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“The charm of history and its enigmatic lesson consist in the fact that, from age to age, nothing changes and yet everything is completely different.”

-Aldous Huxley

On the days Keith writes the Early Look and provides historical context to the current period we are in, it’s always enlightening and helpful to have that context. Yesterday’s Early Look titled “Confirmation Bias” was one of those notes. 

The bottom line for me from yesterday’s Early Look was: stick with what you know and do not fight the tape.  Dollar down = Stocks up; stick with what works.  The dollar will continue to be subject to unprecedented budget deficits, near-zero interest rates and anemic economic growth.  That means capital will flow to hard assets and will find a rate of return that is greater than zero. 

There is no reason to think that President Obama is going to change his policies any time soon.   President Obama’s efforts to lead the world economic recovery by spending his way out of the recession will continue to undermine the dollar.  This will continue to trigger the REFLATION trade and is the reason why Materials (XLB) is the best performing sector year-to-date, up 41.6%.  Rounding out the top three performing sectors year-to-date are Technology (up 38%) and Consumer Discretionary (up 31%). The performance of technology is more understandable, due to growth and innovation, but consumer discretionary is puzzling.

I appreciate history as much as the next guy, but obviously, there are some significant differences between 1933 and today.  President Obama is not FDR, the unemployment rate is not 24%, and one quarter of the population in the U.S. is neither hungry nor starving.

In fact, the opposite is happening. Between 1933 and 1937, employment did not implode.   In 1933 the unemployment rate was 24.9% and by 1936 it was 16.9%.  It bottomed at 14.3% in 1937 before rising to 19% in 1938.  So although the absolute rate of unemployment was much higher then, the rate was coming down, not going up like it is today.

In September 2009, the unemployment rate stood at 9.8% versus 7.6% in January 2009.  In September alone, the economy lost 263,000 jobs, bringing the total number of Americans out of work to 15.1 million.  If you want to play with the number and include the 500,000 unemployed people who gave up looking for work in September, the unemployment rate would be 17%, the highest on record since 1994.

So how is the “Burning Buck” good for consumers, who account for 70% of the nation’s economy?  It’s NOT!  And the latest reading on consumer confidence has turned decisively negative. 

Yesterday, the ABC Consumer Confidence reading came in at (50) for the week of Oct 18th vs. (48) the prior week.  For a historical perspective - (54) is the worst reading ever.  Last week, The University of Michigan confidence index fell to 69.4 in early October from 73.5 in September.  In November 2008 the reading was 55.3.

The other big issue that more and more consumers are facing is housing.  While the government is trying its best to shore up the housing market, the efforts do not get at the heart of the problem –the rising unemployment is making it hard for consumers to make ends meet. 

The REFLATION trade is real and needs to be fully appreciated, but underneath the surface there are some real issues with the consumer that need more time to be worked out. Simply Burning the Buck is not the answer.  Yesterday could be a classic example of what will happen when the buck stops burning.  The S&P was down 0.6% and the two worst performing sectors were Materials and Consumer Discretionary, both down 1%.

I’m not trying to be bearish, just practical.  The S&P 500 is up 61% since the March 9th low and the Federal Reserve has spent TRILLIONS to fight the worst U.S. recession since the 1930s.  Operating stories like Yahoo can have a great quarter in this environment, as comparisons are easy across the board.  It’s staggering to see that 80% of the S&P 500 has beaten analysts’ estimates this earnings season.  That figure is not going to 90% or 100% next quarter. 

The most important headline today is that the Bank of England Governor Mervyn King is talking about higher interest rates.  I love the British because everything is so proper - “it would be wise to take account of the prospect of rising borrowing costs.”  Can Ben be far behind?  Rising borrowing costs are good for the dollar, bad for the consumer and bad for stocks.  It’s looking more and more like 2009 was the eye of the storm – the front wall hit in 2008 and the back side is coming in 2010.

1933 is in the past!

Function in disaster; finish in style.

Howard Penney 



XLU – SPDR UtilitiesWe bought low beta Utilities on discount (down 1%) on 10/20. Bullish formation for XLU across durations.  


FXC – CurrencyShares Canadian DollarWe bought the Canadian Dollar on a big pullback on 10/20. The currency ETF traded down -2%, but the TRADE and TREND lines are holding up next to Daryl Jones’ recent note on the Canadian economy.

EWG – iShares GermanyChancellor 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 GoldWe 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.



UUP – PowerShares US Dollar We re-shorted the US Dollar on strength on 10/20. It remains broken across all 3 investment durations and there is no government plan to support it.


FXB – CurrencyShares British Pound Sterling The Pound is the only major currency that looks remotely as precarious as the US Dollar. We shorted the Pound into strength on 10/16.


XLP – SPDR Consumer StaplesStrong day for Consumer Staples on 10/16, prompting a short versus our low beta long position in Utilities (XLU).

USO – US OIL Fund WTIC Oil traded just north of our overbought line on 10/12. With the US Dollar hitting another higher-low, we shorted more of oil’s curve.

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.