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"In the mountains, the shortest way is from peak to peak: but for that you must have long legs.”
-Friedrich Nietzsche
 
After the most expedited US stock market rally in modern history, how are we going to come off of this immediate term peak? When? Why? These are the questions boggling the minds of plenty a Depressionista.
 
With the SP500 hitting another higher-high on Friday at 1144, this mountainous peak is +69.2% above the March 9th low. Luckily, we got long US Tech and Healthcare again (XLK and XLV) ahead of the latest leg of the rally. The SP500 has not had a down day yet for 2010!
 
I’ve been to these mountains of hope before. While hope is not an investment process, not respecting that it drives many of the minds who chase price momentum isn’t a risk management process either.
 
There was a time when I thought my short little legs could hop from peak to peak, without getting pricked. That was the mentality of a boy born in the tech bubble. Today, I’m simply a battle scarred man of bubbles. While I may have seen one coming in gold and US Treasuries, I do not see one here just yet in US stocks.
 
When my risk management process signals a peak, the first thing I do is wait. Peaks are processes, not points. You need to let them bathe in the sunlight of hope at the same time as the un-experienced climbers of the wall of worry fall on their swords. Peaks are patient. Peaks take their time.
 
Across all 3 of the durations in my risk management model, the US stock market remains in what we Hedgeye knights call a Bullish Formation.
 
A Bullish Formation is when the immediate term TRADE (3 weeks or less) underpins the intermediate term TREND (3 months or more) and the long term TAIL (3 years or less).
 
For the SP500, those 3 lines of support are currently as follows:
 
1.      TRADE = 1115

2.      TREND = 1087

3.      TAIL = 956

 
What the astute risk manager will immediately recognize from these levels is that they are -2.5% (TRADE), -5% (TREND), and -16.5% (TAIL), lower than the current SP500 closing price of 1144. If you are fully invested or levered long up at this market price, that’s your risk.
 
Provided that these 3 lines of support hold, we remain in a Bullish Formation. As you might suspect, all Bullish Formations do is frustrate short sellers. They tend to perpetuate a series of higher-lows and higher-highs. If you are net short this market price, that’s your risk.
 
I measure the risk that we pull back to my lines of support every 90 minutes of marked-to-market trading. I measure ranges, spreads, and deltas. I effectively risk manage within a band of probabilities. If you don’t manage risk like this, real-time, that’s your risk.
 
Peaks, valleys, and the market prices embedded therein, wait for no one. They frustrate us. They fascinate us. They are patient and, sometimes, unkind.
 
This morning’s setup I am measuring more risk than reward in buying US stocks. I have immediate term upside to the 1149 level (up +0.4%). I have Immediate term downside support at the 1132 level (down -1%).
 
My plan isn’t that complicated; but I stick to it, with one very important caveat – the plan is that the plan changes as market data and prices do. I’m not bullish this morning. I’m not bearish. I’m simply tasked with calling out these levels and probabilities as they are, and managing risk around them.
 
In summary, what I am saying this morning is that if my immediate term level of 1132 breaks, the market has a higher probability of sucking back to its immediate term TRADE line of 1115. If 1132 holds, there is a higher probability that we see 1149.
 
That’s the gravitational force of the math in my macro model. It doesn’t always work, but it definitely helps guide me as I attempt to traverse potential market peaks.
 
Best of luck out there today,
KM


LONG ETFS
 
XLK – SPDR Technology
Buying back Tech after a healthy 2-day pullback. Next to Healthcare, this remains our favorite sector in the SP500.

UUP – PowerShares US Dollar Index Fund
We bought the USD Fund on 1/4/10 as an explicit way to represent our Q1 2010 Macro Theme that we have labeled Buck Breakout (we were bearish on the USD in ’09).

XLV – SPDR HealthcareBuying back the bullish position Tom Tobin and his team maintain on the intermediate TREND term for the Healthcare sector.

VXX - iPath S&P500 Volatility
The VIX broke down to our immediate term oversold line on 1/6/10 and the II Bullish/Bearish survey is far too complacent, prompting us to add to our position on VXX.

EWG - iShares GermanyBuying back the bullish intermediate term TREND thesis Matt Hedrick maintains on Germany. We are short Russia and, from a European exposure perspective, like being long the lower beta DAX against the higher beta RTSI as well.

EWZ - iShares Brazil
As Greece and Dubai were blowing up, we took our Asset Allocation on International Equities to zero.  On 12/8/09 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.

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

GLD – SPDR Gold
As the gold price inches up toward the immediate term resistance line of $1137/oz, we’re going to take the other side of a long-standing bullish position.

RSX – Market Vectors Russia
We shorted Russia on 12/18/09 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.

XLY - SPDR Consumer Discretionary We shorted Howard Penney's view on Consumer Discretionary stocks on 10/30/09 and 12/2/09.

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.