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WILL THE BUCK STOP HERE?

"I am a member of a team, and I rely on the team, I defer to it and sacrifice for it, because the team, not the individual, is the ultimate champion. "
-Mia Hamm

At 5 foot 5, from Selma, Alabama, Mia Hamm was the stud-ette of the United States women's national soccer team. This American winner scored 158 goals in international competition  - that's more than any other player (man, woman, or child) in the history of international soccer... and all she wants to talk about is her teammates. This lady doesn't need a "mark-to-model" or a bailout... she needs to be named CEO of the Bank Of America!

Not only on my own investment bench, but on our clients - I have both the pleasure and privilege of working with the best all-around research team that I have ever encountered in this business. In an increasingly interconnected world of interacting global macro factors, the only way to consistently win on the international stage is to collaborate.

One of our European clients sent me a note last night hammering home this New Reality. In his benchmark of competing funds, he's one of only TWO United States funds domiciled somewhere large in Western Europe (I can't say where!) that put up an absolute positive return in Q1. He says we helped him get there - I say he's just pumping our tires. Either way, we have learned quite a bit from his ever so presciently timed research questions.

There is ONE question I have that matters for the US stock market right here and now: Will the Buck Stop Here?

In sharp contrast to Larry Kudlow's view last night that the US needs a "strong dollar", I continue to believe the opposite. At the end of the day, Larry has very politically biased economic views (he considered running for the Republican seat in the CT Senate!), while my views, when it comes to helping protect and preserve your hard earning capital, are simply grounded in the math.

While I am certain that Kudlow and his bank bailout cronies haven't run the math on the inverse correlation between USD and the SP500 in 2009, that really only means one thing - we can all continue to pick off alpha points on this daily playing field. Larry can follow the leaders of The New Reality from the bleachers.

There is a definitive line in the sand here for the US Dollar Index at 84.93. That's what our power users call the intermediate TREND line. If the US Dollar can break down again and close below that line, the SP500 will bust out to higher immediate term highs (immediate term upside target is 825, then 843). Conversely, if the buck stops going down, right here (trading this morning at 85.18), I think the SP500 will see a swifter -5% boat of downside than John Kerry's political career.

Last month is over. So is last quarter. So is yesterday... What we do today is the only game that matters. Without reading Mia Hamm's book, "Go For the Goal",  the Cliff Notes on her winning advice would be to focus on where the ball is going next, not where it's been.

With the US futures indicated up and everyone from Larry to anyone stuck with some of these horse and buggy whip banking stocks praying that FASB changes the rules on "marked-to-market" accounting, remember one thing - prayer is not an investment process!

For the week to-date, the US Dollar is now on the verge of being DOWN again. Don't forget that the 3 straight weeks that we saw of US stocks getting squeezed had the underpinning of Bernanke "Breaking the Buck." The week of March 16th, 2009 was the worst down week for the US Dollar basket, EVER - and yes, ever is a long time.

For the week to-date, the SP500 is on the verge of being UP again. Don't forget that the SP500 started the week at 815 (it went out at 811 on yesterday's close). While I was surprised that we didn't hold onto yesterday's opening SP500 low of 786, and I mistakenly didn't cover any of our shorts into those low bids, that certainly doesn't mean we can't go right back down there today, tomorrow, or next week for that matter. The SP500's immediate term fate will be decided by where the US Dollar goes from here.

The Chinese are doing their part to support a weak US Dollar policy. Never mind the politically charged rhetoric coming out of the G-20 meetings - the Chinese clearly didn't go to these meetings today to make enemies. Ever sit across the table from a Chinese businessman? I have - many times - and no matter what they are thinking, they're always smiling right back at you. Watch what they do, not what they have their translator say.

What the Chinese are doing this morning in global currency markets, while our politicians are sleeping, is of major consequence. The Chinese are providing swap lines, based in Chinese Yuan, on the order of $95B (650B Yuan), to the following countries: South Korea, Malaysia, Indonesia, Argentina, Belarus, and Hong Kong. Why? The Chinese have clients too - and they want those importers to be able to avoid buying le Chinois in ze US Dollar, eh...

I wonder if ze Nicola of de Sarkozy understands dat math? I doubt it. And don't ask Kudlow to run the excel sheets for the French or our moonlighting President of everything rock star Obama either. These guys are big government interventionists - they don't get it.

Thankfully, Ben Bernanke does get it, and he's doing his best to contribute in Breaking the Buck. As China gets the job done on the playing field rather than at the G20 tables of head nodding, Heli-Ben has his nose in the scrum buying back US Treasury Bonds. This, of course, dampens the US Dollar's bid, and also allows assets, from stocks to commodities here in the USA to REFLATE!

Don't let the Depressionistas focus your mind on inflation yet - there will be a time for that, and it's not now. What we have here in the USA is a failure to communicate - a failure of polarized and partisan wanna be economists to articulate The New Reality. From your American home to your 401k, what we have here is DEFLATION - and the only way out is to REFLATE, by not letting The Buck Stop Here!

May the best research teams who continue to collaborate win,
KM


LONG ETFS

RSX - Market Vectors Russia-The Russian macro fundamentals line up with our quantitative view on a TREND duration. Oil has benefited from the breakdown of the USD, which has buoyed the commodity levered economy. We're seeing the Ruble stabilize and are bullish Russia's decision to mark prices to market, which has allowed it to purge its ills earlier in the financial crisis cycle via a quicker decline in asset prices. Russia recognizes the important of THE client, China, and its oil agreement in February with China in return for a loan of $25 Billion will help recapitalize two of the country's important energy producers and suppliers.  

USO - Oil Fund- We bought oil on Wednesday (3/25) for a TRADE and are positive on the commodity from a TREND perspective. With the uptick of volatility in the contango, we're buying the curve with USO rather than the front month contract.  

EWC - iShares Canada-We bought Canada on Friday (3/20) into the selloff. We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's large government recent history, and believe next year's Olympics in resource rich Vancouver should provide a positive catalyst for investors to get long the country.   

DJP - iPath Dow Jones-AIG Commodity -With the USD breaking down we want to be long commodity re-flation. DJP broadens our asset class allocation beyond oil and gold.  

XLK - SPDR Technology-Technology looks positive on a TRADE and TREND basis. Fundamentally, the sector has shown signs of stabilization over the last several weeks.  Semiconductor stocks, which are early cycle, have provided numerous positive data points on the back of destocking in the channel and overall end demand appears to be stabilizing.  Software earnings from ADBE and ORCL were less than toxic this week and point to a "less bad" environment.  As the world stabilizes, M&A should pick up given cash rich balance sheets in this sector and an IBM/JAVA transaction may well prove the catalyst to get things going.

EWA - iShares Australia-EWA has a nice dividend yield of 7.54% on the trailing 12-months.  With interest rates at 3.25% (further room to stimulate) and a $26.5BN stimulus package in place, plus a commodity based economy with proximity to China's H1 reacceleration, there are a lot of ways to win being long Australia.

GLD - SPDR Gold- We bought gold on a down day. We believe gold will re-assert its bullish TREND.

DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.


SHORT ETFS

UUP - U.S. Dollar Index - We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. The Euro is up versus the USD at $1.3296. The USD is up versus the Yen at 99.5890 and down versus the Pound at $1.4616 as of 6am today.

EWL - iShares Switzerland - We shorted Switzerland for a TRADE on an up move Wednesday (3/25) and believe the country offers a good opportunity to get in on the short side of Western Europe, and in particular European financials. Switzerland has nearly run out of room to cut its interest rate and due to the country's reliance on the financial sector is in a favorable trading range. Increasingly Swiss banks are being forced by governments to reveal their customers, thereby reducing the incentive of Switzerland as a tax-free haven.

EWJ - iShares Japan - Into the strength associated with the recent market squeeze, we re-shorted the Japanese equity market rally via EWJ. This is a tactical short; we expect the market there to pull back when reality sinks in over the coming weeks. Japan has experienced major GDP contraction-it dropped 3.2% in Q4 '08 on a quarterly basis, and we see no catalyst for growth to return this year. We believe the BOJ's recent program to provide $10 Billion in loans to repair banks' capital ratios and a plan to combat rising yields by buying treasuries are at best a "band aid".

DIA -Diamonds Trust-We shorted the DJIA on Friday (3/13) and Tuesday (3/24).

EWW - iShares Mexico- We're short Mexico due in part to the country's dependence on export revenues from one monopolistic oil company, PEMEX. Mexican oil exports contribute significantly to the country's total export revenue and PEMEX pays a sizable percentage of taxes and royalties to the federal government's budget. This relationship is unstable due to the volatility of oil prices, the inability of PEMEX to pay down its debt, and the fact that PEMEX's crude oil production has been in decline since 2004 and is down 10% YTD.  Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.

IFN -The India Fund- We have had a consistently negative bias on Indian equities since we launched the firm early last year. We believe the growth story of "Chindia" is dead. We contest that the Indian population, grappling with rampant poverty, a class divide, and poor health and education services, will not be able to sustain internal consumption levels sufficient to meet targeted growth level. Other negative trends we've followed include: the reversal of foreign investment, the decrease in equity issuance, and a massive national deficit. Trade data for February paints a grim picture with exports declining by 15.87% Y/Y and imports sliding by 18.22%.

XLP - SPDR Consumer Staples- Consumer staples was the third worst performing sector yesterday. This group is low beta and won't perform like Tech and Basic Materials do on market up days. There is a lot of currency and demand risk embedded in the P&L's of some of the large consumer staple multi-nationals; particularly in Latin America, Europe, and Japan.

SHY - iShares 1-3 Year Treasury Bonds- On 2/26 we witnessed 2-Year Treasuries climb 10 bps to 1.09%. Anywhere north of +0.97% moves the bonds that trade on those yields into a negative intermediate "Trend." If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yield is inversely correlated to bond price, so the rising yield is bearish for Treasuries.



THAT SINKING FEELING

Position: Short Japan via the EWJ

The BOJ’s Tankan business confidence index data for March registered the lowest levels since inception in 1974 when it was released this morning.  The Tankan indices are calculated from surveys of a broad swath of Japanese private enterprise, representing a view on how favorable conditions are perceived to be near term. Unsurprisingly the manufacturing sector registered the most negative levels, arriving at -59 in the face of collapsed foreign demand. Ominously for Japanese unemployment levels (which yesterday registered at a three year high) and capital investments, the data showed conditions were worse for mid-sized and small companies which are less likely to receive government stimulus directly and have been particularly hard hit by the credit contraction.

 THAT SINKING FEELING - table

Non manufacturing segments are not being spared either as Japanese consumers return to the low spending levels that they adopted during the prior “lost decade”.  As with manufacturers, the sentiment among smaller consumer and service sector companies was significantly more negative than among larger ones.

As sentiment sinks, the Aso administration continues to hide details of the size and scope of the much heralded third stimulus package, which will be announced in the coming weeks.  This political strategy bears the strong risk of creating high expectations among investors who will inevitably be disappointed by the actual package. We retain a negative bias on the Japanese economy and see the primary driver for equities there, which we are short via EWJ, to be currency valuation. Only a weak Yen can push stocks higher in the absence of rebounding external demand.

Andrew Barber
Director

THAT SINKING FEELING - image001 2


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Natural Gas: Production is Key

Position: No position in portfolio currently

From a commodity perspective this year, we have been primarily focused on copper and oil over the last few months.  This is driven both by our re-flation thesis, under which global priced commodities such as copper and oil benefit, and also our bullish stance on China, which is the home of the majority of incremental demand for these commodities globally.   Lately, natural gas has started to come on our radar screens, but for vastly different reasons.

Unlike its use of oil, the United States is largely self sufficient in its use of natural gas.  In 2007, the U.S. produced 19.3 billion cubic feet annually and consumed 23.1 billion cubic feet, for a net import number of 3.8 billion cubic feet.   More than 95% of the net import number for natural gas comes from Canada, which in aggregate makes North America highly self sufficient in its production and use of the commodity.  Unlike oil, the continent is not a net importer for natural gas.

The implication of this is that natural gas is a commodity that is priced much more on basic supply and demand versus oil which is priced partially on natural supply and demand, but also based on geopolitical risks and actions of regional cartels, primarily OPEC.

In the United States, ~28.7% of natural gas is used in the economically sensitive industrial sector.  In economically weak times, demand from the industrial sector declines.  In late 2008, it was a perfect storm for natural gas with a weak economy leading to declines in consumption combined with a natural gas production profile that was increasing at an accelerated rate due to high natural gas prices, which prompted more drilling, and due to a number of the large shale plays coming online.  In the table below, y-o-y growth in natural gas production in the U.S. is summarized:

Natural Gas: Production is Key - chart

The key take away from the table above is that U.S. natural gas production growth on a y-o-y basis was well above its historical norm for the last 6 months of 2008.  We calculated the CAGR for U.S. y-o-y production growth from 1990 to 2008 and the CAGR was 0.80%.  The CAGR in consumption for that period was 0.96%, which implies that historically, at least for the last two decades, the industry acts relatively efficiently in terms of production additions.  This 5.4% growth that we witnessed in the last 6-months of 2008 was well above historical norms.  Not surprisingly, gas in storage is up 372 Bcf, or 22.4% y-o-y, as of March 20th.

The key to thinking about the inflection point for natural gas from a supply and demand perspective is to determine the rate of decline in drilling, which will lead to declining production that will push the market back into balance and obviously stabilize pricing.  Over the next couple of weeks, we will be surveying some of our contacts in the natural gas fields of North America to get more perspective.


Daryl G. Jones
Managing Director

 Natural Gas: Production is Key - image001 1



Ukraine and Kazakhstan Making up the Rules

There’s early indication that the Ukraine and Kazakhstan want to prevent capital flight through outright taxation on investment withdrawals and may require exporters to sell some or all of their foreign-currency earnings to the Central Bank at rates it indicates.

So much for free market Capitalism…welcome socialist Regulation!

Ukraine and Kazakhstan are among the countries often referred to as “Eastern Europe,”  a region that has been plagued with double digit declines in stock market performance YTD (despite upticks in March) and severe currency devaluation over the last six months due to the global recession, especially as demand from the Eurozone, the region’s main trading market, has been smashed.

Kazakhstan and the Ukraine, both heavily dependent on commodity exports (oil, steel, and agricultural commodities) have been hammered in particular by oil’s price plunge since its highs in the summer of last year. Oil’s deflationary pressure has helped increase default risk on foreign-denominated debt, leading to the IMF bailing out the Ukraine to the tune of $16.4 Billion late last year. The Ukraine used some $12 Billion to purchase the local Hryvnia to prevent it from being dangerously devalued, the outcome of which depleted its currency reserves.

Now the Ukraine and Kazakhstan, both desperate for foreign currency to bolster its reserves, are preventing their banks from returning money to investors in foreign denominated currency and may prevent companies from paying dividends to international shareholders. Additionally it’s being reported that the governments are compelling exporters to sell foreign-exchange earnings to the government for local tender. 

The new rules and controls the government hopes to levy to protect against the flight of foreign capital and augment currency reserves will only encourage investor to flee amongst the uncertainty of policy. Foreign investment is paramount for these emerging market countries, and these measures will surely be antithetical for foreign investment needed to aid these struggling countries.

Matthew Hedrick
Analyst

INDIA BULLS ARE GORING US, FOR NOW

Position: We are short the Indian equity market via IFN

The past weeks have been full of mixed blessing for the Indian economy: Tata’s triumphant launch of the Nano, an emblem of India’s ambitions and potential, was marred somewhat by capacity constraints that will prevent production sufficient to meet anticipated full demand until 2011, a full year later than hoped. After weather worries, the wheat harvest is now projected to be a record haul lifting concerns about consumer price pressure, but with collapsing wholesale prices the prospect of cheaper wheat provided little comfort to the more than 50% of the population that toil as small farm operators.

February export data released by the ministry of commerce today leaves little room for positive interpretation however, as collapsing global demand reverberates through the subcontinent’s manufacturing sector. Exports declined by 22% on a year-over-year basis in February as total exports fell at a greater rate of 23% narrowing the trade deficit to $4.9 billion for the month.  Excluding oil (for which India is import dependant) imports declined by 10% Y/Y.

INDIA BULLS ARE GORING US, FOR NOW - table


Since we launched our macro product early last year we have been consistently bearish on Indian equities. The divergence between our view and the India bulls has largely centered on our more negative bias on the potential for internal demand to sustain at high-single-digit growth levels. The glass half full community sees India as the major Asian economy with the least dependence on external demand while we see a massive mismatch between the vaunted drivers of the “Indian Miracle” –high tech services and intellectual property firms, and the reality of the great majority of India’s population that cannot possibly replace foreign demand for call centers and software.  Meanwhile viable products like the Nano, the model T of India poised to meet massive internal demand, have been hindered by bad governmental policies and a dependence of foreign capital (recall that Tata was forced to walk away from a nearly complete factory to produce the Nano after a regional government failed to satisfy the disgruntled farmers whose land had been appropriated for the site, setting the project back by months at massive expense).

Prime Minister Singh is in London today for the G20, and as both the leader of a rising global economic force and a talented economist his ideas will weigh heavily in the talks. At home however, with election starting before month end, the Prime Minister is scrambling to implement more stimulus measures  -rate cuts, tax cuts and infrastructure programs, which may satisfy voters even if the defense it will provide to economic growth is unclear. In the case of infrastructure projects, it is important to note that the ponderous overlapping bureaucracies of India’s state and federal governments will prevent ground from being broken for months or even years on most projects. Wholesale price levels released later this week may well register negative, but consumer inflation data has still not reflected the decline in commodity prices. In the face of all this, the any optimistic rhetoric by the ruling coalition going into the election needs to be discounted.

We are short the Indian equity market via IFN and continue to have a bearish bias despite the fact that the position has been a drag on our portfolio performance over the past month as the market rallied from January lows; the sting is softened by the long string of double and high single digit returns that we have realized shorting IFN over the past year.

Andrew Barber
Director

INDIA BULLS ARE GORING US, FOR NOW - image001


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