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Don't Hold Back

"Don't let the fear of striking out hold you back."
-Babe Ruth
 
After yesterday's move in the market, it's only fitting that today's Early Look is U.S. focused.  We are swinging away everyday at Research Edge without fear.  
 
Largely on the back of "better than bad" economic news, the S&P 500 increased the most in two months since crushing the 200-day monkey average (875) short seller like a bug.  The move higher was convincing with volume up 31% day/day and breadth was very positive (86% advancers/12% decliners).
 
The good news does not end there.  Last night China reported that GDP grew 7.9% (better than consensus) and now trends in Japan are "less bad" as The Bank of Japan raised its economic assessment for a third month.  
 
While the VIX remains broken across all 3 durations, yesterday it was up alongside the S&P 500; this has only happened 13 times since 1990.  My guess is the VIX was reflecting the fact that there are still lingering reminders that things are not perfect in this world.  
 
Apparently, the CIT Group Inc. is probably not going to receive a federal bailout.  Finally, the government is doing the right thing.  While I have a good friend that works at CIT, the federal government SHOULD NOT bail out CIT.  I have no desire to spend my money bailing out another CEO, who may have taken on risk at a time when he should not have.  Let the chips fall where they may!
 
Yesterday's rally was all about REFLATING assets or as we call it "BURNING THE BUCK" - the dollar index got smoked yesterday, down 1.0%.  Not surprising, the consumer names underperformed as they should; the trends impacting the consumer remain weak.  It's being reported today that the US issues with housing are not getting much better.  The number of U.S. households on the verge of foreclosure soared by 15% in 1H09, and foreclosure filings rose more than 33% in June year-over-year and were up nearly 5% from May.  
 
For the next two weeks it's all about earnings and so far the earnings season has started out relatively strong.  Of the 6% of the S&P 500 that has reported earnings so far, 71% have reported a positive earnings surprise relative to analysts' expectations.  
 
Although, as we learned from YUM Brands a positive surprise does not always lead to positive commentary about the balance of 2009, which is another small reminder that consumers around the world are feeling a pinch - still.
 
We have laid out our 3Q themes, and most of them seem to be playing out as expected early in the quarter.  Yesterday, the "BUCK WAS BURING," REFLATING parts of the market.  REFALTION coupled with a powerful short covering rally (inspired by INTC) led the market to the higher end of our other theme "RANGE ROVER" - a call that the S&P 500 will trade in a tight trading range of 9% in the intermediate term.  
 
The futures are slightly lower right now; the economic reality is that the world is healing but the wound is still open and CIT is reminding us there is still trouble in corporate America.
 
Function in Disaster; finish in style   
 
Howard Penney
 

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.

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
 
XLI - SPDR Industrials - We don't want to be long financial leverage, which is baked into Industrials. We want to short this ETF ahead of GE reporting on Friday.

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.

DIA  - Diamonds Trust- We shorted the financial geared Dow on 7/10, which is breaking down across durations.

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.  

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.