Trading Bad News

"Formula for success: rise early, work hard, strike oil."
-J. Paul Getty
 
It doesn't take much to remind you we are in a recession. If you are looking for bad news, it's not that hard to find it. Things are no longer "less bad" - but they are still just bad. US Retail sales unexpectedly fell in April for the second straight month and there continues to be an unsettling rise in home foreclosures.
 
On this "news" the market was down for a third straight session, finishing near the worst levels for the day.  Things are definitively less bad but the economy is not bouncing back as quickly as some hoped.  Hope is not an investment process. This I understand - every investment decision has a time and a price - adjust and move on.
 
What struck me as really bad news yesterday, was that Obama administration may be contemplating a major change to  the compensation practices in the financial services industry and possibly moving beyond banks to include hedge funds and private equity firms.  Is there anyone in the current administration that thinks that a hedge fund manager is going to buy toxic assets in partnership with government and accept limits to his/her compensation?
 
While its unlikely to happen, if it does, it's a real bad sign! Obama has reason to be confident in what he does with an approval rating that stands at 63%, but trying to tell the financial services industry what its employee's can make is border line supercilious and appears if the administration will try to get away with anything.  While there were clear excesses in the past, socializing the pay structure would be devastating over the long run.  Let capitalism run its course!  
 
The formula for success at Research Edge: rise early, work hard and be thankful we don't have politicians breathing down our necks!  I would like to strike oil, but that is hard to do at the William Howard Taft Mansion in New Haven!  (I know J. Paul Getty was given his oil, but that is not the point).
 
With the S&P 500 down 2.6% over the past week, the only two sectors that are up over the same period are Consumer Staples up 0.2% and Healthcare up 1.3%.  The rotation out of the higher beta sectors continues, as the worst two performing sectors over the past week are Financials (XLF) down 6% and Consumer Discretionary (XLY) down 5.8%.  As I said earlier, things are no longer "less bad" they are just still bad ... and that favors what we have been calling the "Safety Trade."
 
Within the construct of Keith McCullough's global macro factors there continues to be positive price momentum across global equity markets on both immediate and intermediate term durations.  The setup is clearly not to repeat the catastrophe that happened in 4Q08.  To that end, yesterday as the market was closing on the lows of the day, Keith was buying select Consumer Discretionary names for a TRADE.  We are now back on the long side of the XLY (Consumer Discretionary ETF).  The MEGA Consumer Squeeze was a block buster call we made in December, and it ain't over till it's over!  Just remember to keep a TRADE a TRADE!
 
Keith has built an incredible track record keeping a "TRADE a TRADE", but when I put on my industry analyst hat, I'm slightly more suspicious how long the momentum will continue. There are just a few minor changes on the margin that I can't stop thinking about.  
 
The Research Edge commodity team has a view that oil could have a meaningful upside as the re-flation trade continues to play out, especially with a weakening dollar.  As we have seen over the past month, gas prices at the pump are on the rise.  At some point, the sequential rate of change (week to week and month to month) will begin to impact the consumer somewhat more than the absolute year-over-year decline.  In addition, the consumer related data points from retail sales to disposable personal income will continue to show a sequential slow down as we lap the Bush stimulus program from last year.
 
Function in disaster; finish in style
 
Howard Penney               
Managing Director
 

LONG ETFS

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.

EWZ - iShares Brazil- Brazil 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. 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.

XLE - SPDR Energy- We bought Energy on 5/13 with the dollar up. We think it works higher if the Buck breaks down.   

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.

CAF - Morgan Stanley China Fund- A close end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the wave of returning confidence among domestic Chinese investors fed by the stimulus package. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth.

EWD - iShares Sweden-We bought Sweden on 5/11 with the etf down on the day and as a hedge against our Swiss short position. From a fundamental setup, we're bullish on Sweden. The country issued a large stimulus package to combat its economic downturn and the central bank has effectively used interest rate cuts to manage its economy. Sweden's sovereign debt holds a strong AAA rating despite Swedish banks being primary lenders to the Baltic states. We expect Sweden to benefit from export demand as global economies heat up.

XLK - SPDR Technology - Technology looks positive on a TREND basis. Fundamentally, the sector has shown signs of stabilization over the last eight weeks.   As the world demand environment becomes more predictable, M&A should pick up given cash rich balance sheets in this sector (and the game changing ORCL-JAVA deal). The other big potential catalyst is that Technology benefits from various stimulus packages throughout the globe - from China to USA. Technology will benefit from direct and indirect investments.

XLV - SPDR Healthcare-Healthcare looks positive from a TRADE and TREND duration. We've been on the sidelines for the last few months, but bought XLV on a down day on 5/11 to get long the safety trade.

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.

GLD - SPDR GOLD -We bought more gold on 5/5. The inflation protection is what we're long here looking ahead 6-9 months. In the intermediate term, we like the safety trade too.
 

SHORT ETFS
 
EWW - iShares Mexico- We're short Mexico due in part to the media's manic Swine flu fear. The etf was up 7% on 5/4, giving us a great entry point.  The country's dependence on export revenues is decidedly bearish due to volatility of crude prices and when considering that the country's main oil producer, PEMEX, has substantial debt to pay down and its production capacity has declined since 2004. 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.

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%.

EWL - iShares Switzerland - We 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.


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