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    MARKET EDGES

    Identify global risks and opportunities with essential macro intel using Hedgeye’s Market Edges.

“Problems cannot be solved by the level of awareness that created them”
-Albert Einstein

I’m in beautiful Camden, Maine this morning. It’s getting chilly up here, and the bears don’t like it.
 
Born and raised in the northwestern woods of Ontario, I know a thing or two about Black Bears. My Dad likes to say that you “don’t want to dance with the bear” and, although that’s probably local consensus, that’s not a consensus you want to try fighting. Consensus can be right.
 
What is consensus? Is consensus when everyone is long or short something? Or is it when you think everyone is long or short something? Is it consensus when you aren’t making money alongside people you deem to be consensus? Or are you consensus when you say something is consensus?
 
After making enough mistakes hunting in global markets, I have come to conclude that I can either be Bullish, Bearish, or Not Enough of one of those two things. My daily risk management task is to figure out how to not to be mauled. If that means being called consensus on my bearish US Dollar stance at this stage of the hunt, so be it. I remain short the US Dollar this morning because I don’t think consensus is Bearish Enough.

To be truly Bearish Enough on the Buck requires some reading beyond your latest tweet. You can listen to the Johnny-Come-Latelys on CNBC, who are now running segments with lead-ins like “When Nixon abandoned the Gold Standard in 1971” (sound familiar?), to truly appreciate that consensus still has no idea how to analyze this fundamentally. “Problems cannot be solved by the level of awareness that created them.”
 
On the topic of the Burning Buck, Niall Ferguson at Harvard is amongst the most aware. Ferguson is what I would call Bearish Enough. He’s looking for a -20% drop in the price of the US Dollar in the next 6-12 months. That would put the US Dollar index at $60!
 
Let’s think about what a -20% drop, from here, in the US Dollar would mean. We call this TAIL risk. Since March, the US Dollar has crashed, losing -16% of its value. Over the same time period, the price of oil (priced in those dollars) has had a Minsky Meltup of +102%. Let’s say Niall is not right, and the Dollar only loses another -16% of its credibility. Using the same leverage ratio of down dollar to up oil, that could equate to $160/barrel oil. Is that consensus?
 
Required reading from Fergusson would be his book titled the Ascent of Money. This fantastic analysis of economic history was all part of the studying we did to make this Burning Buck call 9 months ago, but my having been early on this doesn’t matter anymore. What matters is the here and now.
 
The US Dollar remains in what we call a Bearish Formation. That’s simply when then TAIL sits on top of the TREND, and the TREND sits on top of the TRADE. Bearish Formations are very powerful because they force all types of investor durations (from 3 weeks to 3 years) to either pay attention or “dance with the bear.”
 
My updated risk management levels for the US Dollar are as follows:
 
1.      TRADE (immediate term) = $76.39

2.      TREND (intermediate term) = $78.03

3.      TAIL (long term) = $82.29

 
So what do you do with these levels? You definitely don’t run from them. That’s what consensus does when being chased by a Black Bear. Instead, you hold your ground, and stare at them. Start yelling too, if you want.
 
Provided that the US Dollar cannot breakout above the TRADE line ($76.39); the Volatility Index (VIX) can’t breakout above hers (VIX immediate term TRADE line = $24.19); and the SP500 cannot breakdown and close below her TRADE line at 1065, I think US equities will make another higher-low during this correction.
 
Sometimes, doing nothing – waiting, I mean – can be the best option in avoiding a dance with the bear. In Thunder Bay, Ontario, that’s local consensus – but it’s a consensus that I’m more than happy to be called.
 
Best of luck out there today,
KM

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

FXC – CurrencyShares Canadian Dollar We 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 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.

 
SHORT ETFS
 
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 Staples Strong day for Consumer Staples on 10/16, prompting a short versus our low beta long position in Utilities (XLU).

USO – US OIL Fund We shorted oil on 10/12 and 10/21 and are currently off sides, but with oil getting more over bought we are adding to the position.  Ultimately, the threat of higher interest rates, will be bearish for oil.  In addition, we are concerned with the bearish supply in the shorter term.

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.