US STRATEGY - CHANGE

We live in a moment of history where change is so speeded up that we begin to see the present only when it is already disappearing.

       -  R.D. Laing

Stocks finished lower on Tuesday after the Germany Chancellor said she would introduce a temporary ban on naked short selling and naked CDS on European sovereign debt.  In early trading today, European and Asian indices are trading sharply lower on the news.  As we look at today’s set up the range for the S&P 500 is 38 points or 1.6% (1,103) downside and 1.8% (1141) upside. 

Chancellor Merkel added pressure to the markets after saying "the euro is at risk" and the current situation is Europe's "biggest test" in decades adding that there is currently an "existential test" for the euro and that “a failure of the euro means a failure of Europe”.  Apparently this is not the consensus in Europe.  Speaking to journalists in Paris, French Finance Minster Christine Lagarde said France has no plans to ban the use of any specific financial instruments designed to speculate on sovereign debt. France already has a ban on naked short sales in equities in place since September 2008.

As we stated yesterday in a note to clients “The obvious question is: what will this do to the CDS market for European sovereign debt?  That is, if the market is no longer two ways . . . will there be a market for CDS? And if there is no market for CDS, or ability for large institutions to buy insurance, will they buy European sovereign debt at the same prices or in the same amounts?

Take the market’s reaction for what it is – the wrong type of regulation.  Naked short sellers or CDS buyers don’t take markets down, fundamentals do.  Or in this case, perhaps, fundamentally misaligned government-implemented market regulations do.”

After the close last night, the ABC confidence index rose to -44 in the week ending May 16, up 3 points from a week earlier.   Apparently, consumers get more confident when the price at the pump goes down. 

With the sharp decline in Oil and Copper, the RECOVERY trade is seeing increasing scrutiny from heightened austerity measures and the potential cracks in EU stability.  Importantly, as the politicians perpetuate the problem contagion concerns will continue.  Yesterday, the increased contagion concerns and the increased likelihood of financial reform legislation took its toll on the Financials (XLF), Consumer Discretionary (XLY) and Materials (XLB).

The Hedgeye models only have three sectors positive on TREND - Consumer staples (XLP), Consumer Discretionary (XLY) and Industrials (XLI).  From a fundamental stand point the Consumer Discretionary (XLY) looks to be most vulnerable.  Yesterday, Retail also came under pressure as better-than-expected April quarter earnings once again failed to stem concerns about a lack of catalysts to sustain the momentum in the group. The S&P Retail Index declined 2.5%, as decliners included ANF (5.9%), SKS (4.3%), DKS (3.4%), TJX (3.5%) and HD (2.4%).  The S&P Retail Index is up 8% year-to-date on signs of a broad consumer recovery, but recently retailers have rolled over with some disappointing April same-store sales trends and worries that Q2 may mark a near-term peak for the RECOVERY trade. 

The U.S. dollar is showing continued strength against most currencies although it is trading slightly down against the euro this morning.  Reports suggest that profit-taking in the dollar has caused this support in the euro. 

The Euro is showing a little support near our Hedgeye Risk Management’s $1.21-$1.22 level of intermediate support following a meaningful selloff overnight.  The decline has largely been viewed as a reaction to Germany’s decision to ban naked short selling in CDS.  

Three month LIBOR has ticked up slightly to 0.465.  Yesterday, the TED spread narrowed and the Euro strengthened.  Today, the TED spread has widened to 0.3025 from 0.297 and the Euro has declined further on the news from Germany.  The inverse correlation between the TED spread and the euro has tightened further to -0.95.  This tells us that the euro is still front-and-center of investors’ global risk outlook.  Gold has declined from last night’s $1,219.70 to $1,206 at the time of writing. 

On the MACRO calendar we have:

  • MBA Mortgage Applications
  • April CPI
  • DOE Crude Oil Inventories
  • FOMC Minutes
Howard Penney
Managing Director