This note was originally published
at 8am this morning, October 14, 2010.
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“As long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
-Charles O. Prince (Citigroup CEO) July 10th, 2007
If Chuck were in the game today he would be dancing as the S&P finished higher for the fourth straight day while the already-elevated quantitative easing expectations continue to weigh on the dollar (down 1% this morning and -8.5% in 3Q10) and put a bid under the riskiest assets. It’s just a matter of time before the music stops playing and the consequences of a debased currency are brought to bear on this economy.
If you listen to our morning call, just about once a week Keith says “hope is not an investment process.” Typically, this phrase is used in response to hopeful rhetoric surrounding the markets. More and more people seem to disagree with Keith, turning to hope for more QE, more time, more bonuses… Hope is becoming part of some people’s process.
While I try to leave hope out of it, and remain as objective as possible, it is difficult to suppress the hope I have that the market does not step on one of the many landmines that are scattered from New York to Beijing and back again.
One major landmine in DC is the lack of competence of the Federal Reserve Board and the Administration. Hopefully Ben Bernanke knows what he is doing, but he is clearly not abiding by the dual mandate of the FED: full employment and price stability. The unlimited supply of money created by the Fiat Fools can dwarf the limited supply of some commodities. Thus, the FED policies are inciting increased speculative risk, thereby creating a commodity bubble. This is what we are seeing occur real time:
(1) Gold trading at a record high for the second straight day
(2) Tin trading at a record high
(3) Cotton at a record high
(4) Copper at a 27-month high
(5) Rubber at a 27-month high
(6) Soybean, Corn and Wheat all approaching 2008 record highs
Inflation is becoming a problem across the globe, as the Serbian central bank is telling us this morning. With India, Australia and Canada having raised rates this year, some voices in China are also calling for a move in rates to address inflation in their economy. As one of our clients across the pond pointed out, what if the US and China struck a deal - the Chinese will let the YUAN appreciate in exchange for less QE? That would certainly put a pin prick in the commodity bubble and the reflation trade!
With the market trading at 12x NTM EPS, hopefully we can keep dancing and get it to 13x. That would be another 5% from here – easy money which would be handy going into the holidays. Wall Street and Main Street are not two streets on the same block anymore; they are on different planets. A cursory glance at the headlines will spell out the increasing gulf between the Haves and the Have Nots in this High-Low Society. Hoping to be eligible for the food stamps program is very different than hoping for a record bonus.
It is my view that a decoupling from reality has occurred in many areas of the American economy over the past twenty years. Salaries paid to twenty-something’s to carve up mortgages and sell them were completely unrelated to the actual utility these workers were adding to the economy. At some point, such disconnects are forced to come back to reality.
The “exorbitant privilege” the United States holds as the world reserve currency holder is clearly being challenged by China, Russia, Germany and most importantly, by the markets. While it is ingrained in many people’s minds to take for granted that the dollar will always be king, I would much rather be cognizant of two facts. Firstly, it has not always been the world reserve currency. Secondly, economically buoyant rivals across the globe are calling for a new system. Far from playing a hand in bringing us back to reality – the government is doing everything it can to keep the music going in the markets, only further irritating our Client and Chief Creditor and other trade partners. If that sounds like a bad movie to anyone, you’re not alone.
The financial crisis has played out like a bad movie in many respects and nothing ruins a movie like cheesy quotes. While this morning’s Early Look quote is about as cheesy as cheesy gets, Chuck certainly contributed his part to the Crisis in Leadership that persists today. Our process at Hedgeye is not to listen to the self-proclaimed leaders, but rather, focus on what real-time market prices are telling us. The bull-bear battlefield is becoming a minefield and lines are being drawn around the data points below.
LANDMINES THE BULLS ARE HOPING TO DODGE:
1) Stimulus tailwinds are now becoming headwinds
2) Consumer deleveraging - a household sector that is fearful of taking on debt
3) Declining home prices and the foreclosure fiasco (which got worse last night)
4) Bankrupt states and dry pension funds - ongoing spending cutbacks at the state and local government levels; these are structural issues that the Fed is not equipped to deal with
5) Currency wars
6) Sovereign debt crisis
7) Slowing earnings growth
8) Commodity and Energy inflation
9) No job growth and the employment-to-population ratio of 58.5% that remains stuck near 30-year lows. Over 40% of the unemployed have been so for over six months; 30% for at least a year
10) Health care reform that has frozen small business hiring
11) Cash hoarding by banks and corporations alike because of the lingering uncertainty over the economic outlook
12) Consumer confidence vs. Y/Y PCE growth spread is unsustainable
13) The yield curve is compressing
THE NEXT SMASH HITS TO KEEP THE MUSIC PLAYING:
1) The Republicans take over Washington - gridlock prevails
2) Quantitative easing will be “better than expected.” Ben does know what he is doing!
3) Uncle Sam has plenty of crutches to keep propping up consumer spending
4) Corporate America will print good earnings numbers
5) M&A cycle reaching pre-crisis level
6) Corporations are sitting on a $1.6 trillion stash of cash on their balance sheets
7) There is $2.6 trillion of cash sitting in money market mutual funds
8) Oh yeah; Dubai is “back”
Risk management is not about going with the crowd. One thing we are accountable to here at Hedgeye is our process. Doing something (dancing or making an investment decision) because everyone else is doing it is not our approach. Bad music is as bad music does and we will continue to ignore the dancers until the DJ puts on our song.
Yesterday, Keith shorted the S&P 500 via the SPY. As he said yesterday “We watched. We waited. We are now shorting the SP500.”
As the classic Don McLean song goes:
A long, long time ago...
I can still remember
How that music used to make me smile.
And I knew if I had my chance
That I could make those people dance
And, maybe, they’d be happy for a while.
You know the words!
Function in disaster; finish in style