US equities finished lower last Friday, partly on Fitch’s Spain debt downgrade.  It’s truly amazing that the Fitch, Moody’s, or S&P ratings can still have this type of impact on the market.  After a long weekend, we are looking at growth slowing around the world and markets in a steep dive.


China’s Purchasing Managers’ Index slid to 53.9 from 55.7 in April that was less than the median 54.5 estimate in a Bloomberg survey.  Also, the Eurozone manufacturing PMI declined to 55.8 in May from 57.6 in April (also below an initial estimate of 55.9 released on May 21).  In early trading, the euro is trading down 1.3% to 1.2131.  The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade (1.21) and Sell Trade (1.23).


Over the weekend, Germany’s president unexpectedly quit, making Germany less of a source of stability in the region.  The now former president, Horst Koehler, is also the former head of the International Monetary Fund.


This follows on the heels of some disappointing MACRO data points in the US last week.  Breaking a four-month upward trend, consumer spending failed to deliver in April; spending was flat versus expectations for +0.3% and personal income met consensus at +0.4%.  Also on Friday, May Chicago PMI was reported at 59.7; below consensus 61.0 and prior 63.8. The one bright-spot was the Final May University of Michigan Confidence of 73.6; slightly better than consensus 73.3 - the preliminary reading was 73.3.


On Friday, Financials (XLF), Energy (XLE) and Materials (XLB) were the three worst performing sectors, down 2.2%, 1.9% and 1.8%, respectively.  The XLE Oil services stocks (OSX down 5.2%), were the worst performing sub-sector on the day.   Late Friday afternoon, President Obama addressed the media from Louisiana, where he pledged the full force of the government in responding to the continuing oil spill and cleanup. The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (71.46) and Sell Trade (77.32).


The theme of slowing growth is negatively impacting China and commodity prices.  Over the last two days, China is down 3.3%.  In early trading today, copper and crude prices are down more than 2%.  The XLE and XLB will continue to underperform in this environment.    The Hedgeye Risk Management models have the following levels for COPPER – Buy Trade (3.02) and Sell Trade (3.20).    


In early trading, the dollar is trading up about 1%.  The Hedgeye Risk Management models have the following levels for the USD – Buy Trade (86.49) and Sell Trade (87.51). 


The three defensive sectors of the S&P 500 outperformed on Friday - Consumer Staples, Healthcare and Utilities.  Large-cap Pharma, HMO’s and beverages were all sectors that rose on Friday. 


Despite more instability in the euro zone region, the VIX declined 20% last week.  The Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (28.65) and Sell Trade (45.06). 


Gold has rallied 2.3% last week and is now up 11.3% year-to-date.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,194) and Sell Trade (1,231).


As we look at today’s set up for the S&P 500, the range is 50 points or 1.2% (1,076) downside and 3.4% (1,126) upside.  Equity futures are trading below fair value with the Dow back below 10,000 in reaction to further selling in global equities as global growth is slowing. 


On the economic front, to be reported today are:

  • May ISM Manufacturing
  • April Construction Spending
  • May Dallas Fed Manufacturing
  • API Crude Inventories
  • ABC Consumer Confidence

Howard Penney













Unchangeable Certainty

“The only unchangeable certainty is that nothing is certain or unchangeable”

-John F. Kennedy


It was a nice long weekend. A successful May is over. Let the performance scoring for June begin.


I’m using a JFK quote to kick start the month, not only because we need some American leadership in this country, but because the last time we saw stocks get crushed like we did in May was when Kennedy was the President of the United States.


Ironically enough, the US stock market locked in a cyclical peak on the exact same day (April 23rd) of both 1962 and 2010. So far, the peak-to-closing-trough decline from April 23, 2010 has been -12.3% (1067 SP500). The question for risk managers this morning remains, are the lows for 2010 in?


The best place to start answering this question is from the top down. To understand where we are going, we better have a deep respect for where we came from. Where are we relative to our Q210 Hedgeye Macro Themes? What’s working? What’s not? Market prices don’t lie.

  1. Sovereign Debt Dichotomy: Check, check, check. We thought Greece was the first domino of sovereign debt maturities that would concern the world; then Spain; then Italy and France. Both Spain and Italy implemented austerity measures late in May and over the weekend we saw France’s Budget Minister, Francois Baroin, admit that it was a “stretch” for France to maintain an objective AAA rating. With France’s burgeoning deficit, we concur.
  2. Inflation’s V-Bottom: Across the world, inflation readings hit a series of higher-highs sequentially for the month of April. Our Hedgeye Inflation Index turned down month-over-month in May. Inflation’s V-shaped recovery is what every 12 month chart you look at looks like until the music stopped on April 23rd. Inflation’s V is now setting up to deflate in June. This will help insulate the Fed’s Japanese style monetary policy, and keep treasuries relatively safe.
  3. April Flowers/May Showers: Check. One fund of funds investor from Boston had an interesting take on what we considered proactively predictable: “Attempting to manage risk in an environment where everything that could go wrong does go wrong seems like a fruitless endeavor.” For the month of May, the SP500 was down -8.2%. One manager utilizing the Hedgeye long/short strategy was up +4.05% gross. Another was up +0.52% net. We’ll call that fruitful.

No matter where you go this morning, there market prices are. Spain, China, and France are down -21.6%, -23.7%, and -12.9%, respectively YTD. Our task isn’t to make excuses or point fingers. Our risk management goal is to see the game for what it has become. Are the lows for 2010 to-date already a rear-view event? Unlikely.


We run a multi-factor risk management model across equities, bonds, currencies, commodities, etc., globally. There are very few things that are flashing cover/buy to us yet. Simplifying our model on the US Equity side of the ledger, these are the 2 lines that are most concerning to me:

  1. SP500 intermediate term TREND line resistance of 1144
  2. Volatility Index (VIX) intermediate term TREND line support of 22.19

Provided that the SP500 can’t breakout above 1144 and the VIX can’t breakdown through 22.19, the bear market in US stocks will continue to manifest into consensus that should find another short term cyclical bottom sometime in Q2/Q3.


Another 10 intermediate term TREND lines that remain broken around the world and across asset classes that compliment this simple 2-factor US Equity bear case:

  1. Shanghai Composite Exchange = 2933
  2. Tokyo Nikkei Average = 10598
  3. Hang Seng Index = 20789
  4. London Financial Times Index (FTSE) = 5511
  5. Spain Bolsa (IBEX) = 10499
  6. French CAC 40 Index = 3794
  7. Brazilian Bovespa = 66992
  8. CRB Commodities Index = 271
  9. Copper = 3.33/lb
  10. WTI Oil = $79.11/barrel

Nothing, of course, is “certain or unchangeable” in our risk management model. It’s grounded in chaos theory and, after all, that’s grounded in uncertainty.


My immediate term TRADE lines of support and resistance for the SP500 are now 1076 and 1126, respectively. Our asset allocation to equities, globally, remains zero percent. We continue to be short both the SP500 (SPY) and Nasdaq (QQQQ).


Best of luck out there today and have a great month,



Keith R. McCullough
Chief Executive Officer


Unchangeable Certainty - May Showers

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Housing Datapoints Emerge Suggesting the Post-Tax Credit Expiration Decline Has Begun

We had theorized that housing would drop significantly after the tax credit expiration in April, as it did following November's tax credit expiration, and now we're getting early data to confirm that view. Yesterday, the herd drove housing-related equities modestly higher on a strong New Home sales print and Bob Toll's upbeat commentary. This was in spite of surprisingly high (and rising) existing home inventory and falling home prices (see our notes from Monday and Tuesday). The reality, however, is that since the end of April, demand in the housing market have been deteriorating.


The following chart shows MBA Mortgage Purchase applications indexed to 100 on January 1, 2010. On this basis, average applications in March were up 13.8% from the start of the year, and average applications in April were up 23.2% from the start of the year. In the first 3 weeks of May, however, applications were down 14.4% from levels in April. More striking is the fact that the most recent datapoint - May 21 - is down 25.6% from the average April level. Here's what the MBA's chief economist had to say following the release of the 5/14 data:


Purchase applications plummeted 27 percent last week and have declined almost 20 percent over the past month, despite relatively low interest rates. The data continue to suggest that the tax credit pulled sales into April at the expense of the remainder of the spring buying season. In fact, this drop occurred even as rates on 30-year fixed-rate mortgages continued to fall, and at 4.83 percent are at their lowest level since November 2009.


By the way, the week after the above comment was made - 5/21 - was the lowest weekly mortgage purchase application volume week since 1997. It's an interesting theoretical question to ask whether volume was down because of the pull-forward, the sharp stock market correction or a combination of the two.




The next chart shows Toll Brothers sequential change in buyer traffic from April to May. Bob Toll's comments in the quarterly earnings release yesterday were very positive, generating understandable investor enthusiasm towards not just TOL but the whole space. See Bob's comments below.


It appears our business has finally emerged from the tunnel and into a bit of daylight. For the third consecutive quarter, our signed contracts per community exceeded both of the previous two years' comparable-quarter totals. Deposits and traffic per community have been trending positively for the last four-, eight- and twelve-week periods. And our conversion percentage rate from traffic to deposits (non-binding reservations) was the highest second-quarter total since we began tracking this data in 1994. In the three weeks since the start of our third quarter on May 1st, which coincided with the expiration of the homebuyer tax credit, our per community deposits and traffic were up 23% and 11%, respectively, over last year's comparable period. May's activity suggests that for us the tax credit wasn't the determinative factor – rather, we believe, the past few months' activity has been driven by an increase in confidence among our buyers in their job security, their ability to sell their existing homes, and general trends in home prices.


One important fact check supplied during the Q&A portion of the call, however, revealed that year-over-year growth in buyer traffic - traffic is among the best leading indicators for housing - actually declined by two-thirds in May vs April. See the chart below. The +11% yoy May increase in buyer traffic cited in the release actually compared with a +25-30% increase in April. Suffice it to say that in spite of their claims, Toll is seeing a marked slowdown in activity following the tax credit expiration.


It's also worth pointing out that Toll Brothers houses are not representative of the country. For reference, their average ticket is in the $700,000-725,000 range, which puts them right at the cap of conforming loan limits: $729k for the highest priced markets. Considering Fannie and Freddie together accounted for over 95% of all mortgages issued last year, we would submit that the Toll Brothers addressable market does not reflect demand trends for better than 90% of the housing market.




One striking consideration is that mortgage rates are at incredibly low levels. The 30-year conforming mortgage went out at 4.86% last night, down from a recent peak of 5.25% on April 4. The following chart shows average mortgage rates by month and for quarters going back to the start of the year. The drop in mortgage rates in May is striking. May is down 19 bps, on average, vs April. While the current rate of 4.86% is down 24 bps from the average April rate. In spite of this, purchase applications just posted their lowest reading since 1997.




The bottom line is that May data is starting to trickle in and so far it is very weak. We don't think the market yet appreciates how weak this May data is, but it will figure it out soon enough. In the interim, we offer the following chart that we published recently showing lenders stacked in order of relative exposure to residential real estate by combining residential first lien mortgages, second lien mortgages, HELOCs and 1-4 Construction loans. We think that as the market shifts its focus from the EU and Financial Reform to the worsening state of the housing market this summer it will put pressure on those companies with the greatest credit exposure to housing.




To summarize, here are the negatives on housing at the moment:

  1. May purchase applications are at a record low.
  2. Toll Brothers traffic index goes from +25-30% yoy in April to +11% in May.
  3. April existing home sales data showed a ballooning of inventory (a leading indicator) in spite of a rise in sales.

And here are the positives:

  1. New home inventories are very low.

We think the negatives pretty clearly outweigh the positives here, and we would recommend caution for longs and bearishness for those with short capabilities on all companies with a high degree of sensitivity to home prices heading into the back half of this year.



Now for the silver lining

The April New Home sales data out yesterday was really exceptionally strong, as one would expect in the final month before  tax credit expiration. Sales came in at a 504k annualized rate, +22.6% from the prior month and up 46% from the year earlier, and way above consensus. There's no debating that this was an exceptionally strong result. Moreover, inventory of new homes is down a lot. From a units perspective, new home inventory is reported at 211k, down almost 8% from last month's 229k print. The equally important months supply calculation fell to 5.0 months, down from 6.7 months last month. This had more to do with the huge pickup in sales activity than it did with the decline in inventory, but nevertheless the months supply reading for April was very strong.


The catch is that unlike existing home sales, which measure contract closings, new home sales measure contract signings. In other words, while we'll continue to see existing home sales prints rise for the next two months (a lagging indicator), for new home sales April was it - the end of the good prints. We're now on the backside of the tax credit expiration. If inventories weren't so low we would be bearish on the homebuilders. We expect competitive pressure from the existing home market to weigh on new home sales volume and pricing. That said, the low inventories make the short case quite  challenging. We'll have to wait and see how the new home market evolves.


The following are several charts related to new home sales that we think tell the story of this month's data.


As mentioned before, new home sales were exceptionally strong in April.



Inventories also fell considerably.



From a longer-term perspective, inventories on a units basis are at all time lows, while on a months supply basis, they are near their lows.



We include the following chart more as a reference point. It shows the share of total home purchases represented by new homes. The chart would suggest that the new home sales share is quite depressed by historical standards, and the more likely of the two outcomes would be for some degree of mean reversion to kick in. In other words, it would seem more likely than not that new home sales would gain share from here than that they would lose share. That being said, the world has changed in the last few years and we're still unclear on the extent to which things are going to go back to business as usual. As such we're still cautious in assuming that this penetration should bounce right back to 14-16% - a common refrain from investors long the builders.




Joshua Steiner, CFA


Allison Kaptur

The Week Ahead

The Economic Data calendar for the week of the 31st of May through the 4th of June is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - c1

The Week Ahead - c2

Risk Management Time: SP500 Levels, Refreshed

This market continues to rally on low volume to lower-highs as volatility (VIX) continues to make higher lows. Combined, these 2 factors are bearish for US Equities. Respect yesterday’s rally from the YTD low for what it was – a rally from the YTD low.


Notwithstanding this intraday headline “North Korea says situation is so grave that war may break out at anytime—KCNA”, there remain plenty of reasons to remain short US stocks into month end. The biggest reason remains the Sovereign Debt Dichotomy. We continue to believe that the sovereign debt problems in Europe are going to manifest in the US within the next 3-6 months.


In terms of levels, the SP500 remains broken from both an immediate term TRADE and intermediate term TREND perspective. The intermediate term TREND line of resistance (1144) still leaves plenty of room for the bulls to buy-and-hope, but that also puts more downside risk to this market if our long term TAIL of support at 1074 is violated in June. Nothing makes markets go down faster than bulls having to reduce their gross long exposure.


We’ll be holding our risk management call on Korea at 1PM with renowned Yale Professor, Charlie Hill. If you’d like access to the call please email . Given the intraday headlines coming out of North Korea, the timing of this call is going to help you proactively prepare ahead of the long weekend.


About Professor Hill
Professor Charles Hill was a career minister in the U.S. Foreign Service and is a research fellow at the Hoover Institution. Hill was executive aide to former U.S. Secretary of State George P. Shultz (1985-89) and served as special consultant on policy to the Secretary-General of the United Nations from 1992 to 1996. Professor Hill has served as Chief of Staff of the State Department, a State Department political officer in Hong Kong, a cultural exchange negotiator in China, and a Chinese-language officer in Taiwan.


Keith R. McCullough
Chief Executive Officer


Risk Management Time: SP500 Levels, Refreshed - S P

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