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Crackberry Hysteria

"I did envisage being this successful as a player, but not all the hysteria around it off the golf course."
-Tiger Woods
 
I had the privilege of playing golf yesterday afternoon with one of the most thoughtful investors I have met in this business. As we we're having a few post game refreshments, he made a very simple point - "isn't it great to not have to always be checking your blackberry?"
 
I don't use a crackberry (when I left Carlyle's hedge fund in 2007, I actually gave it to my son Jack to gnaw on). Away from this game of daily risk management, there is a perpetual hysteria that dominates Wall Street/Washington's groupthink. This is an operating culture that we created. As my good friend pointed out on the 10th hole fairway yesterday, "its really just a function of this business becoming all about size and scope."
 
Bigger, as we have learned, is no longer better. Bigger, in many cases,  creates stagnation. Bigger, doesn't allow one to change as the facts are changing . If you want to invest successfully in an increasingly interconnected global market place of interacting factors, you have to be able to move.
 
What if you can't move? Well, Tiger Woods reminds us that that's precisely when you should proactively change what you are doing. Woods has completely shelved his entire golf swing 3 times since he came pro. I wonder what his reaction would be to the idea that someone playing Wall Street's game HAS TO BE fully invested!
 
When investors HAVE TO BE something, creative destruction takes hold. Timmy Geithner and De Banking Club aside, this is America don't forget. Most capitalists I have met in my life, don't HAVE TO do anything other than have the mental flexibility to change and keep looking for new ideas.
 
Today's market is dominated by investors HAVING TO HAVE a risk management process, because the one they told people they had didn't work. Every day you can almost feel the need for analysts and investors alike to HAVE TO make calls on bubbles. Everyone is a bubble watcher, AFTER they blew up in one - now that's progress!
 
Today's US market reality is this:
 
1.       The US stock market is consolidating for its next real move

2.       Volatility (VIX) has been smashed

3.       Volumes have dried up to the bone

 
As a result, while everyone is running around investor conferences trying to figure out where the Great Depression narrative went. Chinese demand is accelerating and so are the prices of the things that they (The Client) need.
 
In the face of plenty an energy all-star telling us that oil's move "isn't fundamental", the US Dollar continues to fundamentally break down and spike that price of oil to higher-highs. Meanwhile, Dr. Copper is hitting a new YTD high this morning as well, trading up to $2.40/lb, taking its YTD performance to +65%.
 
The Client (China) needs oil and copper. That, bear friend British Philosopher, is "fundamental". HAVING TO tell your investors that everything you get right in this business is "fundamental" while everything that goes against you isn't based on fundamentals is , sadly, what some asset management structures that are too big to move HAVE TO say.
 
The Client (China) doesn't HAVE TO buy any more US Treasuries. The Client doesn't HAVE to ignore Russia's handshake. The Client doesn't HAVE TO do anything.
 
The US stock market doesn't HAVE TO crash right here and now. The US stock market doesn't HAVE TO have another +40% short squeeze. The US stock market's winners in 2009 don't HAVE TO do anything.
 
In the intermediate term (3 months or less), I think we're moving into one of the more predictable trading ranges that we have seen in years. No, I don't HAVE TO trade it - but, for now, I will...
 
My immediate term upside target for the SP500 is +2% from yesterday's 939 close. My downside support target is -2% lower, at 922. Play the game, and capitalize on the consensus hysteria. Crackberry updates are a lagging indicator.
 
Best of luck out there today,
KM
 

LONG ETFS

QQQQ - PowerShares NASDAQ 100 - We bought Qs on 6/10 as a better way to be long the US market than the SP500. The index includes companies with better balance sheets that don't need as much financial leverage.

EWA - iShares Australia- EWA has a nice dividend yield of about 5% on the trailing 12-months.  With RBA rate cuts showing signs of working and a commodity based economy with proximity to China's reacceleration, there are a lot of ways to win being long Australia.

FXA -CurrencyShares Australian Dollar Trust-Thanks to recovering Chinese demand for commodities, the sure handed management of RBA Governor Glenn Stevens and comparatively modest consumer debt levels -Australia's GDP continued to expand in Q1 while other industrialized economies saw double digit declines.  As with Canada, we like the Australian economy as an offset to the toxic US balance sheet.  

XLV - SPDR Healthcare -Healthcare looks positive from a TREND duration. We bought XLV on 6/08 to get long the safety trade.

EWC - iShares Canada - We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's large government recent history, and believe next year's Olympics in resource rich British Columbia should provide a positive catalyst for investors to get long the country.   

XLE - SPDR Energy - We bought Energy on 6/05. We think it works higher if the Buck breaks down.  Bullish TRADE and TREND remain.

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

SHY - iShares 1-3 Year Treasury Bonds - If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.

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.

 XLU - SPDR Utilities - As long term bond yields breakout to the upside, Utility investments are the relative yield loser.

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.


JOIN THE CLUB

PKF Hospitality Research released an updated forecast this morning detailing their bearish view of 2010.  This is the first forecast we have seen, other than our own, forecasting negative 2010 RevPAR (including prior PKF reports).  The president of PKF, Mark Woodworth, states that 2011 is the next time we will see "actual growth".  We have been predicting a down year in 2010 since January.

While we have got company, we are still outnumbered.  Sell-side firms continue to project flat-to-positive RevPAR growth in their models.  A recent upgrade was based partly on a "modest RevPAR recovery" in 2010.  Although certain economic indicators have shown signs of improvement (or at least less deterioration) recently, the lodging industry still faces significant challenges that we alluded to in our 01/29/2009 post, "A GIRAFFE FROM HEAD TO TAIL".

We expect any potential increase in demand in 2010 to be driven by lower rates.  Convention business booked in 2009 will be a drag on RevPAR for a couple of years.  Furthermore, ongoing corporate negotiations for 2010 are occurring in a buyer's market.  

The chart below shows the recent RevPAR trend in the United States.  Unlike most consumer discretionary sectors, there is scant evidence of sustainable sequential improvement in lodging demand.

 

JOIN THE CLUB - us revpar


Muscle Flexed? But How Much Muscle?

We had been in the midst of writing the note below that summarizes Russia's increased criticism of the U.S. Dollar as the global reserve currency when we picked up on newswires that Russia may actually start swapping U.S. Treasuries for IMF Debt.  As the dollar continues to fall holders of US debt are rightfully seeking alternative vehicles. Russia has aggressively floated the idea of a supranational currency in the last ten days and countries from China to Brazil have voiced reducing their dependence on the dollar.  While we very much believe "The Burning of the Buck" will have serious implications for global markets, Russia's recent bark (rhetoric) may be larger than its bite. The first chart below is an important call-out, showing the diminutive Russian Holding of US Treasury Debt as a percentage of total US debt.

The broader note below gives more context on this situation.

 Muscle Flexed? But How Much Muscle? - russ1

 

Muscle Flexing

Russia calls for a new global currency to replace the Greenback. Could rhetoric turn into action? (Yes, per above!)

Over the last week Russian President Dmitry Medvedev has openly questioned the future of the US dollar as the global currency, proposing both a "supranational" currency and the possibility of Ruble-Yuan swaps, a position he broached to western media and as host to an international economic forum in St. Petersburg over the weekend.  And the debate has moved beyond the Kremlin in recent days with IMF First Deputy Managing Director John Lipsky saying that it's possible to take such a "revolutionary" step over time and World Bank President Robert Zoellick saying that China may diversify its holdings.

Here it's important to note that both Lipsky and Zoellick take mild stances, yet the possibility of a replacement currency to the USD is a real one. Yet if we stick with Medvedev's proposition it's clear that even if he doesn't have a firm idea of what a supranational currency would consist of, he does understand  the value of using explicit soft power to heighten existing tensions between the US and China over the value of China's US debt holdings, especially following Geithner's failed trip to win over The Client, China.

But who is Russia hoping will benefit?

Ironically it's Russia who stands to benefit from the current devaluation of the USD, but not by issuing a new currency it can exchange in.  Commodity-rich Russia is a major producer of world's oil supply, much of which is sold and traded in US dollars. As any commodity trader would tell you: when the base currency devalues, more dollars chase the commodity, lifting the price. While we don't discount other factors that play into the price of oil, including supply and geo-political risk factors, at a very basic level, it appears antithetical for Russia to want to replace the USD in the immediate term, as Russia benefits from the Reflation trade!

The chart below comparing the US dollar index versus the price of front month contracts of light sweet crude over ten years demonstrates a pretty accurate picture of the reflation trade. The correlation coefficient (R squared) is -0.8, signifying a high negative correlation between the USD and oil.   Interestingly the more that Medvedev continues to talk down the dollar, the more likely it will continue to plunge = advantage Russia.

Matthew Hedrick
Analyst

Muscle Flexed? But How Much Muscle? - russ2


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MACRO WHISPER NUMBERS

Chinese Inflation data was positive; the chatter about trade and production data is even more bullish

CPI data released last evening showed that Chinese consumer prices declined on a year-over-year basis for the fourth consecutive month in May, registering at -1.4%. Producer prices for May arrived at -7.2% Y/Y,  the lowest Y/Y level in decades. With the assumption that rising energy commodity price levels will taper any threat of deflation, the market reaction to the data was uniformly positive.

Last night's rally in Shanghai had less to do with today's data and  more to do with May import and export data scheduled for release by the NBS tomorrow, as well as production numbers to be released on June 11th.  Somewhat absurdly, last night Ming Pao Daily reported that industrial output grew 8.9% y/y in May based on "unspecified sources". That's right, Chinese economic data "whisper numbers" are now driving momentum in Shanghai.

With mounting anecdotal evidence from shipping sources and base metal exporters suggest that the initial flurry of activity after the initial rush of credit stimulus in January and February may be contracting somewhat, not to mention the dearth of reliable data from Central and Western production and transport hubs,  we are frankly suspicious of any and all bullish rumors being promoted by anyone no matter how well placed their sources. 

We are long Chinese equities via the close end fund CAF , and remain bullish on the recovery process there despite peripheral negative data points creeping  into the margin from the credit and commodity markets. There is an old adage, "buy on rumors,  sell on news" - pay close attention to when we make changes in our portfolio in case we decide to heed it.

 

Andrew Barber

Director

 

MACRO WHISPER NUMBERS - china23


Seasonality Matters

We had two questions this afternoon about the importance of these weekly apparel sales numbers as it relates to seasonality. Good question. We're just coming off the seasonally weakest 5-week period of the year. The period following back-to-school is a close second. Numbers start to ramp more meaningfully in the week we're in right now. This is when weekly datapoints matter more. Thanks for the questions. Keep 'em coming...

 

Seasonality Matters - SportScan Seasonality 6 09 2

 

Casey Flavin

Director


Running The Numbers On Obama And Autos

 

We were bemused by the Obama administration's choice to run the dismantling of General Motors: Brian Deese.  Mr. Deese, based on his resume, is a 31-year old drop out of Yale Law School (he dropped out to join the Clinton campaign) who was an undergraduate major in political science, and has no ostensible automotive industry, economic, or business analysis experience.  According to a New York Times article on June 1, 2009:

"Every time Mr. Deese ran the numbers on G.M. and Chrysler, he came back with the now-obvious conclusion that neither was a viable business."

Now we are all about running the numbers, we have a ~20 person research team that "runs the numbers" daily, on markets, industries, and companies.  We think we are good at it based on years of experience at many large investment banks, hedge funds, and private equity firms, with educations from some of the top business schools in the world.  This is not to say that conventional experience is always the most appropriate, or that the Research Edge team is better than anyone else, but rather to suggest that having a 31-year old with no analytical experience "run the numbers" on one of the most complicated industries globally is a little disconcerting.

We don't engage in partisan politics in the office or in our analysis, because that is just a loser's strategy, but it is important to objectively analyze decisions made by our elected leaders, so we can have a view of what they might mean for future decisions and/or approval ratings.  Will Wilkinson from the Cato Institute wrote the following about having Deese in the driver's seat (excuse the pun):

"A fresh-faced 31-year-old, Deese dropped out of Yale Law School last year to work for Hillary Clinton's presidential campaign. When Clinton sank, Deese skipped over to the winning ship, impressed everybody who counts, and landed a desk in the White House. The big guns like Larry Summers and Christina Romer are busy cooking up hilariously sunny budget projections while trying to look like they're keeping the economy from collapsing. So Deese, armed with an undergrad degree in political science, finds the GM portfolio and the fate of millions in his hands.

Some are grumbling about Deese's lack of relevant experience. (He has driven a car and once slept in the parking lot of a GM plant!) But the real issue isn't Deese's résumé. The real issue is why anyone should have the power to "rewrite the rules of American capitalism." Unlike Deese, treasury secretaries Paulson and Geithner are men of experience. But what kind of experience could justify the immense, arbitrary power they've exercised in the wake of the financial meltdown? Experience centrally planning the global economy?"

The point is not suggest that Wilkinson, from the right leaning Cato Institute, is correct in his assessment of Deese, but rather that appointing people like Deese to such positions is going to have serious implications as it relates to the credibility of the leader's decision making process.

So far this decision to put a person like Deese in charge of the decision making process behind one of the largest bankruptcies in U.S. history does not seem to be lost on the electorate when it comes to their analysis of the administration's economic decision making wherewithal.  A recent Rasmussen Poll reported that more voters trust the Republicans now than the Democrats by a margin of 45 - 39 when it comes to the economy.  According to Scott Rasmussen, "this is the first time in over two years of polling that the GOP has held the advantage on this issue."   On healthcare, another key issue, the Democrats are also losing steam.  In May they had a 18 point advantage over Republicans and only have a 10 point lead now.

The Democrats appear to be in a position where they have the wrong man running the numbers, or at least an inexperienced one, and therefore the numbers are starting to run against them.  That said, President Obama, more broadly speaking, seems to be retaining his popularity.   On the Rasmussen Daily Approval Index, President Obama is back up to +9, which is at the high end of the range of where he has been for the last three months, despite the meaningful shift in the key issue polls, healthcare and the economy, that are noted above.

We've been expecting President Obama's numbers to weaken for months and they are impressively resilient.  To the extent that Obama and his advisors attribute this resilience to the recovery of the stock market, there will likely be implications in terms of fiscal policy in the coming months that may relate to a continued path of re-flation, or as we are calling it, "Burning The Buck."

Daryl G. Jones
Managing Director


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