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"The human body can take damn near anything. It's the mind that needs training." - Instructor Reno
For those who took Keith's book recommendation on May 26th, you'll know that quote above is from a drill instructor depicted in The Lone Survivor, Marcus Luttrell's first person account of the 2005 SEAL operation in Afghanistan that resulted in the greatest-ever single-day loss of life in the elite unit's history.  
Instructor Reno says this during the infamous SEAL 'Hell Week,' which puts the candidates through unthinkable mental and physical stress with the purpose of eliminating all but the toughest warriors on the planet. The part of this quote that I can't (and don't want to) shake is that towards the end of Hell Week, if someone expressed the desire to quit, the drill instructors would offer them a second chance before they officially 'rang the bell'. A seemingly kind gesture, but one offered with indifference. Why?
No one who takes the offer actually ends up finishing the program - ever.  Once the thought of quitting manifests itself into action, it's pretty much 'game over.' It's like trying to uncrack an egg. Those that complete the program and join the esteemed ranks of the Navy SEALs were truly in control of their own destiny - mentally and physically -- throughout the entire torturous initiation.
I know... you're probably thinking "Thanks McGough, but I'd love to see how you're going to actually tie all that in to an investable theme." That theme is something that you've seen Keith write about time and time again - proactively building and managing a process that allows you to always be on offense, and in control of your destiny.
Trust me; I'd love nothing more than to tie-in the armed forces theme with bullish comments about US markets as Independence Day draws near. But I cannot.
The real survivor in this interconnected Macro web is China. China is in control of its own destiny, and if it ever feels the desire to 'ring the bell,' it certainly does a great job of hiding that from outside observers like me.  China is always on offense - always in control - always a capitalist.
Check out the third most read story on Bloomberg this morning. "China Allows Yuan Trade Settlement, Offers Tax Breaks To Shift From Dollar."  China's official statement includes the following verbiage...
"Companies in China and neighboring countries are facing relatively huge risks of exchange-rate fluctuations because of big swings in the U.S. dollar, the euro and other major settlement currencies during the global financial crisis."
Need I say more? Probably not. But I will anyway...
Let's also take this to the industry level -- Apparel/Footwear Retail for example (86% of our footwear comes from China alone).
There's a lot that controls the margin inputs for any company. For a company tied to this supply chain, one of the majors is the FOB cost of the goods. In plain English, this is Freight On Board, and represents the all-in cost to land a product on US shores. From 2000 through 2007, this cost came down precipitously as capacity in China grew to fulfill a change in WTO regulations that allowed it to scale up production. The timing and magnitude of this change allowed so many US players to garner more margin dollars than they deserved.
But then China changed its offense. In 1Q07, with the Olympics looming, China cracked down on sweat shops, mandated back-pay for factory owners to employees for unused vacation time, and pulled the ultimate lever to reduce capacity - it lowered the VAT rebate. The VAT (value added tax) stands at about 17% in this category, and the government rebates a given portion of it to encourage exports vs. local consumption. In early-'07 this rebate stood at about 13%, and subsequently came down into the single digits.  Think about it...if you are a factory with a profit margin of 3% (about average over the past 10 years) and then not only do your labor costs go up, but your VAT rebate goes down by 500bps, that turns into a pretty catastrophic event. The result? In '07 and '08 the factory count in China's Pearl River Delta went from about 12,000 down to about 6,000. No joke...
The trajectory of exports fell like a stone - bottoming at -23% in 1Q. So how did China react? Yes, the VAT rebate is headed up again - and now is at 15% (above '07 peak). Other countries such as India, Malaysia, Indonesia, Pakistan, and others have followed suit. We've seen around 1,500 factories reopen in China, and there's more to come.

Capitalist Survivor - image001

How's that for proactively managing growth? Most US retailers don't even have a clue as to this dynamic. I'd argue that we're entering a period where they earn what China wants them to earn.
The bottom line is that the companies that really 'get' China are the real survivors. That's the long-term call. There are the ones that have been investing there over the past 10 years. Not those that started last week because the manic media said that they have to.
Have a terrific long weekend with your loved ones, and thanks to all those courageous men and women who are unable to do so as they fight to protect the freedom of this wonderful country.
Brian McGough

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.

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 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.  

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.

XLV- SPDR Healthcare - We re-initiated our long position in healthcare on 6/29. Our healthcare sector head, Tom Tobin, wants to fade the public plan, and he's been right on this one all year.

GLD - SPDR Gold - Buying back the GLD that we sold higher earlier in June on 6/30. In an equity market that is losing its bullish momentum, we expect the masses to rotate back to Gold.  We also think the glittery metal will benefit in the intermediate term as inflation concerns accelerate into Q4.


EWI - iShares Italy - Italian Prime Minister Silvio Berlusconi has made headlines for his private escapades, and not for his leadership in turning around the struggling economy. Like its European peers, Italian unemployment is on the rise and despite improved confidence indices, industrial production is depressed and there are faint signs at best that the consumer is spending. From a quantitative set-up, the Italian ETF holds a substantial amount of Financials (43.10%), leverage we don't want to be long of.

XLY - SPDR Consumer Discretionary - We shorted XLY on 6/19 as our team has turned negative on consumer in the last week.  

XLP - SPDR Consumer Staples - We shorted XLP on the bounce on 6/17.   Added to the position on 7/1, as our stance on the consumer is no longer bullish like it was in Q2, when gas prices and mortgage rates were dramatically lower.

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