Keith McCullough's  Instablog

“Always bear in mind that your own resolution to succeed is more important than any one thing.”
-Abraham Lincoln
 
As Tiger Woods walked down the 18th fairway at the Bridgestone Invitational yesterday afternoon, Americans saw a man with undeniable leverage to his own resolution to succeed – that’s the kind of leverage you want to be long in this market.
 
In addressing his missing the cut at the British Open, he stated plainly: “I don't think as bad as everyone thought it would have been. You've just got to not have those bad stretches, just clean it up a little bit.”
 
Rather than take my financial advice, I suggest you start off this week and the end of the Q2 earnings season with Tiger’s. “Just clean it up a little bit” – take all of your portfolio mistakes and look at them for what they are. Housing has bottomed; unemployment has peaked; and no matter where you go this morning, there you are.
 
On July the 6th, when I posted our Macro Chart of The Week (posted every week to Research Edge Macro subscribers) and titled it, “Unemployment's Double Top”, I knew almost immediately how right I was going to be on calling a top in the unemployment picture. Why? That’s easy  - no one, other than the math, agreed.
 
When no one agrees with you in this business, that usually implies some level of career risk. Luckily, I don’t work for anyone else anymore – and I can say what I think, whenever I want. This has proven to be a major competitive advantage in a Washington/Wall Street environment that is dominated by a generationally high level of groupthink.
 
Now that the market has absolutely smoked the Depressionistas last hope for immediate term raging double digit unemployment and savings rates. What are the top 3 groupthink “ideas” I see in the market this morning?
 
1.      China is a bubble

2.      Inflation isn’t going to be a problem

3.      The market is going up on low volume

 
Our take?
 
1.      China: We have been China bulls since December of 2008, and in our recently published “China Black Book” Andrew Barber outlined the probability of an initial -7% correction from the overbought highs. Last night, the Shanghai Composite closed down for the 4th consecutive day, taking the 4-day cumulative correction to -6.5%. We remain bullish on China, but at a price. This is not the time to call bubble, yet…

2.      Inflation: In the immediate term, I agree. The USA will report another deflationary CPI # for July on Friday and will print another deflationary # for August (because, at +5.3%, the August of 2008 y/y compare was the highest report of the last cycle). In the intermediate term, America is going to see a major sequential ramp in reported inflation come Q4. Just in time for political football season as Bernanke plays defense for his year end job security.

3.      Volume: While that may have been true 1 month ago, we have seen a major sequential ramp in both daily and weekly volume studies. In May-June, the market was going up on low volume; now the up days are on accelerating volume. Looking at this past Friday versus the Friday of 7/31/09, I had volume up +28%. Not a bad day for the bulls! The chase is on…

 
I’ll let the bubble watchers deal with their rear-view strategies of suggesting China could drop another -7% tomorrow. In the meantime, I think you buy China on down days and sell it on up ones from here. I’m going to start focusing my attention more acutely to groupthink item #2 – the forward looking call on Q4 inflation.
 
For our subscribers, our Macro team will be hosting our monthly strategy call this Wednesday. I’ll be giving an update on all three of our Q3 Macro Themes (Range Rover, Burning The Buck, and Reflation Rotation), and our Asia and Commodities strategists (Barber and Jones) will be diving into the drivers of the price of oil from here (if you’d like information on that call, please email macro@researchedgellc.com <mailto:macro@researchedgellc.com> ). We remain bearish on the US Dollar; bullish on commodities; and bullish on Big Alberta’s (DJ’s nickname) oil.
 
When I was wrong on the high end of my Range Rover target, I changed my daily risk management strategy, immediately. With the exception of last week, where the US Dollar finally registered its first up week in the last five, the Buck has been Burning. Being wrong on the high side of my SP500 Q3 target was largely due to being right on the US government compromising the integrity of her currency at a more expeditious rate than even I thought possible.
 
From the MEGA Squeeze, to Housing’s Bottom, to Unemployment’s Double Top – those matches have been played. Next on this professional tour is Reflation’s Q4 Rotation. We’re looking forward to seeing competing opinions on the course. Bring your weather gear. When it’s raining out, we Macro guys believe you can get wet.
 
My immediate term TRADE target of resistance for the SP500 is 1,017, and I have downside support at 994. Buy low. Sell high.

“Everything comes to him who hustles while he waits.”
-Thomas Edison
 
While it makes perfect sense for market operators to take some time off in the summer, Mr. Macro Market waits for no one. Yesterday, I wrote that I was going to wait and watch for the US Dollar’s reaction to this US unemployment report – that doesn’t mean I stop hustling.
 
For me at least, this is not unlike preparing for a hockey game. The discipline and repeatability of my preparation process is critical. If I sleep in or let someone in my inbox distract me, I will undoubtedly miss something. You have to eliminate all the noise – stay focused.
 
What’s most interesting to me this morning is the Russian stock market getting hammered (down over -3%) after their central bank CUT interest rates. Not only is it interesting from a causal perspective, but it correlates with the reaction we saw in Indonesia on Wednesday (they cut rates to 6.25%, and stocks on the Jakarta Composite Index suffered a -1.8% down day). This is new.
 
What’s new? The marked-to-market reaction to central bankers pandering to the political pressures to cut interest rates is much different than what we saw 9 months ago. At that time, I called it “going Greenspan” – which simply meant that Asian and European central bankers simply followed the strategy that the US Financial System’s “maestro” taught them. Everyone cut rates.
 
Since then (in a testimony to Congress in October 2008), Greenspan himself has gone on the record saying that there “was a flaw in the model that I perceived as the critical functioning structure that defines how the world works.” Doh! Now what?
 
Now what we have are a lot of politically compromised (and very inexperienced) international equity market policy makers being directed by a failed strategy of perceived wisdom. That’s not good – and Mr. Macro Market is going to fix it.
 
As opposed to some of those Blackstone “marks” on their private equity book that Steve Schwarzman marked-to-model (UP!) in his Q2 earnings report, Mr. Macro Market operates on a real-time, marked-to-market, basis. No, this isn’t new. This has been happening for hundreds of years. The only thing that is new is that the American Financial system has allowed the “how much money do you make” mantra to eclipse the laws of bid-asked gravity.
 
Gravity is what you are seeing Mr. Macro Market show you in these countries that continue to cut interest rates ahead of a significant acceleration in reported inflation here in the USA in Q4. This is one of our three core investment Macro Themes for Q3 – we have labeled it “Reflation’s Rotation.”
 
Cramer is too busy getting bulled up on Citigroup to poach that one liner from me this morning, so let me explain what it means before his hounds make a US currency style debauchery out of it. Reflation Rotation means that instead of reflating prices (Q2-Q3 of 2009) from year-over-year DEFLATION price levels, REFLATION will morph into reported INFLATION in Q4. That’s it. It’s that simple.
 
Does Mr. Macro Market see this coming? You tell me – here are his marked-to-market signals this morning:
 
1.      Chinese demand is running in the high single digits now year-over-year now to the point where their government admits the need to tighten “appropriately”

2.      Inclusive of the corrections they’ve seen in the last 3-days, stocks on the Shanghai and Hang Seng are still up a by a moon-shot in 2009

3.      The US Dollar continues to make a series of lower-highs and lower-lows (imports inflation to America by Q4)

4.      The CRB Commodities Index continues to make a series of higher-lows and higher-highs (that’s why the American commoner is bitter)

5.      Dr. Copper, one of inflation’s best prognosticators, is trading at $2.71/lb this morning – that’s will be +94% over Q4 of 2008 prices (no more deflation in Q4)

6.      Oil prices continues to test YTD highs, and will be trading 2x where they were in Q4 of 2008 (no more deflation in Q4)

7.      The US Treasury yield curve is trading within 15 basis points of its all-time steepest this morning at +255bps wide (10’s to 2’s)

8.      3-month LIBOR (as in the rate that $375 Trillion of the world’s debt is based off of) is hitting new YTD lows this morning at 0.46%

9.      The US Financials sector ETF (XLF) is up over +125% since March 5th of this year (classic reflation rotating into inflation)

 
The Bank of England opted for the political compromise yesterday, keeping Quantitative Easing in place. The pound immediately got pounded on that news, and this morning you are seeing the FTSE in London trade down a full -1%. If there is one country that has been willing to sacrifice her currency’s credibility for political job security other than the USA, it’s the UK. The Dow and the FTSE are two of the worst performing markets in global equities YTD for good reason.
 
The New Reality is this: if you maintain an un-objective monetary policy into Q4, Mr. Macro Market is going to sniff you and your lack of domestic rates of return right out of your hole.  As for the right here and now, well… I’ll deal with how the US unemployment report affects the US Dollar in 2 hours. In the meantime, I’ll hustle while I wait.
 
My immediate term upside TRADE target for the SP500 is now 1,012, and I have downside support at 991. A breakdown through 991 puts 969 in play.

“I hear and I forget. I see and I remember. I do and I understand.”
-Confucius
 
Managing risk up here on the high-wire of a global US Dollar Devaluation move is what it is – a daily and athletic exercise of doing. I hear the American commoner’s disgust. I see the bankers getting paid. I trade around everything I see and hear, as I try to understand.
 
Trying to make sense of an interconnected global macro system of colliding dynamic factors isn’t for everyone. Neither is trading. Or at least doing macro and managing risk weren’t given parts of the investment process in years prior to 2008. That’s when a long/short stock picking hedge fund monkey like me could make money in a market that went straight up alongside access to capital. That’s changed.
 
Every day we wake up to slug it out with a global macro consensus. Sometimes consensus isn’t bullish enough. Sometimes it’s so nauseating that you can only fade it. Sometimes it isn’t bearish enough. Consensus is the backbone of the market’s being. Embrace it, daily, and you begin to understand.
 
My daily risk management process includes the measurement of ranges, deltas, and spreads. If there is something we can attempt to quantify on those 3 scores, we do.
 
One of the weekly sentiment indicators that was shining bright red on my screens yesterday was the Institutional Investor sentiment survey. The spread in that survey was one of the most bullish we have measured in well over a year. The spread between Bulls to Bears widened to +21 points (for the Bulls).
 
The most interesting part of the math was how bombed out the Bears were. Less than 4 months ago almost 50% of the respondents in that II survey were outright bearish (at the bottom). In this week’s report, only 26% of investors admitted they are bearish anymore (at the top).
 
My understanding here is quite simple – and it’s no longer that investors aren’t bullish enough – investors aren’t allowed to be bearish! When your director of research or master of the hedge fund universe PM rains down on you every morning for missing the latest daily market move, you end up in a box. You end up with embedded rules that govern your analytical output – it’s called career risk management. Sometimes you just aren’t allowed to be bullish or bearish. That’s obviously a problem.
 
So with the Chinese and US stock markets pinned up here at YTD highs and people not being allowed to be bearish anymore, what do you do? I think the best option is to wait and watch. All the while, keep measuring your ranges, deltas, and spreads. Patience provides opportunity.
 
I know, for Mr. Qualitative Research Superstar… this part of the investment process probably makes you laugh. Trust me, there are a lot of people out there just like you. I used to be one of them. Evolving your investment process should be a perpetual exercise in doing.
 
So let me take you through some of my basic training global macro calisthenics this morning and flash you some US market factors:
 
1.      I have the SP500’s daily range of price probability at 43 points = tight and trade-able (bullish)

2.      I have immediate term TRADE support/resistance for the SP500 at 989-1,010 = risk barely outrunning the reward (bearish)

3.      I have the daily spread for the VIX at 3.15 points = volatility remains broken across durations (bullish)

4.      I have the daily delta for NYSE volume expanding = 1st day in the last 14 where that came on a market down day (bearish)

5.      I have the daily spread of the US market’s breadth deteriorating = one day does not a TREND make (bearish)

6.      I have 9 out of 9 SP500 sectors in my quantitative model signaling positive TRADE and TREND = (bullish)

 
Now let’s flip over to a cross section of asset class and geographical considerations:
 
1.      China closed down another -2.1% overnight, taking its 2-day decline from the YTD high (+92%) to -3.3%

2.      Australia shot up another +1.4%, 2-days AFTER signaling that their next move in interest rates is UP

3.      Germany is up +0.4% again this morning and continues to lead mature western European economies despite a 1.44 Euro

4.      Turkey, a beacon for emerging market growth, is flashing a big daily negative divergence this morning, trading down -2.5%

5.      The US Dollar made a new low yesterday trading below 77.50 on the US Index

6.      The CRB Commodities Index made a new YTD high yesterday, trading up to 268

 
So where does this all wash out? You tell me. We all have different investment styles. We all have different durations. I don’t wake up in the morning trying to be everyone’s banker or politician. I don’t wake-up trying to be bullish or bearish. I wake-up trying my best to do, and to understand.

"Not everything that is faced can be changed. But nothing can be changed until it is faced."
~ James Baldwin
 
Although the title of this note implies I may be teeing myself up for another rant about monkeys clanging for bananas, I’ll spare you my attempt at a zookeeper’s humor. I’m going to shift the Washington/Wall Street global macro debate this morning to a much more sophisticated place – a children’s television series.
 
Our subscribers in the UK will need no introduction here, but The Clangers are an iconic musical band of British characters who originated from the series of “Noggin” books. Yes, to all you Mom’s and Dad’s out there – you know Noggin! – it’s the network of Dora The World Peace Explorer and Sheila Bair’s best buds, Go Go Goldman Geithner.
 
Although the US government refuses to face the fiddle on this, the Buck continues to Burn. The US Dollar Index is trading down for the 5th consecutive week, hitting new year-to-date lows yet again this morning. Meanwhile, the Three Willfully Blind mice (Bernanke, Summers, Geithner) say nothing about the common man’s currency.
 
According to Wikipedia, “The Clangers looked similar to mice, anteaters and, from their pink colour, pigs. They wore clothes reminiscent of Roman armour and spoke in whistles”…  Cash for the Compromised and Conflicted Clangers who are debasing our Currency - ah the alliteration…
 
My submission is that our children will look back on this period in American history for what it is – amazing and ridiculous, all at the same time. We wake up to a Treasury Secretary clanging the alarm bells that Sheila Bair needs to fall in line and let the Federal Reserve oversee this entire gong show. We wake up to Larry Summers not saying a word about the currency his economic team is at least supposed to attempt to support. We need to wake up this morning and seriously smell the coffee here.
 
Get your local 200-day Moving Monkey to pull up a 38-year chart of the US Dollar (1971 is when Nixon abandoned the gold standard, officially making the US Dollar the world’s currency reserve whereby bankers have had the almighty powers to create limitless leverage). That clanging monkey will quickly come to realize that there is no support for the US Dollar other than the only reference point that remains – the 38-year LOW that we established last year BEFORE the US stock market crashed.
 
The Clangers would rather spend their time talking about another $2B in socialized aid for clunkers this morning than address this point. At the same time you have Wall Street analysts waiving off one of the bastions of what was once American corporate credibility (General Electric) having to pay $50M for fudging their numbers as a “small sum for GE.” Non-fictional stories do have inconvenient truths…
 
Think about that thing the Rolling Stone dude said was wrapped around the face of humanity for a second and think some more. The Clangers are running around this country accusing the Chinese of “manipulating” their numbers as they continue to crush whatever credibility we have left. Again, history has a hard core way of writing herself long after the impacts of these political decisions have been made. For everything that happens to this country between now and that, the best investment advice I can give you is this – pray.
 
Hope and prayer are a cornerstone of many people’s lives, but hope is not an investment process. If The Clangers think for one more second that the American public is stupid, this is only going to get ugly. This morning’s weekly read on US Consumer confidence (the ABC/Washington Post weekly poll) quantifies this point. As the US stock market makes daily and weekly highs, Obama’s approval ratings and the American consumer confidence that backs it continue to threaten to make new lows.
 
Politicians, Bankers, and Debtors are all under the same short term gun here – if the Clangers don’t Burn The Buck, not one of these three core constituencies gets paid. As those recipients of a crashing currency frolic in their “Roman armours and speak in whistles”, there are two big losers here: America’s Creditor (China) and her Common Man.
 
Part of yesterday’s intraday stock market recovery was based on the US Savings rate dropping from a 14-year high of 6.2% to 4.6%. This launched a squid onto the face of the super duper smart short seller of everything American consumer. Trust me, I shorted the US Consumer Discretionary ETF (XLY) a few days ago – I get the pain trade.
 
America’s New Reality remains: if the Clangers are going to give away cash and keep interest rates at this fictional storytelling level of ZERO, guess what? People won’t save!
 
If you always keep in mind who gets paid, your macro conclusions will be far less trivial than Go Go Geithner and Burning Buck Bernanke’s current Depression paralysis. The Bank of England’s chief, Mervyn King, is signaling to the global macro crowd that he is done with Quantitative Easing. This comes on the heels of the world’s most competent central banker, Glenn Stevens at the Reserve Bank of Australia, signaling that his next move is to take interest rates up.
 
This Noggin Horse has left the barn folks. Reflation’s Rotation is in motion. Come Q4, reported inflation will be upon us here in the USA, as will Ben Bernanke chasing his own Clanger tail right up the slope of the yield curve that continues up into the right.
 
My immediate term TRADE target for the SP500 is 1,006 and my downside support moves to a higher-high at 986.

If you’re gonna set somebody up, it’s gotta be a surprise, you got that?

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An appeaser is one who feeds a crocodile, hoping it will eat him last.

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