This note was originally published at 8am on January 05, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“He who will not economize will have to agonize.”
Sitting at my desk in New Haven this morning, what I do know is my own pain. What I don’t know, is what someone else’s feels like. We’ll see how the levered-long US stock market bulls feel on the first tweak today. This isn’t a snap, yet – this is a tweak.
The agony of defeat isn’t new to global macro markets as of this morning. It’s been new to US Treasury and Emerging Debt Markets since November. It was new to the Gold market yesterday during a $40/oz swoon (we’re short GLD). What goes around in terms of mean reversion risk, eventually comes around. You can learn this lesson in a variety of ways in life. In markets, the best way to learn this lesson is the hard way.
If you didn’t raise your Cash position in the last week, it wasn’t because we didn’t tell you to. We started the year with a 61% US Cash position in the Hedgeye Asset Allocation Model and the US Dollar Index has been up every day for the year-to-date (including this morning).
Yesterday, on commodity market weakness we invested 6% of our cold hard cash into oil and corn. Now we have 55% of our hard earned capital in cash. Being in Cash means you can invest it lower.
To be sure, there is absolutely no doubt that you can ride Hi-ho, Silver and call yourself Captain Cowboy on the ride to everything making higher-highs, until they don’t. So you better have a risk management plan when the music stops.
In addition to Gold selling off hard yesterday, US small cap and housing stocks got creamed, trading down -1.8% and -1.5% respectively (XBH and IWM). This morning, European stock markets and US Futures are getting hit hard after Portugal raised 6-month paper at a yield of 3.68% (vs 2.04% last!) and Asia closed down across the board.
This interconnected game of risk has always been “on” – it’s just when everyone stops paying attention to the moving parts that it starts to be a lot more fun. On balance, our intermediate-term TREND view on the global economy remains intact:
1. Global Growth Slowing
2. Global Inflation Accelerating
3. Globally Interconnected Risk Compounding
Now, before a US centric stock market bull gets his/her shirt in a knot about this, allow me to kick off this morning’s Global Macro Grind with a remedial reminder that all of the aforementioned points start with the word Global. That’s right, say it just like Paul Newman had the owner of the Charlestown Chiefs say “H-owned”… G-lo-bal… G-lo-bal…
In terms of the global macro data points that are in my notebook for 2011 to-date, here’s the grind:
- South Korean inflation (CPI) jumps to +3.5% in DEC vs +3.3% in NOV and the Korean government declared “war on inflation”
- South Korean exports slow, sequentially, from their NOV highs of +25% to +23.1% in DEC
- Polish Inflation (CPI) jumps to +3.1% in DEC vs +2.7% in NOV and 2-year bond yields in Poland are pushing to +4.9% this morning (highest in a year)
- Chinese manufacturing (PMI) drops for the 1st time in 5 months (53.9 DEC vs 55.2 NOV) as growth continues to slow
- German manufacturing (PMI) accelerates again sequentially to a new high of 60.7 DEC vs 58.1 NOV
- German unemployment stays unchanged m/m at 7.5% for DEC vs NOV
- Brazil’s newly elected President, Dilma Rousseff, kicks off the New Year calling inflation trends pushing to +6% y/y “the plague”
- Pakistan’s PM loses his majority and a key Governor is murdered overnight as Pakistan now has to face the Taliban and +15.48% inflation
- UK manufacturing (PMI) remained flat, sequentially, in DEC vs NOV at 58.3
- Indonesia’s inflation (CPI) accelerates, sequentially, to +6.96% DEC vs +6.33% NOV
- European Union inflation (CPI) accelerates to a 2-yr high of +2.2% in DEC vs +1.9% in NOV
- Australian manufacturing index slows for the 4th consecutive month (pre JAN floods) at 46.3 DEC vs 47.6 NOV
- Thailand inflation (CPI) ramps, sequentially, to +3.0% DEC vs +2.8% NOV
I’ll go Lone Ranger (sans le hi-ho, Gold) and stop at point #13 just to push my own book and summarize that if Captain American Stock Picker (he’s back!) wants to tell me that “growth is back!”… and that the rest of the world’s growth and inflation risks cease to exist… that he/she may want to, at a bare minimum, economize that bullishness and wait for lower prices.
Back to the USA, where consensus is running rampant that the US consumer is Just Lovin’ It (except the collapse of MCD’s stock), this morning’s ABC Consumer Confidence reading (it’s weekly) dropped for the 2nd consecutive week (i.e. dropping both weeks post Christmas shopping) back down to minus -45. That’s only a few points away from its all-time low and even a Thunder Bay Bear on some things US Equities would call that agonizingly cold!
My immediate term support and resistance lines for the SP500 are now 1261 and 1270, respectively. A close below 1261 puts 1237 in play.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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POSITION: Long UUP, Short FXE
One of the most enjoyable aspects of evolving my investment process from Global Consumer in 2003 to Global Macro today has been having the opportunity to un-learn, re-think, and re-learn.
Being right on a currency move is a lot different than being right on what Bill Ackman is going to allegedly file on next. Maybe that’s why my batting averages are higher trading currencies?
Whatever the interconnected reasons for our successes trading the US Dollar over the last few years, we don’t want to break something that doesn’t need fixing, yet. There is absolutely no doubt in my mind that day will come – and maybe soon – but until it does, we’ll call the last 17 long and short calls we’ve made on the US Dollar Index what they are - alpha.
From a risk management process perspective, for us to stay long any security for an extended period of time, that security needs to be bullish on both our immediate-term TRADE and intermediate-term TREND durations. The US Dollar Index currently remains bullish on both.
- TRADE signal = November 4th where we bought it
- TREND line support = $78.70
The question now is whether or not the US Dollar Index can breakout to higher-highs on a long term TAIL duration?
Luckily, we don’t have to answer that question today. In the immediate-term, the best we can do is measure the last price, volume, and volatility in our model in order to come up with our most immediate-term TRADE lines of upside resistance (in the chart below we show that line at $80.98).
All the while, of course, we are coagulating all of the fundamental data we can legally get our hands on, including the fundamental TRENDs in other FX that have an impact on the USD Index basket (Euro, Yen, etc…). In addition to being long the US Dollar, we are short the Euro (FXE).
The US Dollar is now up in 8 of the last 10 weeks and is confounding as many of the USD perma-bears today as the concept of “Euro-parity” confused those who shorted the Euro at the bottom of June, 2010. We like counter-cycle moves – and we love trading currencies.
A bullish currency TREND is bullish for America. Let’s hope that the official convening of the 112th Congress doesn’t screw this up.
Hope, after all, is not an investment process.
Keith R. McCullough
Chief Executive Officer
“Everything has a price. I’d buy anything at a [certain] price if it’s not going to zero”
-Hedgeye Managing Director of Financials, Josh Steiner; 1/5/11
Conclusion: Australia’s economic fundamentals are deteriorating and we expect near-term weakness in their equity market and currency as a result. We do, however, like both Australian equities and its currency over the intermediate-to-long term and will be looking to buy them on a pullback.
Position: Cautious on Australian equities and the Aussie dollar over the near-to-intermediate term; bullish on the intermediate-to-long term.
On December 2, we published a note tilted: “Moderation Down Under”, whereby we outlined several factors that are explicitly bearish for the Australian economy (email us if you need a copy). I’ll save you the time by omitting the details, but, briefly, they are as follows:
- Chinese growth is slowing and the full extent to which China could tighten and slow its growth is being disrespected by global equity markets;
- Rising interest rates are weighting on Australian consumer confidence and boosting the savings rate; and
- Weakness in Australia’s Manufacturing sector continues unabated, contracting for the fourth consecutive month in December to 46.3. Australia’s Service sector also exhibited signs of recent weakness:
In addition to these bearish factors, layer on “biblical” and “unprecedented” flooding (as termed by State Premier Anna Bligh) in the Australian state of Queensland spanning an area the size of both Germany and France combined. The region accounts for roughly 20% of the nation’s A$1.28 trillion ($1.29 trillion) economy and is the location of 73% of the nation’s coal production – Australia’s largest export commodity.
Given this confluence of factors which could lead to slowing growth domestically, why be long Australia?
The answer comes down simply to price. We are bullish long term on Australia because of its commodity production as rising demand from developing nations that may perpetuate global supply shortages. In addition, burgeoning sovereign debt issues in the E.U. and the U.S. will likely serve to keep a floor under commodity prices over the long term TAIL.
In addition to its positive exposure to commodity inflation, we want to be long countries where sobriety reigns supreme in its fiscal and monetary policy (i.e. Australia, Germany and Canada). RBA Governor Glenn Steven’s wasn’t afraid to raise Australian interest rates several times last year to ward off inflationary pressures and Prime Minister Julia Gillard is currently weighing spending cuts to make good on her election promise to balance Australia’s budget in three year’s time. The current flooding in Queensland won’t help, but it will likely help us find a better entry price on the long side when it’s all said and done. Moreover, at 22% of GDP, Australia’s public debt load compares rather favorably with countries we isolate as the worst from a fundamental perspective for a variety of reasons (Spain, U.S. and Italy).
In other news, today's global macro run finally produced some bearish sentiment (albeit moderately bearish) surrounding The Great Down Under. Regarding the Aussie dollar, Thio Chin Loo, currency strategist at BNP Paribas said today:
"The markets are playing it with a very cautious attitude and if China continues to step on the brake to slow growth, then the bets will still be on the downside for the Aussie dollar at the start of the year. So I wouldn't dismiss if the weather situation does not improve or the Chinese policy makers would decide to enact further tightening measures, then the Aussie could clearly break parity."
We expect more bearish sentiment to creep into the market and weigh on the Aussie dollar and Australian equities – at which point we’ll be looking for an entry on the long side of either. To Josh’s point above, every investment has a price and duration. Irrespective of the fundamentals, getting both of these correct is the key to making money on either the long or short side.
From a quantitative perspective, Australia’s All Ordinaries Index is broken from an immediate-term TRADE perspective and bullish from an intermediate-term TREND perspective.
Position: Long Germany (EWG); Short Italy (EWI), Euro (FXE)
While Estonia made news joining as the 17th country to use the Euro as a common currency in the New Year, Europe’s economy continues to be centered on its sovereign debt and deficit issues, with the bailouts of Greece and Ireland in 2010 functioning as mere fiscal band aids. As we’ve pointed out for over a year, we see these fiscal issues plaguing Europe over the next 3-5 years; in the near to intermediate term we’re tasked with managing risk around the volatility throughout the region.
Currently we’re playing Europe’s Sovereign Debt Dichotomy with a short position in Italy (we re-shorted the etf EWI yesterday on strength), a short position in the Euro (FXE), and continued long exposure to Germany (EWG) in our Virtual Portfolio.
However, the data that’s new on the margin is two-fold:
1. Inflation is rising throughout the Eurozone, including the Eurozone CPI average that rose to +2.2% in December Y/Y (versus 1.9% in November), the first time it’s been above the ECB’s 2% target since November 2008; and Eurozone PPI that rose +4.5% in November Y/Y (versus 4.4% in October).
In the chart below we show the growing divergence of CPI across select countries. We continue to emphasize that inflation should rise globally on an absolute basis. When it comes to an investment decision in Europe, we like Germany’s low inflation outlook given the set-up for slowing growth in the region in 2011. (Germany too saw a rise in CPI to 1.9% in December Y/Y versus 1.7% in November, see chart below).
Further, it’s worth note that the inflationary pressures are real (out of pocket expenses) for consumers – the highly publicized and debated austerity programs included measures to raise VAT, and the New Year marked the official increase: the UK from 17.5% to 20%; Spain boosted to 18% from 16%; and Portugal plans to raise its VAT to 23% this year.
Also, weakness in the Euro versus major currencies due to the debt and deficit imbalances could spur inflationary pressures in 2011. We’re currently short the Euro etf FXE with a TRADE (3 weeks or less) range versus the US Dollar of $1.32-$1.35. Certainly, given the magnitude and duration of Europe’s sovereign debt issues, we could foresee significant downside to the common currency that would create its own inflationary pressures.
2. Germany, despite our bullish outlook, is showing signs of “topping” from a fundamental perspective vis-à-vis the Manufacturing and Services PMI.
As the historical PMI chart below shows, from a mean reversion standpoint we see the probability of a move to the downside in these numbers far outweighing the upside over the next months. The 60 line is historically a heavy resistance level. A downturn in the data however isn’t a huge conceptual surprise given that the German economy should slow in 2011 versus 2010: Bloomberg currently estimates GDP at 2.55% in 2011 versus 3.60% in 2010.
Finally, it’s worth refreshing our charts of sovereign bond yields and CDS as a proxy for risk. The takeaway is that both indicators are confirming a continued heightening in the risk trade, and in some cases all-time highs. Interestingly, today’s sovereign bond issuance from Portugal of €500 million found sufficient demand, however at a significantly higher yield demonstrating the increased risk premium that is demanded by investors. The 6-month paper yielded 3.68% (versus 2.04% in September!).
As yields have raced higher over the last year particularly for the PIIGS, and this despite bailouts of Greece (May) and Ireland (December), the equity performance of the periphery also showed marked underperformance. Greece’s Athex was the worst performer globally year-to-date at -35.6% and is down -10.2% since 1st wk of December. And Spain’s IBEX 25 and Italy’s FTSE MIB tumbled -18.1% and -12.4% respectively ytd, to round out some of the worst performing indices globally ytd.
In 2011 we’ll be picking our spots in Europe. We have long biases on countries like Germany and Sweden and short biases on Spain, Italy, and Greece.
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