This note was originally published at 8am this morning, August 26, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK in real-time, published by 8am every trading day.
“Those who stand for nothing fall for anything.”
Keith is out this morning teaching a Risk Management class to MBA students at New York University’s Stern School, so I’ve been handed the quill on the Early Look. I was fortunate to enjoy a week off last week, which afforded me some time to clear my head and do a little pleasure reading. The first book I knocked off the list was Ron Chernow 856 page tomb, “Alexander Hamilton: A Biography”.
The story of Alexander Hamilton’s, or Hammy as his close friends affectionately called him, rapid rise from a dysfunctional family in the West Indies to becoming a confidant of General Washington during the Revolutionary War, to publishing the Federalist Papers, to finally becoming the first Secretary of the Treasury, is as rapid an ascension to influence that will likely ever be recorded in the annals of American history.
Hammy certainly had his faults, as we all do, but he was a learning machine that devoured books. He also had a strong sense for right and wrong. That is, he knew what he stood for. In fact, he was so convicted in some of his beliefs that he ultimately died prematurely in a dual defending his honor against Aaron Burr.
Anyone that reads the missives coming out of the Hedgeye Research Juggernaut certainly understands very quickly that we know where we stand on our processes and our investment positions. The goal in the investment business, though, is to be right, not obstinate. The equivalent in our business of losing a dual is bad performance and client loss, so having conviction is fine if you are alive to trade another day.
While we have strong opinions, we aren't wedded to them and I think our track record speaks for itself on this intellectual flexibility. Since inception we've recommended 978 stock and ETF positions, 499 longs and 479 shorts, and have been right 85.6% on the longs and 83.9% on the shorts. But, I digress. Back to Hammy.
As Secretary of Treasury, Alexander Hamilton’s first objective was to pay back the heavy debt incurred to win the Revolutionary War. As Hammy said, “The debt of the United States . . . was the price of liberty.” So, while this debt had its purpose, Hamilton also quickly realized that paying the debt back was critical in establishing confidence among other nations in the economic future of the United States. This confidence would lead to support of the new American currency and a willingness of other nations to become trading partners.
We have been quite vociferous as to our thoughts on some important metrics relating to the national debt of a nation, specifically debt as percentage of GDP and deficit as a percentage of GDP. Another metric we would like to introduce today is debt as percentage of revenue. On a go-forward basis we will call this the National Coverage Ratio. That is, what is the ability, based on revenues generated, of a nation to both pay down its debt and cover its interest and principal payments, or cover these financial commitments.
In the chart below, we've highlighted the National Coverage Ratio for some relevant global economies. While the United States screens negatively on the other debt ratios, especially on a projected basis, on this ratio it is actually an extreme outlier to the negative. This tells a few things about the economic future of the United States from a policy perspective. First, given current debt balances and revenue projections of the United States, it will be very difficult for the nation to support higher interest rates. Second, and while we don't necessarily support this from an economic growth perspective, it seems likely that government revenues, i.e. taxes, will have to go higher. Neither of these points are very encouraging.
There is of course another option, an aggressive cut in future entitlements. This is perhaps what former Senator Alan Simpson, who is the co-chair of President Obama's Bi-partisan Debt Commission, meant when he described Social Security as a "milk cow with 310 million tits!" in an email. Indeed.
As it relates to the shorter term though, over the past couple of days we have been covering our shorts and adding long exposure to the Hedgeye Virtual Portfolio. This is not because we have become overly bullish on equities, but rather the market has sold off dramatically over the past seven weeks and our key economic catalyst is now behind us, which was the abysmal housing numbers of the past couple days.
While we aren't wedded to our bearish views, both the fundamentals and quantitative set up continue to support this stance. So, perhaps the best way to think of it is that we've gone from being Growling Loud Equity Bears to Cuddly Bears. As a result, we currently have 14 longs and 8 shorts in the virtual portfolio, which is great positioning for a Cuddly Bear.
If you are looking for an equity Bull to support your investment positioning through year end, look no further than Lazlo Birinyi. This morning he is out with the call that the S&P500 will rally 16% into year-end to the level of 1,225. Interestingly, that is below his March target of 1,325. Since this morning we are being Cuddly Bears, we aren't going to challenge Lazlo to a Hamiltonian Macro Economic Dual. Albeit we do question any process that produces a round target for an equity index through an arbitrary time frame, but perhaps that is just us.
As we look forward though, we are not sure how cuddly we will remain. The combination of initial jobless claims this morning at 830 a.m., Chairman Bernanke speaking at Jackson Hole tomorrow, and the second release of GDP for Q2 tomorrow will all combine to set the stage heading into September. While we are not convinced these events will have a negative impact on the market in the short term, they will provide incremental data to inform our view through year-end.
And who knows, if the data is bad enough, perhaps we will drop our SP500 target by EXACTLY 100 points, just like Lazlo. That is unlikely, however, given our macro models don't have a factor which incorporates licking your finger and holding it up to see which way the wind is blowing.
In the chart of the day, we have inserted a cute picture that shows President Obama inadvertently giving Treasury Secretary Timmy Geithner the middle finger. This is not what President Obama really thinks of Timmy, but the President would probably like to Channel Hammy.
Yours in risk management,
Daryl G. Jones