Tuesday, October 5, 2010

Morning Note...

Futures are ~75bps higher this morning as the USD trades ~65bps lower against a basket of global currencies.  In appears that the reflation trade – at least in part – is back again:  USD up, stocks down…USD down, stocks up.   At the same time, two-year Treasury yields continue to make record lows as bonds are bid higher.  The ten-year yield remains just under 2.5%.  Oil is up 1% and Gold is up 1.2% to set another non-inflation-adjusted (i.e. 1973) high.  Overseas, Moody’s is considering another downgrade of Ireland’s debt.  In Asia, China remains closed for holidays but the Bank of Japan unveiled a $418 billion easing program and cut rates to near zero.  Australia’s RBA surprisingly left rates unchanged when a rate hike was expected.  Further, both South Korea and Brazil announced plans to cap their surging currencies.  On the aggregate, one would think that the global currency “weakening” announced all over the world would actually rally the USD, but in fact the USD’s downward trend ahead of looming QE2 seems quite secure.  Someone on TV said the phrase “global currency war,” which certainly feels appropriate today.  Is everyone simply rushing to devalue their currencies in a mad dash to ensure the attractiveness of its exports?  In the end, isn’t this a bit of a zero-sum game?  Looking ahead, YUM reports after the bell today.  COST, MON, STZ, MAR, and FDO report tomorrow.  PEP, AA, and MU report Thursday and we’ll also get September retail sales data that day.   Friday is the big September payroll number.  Also note that the IMF/World Bank meets October 8-10 in Washington, DC.  ISM Non-manufacturing data due at 10am today.  Article in the Financial Times this morning discusses Obama’s failure to repeal the Bush tax cuts.  (For more tax talk, see quote section below.) 

Regarding global monetary policy, here’s this morning’s Hedgeye note:


"Great spirits have always encountered violent opposition from mediocre minds."
-Albert Einstein

I am currently in the middle of reading Walter Isaacson's "Einstein: His Life and Universe." For a young chaos theorist fighting the winds of Washington and Wall Street Groupthink, Einstein's independence of thought is highly motivating.

Chaos and Complexity Theory are the most important mathematical discoveries since Einstein's General Theory of Relativity. While we don't give out our mathematical models here in New Haven, we distribute both their factors (inputs) and themes (outputs).

Like any other dynamic ecosystem in this universe, global markets are constantly changing. As a result, analyzing time, space, and gravity are seemingly rational places to start each and every risk management morning. Trivial points in time like a price-to-earnings ratio are what they are - of very little value to our research.

At 2PM EST today we're going to introduce the 3 global macro risk management themes that we think will matter most to global investors in the 4th quarter of 2010 (if you are a qualified investor and would like to sign up for the call, please email sales@hedgeye.com).

For Q4 2010 our Hedgeye Macro Themes are as follows:

1.  Japan's Jugular - The Keynesian experiment that is Japan will continue to implode in Q4. The Yen, JGBs, and Nikkei all remain at risk.
2.  Krugman's Kryptonite - As the Fed signals its intent to use more Krugman Kryptonite (printing dollars/ quantitative easing) we look at both the short and long term implications behind the faulty math of Dr. Krugman.
3.  Consumption Cannonball - U.S. consumption will roll over sequentially in Q4 based on our bottom-up consumption model. This is a negative catalyst for our below consensus Q4 GDP domestic growth projections.

In sharp contrast to other "top-down" or "global macro" oriented sell-side research that calls everything "long-term", we focus acutely on time (duration) and space (price). It's all good and fine to come up with a "long-term" investment thesis (been there, tried that), but if you get time and price wrong, you're best advised to get a job in academia.

I don't disrespect academia. I just don't want my firm, family, or country's risk management system overseen by academics. Einstein himself would be the first to call out the long-term career risk associated with academic dogma. As markets evolve, we need to evolve the risk management process alongside them.

Living in the violent opposition of mediocre industry standards is one of the tremendous investment opportunities in global finance today. Schumpeter called this creative destruction. God bless the learning opportunities that are born out of the failures of Fiat Fools.

Unfortunately, Washington and Wall Street Groupthink doesn't get this yet. Neither do the Japanese Bureaucrats who continue to believe that the best way to solve for structurally impaired economic growth is to throw more failed government policy action at the problem.

We'll go through the why on this with a 68 slide presentation this afternoon, but the bottom line is that what you are seeing from Japan this morning is ultimately an admission that QE (Quantitative Easing) didn't work.

In fact, after cutting interest rates from ZERO POINT ONE percent (0.10) to ZERO POINT ZERO percent (0.00), the most recent edition of a Japanese Heli-Ben (BOJ Governor Shirakawa) dropped the QE acronym altogether for a new one - CME (Comprehensive Monetary Easing).

The best part about CME versus the QE that is sponsored by "New Keynesian Economics" academic dogma (Bernanke, Krugman, Stiglitz, etc.), is that I can actually understand what CME means. It's very "comprehensive" to see that the Japanese can't cut interest rates (until they raise them) again.

I'm certain Einstein would be a fan of CME. When failed ideologies like QE meet their maker of gravitational force, the next best step for a failed academic is to stop what they are doing. Then either retire, or change as the facts have. After all, it was Keynes himself that would be asking "New Keynesians", what do you do now Sirs?

My immediate term support and resistance lines for the SP500 are now 1126 and 1144, respectively.

Best of luck out there today,

GYMB higher on news it has retained GS in a bid to go private.  JEFF ups SWIR, WAG.  TLB -10% on lowered forward guidance.  WFR sells power plant to First Reserve.  BofAMLCO ups SPWRA.  BCAP ups CIG.  DBAB ups PCG.  GSCO ups AMG, ETH, TX, CNS.  UBSS ups EGP.  BofAMLCO cuts CVA.  BCAP cuts CL, KSP.  CSFB cuts RYL.  DBAB cuts BTU.  GSCO cuts BKS, BLK, EDU, HD, PZN.  OPCO cuts CXDC.  BARD cuts ICLR.  NY Times cautious on MON. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 
Today’s Trivia:  Male students at BYU need a doctor’s note to do…what?

Yesterday’s Question: Name the only river that flows both north and south of the equator (i.e. it crosses the equator twice)?

Yesterday's Answer:  The Congo is the only river that flows both north and south of the equator.

Best Quotes:

The Bill Gates Income Tax

If Washington's most famous billionaires are really worried about their state's finances, they'd write personal checks to the government and leave everyone else alone.


Framed on a wall in my office is a personal letter to me from Bill Gates the elder. "I am a fan of progressive taxation," he wrote. "I would say our country has prospered from using such a system—even at 70% rates to say nothing of 90%."
It's one thing to believe in bad policy. It's quite another to push it on others. But Mr. Gates Sr.—an accomplished lawyer, now retired—and his illustrious son are now trying to have their way with the people of the state of Washington.
Mr. Gates Sr. has personally contributed $500,000 to promote a statewide proposition on Washington's November ballot that would impose a brand new 5% tax on individuals earning over $200,000 per year and couples earning over $400,000 per year. An additional 4% surcharge would be levied on individuals and couples earning more than $500,000 and $1 million, respectively.
Along with creating a new income tax on high-income earners, Initiative 1098 would also reduce property, business and occupation taxes. But raising the income tax is the real issue. Doing so would put the state's economy at risk.
To imagine what such a large soak-the-rich income tax would do to Washington, we need only examine how states with the highest income-tax rates perform relative to their zero-income tax counterparts. Comparing the nine states with the highest tax rates on earned income to the nine states with no income tax shows how high tax rates weaken economic performance.
In the past decade, the nine states with the highest personal income tax rates have seen gross state product increase by 59.8%, personal income grow by 51%, and population increase by 6.1%. The nine states with no personal income tax have seen gross state product increase by 86.3%, personal income grow by 64.1%, and population increase by 15.5%.
It's striking how the high-tax states have underperformed relative to those with no income tax. Especially noteworthy is how well Washington has performed compared to states with no income tax.
If Washington passes Initiative 1098, it will go from being one of the fastest-growing states in the country to one of the slowest-growing. And passage of I-1098 will only be the beginning. Just look at Ohio, Michigan and California to see that once a state adopts an income tax, there is no end to the number of reasons that such a tax could be extended, expanded and increased.
Over the past 50 years, 11 states have introduced state income taxes exactly as Messrs. Gates and their allies are proposing—and the consequences have been devastating.

The 11 states where income taxes were adopted over the past 50 years are: Connecticut (1991), New Jersey (1976), Ohio (1971), Rhode Island (1971), Pennsylvania (1971), Maine (1969), Illinois (1969), Nebraska (1967), Michigan (1967), Indiana (1963) and West Virginia (1961).

Each and every state that introduced an income tax saw its share of total U.S. output decline. Some of the states, like Michigan, Pennsylvania and Ohio, have become fiscal basket cases. As the nearby chart shows, even West Virginia, which was poor to begin with, got relatively poorer after adopting a state income tax.
Washington's I-1098 proposes a state income tax with a maximum rate higher than any of those initially adopted by the other 11 states. In one fell swoop, Washington would move from being one of the lowest-tax states in the nation to being one of the top nine highest. It's economic suicide.
The states that have high income tax rates or have adopted a state income tax over the past 50 years haven't even gotten the money they hoped for. They haven't avoided budget crises, nor have they provided better lives for the poor. The ongoing financial travails of California, New Jersey, Ohio, Michigan and New York are cases in point.
Over the past decade, the nine states with the highest tax rates have experienced tax revenue growth of 74%—a full 22% less than the states with no income tax. Washington state has done better than the average of the nine no-tax states. Why on earth would it want to introduce a state income tax when it means less money for state coffers?
What's true for those states with the highest tax rates is doubly true for the 11 states that have instituted state income taxes over the past half-century. They too have lost huge sums of tax revenue.
A final thought for those who want to punish the rich for their success: As the nearby chart shows, those states with the highest tax rates, and those states that have introduced state income taxes, have seen standards of living (personal income per capita) substantially underperform compared to their no-tax counterparts.
If Mr. Gates Sr. and his son feel so strongly about taxing the rich, they should simply give the state a chunk of their own money and be done with it. Leave the rest of Washington's taxpayers alone.
Mr. Laffer is the chairman of Laffer Associates and co-author of "Return to Prosperity: How America Can Regain Its Economic Superpower Status" (Threshold, 2010).