This note was originally published at 8am on February 05, 2013 for Hedgeye subscribers.
“Zeus ordained that only in sorrow and in suffering do we find wisdom’s way . . . by suffering we shall gain understanding.”
A week ago I had memorable birthday and while I’m not quite forty, I’m getting pretty darn close. As usual, my friends and family delivered in helping me celebrate. Keith and his wife Laura invited me out to their house for a fine birthday dinner. I also received a few books, including one called, “How to Be an Adult in Relationships: The Five Key Lessons to Mindful Loving.”
I think the person that sent me this book meant it as a gag gift, although I’m sure, as with most jest, there was some truth imbedded in the gift. Setting aside an analysis of my relationship history, I think we can all agree on the fact that relationships, and fruitful ones, are really the key to success and happiness in life. As stock market operators, we all have a relationship with a gentleman called Mr. Market.
The quote at the start of this note is actually very applicable to the stock market. The best lessons learned from investing typically come from the mistakes. Further, as my colleague and Hedgeye restaurant Sector Head tweeted last night:
“$YUM is the annual reminder of how humbling this job actually is . . .”
In this instance, Howard Penney was referring to the results from Yum Brands, a company he had been favorably disposed to going into the quarter, which provided disappointing guidance based on worse than expected results in China. Howard gets many more calls right than he gets wrong (see our 300%+ gain in Starbucks as evidence), but his point on $YUM is a good one – just when we are least expecting it the market humbles us.
Speaking of humbling markets, the European sovereign debt market is once again becoming relevant. In the Chart of the Day today, we look at the Spanish 10-year over the last three weeks. On January 14th, the Spanish 10-year was yielding 4.95% and today is yielding 5.44%. In the last three weeks, Spanish yields have spiked 10%.
If I were an investor in Spanish and European sovereign debt generally, I’d probably be demanding a higher yield for the inherent acceleration in risk over the last few weeks. First, Spanish Prime Minister Mariano Rajoy has been under attack for purportedly taking secret payments over a more than ten year period, with the evidence seemingly well documented. Secondly, ahead of the EU Summit this week, French President Francois Hollande stated:
“A monetary zone must have an exchange rate policy or else it ends up subjected to an exchange rate that does not match the true state of its economy.”
The translation from French is simply this: Hollande does not believe the market should determine the price of the Euro.
The economic data out of Europe this morning will likely only serve to bolster Hollande’s arguments. The Eurozone PMI Services numbers were reported this number and on aggregate January came in at 48.6 versus 47.8. There were a number of positive surprises with the U.K. coming in at 51.5 and Germany at 55.7. Unfortunately, for Hollande and his government’s policies France was a disaster at 43.6. The other disaster in European economic data was December retail sales down -3.4% year-over-year.
On one hand, Hollande is correct that with both Japan and the United States actively devaluing their currencies, Europe will be at a disadvantage in terms of exports if they don’t follow suit. Unfortunately, like most wars, this ongoing currency is destined to end poorly. The reality remains that no country in the history of the world has devalued its way to prosperity, though the Japanese have certainly tried.
On that last point, this morning the Japanese are once again upping the devaluation ante. Bank of Japan Governor Shirakawa announced late yesterday that he would be leaving office on March 19th, a full three weeks earlier than planned. At the same, two deputy governors will be leaving office. It seems Prime Minister Abe realizes that political life in Japan is short, and that he needs new leadership at the Bank of Japan to aid in implementing his inflationary policies as soon as possible. And so, the currency wars continue.
The question related to Japan is just how aggressive will the government get in terms of devaluing. As my colleague Darius Dale wrote yesterday:
“The Japanese yen, which is down roughly -16% since we initially outlined our bearish bias back on 9/27, continues to get Taro Aso’d.
The latest developmental jawboning on this front has come in the form of Finance Minster Aso’s recent remarks that the Japanese government is taking a page out of its own historical playbook by pursuing strong anti-deflation policies:
“There is no one in the government, the bureaucracy or the BOJ who has experience in anti-deflation policy. We can only learn from history.”
-Taro Aso, 2/3/13
The history lesson Mr. Aso is referring to is Depression-era Japanese Finance Minster Korekiyo Takahashi’s mandating of the BOJ to directly monetize Japanese sovereign debt (as opposed to open-market operations), which began in 1932 and continued for the next 14 years.
During this era, the ratio of JGB issuance financed directly by the BOJ peaked at 89.6% in 1933 and remained elevated throughout the program. This monetization strategy assisted in doubling JGB issuance and boosting Japanese public expenditures by a whopping +34% in 1932 alone.”
The short answer is that Japan can get a lot more aggressive and this won’t be positive for the Yen, despite the recent sharp correction. If you’d like to set up a time for us to do a briefing with you or your firm on the risks associated with Japan, please email firstname.lastname@example.org. Japan is a risk that you should keep front and center because in this day and age, all global markets are related.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, 10yr UST Yield, and the SP500 are now $1649-1686, $114.55-116.88, $79.02-79.83, $1.34-1.36, 90.77-93.22, 1.91-2.10%, and 1489-1513, respectively.
Best of luck out there today,
Daryl G. Jones
Director of Research