China's Arithmetic

"It will be helpful if Geithner can show us some arithmetic"
-Yu Yongding
 
From the lens of a global risk manager, this morning has to be one of the more fascinating that I have ever woken up to. At the same time as the US Government is setting themselves up to announce one of the largest bankruptcies in US corporate history, we have a squirrel hunting US Treasury Secretary telling the Chinese to "trust us" and America's currency. That a boy!
 
Providing leadership to the world's increasingly interconnected economy is by no means an easy task, and maybe that's why the world is voting against America holding the world's reserve Currency Conch any longer. Timmy Geithner's effectiveness with the Chinese translators overseas this morning is borderline laughable.
 
There was a time when the Wizards of Wall Street's Oz could fly overseas and make a comment like "we are committed to a strong dollar" and it would actually matter. Rather than getting on a plane and shaking hands with The Client (China) himself, President Obama opted to send the same guy that called the holder of $768B in US Debt "manipulators." Nice!
 
When it comes to financial market sophistication, other countries aren't as gullible as they used to be. An internet connection and You Tube screen have effectively changed all that. On the heels of Timmy's "reassuring" comments, the US Dollar is getting spanked again, trading down another -0.73% to lower-lows at $78.63. Rather than fading Geithner from my soapbox, now the world is - it's sad.
 
I understand that this is all doesn't matter yet because someone on CNBC is hopped-up about where the US futures ramped into Friday's close and look here on today's open. That manic behavior really helps America's reputation. At the end of the day, the US stock market could go up another 6% to 9% percent today, and it would still be amongst one of the worst performing stock markets in the world.
 
The Dollar moving into crisis mode matters. First, all of the REFLATION trades pay themselves out in full. Second, all of the global political capital associated with the almighty Petro-Dollar gets redistributed. And Third, well... rather than analyzing this as the said Great Depression Part Deux... how about another Third Quarter of 2008 in US Equities?
 
Nah, that's crazy right? Like they say in the Canadian Junior Hockey Leagues, "crazy is as crazy does"!  There are loads of unintended consequences associated with a US Dollar crashing - the only other sustainable break we've seen in the US Dollar Index below the $80 level since 1971 (when Nixon abandoned the gold standard), was that one that led us to that 2008 Third Quarter...
 
After locking in another +5.3% month for May, the SP500 is up a whopping +1.8% for the YTD. Unlike most global equity markets that are charging to higher-highs this morning, the SP500 is still trading below its January 6th high of 934.
 
On the heels of another strong, albeit not herculean PMI manufacturing report last night (it decelerated slightly month over month), China's stock market charged to higher-highs, closing up another +3.4%. The Shanghai Composite Index is now +49.5% YTD, and we, as our British philosophy competitor likes to say remain "long of it."
 
From Hong Kong to Russia, stock markets are up +4 to +6% this morning. Why? Because, much like the ONLY other time we saw the US Dollar break down to these levels, everything that China needs REFLATES. Oil prices and the promises of a potentially empowering Chinese handshake have the Russian Trading System Index (RTSI) up +83% for 2009 to-date. Now that and the price of oil trading up +19% in less than 2-weeks is getting someone paid - and it isn't the American Consumer!
 
As she trashes her currency, America will continue to lose political capital both domestically and abroad. After all, a -12% three-month swan dive in the US Dollar has hacked over $90 Billion of value from the Chinese position in US Treasuries. Creditors and citizenry hush yourselves! All the while, 17 out of 23 Chinese economists polled are calling holding those Treasuries a "great risk" this morning.
 
I know, I know... an economist or a billion US Dollars aint what it used to be...
 
At some point, China's interpretation of the arithmetic is going to really matter.
 
Best of luck out there this week,
KM
 

LONG ETFS

CAF - Morgan Stanley China Fund- A closed-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-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.

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
 
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. Longer term, the burgeoning U.S. government debt balance will be negative for the greenback. The Euro is up versus the USD at $1.4235. The USD is down versus the Yen at 94.6600 and down versus the Pound at $1.6393 as of 6am today.

XLU - SPDR Utilities - As long term bond yields breakout to the upside, Utility investments are the relative yield loser. TRADE and TREND remain bullish. We're wrong so far.

EWW - iShares Mexico- We're short Mexico due in part to the repercussions of the media's manic Swine flu fear.  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.