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    MARKET EDGES

    Identify global risks and opportunities with essential macro intel using Hedgeye’s Market Edges.

“No one can possibly achieve any real and lasting success, or get rich in business, by being a conformist.”
-J. Paul Getty
 
On the margin, I thought the unemployment report for May was bearish and the one just reported for June bullish. Bearish and bullish for the US Dollar that is...
 
Fully accepting that the aforementioned statement is a long way from consensus, I am cool with that – it was when I called the May report US Dollar bearish. I have a quote taped on the inside of my notebook from the Science and Technology section of The Economist dated February 7th, 2009 that says “what seems to be going on is that everyone instinctively feels compelled to copy the others, rather than making an independent assessment of the situation.” The article was about evolution.
 
Are we, as an investment community here in the United States of America, taking this Crisis in US Financial Credibility as an opportunity to evolve? Or are we doubling down on the groupthink that got us in this mess?
 
Consider the following Bloomberg headline this morning (#2 in terms of stories read as of 530AM EST) “Stocks, Oil, Metals Drop on Economy Concern; Yen, Dollar Gain.” Does that even make any sense? If you believe that global currency markets are lagging indicators, maybe… but the entire notion that long term interest rates (10y year US Treasury yields) and the US Dollar strengthening off its lows in the last 3-days is a lagging indicator doesn’t make any sense to me. Currency markets are leading indicators.
 
With the SP500 having corrected -5.3% from her YTD high of 946, if you are still in the Depressionista camp and you are following the perpetually negative stance of Alan Abelson, you might even believe that unemployment is NOT a lagging indicator. While I still can’t believe he wrote that, he probably can’t believe that Chinese stocks hit another YTD high last night either! 
 
Perpetually polarized in your political or investment view is not an evolutionary process. Objective minds get that. When Abelson called the “second derivative” thesis “hypothetical, but bullish” this weekend, what he was implying, I guess, is that calculus is some form of alchemy.
 
The New Reality is this: the US investment community’s consensus drum beaters need to evolve or the USA is going to continue to get run-over by the Chinese at +71.6% YTD. The ways of investing along the lines of the perceived wisdom of Wall Street’s crowd have rendered a YTD return for the Dow Jones Industrial Index of -5.7%.
 
Yes, the Dow is an old school index that the math guys rarely use anymore (30 components are less statistically relevant than 500 – fascinating conclusion), but next to London’s FTSE index, which has lost -5.6% YTD (as of this morning’s down -1.2% open), that’s about as bad as major country indices get.
 
Now back to last Thursday’s unemployment report. In terms of our intermediate term TREND cycle work, our investment process cares about one line item in that report – the unemployment rate.
 
At 9.5% year-over-year unemployment, the month of June was only a +10 basis point rise versus that of May (9.4%). This stands in stark contrast to the +50 basis point rip we say in May versus April (8.9%) and this, Mr. Hypothetical, is what we call a sequential deceleration in the rate of growth.
 
So what did I do with this? After the May report (first week of June), I started selling down gross long exposure to US Equities  and shorting US Consumer stocks. I currently hold a 9% position in the Asset Allocation Model to US Equities, and I’m short both Consumer Discretionary (XLY) and Consumer Staples (XLP).
 
Now what do I do? With the topping process of a lagging economic indicator in the rear-view, I will be covering my shorts in US Consumer stocks, and taking up my gross long exposure to US Equities. Being short anything on a perpetual basis is no risk management process of mine.
 
I know, I know… this probably doesn’t rhyme with what you’re seeing on CNBC this morning. It definitely doesn’t jive with a front cover article on Barron’s called “Short These Stocks.” But you know what? I really couldn’t care less. If all I did was follow these thundering herds, I might be agreeing with Merrill (or is it Banker of America?) this morning and getting bullish on my Chinese growth estimates AFTER the Shanghai Composite Index has move +80% to the upside!
 
Let’s not get our shorts in a knot this morning. The New Reality is that the crash and bubble watchers are consensus, and we men and women of the risk management gridiron see a fairly straightforward immediate term trading setup that’s both proactively predictable and manageable.
 
Looking back at another peak in sequential US unemployment gains (May) provides the US Dollar an immediate term bid. Dollar up = everything else down. That’s what I saw on Friday. What I see now, at a price, is an opportunity to start getting invested again. Buy low, sell high.
 
I have intermediate term TREND line support for the SP500 down at 871 and long term TAIL resistance for the US Dollar Index up at $82.32. Understanding that US stocks have an inverse correlation to US currency has been the 2009 strategy, and until that math breaks down there’s no reason to dance to the consensus beat of Mr. Hypothetical’s alchemy.
 
Best of luck out there this week,
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.

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.  Energy flashed a major negative divergence last week.  TRADE and TREND are positive.

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.


SHORT ETFS

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.