Yesterday, the S&P 500 was essentially flat on the day but six of the nine sectors declined.  For the second day in a row the Utilities (XLU) was one of the best performing sectors.  Also, for the second day in a row there was no overriding theme that dominated trading.


Ahead of the November sales data the Consumer discretionary (XLY) was the third best performing sector, improving 0.3%.  The gains were driven by SNA (3.4%), MDP (3.3%), RL (3.0%) and WHR (2.8%).  GME was the worst performing stock trading down 8.3%.  Deflation still rules with WMT cutting prices by 20% on the top 25 video games.


Yesterday’s MACRO calendar included some mixed employment data.  The ADP private employment fell 169,000 in November, weaker than consensus expectations for a 150,000 decline.  The absolute decline is the smallest drop since July of 2008 and the eighth consecutive monthly deceleration in job cuts.


While Materials (XLB) kept the RECOVERY trade alive yesterday, the Energy (XLE) sector was the worst performing sector on the day.  Weakness in OIL following bearish inventory data and geopolitical concerns surrounding Iran seemed to be the biggest drag on the group.   January crude settled down 2.3% at $76.60 a barrel.  The government said crude stockpiles rose by 2.09M barrels in the week-ended November 27th, compared with consensus for a 400,000 barrel decline.


I can’t help but to think that the underperformance of the Financials are not foreshadowing some more MACRO drama on the horizon.  Yesterday, the Financials (XLF) underperformed the broader market.  The high quality financial institutions were among the laggards for the second day in a row.


Despite yesterdays mixed performance, the appetite for risk accelerated with the VIX down another 3.6%. 


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 33 points or 1% upside and 2% downside.  At the time of writing the major market futures are trading higher.


In early trading today, crude oil rose above $77 a barrel as the dollar weakened.  Oil rebounded after losing 2.3% yesterday as the U.S. Energy Department reported that stockpiles swelled to the highest level since August.  The Research Edge Quant models have the following levels for OIL – buy Trade (75.61) and Sell Trade (78.88).


China’s central bank views gold prices as very high and will be wary of “bubble” assets, according to the Apple Daily.  The story citied Hu Xiaolian, a deputy governor at the People’s Bank of Chin!  Regardless, gold rose to a record $1,218.25 an ounce in the morning “fixing” in London.  The Research Edge Quant models have the following levels for GOLD – buy Trade (1,176) and Sell Trade (1,224).


Copper futures in Shanghai advanced for a fourth day to the highest level in 15 months on global economic optimism.  The Research Edge Quant models have the following levels for COPPER – buy Trade (3.17) and Sell Trade (3.25). 


Howard Penney

Managing Director














The Garbage Man

A guy walks up to me and asks 'What's Punk?'. So I kick over a garbage can and say 'That's punk!'. So he kicks over a garbage can and says 'That's Punk', and I say 'No that's trendy! <> ”
–Billie Joe Armstrong, Singer, Green Day
Keith is flying back from California this morning, so I’ve been handed the pen on the Early Look.  The title Garbage Man has many implications as it relates to investing and careers.  For me, it was actually my first job.  Yes, this former hockey head and now Macro Analyst started his working career as the Garbage Man back in his home town.  I’m not sure I learned a whole lot about investment analysis while digging through the garbage barrels back in Bassano, Alberta, but what I did learn is that as you dig through all that garbage, every once in a while you find a little treasure.
As I sit here drinking my second cup of coffee, listening to Pandora (that’s what the Millennials use to get music these days!), and reviewing the global macro news streaming on to our floor here in New Haven, there are a few little treasures that are emerging.
1.      The Chinese central bank is noting this morning that they view gold prices as very high and they will be wary of “bubble” assets.   It is interesting that the so called “Communists” see bubbles before He Who Sees No Bubbles (Bernanke) and the purported free marketers at the U.S. Fed do.  From a fundamental perspective, this is negative for gold demand in the intermediate term as China is potentially a large buyer of gold to diversify her reserves, though presumably not at bubble prices.

2.      In stark contrast to concerns over Dubai’s debt issues, both Latvia (whose GDP declined by 18.4% in Q3) and Senegal are marketing bond offerings this morning, which suggests the market for emerging market debt is strong and open.  Additionally, the spread between U.S. treasuries and emerging market debt is at 315 basis points, which is in line with levels before the Dubai restructuring was announced.  The implication is obviously that, for now, Dubai appears to be a blip on the radar screen and credit markets continue to open globally even for weak economies like Latvia. Free money and easy credit continues to flow.

3.      The less traditional gauge of employment, the employment index, which is a monthly gauge of online job demand fell one point sequentially to 119 in November.  However, on a year-over-year basis it declined 17%, which is actually the lowest rate of annual decline since September 2008 (so a positive on balance). Interestingly, the occupation that gained the most in terms of “Top Industries Looking for Employees in November” was Transportation and Warehousing. On the margin, this report does look positive and y-o-y compares will look great starting in January.  Accelerating year-over-year employment number should also be additive to inflationary pressures, as will emergency level interest rates . . .

Another topic I want to discuss this morning is China, which we refer to as The Client.  As many of our faithful readers know, we’ve been all bulled up on China this year and rightfully so given her massive stimulus program, high growth, and low inflation, but I thought it might be interesting to lay out the bear thesis on China.  This thesis comes from well known short seller Jim Chanos.  A short seller is sort of the Garbage Man of global investing, if you will.  He or she is always sniff sniff sniffing for that company, or in this case an economy, that doesn’t quite smell right.  With a batting average of 85.1% on shorts since inception, we too know a fair bit about the dark art of shorting.
Chanos’ thesis on China, according to reports, is as follows.   First, given the enormous size of the stimulus of China, $900 billion, versus the size of the economy, $4.3 trillion, Chanos and the China bears postulate that the Chinese reported GDP expansion of 8.9% in Q3 is actually less than should be expected. Second, there appears to be some disconnect in official statistics coming out of China.  As one example, while the growth in car sales is massive, as we have noted, Chanos and the bears are noting that there is no commensurate increase in gasoline sales. Finally, they theorize that there is massive over capacity being built in many Chinese industries.  An example given is in the cement industry, where there is an estimated spare capacity of 340 million tons, which is more than the consumption in U.S, India, and Japan combined.
As of yet, we have not changed our bullish stance on China, but we are concerned about the potential for a H1 2010 slowdown in China. And certainly, any bull should know which garbage pails the bears are pawing around in before they become “trendy”, or worse before their long positions get “punked”.
Good luck out there today,
Daryl G. Jones
Managing Director


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).

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.

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 -0.3%. 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 and 12/2.

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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MCD is scheduled to report November same-store sales numbers before the market opens on Tuesday.  It is important to remember that headline numbers will look worse than underlying trends as November 2009 had one less Saturday than November 2008.  In October 2009, the calendar shift/trading day adjustment, which included one extra Saturday relative to October 2008, boosted reported same-store sales growth by 1.0% to 1.7%, varying by area of the world.  I would expect about this same magnitude of negative impact on reported results in November.


Taking that into consideration, I wanted to provide comparable sales ranges for each geographic segment as a benchmark of what I think would be GOOD, NEUTRAL, or BAD results based largely on 2-year average trends. 


U.S. (facing +4.5% comparison from last year, calendar shift helped result by 0.0% to 2.8%):

GOOD: Any positive number would signal that October’s negative result was only a 1-month blip.  Considering the negative 1% to 1.7% impact on reported results, I don’t think investors are expecting positive comparable sales growth as this would point to a sequential improvement in 2-year average underlying trends.  For reference, a reported +0.5% would imply that underlying growth is closer to +1.5%, which would signal that 2-year average trends had improved nearly 100 bps from October levels.


NEUTRAL: -1% to flat would imply underlying growth of approximately flat to +1%, excluding the timing/calendar shift, and 2-year average trends that are about even with to slightly better than October.  Like last month, this range of results, though neutral from an investor sentiment perspective as it relates to expectations, is not a favorable sign for current trends.  Before October, MCD had not reported a decline in U.S. same-store sales growth since March 2008 so two consecutive months of declines would not be good.


BAD: below -1% would not be that surprising as it assumes 2-year average underlying trends that are similar to what we saw in October.  Although I would typically consider maintaining 2-year average trends as a neutral result, I think a reported number below 1% (even if does not reflect true underlying trends) will hurt investor sentiment.  MCD has not reported a monthly comparable sales decline of greater than 1% since March 2003.


Europe (facing +7.8% comparison from last year, calendar shift helped result by 0.0% to 2.8%):

According to a Reuters article, MCD’s Europe Chief Financial Officer Jerome Tafani said, “The trend in sales we have seen up until October is not going to change in the coming months.”  Based on his comments, we would not expect to see a BAD result.


GOOD: +6.0% or better would imply that MCD is maintaining its strong 2-year average underlying trends from October, which accelerated sequentially from September.


NEUTRAL: +3% to +6.0% would point to 2-year average underlying trends that have slowed somewhat from October but are still even with to slightly improved from September levels.  September 2-year average trends were up 6.0% so these are still good numbers, but  I think MCD’s strength in Europe has trained investors to need 2-year average trends in the 7%-plus range to get really excited. 


BAD: below +3% would imply a significant sequential slowdown in 2-year average underlying trends from October and a slight deceleration from September.  A +2% or lower would be viewed as really BAD as it would signal a return in 2-year average underlying trends to the low reported June levels.


APMEA (facing a difficult +13.2% comparison from last year, calendar shift helped result by 0.0% to 2.8%):

GOOD: +1.0% or better would signal that MCD maintained its 2-year underlying average trends from October.  Being that MCD’s APMEA trends accelerated rather significantly in October after having slowed somewhat for the four preceding months, I think just maintaining those 2-year average trends in the 7%-plus range will encourage investors that October was not just a one month uptick.


NEUTRAL: -1% to +1% would point to 2-year average underlying trends that are consistent with to slightly worse than what we saw in October.  Although I don’t think investors are accustomed to negative results out of this geographic segment, the tough YOY comparison and the reported negative timing shift must be considered as a reported -1% number still implies 2-year average underlying trends in the 6%-plus range.


BAD: any number below -1% would imply that 2-year average trends have slowed somewhat from October which might lead investors to believe that October’s significant improvement is not sustainable. 









The good news - manufacturing in the U.S. expanded in November for a fourth consecutive month.  It appears to be a given that growth is here to stay!


The not so good news - the rate of growth is slowing.  The Institute for Supply Management’s manufacturing index fell to 53.6, lower than forecast 55.0 and from October’s three-year high of 55.7. 

On this news stocks rallied yesterday and are extending gains into early trading today. 


Yes the “Broken buck” is helping to spur demand from abroad, but the overall impact is inflationary.  Look no further than the comments from the field. 


(1)    Apparel, Leather & Allied Products – “Becoming concerned about the value of the U.S. dollar!"

(2)    Food, Beverage & Tobacco Products - "Low value of the dollar driving commodity costs higher."

(3)    Fabricated Metal Products - "Demand from automotive manufacturers remains strong and building."

(4)    Electrical Equipment, Appliances & Components – “Capital construction seems to be picking up, and we are seeing more jobs that are bid out."

(5)    Primary Metals - "Steady increase in business."   The XLB was the best performing sector yesterday and again today!


Maybe it is just a coincidence but the ISM numbers look just like consumer confidence - making lower highs!  For the second day in a row the low beta SAFETY trade (XLU) is outperforming the other higher beta sectors! 


Just another coincidence?



Howard Penney

Managing Director



Bubbly Gold: Selling Some, Again

Last Wednesday our immediate term TRADE target for Gold was $1190, so we sold some. Then Gold corrected, and we bought back what we sold on Dubai Friday (gold was down, a lot).


This morning we entered the game with a 7% Gold position in the Asset Allocation Model, and I cut that in half as Gold tested our refreshed immediate term TRADE target of $1224. Unlike most sell-side strategists, we like to be on the right-side. Managing risk dynamically; changing our price targets proactively. As prices change, we do.


Some call this trading. It is – but when “long term investors” hit buy/sell buttons, that’s called trading too. What I have learned (the hard way) in this business is that it pays to manage the risk associated with price appreciation in long term TAIL positions. My daily challenge remains to improve this process, using math, as opposed to emotion. I continue to learn a great deal from chaos theory on this score. I continue to learn a lot about myself.


For now, the math says gold is in an immediate term TRADE bubble (TRADE = 3 weeks or less).


I’m not fighting it. I’m not selling all of it. I’m just selling some of it.


My risk management lines are in the chart below. I’ll be a buyer again of what I just sold on a pullback to my immediate term TRADE line of $1170/oz.


It’s ok to be long bubbles. Just be aware when you are in one (yes, Peter Schiff, that means you).



Keith R. McCullough
Chief Executive Officer


Bubbly Gold: Selling Some, Again - gold6m


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