Misunderstood Employment Print?


Yes, the 345,000 print that the manic futures traders chased each other on was better than expected, but I don't think they could have had the time to model the number that matters here - the unemployment rate.


I was at 9.3% for the month and it came in even higher than that at 9.4% (consensus was 9.2%). I was at 9.3% because I thought that the sequential acceleration in the unemployment rate would stay at 40 basis points (month-over month). It shot above that to +50 basis points.


So THE point here is that the sequential rate of unemployment just RE-ACCELERATED!


Recall that one of the main tenets to our bullish bias for the last 3-months has been the (E - Employment) in our US Consumer MEGA Squeeze call. The call was based on the unemployment going up at a lesser rate - and that it did for the past few months...


That delta shifts back to the danger zone today. Sequential accelerations matter.



Keith R. McCullough
Chief Executive Officer


Misunderstood Employment Print? - unemply12



"He who will not economize will have to agonize."
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,


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.

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.



Ministry of Finance Enterprise Investment survey data released yesterday showed a decline of 25.33% Y/Y in investment by Japanese corporations in Q1 as the stagnation in primary industry has curtailed spending.


Last Friday we put up a note in which we argued that the optimism furled by a significant month-over-month sequential industrial production improvement in April  

 (interpreted as signaling a bottom by many, though not us) , did nothing to indicate that positive momentum was anywhere on the horizon. This new data point, while somewhat stale,  continues to support our negative bias.  With inventory stockpiles depleted through months of activity in some basic industry facets stretching back into Q4 09 it is still premature to categorize April production as a recovery signal without  a sizeable corresponding uptick in investment or exports -neither of which has materialized.


South Korea in contrast, has begun to post improving capex figures. FKI investment survey data registered at -12% Y/Y for April and is forecast to be in single digits for May. South Korea's Q1 average investment level also sank below 20% Y/Y but, with a much more severely contracted credit market and a battered Won, the commitment to investment and improvement by corporate leaders there looks tenacious when compared to their Japanese competitors.


Economics 101 suggests that pulling investment during down cycles ultimately hampers recovery. For Japan's corporate leaders, with the "lost decade" still fresh in their minds, perhaps apathy has become normal.


Andrew Barber




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Ominous Clouds Over The Baltic States



This year we've been highlighting the tail risk associated with the Baltic economies for greater Europe, especially as it related to our long position in Sweden (via the etf EWD, which we sold on 6/1) due to Sweden's strong banking presence in the region. The economic forecasts for Estonia, Latvia, and Lithuania for this year and next are already the worst for all of Europe by far, yet last night's failed Latvian Treasury bill auction for 50 Million Lati ($100 Million) signals that the situation there has continued to deteriorate and,  without further international support and defined economic action from Latvia, the threat of default will increase and, in the worst case scenario domino through the region as Scandinavian lenders were forced to withdraw.


While we're cognizant of the relative GDP size of the Baltic states compared with their European peers-Latvia's economy is about 1/100 the size of Germany's on a good day -and, according to the Bank for International Settlements in Switzerland, Swedish Banks have about $75 Billion of loans to the Baltic states, i.e. not an insignificant sum.  


The Lati is currently pegged to the Euro with a trading band of 1%.  There's a mixed response from Swedish, Latvian and international officials on how to attack Latvia's ailing economy, which may contract 18% this year according to the country's Prime Minister Valdis Dombrovskis. One camp  would recommended that Latvia devalue its currency outside of the band to encourage exports and limit imports, thereby improving its trade balance while reducing the current account deficit. The tail risk would be excessive devaluation if a free(er) float was allowed, increasing the prospect of default.  Another camp believes that the band versus the Euro should be maintained, with the Swedish Krona taking the brunt of the devaluation until economic conditions and/or investor confidence improves. Already the Swedish Krona has fallen ~3.7% versus the Euro since June 1.


In response to the economic conditions Dombrovskis is planning to implement budget cuts through decreases in public wage and spending, standards imposed by the IMF and European Commission to receive the next tranche of loans from an original package of 7.5 Billion Euro, which the country began receiving in Q4 of last year.  The fund delayed a 200 Million-Euro transfer in March after the government failed to make budget cuts. The country cannot afford for this to happen again.


The Latvian central bank has bought some 1.3 Billion Lati since the beginning of 2008, which has contributed to a lack of local currency liquidity and to the lack of bids in the auction yesterday. Today the Lati was trading up after the Treasury bought the currency. 


While Sweden's Finance Minister Anders Borg said that his country can weather a "possible bank collapse, or nationalization, sparked by the economic collapse in the Baltic states" and the IMF is likely to grant the next tranche, the ailing performance of the Baltic states, many of which have been seriously hampered by declining appetite from their main trading partner, the Eurozone, creates an economic tail risk for Sweden in particular, and Europe should the flashlight be placed on the weaker emerging economies of Eastern Europe. 


We sold out of our position in Sweden from a technical perspective, believing in part that its YTD performance had run a bit ahead of itself (as compared with Germany for example) with global export demand still weak and its Baltic lending issue looming in the background. Sweden has a dynamic economy with a very strong financial system and currency, one that has traded historically (not on chart) in a tight range versus the Euro. We have a bullish bias on Sweden in the longer term.  


Matthew Hedrick




Ominous Clouds Over The Baltic States - sweden

Canada: The First Nation of Hockey and Capitalism?


Position:  We currently have no position in Canada, though have a bullish bias


We have been consistently bullish of Canada for the last six months.  A primary reason actually jumped out at me while watching "X-Men Beginnings: Wolverine" in a theatre earlier this week.  (I think I appreciated the movie more than my girlfriend did.)  The protagonist, Wolverine, is serving in the U.S. Army in a special platoon and while on a mission in Africa decides to desert.  He is confronted by the leader of the platoon who insists that he is serving his country and has taken an oath to do so. Wolverine responds simply, "It doesn't matter, I'm Canadian anyway." In the context of the global investment marketplace, the reason to invest in Canada may be as simple as that, Canada is not the United States (no offense to our American friends!).


While the United States is Canada's largest trading partner, ie Canada will always be dependent on the U.S. economy, Canada is also one of the most resource rich nations in the world.  Specifically, based on conventional and non-conventional oil reserves Canada ranks 2nd in the world only to Saudi Arabia.  In effect, Canada has what China, "The Client", needs.  Further, Canada has a solvent and functioning banking system.  The Canadians did not let their underwriting standards slide like the Americans did throughout the 2000s, so the credit system is fully functioning north of the border.


More importantly, Canada plays into our theme of socialism versus capitalism, which is the idea that you want to be long of those countries that are moving towards capitalism and short of those countries that are moving towards socialism.  With Conservative Stephen Harper at the helm, the Canada government, despite their socialist roots and tendencies, has been shifting more and more to the economic right.  This is, of course, in stark contrast to the United States and its first few months under the tenure of President Obama (and to be fair the last few years under President Bush).


A few points to consider in regards to Canada becoming an appealing nation from an investment perspective are outline below.  We've borrowed some of these from a report put together by the Cato Institute and while these facts compare Canada to the United States, the point more broadly is the direction in which Canada is moving from a fiscal policy perspective.  These points are as follows:


  • Government spending - Canadian government spending as a percentage of GDP peaked at 51% in 1990 and has been steadily declining every since. In 2008, Canadian government spending as a percentage of GDP was 40% versus the United States at 39%. For the first time in modern economic history, the United States government is poised to spend more money as a percentage of GDP in 2009 due to the massive stimulus plan that the American Congress has passed.


  • Federal public debt - The Canadians have been steadily bringing down their federal public debt as a percentage of GDP since 1995 when it was at 71%. By the end of 2008, this number was at 32%. In 2008, the U.S.'s ratio of federal public debt as a percentage of GDP was 40% and expected to rise to 61%.


  • Balanced budget - Canada has balanced it's budget every year since 1998, and in fact generated a surplus. The American government has run a deficit for that entire period and a time when the Americans will be able to balance their budget again is far, far into the future.


  • Social security - Both the Americans and Canadians spend roughly the same on social security, approximately 4.4% of GDP. The Canadians, though, have a plan that is solvent and full funded, while the Americans have massive unfunded obligations.


  • Taxes - On the tax front, Canada is and has been lowering taxes, primarily because they have the ability to do so. In 2010, it is expected that the U.S.'s highest personal income taxes rate will be increased to 46%, which is on par with Canada, while Canada has a lower capital gains tax rate. On the corporate front, Canada's tax rate is 15% on the federal level and has been trimmed on the provincial level, which, in aggregate, make Canadian corporate rates lower than the United State's standard 40% rate (a rate that is predicted to go up next year).


Canada has rightfully and always been known as the world's superpower of hockey, but the time seems near when Canada will also be held on a podium for their fiscal prudence and free market policies, especially in contrast to the trend that its southern neighbor is on.


Daryl G. Jones
Managing Director


Canada: The First Nation of Hockey and Capitalism? - canada

A Whole Lot of Nothing

I'm not sure if it's because WMT is no longer reporting monthly same store sales are there are fewer companies reporting across the board, but May results feel like a very small part of the bigger picture at this moment (because they actually are!).  Yes, the majority of companies missed estimates but at the same time the actual results were also generally in line with company guidance. Expectations were a little higher as the trend last month got baked in and the trajectory of recovery appeared to be gaining momentum.  At the very least, May results remind us that volatility can and still exists with consumer on a weekly and monthly basis. 


Check out the two charts below showing sales trends in mall-based vs. specialty apparel and in department stores. The 1 and 2-year comps have been all over the place, but the 3-year (which mitigates issues like weather, stimulus checks, tax rebate timing, etc...) has hardly budged at (-3%) to (-5%).

A Whole Lot of Nothing - Apparel Mall Specialty May Chart


A Whole Lot of Nothing - Department Stores May 2009 


Perhaps the term "stabilization" was used a few too many times over 1Q earnings season.  The trend does remain stable but shorter term upticks and downticks will continue.  The facts is, May is the smallest month of the quarter, inventories remain clean across the sector, and everyone knows comparisons are getting increasingly difficult as we lap stimulus checks. 


In looking at the standouts, of which there are few, there is nothing overly surprising.  Those companies with momentum still have it.  TJX, ROST (the only company to cite weather as a positive), ARO, and KSS are the outliers to the upside.  Not so surprising again in that all of these companies are price-driven, value retailers.


In trying to discern product or regional trends, anecdotes were mixed across the board.  Consumable categories appeared to outperform while home related goods were mixed.  On the apparel side, dresses are still the hot category and footwear remains a positive call out.  The Southwest region was most often cited as being an outperformer while the Southwest was the weakest.  Overall, it sounds like the pricing environment remains unchanged (i.e. no uptick in promotional activity or heavy discounting) and traffic was a just a bit weaker than anticipated.


So the question is, what has changed now that May sales have been released?  Nothing.


Eric Levine


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