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    MARKET EDGES

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“Just because nobody complains doesn’t mean all parachutes are perfect.”
-Benny Hill
 
The Benny Hill Show was British comedy that featured sped-up film. Some nights, when I fast forward the Kudlow Report, I feel like I’m with Benny Hill in the 80’s all over again. Many thanks to Michelle Caruso-Cabrera for providing last night’s entertainment. Her currency analysis is definitely in a league of its own.
 
Benny Hill’s sketch-comedies usually closed with a chase scene where Hill would run after scantily-clad women. Ironically enough, after proposing to three different women in his real life, Benny never married.
 
Do you want to get married to the US stock market at yesterday’s closing high? I don’t. I took my cash position up to 67%. That’s the highest Asset Allocation I have had to Cash since the end of July 1st, 2009.
 
These Golden Parachutes of 2009 Wall Street compensation ($30 Billion in bonuses to the Big 3 Bankers – JP Morgan, Morgan Stanley, and Goldman) are almost perfect for the Too Big Not To Pay. Almost. Fortunately, almost isn’t good enough for the risk manager in me.
 
Per our friends at Wikipedia, the term Golden Parachute “is used to describe the effort to pay off someone in power… Originally, the term was used to describe bail-out packages given to dictators”...
 
Just because no one with political power in Washington complains about the Burning Buck moving into crisis mode doesn’t mean this perceived parachute of DOWN dollar is going to reflate your hard-earned life right before you have to comply with the laws of gravity. I am not in the business of trusting these politicians to pull the rip cord for my family either.
 
Yesterday, you saw the biggest one-day down move in the US Dollar since July. Was that the YTD low? What if it was? What if it wasn’t?
 
1.      If it was, the US stock market has a very stiff wind ahead of herself into year end.

2.      If it wasn’t, the US stock market only has one precedent of lower prices from here – the 2008 crash.

 
So that’s why I am selling down my exposure to virtually everything. At a price, Dollar down will start to hurt as much as Dollar up can. How bad can it hurt? I have no idea – and I’m not about to “take a chance again”, as Timmy Geithner is suggesting we should, either!
 
Yesterday was the 6th consecutive day of gains for the SP500. Since its March low, the SP500 has ripped the rails off of the Great Depressionista tracks for a +61.7% REFLATION. Benny Hill couldn’t speed this comedy up any faster than it’s played out. This has been the most expedited and hated rally in US stock market history.
 
As I was selling my long position in Germany (EWG) yesterday and pairing back my position in TIP (inflation protection), I was second guessing myself. I always do. But I woke up this morning and peeped my hockey head into my son’s room, and then walked down the stairs smiling. Selling early is cool.
 
One of my favorite investment quotes is from Bernard Baruch: “I made my money by selling too soon.” I think it’s a favorite because, philosophically, it stands for preservation of capital. I have never used leverage in my career. That has never made my returns the highest. But I have never lost money in a down market year either (2000, 2001, 2002, 2008).
 
When I first started this firm, I tried being everyone’s everything. That’s not me. My name is Keith McCullough, and I sell too early.
 
There are a few ways that I express a more conservative investment stance:
 
1.      Asset Allocation to cash – that’s climbed steadily for the past 6 days

2.      Virtual Portfolio – my ratio of longs to shorts has dropped from 3:1, to 1.2:1.0 (19 longs versus 16 shorts)

 
My investment model is to show everything I do, real-time, and mark it to market. If I am wrong (which I have been for the past 3 days on some shorts), all of our subscribers see that. There is no Level 3 drawer or a “side-pocket” in this thing.
 
I use a multi-factor global risk management model to augment my decision making. It’s not always right – but when it comes to losing money, it’s rarely really wrong. Here are some of the domestic market factors that have started to flash amber lights in the last few weeks:
 
1.      Daily risk/reward ratios for the SP500 have moved to a range of -3.5%-5% (downside) versus +0.5-1% (upside)

2.      Volume studies have collapsed as prices have risen (yesterday’s volume was down -17% versus last Monday’s market down day)

3.      Financials and Small Caps (leading indicators for liquidity risk) have broken their immediate term TRADE lines

 
Globally, we have recently seen markets like South Korea and Japan break both immediate and intermediate term lines of TRADE and TREND support. Despite China closing up for the 8th day in row last night (+74% for 2009 to-date), the Indian stock market remains under pressure (closing down again last night) as the government moves to quell domestic inflation (removing stimulus and raising rates).
 
The Golden Parachute of global free moneys isn’t a perpetual ride. It’s definitely not one that I need to be sped-up through, Benny Hill style, to the alter today. Getting married to stocks is for those Burning Buck sky-divers who are much braver than I. Gravity kills returns.
 
Best of luck out there today,
KM

LONG ETFS
       
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 on 10/20. TRADE and TREND bullish.

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.   

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
 
EWY – iShares South Korea South Korea has joined Japan in the ominous position of broken TREND and TRADE. This is not China or Taiwan. This is an early cycle economy that we want to be short against China/Taiwan.

XLI – SPDR Industrials We shorted Industrials again on 11/9 on the up move as the US market made a lower-high.  This is the best way for us to be short the hope of a V-shaped recovery.   

EWU – iShares UK Despite areas of improvement, broader fundamentals remain shaky in the UK: government debt continues to expand, leadership in critical positions lacks, and the country’s leverage to the banking sector remains glaringly negative. Q3 saw its GDP contract by -0.4%. Further bank stimulus and the BOE’s increase in its bond purchasing program suggest that this will not end well.

XLY – SPDR Consumer Discretionary We shorted Howard Penney’s view on Consumer Discretionary stocks on 10/30. TRADE and TREND bullish.  

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.

UUP – PowerShares US Dollar
We re-shorted the US Dollar on strength on 10/20. There continues to be 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.