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Sand Castles

“Even Castles made of sand, fall into the sea, eventually.
-Jimi Hendrix


Dubai World is an investment company that manages and supervises a portfolio of businesses and projects for the Dubai Government across a wide range of industry segments.  Dubai World was established under a decree ratified on 2 March 2006 by Sheikh Mohammed bin Rashid Al Maktoum, Vice President and Prime Minister of UAE and Ruler of Dubai.   He is the majority shareholder in Dubai World and we are about to find out if the Sheikh has any friends.   


The Sheikh has learned the valuable lesson that leverage is BAD.  There is not much you can do to manage risk around this level of arrogance but here we are.  On Wednesday, we went to 67% cash, zero exposure to international equities, and made an intraday call to sell ½ our gold position.


Is this an isolated incident?  The lesson from the financial crisis of 2008 suggests that Dubai World is probably not the only entity that binged on debt to buy overpriced, rapidly depreciating assets.  The doom and gloom scenario that we are waking up to is the reality that the global central bank coordinated rescue program is just another  sand castle that will be washed away in the sea.   


So what happens next?  What if creditors reject proposals to postpone near-term debt obligations until May 2010?  Default or the Dubai government could be forced to hold a fire sale of its international real estate and a series of global financial institutions will experience massive losses again.


Not surprisingly, we are also waking up to the U.S. Dollar Index up as much as 1% - now up for two straight days.  While there were a number of factors that I thought would contribute to the Bombed Out Buck theme, systematic risk was not one of them.   The implication for everything priced in dollars is obvious.


The other fact we are waking up to today is that the Federal Reserve’s free money punch bowl needs to be removed from the party.  How many other Dubai Worlds are binging at the trough of free money?


I for one did not know about the scale of Dubai's debt problems.  So will Dubai's debt problems plunge global equity markets to new lows?  I don’t think so, but uncertainty will prevail for some time.  A potential scenario we could see develop over the next few days is one that includes Dubai’s neighbor, Abu Dhabi, which could easily bail out Dubai.  Abu Dhabi's sovereign wealth fund has $600 billion in assets and can easily support Dubai's debt problems.


Today is definitely not a typical Black Friday; nor was it easy to get the Early Look written today.  What is happening to Dubai World really does not change much for the typical American.  It’s a reminder that leverage is bad, the BUCK is bottoming and that the FED needs to raises interest rates sooner rather than later.   


Howard W. Penney

Managing Director





VXX – iPath S&P500 VolatilityWith the market hitting its YTD high on 11/23 we bought volatility.


XLK – SPDR TechnologyWe bought back our position in Tech on 11/20. Rebecca Runkle has an innovation story in Mobility and Team Macro has an M&A story in our Q4 Theme, the “Banker Bonanza”. We’re bullish on XLK on TREND (3 Months or more).


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


GLD – SPDR GoldWe 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.




EWJ – iShares JapanWhile 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.


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 DiscretionaryWe shorted Howard Penney’s view on Consumer Discretionary stocks on 10/30.


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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Manic Depressionistas, Be Careful...

This morning’s weekly jobless claims release was the least-toxic we have seen this year.


At 466,000 claims, this was better on both a sequential (week-over-week) and a 4-week moving average basis. In the chart below you can see these points. Last week’s claims were 505,000 and the 4-week moving average (yellow line) is 496,500.


What does it mean? Well it is probably not enough to make the November monthly jobs report much better, but it definitely isn’t something that’s going to make it worse. Manic Depressionistas, be careful. An 11% unemployment rate is not going to be in the cards – not this or next month, at least.


What’s perverse about this (and not being read through in this way by Mr. Macro Market today) is that anything that remotely resembles a less-than-toxic US Employment picture is bad for the stock market, in the immediate term. Why? Well, that’s easy – that would be US Dollar Bullish.


Which leads me to asking myself another question. Is today’s jobless claims report marking the YTD low for the Bombed Out Buck?


He Who Sees No Bubbles at the Fed once claimed to be “data dependent” – this week’s housing and employment data points, combined with last week’s Consumer Price Inflation report are plenty good enough to NOT be holding interest rates at this ridiculous “emergency” level of ZERO percent.


There is an immediate term bubble in Gold and an intermediate term bubble in short term US Treasuries.


Given the recent data, the Fed’s policy of “exceptional and extended” remains unsustainable and unreasonable.



Keith R. McCullough
Chief Executive Officer


Manic Depressionistas, Be Careful...  - claims


Consumer Confidence Wanes on Both Sides of the Atlantic

As one indicator of sentiment that we track, the GfK released its December German Consumer Confidence report today. In contrast to yesterday’s release of the German Ifo Business Confidence Survey that showed a measurable increase in the business climate (93.9 in November versus 92.0 in October), today’s consumer report falls more in line with our overall intermediate outlook for the Eurozone’s largest economy, and the region itself.


Consumer confidence fell to 3.7 in December from 4.0 in the previous month, while the sub-surveys of economic and income expectations declined significantly and consumers’ propensity to spend was flat. More broadly, the data has been trending downward over the last months (see chart below).


We continue to expect the rate of improvement in broader fundamentals to slow sequentially into year-end and in 1H ’10 for Germany, and many Eurozone countries, with mild growth next year. That said, one bullish indicator for Germany has been its rate of unemployment, which has held steady ~8.1% over the last four months. And today the government announced that its program (subsidy) of shortened work hours or part-time jobs, known as Kurzarbeit in German, which was set to expire at year-end and by all measures was the substantial crutch in maintaining employment, will be extended by another 12 months. The decision by Chancellor Angela Merkel’s government means that the state will pay up to 67% of a worker’s salary for a period of up to two years to keep workers across industry “employed”. Recent data suggests that some 1 million workers were covered under the program.


While prolonging Kurzarbeit should hinder joblessness, on the TAIL we’re left to wonder if striking jobs now would be a better solution, both limiting government expenditure and encouraging companies to right-size their labor force...


Irrespective of the government’s extension of short-time work, we still expect joblessness to be a major concern for the consumer in 2010. Neither Eurozone PMI data out this week (See Topping Off on 11/23) nor German private consumption Q3 figures suggest the consumer is ready to spend, and the stimulus associated with the country’s cash for clunkers is now rear-view. Additionally, today’s news from the Bundesbank that German banks may need to further write-down another 90 Billion Euros of bad loans won’t add confidence in the broader economy.    


While we see bearish fundamental headwinds for Germany ahead, and as an extension for Eurozone countries that rely on the stronger economies of the region like Germany and France for trade, we are on balance bullish on the German economy versus some of its European peers as we believe that global demand should melt up to support Germany’s industrial and manufacturing base.


Matthew Hedrick



Consumer Confidence Wanes on Both Sides of the Atlantic  - GfK


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