Sovereign Debt For Dummies

“Who can be wise, amazed, temperate and furious, loyal and neutral, in a moment? – No man.”

-William Shakespeare


On US stock market weakness yesterday, I moved from bearish on US Equities to neutral. On the margin, that’s a bullish shift. Everything that really matters in our macro risk management process happens on the margin.


Can you be loyal and neutral at the same time? Can you be temperate and furious in the same moment? Who can be wise about economic history’s lessons and, at the same time, manage risk daily, unemotionally attached?


In risk management, neutral is as neutral does. Going into yesterday’s macro morning I had more shorts in the Virtual Portfolio than I had longs, I was short the SP500 via the SPY, and I was carrying a cash position of 67% in the our Asset Allocation Model.


This  morning I have 12 longs and 12 shorts in the Virtual Portfolio. I am no longer short the SP500 (SPY), and I have doubled our asset allocation to US Equities from 3% to 6%. I made these moves on a market down day. Yesterday was the first down day for the SP500 in the last five. Can I be bullish on the Dollar, bearish on Treasuries, bearish on China, and move to neutral on US Equities? Apparently yes.


This morning is like every morning. This morning it’s time to play the game that’s in front of me. Yesterday is for the revisionist historians to figure out. They are very good at that – let’s not interrupt them.


From my trusty daily market diary, there are 3 immediate term macro factors staring me in the face this morning:


1.       Chinese Ox In a Box (Chinese stocks were down another -0.69% last night, taking YTD performance for the Shanghai Composite to -9%)

2.       Buck Breakout and Rate Run-up (both the US Dollar and 10-year yields continue to make higher-lows after brief selloffs)

3.       Sovereign Debt For Dummies


Before I focus on that last point about sovereign debt (yes, it sounds like a Hedgeye Macro Theme brewing here in New Haven for Q2), let me say this: managing global macro risk doesn’t occur in the vacuum that the manic media sucks you into. It’s multi-factor; it can be furious; and it can be temperate. The art in managing around all of these global risk factors can be found in orchestrating at the extremes of consensus.


Sovereign Debt For Dummies is a book we might collaborate on with some folks on Yale’s campus. With both Spain and Greece trading down -0.82% and -1.2%, respectively this morning, there is plenty a CNBC pundit with Perceived Wisdom who is racing to call these out as negatives embedded in weak pre-market open US futures trading.


On an absolute basis, the risk management point associated with what we call a negative divergence (for example a country index like the United Arab Emirates trading down -2.2% this morning is a negative divergence versus the DAX in Germany which is flat on the day so far) is crystal clear. Spain and Greece are negatives today, but what are they telling us about what might happen tomorrow? Will the sovereign debt bears be loyal to their short positions, or will they be forced to move to neutral?


Context, of course, is one of the most critical factors you’ll need to answer that question. Historical price momentum, volatility, and volume studies will help you too. These should all be in the index for Sovereign Debt For Dummies. So we’ll work on that…  


When it comes to analyzing sovereign debt, Ken Rogoff at Harvard is no one’s dummy. He was very early in quantifying and cataloging history’s lessons on piling debt, upon debt, upon debt. We were at least earlier than the dummies in calling out what Rogoff was calling out. For accountability purposes, here’s what I wrote in my Early Look from 12/23/09, titled “Standing Still”:


One of the most misunderstood global macro risks in the market today is that of sovereign debt defaults. Many market pundits are brushing off what is happening in Middle Eastern debt, Eastern European banks, and Chinese property stocks as isolated events. Standing still into year-end with that opinion is very risky.
Sovereign defaults, as a percentage of total global defaults, remains at a generationally low level. That can change. Carmen Reinhart (University of Maryland) and Ken Rogoff (Harvard) wrote a great book in the last year titled, “This Time is Different: A Panoramic View of Eight Centuries of Financial Crises”, that provides the best historical context of this critical risk management point. So rather than rehash their work, I will refer you to the Amazon.
The simpleton question that every global risk manager should be asking themselves is this: if sovereign defaults are near all-time lows, and sovereign bailout debt issuance continues to hit all-time highs, how do you think this is going to all end? Until we know, I can assure you of this – we don’t know. That’s what I call risk.


No, this isn’t me saying I am smarter than you. This is just a friendly reminder that managing risk doesn’t happen in a vacuum. There are proactive risk managers you can follow in the marketplace like Reinhart & Roggoff, and then there are reactive dummies who are trying to short the SP500 this morning because Spain and Greece are trading down (note Spain, Greece, and the United Arab Emirates are all down -12% for 2010 to-date already – this isn’t new).


Not unlike Niall Ferguson at Harvard being the most cited US Dollar bear back in November (at the bottom for the Bombed Out Buck), or Nouriel Roubini being the most sought after speaker on the Wall Street Group-thinking Conference Circuit of early 2009 (at the US stock market bottom), sometimes academics find a way of making big long term bearish calls, but also marking the intermediate term peaks in consensus fear associated with those calls.


Ironically enough, this is the #3 most read story on Bloomberg this morning: “Harvard’s Rogoff Sees Bunch of Sovereign Defaults.” Nope, I couldn’t make that up if I tried. It’s not like this guy just published his book last night folks. So realize this, Sovereign Debt For Dummies is now the most consensus macro fear we have seen since the Burning Buck was in 2009. And every fear and fury has a funny way of being neutralized, in the immediate term, at a price.


My immediate term support and resistance lines for the SP500 are now 1099 and 1122, respectively.


Best of luck out there today,





XLK – SPDR Technology — Technology is underperforming the SP500 YTD; a down day on 2/22/10 prompted us to buy more. We expect to see some positive mean reversion for Technology as M&A picks up.


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.


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 StaplesGiven how many investors own Consumer Staples 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.


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 – Financials' Mo, continues…

The S&P 500 finished modestly lower (-0.1%) yesterday on extremely light volume and slightly negative breadth.  The lack of volume is likely a result of the lack of earnings, economic, and political news.  On the global MACRO front, the lack of data suggests that that the MACRO remains a slight headwind, although the RISK AVERSION trade continues its current momentum.


Overall the markets continue to shrug off the potential negative impact of the recent discount rate hike on the favorable liquidity backdrop.  Yesterday, from a sector performances standpoint, most sectors with outsized exposure to the risk/recovery trade put in mixed performances.


Confirming the risk aversion trade the Russell 2000 finished higher for a ninth straight day and the VIX is broken on all three durations - TRADE, TREND and TAIL.  Now having 6 of 9 sectors positive on TRADE, a bearish VIX really does make sense from a contrarian perspective.  With bearish sentiment mounting and the S&P500 still down YTD (plus our bearish calls on China and US Treasury bonds freaking people out alongside the sovereign debt worries), the VIX looks like it wants to suck back down to the mid-teens. The VIX remains positive on TREND at 22.43.  The Hedgeye Risk Management models have the following levels for VIX – buy Trade (18.32) and Sell Trade (22.40). 


The best performing sector yesterday was the Financials (XLF), with upside largely a function of the continued strength in the banking group, with the BKX +1.9%, and up for a third straight session.  There did not seem to be anything specific behind the outperformance, other than some sell-side upgrades in the larger-cap regional space.  The sector also benefited from the high-profile hedge fund buying note in Barron’s over the weekend. 


Heading into the retail earnings season, the Consumer Discretionary also outperformed yesterday.  Overall, retail held up a bit better than the broader market with the S&P Retail Index unchanged, after finishing higher over the past six days. 


As I mentioned above the RECOVERY trade took it on the chin as Energy (XLE) and Materials (XLB) were 2 of the three worst performing sectors yesterday.  Within Energy, E&P stocks were among the worst performing sub-indices.  The oil services group also finished lower on the day, but M&A was in a highlight after SII agreed to be acquired by SLB. 


Equity futures are trading above fair value following yesterday's slow day, as the market awaits further news on Greece's forthcoming bond issue and tomorrow's testimony to Congress by Fed Chairman Bernanke.   This has the Dollar index up by nearly 0.3% in early trading.  The Hedgeye Risk Management models have levels for DXY at – buy Trade (79.60) and sell Trade (80.85). 


As we look at today’s set up the range for the S&P 500 is 23 points or 0.9% (1,099) downside and 1.2% (1,122) upside. 


In early trading, copper is higher in London on a positive demand outlook.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (3.17) and Sell Trade (3.46).


In early trading gold fell in London on a stronger dollar.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,101) and Sell Trade (1,133).


Oil is trading down for the first time is six days on increased supply.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (77.08) and Sell Trade (81.83).


Howard Penney

Managing Director


US STRATEGY – Financials' Mo, continues… - sp1


US STRATEGY – Financials' Mo, continues… - usd2


US STRATEGY – Financials' Mo, continues… - vix3


US STRATEGY – Financials' Mo, continues… - oil4


US STRATEGY – Financials' Mo, continues… - gold5


US STRATEGY – Financials' Mo, continues… - copper6


Nike: Just Do It --- StockTwits TV Interview

Risk Management Time: SP500 Levels, Refreshed...

I am getting a lot of questions on the subtle shift I made this morning in my US stock market view. Subtle is as subtle does but, on the margin, it matters…


On this morning’s market weakness I made the following moves in US Equities:


1.       Covered my short position in the SP500 (SPY)

2.       Covered my short position in US Energy (XLE)

3.       Bought a long position in US Technology (XLK)


This doesn’t make me the bull, but it definitely signals my moving from bearish on the SP500 to neutral. On the margin, that’s a bullish shift.


I can make this move without changing my view on our Top 3 Macro Themes in Global Macro:


1.       Buck Breakout (bullish on the US Dollar)

2.       Rate Run-up (bearish on US Treasuries)

3.       Chinese Ox in a Box (bearish on China)


I have been managing risk around my US Equity long and short positions throughout Q1 as my conviction bobs and weaves in and around the SP500’s intermediate term TREND line (in the chart below at 1099). While price momentum is only one factor in my multi-factor risk management model, it is weighted heavily alongside volume and volatility factors.


As the VIX breaks down further today (no support to $18.11), the probability heightens that we’ll see a near term upside test of the dotted red line in the chart below (1122). I have added 3% to the US Equity side of our Asset Allocation Model so that I can capitalize on some of this potential upside. Remember, risk management works both ways. Markets can work higher when consensus is leaning too bearish.



Keith R. McCullough
Chief Executive Officer


Risk Management Time: SP500 Levels, Refreshed...  - was


Play It As It Lies: SP500 Price Momentum Shifting

For now, price momentum has trumped interest rate fear (see the table below for TRADE and TREND updates, by sector study).


The SP500 finished the week up 3.2%.  As we respect price first and foremost, we have taken a small loss in our Short SPY position (-1.23%).  The interest rate hike (Rate Run-up) and dollar up move (Buck Breakout) of last week were good for stocks; markets’ closing prices did not reflect a fear of higher rates. 


For the SP500, 1099 was resistance but now it is support; 1119 is now the new resistance line and we are seeing posistive price momentum building in the market across all durations.  We now have 7 out of 9 sectors in positive TRADE zone and intend to manage risk around the data. 


The lower volume in the market moves at the end of last week, and the lower-highs being reached (relative to the prior closing highs of 1/19/10), makes for a mixed outlook and one that we will be monitoring closely as the week plays out. 


In particular, we will be observing whether or not new TREND lines of support manage to hold.  As of this morning, the US Dollar Index was trading at 80.56 and the trendline support line lies at 79.57.  Volatility is now indicating bullish for stocks and has broken its TREND line at 22.43, which is now resistance.  Gold and Oil are also testing their TREND lines to the upside, which are now support at 1,122 and $77.09, respectively.  We will look for these levels of support to be confirmed over the next 3 days.


In the immediate term, we have covered our short SPY position and bought XLK (Technology Sector ETF).  On Friday, we bought some small cap and mid cap exposure via Penn Gaming (PENN) and Glacier Bancorp (GBCI).


Howard Penney

Managing Director

US Strategy


Play It As It Lies: SP500 Price Momentum Shifting  - HPT


R3: Discount Rate v. Margins v. Stocks


February 22, 2010


The market seems to be suggesting that underlying fundamental strength will be there to support margins, and subsequently the stocks.  That might be the case. But it has to be the case for the group to outperform, and perhaps even to tread water.





The only thing that has moved higher and faster than margin expectations ahead of the hike in the discount rate has been the retail group itself. Here’s some recent historical context around movement in retail stocks around changes in the discount rate. Mid-04 through mid-06 is probably the best example, as that period shows the systematic rise in rates. It was textbook, actually. The consumer was healthy, industry margin tailwinds were strong, and earnings largely kept trudging higher. Over that time period, we had consensus margin expectations in retail rise by 3 points (from 10.2% to 13.2%).


What do we have now?  Margins have collapsed, and some of these reasons go beyond the simple economic climate. There are several reasons related to sourcing that should make that low-teens margin rate unattainable for a long, long time. Since the March 9 low, the MVR is up 133%, and margin expectations have accelerated by 3.3 points to 9.4%. That’s the largest 1-year boost in expectations in at least 20 years.


The point here is that the market seems to be suggesting that underlying fundamental strength will be there to support margins, and subsequently the stocks.   That might be the case. But it HAS TO be the case for the group to outperform, and perhaps even to tread water.


R3: Discount Rate v. Margins v. Stocks - 1


R3: Discount Rate v. Margins v. Stocks - 2




  • In what is sure to be viewed as a controversial merchandising move, Sears has decided to sell its coveted Craftsman tool brand outside of its own stores.  Late Friday, Ace Hardware announced it will begin selling Craftsman products in 100 doors.  By June, 4,500 Ace stores will have the opportunity to the also carry the brand.  This marks the first time that Sears is experimenting with selling its most coveted brand in a wholesale manner.  We wonder how long it will be before we see Kenmore and DieHard showing up at other retailers as well…
  • While most retailers and manufacturers have begun to note cost pressures building out of Asia for the back half of 2010, JC Penney is still expecting to see year over year declines.  As a result of the company’s extensive sourcing network, and longer lead times, management expect to see cost savings continue throughout the year, albeit a bit more muted in the back half.  Cost of goods savings coupled with tight inventory management and substantial reductions in clearance activity were the key drivers in JC Penney’s reporting of its highest gross margins in 100 years for the year just completed.
  • Good news for US Ski Team Sponsor, Under Armour.  Through February 15th, Freestyle and Downhill skiing topped the list of most watched Olympic events, ranking 1 and 2 respectively.  An average of 26.9 million viewers tuned in for the Freestyle events on opening weekend according to Neilsen.  
  • Olympic merchandise sales in Vancouver have already hit their goal of about $50 million in sales and that’s with about 50% more events to go.  In some cases, retailers have decided to stay open 24 hours in the host city to meet demand and to help alleviate long lines.  Sales of official merchandise in Torino were only about $23 million, far less than this year’s expected total. 
  • The IOC is struggling to monitor ambush marketing in Vancouver whereby companies that have not paid for sponsorship rights are tying their products to the Olympic Games. Among brands mentioned in recent articles is Canadian favorite Lululemon, which is selling red and white mittens that resemble the wildly popular “official” mittens that have now sold over 1million pair. While publicly badmouthing the company for trying to profit without supporting the Games, the Vancouver Olympic Committee (VANOC) failed to mention that the company actually lobbied to be an official sponsor, but lost out to The Hudson’s Bay Company. Oh, and they’ve also hosted over 200 athletes and their families at the “Lululemon House” near the athlete’s village over the past year during their training for the Games – sounds like athletes aren’t the only ones in need of a reminder on the merits of sportsmanship. 




EBay to Launch New Selling Formats, Boost Fashion Quotient - EBay Inc. moves more apparel online than any other company. Yet that’s simply not enough for the giant Web site. In March, eBay will launch “the fashion vault” for “flash” sales of designer goods in a format not dissimilar from that of Web sites Gilt Groupe and Ideeli. Hugo Boss, DKNY, Max Mara and Cole Haan Outerwear were tested last year and there’s a good chance they’ll be seen on the fashion vault again. Initially, there will be weekly flashes, but the frequency will increase in subsequent months. EBay also is creating an online outlet mall for the U.S. with some well-known retail and apparel brands. Lord & Taylor’s outlet division is already on board and Brooks Brothers will be added next month. More brands and stores are seen joining, as they have in Europe, where eBay operates extensive outlet sites, such as in the U.K. with 16 stores including Debenhams, House of Fraser and Schuh, and in Germany, with 24 branded apparel shops including Eastpak, Fila, Speedo and Triumph. <>


Carrefour to Revamp Apparel Division - Carrefour SA, the world’s second-largest retailer behind Wal-Mart Stores Inc., will radically overhaul its apparel division as part of a revamp of its hypermarket operations in France, chief executive officer Lars Olofsson said Friday. “We will have to change our textile [business] quite dramatically. We will have to inverse basically what we’re doing,” Olofsson told analysts and journalists. His statements came a day after Wal-Mart revealed it was re-evaluating its entire apparel merchandising strategy after a disappointing performance. Reporting full-year 2009 results, Carrefour said net income fell 74.2 percent as it absorbed more than 1 billion euros in nonrecurring impairment and restructuring charges. Since his arrival one year ago, Olofsson has implemented measures to cut costs and improve the retailer’s price image. Last month, he appointed former Tesco executive James McCann as executive director for France, charged with tackling underperforming hypermarkets in its home market, which accounts for 40 percent of the group’s sales. Olofsson said Carrefour’s new apparel direction would start taking shape in 2011 or 2012, and likely shift from its current purchasing model toward a shorter cycle, placing Carrefour in competition with fast-fashion retailers like Sweden’s H&M and Spain’s Inditex, operator of the Zara chain. <>


Lucy Activewear Moving HQ From Portland to San Francisco Area - Lucy Activewear is moving its headquarters from Portland to the San Francisco Bay Area to be in closer proximity to its Outdoor Coalition offices and resources. VF Corp., the parent of lucy, said approximately 82 positions will be eliminated. VF will be relocating lucy's offices to Northern California at the end of August. In addition, the brand's primary distribution facility, also located in Portland, will be merged into VF's Outdoor distribution center in Visalia, Ca. during the first quarter of 2011. In a statement, VF said one dozen of the approximately 95 Lucy associates based in Portland will be offered the opportunity to relocate to California. VF reassigned lucy from its Contemporary Coalition, which includes 7 for All Mankind, Ellas Moss and Splendid, to its Outdoor Coalition this past fall to leverage that division's expertise in technical performance. VF's Outdoor Coalition also includes The North Face, Vans, Reef, Napapijri, Kipling, JanSport, Eastpak and Eagle Creek. The offices of The North Face and Jansport, among others, are in San Leandro. The move also comes as VF took a $114.4 million after-tax impairment charge in the fourth quarter because results for lucy, Nautica, and Reef were below the company's expectations since the time each was acquired. The charge reflected the devaluation of goodwill and intangible assets since each acquisition.  <>


New CompUSA Integrates Ecommerce Site Into Retail Stores - CompUSA went out of business in 2007, but now is under new management that is experimenting with a hybrid concept dubbed Retail 2.0, which integrates their ecommerce site into their retail stores. The online shopping experience at an ecommerce site is becoming increasingly comfortable to most consumers, so CompUSA decided to enhance their retail stores with easy access to a retail site via their computers so they can research products. This new way to shop in a retail store, empowers consumers to take control and learn the product details they want quickly by using one of the touch computer screens in the shop. There are roughly 30 CompUSA stores in the U.S. which are testing this Retail 2.0 model, which now takes a lot of stress off of the staff to provide customer service.  <>


Burlington Coat Told to Pay Fendi $4.7M - A federal judge ordered Burlington Coat Factory Warehouse Corp. to pay Fendi $4.7 million for violating a decades-old injunction barring the off-pricer from selling the luxury brand’s trademarked goods without permission. The retailer agreed to the prohibition in 1987 to settle charges that it sold fake Fendi products. Fendi North America Inc., the brand’s U.S. unit, filed a new infringement lawsuit in 2006 accusing Burlington Coat of continuing to sell counterfeit handbags. U.S. District Court Judge Leonard Sand in Manhattan on Feb. 8 granted Fendi’s motion for summary judgment in the latest case. Sand adopted a December report and recommendation from U.S. Magistrate Judge Michael Dolinger that required the off-pricer to pay $4.7 million to Fendi for being found in contempt of the injunction. The sum includes $2.5 million in profits, $1.6 million in interest and more than $540,000 in attorneys’ fees. A Burlington Coat representative said Friday the company will appeal the decision and declined further comment. Bain Capital Partners acquired the retailer and took it private in 2006 for $2.06 billion.  <>


Credit cards are losing some luster with online shoppers - Online shoppers have increasingly turned to prepaid, gift and debit cards, along with so-called alternative payments such as PayPal and Google Checkout, according to new research from Javelin Strategy & Research. Credit cards remain the preferred payment method for online shoppers, capturing 43.5% of the online total payments volume in 2009, Javelin says. The research firm estimates that consumers spent $205 billion online in 2009. The share of credit card payments, however, will decline to 39.4% in 2014, Javelin predicts. Debit cards also will represent a smaller share of online payments, declining to 25.6% in 2014 from 28% in 2009. Meanwhile, prepaid and gift cards will account for 10.7% of online payments by 2014, up from 6.6% in 2009, while PayPal, Google Checkout and other alternative payment methods will capture 19.2% of online purchases in 2014, up from 15.9% in 2009. The remainder, about 5%, will come from store-branded credit cards. By 2014, prepaid and gift cards will have the highest compound annual growth rate for online payment forms between 2009 and 2014—26%. “Prepaid and gift cards are hitting stride in the online payments environment,” says Javelin analyst Elizabeth Robertson. A large part of the reason for the growth of non-credit card payments is that consumers, shaken by the recession and high debt loads, have switched to more immediate methods of payments rather than credit card borrowing. <>


Young and well-educated consumers are likely to go online before a purchase - 46% of consumers with a college degree say that they use a search engine before making an online purchase, and the percentage rises to 50% among consumers between the ages of 25 and 34, Opinion Research Corp. says in a recent study it conducted for digital advertising firm ARAnet. That compares to 39% of all respondents. The survey also found that adults between the ages of 25 to 34 and those with college degrees are also more likely to read an article online or consult social media before making a purchase. Following are information sources cited as important to consider before making a purchase by all respondents, adults ages 25 to 34, and those with a college degree:

  • Search engine: 39%, 50%, 46%
  • Articles read online: 28%, 39%, 36%
  • Marketing e-mail: 20%, 32%, 26%
  • Online ads: 19%, 30%, 25%,
  • Social networks: 18%, 31%, 23%

Opinion Research conducted the study of 1,029 adults in January. <>  

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