"Victory is reserved for those who are willing to pay its price."
- Sun Tzu
This morning we are waking up to Timmy Geithner headlines. He said "it's going to be awhile before we're confident we're going to have a strong sustainable recovery in place" and that "enormous challenges" remain for the US economy. I don't disagree with any of that.
Take the man's word for it - he'd know. Geithner is not the person to be leading America into the next stage of this global economic battle. Neither are the boys in London that he'll be meeting with today. At -7%, respectively, the UK's FTSE and the US's Dow are in a dead heat for the worst performing country indices in the world this year for a reason. Neither country has paid the price of change.
Paying the US Bankers, Politicians, and Debtors is not a long term fix. It's a REFLATION trade, and my best strategy advice is to keep it one. In the long term, you cannot burn the US Currency, her Creditors (China, Japan, etc...) and US Consumers (via zero rates on their savings).
Overnight, Japanese equities got rocked because they finally started hinting at paying that price. The old boy network of a conflicted past has finally called an election. After the LDP's government rule dating back to 1955 (for all but 10 months), there looks to be a very high probability that the DPJ (Democratic Party of Japan) will find a victory in the fall. Old habits die hard, and so will the idea of holding a monster position in US Treasuries.
The shadow finance minister for the DPJ made explicit comments that the new Japan will need to focus on economic gravity. That includes diversifying away from the USD Dollar and US denominated bonds. Since Japan holds $685B worth (2nd most to China), now we know the rest of the story - China, Japan, and Russia are not only net sellers of US Treasuries, they are willing to pay the price.
For Japan, paying the price of repatriating their debt equals a 5% reflation of their currency already for the month of July. It also equates to a smack down of their stock market. This is an island economy that needs to export in cheap Yen, don't forget. Strong currency = bad for the price of exported goods to China. Samurai bonds anyone?
We are short Japan in the virtual portfolio (see www.researchedgellc.com) not because we saw this morning's political news coming, rather because Japan is a levered long disaster in the making. No matter what price this country is willing to pay in the short term, they remain "long of" A) negative population growth, B) government debt/GDP ratio of almost 190%, and C) negative quantitative price momentum developing in the Nikkei.
Japan's Nikkei was down every day last week, and closed down another -2.6% last night. This takes the average of the Japanese stock market below the intermediate term TREND line for the first time since March. This is new.
Admitting that you need to pay the price to change doesn't mean that everything starts to go well for you thereafter. In order to realize long term economic victory, this is just the way that it has to go. After almost 55 years of one party rule, you can bet your Madoff that political change in Japan will be met with concern. In markets, concern breeds contempt.
Across the board, this is the primary reason why Asia got rocked overnight. Chinese equities were down the least, losing -1.1%, taking their YTD gain down to +69% (the peak was established last week at +71.5%). Meanwhile, Hong Kong lost -2.6% and Korea and Taiwan got tagged for -3.5% down moves, respectively. It's been a while since I have logged almost all red in my notebook for a morning in Asia. Everything that matters in my macro model occurs on the margin.
The only country that closed up meaningfully in Asia overnight was Pakistan. Assuming most of you aren't "long of" the tribal traunch, that probably doesn't help you much either. Pakistan closed +2.3% overnight, and it matters.
Why does it matter? Well, the price of oil always implies some level of geopolitical risk. The stock market in Karachi stabilizing in the last few weeks means that tensions in the Swat Valley have at hit their crescendo, for now. From Iran to North Korea, I am comfortable saying that, for now, the rear view of 3 weeks ago looks to have been what it was, a 2009 peak for the price of oil.
Oil prices have corrected -17% in 3 weeks. That's a lot. As the Japanese Yen and US Dollar stop going down, the price of everything you buy in these currencies stops going up. There is a price for currency stability. And, sorry levered long guys, that's not one that the debtors of dollars and yen are going to like.
I don't want to be long financial leverage. I want to be long liquidity and the economic leverage associated with unlevered demand. That's why I am short the Dow Jones Industrial Index right now (DIA). That's also why I am long the Nasdaq (QQQQ). This is a very straightforward way to hedge my macro views.
Intermediate term TREND line resistance for the Dow is 8224. Intermediate term TREND line support for the Nasdaq is 1707. I have no position in the SP500, yet. I am short Japan (EWJ), long China (CAF), and if you can find me some puts on Timmy Geithner's global macro investment process, I'll pay a premium price for those.
Best of luck out there this week,
KM
LONG ETFS
USO - Oil Fund-We bought USO on 7/6 and 7/8 on a pullback in oil. With the USD breaking down, oil should get a bid.
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 and added to the position on 7/7 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.
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
DIA - Diamonds Trust- We shorted the financial geared Dow on 7/10, which is breaking down across durations. We are long the NASDAQ via Qs, which is long liquidity and economic leverage.
EWJ - iShares Japan -We're short the Japanese equity market via EWJ on 5/20. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.
XLY - SPDR Consumer Discretionary - We shorted XLY on 7/9 on a rip as our team has turned negative on consumer.
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.
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.