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Thoughts Ahead of ECB Meeting

Positions in Europe: Short EUR/USD (FXE)

 

The ECB meets tomorrow. We think there’s a high probability the ECB stays on hold to wait and watch the economic and political developments for another month ahead of Greek elections on 17. June.

 

Some observers have suggested a 25bps cut. We think it’s more probable that the ECB could signal a willingness to ease, but won’t cut. To this end, we wouldn’t be surprised if the ECB resumed some of its non-standard measures, including the Securities Market Program (SMP), which has been dormant for the last 12 straight weeks, but has purchased €212B of bonds on the secondary market since May 2010. However, we don’t expect yet another long term LTRO to be announced tomorrow.

 

One main issue at hand is that a rate cut alone won’t solve Europe’s sovereign and banking problems. The ECB, under Trichet and now Draghi, has stressed the need of governments to reduce their fiscal imbalances. And unlike the developing Hollande-Monti handshake in support of Eurobonds and the ECB doing more, Draghi has taken a very Bundesbank approach that fears unneeded ECB intervention, in particular measures that may spur inflation.

 

Further, we think the ECB wants to evaluate the outcome of the Greek elections on 17. June, and monitor the discussion around a fiscal union, Eurobonds, and a Pan-European deposit insurance, all of which are programs many months out if they are ever realized. These programs should be central to the Summits and meetings approaching later in the month, and should be critical for market sentiment.

 

Since the ECB’s last meeting on 3. May, data continues to contract and/or disappoint. The notable highlights are the declines in Manufacturing and Services PMI surveys for the month of May, the Eurozone unemployment rate that ticked up to 11% (a 17 year high), and Eurozone confidence figures that largely deteriorated month-over-month in May.

 

The EMU remains a compromised Union of states. However, we still believe that Eurocrats have a tremendous resolve to keep the Union alive with the existing member states.  For specific questions on anything Europe, please contact me at .

 

Thoughts Ahead of ECB Meeting - 11. SMP

 

Matthew Hedrick

Senior Analyst



Prospects of Survival

This note was originally published at 8am on May 22, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Organisms that treat threats as more urgent than opportunities have a better chance to survive.”

-Daniel Kahneman

 

If you only have time to read one chapter of Dan Kahneman’s Thinking, Fast and Slow this summer, I’d go with Chapter 26, Prospect Theory. It helped me bridge some gaps between the fractal dimensions in our models (math) and behavorial factors.

 

Prospect Theory is a behavioral economic framework that will be much more relevant to the next generation of economists than this one. It will take time to pound the Keynesianism out of our system. Sadly, seeing centrally planned economic systems in Europe and Japan (maybe at some point in the USA) fail, will be the only way to expedite this evolution.

 

On pages 282-283 of Kahneman’s latest book, you’ll get Prospect Theory both with a simple picture and three bullet points of prose:

 

1.       “Evaluation is relative to a neutral reference point.”

2.       “A principle of diminishing sensitivity applies to both sensory dimensions and the evaluation of changes in wealth.”

3.       “The third principle is loss aversion… losses loom larger than gains.”

 

And that brings me right back to the top of this morning’s Early Look quote, to the bottom of your gut feeling at Friday’s lows, and back again to yesterday’s biggest market rip in 2 months. Your Prospects of Survival in this business depend on your process.

 

Back to the Global Macro Grind

 

Losing other people’s money isn’t cool. Losing your own money is even less cool. If you are doing both at the same time, my sense about the matter doesn’t really matter – where your emotions fit on the slope of the loss aversion curve does.

 

That’s why we bought red on Friday and sold green into yesterday’s close. When it comes to your decisions to buy or sell something, there really are no rules about reversing everything you did in the prior day. I am not Warren Buffett. I am your Risk Manager. The only rules in our profession are self imposed by the institutions who think they are managing our risk.

 

But what is risk? What are these institutional investing styles? Why are either measures relevant to what’s happening in your portfolio today as opposed to risk measurements and style factors you may have used in 2005-2007?

 

There are many more questions here than answers. My goal, at the top of every risk management morning, is to Embrace Uncertainty and have markets pick me. The more I try to pick markets, the more risk I impose on myself. What is supposed to work, rarely works. And what shouldn’t happen, usually happens. Either accept that, or whine about it – it’s reality.

 

I sold my SP500 (SPY) long position yesterday – here’s why:

  1. Immediate-term TRADE upside resistance into the close = 1329 (so I only had 1% upside left)
  2. Immediate-term TRADE downside support into the close = 1288 (2% downside makes my risk vs reward 2:1)
  3. Immediate-term RANGE of risk (3 day probability model) = 89 S&P points (that means volatility will be real)
  4. US Equity Volatility (VIX) was down -12.3% on the day but holding my TRADE and TREND lines of support
  5. US Equity Volume was down -17% versus the average volume of last week’s down days
  6. US Equity Correlation Risk to the US Dollar Index remains wacky elevated at -0.96 (USD vs SPY)

Multi-factor, Multi-duration Risk Management – that’s how I roll. On the immediate-term TRADE duration (3 weeks or less), those were the 6 glaringly obvious reasons to be at least a lot less net long. Catalyst wise, I gave you my calendar ones in yesterday’s note.

 

In the Hedgeye Portfolio, we opened the day with 16 LONGS, 4 SHORTS and closed the day with 10 LONGS, 8 SHORTS. That’s easily the most aggressive 1-day swing in what can be considered a proxy for my “net” exposure in 2012.

 

But was it aggressive? Or wasn’t it aggressive enough? Maybe I should have sold everything and gone to 100% Cash. Maybe I should have shifted to net short. Maybe I shouldn’t have done anything at all.

 

Maybe I should just stick with the process and take the high probability cut at the ball, and live with it.

 

And I will.

 

With the US Dollar Index down for the 2ndday in a row, we bought that long position back yesterday on red. That position is one we have been pounding the pavement on with clients as the most asymmetric long-term long idea in Global Macro (email Sales@Hedgeye.com for Theme #3 in our Q2 Macro Themes called “Asymmetric Risks” and you’ll see the long-term mean reversion case for Strong Dollar).

 

In addition to the aforementioned Correlation Risk of staying long the SP500 (SPY) in the face of a -0.96 USD/SPY correlation this morning, here’s a refresh of the other big immediate-term USD correlations jumping off the page:

  1. Commodities (CRB Index) = -0.92
  2. Euro Stoxx600 = -0.97
  3. Gold = -0.89

That’s why I re-shorted Gold (GLD) yesterday too.

 

There’s rain in Connecticut, but Prospects of Survival out there this morning look better than bad.

 

My immediate-term support and resistance ranges for Gold, Oil (WTIC), US Dollar, EUR/USD, and the SP500 are now $1573-1618, $90.57-94.12, $80.82-81.97, $1.26-1.28, and 1288-1330, respectively.

 

Best of luck out there today,

KM

 

 

Keith R. McCullough
Chief Executive Officer

 

Prospects of Survival - Chart of the Day

 

Prospects of Survival - Virtual Portfolio


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THE M3: WYNN COTAI; PONTE 16 3RD PHASE

The Macau Metro Monitor, June 5, 2012

 

 

WYNN COTAI TO BE READY IN 48 MONTHS:  STEVE WYNN Macau Business

Wynn Cotai will take between 46 and 48 months to be fully ready and open.  Steve Wynn said the new casino resort will cost around US$4 billion (MOP32 billion).  Wynn is confident that the government will facilitate the hiring of imported labour given that Macau’s unemployment rate is virtually non-existent.  He also said the company will issue in the future more dividends but refused to give more details

 

PONTE 16'S THIRD PHASE TO GET GOV'T OK SOON:  HOFFMAN MA Macau Business

Hoffman Ma Ho Man, the deputy CEO of Ponte 16, says the third phase of the casino hotel should get government approval soon.  “We hope it arrives in June. We want to start construction still within this year.”  The third phase of Ponte 16 will feature a riverside commercial complex with a total floor area of approximately 40,000 square metres.  The complex will also include space for the expansion of gaming areas and car parks, with construction expected to be completed by 2014.

 

Pier 16 – Property Development Ltd, the owner of Ponte 16 casino resort, announced in April the signing of HK$1.9 billion (US$245 million) and RMB400 million (US$63.6 million) five-year syndicated loan facilities with 11 financial institutions.  Part of the proceeds are to fund the construction of the third phase of the Ponte 16 development.


Ponte 16 is a joint venture between SJM Holdings Ltd and Success Universe Group Ltd at the ratio of 51% and 49% respectively.



Failed Policy

“The fact that this policy had failed spectacularly in 1973 did not deter the weak dollar crowd.”

-Jim Rickards

 

Between today’s G-7 meeting, tomorrow’s ECB decision, and Thursday’s Bernanke testimony, there will be plenty of opportunity for politicians and their pandering economists to beg and fear-monger for more of what simply has not worked.

 

That’s the short-run. The conflicted and compromised will do whatever it takes for their short-term political survival. In the long-run, apparently Keynes had the duration of the policy trade wrong – the rest of us aren’t all yet dead.

 

Taking a step back, the last 60 years of history are obviously littered with examples from Charles de Gaulle to Richard Nixon where sovereign currency devaluation and debt monetization did not work. If you’d like to get back up to speed on that, Jim Rickards does a great job walking through part of this  history in Chapter 5 of Currency Wars (1).

 

Back to the Global Macro Grind

 

Real-time market prices don’t lie; politicians do. Within hours of last week’s US Growth Slowing double-header (US GDP slowed to 1.9% in Q1 versus 3% in Q4, then the May Employment Report bomb detonated), the US Dollar stopped going up.

 

Why? Because the rest of the world fully expects an un-elected central planner in Washington (Ben Bernanke) to launch an iQe4 Upgrade. He did it on January 25th (pushing 0% rates out to 2014) and there’s no reason to expect he doesn’t do something again between Thursday’s Joint Economic Committee meeting and the FOMC meeting on June 20th. He’s fighting for his political life.

 

All that said, we have no idea what he is going to do. So don’t look for us to give you the super-secret whisper on that. Our strategy remains playing the game that’s in front of us, Embracing Uncertainty. We think the US Election puts him in a box.

 

Right, the man walked on water during 2008 and we should perpetually give him thanks and praise. But seriously, what Bernanke should have done and what he did have been 2 very different things since 2010.  

 

By the summer of 2010 Bernanke had bi-partisan support (the Republicans wanted to win the mid-term elections) to move to Quantitative Easing (Policy To Inflate). Both parties wanted the stock market up. Now only one of them do.

 

What Bernanke does next must also be contextualized on a relative basis. This is not 2008 or 2010 in that regard either. Today you have a currency war between the 3 major currencies of the world (Dollar, Euro, and Yen). They trade relative to the expedience of the latest Fiat Fool (failed) Policy that is designed to debauch them. The Fed, ECB, and BOJ don’t get paid to act unilaterally.

 

So what are currency markets signaling happens next?

 

1.   The US Dollar – remains in what we call a Bullish Formation (bullish across all 3 of our risk management durations, TRADE/TREND/TAIL) with immediate-term TRADE support at $81.55 and next resistance = $83.31.

 

2.   The Euro (vs USD) – remains in what we call a Bearish Formation (bearish across all 3 of our durations) with an immediate-term TRADE support/resistance range of $1.22-1.25.

 

3.   The Yen (vs USD) – is in a neutral position with long-term TAIL resistance at $77.68 and immediate-term TRADE support at $79.05.

 

In other words, if we had to pick one and #TimeStamp our highest probability scenario right now (we do), we’d be long the US Dollar and short the Euro (which we re-shorted on yesterday’s bounce).

 

It’s another way of saying that both Hedgeye and Global Macro markets think that the Europeans are in a much more dire situation (for now) than the United States of America is.

 

That could change at literally any minute of any day now – and that, of course, is why most sane people don’t trust these markets or the politicians attempting to centrally plan them.

 

Back to the ‘for now’…  

 

We still aren’t all brain dead, and we have to deal with whatever tomorrow’s European move to debauch the Euro back down to $1.22 brings. Then we have to react to Bernanke’s reaction to the reaction. Then we all have to pray.

 

Prayer, in markets, is obviously not a risk management process. Neither is hope. That said, my only long-term hope for this country and the free-market economy that we used to have is to get Ben Bernanke out of the way of expectations, let prices at the pump clear, and let US Consumption Growth recover again.

 

With Bernanke having not been able to really do anything for the last 5-6 weeks, the US Dollar has risen steadily and Oil, Gold, Copper, etc. prices have fallen precipitously. That’s good for American consumers.

 

That’s bad if you are long Energy stocks (the Energy ETF (XLE) is down -10.3% for the YTD). That’s good if you are short them and long Consumer Discretionary stocks (the Consumer ETF (XLY) is +7.4% for the YTD).

 

Strong Dollar = Strong America (via Stronger Consumption). That’s not more of a 1973 like Failed Policy. That’s a new idea.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1, $97.21-102.78, $1.22-1.25, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Failed Policy - Chart of the Day

 

Failed Policy - Virtual Portfolio


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