Learning What Not To Do

"I think that only daring speculation can lead us further and not accumulation of facts."
-Albert Einstein
 
That Einstein quote can really make you think. It will resonate with most people who like to compete in this world - in order to really win, you have to really let your competition fail. The last 18 months of daring speculation has provided some of the greatest investment price points that this world will ever see.
 
Having worked with plenty a Portfolio Manager in the hedge fund industry and watching them when they didn't think I was looking, I was blessed with the good graces of observation. Each investor has something about them that's unique. For me, it was always about finding that something that could be additive to my investment process. These lessons included learning What Not To Do.
 
Probably the most critical of those lessons was not asking everyone in the room what I should do next. There's a question that some of the winners over at Goldman's J. Aron & Company used to pose: "can you make money in a dark room?"... I am meeting with a former leader of that old Wall Street guard for lunch today, and I can't wait. 'Do what you do' is an investment process that he'll most certainly get.
 
At +24.6% since the SP500's March 9th closing low, and AFTER the biggest 4-week move in the US stock market since 1933, you may or may not be shocked that the #1 question in my inbox this weekend was 'why don't you buy more'?
 
You see, it confuses some people that I have sold down my position in US Equities to 7% currently from the 27% I was carrying in early March (my max exposure to an asset class, other than cash, is 33%). Hyman Minsky used to call this problem that creeps into the investor crowd "the sin of extrapolation" - people have a natural tendency to think that the immediate term future performance of markets will be like the recent past.
 
Some people call it mean reversion. Some people call it being "contrarian". Some people call it being plain cheap. Buying low and selling high is not a new concept. Having the ability to be fully invested AFTER markets move to where you proactively predicted them to go is an exercise for those far braver than me.
 
While I have a 7% position in our Asset Allocation Model to US Equities, I have a 21% allocation to Commodities. But most people don't want to talk to me about commodities - why? Because my buying gold for instance late last week (when it dropped below $900/oz) isn't where that day's return was being generated - there is no momentum there - just value... or is there a store of value in gold?
 
I wrote a note on February 22nd titled "The Safety Trade Peaking", and with gold prices at $995/oz, I shorted the gold etf (GLD) and had a healthy amount of inbound emails telling me that I didn't understand. Having owned gold since 2005, I thought I did - so I locked myself in my room (kept the lights on) and shorted it anyway. Now I'm sitting here buying it -10% lower and no one cares? Thank God for "daring speculation"...
 
So where am I going with this? Away from +25% higher than where we were here in the US stock market 4-weeks ago, or say +40% higher from where oil prices were 7-weeks ago (we're long oil), we are right where we have always been - sitting here staring at a live quote... today's quote... and no matter where you want the storytelling in your head to go this morning, there those prices are - so let's deal with them.
 
On an immediate term basis (today), the SP500 has +1% reward (849) and -2% risk (824). There is no doubt that the US futures are indicated up again. There is no doubt that as long as the SP500 can hold and close above 824, that US Equities are breaking out now on both of my durations (TREND and TRADE).
 
Have the fundamentals here in the USA improved over the course of the last 3-weeks? Rather than ask the latest Depressionista who is trying to sell you his book, ask Dr. Copper or Mr. Steep (as in the US yield curve). Real-time prices don't lie; people do.
 
Copper just charged above the $2/lb line this morning. The spread between 10 and 2-year US Treasury yields has expanded to +195 basis points wide. The TED Spread (3mth Treasuries - 3mth LIBOR) continues to narrow and is now only 95 basis points wide versus the freakout in measurable counterparty risk that we saw in October/November of almost 500 basis points.
 
Chinese stocks are +33% for the YTD, and Russian stocks are +23% YTD after moving up another +4.3% when I woke up this morning. The US Dollar is down again, taking its devaluation to down -6% since that March 9th low in the US stock market. Dollar DOWN = Stocks UP. All inclusive of THE most dominant macro factor at work in the US (Dollar vs. Equities inverse correlation), none of this is new this morning - it's just more of the same...
 
As those who missed all of this dare to speculate at or above 849 in the SP500, make some more sales. As volume dries up at those prices, let them fall (like they did Friday morning), and buy things back. There are no rules against managing risk out there in this market. While we have learned a lot of the What Not To Do's in the last 18 months of trading, what has become crystal clear is that we should keeping doing what it is that we do - managing risk.
 
Best of luck out there this week,
KM
 

LONG ETFS

TIP - iShares TIPS- The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%.  We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

XLB - SPDR Materials -We bought Materials down 2% on the open Friday (4/03). It's a bull on both a TREND and TRADE duration. The Materials sector is, obviously, a key beneficiary of our re-flation thesis.  Domestically, materials equities should also benefit as the stimulus plan begins to move into action.

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. 

GLD - SPDR Gold-We bought more gold yesterday (4/02). We believe gold will re-assert its bullish TREND as the yellow metal continues to be a hedge against future inflation expectations.

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 $1.3523. The USD is up versus the Yen at 101.3530 and down versus the Pound at $1.4918 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.

XLP - SPDR Consumer Staples- Consumer Staples was down Friday (4/03) on an up tape. 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.


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