US Strategy - Earnings Season Looms

On Friday, the S&P 500 closed at 1,071, up 0.6% on the day.  Day five of the S&P 500’s rally as the momentum behind the recovery trade continued all week; volume was shockingly low. 


Last week the S&P rose 4.5% as the MACRO calendar provided some positive momentum.  The bullish tone stemmed from the ISM numbers on Monday and continued through Wednesday and Alcoa's relatively upbeat release into Thursday's better than expected jobless claims and retail reports.  The catalysts in the coming week will be comprised of major earnings reports, which include: top banks JPMorgan, Goldman Sachs, Citigroup, and Bank of America, report this week along with Google, Southwest Airlines, Intel, IBM, General Electric, and Johnson & Johnson.


Friday’s portfolio activity included shorting the XHB – the Homebuilders ETF.  We were the bulls on a Q2 housing turn last December.  Now Keith and I are getting cautious on housing in 1H 2010.  As rates head higher, access to capital tightening is not good for the early cycle home builders.  Additionally, without help from Washington the housing market is not healthy enough to stand on its own two feet and the $8,000 tax credit is expected to expire at the end of November.


The dollar index was up 0.7% on the heels of Ben Bernanke's comments after recovering from a 14-month low hit Thursday.  The VIX declined for the fifth straight day and is now down 14% over the past week. 

As of Friday, four of the nine sectors outperformed the S&P 500, with every sector positive except Consumer Discretionary and Energy.  The three best performing sectors were Healthcare (XLV), Financials (XLF) and Technology (XLK), while Energy (XLE), Materials (XLB) and Consumer Discretionary (XLY) were the bottom three.  We are currently long the XLV, which we would expect to be buoyed this morning by the announcement from Onyx Pharmaceuticals that they are acquiring privately held Proteolix for $810MM.


Today, the set up for the S&P 500 is: TRADE (1,051) and TREND is positive (991).   Day 1 of perfection - the Research Edge quantitative models have 9 of 9 sectors in the S&P500 positive on TREND and 9 of 9 sectors are positive from the TRADE duration.         

Howard Penney
Managing Director


US Strategy - Earnings Season Looms - S P500


US Strategy - Earnings Season Looms - s pperf


US Strategy - Earnings Season Looms - s plevels


Blankfein's Bucks

“Study the past if you would define the future.”

No matter where you go this morning, there’s that Burning Buck consensus again. The #1 headline on Bloomberg is “Dollar Reaches Breaking Point As Banks Shifting Record Reserves Into Euro”…
That article, written by Ye Xie, was very well researched. Xie used the powerful weaponry of math and history. Some of his historical conclusions on US Dollar weightings as a percentage of total central banking reserves came from Barclay’s Steve Englander (former Fed Head), who concluded what we have for quite some time now – this isn’t about a “risk aversion” trade. Moving away from the Burning Buck is mostly about Global Asset Class Diversification.

The levered long glory days of US centric (US currency denominated) global financial dominance are over. Whether his name was Paulson and now Blankfein isn’t the point. The point is that Blankfein is going to be a revisionist historian and start telling the world “we never needed the money.” The problem with Wall Street storytelling, of course, is that until YouTube came along, there was no auditor!
These aren’t political points. They are credibility points. Study the past, and you’ll find that a country’s credibility will define her currency’s future. Mr. Blankfein, I know you are really smart, so be smart this week… and start acting like the accountable leader in US Financial Services that this country needs.
Studying the past is what Englander did, noting that in Q2 of 2009 that 63% of incremental foreign currency fund flows were allocated to buying Euros and Yen. Only 37% went to US Dollars. Going all the way back to 1999, the average share that the greenback would capture was 63%, and total central bank reserves held in US Dollars at the end of Q2 was 62.8%. Yes, per Englander’s math, that was the lowest level of US Dollar representation, ever.
Ever, by my math, is always a long time. In order to define ever, we have to study the past. In the Burning Buck’s case, we simply have to go back to 1971 (when Nixon abandoned the Gold Standard). That’s when the United States of America was benedicted with the almighty power of having a world reserve currency.
What did we do with that power? We levered it up at every turn. We bought into the Washington sponsored mantra of limitless credit creation whenever there was a sniffle in the performance of the “Next Warren Buffett’s” returns (Baron’s called Miller that before he lost 55% of his clients moneys in 2008).
So, when Blankfein reports crushing earnings this week and tells you that becoming a bank holding company was a “long time” pending, just remember two things: the Chinese are watching and the American people are watching. Neither of these massive creditors of US Currency Credibility Lost are as stupid as some of America’s financiers think they are.
Studying the past reminds us that building credibility takes a lifetime, and it takes no time to destroy. While I think that the immediate term TRADE for the US Dollar is Bombed Out,  I don’t see the credibility of our said financial leaders having changed one bit. Please, prove me wrong guys…
Last week the Burning Buck was down -0.90% to close the week at $76.30. That was a higher-low, and this morning we’re monitoring two levels in the US Dollar very closely to see if they hold:
1.      US Dollar Index YTD low = $75.77

2.      US Dollar Index immediate term TRADE resistance = $76.84

With the US Dollar broken across all 3 of our investment durations (TRADE, TREND, and TAIL), there is only hope that it can see a rally that gets it over the immediate term (3-weeks or less) line. Hope is not an investment process. And there isn’t a hope in hell that the US Dollar gets above the long term TAIL line of $82.67 any time soon. That’s the American financial history cross that we will, unfortunately, have to bear.
History now proves that there were no incremental buyers for US Dollars in Q2. Newsflash, there probably weren’t any in Q3 either! Some people, like the aforementioned bullish mean reversion mutual fund investor don’t understand that stocks, currencies, and commodities stop going up not when there are sellers, but when the largest holders stop buying them!
The immediate term risk in this morning’s US market open outruns the reward. This is only the second day in a row that I could say that. After trading up every day last week, studying the past reminds me that as long as the US Dollar doesn’t go up, everything priced in those Burning Bucks will have an opportunity to REFLATE. My immediate term risk/reward levels for the SP500 are now 1051 and 1081, respectively.
Best of luck out there this week,



EWT – iShares Taiwan
With the introduction of “Panda Diplomacy” Taiwan has found itself growing closer to mainland China. Although the politics remain awkward, the business opportunities are massive and the private sector, now almost fully emerged from state dominance, has rushed to both service “the client” and to make capital investments there.  With an export industry base heavily weighted towards technology and communications equipment, Taiwanese companies are in the right place at the right time to catch the wave of increased consumer spending spurred by Beijing’s massive stimulus package.

EWG – iShares Germany Chancellor Angela Merkel won reelection with her pro-business coalition partners the Free Democrats. 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.

XHB – SPDR Homebuilders We were the bulls on a Q2 housing turn but, as the facts change so do we: now we are getting cautious on 1H 2010 US Housing. Rates up as access to capital tightens is not good for new home builders as we enter into a new year and series of potential catalysts for renewed pressure in the secondary market, including the expiration of the $8,000 tax credit.

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

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.



Wynn Macau Ltd. announced today that it exercised the over-allotment option on its IPO, raising an additional HK$1.89 billion (US$242.3 million).   The statement indicated that a further 187.5 million shares were sold via the over-allotment option.  The shares were sold at the IPO price of HK$10.08, which represents a 6.5% discount from Friday’s closing price of HK$10.78. 

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Woolfolk, Tice, Thin, Lynch's Own Words on U.S. Dollar



The Economic Data calendar for the week of the 12th of October through the 16th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.  




If you’ve been following our work you’d know that we’ve had a bearish bias on the UK for the balance of the year. The Producer Price Index numbers for September released today by the Office for National Statistics support our thesis that inflation will outpace growth in the UK, adding to the cocktail of negative headwinds for the island nation.


Annual output price (factory gate) for all manufactured products rose 0.4% in September or +0.5% month-over-month, while annual input prices fell 6.5% compared with a decline of 7.7% in August on a year-over-year basis. In short, producers are still benefiting from lower energy (input) costs on annual compares, but sequentially energy, transport, and food costs are inflating --gaining 2.0%, 0.6%, and 0.3% respectively for the month.


Core PPI, or Manufactured Products other than food, beverages, petroleum and tobacco, rose 1.4% year-over-year driven by a 4.4% rise in motor vehicles and other transport equipment and 3.8% rise in machinery and equipment.


With CPI at 1.6% in August Y/Y --and even with initial forecasts for a decline in inflation to 1.3% when September’s reading is released on October 13th, we’re of the camp that inflation is returning to the UK, an unhappy development  for producers and consumers coming out of a recessed economy.  Remember that Q2 GDP read positive for Germany and France at +0.3% Q/Q, but much of Europe saw contraction, including in the UK at -0.6% Q/Q.  From an inflationary standpoint, we continue to like Germany (EWG) at -0.2% to -0.3% (also the Eurozone average), a level we believe will not profoundly impact consumer demand as long as it remains offset by growth.


Returning to the UK, with both the BOE and ECB sitting on their hands during their latest policy sessions this week and keeping interest rates unchanged at 0.5% and 1.0% respectively, we view the BOE in a tenuous and unfavorable position for the intermediate term.  On one hand, the Pound has significantly depreciated against the USD and EUR, down 4.7% versus the USD and 7.9% versus the Euro since Aug. 1; clearly the Pound’s fall has eroded purchasing power for a country heavily dependent on imports. On the other hand, while raising interest rates may clearly be needed to dampen inflation, it could also stymie growth. 


As we see the tidal shift of Central Banks moving towards raising rates in a post deflationary environment, we’ll have a close eye on BOE and ECB monetary rhetoric and action. Due to the structural nature of the UK economy, we continue to expect underperformance from the FTSE versus its European peers and the S&P500.



Matthew Hedrick




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