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    MARKET EDGES

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

“The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed lest Rome become bankrupt.”

-Cicero, 55 BC

Recently, our stealth Managing Director of Financials, Josh Steiner, sent me that quote with a simple note attached – “Keith, this adds about 3200 years to the 800 years of Reinhart/Rogoff data you have been beating into us.”

Now that Groupthink Inc is coming to realize that the impact of piling sovereign debt upon debt upon debt is bad, I suppose they’ll eventually get to the required reading (“This Time Is Different”, by Reinhart and Rogoff). But sometimes I wonder who actually reads anymore?

There is something about the “arrogance of officialdom” that is starting to make the modern day Rome of Perceived Financial Wisdom shake. Whether it be politicians on the Senate Banking Committee focusing more on their crackberry messages than Paul Volcker, or CNBC’s Larry Kudlow labeling his nightly editorial the “Money Politics Message”, it’s all mashing like potatoes into the same political trend of short-termism.

Yes, I read (roughly a book every 9-10 days), but I certainly don’t consider that a unique skill set. Maybe reading about risk management topics before the risks get baked into this completely politicized cake is the differentiator. I am not sure. I suppose all you need is an investment process that proactively calls out probable risks when Groupthink Inc considers them improbable. Staying ahead of this herd isn’t that hard.

Consider my former employer’s recent prognostication in Davos, Switzerland about emerging markets: “Emerging markets are the most attractive places to invest and rebounding more rapidly” –David Rubenstein, Co-Founder of The Carlyle Group.

Then consider what’s happened in the last 48 hours of global risk management. Then consider that Rubenstein is currently the President of The Economic Club of Washington, DC!

The “arrogance of this country’s officialdom” lacks fiduciary responsibility to the core. If some of these high ranking politicians or private equity men of Rome continue to be this incompetent in calling out macro market risks BEFORE they occur, what will become of Rome’s Groupthink?

Per my friends at Bloomberg, “emerging market equity funds lost $1.6B in weekly withdrawals” so far this week. That’s the biggest weekly outflow in 2 years. Again, because those who get paid to be willfully blind are ignoring the omnipresent global macro risk in the marketplace, doesn’t mean it ceases to exist. What happened yesterday wasn’t new. It was a continuation of more of the same.

So now that stocks in Greece have lost -35% of their value since October 14, 2009 and Spanish stocks have lost -18% of their value since January 6th, 2010, what is a risk manager to do this morning? Freak-out? Revert to Great Depression fear-mongering?

C’mon. Let’s get serious and keep taking advantage of the crisis that the arrogance of America’s officialdom continues to create. Let’s start with how we proactively positioned for this and look at our Asset Allocation Model:

  1. Cash = 52%
  2. International Currencies = 24%
  3. International Equities = 12%
  4. Bonds = 9%
  5. US Equities = 3%
  6. Commodities = 0%

No, I am not worried whatsoever about who manages how much, or whether or not they can manage real-time risk dynamically enough to get themselves in these positions. Being too big to move your asset allocation doesn’t make you too big to fail.

What moves did we make yesterday in order to set ourselves up for today?

  1. We covered our short position in US Equities (SPY)
  2. We covered our short positions in gold and oil (GLD and USO)
  3. We bought German and Brazilian Equities on weakness (EWG and EWZ)

What do we plan on doing next?

  1. Watch and wait for an opportunity to sell some US Dollars on strength (Buck Breakout has been our call for Q1)
  2. Watch and wait for Chinese equities to get washed out (Chinese Ox in a Box has been our call for Q1)
  3. Watch and wait for US Equity fire engine chasers to freak-out

The long term TAIL of bullish support for the SP500 is currently down at 976, and I have an immediate term support line at 1052. Please don’t let other people’s reactive behavior freak you out this morning. This is not going to be a crash like we called for in 2008. This is America, and finally we are going to rid ourselves of Rome’s Groupthink.

Best of luck out there today,

KM

 

LONG ETFS

FXA – CurrencyShares Australia Dollar — Aussi Dollar bulls finally capitulated on the sell side on 2/4/10. We bought FXA as a long term TAIL idea that remains intact, at a price. Glenn Stevens remains our favorite central banker, globally.  

 

XLK – SPDR Technology — We bought back Tech after a healthy 2-day pullback on 1/7/10.

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).

EWG - iShares Germany — We added to our position in Germany on 2/4/10 on 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 — The long term TAIL of support for Brazil's Bovespa remains intact. We added to our position and bought EWZ on 2/4/10 on a -6.1% drop in the ETF, because the math is telling us to.

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 mispriced and that TIPS are a efficient way to own yield on an inflation protected basis.

 
SHORT ETFS

EWW – iShares MexicoWe do not want to be net long Latin America (Brazil) anymore. Mexico short is a solid compliment to our short position on oil and our concerns about sovereign debt risks.

 

EWJ – iShares JapanWe shorted Japan on 2/2/10 after the Nikkei’s up move of +1.6%. Japan's sovereign debt problems make Greece's look benign.

 

UNG – United States Natural Gas FundMacro DJ (Daryl Jones) and I remain bearish on Commodities. Natural Gas had a healthy price pop on 2/1/10, prompting us to short it. 

 

XLE – SPDR EnergyThe Energy ETF was up +1.7% on 1/29/10 and we remain bearish on both oil and commodity prices for the intermediate term. Shorting green.

 

IEF – iShares 7-10 Year TreasuryOne of our Macro Themes for Q1 of 2010 is "Rate Run-up". Our bearish view on US Treasuries is implied.
 
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. Russia’s GDP fell 7.9% in 2009.

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.