"He who will not economize will have to agonize."
-Confucius
Selling down my US Equity position in the Asset Allocation Model to zero looked smart Wednesday, and not so smart yesterday. Whether I'm right or wrong on this morning's unemployment report being worse than expectations won't really matter to our YTD absolute performance. A zero position implies no risk, if you're managing towards an absolute return that is...
Understanding (and respecting) that many investors get paid on a relative basis, having a zero position in an asset class does have repercussions. If the US stock market gets clocked this morning, zero exposure is a big win. If the market makes another higher high, a zero position is a big loser.
On an absolute basis, this week has been what I expected it to be - boring. Credit markets still look great, equity volatility remains relatively low, and the SP500 continues to trade within a very proactively predictable range.
Yesterday's SP500 closing price of 942 takes the week-to-date return to +2.5%, and I have missed all of it. Do I feel shame? Give me 2 more hours and a look-see at that US jobs report, and I'll let you know...
While yesterday's US stock market price recovery was impressive, it was to a lower high (prior closing high = 944) and it came on very light volume. Volume needs to confirm from here on up, and I haven't seen that this week.
I have a top to bottom intermediate term trading range in the SP500 of 83 points. That's roughly a 9% trading range, and no matter what this morning's economic data tells us, I think we'll trade within it. With the manic media perpetually trying to call bubbles and crashes, guess what? They're not going to happen today. They are in the rear view, so trade the range. I have immediate term TRADE resistance of 962 for the SP500 and downside support at 919. For today, that implies +2% reward versus -2.5% risk.
I don't manage a hedge fund anymore but, by training (myself), I am a risk manager. Every 90 minutes I refresh the prices in my macro models and have a view on risk/reward, trading ranges, volatility, calendar catalysts, correlations, etc...
One of the more impressive correlations we have observed in global macro as of late is the trading correlation between copper prices and the Shanghai Stock Exchange in China - it is 88%! This morning, that correlation busted apart. To be clear, it broke for a day... but, on the margin, this may start to matter.
We remain long China via the CAF, and while that closed end fund had a rock-star +7% day yesterday, the local Chinese market did not overnight. It wasn't down a ton, but the point was that it was down (-48 basis points) with A) Asia up and B) copper up ($2.31/lb, a new high).
I call this a negative divergence. Sometimes they matter, sometimes they don't. My job as a risk manager is to get on our Macro subscriber morning call at 830AM and flag, well... the yellow flags. This is a very simple process, but one that requires a tremendous amount of manual and mental discipline (i.e. you have to wake up at an un-Godly hour of the morning every day, and write down every single positive and negative divergence you see, across countries and asset classes, globally). I know, nice life.
Now I may not be as "smart" as Tan-gelo Mozilo, Bernie Madoff, or the voles that followed them right into swallowing their own tongues, but I am smart enough to not hit snooze in the mornings, on the off chance that I might find inside information within this global market of real-time insider trading. Someone on the inside always knows something, and I am tasked with reading into where they may be acting on it.
The most obvious market where I am seeing that people have inside information as of late is in the global currency market. Russian insiders know that Medvedev and Putin are going to amplify the anti-US Dollar rhetoric this weekend. They also know that the current correlation between a DOWN Dollar and the REFLATION trade remains very high. That's one of the main reasons why the Russian stock market (up +3.2% this morning taking YTD performance to +81%) and the commodity prices that underpin it are ripping higher again.
A Credibility Crisis in a currency can be perpetuated by heads of state. Trust what the marked-to-market prices are telling you on that, not Timmy Geithner. They call it the "Russian Davos" for a reason. Expect plenty of "Supranational Currency" headlines to hit this weekend as Putin Power Inc. hosts its version of an international economic summit in St. Petersburg.
All the while Germany's Angela Merkel will be explicitly taking President Obama to task today (he's in Dresden) on the American "skepticism" she discussed yesterday (she was referring to US monetary policy and the politicization of US Federal Reserve powers). Be sure to note that the Russian, Chinese, and even the Australians are supporting her message. US centric investor beware. This shift in global balance of economic power is real, and this is why my position... for now... in US Equities remains zero.
Enjoy the weekend with your families,
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.
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
XLU - SPDR Utilities - As long term bond yields breakout to the upside, Utility investments are the relative yield loser. Utilities underperformed the market yesterday; we're still short.
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.