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Treasuries Will Eventually Revert To The Mean . . . But When?

Conclusion:  We covered our mean reversion short position in long term treasuries via the etf TLT yesterday as there are number of catalysts that will keep long term yields from increasing meaningfully through the end of June.  Beyond that time frame, much of fixed income looks like it could be short (at a time and price).


Earlier today, we covered our short position in the etf TLT, which represents long term treasuries with a 20+ year duration.  A key insight for us to enter this position was 10-year treasuries yields hitting basically an all-time low earlier last week at 1.70%.  The chart below shows the long term range of the 10-year over the past decade.  Currently, the yield of the ten year is 1.79%.  This is more than two standard deviations below average yield of the last ten years of 3.8%.  


Treasuries Will Eventually Revert To The Mean . . . But When? - 10yr.avg


Over the longer duration, the risk reward set up remains asymmetric for yields to increase.  We can see this in our price ranges as the TRADE range is tight at 1.66% - 1.81%.  Meanwhile, the TREND resistance level is 2.03%.  So, up to our intermediate term support levels there remains significant upside in yields and downside in bond prices.


In the intermediate term, despite the massive longer term reversion to the mean potential, it is unlikely to be a money making opportunity being short U.S. treasuries for two key reasons:

  1. Operation Twist – The Federal Reserve’s operation twist is scheduled to continue through June 30th. By some estimates, the Federal Reserve has already surpassed their target of extending average maturities by 100 months, but regardless they will keep buying longer dated treasuries for the next forty days and this will keep yield increases muted.
  2. Europe – As highlighted in the chart below that compares 10-year yields of Germany versus Italy and Spain, the European debt debacle is far from resolved and will continue to support the relative safety (albeit very relative) of U.S. government debt.   As our colleague Josh Steiner highlighted in a note yesterday on Greek elections, the looming June 17th election in Greece will have critical impact on the future of austerity and reform in Europe, and as a derivative the yields of European sovereign debt.  If there is risk in European sovereign debt, U.S. treasuries will remain a safe haven of sorts.  

Treasuries Will Eventually Revert To The Mean . . . But When? - 10yr.euro


Longer term, the increasingly key consideration will be the U.S. fiscal and balance sheet situations, which continues to deteriorate in the year-to-date.  For starters, the Congressional Budget Office raised their estimate for the deficit in fiscal 2012 by $93 billion to $1.2 trillion in March.  This key reason for this is because revenue has basically been flat year-over-year.  As a result federal debt-to-GDP is hovering just over the 100% mark.


The key negative fiscal catalyst for Treasuries beyond June 30thand the end of Operation Twist is the debt ceiling getting hit again and the potential for another downgrade of U.S. sovereign debt (The caveat is that the last downgrade did not lead to an increase in yields.) The current debt ceiling is $16.4 trillion and the public debt balance as of May 18this $15.7 trillion.  Interestingly, roughly seven months ago the public debt balance was $15.0 trillion, which at a similar rate of growth suggest we should hit the debt ceiling by the end of calendar 2012.  Once again, this will be major political football that will increase consternation related to low historical yields.


One last point we wanted to highlight in this note was that of relative yields.  In the table and chart below, we compare U.S. investment grade yields to U.S. junk bond yields to the earnings yield of the Dow Jones Industrial Index to the yields of 10-year treasuries.  Not surprisingly, given the bubble in treasuries, there is a relative bubble of sorts in the rest of fixed income. 


Treasuries Will Eventually Revert To The Mean . . . But When? - 3



Specifically, both investment grade bonds and junk bonds are trading well below their long run average yields and at, relatively, tight spreads to treasuries despite the artificially low yields in the treasury market.  Trailing twelve month earnings yields for the Dow Jones Industrial Index appear relatively cheap, but, as always, equity valuations depend on the future view of growth.  Interestingly, historically the earnings yield spread between the DJII and 10-year treasuries has actually been meaningfully tighter than between junk bonds and 10-year treasuries.   This implies high yield could be most at risk in a mean reversion scenario or if economic growth slows more dramatically.


Treasuries Will Eventually Revert To The Mean . . . But When? - 4


Clearly, Japanese sovereign debt yields have stayed low despite major growth and fiscal headwinds.  The same scenario may well play out in the U.S., or, as they say, this time could be different and reversion to the mean in the fixed income market could catch many off guard. As Hemmingway famously wrote:


“It occurs very slowly, then all at once.”




Daryl G. Jones

Director of Research

Buying German Bunds (BUNL): Trade Update

Positions in Europe: Long German Bunds (BUNL)

Keith bought German Bunds (BUNL) in the Hedgeye Virtual Portfolio today. The move is a continuation of how we are thinking about Europe: there’s a relative advantage to playing the capital markets of the stronger countries on the long side and weaker countries on the short side, at a price. We’re highly sensitive to price and well aware that there’s no simple equation to pair or hedge risk in Europe: political headline risk, even from the tiniest of countries in Europe, can roll country equity indices and influence yields across the continent. 


Buying German Bunds (BUNL): Trade Update - 1. bunl


And we don’t expect political risk to abate the slightest from here. We’re also of the opinion that very little substance will come out of tomorrow’s European Summit. The market hopes to see Eurobonds rolled out to subsidize the region. While we don’t rule them out as a potential “tool” down the road, we think the strong anti-Eurobond stance of the Germans will hold weight. Further, should Eurobonds be highly considered, they’d have to be approved by 27 Parliaments across Europe. This is a tall order, especially considering the UK’s firm opposition to Eurobonds, and logistically there is no chance of this happening over a matter of days.


From a political positioning perspective, we see Eurocrats putting the ball in Greece’s court to decide its fate. Should the anti-austerity party of Syriza win elections (with a coalition) on June 17th, we expect the outcome to be a swift bank-run, bankruptcy, default, and exit from the Union. Again we don’t see this as a high probable event as polls continue to show that nearly 80% of Greeks want to stay in the Eurozone and with the EUR. The gun is loaded, do Greeks want to pull the trigger?


The only other options at hand under a Syriza victory are that the Greeks called the Eurocrats bluff, in which austerity is thrown off the table (we also view this as highly unlikely) or that another massive bailout scheme is issued (possibilities included another Eurobonds, giant EIB loan to Greece) around the election, but this too seems less probable than an outcome in which a pro-austerity coalition (probably New Democracy and Pasok) wins the elections and then maybe concessions are made to Greece’s fiscal consolidation targets. 


For more on the specifics mentioned above, please contact me at and we can set up a call.




Matthew Hedrick
Senior Analyst



Boom, There It Is: SP500 Levels, Refreshed

POSITIONS: Long Healthcare (XLV), Short Industrials (XLI) and Basic Materials (XLB)


The game is moving fast out there, and I like it.


Across risk management durations, here are the lines that matter to me most: 

  1. Intermediate-term TREND resistance = 1369
  2. Immediate-term TRADE resistance = 1330
  3. Immediate-term TRADE support = 1288 

The good news is that we bounced right from where we should have. The bad news is that we can go right back there, fast. Below 1288 support is my long-term TAIL line of 1282, so that’s bullish enough for me to buy back what I sell today, down there again too.


Keep managing your gross and net exposure to this bullish TREND in Volatility proactively.




Keith R. McCullough
Chief Executive Officer


Boom, There It Is: SP500 Levels, Refreshed - SPX

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The Macau Metro Monitor, May 22, 2012




Sands China's CEO and president, Edward Tracy, is hoping the Macau government will soon loosen restrictions on foreign hiring to help the gaming industry sustain growth.  “There’s a political process that has to happen.  My belief is, as long as we develop the next one or two projects, we’ll begin to see some relaxation.  You have a base population of 500,000 and an unemployment rate of 2.1%. That 2.1 is almost zero: those people are probably not looking for a job.”  Tracy says a big worry for him is the 4,000 positions he’d like to fill at Sands China Ltd.



Passenger traffic at Singapore's Changi Airport rose 12.7% YoY to 4,206,420 in April 2012



Ugly Beautiful

This note was originally published at 8am on May 08, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Some are ugly and some are beautiful.”

-Ray Dalio


That’s what Bridgewater’s Ray Dalio wrote recently about Deleveragings. Spell (and box) checkers take note: the plural of deleveraging doesn’t yet register on Wikipedia as a word. By the time this Sovereign Debt Cycle is over with, it will.


I was flying back to New York from Toronto last night and Dalio bubbled up to the top of my Research Pile alongside another one of the most credible Global Macro Risk Management sources to emerge from 2007’s top, Eclectica’s Hugh Hendry.


Not surprisingly, both Dalio and Hendry are talking about the same risk to asset prices (stocks, bonds, commodities, etc. ) that have been supported by Policies To Inflate – deflation. But both have different views on the pace and timing of what asset price inflations and deflations could look like.


Back to the Global Macro Grind


If your risk management process doesn’t embrace the uncertainties associated with a Globally Interconnected Marketplace of colliding factors, it’s more difficult to apply the principles of Chaos (or Complexity) Theory to what it is that you do every day.


People get whipped around by questioning what is “causality versus correlation” all of the time. Our process embraces the idea that both can occur at the same time.


In Chaos Theory you have Emergent Properties and Phase Transitions. The Correlation Risk born out of an emergent property like the World’s Reserve Currency (USD) and asset prices is very real. So are the phase transitions (crashes) born out of that Correlation Risk.


The US Dollar Index is up for the 5thconsecutive day to $79.58 this morning. Look at the immediate-term TRADE correlations that our model is spitting up versus the USD:

  1. WTIC Oil = -0.72
  2. Brent Oil = -0.64
  3. Gold = -0.77
  4. Copper = -0.76
  5. Wheat = -0.71
  6. Soybeans = -0.81

In other words, that’s how I can show you, in real-time, the answer to both Dalio and Hendry’s question on timing asset price inflations and deflations. US Dollar driven Correlation Risk doesn’t matter all of the time. Neither is it perpetual. But some of the time, it matters big time. And that’s when you get paid to be long or short beta.


If you believe (like I do), in the causal relationship between Monetary Policy and Currency moves, you’ll absolutely love learning about this. It forces us to Re-Think and Re-Learn, every day. If you believe, like a dogmatic Keynesian (Bernanke) does, that monetary policy doesn’t infect currency prices which then, in turn, affect inflations/deflations, this will drive you right batty.


Chaos Theory is not part of the current Western Academic Curriculum in Economics. By the time I am dead, it will be. It’s math. And the math will ultimately trump the social science of studying the 1930’s depression in a vacuum.


Don’t take my word for it on this. Read economic history. Overlay Reinhart & Rogoff teachings about the relationships between deficits, debts, and inflation/deflation with what modern day practitioners are writing about. It’s all out there. Educate yourself.


Dalio’s February 2012 research note is titled “An In-Depth Look at Deleveragings” and in it he does exactly what Professor Robert Shiller taught me to do here at Yale – study the long-term cycles, across countries, so that you can begin to understand the scenarios, probabilities, and mean reversion risks.


Dalio considers both the “Ugly” (1920’s Germany) and the “Beautiful” Deleveragings. The most relevant scenarios I thought he nailed down to the risk management board were:

  1. UK Deleveraging 1947-1969
  2. Japan Deleveraging 1990-Present
  3. US Delevergaing 2008-Present

Not one of these deleveragings were the same in terms of numbers of years and/or asset price % moves, but the monetary policies that were engaged in by central planners during all 3 certainly rhyme.


Dalio calls the UK and US Deleveragings of 1947-1969 and 2008-Present “beautiful.” I’ll call what happened in the UK thereafter (1970s) and what is about to happen in the US (if we abuse the US Dollar through debt monetization further), his version of “ugly.”


Hendry said he was long asset price inflation (Equities and Agricultural Commodities) in February. That’s was a good call until the end of February and early March when Global Equity and Commodity price inflations stopped.


Now what you see is what we call Deflating The Inflation. It’s not what Hendry calls “hyper-deflation”, yet. Neither is it the “ugly deflationary deflation” that Dalio warns of. Unless you are long of anything Spanish, Italian, or Greek Equities, that is…


My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, EUR/USD, and the SP500 are now $1627-1651, $112.42-113.87, $79.36-79.68, $1.30-1.32, and 1364-1388, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Ugly Beautiful - Chart of the Day


Ugly Beautiful - Virtual Portfolio


TODAY’S S&P 500 SET-UP – May 22, 2012

As we look at today’s set up for the S&P 500, the range is 42 points or -2.13% downside to 1288 and 1.06% upside to 1330. 












    • Up from the prior day’s trading of -1586
  • VOLUME: on 5/21 NYSE 798.10
    • Decrease versus prior day’s trading of -31.32%
  • VIX:  as of 5/21 was at 22.01
    • Decrease versus most recent day’s trading of -12.31%
    • Year-to-date decrease of -5.94%
  • SPX PUT/CALL RATIO: as of 05/21 closed at 1.58
    • Down from the day prior at 2.08 


  • TED SPREAD: as of this morning 39
  • 3-MONTH T-BILL YIELD: as of this morning 0.08%
  • 10-Year: as of this morning 1.76
    • Increase from prior day’s trading at 1.74
  • YIELD CURVE: as of this morning 1.47
    • Up from prior day’s trading at 1.46

MACRO DATA POINTS (Bloomberg Estimates):

  • 6:15am: Atlanta Fed President Lockhart talks in Hong Kong
  • 7:45am/8:55am: ICSC/Redbook retail sales
  • 10am: Richmond Fed, May, est. 11 (prior 14)
  • 10am: Existing Home Sales, Apr., est. 4.62m (prior 4.48m)
  • 10am: Existing Home Sales (M/m), Apr., est. 3.0% (prior -2.6%)
  • 11:30am: U.S. to sell 4-week bills
  • 1pm: U.S. to sell $35b 2-yr notes
  • 4:30pm: API inventories 


    • Republican presidential primaries in Arkansas, Kentucky
    • Senate in session, House meets in pro forma session, 10am
    • Senate Banking holds a hearing on derivatives rules required by Dodd-Frank; CFTC Chairman Gary Gensler, SEC Chairman Mary Schapiro will testify
    • Treasury Secretary Tim Geithner attends Financial Stability
    • Oversight Council mtg
    • Interior Secretary Ken Salazar, Bureau of Safety and
    • Environmental Enforcement Chief Jim Watson conduct forum on oil-well blowout preventers, federal oversight, 8am
    • NRC advisory panel subcommittee on Fukushima meets to review guidance documents on task force recommendations, 8:30am
    • FDIC Acting Chairman Martin Gruenberg speaks at American
    • Securitization Forum’s annual meeting, 9am


  • OECD said Europe’s debt crisis risks spiraling, damaging world economy; cuts 2012 euro-area GDP forecast to -0.1% from 0.2%
  • Facebook fell 11% to $34.03 in 2nd day of trading
  • U.S. antitrust regulators told EBay, Yelp to provide information on whether Google is competing unfairly, speeding up a probe that began a year ago, people familiar said
  • Accor agreed to sell Motel 6 hotel chain to Blackstone- managed fund for $1.9b
  • Fitch cuts Japan L-T ratings to A+; outlook negative
  • U.S. sales of existing homes probably rose in April for 1st time in 3 months to 4.61m annual rate
  • CFTC to release clearing proposal for index swaps, Gensler says
  • Merkel, Hollande head for showdown on debt at EU summit
  • U.K. inflation slowed more than economists forecast in April
  • IMF says U.K. needs more monetary stimulus, possible tax cuts
  • Former Yahoo! executive, former mutual fund manager at a unit of Ameriprise pleaded guilty to insider trading, the U.S. said
  • MetLife seen scaling back annuities as CEO Kandarian unveils his plan to improve returns
  • Spain borrowing costs rise at 6-month bill auction
  • KKR said to be close to raising $2b for second Asia fund
  • IAEA, Iran reach agreement on atomic inspections
  • No IPOs expected to price today 


    • Williams-Sonoma (WSM) 6am, $0.32
    • Express (EXPR) 7am, $0.49
    • AutoZone (AZO) 7am, $6.25
    • DSW (DSW) 7am, $0.90
    • Cracker Barrel Old Country Store (CBRL) 7am, $0.75
    • Medtronic (MDT) 7:15am, $0.98
    • Best Buy (BBY) 8am, $0.59
    • Ralph Lauren (RL) 8am, $0.85
    • Collective Brands (PSS) 4pm, $0.44
    • Analog Devices (ADI) 4pm, $0.51
    • Universal (UVV) 4pm, NA
    • Dell (DELL) 4:01pm, $0.46
    • PetSmart (PETM) 4:02pm, $0.73
    • Guess? (GES) 4:04pm, $0.26
    • Take-Two Interactive Software (TTWO) 4:05pm, $(0.54)
    • Avago Technologies (AVGO) 4:05pm, $0.63
    • Compuware (CPWR) 4:13pm, $0.14
    • HEICO (HEI) 4:30pm, $0.37
    • Qihoo 360 (QIHU) 5pm $0.15 


  • Diamond-Seller Choksi Takes on World With Bollywood: Commodities
  • Wheat Falls as Rain in Russia and Ukraine May Aid Parched Crops
  • Oil Drops as OECD Cuts Europe Growth, Iran Agrees to Inspection
  • Gold Declines as Rally Prompts Sales and Physical Demand Falls
  • Copper Falls 0.5% in New York Trading, Declines 0.2% in London
  • Palm Oil Climbs for Fourth Day as 10% Drop Lures Investor Demand
  • Robusta Coffee Falls in London on Speculation Price Rose Too Far
  • U.S. Said to Oppose Easing Oil Sanctions at Iran Nuclear Talks
  • Oil Supplies Grow as Seaway Relief Valve Looms: Energy Markets
  • GrainCorp Climbs After Raising Full-Year Forecast to Record
  • Cotton May Drop 23% by Year-End on Inventories: Chart of the Day
  • Flint Hills Has Release at Corpus Christi Plant, NRC Filing Says
  • BHP ‘Chopping Block’ Looms for Nickel, Aluminum Assets Amid Cuts
  • Ships Deter Pirate Stalkers by Signaling Armed Guards’ Presence
  • Indonesia May Cut June Palm Oil Export Tax to 18%: Association
  • Brazil Set to Lose Out as Thailand Meets Chinese Sugar Demand 





US DOLLAR – we bought back our bullish position in the US Dollar on red yesterday and still think it offers the most asymmetry to the upside of almost any big Global Macro trade; the fallout, if we continue to be right on that, will be in the Commodities – we re-shorted Gold yesterday as its immediate-term correlation to the USD is -0.89.











JAPAN – our bearish call on Japan is starting to pick up a broader audience (launched it in March); Fitch downgrades Japan to A+ this morning for some of the wrong reasons, but who actually reads what they say anyway? bottom line is that Japan has huge fiscal/debt issues; we re-shorted Yen on Friday and that’s reacting negatively on the Fitch headline, down -0.54% (vs USD).


INDIA – nope, it’s not all about Greece/Europe folks – India’s stock market stopped going up in February and now their fiat currency is in freefall (Rupee); Sensex failed at its 1st line of (16341) resistance last night and is down -12% from its Feb top. India is not China.










The Hedgeye Macro Team

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