"If you're not confused, you're not paying attention."
~ Tom Peters
Yesterday, the SP500 locked in its 3rd consecutive down day, taking its correction to -3.8% from the year-to-date high (946) established last Friday. With the SP500 having broken my immediate term TRADE line (917), but holding comfortably above the intermediate term TREND line (845), now we have ourselves a good ole fashioned game of bulls and bears trading a proactively predictable range.
The REFLATION bulls have been in it to win it since the US Dollar started collapsing in March. The easy money here has been made. Being long everything that's denominated in Dollars was a winner, and everyone finally has to agree with that revisionist math. Alongside that crescendo of consensus comes compression in returns. As the head trader at a hedge fund I used to work for would say - "that's it - the guys in the white coats have figured this out."
He's a funny guy - he calls the "quants" the guys in the "white coats". You know, the nerdy guys who do math before they do "fundamentals". But isn't math fundamental? The pretension of this business is funny - if you're at a fund that combs through 10K's and engages in the almighty "one on one", you honestly think of yourself as being the fundamental guy, dismissing the scientists and mathematicians process as "quant." I wonder what Darwin would think about this industry...
Darwin taught us that if you are confused and/or losing, that you better evolve. That's what makes a great global market operator - she keeps moving. High R-Squares and inverse correlations are not perpetual. People in this business chase trends and eventually crowd out returns. That's not new. Yes, the tickers might change, but the behavioral side of this business never does.
Out of the 9 sectors in the SP500, the worst 4 performers yesterday were XLF, XLE, XLB, and XLI (in that order of worst (Financials), to 2nd worst (Energy), to Basic Materials and Industrials). With the US Dollar down, this was downright confusing. When the Dollar is down, the REFLATION trade is supposed to work!
Since I am long Energy (XLE), that was annoying. Why is the market all of a sudden starting to annoy us? I'll give you three of my latest thoughts:
1. After both a crash and a squeeze of generational proportions, range bound markets can be annoying
2. REFLATION traversing the last part of its easy money move and morphing into INFLATION will be annoying
3. RE-REGULATION of the US Financial Market is annoying
On the first point, I think I have riffed enough - calling for crashes and bubbles AFTER they occur doesn't work. Managing toward tail risk is a proactive exercise, not a reactive one.
On the second point, my investment team is doing a great deal of work as of late. Yesterday's CPI report in the US not only flashed DEFLATION, but the lowest CPI reading since 1950! I don't see reported inflation coming onto the field as THE political football until Q4. Three of my leading indicators on that front are 10-year US Treasury yields, Dr. Copper, and the prices of West Texas Crude oil.
Here are my current levels where I think REFLATION becomes INFLATION come Q4:
1. 10-year yield > 3.29%
2. WTIC Oil > $71.31/barrel
3. Copper > $2.24/lb
On the third point, this is where confusion reigns. Primarily because his "economic" team is dominated by lawyers, college professors, and politicians, President Obama doesn't get this yet, because no one on his team does. For those of us real-time practitioners of the trade - stock market operators if you will - confusion in market's breed contempt. Contempt erodes confidence. Without confidence, markets lose multiples.
On the topic of RE-REGULATION, I will point to three of the best written points I have read as of late.
1. In his June "Investment Outlook", Bill Gross wrote: "Of one thing you can be sure however: over the next several decades, the ability to make a fortune by using other people's money will be a lot harder. Deleveraging, reregulation, increased taxation, and compensation limits will allow only the most skillful - or the shadiest - into the Balzac or Forbes 400."
2. In his "Weekly Screed", our Chief of Compliance (ex-Carlyle hedgie with me), Moshe Silver wrote: "Bair is, as far as we know, the only regulator in charge of a federal agency who actually gets her hands dirty when things get ugly. Her agency confronts massive financial failures - failures that wreck communities, shutter industries, and ruin people's lives - and Bair has waded in to join the battle on more than once occasion. Bair's public image is that of a person more concerned with doing her job than with keeping her job."
3. In his comments overnight, Bank of England Chief, Mervin King said: "some of these banks may be too big."
Confusion is what it is. Like this rain we are getting on the East coast, it's annoying. But no matter where you go this morning, there it is... and we have to deal with it... so get up from your desk and go buy yourself a white coat would ya!
My immediate term downside support level for the SP500 remains 904, and upside resistance 933.
To Laura's grandmother, Mimi, we will miss you dearly. Thanking you for making us all smile,
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&P 500 is positive from a TREND duration and negative from a TRADE duration. Yesterday was not a bad recovery from the 904 line, but not convincingly bullish either.
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.
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 resourcerich 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
XLP - SPDR Consumer Staples - We shorted XLP on the bounce on 6/17. The immediate term TRADE line here is breaking down and so is consumer confidence. TRADE is negative, TREND is positive.
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.
