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Capital Chases Yield

“Now I know that I can win and that I can beat the best players in the world.”

-Martin Kaymer               

 

Martin Kaymer persevered at Whistling Straits in Kohler, Wisconsin yesterday to capture the 92nd US PGA Championship. The 25 year-old German is only the second player from Germany to win one of professional golf’s 4 majors. With 5 foreign born players finishing in the top 10 this weekend, I couldn’t help but notice that this world continues to become more interconnected and competitive by the day.

 

In the end, the best players in the world will get the most attention, capital, and respect. When it comes to capital markets, this is a critical point for long-time US-centric stock market investors to acknowledge. Capital changes hands every day. Capital seeks winners. Capital chases yield.

 

On the stock market side of the scorecard, Kaymer’s Germany scores better than the US does at this stage of the 2010 game. For the YTD the German DAX is +2.6%, whereas the US (SP500) is down -3.2%. That’s a 580 basis point performance spread.

 

Our top-flight analyst on European strategy, Matt Hedrick, has written extensively on Germany this year (email if you’d like to see his most recent research), but here are some summary points distinguishing Germany versus the US that are important to consider:

  1. German y/y GDP growth is currently stronger than in the US
  2. German unemployment is lower than in the US (7.6% vs. 9.5%)
  3. German fiscal policy is more conservative than in the US (85 BILLION Euro austerity package vs. no austerity).

As a result, global capital is realizing higher rates of return whether invested in German Bunds or German Equities relative to US Treasury yields (hitting all time lows) and US equities (down in 11 of the last 14 days). In hindsight, this probably makes as much sense as most things do in the rear-view mirror.

 

What doesn’t make any sense is an expectation that the Fiat Republic in Washington will win market share for global capital fund flows by marking America’s “risk free” rate of return at ZERO percent. This is going to chase capital out of this country for an “extended and exceptional” period of time.

 

Notwithstanding the fact that Japan has seen more net funds flow into Japanese Government Bonds than the US has seen from China into US Treasuries in the last 6 months, the Japanese have already taught the world that it’s very possible to chase capital out of a large economy for decades. Enough fear mongering about the “great depression” here folks, we need to wake up, smell the coffee, and get America back to winning again.

 

Japan’s GDP growth continues to be hammered down by elevated levels of debt. Last night the Japanese reported another awful GDP number for Q2 of 2010. In a global demand environment where China and its South East Asian neighbors were growing double digit GDP growth rates, Japan grew 0.1% sequentially to 0.4% year-over-year. QE-Japan – nice…

 

Japan didn’t have a player make the cut this weekend at the PGA Championship either (Yuta Ikeda was 2-OVER and No-mora by Saturday). Japan’s population growth is negative and there isn’t a lot to smile about in the island nation once expected to see real-estate prices grow like tulips to a 16th century sky. As China overtakes them this morning as the world’s 2nd largest economy, Japan’s losing streak continues with the Nikkei down -12.8% YTD.

 

But have no fear, Paul Krugman and the Fiat Fools are here… telling you (like Krugman did in 1997 with his “PRINT LOTS OF MONEY” advice to the Bank of Japan), that it’s time for QE2, 3 and 4. No wonder why Kaymer and China’s Wen-chong Liang (tied for 8th at the PGA this weekend) think they can beat the best players in the world. America’s ball is in the water – and we’re trying to fight oncoming water with more “liquidity.”

 

Last week was not a good week for the US on the stock market scorecard. With the SP500 broken across all 3 of our core investment durations (TRADE, TREND, and TAIL), here’s the updated immediate term TRADE ranges for US indices:

  1. SP500 = 1072-1098
  2. Dow = 10,2380-10,554
  3. Nasdaq = 2160-2244
  4. Russell2000 = 603-639

While the perma-bulls were begging Bernanke to take on more QE water, the market’s reaction to QE Light was:

  1. Stocks DOWN (-3.7% wk/wk)
  2. Volatility UP (VIX +21% wk/wk)
  3. 2-year yields UP (closing the week at 0.53% vs. 0.51% in the wk prior)

What was probably least expected was US short rates going up on the week. Then again what’s least expected by consensus is where winners in this part of the 21st century are going to find they can beat the former best players in the world. Capital will chase yield as score changes every day.

 

On Friday morning’s opening market strength we sold our long Singapore position (EWS) and raised our position in Cash from 55% to 61%. My immediate term TRADE lines of support and resistance this morning are 1072 and 1098, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Capital Chases Yield - kaymer


THE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP

As we look at today’s set up for the S&P 500, the range is 26 points or 0.7% (1,072) downside and 1.7% (1,098) upside.  Equity futures are trading below fair value after Japanese Q2 GDP data came in below expectations providing evidence QE does not revive economic growth.

 

The important MACRO data is due out tomorrow are PPI, Housing Starts/Permits and Industrial Production.  On the earnings front, retailers will be in focus this week with Lowe's, Home Depot and Wal-Mart reporting.

  • ADVANCE/DECLINE LINE: -278 (+158) positive on a down day - day 2!
  • VOLUME: NYSE - 871.65 (-13.47%) - 2nd slowest day of the week!
  • SECTOR PERFORMANCE: One sector positive - XLU
  • MARKET LEADING/LOOSING STOCKS: Nvidia +4.8%, Ameren +3.2 and Nordstrom (-7.15%) and Devry (-5.74%)

EQUITY SENTIMENT:

  • VIX - 26.24 1.98% - Big move last week up 20%.
  • SPX PUT/CALL RATIO - 1.83 down from 2.98 (low of 0.87 on 07/15/10)

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD - 22.43 0.203 (0.913%)
  •  3-MONTH T-BILL YIELD .15% Unchanged
  • YIELD CURVE - 2.2063 to 2.1408 (close)  - Now at 2.1265 

COMMODITY/GROWTH EXPECTATION:

  • CRB: 268.79 -0.03% (ugly week down 2.15%)
  • Oil: 75.39 -0.46% (-6.58% last week)
  • COPPER: 327.25 -1.00% (-2.72% last week)
  • GOLD: 1,214 +0.11% (up 0.79% last week)

CURRENCIES:

  • EURO: 1.2754 -0.74% - (trading down 3.96% last week)
  • DOLLAR: 82.948 +0.38%) - (trading up 3.16% last week)

OVERSEAS MARKETS:

  • ASIA - Asian markets traded mixed after data from Japan showed Q2 GDP rose +0.4%, worse than the median forecast for 2.3% growth; China traded up 2.1%.
  • EUROPE - Major markets are trading lower as weaker than expected Japanese Q2 GDP sets the early tone
  •  EASTERN EUROPE - Trading mixed to higher - Russia is struggling while Romania is up 1.4%.
  • MIDDLE EAST/AFRICA - UAE is trading higher 
Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends

 

THE DAILY OUTLOOK - S P

 

THE DAILY OUTLOOK - VIX

 

THE DAILY OUTLOOK - DOLLAR

 

THE DAILY OUTLOOK - OIL

 

THE DAILY OUTLOOK - GOLD

 

THE DAILY OUTLOOK - COPPER


EARLY LOOK: Friday the Thirteenth

This note was originally published on August 13, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK in real-time, published by 8am every trading day.

 

 

__________________________________________

“Dude, that goalie was pissed about something.”
-Freeburg (Freddy vs. Jason, 2003)
 
It’s certainly been an interesting week and its ending with a flurry of shots on goal for global macro risk management net-minders. Sophisticate coaches from Mass call them “net-mind-ahs” by the way. Canucks call dem de goalies, eh.
 
Today is also Friday the 13th, and de goalies with de coaches who got dem-selves lee-verd up long last week are feeling shame. The most infamous American goalie mask of them all has to be Jason’s. He’s seen a lot of red rubber as of late.
 
Another American who found fame on this day in 1907 was a stock market manipulator from Massachusetts by the name of Thomas W. Lawson. Ole Lawsy tried to slip one by de goalie back then by publishing a book titled “Friday The Thirteenth”, which attempted to scare the horses into believing that the market was setting up for a crash on that very day (his book sold 28,000 copies in its 1st week).
 
Per Wikipedia, Lawsy was “a highly controversial Boston stock promoter – he is known for both his efforts to promote reforms in the stock market and the fortune he amassed for himself through highly dubious stock manipulations.” He was a hybrid Barney Frankenstein - fear mongering Americans, then flip flopping his position to the other side of the trade. All the while forgetting that people would remember what he said/did on the last go around.
 
While stock market futures have whipped around a great deal this morning, the Dodd-Frankenstein reform bill doesn’t appear to be today’s excuse. Germany reported a blockbuster Q2 GDP report (+2.2% sequential growth) and Europe’s “net-mind-ah” has apparently left the building on the news. European markets are being chased lower by the old Friday The Thirteenth fear that we call ‘selling on the news.’
 
In addition to the week-to-date Nightmare on Wall Street drop of -3.3%, here’s what is legitimately scaring US equity investors (in the order that the data points occurred):
 
1.      China bought 456B Yen worth of JGB’s (Japanese Government Bonds) in June = most since 05’ (and remains a net seller of US Treasuries).

2.      Goldman Sachs (Jan Hatzius) cut his US GDP growth estimate to 1.9% for 2011 (that’s the closest estimate to Hedgeye’s 1.7%).

3.      Chinese Imports dropped 1100 basis points sequentially in July to 23% (vs. 34% in June) = Chinese demand continues to slow.

4.      Chinese property prices dropped to +10.3% y/y in July versus +11.4% in June.

5.      USA’s NFIB survey for small business confidence hit another sequential low this month dropping to 88.

6.      Bernanke’s QE2 was met with selling of both US stocks and get this, Treasuries!, with this morning’s 2-year yields trading UP versus Tuesday.

7.      China’s bank regulator ordered the transfer of off-balance sheet loans to its books by 2011 (and make provisions for defaults)

8.      US MBA mortgage applications held flat week-over-week, enforcing the reality that Americans refuse to lever themselves up again.

9.      Chinese industrial production, retail sales, and money supply growth (M2) all slowed again sequentially in July versus June.

10.  Chinese inflation hit a 20 month high, accelerating +3.3% in July versus +2.9% in June = oil, food… you know… the things they need.

11.  Venezuelan and Argentinean bond yields pushed higher as their dysfunctional governments try to issue the world sovereign debt.

12.  America’s budget deficit tacked on another $165 BILLION loss in July, taking spending up +10% y/y with tax revenues barely flat.

13.  Russian Bond sales saw only 44% of the demand de goalies in de Kremlin were looking for (25 BILLION Rubles) = Russian bond yield up.

14.  General Disaster (GM) announced their pending $12-16 BILLION Dollar IPO = 2nd largest IPO in US history; what is wrong with America?

15.  US weekly jobless claims ripped higher to 484,000 = representing the highest jump in rolling weekly claims for 2010 YTD!

16.  The Fed’s Balance sheet expanded again week/week going up to $2.33 TRILLION DOLLARS after Ben bought $1.7B more MBS this week!

 
Sorry, for penmanship’s sake I tried to go with 13 bearish points, but I had to print 16 as pushing Hedgeye’s own book of ideas trumps my literary aspirations.
 
Look on the bright side, Monday will be a new day for the professional storytellers in Washington and it won’t be Friday The Thirteenth either. By the way, Thomas W. Lawson died poor.
 
On a fair amount of bearish global macro news, I’ll call the SP500 fairly oversold at 1080 or lower. As a result, we’ll open up the Hedgeye Asset Allocation coffers and move from 70% cash (last Friday) down to 55% on this Friday the 13th, 2010 by going to a 6% allocation to US Equities.
 
My immediate term TRADE lines of support and resistance for the SP500 are now 1080 and 1197, respectively, eh.
 
Best of luck out there today and have a great weekend with your families,
KM


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MACRO: CHINA: SETTING UP TO OUTPERFORM

This insight was originally published on July 16, 2010 for subscribers. RISK MANAGER SUBSCRIBERS have access to SELECT MACRO content in real-time.

 

 

 

____________________________________

Position: Long Chinese Yuan via the etf CYB.
 
Conclusion: Slowing economic data supports sequentially slowing growth in China, and policy actions suggest more slowing is to come. Despite this, China's organic growth story is right on track. Eventually, investors will pay a premium for it again.
 
Like we’ve been saying since our January 15th  Chinese Ox in the Box theme, China’s 6-9 month economic outlook looks bearish. As bearish as that may be, the long term economic outlook for China is equally bullish and at a point, investors will again pay a premium for that growth. The whole concept of premium is hinged upon relative economic health and that will begin to matter a great deal more than it did in 1H10, as investors begin to rightfully get long those nations with strong balance sheets.
 
China has been tightening its economy to cool its white hot growth and inflationary pressures. Those methods have included: targeting a reduction in loan growth, raising lender’s reserve requirements, selling bills to soak up excess liquidly, and tightening controls on the expansion of businesses that are heavy energy users (i.e. manufacturing). As a result of these actions, we have seen Chinese economic growth slow as verified by the following data points:

  • GDP slowed sequentially: 10.3% y/y in 2Q vs. 11.9% y/y in 1Q;
  • Money supply growth (M2) continues to slow: 18.5% y/y in June vs. 21% y/y in May – June marks the slowest growth since Dec. 2008 and has slowed each month since November;
  • Loan growth continues to slow: 603B Yuan ($89B) in June vs. 639.4B Yuan ($94B) in May vs. 774B Yuan in April;
  • Property Prices continue to slow: 11.4% y/y in June vs. 12.4% y/y in May vs. 12.8% y/y in April;
  • CPI slowed sequentially: 2.9% y/y in June vs. 3.3% y/y in May
  • Commercial Real Estate sales growth slowing – Floor Space sold declining: 15.4% y/y Jan-June vs. 22.5% y/y Jan-May; Sales Volume slowing: 25.4% y/y Jan-June vs. 38.4% y/y Jan-May;
  • Fixed Assets Investment continuing to slow: 25.5% y/y Jan-June vs. 25.9% y/y Jan-May;
  • Funds In Place for Investment continuing to slow: 29.2% y/y Jan-June vs. 33.8% y/y Jan-May;
  • Investment in Construction Projects slowing: 27% y/y Jan-June vs. 28.7% y/y Jan-May.

 

MACRO: CHINA: SETTING UP TO OUTPERFORM - chart1

 

 

MACRO: CHINA: SETTING UP TO OUTPERFORM - chart2

 

 

As suggested by the data above, China’s tightening measures are producing the desired results and China has no plans to loosen the reins anytime soon. On Tuesday, The Ministry of Housing and Urban-Rural Development reiterated that it will maintain curbs on speculative purchases and increase market supply. Furthermore, China’s banking regulator said it has made no changes to policies on home loans, calling on commercial banks to strictly enforce home loan rules.
 
The momentum associated with these declining statistics and the government’s resolve to maintain tightening policies towards the Chinese property market suggest that the easy money in China has likely moderated for now. As a result, the Chinese equity markets have suffered (the Shanghai Composite is down 27% YTD and is underperformed by only Greece since the start of the year). Chinese entrepreneur confidence followed suit, down 2.5% Q/Q in 2Q, alongside slowing imports, slowing PMI, and slowing industrial production. Furthermore, weakening commodity prices in the face of a dollar decline are all sings that the Chinese demand side of the REFLATION trade is diminishing.

 

 

MACRO: CHINA: SETTING UP TO OUTPERFORM - chart3

 

 

MACRO: CHINA: SETTING UP TO OUTPERFORM - chart4

 

 

MACRO: CHINA: SETTING UP TO OUTPERFORM - chart5

 

 

All is not cause for alarm, however. As I pointed out in a note last Tuesday, the Chinese government has been busy making moves to position itself to better weather a slowdown in international trade. Those measures include increasing minimum wages by as much as a third in more than 21  provinces and municipalities this year, and, of course, relaxing the Yuan peg. Those measures, combined with further appreciation of the Yuan from here, will help stimulate domestic consumption, which has fallen from 46.4% of GDP in 2000 to 35.6% of GDP in 2009. Domestic consumption in China, much like Singapore, has a very bullish long term outlook and recent developments are further enhancing those prospects.

 

 

MACRO: CHINA: SETTING UP TO OUTPERFORM - chart6

 

 

Those prospects are exactly the reason the international community is pouring capital into the country. Foreign Direct Investment in China just hit its second-highest reading on record in June. Investment sequentially accelerated to 39.6% Y/Y in June to $12.5 billion, the Ministry of Commerce said in Beijing yesterday – the most since December 2007. For the first six months of the year, Foreign Direct Investment rose 19.6% Y/Y to $51.4 billion, after a 14.3% Y/Y increase in the first five months. Foreign Direct Investment in China has shifted on the margin towards investing in China’s growing urbanization. Tesco, the U.K’s biggest retailer, said in April it will spend 2.5 billion pounds ($3.7 billion) over five years to open shopping malls and hypermarkets in China. For China this is a step in the right direction vs. last year when nearly 52 percent of foreign investment went to manufacturing and another 19 percent to real estate (National Bureau of Statistics). Furthermore, China could see even higher foreign investment if it opened up more industries, including telecommunications, transport, and resources to overseas companies. Any policy shifts in that direction will only accelerate the amount of capital flowing into the economy.
 
Rising incomes and the likely urbanization of hundreds of millions of people has also attracted private equity funds flows into the economy. At only 40%, China’s urbanization has a great deal of headway to grow, which is one of the reasons China attracted $10.5 billion (275% Y/Y) of private-equity capital in the first half of this year, accounting for 68 percent of the $15.4 billion raised in Asia in the period (Centre for Asia Private Equity Research). Following in the footsteps of Blackstone Group LP and Carlyle Group, KKR is seeking to raise $800 million to invest in China.
 
All told, China’s organic growth story will matter more when consensus finally comprehends the downside risk associated with the U.S.’s 12-18 month forward economic outlook. As easy money brought on by REFLATION, accelerating trade, and industrial production slows globally, organic growth stories will move to the forefront of investment opportunities. Governments worldwide will have to think twice about levering up and implementing further stimulus, so those economies that have proactively prepared themselves to grow organically will see their equity markets and currencies strengthen in 2H10 and 2011, and beyond.
 
Darius Dale
Analyst


MACRO: SHORTING MEXICO . . . AYE CARUMBA!

This insight was originally published on July 15, 2010 for subscribers. RISK MANAGER SUBSCRIBERS have access to SELECT MACRO content in real-time.

 

 

 

________________________________

Oh, down in Mexico
I never really been so I don't really know
Oh, Mexico
I guess I'll have to go
 - James Taylor
 
Conclusion:  We are short Mexico via the etf EWW due to its exposure to sequentially slowing growth in the U.S., drug wars that are accelerating, and declining oil revenue.

On July 6th we initiated our short position in Mexican equities.  Currently, we are down -1.8% on the position.  As Risk Managers, we aren’t happy being down on any position, even if just a couple of percent.  Call us lucky, or call us Risk Managers , but we have fortuitously only used one allocation for this position, so we still have the opportunity to average down up to three total allocations.
 
The short thesis for Mexico is threefold: oil, drug wars, and U.S. exposure.
 
Oil:

  • The oil industry in Mexico is nationalized via PEMEX, the Mexican oil conglomerate.  In 2004, Mexico was producing 3.5 million barrels per day and that number is expected to be 2.5 million barrels in 2010, or a 29% decline over six years.  The bulk of this decline has come from the Cantarell field, which has declined ~70% from its peak production in 2004 (2.1MM barrels per day).  In the most recently reported quarter ending March 2010, oil production by Pemex was flat y-o-y, but the long term trend of declining volumes remains intact.
  • PEMEX funds an estimated ~35% of the federal budget of Mexico, so as the production of oil declines over time, the federal government will be required to find other sources to fund its budget, or will be required to cut government spending.  In terms of general economic growth, the declining aspect of this national funding mechanism will be a sustained headwind well into the future. The chart below of Mexican oil production on a daily basis shows this clear trend of declining production.

 

MACRO: SHORTING MEXICO . . . AYE CARUMBA! - chart1

 

 

Drug Wars:

  • In 2009, there were more than 6,500 fatalities attributed to Mexican drug wars.  To put this in perspective, in the totality of the Iraq War, over an almost six year period, less than 4,500 U.S. troops were killed.  Based on year to date results in the Mexican drug war, the number of fatalities is expected to exceed 10,000 in 2010.  Currently, the Mexican government has over 45,000 troops directly focused on the drug war.  As the drug war continues to accelerate, alongside the headlines of murders, it will have a direct and significant impact on one Mexican industry: tourism.
  • Tourism is one of the most important industries to the Mexican economy.  Globally, Mexico ranks tenth in tourism with more than 23 million tourist visitors every year.  In 2008, U.S. dollar spending by tourists was north of $13 billion.  In aggregate, tourism contributes roughly 13% of Mexico’s GDP.  Clearly as drug war violence accelerates, as it is, it will have a negative future impact on the tourism industry, a key driver of the Mexican economy.

 

Trade with the United States:

  • Given the massive shared border and the nature of the North American Free Trade Act, Mexico is inextricably tied the economic fortunes of its largest trading partner, the United States.  Mexico is the United States’ third largest supplier of goods at ~$177 billion in 2009, which is more than 15% of Mexican GDP.  The United States is Mexico’s single largest export market.  Therefore, as the United States slows, so too will Mexico.
  • In an attached chart we’ve outlined GDP growth in Mexico versus the United States.  The data for the past few years show us, not surprisingly, that there is a high correlation of growth rates between the two countries.  Additionally, the last down turn indicated that the Mexican economy has a tendency to overreact to the downside versus the United States.  Specifically, in 2009 Mexico experienced negative growth of -7.9% and -10% in Q1 and Q2 of 2009, which lagged the troughs in U.S. GDP growth of -5.4% in Q4 2008 and -6.4% in Q1 2009 by one quarter.


Given these systemic risks to Mexican GDP growth, we continue to like Mexico on the short side and will average in as prices permit.

 

 

MACRO: SHORTING MEXICO . . . AYE CARUMBA! - chart2

 


Daryl G. Jones
Managing Director


The Week Ahead

The Economic Data calendar for the week of the 16th of August through the 20th 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


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.33%
  • SHORT SIGNALS 78.51%
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