“Sharp downward movements do that… they focus the mind… like a good hanging used to in the old West.”
-Judge Roy Bean

After a sharp three day -8.5% hanging of the S&P500, those who have been staring at the trees for the last 12 months have their eyes wide open now, don’t they? They wake up in the mornings surprised that a company that makes ¾ of the world’s computer chips is seeing demand slowing (Intel). They are running around talking about Great Depressions. They are coming to the stupendous revelation that my calling Hank “The Market Tank” Paulson onto the accountability carpet had merit.

Today is just another day in my life. Feet on the floor at the same time; banging through the macro factors in my trusty investment notebook; and now dealing with the same disbelief that I had to fend off at this time in 2007 that the market could actually go down a lot, by suggesting it has upside! If you don’t take the time to laugh at yourself in this business, you may as well just lock your door, tell yourself how smart you are, and cry.

An American alternative to isolating yourself is to just go to the bar. Roy Bean was a good ole Western saloon keeper who was born in 1825 in Mason County Kentucky. He was also “Justice Of The Peace”, and we may have to revive the old legend’s court alongside the Rio Grande to deal with the pending crisis of fear on Wall Street. You see, a lot of people can only justify 2 and 20 when they can lever up in bull market tapes… when the piano players music stops, the finger pointing starts, and the guns of narrative fallacy emerge.

According to FBI figures, in the week of November 3-9 (Obama’s election week), the Bureau received 374,000 requests for background check on new American gun owner purchases. A 49% year over year increase is a lot of firepower! Roy, this fear stuff is getting serious… in the last 3 days of the Street’s typical “he said, she said” ramblings across the crackberry network, I’ve “heard” of some snarly looking “hedgies” who are locked and loaded.

It’s time for real investors to stop the panting and get real here. If you are liquid long cash, this is turning into your second chance in two weeks to buy yourself some of the Street’s wares on sale. Why is it that Wall Street’s manly capitalist savants like to buy everything else in life on sale other than stocks anyway? Maybe it’s because they fear their wives shopping disruptions more than fear itself? Maybe it’s just because they fear their investment process – shouldn’t they?

Not all “hedgies” are crackberry addicts – some of them are doing a fantastic job managing risk and making money for their clients in 2008 - John Paulson, Bruce Kovner, Peter Thiel, and Phil Falcone are some of the new leadership names to add to your notebooks. Today, the Hedge Fund industry’s elite will be testifying in Washington. Undoubtedly, on their breaks, they might just call into their respective trading desks and buy/cover a stock or two down here.

Not one of the 9 bullish macro factors that I highlighted in yesterday’s strategy note has changed materially enough in the last 24 hours for me to change. In fact, some of them have improved on a day over day basis. The yield curve has steepened further, and LIBOR rates are lower (2.13% 3 month rate). Commodity driven inflation dropped another -2.4% yesterday with the CRB Commodities Index hitting fresh lows and Oil testing $56/barrel. There were many days in 2008 where CNBC’s finest would trumpet $3/barrel drops in oil as “stimulus for consumer spending”… today, with oil -60% lower, and oil dropping $3, I hear nothing but crickets. Can someone send them entertainers a calculator and a Research Edge math challenge? (Question #1: Is $3 /$130 a larger % change than $3/$56?)

I know, I know… Keith, ‘you’ve been buying stocks this week and you’re buying them lower today – shame on you… don’t make fun of us… you suck too’… I have to admit, with all of the people out there proclaiming their mystery of investment faith that “at some point fundamentals will matter” and/or “I’m a long term investor”, buying in a 12 day window for the first time in 12 months is a little reckless… God forbid someone gave me one of them guns!

Although Asia sold off last night (Japan -5.3%, India -3.1%... we’re short both), China slapped the drunks upside the head and said “I’m your Huckleberry”… closing up an impressive +3.7% on the Shanghai Composite Index to 1927. If you have a technician in your saloon, wake him up and send him that chart – it’s breaking out. Was China’s export report worse than expected? Of course it was – ASIA HAS SLOWED – this is not new… and if I didn’t make that call on a weekly basis nine months ago, I would actually feel as bad as Goldman should today trying to tell you it’s time to buy the Japanese Yen (short that call).

More importantly, China’s economy is growing high single digits, and now its inflation rates have dropped to low single digits. Last night they cut taxes on almost 1/3 of their exports. Rather than getting freaked out by the Connecticut Cowboys and their guns this morning, tickle your fancy with this narrative reality: CUTTING TAXES, SPENDING $586B in STIMULUS ahead of a SEASONALLY STRONG Q1… no, this is not Ronald Reagan folks… nor is it Roy Bean… this is China.

I have taken our Hedgeye Portfolio Allocation model down to 45% cash… I have plenty of powder left to be firing up my troops with guns… but I’m more into the “Justice Of the Peace” thing these days – so I’ll pass on the fear mongering, and look forward to those Western blue skies of my trip next week to the office we are building in San Diego, California. Don’t stress, it’s time to invest.

Happy shopping,

Long ETFs

EWL –iShares Switzerland- Zurich Financial (EWL: 4.68%), the largest Swiss insurer, reported a 90% y-o-y Q3 earnings decline on write downs and US hurricane exposure and suspended a share repurchase program.

EWA –iShares Australia- Commonwealth Bank of Australia (EWA: 7.2%) shares lost 6% after the company announced that non performing debts will likely double to 0.52% of total portfolio.

EWG – iShares Germany –GDP numbers released today show the economy contracted by 0.5% q-o-q in Q3, the second successive negative growth quarter and the steepest decline since 1996.

FXI – iShares China – Industrial production for October increased by 8.2% y-o-y, the slowest rate of growth in 7 years.

EWH –iShares Hong Kong –The Hang Seng declined by 5.2% today to reach its lowest level since October 29 as selling pressure mounted for financials.

VYM – Vanguard High Dividend Yield ETF – Borrowers whose credit does not qualify for the Fed Window who still have access to emergency bank lines are choosing to access them instead of floating commercial paper driving CP volume to the lowest level in 2 years. Three month LIBOR rose for the first time in 24 days, increasing by 2 basis points.

Short ETFs

UUP – U.S. Dollar Index – Trade numbers today are expected to show a narrowing deficit.

EWW – iShares Mexico – The lower house of congress approved a Federal Budget that factors a deficit of 1.8% of GDP, the first budget deficit in 4 years if approved by the Senate.

EWJ – iShares Japan BOJ Board Member Seiji Nakamura delivered a grave assessment of long-term Japanese economic conditions at a speech in Matsuyama today.

IFN – The India Fund – The Wholesale Price Index declined to 9% y-o-y for the last week of October marking the most rapid decline in inflation in 18 years.

Keith R. McCullough
CEO & Chief Investment Officer