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Chart Of The Day: Devalue, Re-Flate!

Alongside the last note we just posted on the VIX breaking it’s short term momentum line, we have a very powerful macro signal developing in the US Dollar. On a breakdown and close below $86.34, our Investment Theme of “Re-Flation” will be very hard to ignore.

With the US$ Index trading down -1.2% at $85.82 so far here today, you are seeing a real time example of what I mean. Commodities are raging higher alongside stock markets and foreign currencies, globally. “In the end, we’re all dead”, but in the immediate term, FREE money has it’s short term correlations. Just because we have seen this movie end poorly before doesn’t mean we cant watch it live again.

This is what you get when you have a politicized US Federal Reserve working with a Goldman leverage banker. “Heli-Ben”, drop moneys from the heavens, and “Re-flate”!

Positive intermediate “Trend” line support for the US$ is all the way down at $81.85. That’s a long way from here…

VIX: Bullish Breakdown

The VIX is one of the simpler inverse leading indicators for the SP500, that’s why we painted the line in the attached chart green. This is the green light for getting long US equities. This is one of the multiple factors that had me cover my SPY position and buy it long today.

As you can see the VIX and both the Jan & Feb futures are trading below the 50 DMA and well below realized 30 day vol. While I do not use 50 day moving averages for anything other than painting a behavioral picture of how the masses could react, these lines have relevance on days like today.

The VIX is currently down -3% at 58.23. It could go a lot lower and, as a result, US equities higher. I have an immediate term “Trade” target for the VIX of 52.79 – that’s another -9% from here. There’s huge support for the positive intermediate “Trend” in volatility down at 47.52.

The Chart that the bullish narrative will have stamped all over CNBC...

Its all about the narrative. Now that momentum factors are shaping up positively, these simple and undebatable pictures will find be showing at a theatre near you.

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The Comprehensible Patient

“The most incomprehensible thing about the world is that it is comprehensible.”
-Albert Einstein

I like to think that when Einstein wrote that, he was thinking about markets. In mathematics, complexity (or chaos) theory explains many of this world’s outputs through simple, repeatable, and underlying patterns. In hindsight, I guess this is why markets are always “comprehensible” by Wall Street’s finest revisionist historians.

Hindsight, of course, is always crystal clear. Unless the leaders of your organization don’t have any mirrors, you’re probably getting used to our 2009 investment Theme, “The New Reality”, taking hold at your office - transparency, accountability, and trust will be its new governors.

The leadership front is finally starting to get priority coverage in the financial media. President elect, Barack Obama, has inspired a bid this morning in the US futures after speaking to what has seemingly shocked the world in the form of a proactive plan that has a duration of 2 years rather than 2 days. There were also a couple of principles-based battles that emerged this weekend in corporate America’s boardroom. Both were long overdue.

The first was the most predictable – John Thain vs. Bank of America. The WSJ is reporting this morning that Thain is “struggling” with BAC’s management over paying himself a nifty $10M bonus. I expected nothing less of the Goldman alum. This one should be interesting to see play out.

The second was more inspiring – Lazard’s Bruce Wasserstein vs. Blackstone’s Steve Schwarzman. There is a fantastic Bloomberg article this morning comparing and contrasting the views of a levered long private equity man and why he shouldn’t have to mark his book to market versus the Brooklyn born banker’s concept of a transparency. Wasserstein knows a thing or two about private equity, folks – he owns private equity firm Wasserstein and Co. The credibility of this man’s handshake matters. Stay tuned. The ‘You Tubes” are ready to roll.

One of the main investment strategies I have been rolling against consensus with is being long China. Now heads are starting to roll on those desks who stayed short the world’s most relevant economy. Whether you shorted it 4 days ago, or whether you shorted China 4 weeks ago, it’s starting to hurt. The Shanghai Stock index closed up another 3.6% overnight, taking its four day rally to +10.3%. Since the first week of November, China is +22%. The USA is down -13%. This morning the Chinese government is floating the idea of cutting personal tax rates. This is good.

Stocks in Hong Kong raged higher on whispers of American capitalist principles blowing on shore. The Hang Sang Index had a whopper of a day, closing up +8.7%. Some of the reactive market pundits are suggesting Asia was up because India cut interest rates this weekend. I find their math trivial however, as India’s Sensex flashed a negative divergence, underperforming the region in Asian trading. “Chindia” isn’t a word, and much to the chagrin of those who tried making it up, China and India are on two very different economic policy tracks.

I covered all of our Indian and Japanese short positions into Friday’s freak-out US market open. We have been short the IFN and EWJ etfs for the better part of 2008, but that doesn’t mean we have to be short them every day. Consistently making money on the short side is a mathematical exercise that should be managed very proactively. There is no such thing as a “long term capital gain” on the short side, so I don’t manage my duration that way.

Just because I covered India doesn’t mean that their economic issues cease to exist. While they plugged in a token $4B stimulus package this weekend, that was a good 2/3 light versus expectations. India’s yield curve has flat-lined, and their debt balances are beginning to balloon. This is not good folks. This is not “Chindia”. This is a problem, and we will look for strength as an opportunity to re-short this country-level risk.

Back in the USA, I was also doing a little holiday shopping on Friday (covering and buying). I had 9 consecutive buy/cover ideas in the virtual “Portfolio”, so I’ll refer you to that part of our portal for the details (www.researchedgellc.com). Importantly, I opened up our wallet and took our net allocation to US Equities up to 3% - I know, call me reckless! Our US Cash position was dropped back down to 65%, and I continued to add to our mounting position in Commodities, taking that exposure to 15%. China remains the dominant driver in our International Equities position of 18%. We’re not chasing the lemmings buying China high today – trust me.

You can trust me and my team’s investment process. I trust in America’s principles-based resolve. I am confident that we will, at some point, find the new leaders of both our political and economic process. The New Reality will be a wonderful one. While timing it to the day will be next to impossible to get right, we will be able to monitor this patient’s critical market factors daily. Like any complex system, the global market is a very dynamic one. “The most incomprehensible thing about the market is that it is comprehensible.”

Have a great week,

Long ETFs

GLD -SPDR Gold Shares -- LME spot gold contracts rose over 2% in trading this morning.

OIL - iPath ETN Crude Oil – Light Sweet Crude near month contracts traded as high as 43.44 this morning after below 41.00 in late trading on Friday. Last week, OPEC president Khelil acknowledged that the group is considering enacting significant production cuts in their upcoming meeting. 

EWG – iShares Germany  - Stocks in Europe rallied, led by mining and oil shares, after U.S. President-elect Barack Obama pledged the largest infrastructure spending package since the 1950s. The DAX gained 257.21, or 5.89%, to 4639.56. DAX futures expiring this month rose 6.9 %. Audi AG (EWG: 13.6%) said deliveries rose 0.4% last month because of new models, with year-to-date sales advanced 3% to 920,700 vehicles.

EWH – iShares Hong Kong  -- China Construction Bank Corp. led the nation's banking stocks higher in Hong Kong trading on speculation the Chinese government will lower an industry tax to ease pressure on their finances. The Hang Seng closed up 8.66% to 15,044.87.

 FXI – iShares China – The CS1300 closed up 81.86, or 4.07%, to 2095.04. China’s Central Economic Work Conference, a three-day annual economic policy meeting, will start today and run through Dec. 10. The government may cut personal income tax to boost consumption and growth.

Short ETFs

SPY- S&P 500 Depository Receipts— CME futures traded above 897 this morning as a broad rally lifted European and Asian indices.

EWU – iShares United Kingdom – The FTSE is up 4.42% this morning to 4228.78. Royal Dutch Shell (EWU: 5.86%) gained 6.72%.

UUP – U.S. Dollar Index – The Euro rose to $1.29 USD this morning. The Pound traded higher to $1.49 from $1.47 USD.

FXY – CurrencyShares Japanese Yen Trust – The Nikkei closed up 5.20% to 8329.05 today. Mitsubishi UFJ Financial Group, Japan’s biggest bank, said it will raise about 400 billion yen ($4.3 billion) by selling common shares to boost capital.

Eye On Regionalism: The Legacy of Austria’s Jörg Haider

Eye On Regionalism: The Legacy of Austria’s Jörg Haider

I’m not sure if the headline made much of a splash in early October of this year on this side of the Atlantic, but when I saw Jörg Haider’s obituary notice while cruising through the NY Times, I was shocked. My first thought—he was a pretty young guy. I had followed him over the years because of my interest in European politics and had just read an article that noted the support that his newly-found party won in recent Austrian parliamentary elections.

At 1:18am on October 11th Haider died from injuries sustained when his black VW Phaeton crashed on his way home to Klagenfurt, the capital of Carinthia, the southern province where he was governor for twelve years. He was driving 142 kmh (88 mph), nearly double the speed limit, with a blood alcohol level that was three times the legal limit.

Haider was Austria’s boy, whether you agreed with his politics or not. He garnered an international reputation as a controversial and charismatic far-right politician. Some of the remarks he made included that the Third Reich had a “proper employment policy”, that SS veterans were men of “character, honor, and conviction”, and cited “foreigner overrun” (Überfremdung) when speaking about immigration in Austria, a term not used since the Nazi days. With such anti-Semitic and xenophobic comments Haider managed to become a figurehead in Austria and for an array of far-right European groups.

Born in the Upper Austrian town of Bad Goisern in 1950, Haider’s early life was formed from his father Robert, a shoemaker, and former Nazi, who joined the NSDAP (National Socialist German Workers’ Party) in 1929 at the age of fifteen, and his mother Dorothea, a teacher, who had been active in the NSDAP as a leader of the Bund Deutscher Mädel, or the female branch of the Nazi youth party movement.

His first political involvement came in 1970 as youth leader for the right-wing Austrian Freedom Party (FPÖ), a party opposed to the political catholicism of the Austrian People’s Party (ÖVP) and the socialist views of the Social Democratic Party of Austria (SPÖ). Moving through the ranks he became head of the regional Carinthian Freedom Party in 1983, and in 1989 beat out the Social Democrats to become governor of Carinthia. Under his leadership the Freedom Party moved further to the right, reflecting his nationalist, anti-immigration, and anti-EU views. A debate in 1991 over reducing unemployment payments for people he saw as “freeloaders” forced his resignation when he said: “…the Third Reich had a proper employment policy, which not even your [Social Democratic] government in Vienna can manage to bring about.”

Haider re-entered the political scene in 1999 as head of the Freedom Party and took 27% of the vote in Austria’s parliamentary elections, which gained him international prominence. The inclusion of the Freedom Party in the coalition government with then conservative Chancellor Wolfgang Schüssel in 2000 provoked international outrage and sanctions from the EU. The heads of government of the other fourteen EU members ceased cooperation with the Austrian government; other national leaders shunned diplomatic contacts with Schüssel’s government because of Haider’s politics.

Stepping down from politics in 2000 after EU sanctions, Haider returned to his seat as governor of Carinthia in a surprise 2004 election that won him 42% of the vote. The following year he broke off from the Freedom Party to form the Alliance for the Future of Austria (BZÖ), a new movement meant to reflect more moderate conservative policy.

In national elections in late September 2008 Haider’s party received 10.8% and the far-right Freedom Party gained 17.7% of the vote. The combined 29% for right-wing parties placed them on nearly equal footing with the Social Democrats, who came in first place with 29.7%.

The result was seen as a political comeback for Haider and the right-wing politics and made his death all the more devastating for his supporters. Stephan Petzner, Haider’s party secretary said, “For us, this is the end of the world.” Thomas Hofer, an independent political consultant in Vienna said, “This is the end of an era. He was more controversial than any other, but also one of the most politically talented individuals in the country’s history.”

Haider’s death led to an outpouring of grief compared by some to the mourning in Britain after the death of Princess Diana. On Saturday October 18th, 30,000 people turned out in Klagenfurt, a city of less than 100,000 people, for Haider’s funeral service. For those that couldn’t be there in person the state broadcaster ORF had live coverage. Austrian President Heinz Fischer, a Social Democrat, called Haider a “politician of great talent.” Austrians decorated the site of the accident where Haider’s sedan came to rest after flipping over several times. Even Toni Faber, a priest at St. Stephen’s Cathedral in Vienna, said: “We stand, in shock, before the death of a man who moved Austria…When bidding farewell one should consider the good sides of the deceased.”

Maybe it was just human emotion that drove the support for Haider’s death. This was the same Haider that many Austrians were ashamed of, the same Haider that said, “Austria was under siege from Turkish immigrants”, openly made fun of people based on their skin color and ancestry, and in one of his last acts established what he called a Sonderlager, a special camp for criminal asylum seekers, located on an isolated 1,200-meter-high alpine pasture. In his own state of Carinthia, which has more than 10% Slovene speaking inhabitants, Haider pursued a policy of segregation in schools and the removal of existing bilingual street topographic road signs.

Most observers see little chance for Haider’s party outside of Carinthia. Yet his death could mark a crucial turning point for Austrian politics. Anton Pelinka, a professor of politics at the Central European University in Budapest warns: “The possibilities for a rise of the far right in light of the financial and economic crisis are there.” His death could give Heinz-Christian Strache, the current leader of the Freedom Party who is known as a more vulgar version of Haider, an opportunity to position his right-wing nationalist party for future elections.

For now Austria has a new cabinet, led by the Social Democratic Party and the centrist conservative People’s Party, but the popularity of Haider, even after his death, and the rise of his Freedom party highlight the potential for continuing ethnic tensions in Austria, a theme which we have been following closely across Europe.

We will continue to explore our Investment Theme of “Regionalism” in the coming weeks. Last week’s focus on immigration in Germany relates well to Austria, a country with similar multicultural issues. Should you have any feedback on these regional pieces, I can be contacted at

Matthew Hedrick

Eye on “Outliers”: Reviewing Gladwell's Latest

Eye on “Outliers”

This week I was travelling up to Toronto for meetings on a new business opportunity. We are looking at investing in a Major Junior hockey team. As travelling always does, this trip also gave me some quiet time to read. I picked up Malcom Gladwell’s new book, “Outliers”, and managed to plow through it over the last few days and wanted to share some of my thoughts about Gladwell’s ideas. Ironically, Gladwell also uses Canadian Major Junior Hockey to highlight one of his early and key points in the book.

As many of you know, Gladwell is also the author of “The Tipping Point” and “Blink”, which were both New York Times #1 best sellers. Gladwell was the first author, on a mass scale, to take social science research, largely in sociology and psychology, to explain events and phenomena in real life. The Tipping Point explains how seemingly small events can have massive sociological implications. Blink explains how the subconscious mind allows humans to make very accurate snap decisions. Outliers deals with trying to determine what makes some people incredibly successful and others, with seemingly comparable natural talents, much less so.

A good friend of mine, who is a PH.D student at one of the top political science programs in the country, recently emailed me to say she really enjoyed reading our morning note, The Early Look, but she sometimes thought we used too many hockey analogies, which detracted from the seriousness of the discussion. Keith’s use of hockey analogies, and the rationale of taking personal experiences and applying those lessons to investing and managing a business, are actually a topic for a future post, but needless to say I was pleasantly surprised that Gladwell’s book opened with a hockey case study given my PH.D friend’s comments. Warren Buffett cited Wayne Gretzky in his latest NYT Op-Ed piece. Maybe we hockey guys are onto something…

Outliers begins by analyzing the Memorial Cup, which is the Championship in Canadian hockey for amateurs under the age of 21. In theory, the best young hockey players in Canada, which is arguably the best hockey playing country in the world, will be competing for this championship and, ultimately, it comes down to one game between the best 18, 19, and 20 year olds in the country. Gladwell looked at this and asked the very simple question, what allows any specific Canadian kid to climb to the top of the amateur hockey in his country? And, can we define a factor or group of factors that enable some kids to outperform and reach this level?

Hockey experts would certainly theorize on many reasons as to why certain kids excel at the game and others do not. Inevitably, the rationale is always based on some intrinsic talent. Depending on who you ask, the intrinsic talent that enables certain hockey players to excel and others to underperform may be based on a multitude of factors, which could include work ethic, competiveness, “love of the game”, parenting, natural athleticism, and so on. Gladwell’s findings were actually contrary to any commonly held belief: the best predictor of success was actually birth month.

In fact, on the roster of the Medicine Hat Tigers, a finalist for the 2007 Memorial Cup, 13 of the 25 players on the roster were born in the months of January, February, and March. Obviously, having more than 50% of the players being born in a three month period for an elite hockey team is certainly an outlier versus the normal distributions of birthdays in the general population. This could be considered anecdotal if it weren’t for the prior work of Canadian psychologist Roger Barnsley.

As Gladwelll tells it, Barnsley was at Lethbridge Broncos (also a major junior hockey team) game in Southern Alberta in the mid-1980s with his wife and two kids when his wife asked him, “Roger, do you know when these young men were born?”. Barnsely’s quick response was to say their birth years, but his wife’s point quickly jumped out at him, many of the players were born in the first three months of the year. This observation led Barnsley to do a broad study of all elite leagues in Canada across many years and the conclusion was very simply that, “in any elite group of hockey players – the very best of the best – 40 percent of the players will have been born between January and March, 30 percent between April and June, 20 percent between July and September, and 10 percent between October and December.” This is an effect so powerful that the data does not even have to be analyzed, just observed.

The obvious question is, why does this phenomenon exist? The answer is actually quite simple. The cutoff date for hockey age groups in Canada is January 1st. As a result, at a young age, when a year can make a big difference in physiological development, a seven year old that is born on January 1, 2001 will be competing against kids that are up to a year younger than him , which can lead to material outperformance based on natural development of strength and motor skills. That is, the kid born on January 1, 2001 will just be much more naturally developed, which provides a competitive advantage.

In Canada, and many countries (and in many sports for that matter), the hockey system quickly filters off the better players at young age to play on travel teams or all-star teams. In joining these travel teams, the young players ultimately play more hockey, both practices and games, and against better competition. Thus, the kids that were older and more developed received another opportunity, which is that they got to play more hockey and against better competition.

Obviously, playing more against better players will lead to even further outperformance. As players move up the hockey echelon, this effect becomes so noteworthy that, as outlined above, a full 70 percent of elite hockey players are born in the first six months of the year! Therefore, if you are a Canadian parent and you want to give your kids an advantage in becoming a great hockey player, make sure they are born in the early part of the year.

Hockey is only one, although an incredibly statistically significant example, of the advantage of birth month. And while for me, a hopeful future father of NHL hockey players, an important one, the more valuable observation of this phenomenon probably relates to education.

As Gladwell points out, many parents often debate as to whether to enroll their students in kindergarten if the child is born at the end of the calendar year, which would make them one of the younger kids in class. Ultimately, many parents that actually enroll their children, rather than hold them back, likely believe that their kids will overcome the early disadvantage of starting school when they are less physically and mentally developed that their peers. In fact, this disadvantage only seems to expand with time.

Kelly Bedard and Elizabeth Dhuey, two economists that Gladwell cites, show this continued outperformance by older kids in two specific studies. The first study looks at the relationship between scores on an international test called Trends in International Mathematics and Science Study. Their analysis found that “among fourth graders, the oldest children scored between four and twelve percentile points better than the youngest children.” Bedard and Dhuey then looked at colleges in the U.S. and found that the “relatively youngest group in the class are under represented by about 11.6%”. Dhuey probably summarized this research best when she said: “I mean, it’s ridiculous. It’s outlandish that our arbitrary choice of cut off dates is causing these long last effects, and no one seems to care about them.”

Gladwell has been widely criticized for not applying academic or scientific process to his books and that he picks and chooses his research to suit his conclusions, but one thing we have to admire about Gladwell and his work - he asks the questions. And that is the start of any research process, whether it be an investment idea or physics problem. Does he definitely prove that exceptional achievement has much more to do with circumstance than innate talent? Maybe not. But what he does do is prove that parenting, patronage, community, and circumstance certainly play a major role in future success.

By the way, Keith McCullough was born on January 5th, and I was born on January 25th. I need to check the birth dates on our ECAC Championship hockey team’s roster!

Daryl Jones
Managing Director

111 Whitney Avenue
New Haven, CT 06

Early Look

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