Confidence and Cowardice

"Whether you think you can or think you can't - you are right. "

-Henry Ford

 

Like all mornings, today we are waking up to many more global macro risks than what's happening in Greek bonds or how much snow some people have in their Connecticut driveway. While many of us can be distracted by our own personal issues, it's important to remember that global markets wait for no one.

 

I am certainly not suggesting that European sovereign debt issues don't matter any more. We have been calling out the percolating risks in Greek and Spanish credit default swaps for 3 months. These risks are no longer new. They are simply becoming understood. This is progress.

 

Each day we are tasked with re-rating global macro risk. Since these risks are constantly being re-priced on a marked-to-market basis, we let real-time prices rule over our emotions. I can't imagine being called a PIG (Portugal, Italy, Greece) by the US media every day enthuses Europeans. Nor does China laughing at our Treasury Secretary make Americans smile. The art of risk management is just checking all our emotional baggage at the door.

 

From a real-time risk manager's perspective, this morning I see the following three topics as most influential on markets:

 

1. Chinese Economic Data

2. US Monetary Policy

3. Sovereign Debt

 

I'm not going to draw a box around my head and think inside of it, so I won't consider these risk factors with any particular weight of importance. Rather, like any good student of complexity theory, I'll consider them in the aggregate. What deep simplicity can I deduce from the most recent data points on my macro screens?

 

1. Chinese Economic Data

 

The data reported overnight had a little bit of something for everyone. The Chinese stock market closed flat on the session (down -8.9% YTD) reflecting how mixed the economic data flushed out. On one hand, Chinese loan growth for January was a moonshot to the upside (1.39 Trillion Yuan - thats a lot of Yuans!). On the other hand, money supply growth (M2) dropped again, sequentially, by -170 basis points (month-over-month) to +26% year-over-year. It's important to remember that money supply growth in China peaked in November of 2009 at +29.7% y/y. Since we called for this easy money chart to rollover at the begining of 2010, I'll call this inline with what we were expecting.

 

On the inflation front, China had higher than expected PPI (producer prices) and lower than expected CPI (consumer prices). Again, a little something for everyone, but the media seems to be more focussed on the CPI report so let's grind through that. Consumer prices in China have been moving up into the right for the last 6 months and slowed, sequentially, this month to +1.5% y/y inflation versus last month's cycle-high of +1.9% y/y. On the margin, this is less hawkish, sequentially. On an absolute basis, it still means the Chinese will to continue to tighten.

 

2. US Monetary Policy

 

Expectations for interest rate policy in America becoming Japanese (a perpetual return on the citizenry's savings accounts of zero) took a shot in the arm yesterday with Ben Bernanke changing his rhetoric on rates. I understand what a lot of perpetually dovish market pundits are going to say about this - these people are proactively predictable. The reality is that changes on the margin are what matter most in navigating global macro risk - and Bernanke made a significant change yesterday.

 

He Who Thought He Saw Depression is obviously seeing the economic data for what it is at this point. The US is running +5.7% GDP growth, +2.7% CPI inflation, +4.4% PPI inflation, and the unemployment rate is rolling over. So, He Who May Now See The Light (still Bernanke here), signalled to the market yesterday that the US will be raising the Discount Rate "before long."

 

The Discount Rate is not the Fed Funds rate. We get that - and so do the bankers who have been chowing down on the Piggy Banker Spread (the bankers get to borrow at the discount rate - you don't). As a reminder, the Discount Rate was cut to zero (ok, maybe not 0.00%, but 0.50%) in December of 2008 because Bernanke was forecasting the potential of the next Great Depression, no growth, and no inflation. Obviously the man works for the government rather than an asset manager because his economic forecasts are routinely wrong. So here we are now with the data rolling in, forcing him to be rhetorically "data dependent."

 

3. Sovereign Debt

 

Expectations here are what they are - climbing the wall of worry. The worst thing about the manic media's analysis of it all is the paralysis of their scope. Sovereign Debt is a global macro risk that is going to be here for the next decade, not the next New York minute. This is the long term TAIL risk that Global Politicization has given birth to. Piling debt upon debt upon debt is reactive policy that political cowards continue to disguise as short term confidence.

 

Altogether, Confidence and Cowardice is what all 3 of these factors sum to. That's the deep simplicity of living in today's globally interconnected and, sadly, politicized marketplace. The Chinese politicians are confident, tightening at their own pace, on their own terms. The American and European politicians are being cowards, tip toeing around raising interest rates because they are scared of their stock market going down.

 

Who has the Confidence to sell on up days? Who has the Cowardice to live in political fear of the down days? Who have we become when we have become so confident that cowards can never fail?

 

My immediate term suppport and resistance lines for the SP500 are now 1045 and 1076, respectively.

 

Best of luck out there today,

KM

 

 

LONG ETFS

 

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.  

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

 

CAF – Morgan Stanley ChinaThe Chinese Ox Remains In A Box. We shorted CAF on 2/10/10 ahead of another inflationary report that registered China’s CPI at +1.5% in January Y/Y, and PPI at +4.3% Y/Y.

 

RSX – Market Vectors Russia We shorted Russia on 2/9/10 and maintain our intermediate term TREND bearish view on the price of oil.

 

XLP – SPDR Consumer Staples The Consumer Staples sector finally broke both our TRADE and TREND lines on 2/8/10. Given how many investors own these stocks because it was a "way to play the weak US Dollar" last year, we have ourselves another way to profit from a Buck Breakout with this short position.

  

EWW – iShares Mexico Mexico short is a solid compliment to our concerns about sovereign debt risks and our bearish intermediate term view on oil.

 

EWJ – iShares Japan We re-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.

 

IEF – iShares 7-10 Year Treasury One of our Macro Themes for Q1 of 2010 is "Rate Run-up". Our bearish view on US Treasuries is implied.