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SP500 Levels Into The Close

This is getting nasty, and if it weren’t for Gold (GLD) and the VIX not confirming … yet… I’d say we are on the precipice of another SP500 crash. Crash? Yes – the horse and buggy whip US Financials (XLF) are crashing – as they should.

Looking at the chart below, you’ll see my refreshed levels to manage around if we don’t crash. Selling SP500 866 is the dotted red line – that’s where any immediate term “Trade” to the upside runs out of gas. Selling SP500 883 is the new intermediate term “Trend” line – make no mistake, its bearish out there. The US Financials, as a sector, are down -30% for the year to date!

The buy/cover for the immediate term “Trade” line is 803. If you’re in the SP500 crash camp, a 3 standard deviation move in my model will get you SP500 771. That’s another -4% more pain to carry (or risk) if you cover/buy at 803. This Crisis in Credibility has proven to be both well deserved, and painful to the stock market for 2009 year to date, but I still do not think the SP500 will make a lower low versus November’s 752.

Keith R. McCullough
CEO & Chief Investment Officer

Eye On Leadership: President Obama

Transparency, Accountability, and Trust - we like that message, and if only in rhetoric, that's where Obama sides with Research Edge's vision of The New Reality.

Bank of America is no longer America's once vaunted investment banker. Blackstone's lack of transparency is not the new American capitalists interpretation of where this country is headed. Those two stocks are down -19% and -11% today for reasons that are unique to their very own shortsightedness.

Trading down another -9% today, the US Financials (XLF) have already crashed in 2009. Tomorrow that will be yesterday’s news.

For the year to date, we have a developing story of the excesses unwashed meeting their maker. At down -30% for the year to date, in a year that is only 20 days old, today we can say goodbye to the horse and buggy whip thought processes of the leverage cycle past. Goodbye and Good luck.

Before we can “dust ourselves off, and rebuild it”, the SP500 needs to rid itself of the market cap associated with the banking system’s Crisis in Credibility. Everything starts with confidence. Obama has that - and yes, the best things in life take time to build.

We are most likely going to test my downside SP500 support line of 818 in the meantime.
KM

Keith R. McCullough
CEO & Chief Investment Officer

Selling The Brazilian Bull, For Now...

When I woke up this morning to the Russian stock market crashing to new lows (lower than its October low of 549 on the RTSI), I immediately moved to run the risk management math on our position in Brazil (the EWZ etf). While I don’t believe in the nonsensical Wall Street acronym BRIC (Brazil, Russia, Chindia), I very much believe that when my intermediate “Trend” line breaks that an asset can begin to fall like a brick.

That’s my math and I am sticking to it. The reality is that the Bovespa (see chart) finished off a massive +44% move on January the 6th, right after the US stock market locked in its 3-month cycle high up at 941. While the Bovespa’s recent correction has been about the same as that in the SP500, this only means that it has further to fall if mean reversion has any place in the risk management side of the argument.

No, I am not selling Brazil because I don’t think they will cut rates. No, I am not selling Brazil because I don’t think that it will continue to outgrow the rest of Latin America in 2009. I am selling Brazil today, because the Bovespa index broke a critical level in my model at 38,787.

Keith R. McCullough
CEO & Chief Investment Officer

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.28%
  • SHORT SIGNALS 78.51%

Trading Gold: Here Are Our Levels...

Gold is having a strong day here, on both an absolute and a relative basis, trading up another +2% to $855/oz.

This is all the more impressive given that the US Dollar continues to gouge price re-flation in pretty near every other asset class. When there is a Credibility Crisis in the banking sector, gold has its perks.

Below we have outlined the bullish intermediate “Trend” line for gold that remains formidable at the $808 line, but also has the shorts covering all the way up to the $835 level, perpetuating this up move.

I have an immediate term “Trade” sell line (dotted red on the chart) up at $875, but that’s just for a “Trade”. The story the gold bears continue claw at is that we haven’t yet made higher highs for this 3-month cycle move. If we push over $920, that thesis will be under assault.

I currently hold a 6% position in Gold via the GLD etf. That’s a better than bad place to be.
Keep moving out there,
KM

Keith R. McCullough
CEO & Chief Investment Officer

THE UPSIDE OF BEING LEVERED

For the first time during this credit crisis, the gaming operators can see a silver lining in their cloudy financial positions. The three month LIBOR has plunged to 1.09%. All of these companies maintain significant borrowings off of their credit facilities where the interest rate is determined by a (tiny) spread over LIBOR. The EPS tailwind for 2009 EPS is huge. We are not big EPS followers at Research Edge, but the low rate environment will have a big positive impact on cash flow.

Rock bottom LIBOR alone doesn’t pull these guys out of the debtor’s prison they put themselves in. Taking on excessive debt levels to invest in low ROI projects was a strategy that was destined to fail. Fail it did; shareholders and bondholders have paid the price. Unfortunately, that is a sunk cost. On the margin, the liquidity picture may be looking a bit brighter.

The following charts examine the 2009 financial impact from LIBOR going from just over 3% in late October to the current rate of 1.09%. We looked at late October as the starting point because the companies last gave guidance during the Q3 earnings season. Moreover, that may be the last time many analysts updated their models.

ASCA, BYD, LVS and MGM are the biggest beneficiaries in terms of EPS and cash flow. These companies all maintain very attractive credit facilities and significant borrowings off of those facilities. BYD should receive the largest boost with the October to January decline in LIBOR impacting EPS by 46%. ASCA and MGM are on track for over a 30% increase each. In terms of cash flow, LVS, ASCA, and BYD could all see interest cost savings in excess of 10% of their projected 2009 EBITDA.

Combined with deleveraging bond buybacks, the low rate environment should help MGM and BYD get through 2009 without busting covenants. This will put BYD in the clear for 2010 and beyond but MGM still needs new financing to avoid covenant breaches in 2009. The problem for LVS is the leverage covenant in its Macau bank facility which will likely be breached even with the lower rates. Similarly, ASCA faces a potential Q2 senior leverage covenant breach.

Of course, this analysis assumes a) rates will persist here for all of 2009 and b) analysts have not updated their interest rate assumptions since late October. The actual impact is likely to be less, due to a) and b) above, and worse operating trends. However, while investors have certainly focused on the operating fundamentals, we don’t believe the LIBOR tailwind is appropriately reflected in some of the stocks.


Hope and Hypocrisy

Hope and Hypocrisy - asset allocation012009

“Lead, follow or get out of the way!”
George S. Patton

Basically, that’s what I hope Obama gets up and says to the run-of-the-mill market pundit who works for a firm that has no credibility, yet hypocritically questions Obama’s leadership credentials. “Hi, I don’t like Democrats, they aren’t capitalists… but my firm contributes massively to the Democratic party, and my boss asks for bailout money every other day.” Unfortunately, depending on who you are, neither hope nor hypocrisy are investment processes.

Today, of course, is the long awaited Inauguration Day of America’s 44th President. Was the day trader’s Obama rally into the close on Friday? Was it the +5% move in the 5 hours of trading from last Thursday at noon until Friday’s opening SP500 prints at 857? Was it the 6 week +25% rally in the SP500 that ran out of gas on January the 5th? Or is it the +13% cumulative gain we have already baked into the SP500 cake at last week’s 850 close?

Was it none of the above? Do we wait on specific calendar dates that the entire world is staring at on the day of? Or do we have a process that bobs and weaves using prices versus expectations? I don’t know what other people do, but you know where I stand on this. Every day, the math changes alongside both the facts and fictions that the global marketplace offers us. This morning is the first time in a very long time that my math says there is an equally weighted risk/reward setup for the SP500’s price, in the immediate term. I see downside risk to 818, and upside reward to 885. Trade that range.

While the intermediate “Trend” of volatility breaking down as the US market continues to make higher lows remains, that certainly doesn’t mean that the bulls can’t spend a day, week, or month getting water-boarded in a dunk tank. As sure as the sun will rise in the East this morning, you know the bulls who turned bearish in November are still being force fed the apocalypse cometh narrative from the likes of Nouriel Roubini and Jimmy “The Bowtie Cat” Rodgers – this is what these guys do – they are alarmists. They scare people who don’t have a macro process.

Can the perpetual bulls be more bearish than the long standing bears? I really have no idea. While Roubini’s process is an impressively academic one, supported with plenty of history and math, some of these talking heads on the entertainment networks clearly operate using a one factor model – emotion. If they tape goes up, they press play on the bullish narrative fallacy. If the tape goes down, they say “I’m not an economist”, blame the market, and rarely feel shame.

Overseas, the Russians and all those levered to the almighty “petro-dollars” are feeling a whole lot more than shame – they are feeling the pain! Russia’s stock market, which was flashing negative divergences in our model for all of last week, finally crashed again, breaking its October 24th low of 549. The Russian Trading system Index is currently lagging all of European trading, dropping another -3% to 515, taking it -6% below its prior low, and putting its cumulative crash since Christmas at -24%. Yes, the word to describe this is crash.

Crashes happen when what people hope doesn’t happen, happens. It was only 9-12 months ago that I would write about the geopolitical risks associated with “Putin Power” – now those days of his political hubris are gone, but that doesn’t mean that he won’t behave like a man in desperation can behave. As we have seen in Gaza, there are unintended consequences to the realities associated with a crashing oil price. Crash? Yes, at $33/barrel this morning, oil has crashed, losing -78% of its value in 6 months!

Middle Eastern stock markets in Saudi Arabia and Qatar are getting smoked this morning, trading down -4.2% and -6.1%, respectively. Yes this is bad, for some. It will be interesting to see if Maria Bartiromo gets another one of those “exclusive” interviews today with Saudi Prince of Citigroup, and best buds of the Pandit Bandit himself, Prince Alalweed. Remember his interview with CNBC a few months back when he had the campfire and camels in the background? That was embarrassing.

So was my call to short the US Dollar two weeks ago “with impunity.” The US Dollar reminded us all last week that when there is a Crisis of Credibility spreading across the globe, that cash can indeed remain king. The US$ Index and the VIX (volatility) Index outperformed nearly everything other than China last week, closing up +2% and +8%, respectively. In the face of the US government trying their darndest to de-value the US Dollar, it seems that the Japanese, Russians, Canadians, and Asians from India to South Korea are one upping them!

The South Korean Won is down almost -9% already for 2009 to date, and the year is only 2 weeks old! Last year the Won got hammered, losing -26% of its value as their new US trained head of state tried the Greenspan thing, and got clobbered by the oncoming train called macro-economic cycles. The Maestro you see, didn’t do Macro – he did the Politico! We need to re-train these politicized financial neophytes.

With the exception of China, I am effectively net short Asia right now, and this hedged position is paying off nicely so far in 2009. Overnight, South Korea and India closed down another -2.4% and -2.5% respectively underperforming the other Asian country I am short (Japan) by the hair of their chinny chin chin (we are short EWY, IFN, and EWJ – see our virtual portfolio at www.researchedgellc.com <http://www.researchedgellc.com> ). These countries are not China, and now they are decoupling versus China. The next person who has it in them to remind us of their “Chindia” thesis of yesteryear gets a Research Edge fleece.

Despite reporting their first drop in their employment rate since 2003, the Chinese stock market reminded us all last night that they are moving forward with their own organic growth plans. Stocks trade on the future, not the past. Despite broad based weakness in Asian stock and currency markets overnight, the Shanghai Stock Exchange close up another +0.37%, taking its cumulative gain since the new year to +9%. Make no mistake, from a quantitative perspective, any close above the 1951 line on the Shanghai Index is a bullish breakout.

Amidst the hope of many Americans today, there will be plenty of hypocrites dancing on hot coals. Once the drama of Obama passes this afternoon, we’ll all be facing the realities associated with The New Reality. While the apex of the liquidity crisis has passed, a very relevant credibility crisis remains – and there will be no quick fix. The only solution will be to “lead, follow… or get out of the way.”

Best of luck out there this week,
KM

Hope and Hypocrisy - etfs012009


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