“Do not dwell in the past, do not dream of the future, concentrate the mind on the present moment.”
-Buddha
Last week, when addressing the selloff in China, Andrew Barber wrote a fantastic Early Look titled, “The Present” – and no matter where you go this morning, here we are. Don’t get excited. Don’t freak out. Take a deep breath and a sip of your coffee. It's time to grind with the newly issued facts on your screens.
One of our top performing clients is a swimmer. While there is no secret that I have a confirmation bias for athletes, that certainly doesn’t mean everyone on my Research Edge Team had to have been a good one. Barber is one of our best players - ask him how fast he can run 100 meters!
My point here is a simple one. And it’s one that my client made to me last night. She just finished swimming a mile and wrote, “it settles my mind.” Simple is as simple does. Rinse and repeat. She is a testimony to that discipline – her track record ranks her at the very top of all Mutual Fund Growth and Income Funds. No, super duper momentum Fund of Funds dude, not last month - over the cycle of the last 5 years, when plenty an emotional PM was set out to sea.
From the Top, to the Bottom, and Back Again. We’re looking to learn from those who have successfully swam both with and against the current of consensus. Up or down, side to side. Being a successful investor in The New Reality requires a settled mind that does “not dwell in the past” or “dream of the future.”
Dreaming of becoming a billionaire or waking up with that on your mind doesn’t register with me as good pre-game prep. So, let’s do up our chin straps and get ready to settle our minds into the dirty stuff. Ranges, deltas and spreads – risk management style. This next part of this market’s move is going to be all about the grind.
The SP500 hasn’t budged this week. On a closing basis, over the course of the last 3-days, it has traded in a 0.30% range. It’s a grind. So settle your mind, and deal with it.
When we grind like this, we’re setting up for a big move. You don’t need to be a swimmer to get the analogy that I like to use with my team – the grind is the time where we’re holding a Ball Underwater.
The question here is which Pain Trade is going to explode out of this grind? The answer, as you’ll probably guess, lies with one global macro factor – the US Dollar.
Dollar up = everything priced in dollars down. Dollar down = everything priced in dollars up. If you don’t like getting dirty, get wet – and rinse and repeat this inverse correlation until you are soaking with alpha.
While the SP500 was dead flat yesterday, the componentry of the US market was very much anchoring on this dominant inverse correlation. Consider the following 3-factor setup of closing prices:
- US Dollar Index up +0.35% to $78.60
- US Financials (XLF) down -0.27% to $14.58
- US Consumer Discretionary (XLY) up +0.57% to $36.55
If Dollar down gets the Bankers, Debtors, and Politicians paid. Dollar up gets the American Consumers and Creditors paid. Yesterday gave us a sneak preview of what a Dollar rally scenario could look like.
This will sound counterintuitive to the legions of hedge funds that remain short the Pain Trade (short the US Consumer), not because of the math – more so because anything that doesn’t rhyme with what gets them paid is sometimes hard to reconcile. Trust me, I have tried shorting these consumer stocks for the last 3 months – I understand pain.
As bearish as I have been for the last 9 months on the US Dollar is as bullish a breakout it can have if that’s the Ball Underwater that we are going to have to deal with. In the last 3 weeks our call on the US Dollar has definitely morphed into consensus (Buffett, PIMCO, etc…). Consensus groupthink can be a scary place.
Not surprisingly, of the four SP500 Sectors in our Sector Views Risk Management product that were down yesterday, the aforementioned Financials (XLF) were one of them, and so were Basic Materials (XLB). These are two of the highest beta sectors in the market. Both are REFLATION sectors. So, AFTER, the most expedited short squeeze in US stock market history, we’re now forced to deal with a scenario that is potentially much different than the lay-up we have had for the past 6 months.
Bernanke now has his job security. On the margin, that means he doesn’t have to pander as much. Less political pandering = less US Dollars for sale. Why? When reported inflation accelerates in Q4 (it will), he will start to move to where the bond market is already headed – HIGHER THAN ZERO on the Fed Funds rate.
Rates up = Dollar up = REFLATION trades down. Most will probably agree with me on that. I have the immediate term TRADE breakout line for the US Dollar 8 cents (and 8 seconds) away from breaking out. That line is $78.62. That’s The Present. That’s your Ball Underwater.
I have immediate term TRADE resistance for the SP500 at 1041, and immediate term downside support at 1009.
Best of luck out there today,
KM
LONG ETFS
EWH – iShares Hong Kong — The current lower volatility in the Hang Seng (versus the Shanghai composite) creates a more tolerable trading range in the intermediate term and a greater degree of tactical confidence.
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 reflation call.
QQQQ – PowerShares NASDAQ 100 — We bought Qs on 8/10 and 8/17 to be long the US market. The index includes companies with better balance sheets that don’t need as much financial leverage.
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.
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. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient 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 that bonds will give some of that move back. Shorting ahead of Q4 cost of capital heightening as access to capital tightens.
XLP – SPDR Consumer Staples – We shorted XLP on a bounce on 6/21. One way that investors chase a bearish USD is buying international FX leverage in global consumer staples. Shorting green.
DIA – Diamonds Trust- We shorted the financial geared Dow on 7/10, 8/3, and 8/21.
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.
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.