Latin America currently.



All % moves week-over-week unless otherwise specified. As of Friday’s closing prices.

  • EQUITIES Median: +2.8%; High: Brazil +5.4%; Low: Chile +1.7%; Callout: Brazil closed last week up +9.8% for the YTD vs. a regional median of +6.9%
  • FX (vs. USD) Median: +1.2%; High: Mexican peso +3.2%; Low: Argentine peso -0.3%; Callout: Peru’s Nuevo sol is the only LatAm currency that has appreciated vs. the USD over the last six months (+1.7%)
  • S/T SOVEREIGN DEBT (2YR) High: Colombia -3bps; Low: Brazil -16bps; Callout: Colombian 2yr yields up +116bps in the LTM vs. down -235bps for Brazil
  • L/T SOVEREIGN DEBT (10YR) High: Colombia +1bps; Low: Mexico -25bps; Callout: Mexican 10yr yields down -46bps over the last month vs. up +24bps for Brazil
  • SOVEREIGN YIELD SPREADS (10s-2s) High: Brazil +10bps; Low: Mexico -15bps; Callout: Brazil up +37bps over the past three months vs. down -48bps for Mexico
  • 5YR CDS Median: -2%; High: Peru -0.9%; Low: Argentina -9.7%; Callout: Peru up +9.8% over the last three months vs. a regional median of -3.2%
  • 1YR O/S INTEREST RATE SWAPS Median: -0.9%; High: Chile +0.7%; Low: Brazil -1.9%; Callout: Brazil down -6.3% over the last three months vs. a regional median of +2.5%
  • O/N INTERBANK RATES Median: -0.3%; High: Chile +1.2%; Low: Brazil -4.6%; Callout: Brazil down -15.1% over the last six month vs. a regional median of -2.2%
  • CORRELATION RISK Brazil’s Bovespa Index is becoming increasingly correlated with the S&P 500: +97% over the last three weeks vs. +72% over the last three months.

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



Brazil’s central bank lowered the country’s benchmark interest rate -50bps for the fourth consecutive meeting.  The rate, now at a 18-month low, is now much closer to market expectations for Brazilian monetary policy:


Weekly Latin America Risk Monitor: All Eyes on Brazil Part II + A King Dollar Update - 1


Based on our propriety G.I.D.P. analysis, the Brazilian economy remains in the sweet spot for equity investments:


Weekly Latin America Risk Monitor: All Eyes on Brazil Part II + A King Dollar Update - 2


Moreover, the outlook for Brazil’s growth, inflation, policy, and equity market beta that we published at the top of our 9/1/11 note titled: “Eye On Brazilian Policy: Oh No You Didn’t” continues to play out in spades: “We view the central bank’s aggressive and proactive rate cut as supportive of Brazilian equities because it will likely coincide with a peaking of CPI and a deceleration in Brazil’s current economic slowdown. Our quant models aren’t in full confirmation of this, however, which suggests the turn is likely further out in duration.” Aside from TIME, the only difference between then and now is that the Bovespa’s quantitative setup is in full support of our bullish bias on Brazilian equities:


Weekly Latin America Risk Monitor: All Eyes on Brazil Part II + A King Dollar Update - 3



Growth Slowing’s Bottom:

  • Mexico: Unemployment Rate ticked down in DEC to 4.5% vs. 5%; ANTAD Same-Store Sales growth slowed in DEC to +3.8% YoY vs. +14.6%.
  • Peru: Unemployment Rate held flat in DEC at 7%.

King Dollar:

  • Brazil: For the fourth time since AUG, Tombini & Co. lowered the country’s Benchmark Interest Rate by -50bps, taking the Selic to 10.5%, which is the lowest since 3Q10. The latter point suggests to us that the QE2-inspired rate hike cycle has been completely reversed in Brazil, which is bullish, on the margin, for perception of Brazil’s intermediate-term growth prospects. Looking forward, Brazil should remain in quadrant #4 of our GIDA chart (see above) through Q1, suggesting further easing is likely. We received confirmation of this over the weekend, as O Globo reported that Rousseff is prepared to make fiscal adjustments to help the central bank cut the [Selic] by at least a another percentage point in 2012.
  • Brazil: In addition to the currency headwind that is monetary easing, Brazil’s government is reported to be studying ways to stem the recent rally in the real. The inflection in USD-denominated loan rates (+14bps since Wed) suggests that the central bank may be hinting at additional dollar purchases.
  • Mexico: Despite three consecutive months of acceleration in CPI to a mere 20bps shy of their upside inflation target, the central bank kept the country’s Benchmark Interest Rate at a record-low of 4.5% for the 24th-consecutive meeting. In fact, the monetary policy board led by Governor Agustin Carstens tilted their commentary to the dovish side, signaling that: a) their policy is consistent with their outlook for inflation; and b) that they stand ready to lower rates should growth come in to the downside.
  • Argentina: Argentina’s Benchmark ARS Deposit Rate continues to make new intermediate-term lows, touching 15.6% today (down from a peak of 22.9% in mid-NOV). The trend is proof that President Fernandez was successful (over the short term) in her bid to slow capital outflows by increasing the supply of pesos in the economy by imposing USD scarcity via a series of repressive regulations. This does not include the latest scheme, which will force importers to require gov’t approval for all overseas purchases after FEB 1. The change is likely to limit imports on the margin in order to support the trade balance; that may ultimately serve to push up Argentine CPI as certain products become more scarce and/or more expensive to produce.
  • Argentina: The peso’s -6.5% YTD slide vs. the Brazilian real has been supportive of Argentina’s USD-denominated sovereign debt, with yields falling -61bps to 10.7% (through JAN 18). This is because increased competiveness w/ Brazil, Argentina’s largest trade partner, is supportive for growth in the country’s FX reserves, which Argentina uses to service its USD debt burden.


  • Argentina: The latest news surrounding Argentina’s sovereign default/bankruptcy proceedings takes us to D.C., where the Supreme Court asked the Obama administration for advice on whether it should hear an appeal from the hedge funds EM Ltd. and NML Capital (both units of Elliot Management Corp.). Having turned down both of Argentina’s restructuring attempts (2005 and 2010), the creditors claim they are owed at least $2B in principal and interest payments. The Supreme Court is specifically debating whether or not to rule on the funds’ failed attempt at seizing $100M in Argentine assets being held in custody of the Federal Reserve. A ruling in favor of the funds may set precedent for increased legal recourse for investors in the event of sovereign defaults – a very apropos subject given the current issues in Europe.


Moshe Silver, our Chief Compliance Officer, is fluent in Portuguese and mines the local Brazilian press for hard-to-get data points for us each day. Below, we flag his top three callouts from the previous week:

  1. Brazil’s national labeling program is urging consumers to trade in their low-efficiency appliances and lighting fixtures for those labeled “A”, which represents the highest level of quality and energy efficiency. A concerted marketing effort plus any new rebate program are likely to be a tailwind for Brazilian retail sales over the intermediate term.
  2. According to Valor, the $3.5B of foreign investor inflows into the Bovespa in the YTD (through first 12 trading days of 2012) is the highest in at least seven years.
  3. Brazilian leadership continues to demand more say in how IMF funds are allocated in exchange for its continued financial support.


Key economic data releases and policy announcements:

  • TUES: Brazil: mid-month CPI (IPCA-15); Mexico: Global Economic Indicator; Argentina: Industrial Production, Consumer Confidence, and Shop Center Sales
  • WED: Brazil: FGV Consumer Confidence; Argentina: Supermarket Sales
  • THURS: Brazil: Central Bank Monetary Policy Meeting Minutes and Unemployment Rate; Mexico: Retail Sales and Presidential Election Poll (Consulta Mitofsky)
  • FRI: Brazil: Aggregate Credit; Chile: Central Bank Monetary Policy Meeting Minutes
  • MON: Brazil: FGV CPI (IGP-M); Chile: Industrial Production and Retail Sales

Darius Dale



Weekly Latin America Risk Monitor: All Eyes on Brazil Part II + A King Dollar Update - 4


Weekly Latin America Risk Monitor: All Eyes on Brazil Part II + A King Dollar Update - 5


Weekly Latin America Risk Monitor: All Eyes on Brazil Part II + A King Dollar Update - 6


Weekly Latin America Risk Monitor: All Eyes on Brazil Part II + A King Dollar Update - 7


Weekly Latin America Risk Monitor: All Eyes on Brazil Part II + A King Dollar Update - 8


Weekly Latin America Risk Monitor: All Eyes on Brazil Part II + A King Dollar Update - 9


Weekly Latin America Risk Monitor: All Eyes on Brazil Part II + A King Dollar Update - 10

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