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Chinese Wisdom

“They must often change who would be constant in happiness or wisdom.”

-Confucius

 

Changing your economic policies as the facts do is not easy; particularly if politics stand in your way. Unlike Western countries, China has positioned itself to make monetary and fiscal policy decisions when it wants to make them, not as the political wind of Fiat Fools blows.

 

Club Myopia  in Washington will tell you that China’s decision to allow the Chinese Yuan to appreciate this morning was driven by American political pressure. That’s obviously ridiculous. Ever since they laughed at Timmy Geithner last year, the Chinese have done nothing but smile and nod.

 

Not unlike their decisions to appreciate the Yuan between 2005 and 2008, the main drivers of China’s move this weekend were domestic growth and inflation. We’ve shown this chart many times and we’ll put it up on Hedgeye.com again today, but when you overlay the sequential rate of change in China’s consumer price inflation (CPI) with the Chinese Yuan, the catalyst for currency revaluation becomes crystal clear.

 

Ronald Reagan and Paul Volcker figured this out a long time ago. Now the Chinese are trying to apply past American Wisdoms. Whether it works or not remains to be seen, but the domestic benefits associated with having a strong national currency are huge.

 

Both inflation and politics are local. The best way to ensure political safety and benign inflation at home (at the same time) is to maintain a strong currency. This will sound very foreign to the Japanese, European, and American Fiat Fools. They believe in debasing the Yen, Euro, and Dollar anytime there is a whiff of stock market weakness. It’s sad.

 

Stock and commodity markets around the world are moving higher on this Chinese news this morning because a stronger currency for the world’s strongest sovereign balance sheet means China has more purchasing power. Gold is hitting all-time highs at the same time that prices from sugar to oil are charging convincingly above their immediate term TRADE lines of support.

 

After he is done attempting to smirk, Timmy Geithner should realize that the corollary to a strong Chinese Yuan is a weaker US Dollar. This is another reason why assets priced in US Dollars are charging higher this morning. Dollar down equals assets priced in dollars up, for a trade.

 

Unfortunately, this also means that the sovereign risk implied on America’s balance sheet goes up this morning. The US Dollar is hitting a 4-week low, and is now decidedly broken from an immediate term TRADE perspective.

 

We are long a 12% position in Chinese Yuan (CYB) in the Hedgeye Asset Allocation Model. We’re also short the US Dollar (UUP) so from a currency exposure perspective, today is going to be a good day. Unfortunately, irrespective of what US stock market futures are doing this morning, today is not a good day for modern day Rome’s Financial Empire.

 

We showed this chart in Friday’s Early Look “Guarding The Guards”, and it’s worth reminding you of its long term consequences. Since the US was endowed with the global fiduciary responsibility of managing the world’s reserve currency in 1971, with the exception of the Volcker years, it has done nothing but erode the credibility of that global currency.

 

In that chart we outlined the long term TAIL line of resistance for the US Dollar Index at $88.89. China’s decision this morning is only going to reinforce that long term level of resistance as the US Dollar continues to break down below what was immediate term support.

 

When support becomes resistance in the immediate term (3 weeks or less in our model), we call that a change on the margin worth managing risk around. On this score, risk works both ways (when resistance becomes support it’s bullish), and that’s why we covered our short position in the SP500 (SPY) earlier last week.

 

Currently, the immediate term TRADE line of resistance for the US Dollar is $86.69. Last week alone, after the Fiat Fools at the Fed ballooned the balance sheet to $2.35 TRILLION Dollars, the US Dollar Index lost -2.1% of its value on a week-over-week basis. Since its intermediate term closing highs early this month, the US Dollar Index is down -3.3%.

 

China is America’s creditor. I’m not sure whether or not the professional politicians in Washington get that or not yet. But, as we head into the G-20 meeting next week in Toronto, the Chinese are definitely going to remind the world who is wearing the pants in this financial relationship. China holds $900.2B in US Treasuries and has plenty a reason to ask Timmy what he’s thinking about Chinese Wisdoms now.

 

My immediate term support and resistance lines for the SP500 are now 1097 (immediate term TRADE line) and 1144 (intermediate term TREND line), respectively. On Friday, we took our asset allocation to US Equities up from 3% to 6% - we bought the ETF for Utilities (XLU).

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Chinese Wisdom - CHINA


US STRATEGY – MACRO MOVES

Overnight Global markets rose for a 10th day, the longest rally in 11 months, as oil and copper are higher and Treasuries are lower after China signaled it will relax the Yuan’s fixed rate to the dollar. 

 

The S&P 500 finished fairly flat on Friday, with the strength coming from only three sectors Financials (XLF), Materials (XLB) and Energy (XLE).  Volume was up 53% day-over-day, which was largely a function of quarterly options and futures expiration, as well as the quarterly S&P 500 rebalancing.

 

With no MACRO news-flow on Friday, the NASDAQ and Russell 2000 all traded in a tight range as the markets took no real direction throughout the day.  Treasuries were little changed and the dollar index was flat on the day.  The DXY declined by 0.4% yesterday and the Hedgeye Risk Management models have the following levels for the USD – Buy Trade (84.89) and Sell Trade (86.61).  The only factor in the model to make a convincing move in either direction was the VIX which was down 4.39% on Friday and 16% for the week.  The Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (23.41) and Sell Trade (31.93).

 

The three best performing sectors on Friday were Financials (XLF +0.3%), Energy (XLE +0.2%) and Materials (XLB +0.1%).  The Oil Service index was up 1.8% on Friday and 5.5% for the week.  Crude traded up 0.5% to 77.18; RIG (+10.3%), APC (+2.3%) and HAL (+2.2%) were the notable gainers on the day and BP rose 0.2%.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade ($73.79) and Sell Trade ($79.56).

 

The S&P Materials Index +0.50% rallied on easing MACRO concerns. CAT +1.4% reported improved machine sales and encouraging strength in Asia, especially China, which pared some investor concerns about Asian demand, especially from the materials sector.  In early trading, Copper rose the most in a month in London on speculation a stronger Yuan may accelerate imports into China.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.99) and Sell Trade (3.05).

 

Commodities continued the move to the upside, with the CRB up 1% for the week.  The Philadelphia Gold and Silver index moved up 1.8% along with a continued climb in the commodities.  Gold closed at $1,259, up 0.9% on the day.  Gold remains in a bullish formation and we are long.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,233) and Sell Trade (1,258).  

 

Rounding out the top performing sectors on Friday was Financials (XLF).  Looking ahead, financial reform will see a busy push in DC as the summer approaches.  The AMEX BioTech index rose 1.1% on the day, as AMLN was up +19.9% on Roche’s 12-18 month delay for taspoglutide.

 

Underperforming for the third day in a row was Consumer Staples (XLP -1.1%) and Consumer Discretionary (XLY -0.6%).  Leading the XLY lower was the Homebuilders, with the S&P 500 Homebuilding index (-2.2%) continued to decline on weakness following yesterday’s worries about fading demand after the homebuyer tax credit expiration.  Lennar led the group down, declining 3.7% on the day. 

 

The EURO has rallied for the past two weeks, rising 2.2% last week.  The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade ($1.22) and Sell Trade ($1.24). 

 

As we look at today’s set up for the S&P 500, the range is 47 points or 1.8% (1,097) downside and 2.4% (1,144) upside.  Equity futures are trading above fair value after China announced it has effectively abandoned its dollar peg thereby allowing some flexibility in its exchange rate. There are no economic or corporate releases scheduled for today but Wednesday's FOMC Policy Announcement will take center stage in what is a busy week for data.

 

Howard Penney

 

US STRATEGY – MACRO MOVES - S P

 

US STRATEGY – MACRO MOVES - DOLLAR

 

US STRATEGY – MACRO MOVES - VIX

 

US STRATEGY – MACRO MOVES - OIL

 

US STRATEGY – MACRO MOVES - GOLD

 

US STRATEGY – MACRO MOVES - COPPER


LVS KEEPS TALKING

Despite public commentary by management, Four Seasons apartment sales are unlikely to happen any time soon.

 

 

Once again, LVS management are out in the public domain claiming that government approval is forthcoming for the sale of Cotai apartments.  This time it came from LVS’s Macau CEO Steve Jacobs who said approval may come this year.  We’ve been hearing this at least since October 2007 when LVS made a public announcement.

 

This issue came up quite frequently in our discussions in Macau last week.  Based on those discussions, it became apparent that government approval for apartment sales was actually unlikely this year and was complicated recently by Sheldon Adelson, LVS Chairman and CEO.  “[Edmund Ho, former Macau CE] made a commitment to us that, if we started parcels 5 and 6 and if we did an IPO, then for sure we could sell [the Four Seasons apartment hotel as] strata condos…”  Apparently, Bank of China was backstopping the sales but after Sheldon’s comments and a quick phone call from Beijing, that no longer seems to be the case. 

 

Mr. Adelson has also opined on the table caps (“not a good idea”) and relaxing imported labor quotas (“the right thing to do”).  While he maintains that Lots 5/6 are on track for a Q3 opening next year, we saw little construction activity and he still needs the government to get it done.  Following our Macau visit last week, we think a 2012 opening may be more likely.

 

Sheldon thinks that if he makes privy conversations with the government public then the government will be forced to oblige.  When will he learn - as Steve Wynn has learned - that it is just the opposite? 


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US Growth: Taking Off the Training Wheels?

“God help us if earnings [in the U.S.] are anything short of fantastic.”

-Keith McCullough, June 17, 2010

 

Conclusion: Despite the remaining bullish sentiment, China still matters to the U.S. growth story. Moreover, signals from China and Dr. Copper are telling us that U.S. 2H10 growth will more than likely surprise bulls to the downside.

 

With the Shanghai Composite down 22% YTD, Chinese loan demand and loan growth slowing sequentially in 1H10, and Chinese property prices starting to show signs of deflating, it’s been clear for quite some time that the Chinese Ox is still boxed in.  Furthermore, Dr. Copper – a leading indicator for global growth – is in a bearish formation and continues to break down quantitatively.

 

What does this all suggest? Simply put, growth internationally is setting up to slow and the most leading of all indicators (marked-to-market prices) are telling us just that. U.S. bond yields have been creeping down, which has historically been a leading indicator for slowing growth. The yield on the 10Y Treasury is now at 3.22% - down 79bps from the YTD high on April 5. Factor in a slowdown from the European demand side of the equation as a result of austerity measures and rising illiquidity, and it’s not hard to see why we think growth will slow both globally and domestically in 2H10.

 

Bullish sentiment in the U.S. has hinged largely on a hopeful domestic growth outlook in 2H10, which is a large divergence from the Chinese growth story that pulled up equity markets globally since the March 2009 bottom in the S&P 500. Again, using market prices a leading indicator for growth, the S&P sectors most levered to the U.S. growth story (Industrials - XLI, Energy - XLE, and Basic Materials – XLB; each broken from an intermediate-term TREND perspective) are telling us that the U.S. is not yet ready to take off the training wheels. In fact, a very high positive correlation still exists between each of those sectors and Chinese equities and copper (see charts below). As noted before, both China and Dr. Copper are still in very bearish setups from a quantitative perspective and weakening international and Chinese fundamentals strongly support that. Despite that, a divergence has emerged between bullish domestic sentiment and marked-to-market leading indicators globally.

 

When it’s all said and done, we expect this bifurcation to create more downside risk in the U.S. equity market. As Shakespeare once penned, all crashes occur against expectations; and expectations domestically are still far too high in our option. Bulls are too bullish. Bears aren’t bearish enough. With U.S. sovereign debt and deficit issues approaching the limelight, a disastrous setup for housing domestically, and rising joblessness each not fully on everyone’s radar, U.S. growth is likely to crash against current expectations.

 

Darius Dale

Analyst

 

US Growth: Taking Off the Training Wheels? - 1

 

US Growth: Taking Off the Training Wheels? - 2


The Week Ahead

The Economic Data calendar for the week of the 21st of June through the 25th 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 - c222


KEEPING IT REAL IN BRAZIL

Conclusion: Recent policy developments out of Brazil are bullish for interest rates and the real. 

 

We’ve noted recently that the Brazilian Central Bank’s hike in the Selic rate to 10.25% last week showed a much needed bout of sobriety in monetary policy amid white-hot GDP growth (9% Y/Y in Q1) and 5.22% Y/Y inflation. As is the case with most emerging market economies, one step forward is followed by two steps back.

 

The latest developments out of Brazil show that the government is still not yet ready to leave the party. This week, Brazilian President Lula approved an increase of 7.72% in pension rates – even more than the 6.14% originally proposed. He defended his decision in the media by saying that his economic team “guaranteed” him that they could find budget cuts sufficient to offset the increase, and also that added consumption from the pension increases would mean increased tax revenues. Shortly after he approved a hike in pension fund rates, President Lula approved pay rises of between 15% - 38% for members of the Chamber of Deputies. On a side note, in the wake of Lula’s approval of legislative pay raises, the Chamber of Deputies approved new proposals – including social security and pension reforms – which, if confirmed by the Senate and signed into law, would cost R$90 billion to implement – the equivalent of eight years’ worth of the entire Bolsa Familia program’s budget. Lastly, Brazil’s Senate approved an 18% pay increase for over 32 million government employees whose representatives have lobbied the government hard during the past several months, including Agriculture Ministry workers, federal prison worker, armed forces medical personnel and intelligence agency employees. 

 

Conclusion: if you want to get paid, move to Brazil.

 

All joking aside, the latest wage increases will be positive for domestic consumption. Furthermore, a recently announced export subsidy for exporters who derive at least 30% of their revenue from exports, and who are current with their tax payments will help offset any potential revenue lost from slowing growth internationally.  The measure went into effect in April and is expected to cost R$ 1 billion this year.

 

All told, the recent policy developments out of Brazil are bullish on the margin for Brazilian growth and inflation – which will put additional pressure on the Central Bank to raise rates again. Speaking of inflation, The general market price index increased 1.06% in the second June sampling.  This was more than the 0.95% increase in the comparable period for May, but less than the 1.55% average projection of economists surveyed.  Producer prices for the second June reading grew 1.37%, versus 1.19% in May.  Agricultural prices were down (0.24% increase, versus 0.80% in May) while industrial prices grew 1.88%, greater than May’s 1.32%. 

 

In a June 8-9 meeting, policy makers forecast that 2010 inflation will remain “markedly” above their 4.5% target. The minutes of that meeting, published today on the central bank’s website, spurred Brazilian interest rate futures to jump to the highest level since February 2009 (up 6bps to 11.26% as of 9:30am EST). Economists are forecasting that Brazilian policy makers will raise the Selic rate by an additional 75bps in July. The Brazilian real gained 3.4% vs. the U.S. dollar last week, which coincided with a 75bps hike in the Selic rate.

 

While the Bovespa continues to be broken from an intermediate-term trend perspective, we are starting to warm to the real on the long side as a currency play as a result of the aforementioned hawkish setup and our bearish view on the dollar. Stay tuned.

 

Moshe Siver

Chief Compliance Officer and Managing Director

 

Darius Dale

Analyst

 

KEEPING IT REAL IN BRAZIL - 1

 

KEEPING IT REAL IN BRAZIL - 2


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