Currency Wars

This note was originally published at 8am on August 22, 2012 for Hedgeye subscribers.

“The first panacea for a mismanaged nation is inflation of the currency; the second is war.  Both bring a temporary prosperity; both bring a permanent ruin.  But both are the refuge of political and economic opportunists.”

                -Ernest Hemmingway


Anyone who has analyzed the United States federal budget understands that this fine country spends a lot on its military.  In fact, based on estimates from the nonpartisan Congressional Budget Office defense spending, that is considered discretionary, will total $635 billion in fiscal 2013. This is more than 52% of the total discretionary budget of the U.S. government and just under 20% of total federal government spending.


In terms of all global defense spending, the  U.S. is dominant.  According to the Stockholm International Peace Research Institute’s (SIPRI) 2012 Yearbook, the U.S. spends more than 40% of the combined global military spending pie.  The next four countries on the list are as follows: China at 8.2%, Russia at 4.1%, the UK at 3.6%, and France at 3.6%. 


Since the U.S. spends the most on defense on a gross dollar basis and as a percentage of GDP at 4.7%, it is obvious that the U.S. has solidified its so-called “hyper power” status as the world’s primary military power.  As a Canadian, I can assure you that I appreciate the powerful U.S. military and the people that currently serve and have served in the military.  But as a global macro analyst, it is difficult not to question whether the U.S. is overspending, if not at least spending inefficiently.


The most recent military spending controversy occurred last month when a well-connected supplier received a contract to produce oil pans for $17,000 a pop.  (If I could get a deal like that, I might even consider getting out of the research business!) Yesterday, in fact, the ever-controversial Grover Norquist made the following statement regarding wasteful defense spending:


“Conservatives need to remember that, just as spending money on something called education doesn't mean people are educated and spending money on welfare doesn't mean it adds to the general welfare calling something national defense doesn't mean it is. It may not be. It may undermine national defense if it's a waste of resources, if it's a misallocation of resources.”


Later today the CBO will release its updated budget and economic outlook, we will analyze this update in a note, but we certainly do not expect positive news from the CBO.  It’s important because the direction of the U.S. budget is a key factor that will drive the value of the U.S. dollar over time. 


The obvious conclusions from the CBO’s reports will likely be that the U.S. needs to drastically cut spending and that an effective growth policy needs to be implemented to juice revenue.  On the military spending front, an improved spending outlook will come from more efficient spending and also more unique ways of waging war.


To the last point, next Wednesday at 11am we will be hosting a conference call with Jim Rickards, the author of Currency Wars: The Making of the Next Global Crisis. A key catalyst for writing this book was that Rickards has been a long time consultant to the Department of Defense and has participated in large-scale economic war games. 


Rickards’ view is that the U.S. is already facing national security threats via economic warfare including: clandestine gold purchases from the Chinese, to hidden agendas of sovereign wealth funds, to explicit threats from the Russians about diversifying away from the dollar.  In an even more controversial stance Rickards believes that the biggest economic threat we currently face may well be from an overly exuberant Federal Reserve Chairman in Ben Bernanke.  While it sounds like Rickards is carrying Hedgeye water so to speak, we actually disagree on a number of key points and will be pushing him on some of his more extreme views.


On the call with Rickards we will also provide you with our updated investment views on the major currency pairs.  Our institutional subscribers will automatically get access to the call, if you are not a current institutional subscriber but would like to participate, please email


Now as for the war that is currently going on in your portfolio, I have a couple of points to highlight this morning.  Near the close yesterday, we released a note that emphasized the quantitative set up, which is what we call an “outside day”.  This occurs when the SP500 trades higher than the previous close intraday but then closes below it.  From a fundamental perspective, this suggests that there is likely a good overhead supply of stock for sale at that level.


The inability of the SP500 to break through that key level is even more negative when combined with where we see investor sentiment, which is in a word: complacent.  For starters, as we’ve stated repeatedly, the VIX at/or near the 15.0 level has consistently signaled a time to sell equities over the past three years.  After yesterday’s action, the VIX also became bullish from a TRADE duration in our models. This implies the VIX has even more upside in the short term. Further, the bull/bear spread from the U.S. Investors Intelligence Poll is now 2,260 basis points wide to the bull side.  So, yes investors are leaning long.


And on the old global growth watch, Japan posted a -8.1% decline in exports on a year-over-year basis.  Not surprisingly, exports to the European Union were down -25% and to China were down -11.9%.  But don’t worry, Japan is only the fourth largest economy in the world . . .


Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500 are now $1617-1642, $113.52-115.18, $81.91-82.46, $1.22-1.24, 1.75-1.82%, and 1409-1419, respectively.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Currency Wars - Chart of the Day


Currency Wars - Virtual Portfolio


The Macau Metro Monitor, September 5, 2012




Melco International Development Ltd is planning a US$300 million (MOP2.4 billion) dual listing on the Manila stock exchange.  The proceeds are to be used in a casino resort in Manila to be developed in a JV between MPEL and Belle Corp, controlled by Philippine billionaire Henry Sy.

MPEL has said its total investment over the course of the project was expected to be no more than US$580 million.


Industry insiders said VIP business was down 15% YoY in August.  Some VIP operators have suspended lending as a result of high rollers not repaying their loans.  Some VIP clubs with less financial strength have cut jobs and benefits for its staff.


TODAY’S S&P 500 SET-UP – September 5, 2012

As we look at today’s set up for the S&P 500, the range is 9 points or -0.49% downside to 1398 and 0.15% upside to 1407. 











    • Decrease versus the prior day’s trading of 1174
  • VOLUME: on 09/04 NYSE 639.22
    • Decrease versus prior day’s trading of -14.32%
  • VIX:  as of 09/04 was at 17.98
    • Increase versus most recent day’s trading of 2.92%
    • Year-to-date decrease of -23.16%
  • SPX PUT/CALL RATIO: as of 09/04 closed at 1.17
    • Down from the day prior at 1.84


YIELD SPREAD – one of the top3 risks we’ve discussed in our Global Macro Themes deck for Q312 remains a question – will the Yield Spread snap this 125bps level (held it in 2008 and a few times since)?; 133bps wide this morn, down -20bps in 2wks like a knife through hot bull butter. 

  • TED SPREAD: as of this morning 32.06
  • 3-MONTH T-BILL YIELD: as of this morning 0.10%
  • 10-Year: as of this morning 1.56%
    • Decrease from prior day’s trading of 1.57%
  • YIELD CURVE: as of this morning 1.33
    • Down from prior day’s trading at 1.34

MACRO DATA POINTS (Bloomberg Estimates)

  • 7am: MBA Mortgage Applications, Aug. 31 (prior -4.3%)
  • 7:45am: ICSC weekly sales
  • 8:55am: Johnson/Redbook weekly sales
  • 8:30am: Nonfarm Productivity, 2Q final, est. 1.8% (prior 1.6%)
  • 8:30am: Unit Labor Costs, 2Q final, est. 1.4% (prior 1.7%)
  • 9:45am: ISM New York, Aug. (prior 55.2)
  • 11am: Fed to buy $4.5b-$5.5b notes
  • 11:30am: U.S. to sell $40b 4-wk bills, $35b 11-day cash management bill
  • 4:30pm: API weekly inventories


    • President Barack Obama arrives in Charlotte for DNC, 2:45pm
    • Prime-time DNC speakers include former President Bill Clinton, who will formally nominate Obama as party’s candidate for a second term, and Chicago Mayor Rahm Emanuel
    • House, Senate not in session
    • American Bankers Association set to vote tmw on whether to create non-profit political fund allowing members to funnel donations anonymously to pro-industry candidates


  • FedEx cuts profit forecast as sales slump on economy
  • Facebook CEO Zuckerberg won’t sell shrs for at least a yr
  • 3M still in talks to buy Avery unit after regulator objections
  • GM August China sales rise 7.3% as demand for Chevrolet rebounds
  • GE wins $7b contract as Pentagon August awards drop 40%
  • American, United Airlines can’t avoid trial over 9/11 attacks
  • Nokia, Microsoft unveil latest interation of Windows phones
  • Motorola, Verizon Wireless roll out new phone
  • Americans say better off since Obama even as slump impact lasts
  • Australia’s eco growth slows more than forecast on housing
  • ING to sell entire Capital One stake after online bank deal
  • Solyndra will add tax-break details to resolve U.S. objection
  • Hackers claim release of 1m Apple IDs; FBI denies breach
  • Portugal 10-Year Yield Falls Below 9%, First Time Since May 2011


    • Pharmacyclics (PCYC) 6am, $(0.26)
    • Dollar General (DG) 7am, $0.64 - Preview
    • Conn’s (CONN) 7am, $0.35
    • Alimentation Couche Tard (ATD/B CN) 11am, $0.90
    • H&R Block (HRB) 4pm, $(0.37)
    • VeriFone Systems (PAY) 4:01pm, $0.70
    • Verint Systems (VRNT) 4:05pm, $0.51
    • Korn/Ferry (KFY) 4:30pm, $0.18
    • ABM Industries (ABM) 5pm, $0.42
    • Men’s Wearhouse (MW) 5:30pm, $1.13
    • Harry Winston Diamond (HW CN) Post-Mkt, $0.15
    • FuelCell Energy (FCEL) Post-Mkt, $(0.05)


  • Oil Supplies Tumble on Hurricane Isaac in Survey: Energy Markets
  • Monsanto Corn Seen Losing Effect Amid U.S. Drought: Commodities
  • Gold Holdings Signal Prices Surging to $1,900: Chart of the Day
  • Oil Trades Near One-Week Low as U.S. Manufacturing Contracts
  • Europe’s Grains Won’t Make Up for Losses of U.S., Russia Drought
  • Gold Set to Decline in London as Stronger Dollar Curbs Demand
  • Copper Drops as Australian Slowdown Fuels World Growth Concern
  • German Next-Week Power Falls on More Wind; French Contract Drops
  • India to Maintain Price of State Wheat for Mills, Traders
  • U.K. Gas Rises as Norway Deliveries to Belgium Resume After Work
  • Total, Lukoil to Halt Hydrocracker at Dutch Refinery Tomorrow
  • Hormuz Strait Unlikely to Close, Iraq’s Shahristani Tells Sabah
  • Venezuela’s Amuay Refinery to Resume Normal Operations in ‘Days’
  • Ghana Cocoa Buyer Cancels $260 Million Debt Sale on High Yields
  • India Rules Out Banning Grain Exports
  • Wheat Drops as Cheap Russian Supply Lures Buyers Away From U.S.
  • Robusta Coffee Extends Losses on Producer Selling; Sugar Rises









RUSSIA – can you say beta? If the USD rises and Oil/Gold etc fall from here, this could be Epic Part Deux (remember the March to May fall?); Russian stocks (RTSI) move back into crash mode this morning (-21% from the March top). Beta eats alpha.






ASIA – in a replay of March/April, Asian Equities are leading indicators for US Equities which seem to hold out for the hope until the bitter end of lower-highs; #GrowthSlowing is accelerating on the downside in both Japan and China (big economies that are #TooBigToBail); Nikkei’s decline since March to -15.4% (China hits another new low this morn, -17.1% since May).










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Manufacturing To Nowhere

“You can’t build a railroad from nowhere to nowhere.”

-Cornelius Vanderbilt


While I am sure some partisan politician had a rebuttal to one of America’s most successful businessman’s thoughts on the matter at the time, that remains one of the most poignant risk management quotes from 1873.


“The Panic of 1873 began shortly before 11AM on Thursday, September 18, when the Wall Street branch of the nation’s most prestigious private banking house, Jay Cooke & Associates, unexpectedly ushered its customers out and then literally closed its doors, signaling it was bankrupt.” (John Lubetkin, in Jay Cooke’s Gamble)


Yes, I know. We have centrally planned our way to never worrying about fundamentally flawed policies and business risks again in this country. Right?


Back to the Global Macro Grind


While the Keynesians are storytelling about needing “more time”, the fact remains that Policies To Inflate haven’t done a darn thing they were designed to do:

  1. Debauching the Dollar was supposed to generate “export and manufacturing growth”
  2. Economic growth slowing was supposed to be met with a “growth recovery” that lasted more than 3 months
  3. Corporate growth and earnings were supposed to remain at all-time highs; hiring would follow

Political theory versus economic reality: let’s fast forward to, well, yesterday:

  1. America’s ISM Manufacturing Survey for August slowed for the 3rd consecutive month to 49.6 (signaling economic contraction)
  2. The Prices Paid component of the ISM survey ripped higher month-over-month to 54 vs 39.5 in July (+37% sequentially)
  3. Fedex, a $28B US company, pre-announced another revenue and earnings miss after the market close

But no worries…


We need to beg for more of what has not worked – must do something – need more stimulus – need more time so that we can build elevated stock market prices, on no-volume, into the market’s risk matrix so that we can get from nowhere to nowhere, again.


To review what the aforementioned data points mean to real business people in this country in September 2012:

  1. Global Demand (yes, including Asia) slowed in August as inflation, on the margin, rose
  2. As inflation (prices paid by manufacturers, consumers, etc.) rises, on the margin, profits slow
  3. As profits slow, hiring slows – again

This isn’t a vicious cycle anymore. It’s just a sad one to watch. How definitively insane it is to watch people make the same mistakes over, and over, and over again?


I know, I know. After they are wrong on growth, and half-baked right on how bailout policies keep market prices up for 6 week intervals, perma-bulls say “the market is up and stocks are cheap.”


Well, there’s a little fibbing in that too. Since the 2007 top (1565 SPX) and lower 2012 high (1419 SPX) that followed it, stocks are down – and they’re expensive, if you don’t use the wrong growth and earnings numbers.


So where does the great Keynesian economic vision of building bridges and railway tracks to end demand that’s slowing take us? I don’t know. And, if they tell you the truth, neither do they.


My immediate-term support and resistance risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500 are now $1, $111.51-115.78, $81.19-81.98, $1.24-1.26, 1.54-1.63%, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Manufacturing To Nowhere - Chart of the Day


Manufacturing To Nowhere - Virtual Portfolio

UnderArmour Endorsement Dollars At Work

Takeaway: $UA's endorsement dollars paid off in a venue it is rarely known to frequent -- the US Open (that's right, tennis, not golf).

People often debate the efficacy of athlete endorsements. Generally speaking, we think that those that perform at the highest level in their respective sport BUT can also cross over to mainstream appeal are the only ones worth paying for. For example, just after the Olympics, Nike's Alyson Felix was featured in Sports Illustrated while also being on the cover of Teen Vogue. That's when endorsements turn commercial. Same goes for someone like LeBron James, who dominates sports headlines, but also has dominated the cover of GQ.


There are always exceptions. Sometimes those exceptions are with people, like Tom Brady, who simply can't sell due to his lack of mass appeal to most men (not our opinion -- those are simply the facts -- it's why Nike ditched him). Sometimes the exceptions are with brands, like UnderArmour, which brings us to the image below. 


Enter Sloane Stephens, the youngest tennis player ranked in the top 50. While sh'e not going to win the US Open, she raised eyebrows when the 44th seed upset Francesca Schiavone -- who was ranked as high as #4 last year. 


It takes all of about half a second to look at this picture and realize that something is different. No Swooshes. No Stripes (Adidas). No K Swiss Shield. No Reebok (remember them?). All you see is the edgy UA logo.


If Sloane was wearing a Swoosh, would anyone notice? No way. They'd probably expect it. But when they see the logo of a company Wall Street discounts will ever actually build a footwear business, it matters.


Remember, from a branding perspective, the US athletic market is a 2-horse race. Nike and UnderArmour. This is fairly represented in Apparel market share stats. 


But Nike has about 40% share of the footwear market versus UA at 1%. We understand that this seems like a very unfair comparison. It is. But brands like Adidas, Asics, Reebok, and New Balance have between 5-7%.  Brands like Saucony, Brooks and K-Swiss have another 3-4%. 


Every point of share gain in footwear amounts to about $0.20 per share off of UA's $0.92 EPS base in 2011.


UnderArmour Endorsement Dollars At Work - 9 5 2012 6 29 50 AM

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