Risky Expectations

This note was originally published at 8am on March 20, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Risk appears to be at its greatest when measures of it are at its lowest.”

-Mark Carney


Keith and I have been on the road meeting with subscribers this week and spent the first part of the week in Winnipeg, so it seemed appropriate to start the Early Look this morning with a quote from Mark Carney, the current Governor of the Bank of Canada.  


Setting aside the fact that Carney played hockey at Harvard, which raises some character questions in our minds, he has had a respectable tenure as the Governor of the Bank of Canada.  In fact, even though we at times question too much government involvement, his actions are rightfully credited for getting the Canadian economy back to normal levels of output and employment quicker than the G-7 following the 2008 meltdown.


Personally, after reading the above quote from Carney, I was almost ready to forgive him for wearing the crimson colors of Harvard.  To me that quote shows perhaps the most appropriate understanding of risk, which is that risk in the market is greatest when we least expect it.  For us, a key measure of risk is volatility.  As it relates to equities, a key measure of this is the VIX, or volatility index of the SP500.


Like much of modern risk management, the VIX is a relatively new creation.  In fact, it was developed by Professor Robert Whaley in 1993 (courtesy of Wikipedia).  The VIX is a weighted blend for a range of options on the SP500.  More specifically, the VIX is the square root of the par variance swap rate for a 30-day term initiated on the current day.  So, in layman’s terms, it is the expected movement of the SP500 over the next thirty days on an annualized basis. 


As an example if the VIX is at 15, the expected return for the next twelve months is 15%.  Over the next thirty days, the range of return is calculated by dividing the VIX by the square root of 12.  Therefore with the VIX at 15%, there is 68% likelihood, or one standard deviation, that the SP500’s move, up or down over the next thirty days, will be 4.3%, or less. 


In the Chart of the Day, we show the chart of the VIX going back five years.  The takeaway of this chart, a point we have been hammering home as of late, is that when the VIX reaches levels around 15, it has been a contrarian signal to shift out of risk assets.  In the course of the last two years, this signal has been reached three times – April 2010, May / June 2011, and now.  (Incidentally, we are long the VIX, via the etf VXX, in our Virtual Portfolio.)


In our meetings with subscribers, the push back we often receive on the VIX discussion is that in the 2003 – 2007 period, or thereabouts, the VIX reached lower levels and stayed at these levels for sustained periods, which buoyed equity market returns.  So, what’s different this time?


This is certainly a fair question.  Our retort is that the economy itself is more volatile than it was in that period.  This is due to the active management of the economy by Keynesian central planners, but also accelerating debt burdens of the economy.  Think of the economy like a highly levered company, with more debt on the balance sheet a company’s earnings become much more volatile, so equity returns are inherently more volatile.  (Not to mention, the “awash with liquidity” period of 2003 – 2007 was far from normal.)


In part, this is why we are long Canada in the Virtual Portfolio via the etf EWC and, if you think about, long Mark Carney policy.   Canada’s debt-to-GDP is 83% (per the CIA Factbook), which while higher than we would like, is below the critical 90% bound which historically leads to slowing economic growth, and less than the United States’ ratio that is north of 100%.  In Canada, the deficit is actually now in decline, which will lead to lower debt-to-GDP ratios in the future.  This compares to the United States, which had the largest monthly deficit of any nation in history in February.


Another key discussion or debate point in our recent meetings with subscribers has been the outlook for economic growth, both in the United States and abroad.  As we’ve stated repeatedly, we expect lower growth than many Wall Street 1.0 prognosticators.  This is primarily driven by the math of our predictive algorithms and further supported by incremental data points.


For us, the price of oil is a critical data point when contemplating economic growth.  As I wrote two weeks ago:


“Charles Hall, Steven Balogh, and David Murphy did an analysis of the connection between the price of oil and when recession can be expected, examining the Minimum Energy Return on Investment (EROI). In their assessment, recession is likely to occur when oil amounts to more than 5.5% of GDP. Logically, this makes sense. Even based on the very tainted calculation of CPI, the average U.S. consumer spends 9% of his or her income directly on energy, with the majority allocated to gasoline. This obviously also excludes the derivative impact of increasing energy costs, such, as we noted above, the increasing costs of food.”


Incidentally, Brent oil at $116 per barrel is equivalent to 5.5% of U.S. GDP based on current usage patterns.  Brent is trading at $124 per barrel this morning.


The most recent data point supporting lower global economic growth came from the mining giant BHP Billiton this morning who said they are seeing signs of “flattening” of iron ore demand from China.  It seems when China tells you they are going to gear down economic growth, they actually will.


T.S. Eliot once wrote:


“Only those who will risk going too far can possibly find out how far one can go.”

From a personal perspective, I’d agree with Eliot, from a portfolio risk management perspective, not so much.


Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, and the SP500 are now $1633-1677, $122.96-127.19, $79.33-79.88, and 1385-1411, respectively.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Risky Expectations - Chart of the Day


Risky Expectations - vp 3 20


The Macau Metro Monitor, April 3, 2012




Singapore visitors rose 13.5% YoY in January with Mainland China visitors soaring 52.9% YoY due to Chinese New Year.





Local police expects more than 1.1 million people to go through the Barrier Gate checkpoint between Macau and Zhuhai during the Qing Ming festival.  Police said the overall number of visitors crossing the boundary last year was 1.09 million during the festival, and is expected to increase by 3 to 5% this year.



After being unused for more than a month since the last Cirque du Soleil Show, Venetian’s theatre will be re-launched on Sunday, April 8.  Gus Liem, vice president of entertainment at Venetian, says Sands China’s other entertainment location “CotaiArena” is “full every week.”  He sees no difficulty in attracting Chinese gambling tourists to the events as he says “80% of the arena public is from outside”. 

Early Look

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Dollar Debauchery

“The current international currency system is the product of the past.”

-Chinese President Hu Jintao, January 2011


If Ben S. Bernanke thinks that he can continue to debauch the US Dollar and the rest of the world is going to say nothing this time, that will be different.


In James Rickards chapter titled “Prewar” of Currency Wars, he uses the aforementioned Chinese quote. It’s a year old now, but the East versus West policy waters are starting to boil. Since Commodity Inflation Slows Global Growth, many sharp minds are figuring this out.


Whether it’s the Reinhart & Rogoff Op-ed for Bloomberg this morning that tells the Fed to “stop moving the goal posts”, or it’s China’s Central Bank Governor Zhou telling the Fed it has a “responsibility to consider the global effects” of devaluing the world’s reserve currency, the battle lines are being drawn. Bernanke’s War is on.


Back to the Global Macro Grind


It’s really easy for US centric stock market investors to not see what’s going on across the rest of the world right now. It requires a repeatable and globally interconnected Macro process to absorb all of the world’s real-time data. Few on the Old Wall have one. Even fewer Washington “economists” and “strategists” even know what that means.


Got un-awareness? In Currency Wars, Rickards hammers my point home in telling his story about a war games exercise he took part in that was sponsored by the Department of Defense: “I noticed the absence of representatives with any actual capital markets experience… we needed people who, in the immortal words of John Gutfreund, were “ready to bite the ass off of a bear”…” (page 9)


To be clear, I’d much rather dance with a bear than bite one.


Altogether though this is a very serious point that needs to be crystal clear in the minds of any American Patriot who regards the credibility of his or her currency as something worth fighting for. Cheering on a market that moves like it did yesterday (Down Dollar = Up Oil and Energy stocks) is effectively asking for $5 bucks at the pump come Memorial Day weekend.


Taking a step back to Bernanke’s Dollar Debauchery Decision of 2012 (January 25th when, despite running 3% US GDP growth in Q4, he pushed the 0% rate of return on American Savings accounts to 2014), here are the 60-day correlations to the US Dollar Index:

  1. SP500 = -0.47
  2. EuroStoxx600 = -0.70
  3. MSCI EM Index = -0.72
  4. CRB Commodities Index = -0.47
  5. CRB Raw Industrials Index = -0.74
  6. CRB Food Index = -0.41

In other words, no matter what you think about correlation versus causality (I think the relationship between a country’s monetary policy and currency valuation is very causal), these are highly correlated moves.


Now, Bernanke or his banker buddy at the NY Fed, Bill Dudley (who also takes car service to work), might tell you to go eat an iPad or stick some natural gas in your tank – and like it. But the rest of the world doesn’t get paid that way.


The people who get paid are the few of us who have figured out that this Policy To Inflate is something to be long, until that very moment when it becomes obvious to everyone else that commodity inflation is slowing growth, again.




If Inflation from these food and energy price levels doesn’t slow growth – then why:

  1. Didn’t yesterday’s no-volume rally in US Stocks equate to higher bond yields? Treasury yields are down -3bps day/day
  2. Didn’t the rest of the world’s Equity markets open with a boom this morning? Italy chasing Spain lower now
  3. Didn’t Commodities continue to rock to the upside? Most of them are down this morning because the US Dollar isn’t

A: because world markets know (just as well as Bernanke should) that the US Dollar is being held, artificially, like a ball under-water.


How much longer can he hold the ball under water? How close does he have it to his face? What happens when that thing rips out of the water (like it has multiple times since he took over at the Fed), and deflates every asset price he’s trying to inflate?


I fear, my friends, that gravity is going to catch up with us when the least amount of us are positioned for it. Whether I am right on this or Reinhart, Rogoff, and the Chinese are doesn’t matter – it’s the when that will determine Bernanke’s legacy.


My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, and the SP500 are now $1, $121.94-126.12, $78.62-79.21, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Dollar Debauchery - Chart of the Day


Dollar Debauchery - Virtual Portfolio


TODAY’S S&P 500 SET-UP – April 3, 2012

As we look at today’s set up for the S&P 500, the range is 16 points or -0.92% downside to 1406 and 0.21% upside to 1422. 











  • ADVANCE/DECLINE LINE: 1516 (1043) 
  • VOLUME: NYSE 763.39 (-21.01%)
  • VIX:  15.64 -0.90% YTD PERFORMANCE: -33.16%
  • SPX PUT/CALL RATIO: 1.86 from 2.63 (-29.28%) 


INFLATION – inflation slows growth. Yesterday’s US Equity move was led by Basic Material and Energy stocks + the CRB Index was up 2x what the SP500 was. The Bond market agrees. The 10yr and the Yield Spread (10s – 2s) wouldn’t be down 3bps for the wk to date if US growth was still 2.5-3%). 

  • TED SPREAD: 40.72
  • 3-MONTH T-BILL YIELD: 0.07%
  • 10-Year: 2.17 from 2.18
  • YIELD CURVE: 1.84 from 1.86

MACRO DATA POINTS (Bloomberg Estimates):

  • 7:45am/8:55am: ICSC/Redbook weekly retail sales
  • 9:45am: ISM New York, Mar., (prior 63.1)
  • 10am: Factory Orders, Feb., est. 1.5% (prior -1.0%)
  • 11:30am, U.S. to sell 4-week, $26b 52-week bills
  • 2pm: Minutes of FOMC March 13 meeting released
  • 4:05pm: Fed’s Williams participates in university symposium simulating FOMC meeting in San Diego
  • 4:30pm: API weekly inventories 


    • Republicans hold presidential primaries in Wisconsin, Maryland, Washington, D.C.
    • EIA Acting administrator Howard Gruenspecht speaks about gasoline supplies. 9:15am
    • President Obama addresses Associated Press’s annual convention. Noon
    • Treasury Secretary Timothy Geithner presides over FSOC mtg, vote on final rule regulating non-bank financial firms. 2:30pm
    • Vice President Joe Biden answers questions via Twitter on college affordability. 3:45pm
    • House, Senate not in session      


  • U.S. auto sales released today; March light-vehicle sales may have climbed to 14.5m seasonally adjusted annual rate; analysts
  • Carl Icahn’s tender offer to acquire CVR Energy expired yday; Icahn said he wouldn’t extend unless 36% shrs tendered
  • U.S. factory orders may have risen 1.5% in Feb., rebounding from a drop
  • China eco. may have expanded ~8.4% in 1Q, the least since 1H of 2009, according to an est. given by an official 10 days before the data are due
  • European producer prices rose 3.6% in yr, ahead of est. 3.5%
  • Royal Bank of Canada sued by U.S. regulators over claims engaged in illegal futures trades worth hundreds of millions of dollars to garner tax benefits tied to equities
  • Coty said to flip from seller to Avon buyer; yesterday went public with $10b offer that was rejected
  • Cablevision accused NY Daily News publisher Mort Zuckerman of “a campaign of intimidation and extortion” to bring about a merger with Cablevision’s Newsday
  • U.S. sales of repossessed properties probably will rise 25% this yr from 1m in 2011: Moody’s Analytics
  • Olympus said it received capital alliance offers from Sony, Fujifilm Holdings and Terumo, may decide by next month
  • IATA says outlook “fragile,” raises concerns about business travel growth
  • Analyst says Roche to hold meeting this morning in New York after Illumina rejects offer
  • is testing a service that lets tablet users make purchases through mobile applications
  • SecondMarket said to hold its final auction of Facebook shares 


    • International Speedway (ISCA) 7am, $0.39
    • Comverse Technology (CMVT) 7:30am, $0.17 


  • Arabica Premium Seen Higher on Robusta Supply Surge: Commodities
  • Copper Retreats 0.6% to $8,590 a Ton on London Metal Exchange
  • Copper May Drop as Higher Inventories Undermine Demand Outlook
  • Oil Drops After Biggest Gain in Six Weeks on Outlook for Supply
  • Palm Oil Rallies to One-Year High on Soybean Planting Concerns
  • Gold May Fall in London on Concern Physical Buying Is Slowing
  • Wheat Drops as Global Crop Prospects Improve; Corn Increases
  • Sugar Falls in London for Second Day on Surplus; Cocoa Declines
  • Australia LNG Boom Threatened by U.S. Shale Exporters: Energy
  • India May Remain a Net Sugar Exporter for Third Year
  • Fortescue’s Power Says China Steel Demand Will Be ‘Very Strong’
  • Rusal Would Study Norilsk Sale at Right Price, New Chairman Says
  • Pakistan Exchange to Begin Foreign-Currency Futures by June
  • Tanker Rates Seen Reversing Rally as Oil Glut Expands: Freight
  • Oil Drops After Biggest Gain in Six Weeks
  • Oil Supplies Rise to Seven-Month High in Survey: Energy Markets
  • Jewelers in India Extend Strike for 18th Day Over Higher Taxes 










ITALY – joins Spain this morning as the 2nd major Global Macro Equity market to snap its intermediate-term TREND line (15,961 was TREND support for the MIB Index). On a no volume rally in US Equities (down -17% vs my intermediate-term TREND avg yesterday), do not forget how bad those European PMI prints for March were yesterday.






CHINA – explicit comments from Chinese central bank head Zhou this morning telling the Fed that Bernanke has a “responsibility to consider global effects” of its dollar debauchery policy. We called this Bernanke’s War last week and from a Global Macro perspective, it’s on. Japan just printed its lowest money supply number in 3yrs. Japanese Liquidity drying up.










The Hedgeye Macro Team


President Obama's Reelection Chance Stands at 62% -- Hedgeye Election Indicator



President Obama's Reelection Chance Stands at 62% -- Hedgeye Election Indicator  - Screen Shot 2012 04 03 at 6.01.26 AM



With Mitt Romney's nomination as the Republican presidential candidate nearly secure, the former governor of Massachusetts and Bain Capital CEO would stand little chance of beating President Obama if the US presidential election were held today, according to the Hedgeye Election Indicator (HEI). President Obama would have a 62% chance of winning reelection, according to the HEI, down slightly from last week's record level of 62.3%.



President Obama's Reelection Chance Stands at 62% -- Hedgeye Election Indicator  - HEI


Hedgeye developed the HEI to understand the relationship between key market and economic data and the US Presidential Election. After rigorous back testing, Hedgeye has determined that there are a short list of real time market-based indicators, that move ahead of President Obama’s position in conventional polls or other measures of sentiment. One of those factors, the timing of the performance of key equities in the US stock market including stocks in the financial sector, is keeping President Obama's reelection chances strong.


Based on our analysis, market prices will adjust in real-time ahead of economic conditions, which will ultimately shape voters’ perception of the Obama Presidency, the Republican candidates and influence the probability of an Obama reelection.   


Hedgeye will releases the HEI every Tuesday at 7 a.m. ET, all the way until election day Tuesday November 6.




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