This note was originally published at 8am on June 13, 2013 for Hedgeye subscribers.
“Somebody had to pay.”
That’s what Britain’s Prime Minister had to say about German reparations at the Paris Peace Conference of 1919. He added, “If Germany could not pay, it meant the British taxpayer had to pay. Those who ought to pay were those who caused the loss.” (Paris 1919,pg 181)
What George forgot to mention was his founding of the British welfare state; part of the British bill had to cover government spending. The Germans didn’t like that. They didn’t like the pomp of John Maynard Keynes floating around Paris smoking the peace pipe either.
Oh yes, my friends, there are roots to this central planning Gong Show. They run far deeper than through Krugman’s craw. Japan is going to learn that the hard way now. Indeed, someone needs to pay the price. For the last decade American, European, and Japanese politicians have tried imposing that tax on their people via currency devaluation. Now the timing is ripe for politicians to pay the piper.
Back to the Global Macro Grind…
“To be crystal clear on our conclusion on how we think this ends for the Japanese people: in tears. Never mind a country that starts doing it with a quadrillion in debt, there has never been a country in the history of humanity that has devalued their way to long-term economic prosperity. Championing Japan’s economics today is the equivalent of cheering on the Weimar Republic circa 1924.”
The title of that Early Look was “Weimar Nikkei.” The date was May 30th, 2012. Today, the Japanese stock market is crashing.
To crash or not to crash, remains the question. Darius Dale and I get into this debate with clients all of the time – “so, when do you guys think this all hits the fan?”, “can’t the Japanese keep this going for a little while longer?”
It’s a very intellectual debate because all of Wall Street is trying to figure out how long a failed team of politicians (we call Abe and Aso the Keynesian Duo) is going to be able to suspend economic gravity.
And maybe that’s why even a hockey and football player (Darius was a 325lb offensive lineman at Yale) can remind you that there’s nothing intellectual about Krugman and/or Abe’s Policy To Inflate at all. It might sound clever, but as a practical matter it’s just dumb.
So what’s the risk to the Japanese completely screwing this up?
- The currency market stops believing this will end well (i.e. in sustained Japanese economic growth)
- The Yen rips and the US Dollar falls
- The Correlation Risk (USD vs SPX = +0.84 on our TREND duration) goes squirrel
I’d say those are some pretty big risks.
But don’t blame the politicians. Don’t ask them to pay the price. This isn’t the time to be talking about pounds of flesh or anything at all like that. Instead, let’s just watch the country where this whole money-printing experiment started (Japan) implode on the world stage.
The context of central planning history is critical:
- Post 1913 Federal Reserve Act gave birth to Bloomsbury flower power act of John Maynard Keynes
- Paris Peace Conference 1919 gave a platform for government spending gurus to lay the railway tracks of political plunder
- Post 1971 Nixon abandoning the Gold Standard, 1997 was a no brainer for Krugman to tell Japan to “PRINT LOTS OF MONEY”
To be fair, going back to the 13th century, free-market folks like Genghis Kahn have been fighting the aristocracy of kingdoms and political plunderers. So the idea that Charles de Gaulle devaluing his people’s currency was going to fail inasmuch as the Weimar Republic’s did and/or the 2013 Japanese version of the same will may be consensus amongst people who have studied history.
But who cares about causality (central planners), let’s talk correlation – this is where this market’s risk is at!
- As soon as the Japanese Yen snapped our 95.85 TREND line, the Weimar Nikkei went squirrel last night
- Closing down -6.4%, that puts the #WeimarNikkei in crash mode (-20.4% since May 22nd!)
- When the big stuff starts snapping and crashing like that, we get out of the way
Actually, we got out of the way before it happened – think Hedgeye-style “Waterfall” - and how we proactively risk manage the oncoming entropy of a burst of interconnected H20 crashing over the damn. #oncoming!
With time this Correlation Risk (driven by political causality) will burn off – but not today; water doesn’t burn:
- USD/YEN snaps 95.85 TREND line as US Dollar Index snaps 81.21 TREND line
- Weimar Nikkei’s TREND line of 13,848 #snapped
- China, Hong Kong, Germany – all of their Equity markets are over the waterfall now too (bearish TREND)
Most of this isn’t new. It’s just all happening faster now. That’s how risk works – it happens fast. This is big water, moving real fast, and I can assure you that most of the macro “tourists” out there who didn’t respect either the Yen or Nikkei signal are now very wet.
What does this mean for our asset allocation?
- We already have a 0% asset allocation to Fixed Income (Bond Yields aren’t going down on this fyi)
- We already have a 0% asset allocation to Commodities (Gold is down on this, fyi)
- We’d already cut our US Equities allocation in half versus its max (on Monday)
Since we are bearish on #EmergingOutflows (Emerging Markets), we don’t have to deal with that this morning either. What we need to make a decision on is whether to get out of US Equities altogether.
Here’s how I think about US Equity Market risk:
- It all starts and ends with the Dollar; the TREND is broken (but can be recovered with time; long-term TAIL support = 79.11)
- SP500 TRADE line of 1624 is broken, but TREND support of 1583 remains intact
- US Equity Volatility TREND resistance of 18.98 is going to be under siege this morning
Volatility, entropy, convexity – this is the stuff that makes people go squirrel. Yes, I’ve used the squirrely metaphor 3x this morning because that’s what my inbox looks like. We are getting a lot of questions on this. Which means institutional clients are in the water.
My first move this morning will be to do nothing. We’re not wet, so we can watch this political gonger play out a little before we let the market tell us which of these interconnected TREND risks confirms.
As for who ultimately pays the price for all these unintended consequences, I formally nominate Bernanke, Kuroda, and Aso. Especially for that Aso guy, ripping their countrymen a new one via currency devaluation is something they should all be ashamed of.
Our immediate-term Risk Ranges for Gold, Oil, US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1370-1418, $100.36-103.94, $80.46-81.21, 93.69-95.85, 2.06-2.27%, 14.61-18.98, and 1601-1624, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer