Walk The Line

“The key to change is to let go of fear.”
-Rosanne Cash
 
If you ask the Kudlow “King Dollar” crowd, US Cash is king. I agree. But that notion definitely doesn’t apply across durations to the stock market. In the immediate term, what we have learned in the last 4 days speaks for itself. Dollar up = everything priced in dollars down.
 
Do the perma-bulls want to believe that if rates on our cash go up, that everything priced in cash will keep going up? Are we ready to let go of the short term fear in exchange for the longer term fix? Are we ready to Walk The Line?

Admittedly, after a -57% stock market crash from the October 2007 peak to the 676 low, then a +62.3% rip to the October 2009 high, no one is really too sure what kind of cash they are looking for. Maybe the answer is the Johnny or Rosanne kind!
 
By virtue of the 48% position I have in US Cash in our Asset Allocation Model, I could pretend that I felt fine about yesterday. I didn’t. Yesterday we saw the US Dollar walk what we call the TRADE line.
 
The lines that matter from an immediate term TRADE perspective in the US Dollar versus SP500 inverse correlation are:
 
1.      SP

2.      US Dollar Index $76.20

 
If you don’t think those lines matter, look at the data again. Look at the expediency of the breakdown you saw in the US stock market the minute that the US Dollar Walked over that Line.
 
Yesterday, the Bombed Out Buck closed up another +0.5% on the day at $76.51. As a result, the SP500 waited for no one and chased the bulls right out of the building for the 4th straight down day, closing down a full -2% at 1042. The cumulative correction in the SP500 from the YTD high is now -5%. The key to this change in market momentum is not to fear it, but to understand it.
 
We are Walking the only line that really matters. Can the US Dollar hold these gains? Will Bernanke fade like a fall flower on signaling a rate hike next week? Are we brave enough to slap handcuffs on more insider traders? Can we re-build the credibility side of America’s currency and hold the longer term lines of support for the SP500? For now, I think we can – provided that the US Dollar doesn’t breakout above its TREND line.
 
The intermediate term TREND line for the SP500 and US Dollar, respectively are 1017 (-2.5% lower) and $77.89 (+2% higher). Understanding the difference between a TRADE and a TREND here is critical.
 
Best of luck out there today,
KM


LONG ETFS
 
EWZ – iShares Brazil — President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt –leading to an investment grade credit rating. Brazil has managed its interest rate to promote stimulus. Brazil is a major producer of commodities. We believe the country’s profile matches up well with our reflation call.

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.

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 and again on 10/28. The TREND and TAIL lines for the Canadian Dollar remain bullish.

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.

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.

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.