• It's Coming...

    MARKET EDGES

    Identify global risks and opportunities with essential macro intel using Hedgeye’s Market Edges.

“It’s frightening to think that you might not know something, but more frightening to think that, by and large, the world is run by people who have faith that they know exactly what’s going on.”

-Amos Tversky

The world lost a wonderful mathematical mind in June of this year. Amos Tversky was a pioneer in many of the not yet accepted halls of cognitive science and  behavioral economics. Not yet accepted by the Perceived Wizards of Wall Street Oz that is…

Whether it was my having to endure Larry Kudlow’s market call last night on CNBC, or scanning this Bloomberg article on my desk about Legg Mason’s Bill Miller making a “comeback” this morning, it’s all one and the same. These guys apparently don’t have mirrors or a YouTube. They both missed calling the crash. They are both perpetually bullish. They, sadly, are both part of the incompetent old boy club that aids and abets an American culture of recklessly buying high.

I could not make this up if I tried, but this is a direct quote from Bill Miller after the SP500 closed at a year-to-date high of 1127 last night: “There is a lot of upside left.” After the most expedited 9 month rally in modern stock market history (+66.7% from the March 9th lows), that’s what you get. That advice, and Kudlow calling for a “mini-boom” last night are classic contrarian indicators.

Legg Mason’s marketing machine will be the last to remind you, so I’ll be the first this morning. Miller lost -55% of his clients’ money in 2008, and has been beat by 99% of his peers on a 5 year basis. To his defense, he also remarked that “we positioned the fund for a recovery.” Thank God for that proactive plan, Bill.

Whether it’s Kudlow, or Miller, or Larry Summers (whose interest rate swap positions that he signed off on in 2006 almost blew up the Harvard Endowment), it’s all one and the same folks. As your favorite market savants roll out their “2010 predictions”, here’s mine: these guys will miss calling out most of the 2010 risk, and swing with the monkeys from the market highs. They do not have a repeatable risk management process to do otherwise. They never have.

Back to being your risk manager…

Higher-highs in the SP500 and the Nasdaq were bullish confirmations of a bullish intermediate term TREND in US equities yesterday. However (and yes old boys, there is always a however), these higher-highs were not confirmed by small caps or the financials.

The Russell 2000 (IWM) closed down small on the day, and the Financials Sector ETF (XLF) closed down another -0.34% at $14.48. The XLF remains the worst sector out of the 9 we assign risk factors to in our SP500 Sector model. The Financials are broken from both an immediate term TRADE and an intermediate term TREND perspective. There is a long term TAIL line of support for the XLF down at $12.05/share. That’s -16.8% lower than last night’s close.

When Josh Steiner, our new Sector Head of Financials Research, launched last month, he came out bearish on the money center banks. We took a lot of heat from a certain corridor of the hedge fund community with that call, so we knew the Street was long some of the brokers and government sponsored banks (BAC, C, GS, etc…). After a +128% rally from her early 2009 lows, seeing bulls chase price was no surprise whatsoever.

Since October 14th, the financials (XLF) are down -8.3% and the SP500 is +3.2%. If you aren’t living in the land of perpetual bullishness, for the financials that’s what we call a nasty negative divergence. If you have been short the financials and long the market, that’s called alpha.

Now, from a global risk management perspective, what else is interesting about October 14th?

1.       The stock market in the United Arab Emirates peaked, and has since lost 24.6% of its value

2.       The stock market in Greece peaked, and has since lost 24.3% of its value

3.       The stock market in Vietnam peaked, and has since lost -22.4% of its value

Yes. If you have your calculator out doing your own work Larry, you’ll realize that I purposefully just made an inaccurate statement. Vietnam peaked on October 22nd. I just wanted to make sure you are reading my work extra closely this morning. These cross market macro correlations are not ironic. They are leading indicators that not all is going “mini boom” in global macro – or wait, maybe some things are…

I’m all for a country that’s everything that we want it to be. But when it comes to your financial freedoms and safeties, I think you need to start with either your own investment process or augmenting it with people who do their own work and are accountable to it. That’s it. It’s that simple.

To ignore risk for the sake of sounding positive may not deserve the capital punishment that the Chinese gave that British drug lord last night, but it certainly deserves your losing the ability to manage other people’s capital or to broadcast your views to a national audience of impressionable young Americans.

From the US financial stocks falling, to the price of oil hitting a 5-week high post plenty of geopolitical risk being reflected via oil price premium, this game is all about risk. Real-time prices are always telling us where to look for those risks. Its hard work. The days of looking to the likes of Kudlow, Miller, and some Robert Rubin disciple are thankfully ending. For far too long this country upheld some Frightening Faith in their hope based bullishness.

Remember, hope is not an investment process. God bless Amos Tversky.

My immediate term TRADE lines of support and resistance for the SP500 are now 1113 and 1133, 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 BrazilAs 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 GoldWe 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 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.