EARLY LOOK: Red Letter Day

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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“You can sneer or disappear behind a veneer of self-control.”
-Pet Shop Boys

 

 

EARLY LOOK: Red Letter Day - Red Letter Day

 

 
We have our British electronic dance music playing this morning in New Haven as the bulls are forced to sneer at the tail that’s been wagging this US growth dog since US Housing saw its cycle peak in April. As one of our three Hedgeye Macro Themes for Q3, we’ve called this Housing Headwinds.
 
The aforementioned quote comes from the Pet Shop Boys 1996 top ten hit, “A Red Letter Day.” What an appropriate quote and song name for a day like today where expectations for a bomb of an Existing US Home Sales report are finally being baked into this bear’s cake.
 
This day in 410 (AD) was also a Red Letter Day for the Roman Republic. Historians refer to this day as “The Sack of Rome” when the enemy (the Visigoths) took over the city for the first time in 800 years. This was a bad day for the professional politicians of Rome.
 
The US stock market has had a bad day for the last 3 days in a row. While our 2011 estimate for US GDP growth is still approximately half of the Bloomberg consensus, the Street is finally taking down its expectations for Q3 and Q4 of 2010. In recent weeks we’ve seen both Goldman Sachs and JP Morgan cut their estimates. There will be more of that to come.
 
Combined, with the prospective outlook for US unemployment, housing, and GDP growth finally getting a reality check, it will be interesting to wait and watch today as the SP500 finally takes a good hard look at our immediate term TRADE line of 1059 support.
 
Last week we penned this Red Letter Day on the calendar with both The Catalyst and The Line. While we do not think that the Fiat Republic will fall today, we do think that members of the risk management community will most certainly get paid on the short side.
 
To be crystal clear on this, today is not the day to be shorting stocks. Today is a day to book your gains and increase both your gross and net exposure. If you don’t run an asset management firm and you’ve gone self-directed, in Hedgeye Risk Management speak that means today is a day to invest some of the 61% we have allocated to Cash in the Hedgeye Asset Allocation model.
 
In terms of asset allocation, there’s an emerging and healthy debate about what percentage of your assets you should have in US “bonds versus equities.” This, of course, is born out of the last bubble that remains in global markets today – that which the Fiat Republic perpetuates by marking short term Fed Funds rates to model rather than letting the world mark them to market.
 
There will undoubtedly be a Red Letter Day for US Treasury bonds, we just don’t know when that will be yet. However, what we are comfortable saying right here and now is that it’s relatively safe to start shorting short term US Treasuries. The long end of the US Treasury market is not where we’d be focusing short positions. The 10-year yield could easily drop another 40-45 basis points from here and retest its prior lows.
 
On the short end of the curve, this morning you are seeing record lows in 2-year UST yields. At 0.46%, this may not be the lowest level of confidence global investors have had in US growth in 800 years, but the lowest US Treasury yields ever is still, by our calculations, a very long time.
 
So why is this so? Isn’t this ok? Yesterday while I was debating him on this topic on Bloomberg TV, Dean Baker of the Center for Economic Policy Research said it’s perfectly fine for America to keep on borrowing. He went on to say that “the bond market doesn’t have a problem with it.”
 
Admittedly, I think I was too surprised to absorb his summary conclusion on the spot. But after a good night’s sleep and some googling this morning, I am reminded of the partisan nature of Mr. Baker’s view point. After all, he does work at the center of modern day Rome in Washington, DC.
 
Rather than have barbarians hold professional politicians in the Roman Republic accountable, modern day risk managers have YouTube. For more Dean Baker and Paul Krugman thoughts on why we need to jack up government spending by another $800 BILLION dollars, please peruse the web.
 
Back to the question of whether you should buy US Treasury Bonds or US Equities - I don’t think you need to accept the preface of the question. Why not Brazilian or Chinese or Peruvian Equities? Why US Treasury Bonds? Why not cash?
 
Since 1997 when Paul Krugman told the Japanese to “PRINT LOTS OF MONEY”, you can pull up a chart of Japanese Government Bonds versus Japanese Equities and you’ll start to answer some of these questions on “bonds versus equities.” Foreign direct investment has been leaving Japan altogether for a very long time and Japanese bureaucrats are still trying to do more of what hasn’t worked.
 
On this Red Letter Day of August 24th, 2010, Japan will sell another 1.1 TRILLION Yen (that’s a lot of yens) in 20-year debt in order to attempt to boost expectations for another broken promise of “stimulus spending” still being the answer to their structural economic growth mess.
 
After losing another -1.3% overnight, Japanese equities have crashed, again, losing -21% of their already “cheap versus bonds” valuation since April the 5th.  Japan’s bond market “may not see a problem with monster debt levels” yet Mr. Baker, but her stock market sure does!
 
Best of luck out there today,
KM


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