"All the busy little creatures chasing out their destinies... living in their pools they soon forget about the sea..."
- Neil Peart
Ok, Keith quotes Nietzsche, and McGough quotes lyrics from Canada's most successful progressive rock trio. Poke fun if you'd like, but no one can ever claim that we at Research Edge are not open to inspiration from all angles!
But this quote hit home with me yesterday as I drove down I-95 from Boston to Connecticut. I had the pleasure earlier in the day of having lunch with one of the future leaders of Wall Street. Half of our conversation revolved around the obscenity surrounding how so many people are trying to time little ripples of info related to 3Q and 4Q EPS instead of focusing on 30-foot waves forming on the horizon. Ever sit on a surfboard and get caught up watching the beach instead of the horizon? I don't suggest you try. It hurts...
But that is what we're seeing now on the Street. There's no shortage of stats that should make us step back and question where the long term opportunity really is. Consider the following...
1. US retail sales growth came in at -8.99% last month, and the 'chatter' was all about how this was a positive development because it was better than expectations. But what about the 15% growth number we saw in China?
2. 860k autos were sold in the US in June per Motor Intelligence. But that compares to 1,142k in China in the same period.
3. 510,563 total new accounts opened throughout the second quarter at Etrade, TD Ameritrade and Charles Schwab combined. Yes, that's a big number. But what about the 484,799 new individual equity accounts opened in China LAST WEEK?
I won't beat this China horse any more. Our Macro team just published a China Black Book that more than covers everything any investor needs to know on the topic. (If you'd like a copy, feel free to email )
But what about investors that are staying closer to home (either by choice or by mandate)? Even within the US, I feel like people are hyper focused on the tidal pools. The best example is CIT.
I can't even count the number of calls I got last week on this whole CIT situation. "Hey McGough... what name can I play on this theme?" The answer? No one. To try and pick one company that will get hurt is a useless exercise. Spending effort on that is completely missing the potentially HUGE call, which is picking the second and third derivative of this situation. This all boils down to private equity as a three-legged bar stool. What do I mean?
a. Let's look at all the PE deals done over 5 years at peak multiples and peak (single digit) margins. Now layer on a weaker consumer and 100% debt to total capital. Cash flow ain't looking too good. These smaller and/or private companies are the ones that will be most impacted by tightening credit/factoring.
b. Now let's look at the portfolio of companies for each private equity firm - it's not that tough to do. All it takes is for one domino in the portfolio to topple, and then others could follow as they trip covenants, and act irrationally as they try to keep their heads above water. (2nd derivative).
c. Then this plays into the third derivative (mathematically speaking, there's probably a better way to frame this up - but you get the drift). This includes the impact of the vendors, retailers, sourcing companies, and other trade partners that will be impacted as dominos fall. You can go to your little one-on-one meeting at a conference and have a CEO tell you that all is hunky dory. But I can all but guarantee you that 90%+ of them are not spending a whole lot of time on whether this key critical uncertainty even exists - nevermind how to come out on top.
This is when investors get paid to not only think a step ahead of the competition, but to think a step ahead of the people running the companies.
Rock on...
Brian McGough
LONG ETFS
CYB - WisdomTree Dreyfus Chinese Yuan- The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.
COW - iPath Livestock - This ETN tracks an index comprised of two thirds Live Cattle futures, one third Lean Hogs futures. We initially began looking at these commodities because of recession inspired capacity reductions combined with seasonal inflections. A series of macro factors including the swine flu scare, a major dairy cattle cull in response to collapsing milk prices and the collapse of the Argentine agricultural complex due to misguided policy provided us with additional supporting fundamental data points for the quantitative set up in price action.
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 - 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
LQD - iShares Corporate Bonds - Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back.
XLI - SPDR Industrials - We don't want to be long financial leverage, which is baked into Industrials.
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 - As Reflation morphs into inflation, the US Consumer Discretionary rally will run out of its short squeeze steam. We shorted XLY on 7/9 and again on 7/22.
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.
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