The House That Leverage Built

“This nation will remain the land of the free only so long as it is the home of the brave.”
-Elmer Davis
Last week’s news out of Dubai brought me back to a talk that former Goldman CEO and head of the US Treasury, Robert Rubin, gave earlier this year at the Yale Law School. When asked about the future risk of Sovereign defaults, Rubin said, "There is no risk of any defaults on sovereign debt globally."
Here are 3 more fascinating revelations from Rubin at that April 2009 speech that I have in my notebook:
1.      "No one saw the extreme confluences of events that led to this recession."

2.      "The most important academic experience for my career in finance was my first year class at Harvard in Greek Philosophy."

3.       "A key problem in our Democracy is that our electorate is not informed."

In prior centuries, when the Wizards of Perceived Financial Wisdom couldn’t be YouTubed (held accountable for what comes out of their mouths), Rubin would have gotten away with saying some of these things. Maybe that’s why he has been suspiciously missing from the current economic debate. Apparently, The House that Leverage Built didn’t come with a warranty.
Economic historian, Niall Ferguson, recently titled a chapter in The Ascent of Money, “Safe As Houses.” It’s a must read historical account of the perceived safety Westerners ascribe to real estate. Ferguson calls the British, “The Property Owning Aristocracy”, and Americans, “The Property Owning Democracy.”
Maybe we should call the boys in Dubai, The Property Owning Insolvency. The only thing harder than building a levered up Disneyland on man-made ocean sandcastles has to be having worked at both the Treasury and Fed overseeing this American leverage-fest for the last 20 years and retaining your job. If the land they call The Kingdom got their Dubai World, America got Robert Rubin’s protégé, Timmy Geithner,
This morning, as the United Arab Emirates central bank proclaims that they are easing credit and “standing behind” the country’s banks, I cannot help but think of Hank The Market Tank Paulson. Yeah, you can call the crisis local to the Middle East. But the resolve is the same. He Who Sees No Bubbles (Bernanke) has Geithner’s banker buddies backs too. Standing behind those who levered up America is perceived to be what will keep this the home of the brave. Perception can be very deceiving.
“A key problem” for us commoners who think debt piled upon debt is bad is probably that we, like the electorate, are “not informed.” That said, there are a few economists in our camp. Hyman Minsky submitted that economic crisis is born out of a capitalist economy that creates debt financed speculation on asset prices. This creates asset price bubbles. They pop. Then, as prices collapse, we “stand behind” them, re-lever them, and set them up for their next fall.
I know, I know. This is coming from some math guys who shun the perceived wisdoms of Debtor nations like Japan and now the USA. What we really need here is a lawyer like Rubin who knows how to really lever up a return and teach us how a Greek Philosopher would approach this moral conundrum.
Back to reality. Last week’s action in marked-to-market prices came on very light volumes, but we are starting to see some cracks in global equity and commodity market foundations. In addition to Dubai, here’s what those who are not paid to be willfully blind might see:
1.      US Financial Stocks (XLF) broke our intermediate term TREND line of support = $14.69

2.      US Small Cap Stocks (RUT, Russell 2000) broke our intermediate term TREND line of support = 589

3.      Japanese Stocks got smoked again – they remain broken on both TREND (3 months or more) and TRADE (3 weeks or less) durations

4.      South Korea’s KOSPI index broke its intermediate term TREND line of support = 1615

5.      Oil has finally broken its immediate term TRADE line of support ($78.79/barrel), despite the US Dollar having closed down again week-over-week

6.      2-year US Treasury yields are testing their lowest levels since December of 2008 (prior to that you need to go all the way back to 1938 for lower-lows)

So what do we do now? In the Asset Allocation Model we called an immediate-term top in the price of Gold on Wednesday, and cut that position in half. On Friday, at one point gold was having a freak-out session, so we bought what we sold back. This isn’t rocket science. This is called risk management.
At Wednesday’s YTD high in the SP500 (1110) we also raised our position in Cash to 67%, then we used Friday’s weakness to invest 7% of that cash at lower prices. We took our Allocation to US Equities up to 10%, splitting between a 7% position in Tech (XLK) and a 3% position in Utilities (XLU).
On the International Equity side of the ledger, we covered our short position in Korea (EWY) and bought back our bullish position on China (CAF). Prior to the Thursday-Friday selloff in International Equity markets we actually cut our position in International Equities to ZERO. That’s the first time we had done that this year. Again, we call that managing risk.
Samuel Johnson said that “bravery has no place when it can avail nothing.” This Thanksgiving reminded me that America remains the home of the brave. But not on every score of this country’s financial leadership. Far from it. We should be very afraid of the Wizards of Perceived Financial Wisdom and The House That Leverage Built.

From Dubai World to Citigroup, Robert Rubin and Tim Geithner were brave enough to submit that they saw none of this coming. I suggest you take their word for that. They won’t see what’s coming next either.
My immediate term support and resistance lines for the SP500 are 1081 and 1102.
Best of luck out there today,


CAF – Morgan Stanley China Fund A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the more volatile domestic equity market instead of the shares listed in Hong Kong. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth. Although this process will inevitably come at a steep cost, we still see this as the best catalyst for economic growth globally.

XLK – SPDR Technology We 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 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.

FXY – CurrencyShares Japanese Yen We took the opportunity to short a 14-year high in the Japanese Yen on 11/27.  The BOJ will definitely be intervening if the unintended consequences of a Geithner Buck Burning persists.


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.

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.

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.


The Macau Metro Monitor.  November 30th, 2009.



Shares of LVS’ Macau unit fell more than 10% on its Hong Kong debut on Monday.  Chairman Sheldon Adelson dismissed the drop, telling reporters, “there is no reason to think a little bump in the road is going to last”.  The Sands’ underwhelming first day follows several disappointing listings in Hong Kong recently, including Minsheng Banking and Wynn Macau.  Sands raised US$2.5 billion from the IPO – less than the US$3.4 billion that executives had expected.





Chief executive Edmund Ho Hau Wah has announced China’s approval of a Macau government proposal to reclaim 3.6 square kilometers of land.  The Macau Post Daily has stated that the land reclamation is for the creation of a “new urban zone”.  Macau’s current land area amounts to 29.2 square kilometers; the proposed land reclamation project will increase Macau’s land area by 12.3%.




Macau’s gross domestic product, in real terms, expanded 8.2% year-over-year in the third quarter.  The rise ends three quarters of contraction.  In the first and second quarters, the GDP contracted by a revised 12% and 15.3% respectively.  


I’m not referring to Tiger Woods, but the Financials (XLF).  The XLF is the first sector to break TRADE and TREND!


After a mini crisis on Friday, the market looks to open modestly higher today as some of the fears from the Dubai debt crisis are mitigated and the focus is holiday sales trends.  The S&P 500 closed down 1.7% on Friday and has now been down five of the last seven days.  On Friday the S&P 500 held the 1,081 TRADE line in quiet post-holiday trading. 


The Dubai World credit issue has taken the wind out of the sails of commodities and commodity stocks, which have been the biggest beneficiaries of the RECOVERY trade.   The Dollar rose 0.2% on the day and volatility surged as the VIX rose 21% on the day. 


The Holiday shortened week was relatively quiet one with the Dow and the S&P 500 basically unchanged on the week.  The NASDAQ declined 0.4% and Russell 2000 1.3%.   Last week the MACRO calendar provided some better-than-expected economic data on the employment and housing picture.  Also adding to the positive tone was increased M&A activity and some better than expected earnings and guidance from some selected retail names.   


On Friday, four sectors outperformed the S&P 500, but every sector was down on the day.   Consumer Staples (XLP), Healthcare (XLV) and Technology (XLK) were the best performing sectors.   The

relative outperformance came from renewed momentum in the SAFETY trade due to the strong dollar and weak commodities. 


The worst performing sectors were Materials (XLB), Financials (XLF) and Consumer Discretionary (XLY).  The XLF is the first sector to break both key durations - TRADE and TREND.  The Energy sector (XLE) is the other sector to be broken on the TRADE duration.  Within the XLF, Insurance and Diversified Financials were the worst performing industries and regional banks were the best performing names.  The three best performing names in the XLF were STI, PBCT and HCBK.


From a risk management standpoint, the ranges for the S&P 500, the Dollar Index and the VIX are seen in the charts below.  The range for the S&P 500 is 21 points or 1% upside and 1% downside.  At the time of writing the major market futures are down slightly.


Crude oil is trading higher on U.A.E. backing of the Dubai Banks and a weaker dollar.  The Research Edge Quant models have the following levels for OIL – buy Trade (74.31) and Sell Trade (75.49).


On Friday, Gold dropped over 4%, but it remains in a bullish formation from a TREND and TRADE perspective.    The Research Edge Quant models have the following levels for GOLD – buy Trade (1,163) and Sell Trade (1,190).


Copper is higher in early as concerns of Dubai World eases.  The Research Edge Quant models have the following levels for COPPER – buy Trade (3.09) and Sell Trade (3.18). 


Howard Penney

Managing Director














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The Economic Data calendar for the week of the 30th of November through the 4th of December is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on. 





Credit Problems: It's Not Just Dubai

This is more of a reminder chart than anything else, but don’t forget that worries about global credit are not just Dubai based.


In the chart below, Matt Hedrick and Howard Penney have outlined the recent activity in Greek CDS – as in the credit default swaps (CDS) of a country (Greece). The Greek stock market was down -7% last week for reasons that are not new this morning.


Issues with credit default swaps are also glaring in Japan. This has been one of the major reasons why we have remained short the Japanese stock market. When a country’s currency appreciates like Japan’s has (hitting 14-year highs today), it puts tremendous pressure on DEBTORS.


Again, this Aiful news out of Japan is not new, but maybe it matters more in concert when considered with Greece and Dubai. Japan’s 2nd largest consumer lender by assets, Aiful, is having major issues with their CDS. We are also seeing CDS issues related to Thomson (levered European media company) and Cemex (levered Mexican materials company).


Aiful – as in awful. That’s what a world addicted to debt gets – new spellings for new paradigms of globally interconnected risk.



Keith R. McCullough
Chief Executive Officer


Credit Problems: It's Not Just Dubai - cds


US Strategy: Managing Risk on Black Friday

Heading into an abbreviated trading day I’ve include our TRADE levels for the S&P500, US Dollar Index, VIX, Oil, Gold, and Copper in the charts below.


Howard Penney

Managing Director


US Strategy: Managing Risk on Black Friday - sp1


US Strategy: Managing Risk on Black Friday - usdx2


US Strategy: Managing Risk on Black Friday - vix3


US Strategy: Managing Risk on Black Friday - oil4


US Strategy: Managing Risk on Black Friday - gold5


US Strategy: Managing Risk on Black Friday - copper6


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