EARLY LOOK: Capital Chases Yield

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

 

 

 

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“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 sales@hedgeye.com <mailto:sales@hedgeye.com> 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


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