Standing Still

“The United States needs to move very fast to even standstill.”
-John F. Kennedy
 
As I was overlooking the shoreline, making my coffee this morning, the big lake they call “Gitche Gumee” was inordinately calm. In the 17th century, French explorers called this massive body of fresh water, “The Highest Lake.” Today, we call it Lake Superior.
 
After seeing the US stock market hit her highest levels in the last 14 months yesterday, I suppose it’s only fitting that the manic media is anything but calm. A +65.4% meltup in the SP500 has a frantic cast of characters at CNBC scrambling for the latest crackberry sound-bite. Bull markets drive advertising dollars, don’t forget.
 
Sometimes, in markets, the best thing to do is to do nothing at all. Sometimes, standing still gets you to exactly where you need to be. Sometimes, it doesn’t.
 
Every market minute presents us with an opportunity to move. Discerning which opportunities to act upon is where the real risk managers of this game make a name for themselves. Everything has a time and a price. Every time you act, you put your (or other people’s) hard earned capital at risk.
 
When it comes to addressing the highest level of proverbial water on this US stock market lake, there is no denying that I have failed to discern the opportunity in the last 3-days. On Friday, I did not stand still. I sold my bullish position in US Technology (XLK). Standing still and holding that investment in our Asset Allocation Model was the winner’s reward.
 
Every market minute presents us with wins and losses. Booking a gain on the long side of Tech was a win. Not turning around and shorting the tech ETF prevented my having a loss. Altogether though, I could have played this better.
 
Standing still and watching a low volume holiday rally is what it is. It’s a call I made. It’s been a rigorously thought out and conscious decision. I don’t wake up every morning, dunk my head in the lake, and go with the flow. I grind through my global macro investment process and look at everything in terms of risk versus reward.
 
One of the most misunderstood global macro risks in the market today is that of sovereign debt defaults. Many market pundits are brushing off what is happening in Middle Eastern debt, Eastern European banks, and Chinese property stocks as isolated events. Standing still into year-end with that opinion is very risky.
 
Sovereign defaults, as a percentage of total global defaults, remains at a generationally low level. That can change. Carmen Reinhart (University of Maryland) and Ken Rogoff (Harvard) wrote a great book in the last year titled, “This Time is Different: A Panoramic View of Eight Centuries of Financial Crises”, that provides the best historical context of this critical risk management point. So rather than rehash their work, I will refer you to the Amazon.
 
The simpleton question that every global risk manager should be asking themselves is this: if sovereign defaults are near all-time lows, and sovereign bailout debt issuance continues to hit all-time highs, how do you think this is going to all end? Until we know, I can assure you of this – we don’t know. That’s what I call risk.
 
The United Arab Emirates stock market is getting hammered again this morning, trading down another -3.8%, after Dubai World got 100 bankers into a room at the Dubai International Convention Center and peddled them a “Standstill Offer.” No one bought that line. So Dubai World pushed the discussion out to sometime in January. Ladies and gentlemen of Dubai, this is not a time to standstill. Stock markets wait for no one.
 
Middle Eastern debt defaults, combined with a breakdown in the price of oil from an intermediate term TREND perspective, are some of the main reasons why I have recently raised my water levels of cash in the Asset Allocation Model to 62%. With the US Dollar and long term US Treasury rates breaking out to the upside, I am more comfortable standing still with US Cash now than at any other time other than 16 months ago, when I recommended you move to 96% US Cash.
 
I will be the first to admit that US stock and debt markets are much less risky now than they were back then. I will also be one of the first to remind you this morning that emerging markets from Asia to the Middle East may not be. As cost of capital in the US continues to heighten (10-year yields are hitting new 4 month highs again this morning at 3.74%) and global access to capital continues to tighten, I see plenty of global default risk heading into 2010 and beyond.
 
In the meantime, like the mountain they call the Sleeping Giant on The Highest Lake, I intend to sleep soundly with my cash, standing still.
 
My immediate term support and resistance lines for the SP500 are now 1107 and 1120, respectively.
 
Best of luck out there today,
KM

LONG ETFS

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 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

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 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.

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.   

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.