Manage Responsibly

“International cooperation and coordination have been robust, and we appreciate the responsible role China has played during the turmoil”
-Hank Paulson

Hank “The Market Tank” rolled into China last night and gave the aforementioned and overdue praise to the Chinese government for proactively preparing for this global economic tsunami. China acted “responsibly” while Hank behaved reactively. For a compromised Bush Administration, this is both an about-face and a confirmation that the end of American dominance as the world’s economic superpower is here.

When I took an oversized long position in US Equities in mid November, one of my main macro catalysts was Hank Paulson being replaced. That, not bailing out the Pandit “Bandit” at Citigroup, was the biggest contributor to the five day +19% short squeeze rally in the SP500. It was a vote of confidence in team Obama, Summers, Volcker. Now, unfortunately, that catalyst is in the rear view mirror, and all squeeze rallies have less oomph, as a result.

After dropping -8.9% on the first day of December trading, the US market has rallied 6.6% in two days, lifting the hearts and minds of the perpetually bullish. Currently, I have been getting a lot of questions as to why I have a zero position in US equities. One of the obvious answers lied in the math. We booked our gain on the long side of the SPY before Monday’s swan dive, and actually shorted it, making money on both sides. If you simply owned the SP500 for the last 3 days, you lost money. Math, like Paulson’s idea of leadership, does have its inconvenient truths.

We live in an increasingly interconnected global marketplace, where multi-factor asset allocation and risk management models are winning. There was a day, not so long ago, when your average underage and underperforming “hedgie” would tell you, “I don’t do macro… I’m a stock picker.” That was all good and fine, until stocks stopped going up every day. While it’s easier now for everyone to differentiate winners from losers in this game of global risk management, I still think it’s very difficult for investors to find a sell side process that they can use, daily, to augment their own investment process. That’s why I started Research Edge.

Research Edge is a proactive global research and risk management process. We work as a team rather than in silos. We have our feet on the floor earlier than most, and we have our “Eyes On” most things, real time, that we can quantify for you. This isn’t a sales pitch. This is all part of a critical investment theme for 2009 – we call it “The New Reality.”

The New Reality means that you can have a zero position in US Equities, and have an 18% allocation to International Equities. The New Reality means that you can be in cash and that you don’t “have to buy” anything. The New Reality is that country level exchange traded funds provide you the opportunity to be long a dynamic economy like China, AFTER you’ve waited for the “70% OFF” sale. The New Reality is that the self directed investor who has the cash now has the leverage, not the master of the ‘Investment Banking Inc.’ “prop desk” who was having fun being overpaid to lever up your money.

The New Reality is that I am waking up to China closing up another +1.8% this morning. Why be long anything in the USA since the 1st week of November with the SP500 down -14% and the Shanghai Stock Exchange up +17%? Why not think about shorting stocks and markets, like the US, high… and covering them low? I, for one, am a Canadian who has had the lifetime opportunity to live, work, and to be a part of this wonderful melting pot of cultures that the world has come to admire as the United States of America.

While the “Fast Money” CNBC crew tells you what to do, after the market closes. Allow me to submit a proactive process rather than that reactive one. If you don’t want to wake up at 4AM (you shouldn’t), let my family and team do it for you. We may not be right all of the time, but we are more right, more frequently, across global markets and asset classes than most.

This morning, if you asked our soon to be ex-Treasury Secretary what he would do after a 2-day stock market move of +6.6%, what do you think he’d say? I have no idea. If they have anyone left over there, he might call up the Goldman “prop” desk and “get a look.” You can decide for yourself whether that “look” is a proactively prepared one or not. Thankfully, we wake up every day in The New Reality to new rules of Transparency and Accountability. These levered up investment vehicles now have to show you what they own and mark it to market. The score won’t lie to you; people will.

My “Early Look” this morning is this: Globally, overnight rate cutting is as broad based and reactive as any morning I have woken up to in 2008. On top of the expected panic button 100 basis point rate cut in London by the BOE, we have other former European proactive central bankers freaking out. Sweden’s Riksbank cut by 175 basis points! In Asia, countries who haven’t cut in well over a year did so in unison (Indonesia, Thailand), and central bankers in New Zealand smoked those who aspire to earn a return on cash savings by cutting rates by another 150 basis points.

The market reaction, globally, is not what these central bankers are hoping for. Hope is not a process, neither is reactive management. Despite the two day run in the US market, most of this is based on hope. I see 2% upside and -13% downside from here. I have a zero allocation position (net short actually) to US Equities. I have a 6% position allocated to China. I am part of “The New Reality.”

Pretend you are Chinese this morning, smile, and say goodbye to Hank, and all those who failed to manage your money “responsibly”. Upward and onward into 2009 we go.

Manage responsibly out there today,

Long ETFs

GLD -SPDR Gold Shares –LME Gold spot prices declined by as much as 0.8% in trading today, reaching $778.07 per ounce.

OIL iPath ETN Crude Oil –Light Sweet Crude futures fell as low as $45.30 this morning, testing the lowest level since early 2005, with EIA crude stock levels showing a declining of almost 500k barrels last week.

EWG – iShares Germany  -- The DAX Index rose 1.6 % to 4,638.43 in trading today.  Verband der Chemischen Industrie, a trade association that includes BASF (EWG: 4.6%) and Bayer (EWG: 6.0%) guided down for production and sales by the chemical sector as a whole for 2009.

EWH – iShares Hong Kong – The Hang Seng dropped 0.6 % to close at 13,509.78.

FXI –iShares China – Baosteel -China’s largest steelmaker, commented on “drastic shrinkage” of sales to Automotive sector in H2.

 Short ETFs

IFN iShares India –
Yields on India’s benchmark 10-year government bonds have dropped 30 basis points to 6.79% after India’s inflation rate unexpectedly fell to a seven-month low. The benchmark Sensitive Index rose 2.7% to 8987.47. Wholesale prices rose 8.40% in the week to Nov. 22 from a year earlier.

EWU – iShares United Kingdom – The pound fell versus the dollar to an all-time 6-year low. Home value declined 2.6% from October. Prices fell 16.1% from a year earlier.

UUP – U.S. Dollar Index –The Euro declined to $1.26 USD and 117.05 yen on speculation the ECB will cut interest rates by half a percentage point today from 3.25%.

EWJ – iShares Japan –The Nikkei 225 closed down 1% to 7,924 today. Japanese stocks fell partially because of speculation that US carmakers will enter bankruptcy.

FXY – CurrencyShares Japanese Yen Trust – The yen declined to 92.73 USD in trading this morning.


PNK has doubled since bottoming at $2.82 on November 20th, yet the stock is still down 76% on the year. There have been rumors circulating regarding a PENN takeout of PNK. I don’t have insider information so I can’t speak to the immediate validity of that hearsay. However, I think I made a pretty compelling argument that such a combination should and could happen. See my 11/11/08 post, “LIKE PEANUT BUTTER AND CHOCOLATE”. That view hasn’t changed.

After such a big move in the stock, I consulted our technical and quant expert Keith McCullough for his thoughts. The stock still appears undervalued and there would be significant upside in a takeout scenario. For those of you who need a little more here are Keith’s thoughts:

Looks better and better every week, usually flashing positive performance divergences, correcting on lower volume days … the patient is out of emergency.

Immediate term “Trade” is to 6.57. “Trend” line support is starting to build, but really takes off on a close above 7.26.

Short interest is your friend (21% of float) and so are the insiders who are net buyers all of a sudden. Shareholder list was a big negative factor (too concentrated), and deleveraging by the weaker hands in October simply took it to $3 with more sellers than buyers. Combining the latest quarter’s positive surprise (liquidity) getting mutual fund yr end out of the way are calendar catalysts that play to the bull side.

Political Brouhaha in Canada

Although we haven’t bought the Canadian stock market yet, from a purely capitalistic perspective, we have had a more positive view on Canada recently based on the political shift to the right of center driven by current Prime Minister Stephen Harper. As we have previously noted, Harper solidified his minority government just seven weeks ago. We took this as a sign that Canadians, on the margin, were more predisposed to the conservative economic policies espoused by Harper and his Conservative Party.

Unfortunately, in the last couple of days, the political outlook in Canada has clouded over dramatically. Late yesterday, Reuters called recent events “one of the worst political crises in the country’s (Canada) 141-year history.” As a Canadian, it is an assessment I have a hard time denying.

A coalition has formed between the Liberal Party, the National Democratic Party (the NDPs), and the Parti Quebecois. In combination, the coalition has 163 seats (Liberals 77, NDP 37, and Bloc Quebecois 49) versus 143 seats for the Conservatives. On December 1st, the three opposition leaders signed an accord in which they agreed to form a coalition to pursue a non-confidence vote in Parliament. Under the accord, the Liberal leader will become Prime Minister and the cabinet will be split between the Liberals (75%) and the NDP (25%). Collectively, the three parties have agreed to vote together for the next 18 months on all matters of confidence.

As a result, Prime Minister Harper faces a non-confidence vote on December 8th. Given that the coalition has 163 seats, he will almost certainly lose the confidence vote and have to resign and/or call a new election. In order for the new election to proceed, the Governor General has to approve the plan for a new election. Harper’s only option to circumvent the non-confidence vote, and either a new election or handing the government over to this Liberal led coalition, is to get the Governor General Michaelle Jean, a Liberal appointee, to end the current session of parliament, which would then reconvene in January.

The coalition is taking advantage of the current economic turmoil to gain power under the guise that the Conservatives do not have an economic plan. Ironically, the coalition has not put together a new economic plan of substance, nor do they have a history of working effectively together. In fact, in the most recent election the Liberals and NDP were much at odds over economic policy. The largest disagreement was over $50 billion in corporate tax reductions that the Liberals supported and that the NDP wanted to invest into social programs.

As David Frum wrote on December 1st in the National Post, Canada’s major newspaper:
“Imagine Canada 6 months on. There’s a Liberal prime minister. He will head an unstable coalition of Liberals and socialists aligned with separatists. To appease the socialists, he will have to raise taxes. To appease the separatists, he will have to direct disproportionate money and attention to the province of Quebec.”

Frum’s point is adroit. A Canada in six months from now, under this leadership team, could well be an unmitigated economic disaster. We can debate whether Prime Minister Harper has the qualifications and wherewithal to develop an economic plan that will soften the current economic crisis, but undoubtedly a coalition led by the Liberals and backed by a self proclaimed socialist and a leader of a party whose primary goal is the separation of Quebec, leaves much to be desired.

Keith and I, reluctantly, may have to short the homeland in the coming weeks.

Daryl Jones
Managing Director

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Dear Speaker Pelosi,

Tuesday, December 2nd, 2008
Somewhere in America

Dear Speaker Pelosi:

We saw you this afternoon announcing that the auto makers have come and gone, and at least two of them left behind large missives explaining why they are entitled to $25 billion of our money. We might underscore that this is our “hard-earned” money, as opposed to the money with which the automotive industry appears to have been awash over the years. Granted, on Wall Street we get astronomically overpaid for even mediocre performance (kind of like the senior management of our nation’s automotive industry, come to think of it…) but even this Vatican of capitalist greed has not come up with an idea to rival the two-headed labor/management monster that is the Jobs Bank.

We have heard the tenor of what the Motown crowd’s arguments are likely to be. As our dear departed Dad used to say: “You can’t kid a kidder.”

Once upon a time, we started our own company. People liked us. They not only liked us, they also trusted us, and they thought we were smart. This is what we call a win-win-win combination. Yet, every potential investor we approached asked the same question – and they asked it right at the beginning of the conversation: How much of your own money are you putting up? The argument we made – having learned it in our days as stockbrokers – was: you are only risking capital. We are risking our reputation! Surprisingly, it failed to gain traction.

The offer of the Motown Mousketeers to forego compensation for the forward year is laughable. After taking home tens of millions of dollars apiece in all the previous years – years during which both management and labor were doggedly not addressing the death rattles of the American automotive industry – the CEOs now offer to take “only” $1 in compensation.

Since the twenty-five billion dollars at stake is our money, we believe we should be heard in the negotiations. Here is our counter-proposal:

We have no illusions that we will personally benefit from any future profit the Government may win out of buying warrants on the US automotive industry. We pay our taxes every year and, though we think we have better uses for the cash, we smile as we write out the checks on April 14th and we thank God that we live in America today, and that we make so much money that we have to pay this much in taxes. It is a great feeling, even though we know that your colleagues, Madam Speaker, will waste ninety cents on the dollar on evil, pernicious programs like Fannie and Freddie.

Now to Detroit: These faltering giants have come to us like a stockbroker trying to talk his way out of a losing streak. “We’ll sell something! And we’ll buy something else! We’ll average down! We’ll take our losses! And we’ll…” As Shakespeare has it in Cymbeline; “I’ll… do something!” Never mind.

Here’s the deal, Motown: The CEOs and senior management of the auto makers, and of the UAW, sign full-recourse notes for their entire net worth. And no sneaky hiding assets in your spouses’ names, because they have to sign too. In addition, each executive – and all members of the boards of directors – must put their entire compensation, in cash, for all the prior three years into the Government bailout fund, to establish an equity pool as a guaranty against the $25 billion. They may have to sell stock at depressed prices, or mortgage their homes to do so, but that is not our problem. You want our money, here are our terms.

This program will extend to the UAW. The Jobs Bank gets cancelled today, and all Jobs Bank-related monies paid out over the last three years gets, likewise, turned into cash and deposited in the guaranty pool. As an added incentive – since you believe the industry will turn the corner – any industry executive or employee, any union member, can buy into this equity pool. The pool will be open for ninety days, while the Government starts feeding the cash into the coffers of the auto makers. For those of you who have trouble imagining the unimaginable, by the way, the amount of money we are being asked for looks like this:


We think that’s a lot of zeroes. We believe that everything to the right of that first comma represents our ultimate return on investment. But we admit to knowing nothing about the automotive industry, except that there are 2.2 cars for every household in America. Still, perhaps there is hidden demand. To us, it looks very well hidden indeed.

Here’s an idea we like – now that we are your partners, to the tune of 25 large: the automotive industry gets paid to retrofit all the cars now on the road to improve mileage and reduce emissions. If we got a tax break, for example, we would be motivated to spend two thousand dollars on fixing up the old jalopy – especially if the alternative was being required o buy a new $35,000 electric car in 2012 to meet the Obama Administration’s new Personal Carbon Footprint standards.

We should be willing to help out an industry that lies at the heart of what makes us America. And we should do so in a manner that incentivizes them to re-invent themselves in a way that contributes to society. If they succeed, we will be better off as a country, and as consumers, and they will be rewarded financially when they repay the $25 billion loan, plus interest, and divvy up the remaining profits.

If they fail, Mulally and Wagoner and Nardelli and Gettlefinger – and their families – lose their shirts, homes, cars, private school, limos, Detroit Lions season tickets, 401(K)s, IRAs, jewelry, golf club memberships, Detroit Tigers season tickets, golf clubs, summer homes, executive suites, corporate expense accounts, and those suddenly-notorious corporate jets. This is not harsh, vindictive or unreasonable. It’s called Capitalism, and it’s extremely fair all around.

Madame Speaker, we believe fervently in the creative power of Capitalism. You have our permission to use our money to promote Capitalism in the country that values it most. But, Madame Speaker, please spend our cash wisely. We beg of you, do not sell the patrimony of American Capitalism for a mess of pottage.

Very truly yours,

A. Taxpayer

Moshe Silver
Director Of Compliance

111 Whitney Avenue
New Haven, CT 06

XLF vs. SPX: When Financials close the gap, Short them...

This chart speaks for itself. During the 5 day +19% US market squeeze, US Financials had a +35% move. Selling the XLF when this relative performance gap closes is the money making move.

Goldman Sachs: Charting Global Credibility Risk

This is a fascinating chart that finally captures what I have been stressing for the last few weeks – the US no longer has a liquidity crisis. It has a US Financial System credibility crisis. The Chinese called America out onto the mat on this score today. They were right to do so.

Since the beginning of November, GS has lost over a 1/3 of its already drepressed value. When people talk about the Great Depression, I think they are talking about having their compensation tied to this Titanic’s sinking chart.

More interestingly, since CEO Lloyd Blankfein was ‘You Tubed’ (November 11, 2008), look at what the stock has done on a relative basis to 3mth LIBOR.

Question: Since LIBOR is a reference rate for “counterparty risk”, and it’s been relatively stable since November 11th, after coming in meanginfully from it’s October highs, what does the GS chart’s volatility really tell us?

Answer: stating that leverage has no correlation with returns lack credibility.


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