"Only the wisest and stupidest of men never change."
-Confucius
Having played plenty a Canadian Junior Hockey Night cage match in the Bear's Den of Smith Falls, Ontario (instead of glass behind the end boards, they had chicken wire), I can assure you that I am definitely not the stupidest of men. Most guys who I chirp at with these morning investment missives will assure you that I am neither the wisest!
Ah, if you can't have fun playing this game, what's the point in waking up at this un-Godly hour and playing it at all! That said, even after taking my US Cash position back up to 62% on Friday, yesterday wasn't much fun for me. My Asset Allocation Model lost -1.05% on the day, largely because I got smoked out of my hole with a 12% allocation to Commodities. The Buck broke out, and it broke my bank.
When we did our Q2 Macro Trend call a few weeks back, I gave explicit levels on the US Dollar. I outlined a critical resistance line of 86.33 on the US Dollar Index as being my line in the sand. With that crystal clear in my rear view mirror now, yesterday's meltdown in everything other than yellow rocks (Gold was +2.4% on the day) was proactively predictable. Yes, we're long TIPs and sold out of our long positions in China, Canada, and Russia, but we still lost money, and that's unacceptable.
In conjunction with the 19 component CRB Commodities Index closing down -3.6% on the session, the SP500 got tagged for an even larger loss of -4.3%. Thankfully, I have shunned everything US Financials (XLF was -11% on the day), and have opted to stay away from being long any index with Financials in it (XLF, SPY, DIA, etc...). Regardless, on DEFLATION Day, I still took it on the chin with the 13% exposure I have to US Equities via the XLK and XLY (Tech and Consumer Discretionary ETFs).
So what to do from here? Well, as usual, the plan is that the plan is going to change. As market prices and the risk/reward embedded within them changes, I will. Only the bravest of men and women stepped up and bought additional US or International Equity market based exposure yesterday, and for that, if they get paid on this morning's US market open, I salute you. I think we have at least one more round of selling left in this thing.
Although I'm not sure what he'll have to say about this, I have never thought of my Dad's primary job as being brave - neither is mine. Notwithstanding that my cushy job up here in New Haven is nearly as dangerous, Dad's job as a firefighter, and mine as a stock market operator, is to proactively manage risk/reward.
I put up an intraday note to our Macro clients yesterday telling them that I was going to wait. With the SP500 breaking down through an important immediate term momentum line at 846, the 815-819 intermediate TREND base of support is now in play. Waiting may not seem brave, but neither is losing a toe for the sake of being in a hurry. If anything has held true for the last 18 months, it is that patience pays a big performance premium.
The entire way up to that 874 line in the SP500 I was rightly pressed by our clients and prospective ones as to why I wasn't choke full of US Equity exposure. On the way up to the top of a proactively predictable trading range, those questions get harder to answer. On the way down however, I rarely hear a peep...
Peeping is what people do who are trying to get a look-see on something that they probably shouldn't. When it comes to the inverse correlation of the US Dollar versus virtually everything else that's asset based on your screens, there is hardly any peeping required. Dollar UP = DEFLATION. If you need a chart to show you this more succinctly, we can send you one. For the guys and gals up in Boston last week, we called it The Green Monster.
In 1999 I worked on the "sell side" at CSFB, then I moved to the "buy side" for the next 8 or so years... and now I like to think that I am on the right side. I am in the business of being right, or being fired - and I like that. It keeps me awake.
Being long is one thing. Being wrong is completely another - and I don't need to stick around to see the reruns of how this movie went post mid-January when the US Dollar caught a bid again. If the Dollar goes up, I think everything else is simply going down.
The good news now (if you're long anything other than cash and gold that is) is that at 86.59, the US Dollar Index is overbought from an immediate term TRADE perspective. If the US Dollar fades here, it will put in another lower high, and that, on the margin, will be bullish for anything that you'd like to see REFLATE.
Just remember, what you'd like to see, and what the malfeasant of our Financial system still hope to see... may not be what you end up seeing. Peeping isn't cool, and neither is a risk management model that doesn't have the ability to change as the macro factors embedded within it do.
Best of luck out there today,
KM
LONG ETFS
EWZ - iShares Brazil- The Bovespa is up 18.3% YTD and continues to look positive on a TREND basis. President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt -leading to an investment grade credit rating. Brazil has managed its interest rate to promote stimulus. The Central Bank cut 150bps to 11.25% on 3/11 and likely will cut another 100bps when it next meets on April 29th. Brazil is a major producer of commodities. We believe the country's profile matches up well with our re-flation theme: as the USD breaks down global equities and commodity prices will inflate.
XLY - SPDR Consumer Discretionary-TRADE and TREND remain bullish for XLY. The US economy is showing faint signs the steep plunge in economic activity that began last fall is starting to level off and things are better that toxic. We've been saying since early January that housing will bottom in 2Q09 and that "free money" for the financial system will marginally improve the US economy in 2H09, allowing early cycle stocks to outperform. The XLY is a great way to play the early cycle thesis.
EWA - iShares Australia-EWA has a nice dividend yield of 7.54% on the trailing 12-months. With interest rates at 3.00% (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.
XLK - SPDR Technology - Technology looks positive on a TRADE and TREND basis. Fundamentally, the sector has shown signs of stabilization over the last six+ weeks. As the world demand environment becomes more predictable, M&A should pick up given cash rich balance sheets in this sector (despite recent doubts about an IBM/JAVA deal being done). The other big near-term factors to watch will be 1Q09 earnings - which is typically the toughest for tech, along with 2Q09 guide. There are also preliminary signs that technology spending could be an early beneficiary of the stimulus plan.
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.
USO - Oil Fund-We bought more oil on 4/20 after a 9% intraday downward move. We 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.
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 on 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
VXX - iPath VIX- The VIX is inversely correlated to the performance of US stock markets. On 4/20 the VIX shot up 15.5% intraday, an overcorrection we want to be short as we believe US indices will make higher highs and the volatility is currently overbought.
LQD - iShares Corporate Bonds- Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back. Moody's estimates US corporate bond default rates to climb to 15.1% in 2009, up from a previous 2009 estimate of 10.4%.
SHY - iShares 1-3 Year Treasury Bonds- 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.
EWU - iShares UK - We shorted the UK on 4/08. We're bearish on the country because of a number of macro factors. From a monetary standpoint we believe the Central Bank has done "too little too late" to manage the interest rate and now it is running out of room to cut. The benchmark currently stands at 0.50% after a 50bps reduction on 3/5. While the Central Bank is printing money and buying government Treasuries to help capitalize its increasingly nationalized banks, the country has a considerable ways to go to see recovery. GDP declined 1.5% in Q1 and unemployment is on the rise.
EWL - iShares Switzerland - We shorted Switzerland on 4/07 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.
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 $1.2970. The USD is up versus the Yen at 98.2010 and down versus the Pound at $1.4582 as of 6am today.
EWJ - iShares Japan -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".
XLP - SPDR Consumer Staples- Consumer Staples broke down through TREND line support, closing under the TREND line by a dime. 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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