The two things most “talking heads” have been chirping about recently is oil going to $100 per barrel and the U.S. dollar going lower. The pile-on effect of the ubiquity of these opinions left “long” oil / “short” the dollar very crowded trades. Therefore, in Thursday’s strategy comments we recommended that traders take the other side of these trades on a short-term basis.
Indeed, into last weekend’s G-7 meeting we suggested the subsequent rhetoric would likely be an attempt to talk-up the battered buck. If that happens, overbought crude oil should weaken.
Our vehicles of choice were to go long the PowerShares DB US Dollar Bullish Fund (NYSEARCA:UUP), as well as “longing” the Claymore MACROshares Oil Down Tradeable Shares (DCR). “If,” we said, “These trades are not working by Monday afternoon, or Tuesday at the latest, participants should exit them hopefully with small losses. Almost immediately our phones “lit up” with folks exclaiming that DCR was trading at a substantial premium and that we would be better off longing the ProShares Ultra Short Oil & Gas (NYSEARCA:DUG). While that’s probably true, we don’t really care which vehicles are used. It is the idea of being long the dollar and short crude oil that we think is important.
To be sure, Wall Street spends inordinate amounts of money in an attempt to find the coal stock that is going to outperform all of the other coal stocks. However, the REAL insight was knowing you needed to own some coal stocks four years ago. Clearly there are coal stocks that have outperformed ours, yet we are pretty happy with the ones we have embraced over the past four years. So, we’ll say it again, “It is the idea of being long the dollar and short crude oil that we think is important” . . . at least on a short-term trading basis.
As for the equity markets, last week was pretty brutal with all the major indices we follow suffering substantial losses. We have been warning of such an environment, having discussed the mounting upside non-confirmations in various indexes, and cautionary “finger to wallet” indicators, since mid-September. Still, even though we were prepared for a decline, our portfolios got “nicked” last week.
Typically, following a session like Friday, one would expect a down Monday morning opening, followed by a rally attempt that fails to gain much traction, leading to a downside wash-out (and trading bottom) into Tuesday’s session. Whether that pattern plays this time only time will tell, but we remain cautious. Our worries center not so much on the burgeoning sub-prime contagion and attendant seizure of the asset-backed commercial paper [ASCP] markets, but rather the over-spent, under-saved U.S. consumer and the possibility that we are at a peak in the credit cycle.
Over the past few months credit card debt has risen noticeably. Ladies and gentlemen, when you have borrowed all the money you can against your first house, second house, 401(k), etc., the lender of last resort becomes, by default, credit cards. The inference is that U.S. consumers may be tapping their last source of cash. Unsurprisingly, the U.S. economy, which is two-thirds driven by the consumer, has become dependent on ever increasing credit expansion. In fact, according to certain savvy seers, beginning somewhere in the early 1990s consumers’ “new debt” exceeded operating cash flow (read: income) as the source of new cash. That ratio has increased whereby last year it is estimated that households depended on “new debt” for nearly 90% of new cash flow. If correct, this begs the question is the real economy sated with debt? Clearly that’s an intriguing question, for it implies that the Federal Reserve could just be “pushing on a string” in that no matter what the interest rate, the consumer doesn’t want any more debt. To a debt-driven economy the result would be obvious.
Consistent with these thoughts, we continue to underweight most sectors/stocks that are consumer-centric. Rather, we continue to like themes that should “play” irrespective of if the collateral crunch morphs into an honest to gosh credit crunch, which then has the potential of spilling over into a recession. In addition to themes like rebuilding this country’s aged electric complex and water infrastructure, we have invested in the defense and security arena for more than five years. And, investor appetite in the security arena continues to build as investors look to position portfolios in front of the 2008 elections, as business models in the sector mature, and as the cycle of security spending gradually gathers momentum.
However, volatility remains a constant with the group. Companies supplying products to support the war have fared the best, followed by those with upcoming product or program cycles. Interestingly, in light of Friday’s crashett (-367 DJIA points), a pattern has emerged where stock sell-offs are sharp on disappointing news but the ground is quickly retraced. Therefore, we see “buying dips” as a key strategy to outperform the sector and the overall market.
Spending on products suited for deployed troops in harm’s way remained the most dominant spending driver for the group. Companies such as FLIR Systems (NASDAQ:FLIR) and Aerovironment (NASDAQ:AVAV) continued to see strong order flow, deliver strong results, and have exceptionally optimistic outlooks for 2008. FLIR will almost certainly exceed consensus estimates next year and has positive announcements pending, while AeroVironment has the potential to do the same. Consequently, situations like these should be on your “watch list” for potential purchase should Friday’s decline extend into a more serious correction.