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“Art is making something out of nothing and selling it.”

-Frank Zappa

Frank Zappa was an iconoclastic musician who wrote all of the lyrics to his own songs. He was a critic of mainstream groupthink. He was a father of four. He was an American success story who understood how to make the passionate sale.

In 1966, Zappa and his band, The Mothers of Invention, released their debut album, “Freak Out!” You know I love that album’s name as much as I loved Zappa’s facial hair. Zappa had a great firefighter’s ‘stache. He could have easily doubled as Al Nicholls in Slapshot (Captain of the Charlestown Chiefs).

The art of risk management is “making something out of nothing and selling it” when the Manic Media is having their little Freakouts. We’ve talked about the efficacy of Selling Fear and shopping You Tube videos of empty Chinese cities to your local trading desks – when it’s consensus, these aren’t very effective short selling strategies.

With Greece up +3% and the SP500 up +1%, global stock markets put on quite a show yesterday. Short sellers from Athens to Albany got run-over old-time hockey style. Sorry wanna-be short sellers, the pros are playing this game now and this is what happens when you are Selling The Freakout!

Back in my day, I wasn’t afraid to dawn the cut-off jean shorts on Yale’s campus, so I can assure you that changing my mind from the long to the short side of a market isn’t a conceptual problem. Having a pair of scissors is sometimes all it takes when you want to make art out your Canadian denim portfolio.

Covering your shorts can be both a figurative and mathematical exercise. It all depends on where your goods are positioned before the tide rolls out. Every short position is a liability. Never forget that, or the water level will forget you. Gains on the short side are meant to be taken.

As opposed to some of the unaccountable 2009 short selling artists formerly known as Depressionistas, I have an investment portal where I can change my tunes real-time. It’s not iTunes, but it seems to work. Sometimes I’m buying. Sometimes I’m selling. It’s all virtual – and I’m cool with that too.

Currently I have 11 short positions in the Virtual Portfolio. On strength yesterday, I shorted the Russell 2000 (IWM) smaller cap index into the market’s close. We professional short sellers call this the ole hedge in the Hedgeye.

Zappa’s “Freak Out!” is frequently cited as one of America’s first “concept albums” (unified by a theme), and I think that’s a good way to think about how a global macro risk manager makes intraday moves. I start every investment quarter (every 3 months) with 3 Macro Themes. This quarter, those themes have been:

  1. Buck Breakout (long the US Dollar (UUP); short gold, GLD )
  2. Rate Run-up (bearish on long term US Treasuries – short IEF)
  3. Chinese Ox In A Box (we have covered our short position in Chinese equities, CAF)

Like a musician, I wake up repeating these themes over and over again, until I think I have it right. Sometimes, I wake up realizing that I either have it wrong, or that I am about to get it wrong. So I stop the music, and start over. Why be wed to your own lyrics when you can just change them?

Of our 3 Macro Themes for Q1 of 2010, the one that’s most likely to turn on me is the 3rd one – Chinese Ox In A Box. Rather than overstay my bearish welcome,  I have already started to transition my team to focusing on where we could go wrong in staying negative on China. Consensus is clearly starting to Sell The Freakout!

Here are some Chinese lyrics from Mr. Macro Market that we are listening to:

  1. China rallied +1.2% yesterday on a horrible (but proactively predictable) Producer Manufacturing (PMI) print of 52 (vs. 55.8 last month)
  2. Chinese stocks then traded down -0.48% last night, but made another higher-low
  3. The Shanghai Composite closed at 3073 and, critically, that’s held my immediate term TRADE line of support at 3041

On their own, these one liners are less-bearish. Collectively, they may start singing a song that’s outright bullish. Stay tuned. The art of risk management is that the music is always changing. After all, Selling The Freakout isn’t a unique idea. Zappa started doing that in 1966.

My immediate term TRADE lines of support and resistance for the SP500 are now 1103 (which is also the intermediate term TREND line of support) and 1122, respectively.

Best of luck out there today,

KM

 

LONG ETFS

FXC – CurrencyShares Canadian Dollar — Canada's currency was on sale on 2/25/10 and we are bullish on the Loonie's long term TAIL, at a price. Look for rate hikes in Canada in the coming 6-9 months.

 

XLF – SPDR Financials — With sentiment negative and a Piggy Banker Spread hitting a record wide spread on 2/23/10, we bought red.

 

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.
 

SHORT ETFS

IWM – iShares Russell 2000With the Russell 2000 finally overbought from an immediate term TRADE perspective on 3/1/10, we got the entry price that the risk manager makes a sale on strength.

 

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.

 

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.