Time Changes Things

"They say that time changes things, but you actually have to change them yourself"
-Andy Warhol
 
Yesterday's intraday reversal in the US stock market was one of the most confusing of the year. Stocks opened higher, REFLATING alongside a deflating Dollar (makes sense)... then completely collapsed, breaking the macro inverse correlation (USD vs. SP500) that has held for the better part of 2009. I guess that's why correlations aren't 100%.
 
This of course was only a 6-hour affair and, as such, can hardly be considered an immediate term TRADE (3-weeks or less), never mind an intermediate term TREND (3-months or more). That said, prices rule in our macro models and when they change, we do.
 
Trading volumes were light, but volatility (measured by the VIX) shot above its immediate term TRADE line of resistance (30.64) to 32.68 in conjunction with the SP500 breaking down through its immediate term TRADE line of support (917). With the US Dollar down on the day, why did this happen? Sometimes the answer is I don't know. Sometimes I just call it squirrely. Sometimes, real-time prices end up discounting something that I can't quite see, yet. Remember, market prices don't lie; people do.
 
Are we starting to discount the end of the inverse correlation between REFLATION in Global Equities and the US Dollar? At this juncture, that would be a very premature conclusion to make - we don't have anywhere near the amount of days or volume in the data series to confirm anything other than what you see in front of you today. That said, extremely high r-squares like this aren't perpetual. When consensus hits its crescendo, correlations start to unwind.
 
Three and six months ago, when I'd write about Breaking The Buck, some people saw what my investment team was seeing. Today, when I write about Burning The Buck, most people do. Those who are ultra patriotic about the currency or their politics don't see anything other than the qualitative stories they like to tell themselves, but quantifying things seems to at least tone them down.
 
Being politically polarized or ragingly bullish/bearish probably isn't going to help you at this stage of the game. This game of global investing is as interconnected across asset classes and geographies as it has ever been. No matter how politicized the US Financial System has become, you have to accept it for what it is, and keep playing the game that's in front of you.
 
Why does the US Dollar continue to trade lower this morning? I see two reasons - both are political:
 
1.       The BRIC Summit is ending with explicit comments from the Brazilians, Chinese, Indians, and Chinese that the world needs a new reserve currency
2.       The US Federal Reserve is starting to signal to the manic media that they won't be talking about raising interest rates at next week's FOMC meetings
 
Both of these lines of political rhetoric are perfectly predictable. There is no way on God's good earth that President Obama is going to let Bernanke be objective and address where inflation expectations are going come the 4th quarter - at least not next week. Obama signaled this last night on Bloomberg, floating the 10 bagger out there (as in 10% unemployment), as his political trial balloon. The US Treasury market bought that hook line and sinker, as it should have, and bond yields are treading lower for the 3rd straight day.
 
In the face of the yield on 10-year US Treasuries dropping 32 basis points since last Thursday's crescendo of consensus that printing money forever doesn't end well, can the US stock market put in her 3rd consecutive down day? We will have to see wont we...
 
The New Reality remains: Americans aren't stupid like some of the economic savants from Washington to Wall Street consider them to be. When Joe Biden starts framing up the unemployment line political football on Meet The Press by talking about his team's "Econometric Models", what do you think your average American sniff tester smells? I can tell you this - this morning's ABC/Washington Post Consumer Confidence survey tells you this smells like a fart.
 
Consumer confidence erosion is collateral damage that the US stock market has to deal with as REFLATION moves towards INFLATION. Prior to this 3-day drop in bond yields and oil prices, the US Consumer was faced with higher cost of capital, higher gas prices, and a credibility crisis in her currency. That's why the ABC confidence reading dropped to -49 versus -47 last week. Americans vote with their wallet.
 
This morning, our macro models are showing a price of oil at $71.31 or higher as the elasticity point that triggers turning REFLATION into INFLATION. If the US Dollar can regain some credibility, the Obama "econometric" team doesn't have to worry - a stronger dollar will imply a lower oil price. Stay tuned on that front...
 
For now, across asset classes, the real-time marked-to-market prices that matter to Americans are at a very critical stage. "They say that time changes things, but you actually have to change them yourself." My downside support level for the SP500 is now 904, and I have immediate term upside +3% higher than yesterday's close at 936. Trade the range and  keep moving out there. After a day that was as confusing as yesterday, that's all you can do.
 
Best of luck out there,
KM

LONG ETFS  

EWZ - iShares Brazil - President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt -leading to an investment grade credit rating. Brazil has managed its interest rate to promote stimulus. Brazil is a major producer of commodities. We believe the country's profile matches up well with our re-flation theme.

SPY - SPDR S&P 500 - The S&P500corrected on 6/15 from the YTD high on low volume.  The S&P 500 is positive from a TREND duration and negative from a TRADE duration. This is a market that has a very predictable range, one we'll trade with a bullish bias.

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

XLV - SPDR Healthcare -Healthcare looks positive from a TREND duration and moved to negative territory for a TRADE. 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 think Energy works higher if the Buck breaks down.  Bearish TRADE and bullish TREND.

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.  

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.


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