Confidence

"Confidence comes not from always being right but from not fearing to be wrong."
-Peter T. Mcintyre
 
Although the unemployment rate reached a 25 year high in May, it appears that most consumers are still relatively hopeful about our economic future.  The S&P 500 being up 40% since the March 9th low and the NASDAQ up 18% year-to-date has a little something to do with the increased confidence readings.  I'm not sure if the stock market can accurately reflect the strength of the current economy, but it has a great track record.
 
If the market goes up, most consumers are going to say, if asked, that they are confident or very confident in chances for a strong economy over the next six months.  There are other forces at works too.  On the margin, if consumers have less money in their pockets at the end of the month because of higher gas prices, are they going to be more or less confident?
 
With today's University of Michigan confidence reading, it appears that we are more likely to see that the numbers PEAKED sequentially last month rather than a big upside surprise.  Right now the consensus reading for the University of Michigan Confidence June number is 69.5 versus 68.7 in May.  A 67.7 reading would suggest that the best is behind us.  The market has been churning in a very tight range, as there has been no help from consumer related names.  Confidence has peaked!    
 
The call on today's confidence reading is a very important call for Research Edge given that we were one of the few macro strategy firms who proactively predicted that things were going to TROUGH sequentially, back in February when they did.  
 
Coming into today's confidence reading, the underperformance in consumer related names has become more pronounced and yesterday was no exception.  The Consumer Discretionary (XLY) has been underperforming on a relative basis for the past month, and is down 0.5% over the past week while the S&P 500 is up 0.5%.  The increase in interest rates and higher gas prices are two reasons for the underperformance and the consumer confidence number today could be the river card.  
 
The REFLATION trade is alive and well, but that is bad for the consumer and the consumer matters!  Inflation sucks!  Utilities, Energy and Materials were the best performers yesterday, as the dollar index finished down 0.8% yesterday.  
 
The dollar got smoked in the face of the Japanese Finance Minister Kaoru Yosano saying that they are confident about the outlook for U.S. Treasuries!  Committing hari-kari?   "We have complete trust in the fact that the U.S. views its strong-dollar policy as fundamental."  I'm happy the Japanese have confidence in us, but one thing is for sure, their Finance Minister is not on the Research Edge distribution list.  
 
The Chinese are on a roll - China's credit continues to grow at a breakneck pace and industrial output and retail sales climbed more than consensus expectations.  At this point, the Chinese are confident in the programs they have established to reinvigorate their economy.
 
The market's REFLATION story has been remarkable to watch, but knowing the end could be ugly does not instill CONFIDENCE.
 
Function in disaster; finish in style
 
Howard Penney
Managing Director

 
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.

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 TRADE and 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.