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,




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.


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.


The Macau Metro Monitor.  December 23rd, 2009




Macau’s Statistics and Census Service or DSEC announced that the number of visitor arrivals increased by 2.7% year-over-year in November, slower than the 5.2% growth seen in October.  Visitation from mainland China grew by 14.6% y-o-y, while visitation from Taiwan and Malaysia increased by 15.8% and 5.1% respectively.  Visitation from Hong Kong, Japan, and Singapore decreased in November.  For the year-to-date, visitation has dropped 6.2% compared to the same period of 2008.



Yesterday, the S&P pushed to a new a high for the year, closing up 0.4% on yesterday’s trade line of 1,118.  In very light pre-holiday trading, volume declined 5.6% day-over-day and the breadth of the market narrowed.  The MACRO calendar drove yesterday’s optimism on the better-than-expected housing data, which sparked a rally in the homebuilders and housing-leveraged stocks.  Countering that optimism was another downward revision to Q3 GDP. 


The higher beta small-cap names continue to outperform with the NASDAQ and Russell 2000 rising 0.7% and 0.8%, respectively.  The VIX continues to be broken on all three durations (TRADE, TREND and TAIL), breaking below 20.00 yesterday to close down 4.6% at 19.54. 


There continues to be a breakdown in the inverse correlation between US equities and the dollar that has dominated the MACRO landscape in 2009.  The Dollar index has increased for the past seven days and the S&P has now been up for the last three.  The Dollar index is up 0.71% in the past three trading days and the S&P 500 is up 1.99%.


Housing-related stocks were among the best performers yesterday with the XHB +2.25%.  The main driver of yesterday’s performance was a better-than-expected existing home sales number.  The NAR reported that existing homes sales rose 7.4% month-over-month in November to a 6.54M annual rate; the highest since February of 2007. Total inventories fell 1.3%, while the months’ supply dropped to 6.5 from 7 in October (single-family months' supply fell to 6.2 from 6.8).  Notable gainers in the group included builders KBH +6.9%, PHM +4.7% and TOL +4.5%.


Yesterday, the three best performing sectors were Technology, Consumer Staples and Materials.  Increased earnings expectations helped the Technology (XLK) sector outperform the S&P 500 by 0.4%.  The bright spot was the semi space with the SOX +0.6% yesterday.  Two standouts were AMKR and JBL, which both posted guidance ahead of Street expectations.


The momentum behind the RECOVERY trade has helped Materials (XLB) outperform, but has left the Industrials (XLI) behind.  The Road& Rail (R), Air Freight (FDX) and Machinery (FLS) were among the laggards.  The best performing stock was FLIR Systems, up 3.5% on the day. 


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 16 points or 0.5% upside and 1.0% downside.  At the time of writing, the major market futures are slightly higher.


The CRB improved by 0.04% yesterday; grains, Energy and Livestock all traded higher on the day.


In early trading, crude oil held steady above $74 a barrel in New York before a U.S. Energy Department report on inventory levels.  The report today is expected to show oil inventories shrank by 1.6 million barrels in the week ended Dec. 18, according to the median estimate by Bloomberg.  The Research Edge Quant models have the following levels for OIL – buy Trade (70.49) and Sell Trade (74.52).


Gold declined for the third day in London.  Gold declined by 0.3% to 1,080.  The Research Edge Quant models have the following levels for GOLD – buy Trade ($1,071) and Sell Trade ($1,151). 


Copper rose in London on speculation that demand in China and the U.S. will strengthen.  Also, the dollar decline has created an arbitrage opportunity for Chinese speculators.  The Research Edge Quant models have the following levels for COPPER – buy Trade (3.09) and Sell Trade (3.15).


Howard Penney

Managing Director









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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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