“Would you please put some pants on? I feel weird having to ask you twice.”
-Phil Wenneck, The Hangover
This morning’s most important quote is the same one that’s been the most critical to global macro on every morning of 2009 - the US Dollar. The #1 headline on the Bloomberg box today is “Stocks, Commodities Retreat; Dollar, Treasuries Rise.” This correlation isn’t new. This is the inverse relationship between REFLATION and the once almighty Buck.
The #2 story on Bloomberg is about the same thing, Alexei Kudrin’s commentary that the US Dollar is in “good shape.” Getting less attention is the second part of what the Russian Finance Minister had to say overnight, which is that “it’s too early for an alternative” to the world’s reserve currency.
“Too early” simply implies the simple matter of time. The New Reality in the global financial system is that heads of state and finance have finally shifted away from the “if” to the “when”. This is what’s new. The Piggy Bankers have been paid, but America is going to pay for this by losing her status as the world’s financial fiduciary.
Kudrin is making comments ahead of the BRIC Summit (Brazil, Russia, China, India) that is being held in Russia tomorrow. Like Geithner, Kudrin doesn’t really do macro, so he’s probably having a little sit down with Putin and Medvedev right about now, given that his comments have crushed the Russian stock market for its biggest one-day drop in 2-weeks (down -4.1%). If you sponsor strong Dollar rhetoric, you are sponsoring The Hangover associated with the unwind of the REFLATION trade.
China doesn’t seem to mind the US Dollar moving higher for once. Why is that? Well, because they are one of the biggest losers of the great American REFLATION trade. As American policy makers are Burning The Buck, the US Dollar denominated Debtors get paid, not the Creditors. The Chinese, like American Consumers, could do without spiking costs in terms of what they actually need – crude and capital.
Maybe this is why the Chinese stock market flashed such an eye opening positive divergence overnight versus the rest of Asia’s stock markets. With stocks in Japan and Hong Kong giving back 1-2% of their respective recent rallies, the Shanghai Stock Exchange powered forward for another +1.7% daily gain.
US Dollar up was what we saw the US stock market digest on Friday. The immediate rotation that US risk managers moved toward was impressive. The entire complex of the REFLATION trade had The Hangover, while the recipients of lower energy/commodity prices (US Consumer and Healthcare stocks) outperformed. In the face of a rational rotation, the SP500 registered a new YTD high at 946. Again, albeit on low volume, that was impressive.
After a +40% trough-to-peak move that a lot of people missed, can the US stock market continue to work higher without REFLATION? That’s a good question. Is the REFLATION trade over? That’s obviously another one that one should be considering this morning.
Until I see a breakout and close above the $81.86 line in the US Dollar Index, my answer will be that the REFLATION trade will continue to dominate. This morning, the Dollar is trading +0.85% at $80.81, and you’re seeing the US Equity Futures trade down alongside REFLATION markets like the aforementioned one in Moscow. You’re also seeing the price of Dr. Copper trade -4.5% below its YTD high that was established last week. Burning The Buck has dominating impact across currency, commodity, and country level ETFs.
After Alexei Kudrin has his slap on the wrist talk with the boys who run the joint, I expect Russian rhetoric to lock arms with the same that has dominated world markets for the last 3-weeks. In the long run, the world’s reserve currency is going to be a basket, not a Buck. This will take time. Understanding the difference in duration between The Hangover and The US Currency Credibility Crisis will be all that remains in between. Trade the range.
My immediate term upside target for the SP500 is now 949 and downside is 932.
Best of luck out there this week,
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.
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. So far this thesis has gone against us.
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
