Discounting The Obvious

“Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.”

-George Soros


Soros’ track record calling macro market moves speaks for itself. He was born in Budapest, Hungary. He went to school in London. He has worked against New York City’s traffic jams of consensus for most of his career. When it comes to betting on the unexpected, he’s no stranger to Discounting The Obvious.


For real-time risk managers, our daily task is to reveal consensus for what it is, then to capitalize on it when the timing is right. Sometimes consensus is right. Sometimes it isn’t. For the last 3 months, consensus has had the pace of global monetary tightening dead wrong.


Rather than get into an academic debate about whether the Fed’s move to raise the Discount Rate last night is an explicit tightening signal or not, we market practitioners will simply refer investors who are marked-to-market to the charts of the US Dollar and US Treasury Bond Yields. Markets don’t lie; people do.


You can pull up a 3-day or 3-month chart of either and the take-away is the same. Both the US Currency and Bond markets have been Discounting The Obvious now for 3-months.


The last holdout in the US Bond market has been the short end of the yield curve. That’s because it was being politicized and held artificially low. This morning, that’s changed. Short term yields (2-month US Treasuries) are shooting straight up, breaking-out above my intermediate term TREND line of 0.88% to 0.94%.


Taking a step back to consider where global market moves are versus our out-of-consensus expectations, we kicked off 2010 with 3 Macro Investment Themes:

  1. Buck Breakout (bullish on the USD, bearish on gold)
  2. Chinese Ox In a Box (bearish on Chinese equities, bullish on Chinese currency)
  3. Rate Run-up (bearish on Treasuries, bullish on Global Bond Yields)

Altogether, given the economic data coming out of both the US and China, these calls weren’t that difficult to make. Both countries continue to reveal higher than expected growth and inflation data. In the face of these facts, an assumption of an “extended and exceptional” US monetary policy of ZERO percent interest rates is both unsustainable and unreasonable.


In terms of the Buck Breakout call, a lot of consensus strategists in America started to justify US Dollar strength by virtue of Europe’s sovereign debt problems. While that may be a convenient explanation, it’s not the entire explanation. Since we called it the “Bombed Out Buck” in Q4, the US Dollar Index has had a +9.3% melt-up from its Burning Buck lows. There is a lot more to a monster currency move like that than just Greek and Spanish CDS.


I don’t think I have been too critical of Ben Bernanke. I simply had an inflation forecast that didn’t line up with his. This morning I am going to pat the man on the back for seeing the inflation data for what it is – inflationary. He Who Sees No Inflation is seeing the light. This is progress.


Inflation? Yes, it’s out there. The US Producer Price report (PPI) for January was reported well ahead of consensus expectations yesterday at +4.6% year-over-year growth. Now a man making CDO’s on Park Avenue in New York might not feel that in his cost of goods sold, but I can assure you that a Hungarian carpenter who uses anything with metal does, particularly versus this time last year.


In terms of consumer prices (CPI), it’s both hypocritical and political to call last year’s deflationary low of -2.1% CPI (July 2009) the Great Depression Part Deux, and at the same time not recognize that the year-over-year inflation report you are going to see at 830AM this morning as inflationary. Fortuitously, we had this reported inflation catalyst in our assumptions when we made both our Buck Breakout and Rate Run-up calls.


So what do this morning? Well, I’d actually sell some of your hard earned US Dollars to the consensus beaters as they clamor for them. The US Dollar Index is trading up almost a full percent. That’s a lot in a day, and as they say on a cold winter day on Simpson Street in Thunder Bay, ‘if you gottem', sellem’!


At $81.19 this morning and $1.34, respectively, the US Dollar Index is finally going to be immediate term overbought and the Euro oversold. I am not making a call that we are no long bullish on a Buck Breakout. I am simply telling you to ring the register as consensus is finally starting to Discount The Obvious.


My immediate term support and resistance lines for the SP500 are now 1079 and 1111, respectively.


Best of luck out there today and have a solid weekend,





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).

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.



EWU – iShares United KingdomThe TREND of higher y/y inflation and stagnant growth = stagflation. For a country with the UK's balance sheet and leadership problems, that’s not good.


SPY – SPDR S&P 500We re-shorted the SP500 at an attractive re-entry point on 2/16/10. We are bearish on US Equities for the immediate term from this price. Shorting green.


XLE – SPDR EnergyWe remain bearish on Oil for the intermediate term TREND and bullish on the US Dollar on the same duration. Everything has a time and a price.


GLD – SPDR Gold We re-shorted Gold on this dead cat bounce on 2/11/10. We remain bullish on a Buck Breakout and bearish on Gold for Q1 of 2010, as a result.


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


XLP – SPDR Consumer StaplesThe 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.


EWJ – iShares JapanWe 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 TreasuryOne of our Macro Themes for Q1 of 2010 is "Rate Run-up". Our bearish view on US Treasuries is implied.












US STRATEGY - copper6


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Scratch This

The 7-Year Itch of reliquifying $550 billion in levered loans from the 2003-2008 PE shopping spree is in full force. It needs to be medicated.


One of our key themes in 4Q09 was the ‘7-Year Itch’, the crux of which is that the spend-a-thon that occurred in the private equity world from 2003-2008 at peak valuations and peak margins needs to reliquify to save pro-cyclical buyers from their own bad bets. The tally is a frightening $550billion in levered loans that need to come to market.


Scratch This - 7 YEAR ITCH


With the Piggy Banker Spread (between 10s to 2s) near all-time highs, the average CEO just having seen their net worth pop by over 50% from a scary bottom, and the Mensa Society running our investment banks showing their propensity to dole out the big bonuses for performance that is grossly misaligned with what is needed for a healthy US financial system, it should not come as a shocker that deal activity is ripping.


Can you please quantify ‘ripping’ McGough?  Ok.

  1. We saw 90 equity offerings worth $40.2 billion come to market since 1/1/08.  Ironically, one transaction – Visa – accounted for 45% of this total. Excluding this, we’re looking at $22.3bn gross over 2 years.  A full 62% of that occurred since September, when ‘the most hated rally in history’ was a stone cold reality and the spread between 10s and 2s hitting all-time highs was acknowledged as the gift that it is.
  2. Aside from IPOs, we’re seeing stepped-up M&A activity. Heck, if you’re a banker, you get paid more on a merger/acquisition than you do an IPO – so why not?  Just this week we saw Walgreens buy Duane Reade. Not a lot of detail was given, but based on facts given, our analysis is getting us to a (levered) loss of about 45% for Oak Hill on the deal.
  3. Back in IPO land, now there’s talk of Toys R Us coming back to market. Dollar General is one of the biggest pigs thus far to don enough lipstick to switch hands. Toys R Us is bigger. We think Sports Authority will follow. We’re gonna need a lot more lipstick.

Scratch This - IPO COUNT vs SPREAD


But it’s not all positive, folks. In fact, over the past month, we’ve seen 15 IPOs and 16 debt offerings pulled. One of the more notable retractions is this morning’s announcement from Blackstone that Travelport is not ready for Prime Time (actually, they’d argue that Prime Time isn’t ready for them).


What is almost ready for prime time is a BX short, which has a broken TREND line on Keith’s models of $13.97. Stay tuned on that one.


Scratch This - BX


Brian McGough


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