The Great Swells Of The Sea

Thank God for fire places. I am writing this ‘Early Look’ from a chilly sea view Inn outside of Camden, Maine this morning. The Penobscot Abenaki Indians called this part of the country Megunticook, meaning "Great Swells of the Sea” – what a fitting theme for this increasingly interconnected global market place of macro factors…

Up until I left the hedge fund First Class travel circuit of Four Seasons hotels and sunny Floridian terraces, most of my friends from back home would say ‘hey man, you have this pretty darn good!’ – warmer, yes… but thought inspiring? Not so much… My last Wall Street luxury resort conference was roughly a year ago, and I must say that I am no dumber a man for losing access to those groupthink sessions.

Thankfully, my professional life has more balance now. The hotel rooms are smaller, but they are a lot cheaper! I am staying just outside of the site of the US National Toboggan Championships. I am away from the crowds, thinking about our 2009 investment themes. Understanding that the most common one-liner I hear from investors today is that they are “long term”. It seems reasonable to stop focusing on what we’ve had right in 2008 (being in cash), and looking forward to the future.

The cover of ‘The Economist’ this past week was titled “Capitalism At Bay”; markets around the world have crashed; and we are seeing an auto correlated meltdown across asset classes. From a quant perspective, the only two models that look intermediate term “Trend” bullish are US denominated cash and equity volatility. From a sentiment perspective, the latest and greatest idea out of the “smart money” hotel conference halls is “we’re going to cash” – gee, thanks…

As of yesterday’s close, our ‘Hedgeye Portfolio Allocation’ model was set up as follows: Cash (US$) 74%, Canadian Cash (FXC) 3%, Gold 3%, and Equities 20%. While yesterday was not an up day for us in the Portfolio, I don’t feel shame. Rather, I feel quite excited about the prospects of getting fully invested, albeit patiently.

In the US, stocks remain to be rented, not yet owned. Buying into the swells of the seas worked for us from the October 10th lows, and I think it will again from the current ones. Yesterday’s breakdown of our critical support line in the S&P500 was undoubtedly bearish for the immediate term “Trade”. That support line of 948.11 now becomes resistance, and it should be respected. If we can overcome it, it’s as clearly bullish as it was bearish. That’s math.

In terms of downside support, we are using 870.08 in the S&P500 as our buy/cover signal line. Look for us to take both our gross and net long positions in US stocks up as the waves of fear roll onto the desks of the levered long community. The freak-out volume is out of the way. The last two trading days have flashed NYSE volumes that are ½ of that seen earlier in the month when credit spreads were much wider, and liquidity tighter. Volatility (VIX) is testing 70 for the 4th time in October, and it actually looks like it could take a peak at 77.89. I would love to see that shark jump out of the water. That level would really get me invested in America’s waters.

Asian markets looked horrendous across asset classes last night. From currencies to commodities and stocks, the waters have swelled. The South Korean won lost another -3.4% and the KOSPI stock market index got hammered for another -7.5% dunking. We haven’t seen these levels in Korea since the Asian Crisis in 1998. Are they “bearish enough” in Asia yet? You tell me…

We liked China yesterday, and we like it more today. Lower prices are what true capitalists seek. Both China’s currency and stock market flashed another positive divergence overnight in Global equity trading. The Shanghai composite Index closed down -1.1% at 1875, and with 1866 as our signal line to buy, you can expect us to be adding to our FXI (Chinese etf) position today (provided that it’s down). This morning, China’s Premier, Wen Jiabao, is supporting our new investment theme that we have been discussing in recent weeks, signaling that ramping up domestic consumption will offset their well publicized industrial growth slowdown. Buy Low.

There isn’t much to get excited about in Europe, yet… We are long Germany, and that’s been a mistake, so far… German stocks are trading down again alongside the region as the Euro continues to get drowned by deleveraging across eastern european countries. The Russian stock market actually stopped going down this morning, and that’s the 1st positive divergence that it has flashed in forever. That said, the Russian Trading System has lost almost 70% of its value since May of this year, and now we have ex-Soviet states like Belarus requesting emergency bailout money from the IMF this morning.

Belarus and Hank “The Market Tank” Paulson aren’t the only ones looking to bailout their comrades. Iceland, Pakistan, Hungary, and the Ukraine have all asked for similar bailout support from the International Monetary Fund. Can someone remind the said macro key-note speaker savants from the podiums of Four Seasons past that “it is global this time”? Investing in these illiquid cesspool economies is not an investment theme coming out of Camden, Maine.

While Greenspan reminds Americans that he has no accountability mirror this morning and testifies in front of the House that the solution to part of the leverage mess that he helped create is to RE-REGULATE markets, take a deep breath, and think. Credit spreads are tightening and the yield curve is steepening – these are great signs for the American capitalists who have cash. The “Great swells Of The Sea” are yesterday’s news. Let people reactively manage the past as you proactively look forward to the future.

Stay warm,
KM