“We can't solve problems by using the same kind of thinking we used when we created them.”
-Albert Einstein
We have been in a recession since December 2007 and what has changed? Ok, George Bush is no longer in office, but Barack Obama has not been able to solve anything, largely due to a screwed up political system and corrupt politicians. That’s the obvious answer….
The financial crisis was born out of a pattern of accumulating hidden risks in the system, coupled with an increasing complexity of the financial system around the world. Never before have we had so much complexity and so much ignorance as to what is going on. After more than two years of trying to fix the system, some corporations are slightly better off, but the reality is that nothing has changed.
For the last two days I have found myself writing about structural problems which are hard to ignore, and some are worse than others.
First, consumers account for more than 70% of GDP, yet growth in personal consumption cannot be sustained without growth in inflation-adjusted income. Short-term benefits can be gained through debt expansion, but consumer credit continues to contract, and disposable consumer income is not keeping up with inflation. This is a long-term structural problem, and until it is addressed, there can be no sustained economic recovery.
Second, the most recently revised GDP report revealed another structural problem as current trends are not sustainable. Private inventory growth accounted for 4%, or 67%, of the revised 5.9% annualized growth in 4Q GDP.
Third, Washington has dug a very big hole and there is no real insight on how to deal with the issues, and now the politicians and Washington’s “Groupthink” is begetting speculation that is potentially unhealthy. More importantly, the federal government or “the system” appears to be accumulating more hidden risks which could end up leading to an “extreme improbable event.” At Hedgeye Risk Management, we call that “TAIL” risk.
As a financial analyst, I have learned that all of the real juicy stuff can be found in a company’s footnotes. I’m not claiming to have read all of the 2009 Financial Report of the U.S. Government, but the footnotes and the statement of the comptroller general of the United States are alarming. Anybody reading them would come to the conclusion that the US government is a short.
Consider the report’s covering Statement of the Comptroller of the United States, the overseeing accounting authority, where "material" questions are raised in terms of the valuation of the bailout liabilities and assets. According to, Gene L. Dodaro, Acting Comptroller General:
"The economic recession and the federal government’s unprecedented actions intended to stabilize the financial markets and to promote economic recovery have significantly affected the federal government’s financial condition. The resulting substantial investments and increases in liabilities, net operating cost, the unified budget deficit, and debt held by the public are reported in the U.S. government’s consolidated financial statements for fiscal year 2009. Because the valuation of these assets and liabilities is based on assumptions and estimates that are inherently subject to substantial uncertainty arising from the uniqueness of certain transactions and the likelihood of future changes in general economic, regulatory, and market conditions, actual results may be materially different from the reported amounts. Further, the ultimate cost of these actions and their impact on the federal government’s financial condition will not be known for some time."
Or how about this one….
“Certain material weaknesses in internal control over financial reporting and other limitations on the scope of our work resulted in conditions that prevented us from expressing an opinion on the fiscal year 2009 and 2008 financial statements other than the Statements of Social Insurance. “
The internal controls of the US Government are so bad the books can’t have an official opinion from the Comptroller of the United States.
The US government is spending money it does not have, it can’t balance the books and the most read story on Bloomberg over the past eight hours is “Germany Snubs Greek Aid Plea as Protest Snarls Athens Traffic.”
How Germany and the EU end up dealing with Greece has broad implications for the other troubled countries in Europe. I get that. Europe has a real big problem and it’s called leverage and leverage is bad. The US has a leverage problem too and we don’t have the internal controls to know where all the problems are. The US fiscal issues don’t stop with the US government as there are many individual states (see Hedgeye.com for the details) that are nearly bankrupt and have funding issues too.
Despite the current policies of the US government, the willingness of foreigners to fund our problems has been unwavering. However, it’s worth note that yesterday the Dollar Index experienced its biggest one day drop since December 1, 2009 and has now fallen five of the last six days. Unfortunately, it’s seems that the US could be headed toward one of those extreme improbable events.
When a company can’t balance its books that is a real problem, but it’s ok for the US government to not have a handle on the numbers? Something does not add up.
Wishing Keith and his family all the best today!
Function in disaster; finish in style!
Howard Penney
Managing Director
LONG ETFS
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
EWP – iShares Spain — The etf bounced on 3/3/10 in part from a strong day from Banco Santander, the fund’s largest holding in the Financials-heavy (43.8%) etf. We shorted Spain for a TRADE, and have a bearish bias on the country. Massive unemployment, public and private debt leverage, and a failed housing market remain fundamental concerns.
IWM – iShares Russell 2000 — With the Russell 2000 finally overbought from an immediate term TRADE perspective on 3/1/10 and added to it on 3/2; 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 Staples — Another capitulation squeeze is in full motion for the short sellers of everything "consumer". Shorting green as inflation starts to creep into the system again.
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.
