It's Time

11/03/08 02:56AM EST

“What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know.”
-Warren Buffett

How prescient the “Oracle of Omaha’s” simple statements continue to be… this past week’s action across stock markets, globally, implied that consensus couldn’t have possibly have been realistically understood. Since the 10/27 lows, the Hang Seng Index and the S&P500 rallied +30% and +15%, respectively. If you weren’t short that, or “all in” on the “going to cash” call, congratulations! US denominated cash ended up losing over 4% in that same period of time.

Bottoms are processes, not points. We have been hammering home that we see a bottom forming in consumer and investor confidence, globally. While any data set can get worse, we are paid to be realists, not alarmists. Provided that Obama wins tomorrow, the election math implies that over 50% of American voters will soon see the USA as a better place than it was yesterday (see out Macro note titled, “Could Obama Signal A Bottom In Confidence”, 10/31).

Daryl Jones wrote an outstanding thematic piece for our ‘RE Macro’ clients this weekend titled “Eye On Behavioral Finance: The Power and Pitfalls of Confidence” (, 11/2). This is clearly one of the misunderstood frontiers of finance, and one that we will continue to explore in the coming months. Wall Street has had a long history of “old boy club” investing based on what Nasim Taleb labels “narrative fallacies” (story telling that supports your invested position). As this weekend’s ‘Economist’ notes on its cover, “It’s Time” – it is time for these reactive and qualitative investment management styles to take a turn warming up the bench. It’s time to proactively manage risk. It’s time to quantify all investment scenarios. It’s time to ‘You Tube’ our business for what it is, and rebuild it.

Despite all of the excuse making in the market place, two of the last three weeks have been positive ones for the S&P 500. Stock markets, globally, are beginning to discount better than toxic expectations for the immediate days ahead. Alongside the aforementioned rallies in the US and Asia, Europe is trading up for the 5th consecutive day this morning. We are long Germany via the EWG exchange traded fund where the stock market has appreciated +17% since the 24th of October. Unemployment in Germany remains low, and inflation readings have began to abate. This is progress.

Progress, at least in capital markets, can reveal itself in many forms. One of the most critical ones is expectations. This morning the European Union is leveling expectations for 2009 by cutting its economic growth outlook to zero. Yes, zero… Could they be worse than zero? Sure. Is this easier to swallow than the unrealistic expectations of the said economic forecasting savants of horse and buggy whip investment banks past? Definitely.

Alongside credit markets thawing, and yield curves steepening, our expectations for appreciation in our equity portfolio allocation continues to be positive (see ‘Hedgeye Portfolio Allocation’ above). Away from the US Dollar underperforming last week (we are short it via the UUP etf), so did gold. Gold wasn’t down much, but the point is that it was down – like credit spreads and slopes, this is one more global macro sign of stress in the global economic system abating.

Context is always critical, and you don’t need to look too far from the vacuum of available financial media to come to realize that, on a week over week basis, last week saw the S&P500 +10.5%, the CRB Commodities Index +5%, and the Volatility Index (VIX) drop -24%. Just as ole Bushy gets to see Hank the Tank’s “Investment Banking Inc.” ice get “unstuck”, he’ll be waving goodbye to the prospects of John McCain leading another reactive “B” Team at the US Treasury into 2009’s global economic battle.

Nobel Prize winning economist, Robert Aumann, who is holds a special place in my investment heart for his game theory conclusions, came out this weekend simply calling Paulson “not smart.” At least I have some decorated company in my camp now. Perhaps the most important catalysts of an Obama victory, will be a wholesale change to the American lineup at the US Treasury.

Team “Buffett, Volcker, and Summers” has a better than bad ring to it… with all time lows in US consumer confidence in our rear view mirror, that might very well be all this stock market needs in order to support the current squeeze. Everything that matters in markets happens on the margin, and “how realistically you define” what you may not know is going to occur next. Keep your eyes open for more of the unexpected.

Have a great week,

Long ETFs

JO – iPath Coffee – India’s Coffee Board estimates January – October exports increased 3%, slightly more than anticipated after problematic weather.

EWG – iShares Germany – Commerzbank to receive 8.2bn in EUR from the government after a write down. The stock is up +6.8% post the announcement.

FXI – iShares China – China’s state news agency reported that the central bank removed temporary controls on loans to bolster economic growth. China Purchasing Managers Index fell to 45.2 in October from 47.7 in September, the largest contraction since the survey began.

EWH - iShares Hong Kong – The “hairy crab index” has dropped between 30 – 50% in recent months, which is used as a proxy for consumer luxury spending in Hong Kong.

VYM – Vanguard High Dividend Yield ETF – Credit Default Swap contracts on the CDX North America Investment Grade Index of 125 companies in the U.S. and Canada increased 5 basis points to 203 on Friday.

Short ETFs

UUP – U.S. Dollar Index – The USD is down for the 4th straight day against a basket of currencies and ahead of the ISM manufacturing report in the U.S. this morning.

EWU – iShares United Kingdom – European Commission data estimates UK debt levels will exceed 60% of GDP in 2010. PMI data indicates that manufacturing has declined for 6th consecutive month.

IFN – The India Fund – Central bank lowers benchmark rate by 50bps to 7.5% and the reserve ratio by 1% in surprise move. The reserve ratio cut is expected to add $8.1bn to India’s financial system.

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