A Crisis of Confidence







Another day of what Jesse Jackson would call “keep hope alive.” The market is rallying pre-open this morning as the masses use hope as a risk management process. The hope is that Fed Chairman Ben Bernanke will continue on his path of quantitative easing, kicking the goalpost down the line past the current 2014 date. And in turn, oil is ripping higher with Brent crude at $104 a barrel. It appears everyone really enjoys those prices at the pump.



...and you get a lot of other things right, especially in lieu of Bernanke today. Get the USD right and you’ll solve the correlation puzzle connected to commodities, oil, currencies and equities. Just so you know: we view the USD in a bullish formation and gold in a bearish formation.



71% of the US Economy is based on consumption. That’s a lot of big macs, Ford trucks and Chinese buffets. The inflation in food and oil we’ve experienced since the dawn of the age of QE has pissed the public off and with good reason. Why people continue to subject themselves to $10 boxes of cereal and $5 a gallon gas is beyond us. You get the US economy right and it helps guide you on the slope of growth.




Cash: Up                U.S. Equities: Down


Int'l Equities: Down    Commodities: Down


Fixed Income: Up        Int'l Currencies: Down





The bulk of the bad news is on the table following disappointing F2012. Rebased F2013 estimates far more reasonable, and revenues should be supported by our expectations for rising physician utilization, and in the near-term, a flu season that is shaping up as a considerable tailwind.







SS volume accelerated in 1Q12 and employment remains a tailwind to both admissions & mix. We expect acuity to stabilize and births and outpatient utilization to accelerate out of 1Q12, while supply cost management continues as a margin driver and acquisition opportunities remain a source for upside.







The company continues to control its own destiny through investments in all the right areas. We think 30%+ top line and EPS growth for 5+ years. One of its failures, however, has been in penetrating markets outside the US. That will happen. But for now, its failure is a competitive advantage in the face of a strengthening dollar. We like it in sympathy with a LULU sell-off.








Tweet of the Day: “BoE's KING: First we knew of LIBOR fraud was two weeks ago; BoE not responsible for regulation of markets.”-@DailyFXTeam


Quote of the Day: “Character is much easier kept than recovered.” –Thomas Paine


Stat of the Day: CHINA: +0.6% for the Shanghai Comp on the bounce after yesterday's -1.7% smackdown






Lie-bor Losses Set to Balloon

This note was originally published at 8am on July 03, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The fellow that can only see a week ahead is always the popular fellow, for he is looking with the crowd. But the one that can see years ahead, he has a telescope but he can't make anybody believe that he has it.”

-Will Rogers


To Will Rogers’ point, telescopes are in short supply these days. Ask an investor what they would have predicted for the XLF three years ago, and chances are their reply wouldn’t have looked much like the chart at the end of this note. The reality is that it’s a natural investor tendency to extrapolate the recent past as the most likely path for the next twelve months of trading. Obviously, the problem with this approach is that it misses big turning points.


Looking at the last three years there have been at least six big turning points in the Financials space. We’re not talking about small rallies or corrections. Being on the right or wrong side of these big moves has made or broken investors’ years.


What’s so interesting to us is that in hindsight they seem to follow a very recurring and seemingly predictable pattern. The XLF peak in 2010, 2011 and 2012 occurred on April 14, February 21 and March 26, respectively. The XLF low for those same years occurred on August 30, 2010, October 3, 2011 and as-yet-to-be-determined, 2012, though no earlier than June 4.


We’ve come up with a framework for thinking about why the pattern seems to rhyme so consistently over the last three years. The foundation of the framework is the distortion of government economic data, which was introduced by faulty seasonal adjustment factors arising from Lehman Brothers’ bankruptcy. The recurring annual effect makes many of the government’s data series appear stronger than they really are from September through February and weaker from March through August. We’ve quantified this effect in the initial jobless claims series, and it is strong enough to create the illusion of both robust recovery in Q4 and Q1 of each year and an economy teetering on the brink of recession in Q2 and Q3. Given that we just entered Q3 on Monday, we think the effect still has a few months to go before predictably beginning to reverse.


The second thing to understand is that central banks play a predictable role in exacerbating this trend. As the data appears to weaken steadily over the course of the March through August period, the calls for QE grow louder. In 2010 this culminated at Jackson Hole with the unveiling of QE2. In 2011 QE-Light (aka Operation Twist) was unveiled in September while the ECB’s large-scale LTRO program came out that December. The takeaway here is that the announcement or start of these massive intervention programs coincides with the turning point in the cycle when the economic data is already beginning to roll from bad to good.


This phenomenon is likely to be with us for the next two years. Government seasonality models work on a five year look back, this being the third year following the incorporation of the original data distortion. As such, we’d expect to see this effect present itself again in 2013 and again in 2014. That said, the effect should become progressively smaller, as the government models weight older years less heavily than more recent years.


There are other factors at play. For instance, May 2010 saw Dodd-Frank roll out – a major Financials sector overhang. 2011 saw the debt ceiling debate culminate in the S&P downgrade of the United States. Additionally in 2011, the large cap banks were plagued by mortgage putbacks and Basel III SIFI concerns; none more so than Bank of America. And, of course, Europe has played a central and recurring role in the last three years. This year it’s a combination of Europe (again) and angst over how punitive the Volcker Rule will be for the large banks.


Looking ahead, the most likely candidate on the radar for the next large-cap bank boogeyman is the rapidly emerging LIBOR scandal. So far it has claimed only Barclays as a victim, as that bank agreed to pay three regulators a total of $451 million in penalties in addition to actually admitting wrongdoing – when was the last time you heard a bank admit that? Specifically, the bank has acknowledged that it deliberately reported artificial borrowing rates from 2005 through 2009. The company’s Chairman resigned over the weekend and CEO Diamond bowed to the pressure to resign this morning. Barclays got a slap on the wrist in exchange for enormous cooperation in helping regulators understand the extent of the wrongdoing. Remember that price fixing is a criminal violation under the Sherman Act, so Barclays was treated with kid gloves. The fear that the large US banks will be treated less favorably is appropriate.


There are approximately $10 trillion in loans tied to Libor and another $350 trillion in notional value derivative contracts linked to the rate. Just one basis point of that notional total, for reference, equates to $36 billion. Early indications suggest that Libor may have been manipulated by as much as 30-40 bps, though this has yet to be confirmed. Any way you slice it, the math is big. Back in the Fall of 2010 we estimated that the mortgage putback fiasco would cost the big banks $49 billion in total, with Bank of America shouldering almost half that amount. Putbacks were the principal concern driving BAC shares down to $4.99 (38% of tangible book value). Given the magnitude of the affected securities in this scandal, it doesn’t seem hard to imagine a class action process that reaches into the tens of billions of dollars, with fears and chatter about “hundreds of billions”. We expect this issue to heat up over the coming 12 months as there are active investigations by the Dept. of Justice into all the large banks involved in setting LIBOR. Domestically, JPMorgan, Citigroup and Bank of America appear at risk.


Perhaps the most important thing to understand is that the big banks have, in the last few years, been overshadowed by one cloud of uncertainty after another: mortgage putbacks, AG settlements, Durbin, Reg-E, Volcker, etc. Until it’s crystal clear to the market how much an issue is going to cost and/or how detrimental it will be to the business going forward, the market shoots first and asks questions later. This Libor scandal fits that mold perfectly: it’s big, it’s as yet unquantifiable and the media is in the bottom of the first inning getting its arms around what’s happened. The numbers that will start to get thrown around will be staggering: “trillions”. Very few investors, as well as the banks themselves for that matter, will have any real handle on what the loss profile may look like. As such, the prospects for the large banks finally achieving escape velocity out of their March 2009 to February 2011 price/tangible book value ranges is unlikely over the next year.


As a final point, it’s worth pointing out where we are in this current cycle. It certainly looks as though 6/4/12 was a possible major turning point. From our vantage point the most glaring difference between this year and the last two years is the level of recorded fear. In both 2010 and 2011 the VIX exceeded 45 briefly and traded for some time above 30. So far in 2012 the VIX has only exceeded 25 on a few days and hasn’t exceeded 30 at all. Considering this emerging LIBOR scandal and that the problems in Europe seem larger today than what we faced in 2011 or 2010, it strikes us as counterintuitive that the market would be less afraid today.


Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Germany’s DAX, and the SP500 are now $1593-1615, $92.99-98.53, $81.41-82.31, $1.23-1.27, 6284-6581, and 1337-1373, respectively.


Josh Steiner, CFA
Managing Director


Lie-bor Losses Set to Balloon - xlf chart


Lie-bor Losses Set to Balloon - vp 7 3

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You Built This

“If you’ve got a business, you didn’t build that.”

-Barack Obama, July 16th, 2012


Really? I couldn’t make up what the President of The United States said (off teleprompter) yesterday in Roanoke, Virginia if I tried. I guess I should send some wine to Barry and Timmy for keeping Citigroup’s research unit intact. Thanks for the help boys.


Obama went on to say that “somebody else made that happen.” I thought for a minute he was referring to my almighty God. Then I thought again. By somebody, he meant government.


Sadly, the same goes for how Obama, Bernanke, and Geithner think about the US stock market. They fundamentally believe that by not intervening, our markets won’t work. That’s not the America I came to in the early 1990s. That’s just sad. This is a No volume; No Trust market – if you’ve got a confidence and hiring problem Mr. President, you built this.


Back to the Global Macro Grind


Now that I got that off my chest, onto the American Made Central Planning Hope of The Day – Ben Bernanke’s testimony at 10AM EST in front of our clueless economic overlords in the Senate.


This is actually getting as funny as it is pathetic. Ahead of whatever sweet-nothing Bernanke will whisper about Qe4 today, markets are front-running him again. This has been happening all year. Each rally is shorter in duration, and to lower-highs in elevation.


Commodity markets in particular are straight up into the right. If you are into the Down Dollar Drugs (USD was up yesterday until that bomb of a June US Retail Sales print of -0.5%), that’s where you get your short-term fix. That’s where the boys who jacked 1.05 million commodities options contracts (CFTC data) right back up to their early April highs are looking for some pop.


“Pop, pop, bang!” (Jimmy Braddock’s punching combo in Cinderella Man).


Unfortunately, that’s how it all ends. They’ll get their pop, then its lights out for whatever is left of US Growth. With US GDP Growth this slow, everything on the margin really counts – and the last thing the US (and global) economy needed was a +17% rip in the price of oil since late June on Bernanke Begging.


That’s why we are starting to see the market leaders of both the US economy and US stock market (Technology and Consumer Discretionary) start to lag. While they loved the tax cut of $89 Brent oil in mid-June, they do not appreciate $104/barrel staring them in the face this morning.


With the SP500 down for 7 of the last 8 trading days, this is how the S&P Sector ETF laggards look like for July and Q3 to-date:

  1. Consumer Discretionary (XLY) = -1.01%
  2. Technology (XLK) = -1.69%
  3. Industrials (XLI) = -2.92%

Now if I have been anything since March 12th when we shorted Industrials (XLI) on the #GrowthSlowing call, I have been consistent. My team’s research has also been very consistent on what infects real (inflation adjusted) US Consumption Growth too – the marginal price inflation of food and energy.


Since 71% of the US Economy = Consumption, this is one of the main things you need to get right if you want to get the slope of growth in the US economy right. That’s precisely why the politicians of the 112th Congress have had their policy to inflate food/energy prices all wrong.


Post 2006, Bush had this as wrong as Obama has it now. Don’t forget that both Presidents empowered Bernanke. For Bush, that was then. For Obama, we live in the now. And not letting free-market prices clear for the sake of a broken belief system that central planners can “smooth” economic cycles and suspend economic gravity is now his problem.


Your conflicted and compromised cronies built this environment for small business owners and market participants in America. My team and I have been building our business in spite of you.


My immediate-term risk ranges of support and resistance for Gold, Oil (Brent), US Dollar Index, EUR/USD, Spain’s IBEX, and the SP500 are now $1, $100.25-104.02, $82.47-84.03, $1.20-1.23, 6, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


You Built This - Chart of the Day


You Built This - Virtual Portfolio

President Obama’s Reelection Chances

The climb is finally over. After three weeks of watching his reelection chances climb, the growth has stopped. For the week of July 16, 2012, President Obama’s odds of being reelected held flat at 57.8%. It reminds us of the market’s recent performance along with the US dollar last week. There is a lot of work ahead for the President as Romney’s political machine moves into full swing ahead of November.


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.


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.  The model assumes that the Presidential election would be held today against any Republican candidate. Our model is indifferent toward who the Republican candidate is as the sentiment for Obama and for any Republican opponent is imputed in the market prices that determine the HEI. The HEI is based on a scale of 0 – 200, with 100 equating to a 50% probability that President Obama would win or lose if the election were held today.


President Obama’s reelection chances reached a peak of 62.3% on March 26, according to the HEI. Hedgeye will release the HEI every Tuesday at 7am ET until election day November 6.



President Obama’s Reelection Chances - HEI

HedgeyeRetail Visual: $130 and Up

There was a notable acceleration in the underlying $130+ footwear price point growth in June which accounted for 17% of sales throughout the month. Additionally, Basketball (30% of sales within the channel), which typically carries a greater ASP relative to other athletic footwear categories, appears to have been the only category in the channel to also show a sequential acceleration in underlying trends. We expect FL was the primary benefactor of the incremental $130+ strength given it has the greatest exposure to basketball footwear within the athletic specialty subsector.  


HedgeyeRetail Visual: $130 and Up - price point COTD


HedgeyeRetail Visual: $130 and Up - Monthly FW Categories

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