Beware Of The Squeeze

“Study the past if you would define the future.”
-Confucius

Being in a fishbowl and being the guy trying to proactively predict market moves isn’t easy – that’s why I like it. Studying the past gives my macro process a fundamental base from which I can step up and take shots. Am I going to miss the net sometimes? Of course… but a better question is can my team score more often than the competition? The answer to that question won’t be a lie – the score is up on our ‘Hedgeye Portfolio’ accountability board, daily.

On October 27th, I stepped up and slapped a title on the Early Look called “Buy’em” (www.researchedgellc.com , 10/27/08). No, that wasn’t in October of 2007 when I was about to leave Carlyle for being “too bearish” – that’s a 2008 print; you can ‘You Tube’ it.

Inclusive of yesterday’s -2.2% low volume selloff in the S&P500, the US market is +6% from that historical point. Not great, but not bad either. Since we have a global macro asset allocation model, which included a bullish call on China on that same date, it’s noteworthy that Hong Kong has gained +27% since 27th. No, no, no… that’s not October 27th 2007 where “they” called it “global this time!”

I’m going to keeping taking the shot here this morning and repeat that I think that a significant global trading bottom is in. Asian, European, and US indices will continue to make higher lows on down days until the facts in my macro models change. No, I am not calling this a “Trend” (intermediate term view, 3 months or more). This is a call on the “Trade” (immediate term, 3 weeks or less). Can a “Trade” morph into a “Trend”? Definitely. But I don’t have to take that shot until I see it.

Let’s strap on the “Macro” pants and take a walk down the path of my being bullish for the “Trade”. What are my 9 top factors?

1. Global counterparty risk (measured by the TED spread) has calmed for almost 6 consecutive weeks – TED is only 181bps wide this morning.
2. The US Yield Curve continues to steepen. The spread between 10’s and 2’s is now 250bps wide today. Borrow short, lend long. Liquidity is king.
3. Debtors (the levered long hedge fund community) are getting smoked out of their holes. Leverage is a disease when long rates ride higher.
4. Levered nations like Russia and Pakistan are being forced to raise interest rates this morning by 100bps and 200bps respectively. Now the USA can beat on them.
5. Access to capital is tightening and long term cost of capital is heightening – this expedites the blowing up of over-geared businesses that we don’t need.
6. Market share opportunities born out of the bankruptcy cycle are emerging (think BedBath vs. Linen’s N Things). GS, Thanks for BBBY the upgrade this morning!
7. Global Sentiment is bottoming (see Australian and German confidence readings this morning). The rest of the world actually likes Obama.
8. Inflation is deflating, domestically (CRB -47%, Oil -60% SINCE JULY!). GM’s Texas SUV plant announced they are running on overtime yesterday – huh?
9. US Consumer Discretionary stocks have been crashing for longer/further (peak to trough decline from 07’ is now -55%, and now the Street is bearish on spending!)

So where’s your head at? Is it where I made the call to leave the Street a year ago, or is it with me here and now covering and buying stocks today? Don’t get mad at me – get in the fishbowl and take a swim with me and the aforementioned facts. Consensus calls can definitely take markets higher and lower than we can all remain liquid, but so can contrarian ones. I am not being contrarian here for the sake of being on the other side of consensus. I am data dependent, and the river cards lay on the table here as you see them.

Domestically, the macro calendar is lining up for a massive squeeze. November 15th is the final date for hedge fund redemptions, so next week you won’t have to attempt to trade this market around said hedge fund “selling” or “blowing up”… guess what – they’ve been blowing up since the leverage trade has - this is not new! In conjunction with that fear morphing out of our melons will be next week’s US inflation reports (CPI and PPI) – they will be bullish for equities. Finally, earnings season will have ended, and that’s a catalyst in and of itself. Why? Well… because it’s history.

Studying history provides us context. Studying history stokes our fears and hopes. Studying markets is what I do in order to proactively prepare you for tail risks. With -2% downside left in the S&P500 (my buy level is 879) and +30% upside, the tails are growing into those books who think they have now mastered the art of short selling. I have moved our US Cash position down from 96% (September) to 51% this morning. Beware of the squeeze.

Good luck out there today,
KM

Long ETFs

JO – iPath Coffee –The Indian Commerce Department has launched a program aimed at increasing Indian market share for US Robusta consumption.

EWL –iShares Switzerland- Swiss Life Holdings (EWL: 0.52%), the largest Swiss life insurer abandoned prior profit targets and halted a share repurchase on investment losses driving the stock price down by as much as 18%. The company can no longer guarantee that dividends will not be cut.

EWA –iShares Australia- The Bureau of Statistics seasonally adjusted wage-cost index declined for Q3 to a growth rate of just under 1% q-o-q or 4% Y/Y suggesting that wages are trending down with the cooling commodity markets.

EWG – iShares Germany – Euro zone industrial production decreased 2.4% y-o-y, the lowest level of growth since 2002. The “wise man” group recommended that Chancellor Merkel should expand a 50 billion-euro stimulus package in their annual report.

FXI – iShares China – October Retail Sales figures came in at 22% y-o-y, a slight decrease from September.

EWH –iShares Hong Kong –The Hang Seng has declined by 5.5% in the past two sessions on increasing concerns about slowing mainland industrial production.

VYM – Vanguard High Dividend Yield ETF –Pelosi’s support for a GM puts pressure on the Bush Administration -automakers had asked for access to an additional $50 billion.

Short ETFs

UUP – U.S. Dollar Index – Bank of America strategists issued a report anticipating a dollar decline into Q1 09 on lower rates and credit market concerns.

EWW – iShares Mexico - Banco de Mexico sold as much as $85 million dollars yesterday as they attempted to stem a selloff in the Peso spurred by the Fitch downgrade, which declined over 1% for the day. Since October the foreign reserves have been reduced by $13.6 billion in such transactions.

EWJ – iShares Japan The cabinet office consumer confidence survey level for October was 29.4, the lowest ever for the Index. Societe Generale issued a report stating that banks may be forced to purchase more than as $100 billion in Yen to hedge currency derivatives heavily marketed in recent years.

EWU – iShares United Kingdom – Unemployment increased at the fastest pace in 16 years in October with claims rising by 36,500 to 980,900, the highest level since March 2001. ILO Unemployment for September registered at 5.8%.

IFN – The India Fund – Industrial Production data for September showed a slight increase to 4.8% y-o-y from the prior month decade low of 1.27 on seasonal pressure as factories increase production in advance of upcoming religious holidays which curb production.


Keith R. McCullough
CEO & Chief Investment Officer



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