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Cotton: Back on the Front Burner

Cotton is back up to $0.76/lb after following the market up from the March 9th lows, though with a more notable 90% move off the bottom. Definitely not a good event for most components of the apparel/footwear supply chain, especially given that petro-based inputs are clocking similar gains. On a combined basis, these two represent roughly 20-25% of the underlying cost of goods sold for most apparel/footwear units at retail. This gets more pronounced as we get closer to the point of origination as opposed to consumption (i.e. it is near 50% of COGS for a wholesaler, and 75% for a bricks, mortar, and sweat manufacturer).  We can argue six ways til Sunday about who bears the cost of this, but 1) it won't be the consumer, and 2) the fact is that it is a suck of capital out of the supply chain.


Here's Keith's take on cotton prices based his factor models.

KM: In my model I have the DJ UBS cotton index and the BAL (ipath etf)… BAL literally just broke its TRADE line at 36.40; bullish TREND line all the way down at $34.39… looks like a lot of the emerging markets actually.


Earlier today someone pointed to a 10-year chart and made the case as to how unlikely it was that we breach new highs (implying that the ride is over). I wonder if people made that case in the early 1990s before cotton raced up to a $1.15 peak?  Something to watch as the year draws to a close.


Cotton: Back on the Front Burner - 12 22 2009 3 46 43 PM


Today, the second revision to 3Q09 Gross Domestic Product was released and showed a downwardly-revised annualized real growth rate of 2.2%, reduced from the second estimate of 2.8% and the initial estimate of 3.5%.  This followed a 0.7% decline in reported 2Q09 GDP.  The vast bulk of the growth comes with a significant cost to tax payers and remains dependent on short-lived stimulus programs, like housing.


Consumers, like the “piggy bankers,” are benefitting from the free money policies of the FED and the government stimulus programs.  The NAR reported today that sales of existing U.S. homes rose to the highest level since February 2007.  Existing home purchases increased 7.4% to a 6.54 million annual rate from a revised 6.09 million pace the prior month.  The median sales price declined 4.3%.  A sustained recovery in housing and the economy depends on low interest rates and a resumption of job growth. 


As you can see from the chart below, lower mortgage rates have helped sales of existing homes!  But that could change!


Right now, yields on mortgage securities have climbed from 3.9% on November 30th to 4.5% today, the highest level in four months.  The implications are that the market is responding to the acceleration in housing despite the fact that rates are rising.  It’s possible that higher rates will slow the housing numbers down. 


We continue to argue that the FED is behind the curve and that interest rates are likely headed higher in Q1.  At the very least, the FED will be altering it official “verbiage” that will signal rates are headed higher.   


Looking ahead, the "advance" estimate of 4Q09 GDP growth is scheduled for release on January 29th.  Consensus estimates are for continued, positive quarter-to-quarter real growth of 3%.  For 2010 the consensus has GDP growth of 2.6%.  How the 4Q09 estimates hold up will depend on initial reporting of December employment, retail sales, industrial production and housing data due to be released in January. 


While some parts of the economy are showing some bottom-bouncing, if you eliminate the non-recurring, short-lived spikes from temporary stimulus measures, there is little or no GDP growth.  The upturn in real GDP growth reflected the following three factors; all are a result of temporary stimulus measures:


  • Spending for new cars and trucks was particularly strong, reflecting the federal “cash for clunkers” program that was in effect during July and August.
  • Export and inventory investment also contributed to the upturn.  The three week dollar rally will slow this factor down.
  • Residential housing rebounded due to the home buyer tax credit. The current program expires April 30, 2010.


Despite all of this good news, the Rasmussen daily Presidential Tracking Poll is reporting that the Obama Presidential Approval Index stands at -21, the lowest approval Index rating for Obama since he has become president. 


The market is making a new high today on the strength of the economy and more people disapprove of the way Obama is handling things.  What is wrong with this picture!



Howard W. Penney

Managing Director




Chart of the Week: Piggy Banker Spread

When Matt Hedrick signed up to wear the Hedgeye Risk Management jersey, I don’t think he thought he was going to be charting our fundamental views in pink. Get used to it Matt - really rich piggy bankers wear pink.


The chart below has a very high correlation with banker bonuses. Not only is this morning’s Piggy Banker Spread the widest it has EVER been, Bernanke’s banker bonus inspiration outruns Greenspan’s by a considerable margin. That’s saying something!


Academic types call this the yield spread. This is the difference between 10-year and 2-year US Treasury yields. This is also the difference between what American savers earn on their fixed incomes and what the bankers borrow to them on their loans. Iggy piggy, indeed…


While 10-year yields have been busting a move to the upside ever since the November US employment report, they have been making a series of higher-lows since this time last year. The long term TAIL for long term interest rates, in our risk management speak, is BULLISH.


If you are looking for another opinion on this, ask a sell-sider who is pleading for perpetual short rates of ZERO. Goldman’s David Kostin has a 2010 Fed funds target of ZERO and a 2010 forecast for 10-year yields of 3.3%.


Warning: that GS estimate is what Washington’s economic groupthink team of Larry Summers, Timmy Geithner, and Christina Romer call a “blue chip” estimate.


Today’s marked-to-market price for 10-year yields is 3.71% and, for the bankers at GS at least, this chart definitely tickles them pink.



Keith R. McCullough
Chief Executive Officer


Chart of the Week: Piggy Banker Spread  - PiggyFinal


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Casual Dining – November Trends

Malcolm Knapp reported last Friday that casual dining same-store sales declined 4.6% in November with traffic down 4.4%.  These were surprisingly strong numbers with comparable sales growth improving nearly 180 bps sequentially from October on a 2-year average basis and traffic getting better by more than 150 bps (helps to explain the group’s 6.2% move over the last two days and moving higher again today). 


Making these results even stronger is the fact that November was the first month in 2009 when both average check and traffic 2-year average trends improved on sequential basis.  On a 1-year basis, traffic has gradually gotten less bad in 2009 with November coming in -4.4% versus -10.5% in December 2008.  At the same time, average check has weakened and even turned negative in May and has remained negative through November.  Seven consecutive months of average check declines is significant as the industry had not reported one month of negative average check growth prior to May 2009 going back through 2000.  Lower average checks are a sign of increased industry discounting.


Malcolm Knapp pointed out that although traffic growth continued to outperform same-store sales growth by 0.2% in November, it was the first month since April when not all of the weeks of the month followed this trend and it was also the lowest level of outperformance over that same timeframe.  To that end, Malcolm Knapp stated, “The level of discounting fell in November as wholesale food costs increased 1.29% for the month vs. the prior month, October.”  His statement only increases my conviction that restaurant operators cannot afford to continue to discount to the same extend they have in 2009 as food costs move higher in 2010.  That being said, I thought this lower level of discounting would translate into bigger traffic losses.  This was not the case in November.  As I already said, both average check and traffic ticked up in November on a 2-year average basis.  We will have to wait and see if the November trends are sustainable.  For reference, DRI said last week that industry trends continued to get better in December but would not clarify whether the improvement was on a 2-year basis or a 1-year basis (the latter would be less impressive).

Confidence in the Slush

Today’s release of German Consumer Confidence from GfK yields two observations: Germans are neither overly optimistic, nor glaringly negative on current and future economic expectations. This rhymes with our call that macro headwinds are still bearing down on confidence in Germany, and throughout the Eurozone. The chart below shows that while consumers’ economic and income expectations rose for the December survey, the overall index of sentiment (January) and consumers’ propensity to spend deteriorated.


While one survey doesn’t make a thesis, it contributes to evidence that the threat of future joblessness is still weighing on German sentiment. And the trend appears similar throughout much of the Eurozone. Consumer confidence in Denmark fell to -3.6 in December from -2.4 in the previous month in a survey yesterday, which contributed to the underperformance of its equity market (OMX Copenhagen) in yesterday’s close versus an otherwise positive close for most Western European equity markets, including the DAX that climbed to a YTD high and today further inched upwards.


Although German labor market conditions improved in the Fall, which has helped to stabilize the unemployment rate, and despite Chancellor Merkel’s recent extension of state-subsidized part-time work program for another year, the survey suggests that other concerns, including expectations of price inflation, especially energy prices, persist. With major stimulus programs (including a robust cash-for-clunkers program) in the rear view, consumers may shun spending to increasing savings, which could diminish growth prospects from private expenditure next year. 


Although forecast for modest GDP growth next year, we expect German’s  robust industrial and manufacturing export base to lead Eurozone economies as its major trading partners heat up.  In recent weeks we’re seeing a trend of outperformance from the DAX over the FTSE.  At times this year we’ve traded Germany on the long side via the etf EWG and the UK on the short side via EWU.


We’re currently not invested in Europe and happy to stand out of the way of a fairly long list of countries (including Ireland, Spain, UK) whose future growth is threatened by ballooning debt balance sheets, among other structural issues; certainly Greece has made the most recent splashes on this front.


Matthew Hedrick



Confidence in the Slush - gfk


Burning Bubbles

“The process by which banks create money is so simple that the mind is repelled.”

-John Kenneth Galbraith


I finally got my family to Thunder Bay for the holidays last night, so I figured I’d use a Canadian-American economist for my introductory quote. John Kenneth Galbraith became an economics professor at Harvard in 1949 and then published one of his more famous works, ‘American Capitalism’, in 1952.


The definition of American capitalism in the 1950’s is certainly different than the one you are seeing today. It’s sad. Galbraith was a Keynesian, and all for the government having a hand in the economy, but I highly doubt he envisioned the socialization of losses at Wall Street banks like we are seeing now.


As Galbraith points out, the process by which banks create money is not complicated. All you have to do is watch the Piggy Banker Spread, and you’ll have a pretty good idea what the direction of banker bonuses will be. Watch what this spread does, not what Timmy Geithner says.


This morning, the Piggy Banker Spread (or the Yield Spread) is trading at its widest spread EVER. Yes, I am sure Galbraith would agree – EVER is a long time! The yield spread is the difference between 10-year and 2-year US Treasury yields. That spread has finally eclipsed its prior all-time record from June of this year (276 basis points), shooting up to +283 basis points wide this morning. Is this a bubble?


You bet your Merry Madoff it is. I have said it before, and I will say it again - there is a long term bubble forming in US banker bonuses. For all the bankers out there who are running this American outfit, here’s my advice: if you can borrow short from your starving citizenry on the short end of this curve, then plug them with higher rates on the long end… have at it piggies! Your boys at the US government set this up for you on the silver platter for the holidays.


I wrote about this yesterday, but it’s worth highlighting one more time - He Who Sees No Inflation (Bernanke) is taking a world class face wash (as in the Thunder Bay kind, when a kid buries your face in the snow bank when your parents aren’t there to bail you out) on the marked-to-market pricing front. The US Dollar is breaking out to the upside, trading above my intermediate term TREND line, and now chasing the long end of the US Treasury yield curve higher to new 4-month highs at 3.71%.


While Ben Bernanke seeing his economic forecasts fall behind the curve is nothing new, the Chinese were out there again overnight attempting to fan the fires of a credit bubble. Chinese stocks got pummeled again, trading down another -2.3%, taking their 3-week correction to -8.6%. Can a bubble be on fire?


After what we have witnessed in terms of government bailouts in the last 18-months, anything is possible. From alchemy to Burning Bubbles, we may as well keep making things up here as we go. Heck, the US government telling you there is no inflation out there so that they can keep feeding these Piggy Bankers is one heck of a story.


As opposed to some of these Johnny-come-latelies out there who are now professional bubble watchers, at least I put a time stamp and a price on them before they start to burn. While I continue to feel shame for missing the YTD highs here in the SP500 (again! we hit 1114 last night), I can say that we called out the following bubbles in the first week of December:


1.       Gold – immediate term

2.       Short Term Treasuries – intermediate term

3.       Banker Bonuses – long term


Now, if you want to be in the business of calling things on the short side, particularly bubbles, you probably don’t want to start with one of Morgan Stanley’s latest financial innovations: “short term tactical” recommendations. As my retired firefighting Dad would say, never hire a banker to put out a fire.


From an immediate term TRADE perspective (3 weeks or less), the gold price bubble is burning. Since the US Dollar bottomed in the last week of November, the gold price has corrected -11%. We sold plenty of yellow rocks up there to the latest hedge fund artist turned alchemist, and I’ll be looking to buy back what is turning into a mother of a pain trade into year-end closer to my intermediate term TREND line of support for gold, which is at $1071/oz.


We shorted the SHY (1-3 year Treasury) ETF after we called short term Treasuries out as intermediate term bubbles. Since the He Who Sees No Inflation (Bernanke) lows were established in that prescient 1st week of December, the yield on 2-year Treasuries has locked in its intermediate term bottom. After taking a look-see at 0.66%, 2-year yields have tacked on a +35% move in the last 3 weeks. Ah, now we see Burning Bubbles


Since I used my longest term duration (the TAIL, 3 years or less) to make my bubble call on banker bonuses, I guess we’ll have to see how the next 3 years pan out. The Chinese are definitely getting a head start on Burning Credit Bubbles and the Asian banker bonuses embedded therein.


Last night, Chinese central bank Governor, Zhou, reminded his top 10 banks that he is going to tighten reserve ratios. The Shanghai Property Index got clocked again overnight and is now down -11% for December alone. Gold and Chinese property stocks down the exact same percentage over the exact same duration. Burning Bubbles? Ah, now that sounds like a story the Wall Street bubble watchers can poach.


My immediate term TRADE support and resistance lines for the SP500 are now 1102 and 1118, respectively.


Best of luck out there today.





VXX - iPath S&P500 Volatility
For a TRADE we bought some protection at the market's YTD highs by buying volatility on 12/14.

EWZ - iShares Brazil As Greece and Dubai were blowing up, we took our Asset Allocation on International Equities to zero.  On 12/8 we started buying back exposure via our favorite country, Brazil, with the etf trading down on the day. We remain bullish on Brazil's commodity complex and believe the country's management of its interest rate policy has promoted stimulus.

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 YuanThe 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 TIPSThe 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.



RSX – Market Vectors Russia
We shorted Russia on 12/18 after a terrible unemployment report and an intermediate term TREND view of oil’s price that’s bearish.  

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 IndustrialsWe 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.   

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 BondsIf 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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