“Man has made some machines that can answer questions provided the facts are profusely stored in them, but we will never be able to make a machine that will ask questions. The ability to ask the right question is more than half the battle of finding the answer.”
-Thomas J Watson
The Research Edge client base is constantly peppering us with questions on numerous topics every day. The challenge of addressing them helps to build the quality of the Research Edge team and the product we produce.
Yesterday, we were asked the following; “At what point does a burning buck get to the point that it's just BAD for everything, especially the equity markets? What are you watching to gauge this risk, and what could be the potential tipping points that kick the correlation the other way...Down Buck, Down Equity Markets?”
The question is very topical but also a very scary one. While we are very happy to have coined the phrase “burning the buck,” the real world implications of a BURNING BUCK are not good! The bottom line - a “burning buck” can only end badly for every one!
We have been saying for months that the most dominant driver of the market is a simple two factor model - the US dollar down and Chinese demand up - REFLATION. Much to my dismay, these factors have trumped any fears of a weak consumer here in the USA.
Yesterday was a classic two-factor day. We saw the US Dollar once again lose its early morning bid! As the dollar lost ground, the S&P 500 recouped most of the day’s losses and finished around the best levels of the day.
This relationship can’t go on forever so what are we watching to gauge this risk that the correlation might end?
(1) A breakdown to the $72-74 range for the US Dollar index only has one precedent (a US stock market crash in Q3 of 2008), so watch for that
(2) Volatility (VIX) breaking out above the $27.13 level combined with an expanding TED spread (haven’t seen either yet)
(3) A breakdown in the SP500 below the TRADE line at 1014 combined with the Nasdaq cracking 2,008
“What could be the potential tipping points that kick the correlation the other way?” That is a much harder question to answer because we could easily see the dollar up and stocks down as we head to Q4 and our REFLATION ROTATION theme continues to play out.
We need to look to the Chinese as a critical factor to understand if we will see “dollar down and stocks down.” Right now Washington is doing everything possible to make the Chinese officials hate us more than they already do. Despite the administration’s moves over the weekend, President Obama said yesterday “we are not going to see a trade war.” He is right there will not be a trade war because we can’t afford it.
While there may be “rules on the books” that sparked the recent trade issues, the Chinese have us over a barrel when it comes to more important issues like funding our deficits.
I understand that the president is a politician first, and that he needed to throw the UAW a bone to help pass his healthcare reform plan, but this is not a good situation. Clearly, this is a dangerous road the Obama administration is going down and I’m very surprised that it has not set off a correction in the equity markets.
On the contrary to the market selling off yesterday, the Research Edge quant models moved back to a perfect nine of nine sectors positive on both TRADE and TREND.
What do you think will happen to the dollar and the markets if the Chinese send another message next week at the G20 meeting that they are “worried” about the safety of its investment in U.S. debt, as the BURNING BUCK erodes the value of their holdings? That’s right there is no trade war!
Keep the questions coming!
Function in Disaster; Finish in style
GLD – SPDR Gold — We bought back our long standing bullish position on gold on a down day on 9/14 with the threat of US centric stagflation heightening.
FXC – CurrencyShares Canadian Dollar — With the USD continuing to Burn we added to our International FX exposure (we’re also long the Chinese Yuan) on 9/14 via the Canadian Dollar.
XLV – SPDR Healthcare — We’re finally getting the correction we’ve been calling for in Healthcare. It’s a good one to buy into. Our Healthcare sector head Tom Tobin remains bullish on fading the “public plan” at a price.
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.
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.
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.
EWU – iShares UK — We’re bearish on the UK’s leadership and monetary policy to weather its economic downturn. Although we’re seeing improved fundamentals within the country and across Europe we continue to see the country’s financial leverage as a headwind and increasingly the data suggests that inflation is getting ahead of growth. With the FTSE reaching a YTD high on 9/9, we shorted EWU.
DIA – Diamonds Trust — We shorted the Dow on 9/3. In the US, we want to be long the Nasdaq (liquidity) and short the Dow (financial leverage).
EWJ – iShares Japan — While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership appears, if anything, to have a less developed recovery plan than their predecessors. 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.