Fantasy Forecaster

“We have two classes of forecasters: Those who don’t know – and those who don’t know what they don’t know.”
-John Kenneth Galbraith
 
I was flying back to New York from Seattle last night, and for the life of me could not shake this ‘dude’ they have on Fast Money who keeps pronouncing China, “Chi-nar-r.” We’re not asking much from these Fantasy Forecasters, but for the love of God, CNBC, get us someone who at least knows what they don’t know about basic spelling and pronunciation. The Chinese are watching.
 
Rebecca Runkle’s vision of Mobility is a wonderful thing but it can really infuse some distractions to my research while I am on the road. After getting what I needed from CNBC’s broadcast (closing prices for factors in my macro model), I promptly moved back to the country music channel.
 
Some people call me a forecaster. Some people call me names. Most people are starting to call me their Risk Manager. After spending a lot of time on the road in the last few weeks with Global Macro investors from Calgary, Alberta to Kansas City, Missouri, that’s where people say my team adds the most value.
 
Howard Marks has been adding value for Oaktree Capital Management investors for a long time. He founded the firm in 1995 and runs $60B in a way that a lot of people respect. They should. He is no Fantasy Forecaster – this man is a world class risk manager. In his recent letter to investors, Marks outlined some thoughts on risk management. Here were two that found their way into my notebook:
 
1.      “Ignoring bubbles is a special case of ignoring risk in general.”

2.      “I say we never know where we are going, but we sure as heck ought to know where we are.”

 
No matter where we go this morning, there those real-time, marked-to-market, prices are. Ultimately, this is a very simple way to start knowing what you may not know. Never forget that market prices don’t lie; people do. Price action is a leading indicator for something. Our daily task, as risk managers, is finding a way to understand what it is about those prices that we don’t know.
 
After being on the road meeting with a lot of people who are in the know, I thought I’d start to share my list of what seems to strike investors as something they didn’t know:
 
1.      Japan’s stock market is breaking down at the same time as her sovereign default swaps have doubled since August

2.      Japan’s stock market is down -5.4% for the month of November vs. China’s being up +10.5%

3.      Japan’s debt/GDP has gone from 50% in 1988 to 196% today, and government debt could top 240% within the next 3 years

 
That’s just Japan. And I have to keep this morning missive under 1000 words, so I better jump to another country. What is it about America that Washington doesn’t want anyone to know?
 
1.      Ben Bernanke’s new nickname is “He Who Sees No Bubbles” (see Daryl Jones, note titled “Geronimo” from Tuesday November 17th)

2.      America’s debt/GDP is tracking the exact same path as Japan’s, from 50%, to 80%, to … ?

3.      America’s debt, all in, per the Federal Reserve, is $53T (includes government, corporate, and consumer debt) actually close to 380% versus GDP

 
Wait. We know this – or do we? Do we know that levering ourselves up with debt is bad? Do we know what one TRILLION dollars is? How about $53 Trillion, and counting? Do we know what we don’t know?
 
Do American politicians know what off-balance sheet debt obligations are? If I throw those into the mix (Medicare, Social Security – you know… that other stuff), I can get to $56 TRILLION. That’s not a Fantasy Forecast either. That’s a number that “we sure as heck ought to know” we are running up here!
 
What does Timmy Geithner know? He claims to know that he “brought America back from the brink.” But the minute that Texas Congressman, Kevin Brady, insinuated that Timmy may not know what he doesn’t know… well… you saw that Squirrel Hunter get all fired up Rouge didn’t you. I have never seen a squirrel turn red before. Heck, I guess that’s just one more thing I didn’t know.
 
What most Americans know is that they are getting the bill. The Piggy Banker Yield Curve gets the Bankers, Debtors, and Politicians paid. Geithner’s job was to ensure the top 3 banking firms in America got their $30B in 2009 bonuses. Enough with your having brought us back from the brink already, ‘dude’.
 
Back to Bernanke. Depending on what slope you want to look at, the ‘He Who Sees No Bubbles’ yield curve is 2-4x its historical slope. If you didn’t know, that’s steep. There is a bubble forming in US Treasuries.
 
This morning you are seeing massive politicization on the short end of that yield curve. The 2-year US Treasury rate is plummeting to new lows (0.69%, levels not seen since the crash). The Yield Spread (10-year yields minus 2-year) is +265 basis points wide (11bps from its widest spread EVER), and the Term Structure (30-year yields minus 3-month) is +401 basis points wide (the historical median is 129bps!).
 
By any historical measure – government debt, yields, spreads – America has never looked more like Japan did in 1989. Rather than hiring a student of the Great Depressionista “brink” school to run this country’s debt levels up and into monstrous bubble proportions, maybe we should get someone who knows something about Japan to explain this to our President.
 
President Obama,
 
If one of your aides passed you the Early Look, I am satisfied – because now you know.
 
Ignoring America and Japan’s debt bubbles is, as Howard Marks can teach you, a special case of your in-house Fantasy Forecasters “ignoring risk in general.”
 
My immediate term TRADE support and resistance levels for the SP500 are now 1082 and 1115, respectively.
 
Enjoy the weekend with your families and best of luck out there today,
KM

 

 

LONG ETFS

EWA – iShares Australia We remain bullish of Glenn Stevens at the RBA and how Australia is issuing its citizenry a rate of return. With growing confidence in domestic demand recovery and a commodity export complex with strategic proximity to China’s reacceleration, there are a lot of ways to win being long Australia.

XLU – SPDR Utilities We bought low beta Utilities on discount on 10/20.

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.

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 and 11/16.

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.


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