“If stupidity got us into this mess, then why can’t it get us out?”
-Will Rogers
That’s the quote that leads off Chapter 17 of Liaquat Ahamed’s “Lords of Finance.” It is one of my favorite chapters in the book. It’s titled “Purging The Rottenness.”
In the rear-view mirror, was the American Financial system as we knew it rotten? You bet your Madoff it was. And it doesn’t stop with 2008 or with the Bernies (Bernie Marcus was the rotten rat who ran The Bank of the United States (BUS) ponzi scheme out of NYC in the 1920’s before it was went Lehman Light (under), causing most Americans to distrust the Wall Street system).
Versus the constant banking crises of the 1920’s and 1930’s, the really bad news is that now we have YouTube and the internet. Bad news for some of these CEO bankers that is…
But don’t worry, they get it. In the last 48 hours, after announcing he is stepping out of his CEO seat, we’ve had Morgan Stanley’s John Mack proclaim his mystery of faith that now we need a “Global Banking Regulator”; Kenny Lewis has resigned; and the Almighty Jaime Dimon has been rumored to be tee’ing up his exit stage left from the house that JP Morgan built.
To be willfully blind to the idea that these guys only know what they know as of yesterday’s P&L is one thing. To understand how they manage their career risk is entirely another. “If stupidity got us into this mess, then why can’t it get us out?” There are no more big checks waiting at the end of that rat tunnel folks. The Rottenness is being purged…
I’m still too young for most people to take my word for these lines of thoughts, so take Paul Volcker’s. I can’t stop rewinding the DVR of this Charlie Rose interview with the ex-Chairman of the US Federal Reserve. His clarity of thought on what caused the Rottenness is impressive. He basically calls the Fuld’s and the Mack’s and the Paulson’s (nope, it want just Dick!), the “financial engineers” who were paid to be willfully blind to the math.
No matter what career risk management moves these CEOs make in the coming years, history will remind us that they didn’t do the math associated with risk management outside the bell curve of shareholder probabilities. If you are depending on these guys to get us out, think again. Accountability will not be purged from this mess.
Back to the grind…
Yesterday, I was focused on The New Reality’s 3-Some (Warsh, Plosser, and Fisher). Bond yields were shooting up in the morning and, come the afternoon, the Fed’s Vice Chairman, Donald Kohn, was shooting them down…
You see, to be In De Fed Head Leadership Club, you need to tow the political line. Kohn is a veteran of this conflicted and compromised US Government institution, so don’t blame him for any of that Rottenness we’ve been talking about. He was just one of the guys who has been overseeing it!
Kohn came out intraday reiterating what Heli-Ben Bernanke said to take the US Dollar to its knees last Wednesday (the September 23rd intraday low of $75.80 for the US Dollar Index). Kohn said that “exceptionally low interest rates are likely to be warranted for an extended period…” To America’s Creditors (The Chinese), that surely sounded as rotten as it has for the last 6 months. The US Dollar started to tank and 2-year yields took an intraday swan dive, breaking my immediate term TRADE line of 0.97%.
Some traders clinged to that “exceptional” headline, but I found Kohn’s follow-on comments inflectionary. He said “we must begin to withdraw accommodation well before aggregate spending threatens to press against potential supply, and well before inflation as well as inflation expectations rise above levels consistent with price stability.” On the margin, that’s much more hawkish than the Vice Chairman has been. Take note.
Until the math changes, what matters to anything priced in US Dollars is Fed Policy. Rhetoric will signal the timing of the hike. If you wait until the day of the hike, you’ll be left behind. Markets move on expectations.
Both Dr. Copper and the Burning Buck are telling me that the timing of the 1st hike from ZERO is sooner than consensus thinks. For the first time last night, all of my quantitative studies were flashing lower-highs in everything REFLATION (copper, SP500, BAC, RIMM, etc…), and this morning, for the 3rd day in a row, my models are registering a higher-low for US Dollar price support.
On the margin, that is bearish for things priced in Dollars. No, I’m not a raging US stock market bear now. I’m simply calling out changes on the margin as I see them. Here are three other factors to consider:
1.      Volatility (VIX): breaking out above my immediate term TRADE line of resistance at $24.96 (bearish for stocks)

2.      Volume: the last 2 days in my broad US equity volume studies have shown 26% and 31% spikes. Combined with market down days, that’s bearish.

3.      Japan: trading down -1.5% last night makes it the first major equity market to break both my TRADE and TREND lines. It’s still the world’s 2nd largest economy.

Is the Rottenness in the Global Financial System still there this morning? You tell me. Remember, everything rotten has a time and a clearing price – if there’s anything we have learned in the last +56.4 percentage points from the SP500’s lows, that’s it. My immediate term support and resistance levels for the SP500 are now 1040 and 1076, respectively. Yes, for the SP500, that’s a lower-high. Lower-highs, on the margin, have some rottenness that I don’t have to buy into.
Best of luck out there today,


EWG – iShares Germany
Chancellor Angela Merkel won reelection with her pro-business coalition partners the Free Democrats over the weekend. We expect to see continued leadership from her team with a focus on economic growth, including tax cuts. We believe that Germany’s powerful manufacturing capacity remains a primary structural advantage; with fundamentals improving in a low CPI/interest rate environment, we expect slow but steady economic improvement from Europe’s largest economy.

CAF – Morgan Stanley China Fund A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the more volatile domestic equity market instead of the shares listed in Hong Kong. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth. Although this process will inevitably come at a steep cost, we still see this as the best catalyst for economic growth globally and are long going into the celebration of the 60th Anniversary of the People’s Republic.


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.   

XLV – SPDR Healthcare We’re finally getting the correction we’ve been calling for in Healthcare. We like defensible growth with an M&A tailwind. Our Healthcare sector head Tom Tobin remains bullish on fading the “public plan” at a price.

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.

USO – US OIL Fund We shorted oil on 9/30. The three Fed Heads just put rate hike rhetoric right on the table. If the Buck stops Burning, Reflation stops working.

XLP – SPDR Consumer Staples Looking for low-beta short exposure to US Consumer spending. Consumer Staples short interest is low, and the stocks are over-owned.  

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.

DIA  – Diamonds Trust 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.



The Secretary for Transport and Public Works said that the Macau government is set to pay US$150 million for a 1.1 square kilometer plot of land leased from the Chinese municipality of Zhuhai, bordering Macau, for a 40-year period.  Macau already has jurisdiction over the land which is being fenced off so that the new campus of Macau University can be built.  Although situated on the Chinese mainland, the land will be under the jurisdiction and legislation of Macau and access to the campus will be via an underwater tunnel from Macau.

Early Look

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We were asked by a subscriber why we covered our Warnaco short so quickly. Let’s be clear…fundamentally, our retail team does not like this story. There are secular margin headwinds here, license loss risk, mediocre brand portfolio, limited cushion if things go south, and downright poor quality of management. As it relates to the stock, sell sentiment is quite high (80% of ratings are Buy), short interest is re-testing lows, and management is selling. To cap it off, yesterday there was a sell-side upgrade, which Keith shorted in to. I’m surprised that the stock is only off by 1.2% today given the big miss at Iconix (another questionable quality model that is tied to a licensing model) just 2 months after a secondary.  But we are mildly concerned about event risk into an analyst event WRC is hosting on Friday. What you see here is Keith managing risk around his TRADE duration (3 weeks or less). Just because he covered a TRADE for a gain, it does not mean that it is no longer on our bench as a fundamental short. It will take more than a few percent in the stock for that to happen. Unless the bottom falls out from under this stock very soon, my sense is that we will be more vocal on WRC in the not-too-distant that we will be more vocal on WRC in the not-too-distant future.

Trust Volcker!

I say this a lot and I’ll say it again. I am grateful to be at the hub of our growing exclusive research network. Every day provides a tremendous opportunity to learn from my investment strategy mistakes.


It builds confidence to know that we can take a point of view, put it on the tape real-time, and receive real-time feedback. We learn what we don’t know first, then we evolve our thinking. Below is a note from a man who I have a great deal of respect for. He’s been in the macro “fire” for years. He says “Trust Volcker.”


Unedited, from Mark.





Keith –


Your morning perspective got me thinking.  In 1979, I was an up & coming executive at a mortgage bank that now is the core of Chase’s mortgage lending operation.  It was quite a time.  The certifiably worst president in our history was dealing with one crisis after another, running around and crying “Oh, me…Oh, my”.  His political crony, G. William Miller, had sacrificed the Fed’s independence and the US economy was on the verge of collapse.  My job, at the time, was to manage our firm’s secondary marketing + sales & trading.  Hedging an inventory of mortgages was quite an experience.  GNMAs traded in at least a ½ point spread (bid to ask) and markets for FNMA/FHLMC securities were as thin as Twiggy (are you old enough to remember her?).  Daily volatility was in the stratosphere.  Gov’t changes in the FHA rate (it was set by fiat then, not by the market) were occurring in matters of weeks instead of years as in the past.


Then along came Paulie. A real grown-up took charge.  And, saved America’s financial system.


During that time, I wrote a weekly market letter for our national sales operation + an addendum for our executive committee regarding hedging opportunities, risks and costs.  I remember one day being challenged by our CEO about my belief that rates were headed higher, but that the impact would be incredibly positive for the economy.  The CEO was an ardent Keynesian and had a hard time with monetarist prescriptions (he was a very quick study, though, and changed fast – even became a devotee of Milton Friedman & Jude Wanniski).  As I tried to make my case, I finally spurted out “TRUST VOLCKER!”


That became a byword for our management for years and years.  Our company managed through the era and came out the other side in fantastic shape.  My career took a decidedly upward tilt, too.


When Volcker came out in support of Obama last year, I was willing to hold back my visceral dislike for our new president.  After all, the man I believed saved our financial system couldn’t be a radical.  So I tempered my view.  What a mistake!


You used the word “muted” when discussing the lack of influence PV is having right now.  A better choice would have been “ignored”.  All the measured men who are supporting the ideologues in the WH are enablers.  When and if PV disowns the Obama Administration, I’ll trust him again.  Until then, I’ll chalk it up to old age.  It’s sad to see so many thoughtful people become apologists for the indefensible.  Volcker knows better and may yet be willing to stand athwart the establishment and yell “STOP!”  I sure hope so.  He is one of my great heroes.  I hate thinking he has become another hack in Washington.


Hope to see you again soon. 




Trust Volcker! - pv


We Are Short Of Oil

Position: Short etf USO (United States Oil Fund)


Yesterday in our morning meeting that we host for clients, we had an interesting debate regarding some of the global macro signals that we are seeing these days relating to oil.  We seem to be clearly seeing signs of heightened global tensions with the Iranians announcing that they have a second facility for converting uranium and are also testing longer range missiles this week.  Despite these events, the price of oil has completely shrugged off any longer term implications from Iranian chain rattling.  This is partially due to the strength in the U.S. dollar, as the U.S. dollar has been one of the key fundamental drivers for oil prices this year.


Setting aside the U.S. dollar, over time supply and demand metrics in the world’s largest oil markets, the domestic United States and China, should also be key drivers for the price of oil.  As we’ve noted a number of times in the last few months, oil fundamentals are actually quite bearish. The most recent date from API, the EIA, and China are bearish as outlined below:

  • According to the most recent date from API, gasoline inventories in the United States are 12.6% higher than a year ago and 5.6% higher than the five year average;
  • According to most recent date from EIA, oil inventories are more than 10% above year ago levels (at 335MM bbls) and gasoline inventories are 19.7% above year ago levels; and
  • The Chinese reported today that crude oil inventories hit a record 39.9 million tonnes at the end of August, which equates to a rather significant 278MM barrels.

Despite the bearish date, the price for oil, as we’ve discussed, has had an incredible move this year and as a result we are starting to see an uptick in drilling activity for oil, which is also bearish as it relates to future supply. To this point, the EIA noted last week that:


“As of September 18, Baker Hughes Incorporated reports 293 rigs drilling for oil and 705 rigs drilling for natural gas. The current oil rig count reflects a 64 percent increase from the lowest 2009 level reached in early-June, while the natural gas rig count is only 6 percent above its mid-July level (Figure 1). Rigs drilling for oil now account for 29 percent of the total, up from 21 percent at the beginning of the year. Despite the uptick in oil drilling, both oil and natural gas rig counts remain substantially below their peak levels in 2008.”


Interestingly, for the first time in nine years, we have also seen oil drilling activity surpass natural gas on a relative basis in the domestic U.S. and is up an amazing 64% from its lows.


As Keith noted in The Early Look this morning, we’ve also had three separate statements from Fed Governors recently suggesting that rates will have to go higher.  That is, they’re starting to get hawkish.  In the short term, higher rates should be positive for the U.S. dollar, which will be, all else equal, bearish for those commodities that are priced in U.S. dollars.  So, we are shorting oil today because: a) supply is building, b) the likelihood of a rate hike has increased, which is good for the dollar and bad for commodities priced in the dollar, and c) oil is largely shrugging off heightened geo-political news flow.


Daryl G. Jones

Managing Director


We Are Short Of Oil - a2


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