Why Investment Community Needs to Evolve

Includes: UDN, UUP, XLP, XLY
by: Keith McCullough

“No one can possibly achieve any real and lasting success, or get rich in business, by being a conformist.”
-J. Paul Getty

On the margin, I thought the unemployment report for May was bearish and the one just reported for June bullish. Bearish and bullish for the US Dollar that is.

Fully accepting that the aforementioned statement is a long way from consensus, I am cool with that – it was when I called the May report US Dollar bearish. I have a quote taped on the inside of my notebook from the Science and Technology section of The Economist dated February 7th, 2009 that says “what seems to be going on is that everyone instinctively feels compelled to copy the others, rather than making an independent assessment of the situation.” The article was about evolution.

Are we, as an investment community here in the United States of America, taking this Crisis in US Financial Credibility as an opportunity to evolve? Or are we doubling down on the groupthink that got us in this mess?

Consider the following Bloomberg headline this morning (#2 in terms of stories read as of 530AM EST) “Stocks, Oil, Metals Drop on Economy Concern; Yen, Dollar Gain.” Does that even make any sense? If you believe that global currency markets are lagging indicators, maybe… but the entire notion that long term interest rates (10 year US Treasury yields) and the US Dollar strengthening off its lows in the last 3-days is a lagging indicator doesn’t make any sense to me. Currency markets are leading indicators.

With the SP500 having corrected -5.3% from her YTD high of 946, if you are still in the Depressionista camp and you are following the perpetually negative stance of Alan Abelson, you might even believe that unemployment is NOT a lagging indicator. While I still can’t believe he wrote that, he probably can’t believe that Chinese stocks hit another YTD high last night either.

Perpetually polarized in your political or investment view is not an evolutionary process. Objective minds get that. When Abelson called the “second derivative” thesis “hypothetical, but bullish” this weekend, what he was implying, I guess, is that calculus is some form of alchemy.

The New Reality is this: the US investment community’s consensus drum beaters need to evolve or the USA is going to continue to get run-over by the Chinese at +71.6% YTD. The ways of investing along the lines of the perceived wisdom of Wall Street’s crowd have rendered a YTD return for the Dow Jones Industrial Index of -5.7%.

Yes, the Dow is an old school index that the math guys rarely use anymore (30 components are less statistically relevant than 500 – fascinating conclusion), but next to London’s FTSE index, which has lost -5.6% YTD (as of this morning’s down -1.2% open), that’s about as bad as major country indices get.

Now back to last Thursday’s unemployment report. In terms of our intermediate term TREND cycle work, our investment process cares about one line item in that report – the unemployment rate.

At 9.5% year-over-year unemployment, the month of June was only a +10 basis point rise versus that of May (9.4%). This stands in stark contrast to the +50 basis point rip we say in May versus April (8.9%) and this, Mr. Hypothetical, is what we call a sequential deceleration in the rate of growth.

So what did I do with this? After the May report (first week of June), I started selling down gross long exposure to US Equities and shorting US Consumer stocks. I currently hold a 9% position in the Asset Allocation Model to US Equities, and I’m short both Consumer Discretionary (NYSEARCA:XLY) and Consumer Staples (NYSEARCA:XLP).

Now what do I do? With the topping process of a lagging economic indicator in the rear-view, I will be covering my shorts in US Consumer stocks, and taking up my gross long exposure to US Equities. Being short anything on a perpetual basis is no risk management process of mine.

I know, I know… this probably doesn’t rhyme with what you’re seeing on CNBC this morning. It definitely doesn’t jive with a front cover article on Barron’s called “Short These Stocks.” But you know what? I really couldn’t care less. If all I did was follow these thundering herds, I might be agreeing with Merrill (or is it Banker of America?) this morning and getting bullish on my Chinese growth estimates AFTER the Shanghai Composite Index has moved +80% to the upside.

Let’s not get our shorts in a knot this morning. The New Reality is that the crash and bubble watchers are consensus, and we men and women of the risk management gridiron see a fairly straightforward immediate term trading setup that’s both proactively predictable and manageable.

Looking back at another peak in sequential US unemployment gains (May) provides the US Dollar an immediate term bid. Dollar up = everything else down. That’s what I saw on Friday. What I see now, at a price, is an opportunity to start getting invested again. Buy low, sell high.

I have intermediate term TREND line support for the SP500 down at 871 and long term TAIL resistance for the US Dollar Index up at $82.32. Understanding that US stocks have an inverse correlation to US currency has been the 2009 strategy, and until that math breaks down there’s no reason to dance to the consensus beat of Mr. Hypothetical’s alchemy.