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    MARKET EDGES

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

“It ain’t what you don’t know that gets you into trouble.  It’s what you know for sure that just ain’t so.”
-Mark Twain  
 
Mark Twain died in 1910, but my guess is he would have been a contrarian investor.  
 
I have been early on being the bearish one, but the facts have not changed to support a different conclusion so I’m sticking to my guns.  For the record, I was officially bearish when the S&P 500 was at 1066 and it closed yesterday at 1087. The issues that cause me to be cautious are TAIL related – 3 years or less – and on the margin things are slowing in my favor.  
 
The central thesis is not new, the Federal government’s attempts to sustain a $14 trillion economy cannot continue without implications on inflation and the dollar.  Inflation is on its way (Inflation Rotation) and the dollar is bottoming, or what we call the “Bombed Out Buck.”  Neither is good for equity prices.
 
Since 10/26 we have had multiple M&A transactions, a blow-out GDP number, and a number of MACRO data points in the US and China that are very supportive of the RECOVERY/REFLATION themes and still the market is up less than 2%.  Today we are waking up to some GDP numbers out of the Euro zone that are supportive of the global recovery theme and the futures are up small.
 
That could change at 10 am.  Today we are going to get the preliminary November University of Michigan confidence numbers.  The consensus is expecting a slight improvement to a 71.0 reading.  A slowing to below the prior reading of 70.6 is more likely.   
      
During my short tenure as being the bearish one, the dollar index has fallen to 75.60 from 76.13, and our TRADE line of support is 75.92. The dollar looks to be down again today despite some of the biggest emerging economies in the world trying to arrest the decline and President Obama’s shaking hands with the Client.  While the President is doing the right thing, there should have been a hand shake in the first 100 days.  Right now the Chinese don’t care!  
 
Under the surface of all the good news of a 3.5% GDP number and a 61% rally in the S&P 500 are the rumblings of uncertainty that are not being factored in.  Part of the “Bombed Out Buck” process is that there is “risk” in the system that is not being accounted for that will provide some support to the dollar.
 
Given where we came from relative to the 3Q08 “depression” scenario, the recently reported 3.5% 3Q09 GDP number is truly amazing and we have unprecedented federal deficits to thank.  If the 3Q GDP number was company earnings, the quality would be low and “the equity” would be a short.  The 3Q09 number included a 1.7% gain from the “cash for clunkers,” a 0.6% gain from the government throwing tax dollars at the real estate market and a 0.9% gain from a largely-involuntary inventory build-up.  All those “one-time” stimulus items represent 92% of the reported growth and it’s not sustainable.
 
On the margin, GDP looks to be slowing from here as the 4Q09 GDP estimate is now at 2.5% according to a Bloomberg survey.  Adjusting for “one-time” items in 4Q09, we are still in a recession. The money the government is spending on stimulus programs is borrowing from the future and not generating real growth.  
 
At Research Edge, we generally believe that the Healthcare reform madness will not happen.  And I would say with the S&P 500 at 1087, the market generally believes that it’s not going to happen either.  The uncertainty of how healthcare reform will impact consumer spending and corporate profitability is an unknown.    
 
Healthcare reform is a TAX on society that will require an adjustment period that will likely be a drag on consumer spending.  The increased TAX burden on small business owners is massive and creates uncertainty about profitability.  In fact, it could lead to further job losses as businesses adjust labor costs to maintain margins.  
 
For most small businesses, the number of employees required to be covered is unknown because the definition of “full-time, part-time and seasonal” employees would be left to a newly created “Health Benefits Advisory Council” who will figure it out at a later date. The uncertainty of the unprecedented employer mandate TAX would give small business owners no choice but to cut jobs, not create them.  
 
If health care reform passes, I could be out of a job as a restaurant analyst because nobody would want to own restaurant stocks. The current economic downturn did not weed out many of the marginal players in the industry, but Healthcare reform will!  This is not good!
 
Howard Penney

 
LONG ETFS
 
F
XE – CurrencyShares Euro TrustWe bought the Euro on 11/12 on a down move against our short position in the British Pound. A bullish formation in the Euro remains and we think the ECB could hike before the Fed does.

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.  

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.