This week's notable callouts are the MCDX municipal swap index breaking to its lowest levels since last November (this is a positive reflection on Muni credit), and the TED spread backing off its prior week highs. Among US Financials, ALL, AON and MMC tightened the most week over week, while JPM, C and RDN widened the most.
Financial Risk Monitor Summary (Across 3 Durations):
- Short-term (WoW): Negative / 2 of 10 improved / 4 out of 10 worsened / 5 of 10 unchanged
- Intermediate-term (MoM): Positive / 2 of 10 improved / 1 of 10 worsened / 8 of 10 unchanged
- Long-term (150 DMA): Positive / 5 of 10 improved / 3 of 10 worsened / 3 of 10 unchanged
1. US Financials CDS Monitor – Swaps were mostly wider across domestic financials, tightening for just 1 of the 27 reference entities and widening for 26.
Tightened the most vs last week: ALL, AON, MMC
Widened the most vs last week: JPM, C, RDN
Tightened the most vs last month: COF, MBI, AGO
Widened the most vs last month: PMI, RDN, MET
2. European Financials CDS Monitor – Banks swaps in Europe were mostly wider, tightening for 15 of the 39 reference entities and widening for 24.
3. Sovereign CDS – Sovereign CDS rose across Europe, climbing 11 bps on average last week.
4. High Yield (YTM) Monitor – High Yield rates rose slightly last week, ending at 7.83, 4 bps higher than the previous week.
5. Leveraged Loan Index Monitor – The Leveraged Loan Index fell last week, ending the week at 1614, down from 1619.
6. TED Spread Monitor – The TED spread tightened last week, a reversal of the prior week's widening. It ended the week at 17.6 bps, down 3.5 bp week-over-week.
7. Journal of Commerce Commodity Price Index – Last week, the index held close to flat, falling just under a point to 33 by Friday.
8. Greek Bond Yields Monitor – We chart the 10-year yield on Greek bonds. Last week yields rose 16 bps to 11.88%.
9. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on four 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. Our index is the average of their four indices. Spreads fell last week by 2.5 bps, closing at 154 bps on Friday, eclipsing their prior low from last November.
10. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production. Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion. The BDI ended the week at 1245, down 4.3% week-over-week.
11. 2-10 Spread – We track the 2-10 spread as a proxy for bank margins. Last week the 2-10 spread tightened by 11 bps to 270 bps.
12. XLF Macro Quantitative Setup – Our Macro team sees the setup in the XLF as follows: 0.8% upside to TRADE resistance, -0.5% downside to TRADE support.
Joshua Steiner, CFA
Notable news items from the past few days and price action from Friday’s trading.
- SBUX price target was raised to $42 from $40 at Piper Jaffray
- SBUX saw the U.S. Court of Appeals for the Second Circuit uphold a lower court’s ruling denying Kraft’s request for a preliminary injunction against Starbucks Coffee Company.
- YUM’s Taco Bell is launching a $3 million television ad campaign this week to battle damage to its image from a lawsuit questioning its taco filling.
- JACK and SONC traded strongly on Friday on accelerating volume to close out a poor week.
- CMG traded down 6.5% last week.
- Aside from MRT, RRGB, KONA, and CHUX, last week was a poor week for casual dining.
- MRT traded up on Friday on strong volume as the company announced FY11 EPS guidance above Street estimates.
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This note was originally published at 8am on February 23, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“The only real failure in life is not to be true to the best one knows.”
Yesterday was the biggest down day for US stocks since August 11th of last year. If and when the US stock market starts to really break down again, I think the only real failures in our industry will be revealed by those who have chosen not to evolve their global risk management process from 2008.
One down day certainly does not a bearish trend make. But a -2.1% drop in price momentum on an accelerating volume study of +31% (week-over-week) combined with a one-day rip of +27% in volatility (VIX) should definitely have the bulls’ attention.
PRICE, VOLUME, VOLATILITY …
That’s the core 3-factor model I use across risk management durations. That’s what I have stayed true to since I re-built the model in 2007. That’s just part of my process. In order to embrace uncertainty as a given, I think a risk manager is best equipped to be Duration Agnostic.
The only real failure in my process would be choosing not to change the process as this globally interconnected marketplace changes. One of the key changes that I’ve made in the last 3 years is changing the durations in my models, dynamically, as volatility levels change.
I model all security level volatility from the bottom up, but to simplify this point I’ll use the VIX. Here’s where a closing price of 21.11 in the Volatility Index (VIX) fits across my 3 core risk management durations (TRADE, TREND, and TAIL):
- TRADE (3-weeks or less) = bullish, with TRADE line support at 16.17
- TREND (3-months or more) = bullish, with TREND line support at 18.09
- TAIL (3-years or less) = bearish, with TAIL line resistance at 22.09
So, in Hedgeye-speak, what’s happened to the VOLATILITY factor in the SP500’s 3-factor model is critical to acknowledge. Whether the TRADE and TREND lines of bullish VIX support hold or not is something that Mr. Macro Market will decide but, for now, what was overhead resistance in VOLATILITY is now support – and that’s bearish for US stock market price momentum. A breakout in the VIX above the TAIL line will make things crash.
Now if you take this 3-factor model:
- PRICE down
- VOLUME up
- VOLATILITY up
And overlay it with a critical correlation – the inverse correlation between the SP500 and the VIX – you’ll see that this relationship has been one of the most important concurrent risk management indicators we’ve been offered since the early part of 2008. Ignore it at your own risk.
In the chart below, you can see that this isn’t foreign land for me to be treading on. When I made the bearish call for a US stock market correction in April of 2010 (our Hedgeye Macro Theme was “April Flowers, May Showers”) I gave you the same signals.
Well, almost the same…
Nothing in my models are ever really the same, particularly when I blow out the vantage point to that other sneaky little critter called The Rest of the World. That’s why my baseline Global Macro Risk Management Model includes 27-factors (which also change and re-weight dynamically) and include important real-time prices like the US Dollar, Indian stocks, Copper, etc…
And this is really where I can look myself in the mirror and say, despite the fierce lobbying for me to chase US stock market fund “flows” into their mid-February crescendo, I stayed true to the best top-down risk management process I know – when Global Inflation Is Accelerating, and Global Growth Is Slowing, it’s time to build up a large asset allocation to Cash.
Now not a lot of people have Street credibility on moving to Cash. Not only because they didn’t start making this move in early 2008, but because they don’t have an investment mandate that allows them to move into Cash. That’s an industry problem, not yours.
Global Growth Slowing is perpetuated by Global Inflation Accelerating. Anyone who has ever invested in emerging markets recognizes this basic reality. Everyone who is short Emerging Markets (EEM), India (IFN), and Brazil (EWZ), like we are in the Hedgeye Portfolio gets the profitability of it too.
The biggest question about Growth’s Failure in virtually all of Asia and the austere side of Europe that you can answer for yourself is will Global Growth Slowing affect the said “safe havens” of US and Japanese stocks?
My answer to this is not only implied by the high-frequency growth data that I grind through every macro morning, but it’s amplified by the math that stands behind the reality that Structural Long-Term Growth Is Impaired By Rising Sovereign Debts.
Whether it’s American, Japanese, or Western European debt, it’s all the same thing – debt. And that’s why we’re not surprised to see consumption growth slowing in these Developed Debtor countries as we infuse them with $95 oil and other inflation related taxes.
Growth’s Failure won’t be crystal clear to Wall Street until it’s in the rear-view mirror, but yesterday’s PRICE, VOLUME, and VOLATILITY readings combined with continued breakdowns in Asian Equities and a breakout in oil prices should read true “to the best one knows” about globally interconnected risks.
My immediate term support and resistance lines for the SP500 are now 1307 and 1330, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
“As the shark lunged for his head, Louie bared his teeth, widened his eyes, and rammed his palm into the tip of the shark’s nose.”
-Laura Hillenbrand, "Unbroken"
That’s a quote from an outstanding non-fiction novel that I’m reading by Laura Hillenbrand titled “Unbroken: A World War II Story of Survival, Resilience, and Redemption.” It’s a story of a selfless American Olympian by the name of Louis Zamperini who sacrificed more than this modern day man can begin to comprehend. They’ll turn this into a movie – and if they do it right, it may win an Oscar trophy someday too.
The story of American Sacrifice is one that we all know well. Alongside our Trashing Treasuries and Housing Headwinds Macro Themes for Q1 of 2011, it’s also something that we talk about during each and every one of our research team’s Morning Meetings here in New Haven.
Fundamentally, we do not believe that this country’s political leadership (Republican or Democrat) has it in itself to deliver on American Sacrifice. Since the introduction of the 112th Congress, handshakes and promises to the American people of cutting deficits and debts have already been broken. The credibility of America’s currency is broken too.
What remains Unbroken is the passion and faith that Americans who aren’t tied to a Washington compensation structure hold in their hearts and minds. From Wisconsin to New Jersey, that’s what you see rising to a boil. If it takes punching these political sharks in the proverbial nose, so be it…
We recognize what Washington and Wall Street’s Easy Money Elite want. They want us to keep doing what we’ve allowed them to do since Nixon abandoned the gold standard. He, not unlike Charles de Gaulle, moved to a deficit and devaluation strategy so that he could win the 1972 election.
Washington wants us to roll over and take it in The Inflation. They want to fear-monger us. They want to sell us. They want to lunge at us with the price volatility born out of the crises that they created.
Well, that might work for a select amount of the compromised, conflicted, and constrained few. But it doesn’t work for me and it doesn’t have to work for you or The Rest of the World either.
China’s Premier announced to the world last night that he’s willing to sacrifice short-term growth for price stability. In the 12th Five-Year Plan, China outlined an economic growth rate expectation of 7% annualized from 2011 to 2015. Sure, if they wanted to drop free moneys from the Eastern heavens and perpetuate The Inflation that would consume their citizenry, they could. But they aren’t. The Chinese don’t have to be re-elected.
After all that America has been through to fortify its individual rights and civil liberties, it’s both frightening and sad to see a State-managed economy like China’s manage The Inflation with more respect than we do. Tomorrow you’ll have our Almighty Central Planner outline to the world that he sees no inflation – or at least he sees none in his conflicted and compromised calculation.
Ahead of The Ber-nank’s semi-annual report on US Monetary Policy tomorrow, the US Dollar Index is hitting a fresh 4-month low. Sadly, this is more of the same in terms of intermediate and long-term trends. The US Dollar Index was down another -0.5% last week. It’s been down for 7 of the last 9 weeks. It’s a mess.
Surely, the US Government will blame last week’s inflation on a nut-bar in Libya. But don’t disrespect for one minute that for the last 3 years The Rest of The World has started blaming us too. Standing as the world’s fiduciary of the world’s reserve currency isn’t the next entitlement that our professional politicians can abuse – it may very well be the last.
On a week-over-week basis, this is The Inflation and Price Volatility that The Ber-nank will ignore:
- US Dollar Index = DOWN -0.5% (down 7 of 9 weeks)
- CRB Commodities Index = UP +2.9% (hitting fresh 2-year highs)
- Volatility (VIX) = UP +16.3% (up 22.5% in the last 2 weeks)
In the face of inflation and price volatility, growth signals continued to slow week-over-week:
- US Treasury Yields = DOWN across the curve last week
- Copper = DOWN -0.9% (despite Commodities being up)
- Yield Spread = DOWN 9 basis points to +270 bps (10s vs 2s)
But, have no fear, the US stock market remains Unbroken from an immediate-term TRADE perspective:
- SP500 TRADE line support = 1309
- NASDAQ TRADE line support = 2760
- Russell2000 TRADE line support = 803
So, Bernanke is doing his job, inflating the stock market - and you have nothing to fear other than his fear-mongering itself. Right.
In the Hedgeye Asset Allocation Model, my teeth are barred with Cash and my eyes are wide open:
- Cash = 58% (up 3% week-over-week from 55%)
- International Currencies = 24% (Chinese Yuan and Canadian Dollar – CYB and FXC)
- Commodities = 6% (Oil and Grains – OIL and JJG)
- International Equities = 6% (Germany and Sweden – EWG and EWD)
- US Equities = 6% (Healthcare – XLV)
- Fixed Income = 0%
My immediate term TRADE lines of support and resistance for the SP500 are now 1309 and 1325, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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