Archive for the 'Bonds' Category

Welcome to the FOMC Transparency Tour: 1st Stop is the Sausage Factory

Welcome to the FOMC Transparency Tour: 1st Stop is the Sausage Factory

The week at least started well as the upper echelon of fund managers heard from their “well-placed sources” that Helicopter Ben had miscommunicated the FOMC position when he spoke about tapering and would set the record straight at his press conference, imbuing them with the fortitude to get long in front of Wednesday afternoon.   Well, they got half the story right as he did set the record straight.

Taken alone, the FOMC minutes were positive for the market as nothing indicated that policy was going to change course.  The indices acted accordingly, swaying between green and red.  Then we found out that those sources were no more well-placed than a convertible parked beneath a tree with hanging bird feeders.  First, the FOMC projections were released showing that the targeted 6.5% unemployment rate was now forecast to occur in 2014, not 2015, and that GDP growth was accelerating.  Then, just prior to the reporter from TMZ asking Bernanke about his personal plans, his prepared remarks were released. Therein, Helicopter Ben dropped not more cash, but the bomb:

“We also see inflation moving back toward our 2 percent objective over time. If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year; and if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear. In this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7 percent, with solid economic growth supporting further job gains—a substantial improvement from the 8.1 percent unemployment rate that prevailed when the Committee announced this program.”

So here we are: the transparency thing as he explained the Fed’s thought process.  The FOMC will begin to cut back this year and, depending upon the next jobs number, may do so before the third quarter ends.  The point that we reach 6.5% has been moved up but that is no longer the trigger; now it is 7% accompanied by an upward bias in the economy and inflation at 2%.  If only they kept that information to themselves we could have read the minutes and gone on our merry way as the market stabilized and perhaps moved higher.  In the old days, pre-openness, the market took the real hit when the rate increase actually occurred and usually upon the move deep into neutral policy territory.  I liked that more because the economy was then on better footing, earnings growth was apparent and valuation could withstand less accommodative policy.  But this is the worst of all worlds since we likely won’t see much growth in earnings this quarter, Europe is still uncertain and China is on the verge of a credit crisis that will make 2008 look like boom times.

I can’t imagine too many visitors to Jimmy Dean’s factory leave the tour and buy a few links in the souvenir shop, anxious to cook them up when they get back to the trailers.  Seems like traders feel the same way about the Fed post press conference, puking out their stocks and bonds, violating important levels of support.  However, once the vision fades and their stomachs settle, a curing period that will likely take us through earnings and up to the next FOMC meeting, they will recognize a great buying opportunity– at least for stocks.  Bonds, unfortunately, will stay in the grinder. For now, though, the carnage, bred through emotion, is likely done as atrophying now takes over.  Within that time frame there will be peaks and valleys as volatility, courtesy of Fed transparency, becomes the norm.  I’m up for nibbling for the long term but the market hasn’t corrected enough to find many real values.

Advertisements

If Brussel Sprouts Could Do It Why Not Equities

Could brussel sprouts be the new leading indicator for equities?   They have made a helluva comeback, a resurgence and rebranding the likes of which no one has ever seen.  Long gone are the days when entire episodes of sitcoms were devoted to the haters of the innocently hued green vegetable as we witnessed in Leave It To Beaver circa 1960-something.  Put another way, Mel Gibson would have to convert to Hasidism to rival this return to flavor – I mean favor.    BP’s, as those who have been closet lovers of this leafy cabbage affectionately refer to it, are ubiquitous on the menus of the finest restaurants, replacing perennial favorites such as string beans almondine.    Barbecued brussel sprouts, brussel sprout hash, roasted brussel sprouts, Gordon Ramsey and Martha Stewart recipes – all trumpet their chicness.  But what does this have to do with equities?  The point is simple: the hate for brussel sprouts was much more deep seated than it ever was for equities.  To wit: do you recall at any point in your adolescence, despising stocks, turning up your nose and running away from the table when your parents mentioned the stock market?  Of course not.  In fact, it was likely that your school had a stock market game or your parents talked about how they bought you 10 shares of DIS when you were born, a subliminal endorsement of the equities markets.

So if the despised and much maligned brussel sprout can make a comeback of heretofore unforeseen proportions, why not equities?  In fact, the comeback has already started.  Lipper reported that in January, equity and mixed equity funds brought in $62 billion, the largest monthly inflows in 6 years.  Money also flowed into bond funds indicating that cash is likely coming out of the mattress and out of negligible yielding bank accounts.  The flows continued into February, although US equity funds took a vacation last week from gathering assets which could be an indication that the market will soon follow (it has).   But before getting too excited, let’s not forget that the indices have doubled since the market bottom despite massive outflows, thus, in the eyes of the bears, limiting the use of inflows as a correlation.  And supporting the bear case is that long/short equity managers reportedly have the highest net exposure since 2008 at 50-60%. Price action shows us where the love has been spread: consumer discretionary reportedly the highest concentration, financials the largest increase and technology the second biggest underweight. When a feeding frenzy occurs, and we’re not quite there yet, asset values increase ergo the 8% run-up prior to this week.  And for all the self-interested bond fund managers who believe we are not in a bubble, I caution them to start cutting back on their overhead or risk equity fund managers putting in a low ball bid in on their Hamptons homes, that is once they soak up the capacity from a shrinking sell-side equity business model.  Not all the bond assets will flow into equities, but more than enough will find their way to drive the indices higher.

Despite having just experienced a two day sell-off, we are perhaps still overbought.  And depending upon how much or if we further correct in front of the March 1st Washington deadline for mandatory cuts, we could actually trade higher into the event.   Investors are unfortunately accustomed to Washington’s ineffectiveness and if you sold in front of the fiscal cliff, you missed a strong rally.  So having stared down the abyss and survived quite nicely, I doubt a return engagement will be more than a nuisance for the market and, in any event, a much needed respite.  The payroll tax impact may prove to be more of an issue but hopefully a strong jobs number on March 8th will be more of an offset.

And then there is the Fed, China and Europe.  The tide seems to be turning in FOMC blather among the new entrants but is this just a case of the young just feeling their oats, only to be slapped down by the reality of a stumbling economy, or a change in true sentiment?  Bonds remain a short.  China has apparently adopted a bipolar monetary policy, easing for a few months then tightening, allowing the mixed with a downward slope but plenty of firepower and, hopefully, a rebuke of Hollande sooner rather than later.

So pick it: do you want to follow the path of brussel sprouts or do you believe equities more closely resemble Mel Gibson?  I prefer to eat healthy rather than imbibe, although I have removed some of the spice by taking down beta.

iPad At The Ready; Is Icahn Greek & Germany’s 4 Day Work Week

Night after night, morning-to-morning, it’s the same routine.  The iPad sits at the ready, less than an arm’s length away on the nightstand, sharing space with an old school Blackberry, an alarm clock separating two generations of technology.  It’s the last thing I look at before I go to sleep and the first item I reach for when I wake.  I’m seeking out news, waiting for the solution.  That’s what I need to get off the sidelines, to put my cash to work. Sure equity valuations are cheap, that is if you believe the global economy is not worsening. Sure Treasuries are overvalued and in a bubble and asset allocation begs for a swap into equities but these factors have been in place for a year.  In the interim, China has markedly slowed and Europe is in an economic near death spiral. Ergo, I need something new: a plan that will work. I am fairly confident that I know what the answers are, I’m just hoping that some variations of it appear in a Reuters or Bloomberg headline:

ECB Lends $2 Trillion to Spain and Italy – Funds Targeted for Banks;

Greece Accepts Receivership: Icahn Reveals That He is Part Greek and Agrees to Head Creditors Committee

I would settle for one out of two, the ECB lending program being my first choice.  The last two days brought scant hope, with Spain’s Budget (a clear oxymoron) Minister asking for other “European Institutions” to “open up and help facilitate” a recapitalization of their banks.   (http://www.bloomberg.com/news/2012-06-05/spanish-minister-urges-eu-aid-for-banks-in-first-plea-for-funds.html).  I guess, a recognition by Spain that they have a problem is the first step toward a solution.  Record outflows of capital and the seizing up of the banking system has a way of offsetting the effects of too many carafes of sangria at three hour lunches more so than afternoon siestas.  However, there is little chance of Germany injecting capital directly into Spanish banks.  And then today, we had the ECB’s Mario Draghi tell us not to worry, capital is not fleeing, hoping to dispel us of the facts.  Nice try, Mario, but this will not help me sleep any better.

Here is how I believe the issue should be resolved in order to restore some semblance of sureness to the market. Actually, this is not really my original thought but rather that of an extremely successful hedge fund manager as we discussed the issues during a game of golf.  However, as a part-time talking head and part-time author, I am in conflict: the former imbues me with little respect for identifying ownership of ideas, claiming all as my own, while the latter avocation imbues me with abhorrence for plagiarism.  Since no one is paying for this advice, I will default to the former and provide what believe would put the market back on firmer footing in response to Europe.  While the ECB is not allowed to buy new issue debt from sovereigns, it can loan money to them.  Spain will ultimately agree to a program and, in return, the ECB will provide a 30 year loan with a nominal coupon to the government, specifically targeted for the banks.  This will not crowd out any other creditors, thus limiting resistance.  As part of this rescue package, and in lieu of using Spiderman towels and English lessons (wouldn’t German be more appropriate?) to lure potential depositors, the banks will offer greater levels of deposit insurance, backstopped by the ECB.   There will be greater, collective EU oversight to large EU banks as a condition to German participation without obligation of further German funding.

Perhaps the above won’t happen so here’s another thought.  It was also reported by Bloomberg that the EU and ECB is at work on a Master Plan (http://www.bloomberg.com/news/2012-06-03/ecb-eu-drawing-up-crisis-master-plan-welt-am-sonntag-says.html) and may have something ready by the end of June.  Well, that would be nice but this would have to be authored and led by someone other than Merkel’s countrymen since Germany’s last Master Plan didn’t work out well for anyone and time has done little to  erase the memory.  The problem is that no other European economy has the economic wherewithal to plug the dyke.  I imagine that Germany does a daily calculation comparing the breakup of the currency and the potential impact on trade with the cost of being the sugar daddy for the rest of the EU, albeit without the typical prurient perks of being so benevolent.  The Germans undoubtedly realize that they would have the world’s strongest currency were the EU to fail, thus crippling their own economy by making the price of their goods uncompetitive.  Here’s a solution: cut off the EU like you would a drug addicted stepchild and allocate those funds to internal spending, thus inflating the D-Mark and maintaining competitiveness in global trade.  Instead of the annual Oktoberfest, have a  Freitagfest and a 4 day workweek, placing them on more even footing with the rest of socialist Europe. That won’t drive the DM to levels on par with the drachma but will get you moving in the right direction.

So as my search for the evidence of a solution forges on, I remain on the sidelines although even the hint of a legit solution (or of an improving US economy) will rally an oversold market.  Oversold rallies, however, such as today’s (June 6), are to be sold, not embraced. Commodities will remain under pressure and steel is still a great place to be short as analysts now begin to look for losses in the upcoming quarter.  Recall that last year, X reported a loss despite a combined 13% volume and price increases.   Their end markets, with a slowing global economy, won’t be so kind this time around.   They didn’t even bother to offer a mid-quarter update at their analyst day today.

One more thing – look for downward revisions to multinationals pick up speed as the dollar retains its strength.

Playing Poker with the EU: Why There Won’t Be A QE 3

Wistful visions of a Bernanke Put have kept many invested. It is everything they want it to be: the lifeline, the safety net, the impetus for economic growth.  However, I believe it is unlikely to happen.  The logic is simple: Europe is much more fiscally troubled than the US and is arguably the source of not only market turmoil but also for economic angst in the US.  Without a shock and awe resolution from the EU, any further easing from the US will be ineffective in reversing our declining economic fortunes so why waste the powder.  And with Europe in much more desperate shape, in recession , broadly, and possibly headed toward a depression in Spain (Greece there already) it is much more incumbent upon the EU to provide a shock and awe solution to their economic woes sooner rather than later.  Additionally, Bernanke has come under significant criticism for his prior QE’s so why not let Europe do the heavy lifting this time around?  The European solution, if credible, will obviate the need for further stimulus from the US.  China keeps threatening to stimulate their economy and should this happen,  this could also lessen the burden on the American economy.   If I were Bernanke, I would play this hand to conclusion.  Not even another deficient jobs number will change my view.  In fact, I believe that the payroll report will come in above consensus based upon what I hear from my source who has been almost clairvoyant in their forecasts based upon real-time information.  They see strength across all sectors.  It won’t be a blow out number but should be comfortably above consensus.  This will lead to a short covering rally and a good opportunity to lower exposure

Separately, a great review for The Big Win http://seekingalpha.com/article/625331-book-review-the-big-win :

Book Review: The Big Win
Just as whale watching is a popular adventure tour for nature lovers, reading about the whales of finance is a popular pastime for investors. InThe Big Win: Learning from the Legends to Become a More Successful Investor (Wiley, 2012) Stephen L. Weiss profiles one woman and seven men who have truly excelled.

First, a caveat about what Weiss describes as “the ugly reality of whale watching,” by which he means “blindly following large, smart buyers into a stock or other investment.” (p. 25)

 

Unless an investor has insight into the whale’s rationale for making a particular investment, his time frame, and his risk appetite, the investor is at a considerable disadvantage. It is critically important, as Weiss writes, to “understand the process. … The true value of these case studies … is in understanding each investor’s methods, not standing in awe of their results.” (pp. 32-33)

 

Weiss’s eight legends—Renée Haugerud, James S. Chanos, Lee Ainslie, Chuck Royce, A. Alfred Taubman, James Beeland Rogers Jr., R. Donahue Peebles, and Martin J. Whitman— each carved out a niche and developed an investing style.

Haugerud, for instance, is a top-down investor. Her hedge fund, Galtere Ltd., has a five-stage investment process: taking the temperature of the global markets, developing a few themes, microanalyzing and selecting strategic investments, timing trades technically, and applying risk management. Her “big win” came in 1993. With gold trading as much as 40% above the world’s highest cost of production and the one-year bonds of Canada’s western provinces yielding 9 to 12%, she shorted gold for a rate of less than 1%, bought the bonds, and hedged her short gold position with undervalued small-cap stocks of mining producers in Australia that had high margins and low production costs. “‘All three legs worked,’ as Haugerud puts it, and all kept working for a good long while. It was a simple trade, and the returns were good enough to carry that year’s performance to her stated goal and beyond.” (p. 50)

Chanos is a short seller, Ainslie a stock picker, Royce a small cap investor. Taubman and Peebles are both real estate developers, Rogers is a commodities investor, and Whitman is best known as a distressed debt investor.

What do all these legends have in common? Weiss catalogs seven traits: no emotion, no ego, long-term investors, discipline, thorough research process, passion and work ethic, and drive. Or, reduced to six words:

 

“Drive. Passion. Process. Equanimity. Discipline. Humility. These are the commonalities between all those profiled in this book and the qualities that make for a great—and legendary—investor.” (p. 17)

 

The Big Win is an easy, thoroughly enjoyable read for those who want to learn from the whales.

The Perfectly Written FOMC Statement For Stock Pickers

The concerns supporting a bear view on U.S. indices issues prior to yesterday’s FOMC press release were clear:

1)      “I’m negative on the market because the economy is not recovering.”

2)      “The Fed is killing us by keeping interest rates so low.  Savings accounts are a negative carry, hurting the household.”

3)      “The QE’s were a disaster and did nothing but we’ll take another serving.”

4)      “The banks can’t make money with a flat yield curve.”

5)      “Inflation is an issue.”

6)      “Europe and China will take us down.”

In my view, the FOMC press release was perfectly turned out for everyone except for those misguided souls staying too long at the bond party.  To paraphrase the statement:  the economy is recovering but we’re going to keep rates low until the end of 2014.  Instead of driving the markets lower, investors should do a hosanna, take a breath and start picking stocks – not any stocks, but those more dependent on the U.S. economy.   The rising tide lifting all stocks is ebbing making this a great environment for stock picking.

 

By not hinting at a QE3 while paying homage to an improving economy and labor market – I trust the Fed’s mark-to-market much more so than their forecasts –  a large part of the bear case for US equities was served a debilitating blow.  After a short period of adjustment the market will continue its assent.  Yes, markets do rise as the Fed tightens as long as monetary policy remains fairly accommodative.  But all is not lost as to the Fed and monetary policy.  As with a recovering addict in rehab who has been mainlining heroin courtesy of a benevolent pusher, the Fed will not force us to go cold turkey so I look for a modest bridge to higher rates upon the expiration of Operation Twist in June.

The focus of naysayers will now increase on the purported impact a slowing global economy may have upon the U.S.  and, ultimately, our equities.  What has resonated so loudly is silence on the fact that the U.S.  still has largest economy in the world and that while not entirely self-sustainable, we can drive decent growth given that our reliance on the EU and China as markets for our goods is small relative to our internal consumption.

Banks, already on the upswing from improving credit, upward trending existing home sales, and being the beneficiaries of distressed European banks’ need to sell non-distressed assets at distressed prices, will soon be able to make money on a steepening yield curve.  This environment should be panacea for U.S. banks providing they remain disciplined in feeding out their inventory of homes to an improving market.

Inflationary pressures caused by a weaker dollar will abate, not that the Fed ever saw them as anything more than transitory, pressuring gold but helping the consumer as will higher yielding bank accounts but pity the fool who doesn’t see major principal loss in much small moves in yield.

I continue to like the market primarily because I anticipate upside in this reporting season relative to expectations, laboring under the belief that businesses and individuals are stronger.  I like the USD long versus the Euro short.  I hate the Aussie dollar and added to my short; China is a drag on their export and minerals economy and they have extremely high rates that have to come down.  I am long domestically focused equities.  Technology continues to play an important part in my portfolio, the issue with SNDK specific to their business model (I bought today).  I am opportunistically shorting steel, copper and coal on a trading basis.

Go U-S-A.  U-S-A.  U-S-A.

——————————————————————————————————————————————————–

The market of the last two days reminds me of my grandfather, Phil.  He was a surly guy and had his voice been disassociated from his body, one would have envisioned a much more stout individual than he actually was. Gravity had taken its toll as he advanced into his 90’s, shrinking his frame to little more than five feet two on his tallest days.  The often inverse correlation of age to patience took its toll and his gruff and demanding personality continued to overshadow a diminutive frame, expanding to a size that would better fit someone sporting the physique of Ray Lewis or Vitali Klitcshko.  Phil was never indecisive in his demands but increasingly, he never wanted what he asked for.   The following true story provides an example and a parallel to today’s market.

“I’ll take the sirloin,” he grumbled.

“Of course, sir.  How would you like it prepared?”

“Medium” he groused in response.

The kitchen turned it out perfectly medium but his rote response, his knee jerk reaction, was to send it back.

“This is raw,” he said, misconstruing pink for red.  “It needs more fire.  I don’t want to see any pink.  I want it well-done,” he barked, clearly contradicting his original order although he didn’t see it that way.

The waiter did as he was told and again delivered the steak perfectly prepared to order; well-done, not charred.  My grandfather’s rebuke was even more harsh.

“This is burnt,” he said, chastising the defenseless waiter.

And so it went.  I left significant compensatory damages behind, padding my grandfather’s meager tips, hoping to assuage my embarrassment and to maintain my good standing with the service establishment in New York City.

The moral: .   While you can hardly compare ordering a steak to positioning a portfolio but if Phil had not pre-judged the result, determined to return the slab of meat even if it came out perfectly cooked, perhaps he would have been able to profit from a good result.

News Flash: Europe is Slowing; News Flash: China is Slowing

March 22, 2012

News Flash: China is Slowing

News Flash: Europe is Slowing

News Flash: Goldilocks May Have Left the Building

“There is the school of thought, of which I am not a student, that believes we shouldn’t worry about China and Europe since U.S. GDP is not overly reliant upon either Europe, 2% of total U.S. GDP, or China, 0.6% of GDP, but given that our economic revival is not particularly robust, any potential hit to growth has to be regarded seriously.   And it is the strengthening domestic economy, abetted by perhaps misplaced optimism on the global economy that overshadows the current weakness abroad.”

Like most, I tend to operate from selective memory. Sometimes I have to venture far into the archives to find a pearl of wisdom, other times the proverbial ink has yet to dry. Fortunately, this occasion finds me in the latter camp leading to a trip back to March 6th.  I actually present this somewhat cheekily since the S&P has had a nice move since the date I wrote the above but completing the thought, I remained bullish equities within a much reduced net long position laboring under the belief the non-US swoon would not really hit our economy until year end.  That is still the case from an economic standpoint.  It shouldn’t be a surprise to anyone that the massive credit issues in Europe have caused a slowdown nor should anyone be surprised about China, where economic indicators have revealed a contracting economy for 4 months.  However, with the market being a discounting mechanism perhaps I was too optimistic.  I went on to say:

“To bottom line it, the market is in a consolidation phase and faces the likelihood of a minor correction near term while remaining highly dependent upon data in the U.S. and continued optimism about the European and Chinese economies.” 

This will update my outlook and clarify my views.  The market is in a consolidation phase with a slight bias to the downside in the very near term as we are in a good news vacuum pending earnings.  Optimism still reigns regarding China’s ability to manage their way out of their declining economic fortunes and the yields on sovereign debt in the countries that matter, while recently forfeiting some of their optimism, are still at much more reasonable levels.   THE KEY FACTOR GOING FORWARD WILL NOW BE EARNINGS SEASON which I suspect will acquit itself well in most areas of the economy except for certain sectors, such as coal and steel, where I have been very visibly short, and which have already updated their outlook.   (Every steel company, regardless of business model, has disappointed but has guided to a turn in fundamentals resulting in a nice move off the bottom.  I am still short.  And coal remains in a death spiral.)   This will provide support for the market at that juncture but for now, in a good news vacuum, the path of least resistance is slightly lower.

But the key to a further rise in equities is the direction of US govt bonds.  While flows continue into bond funds in a meaningful way and out of equities in a less meaningful manner, a situation that surprises me, I believe this will reverse. I am short through TBF and TBT because I believe most investors have come to expect unabated and unprecedented performance and don’t realize that a an 85 bps back-up in yield from 2.15% to 3% will result in approximately a 7% loss in capital, an untenable risk/reward when considering that any appreciation of Treasuries is in the best case, severely limited.   And as the EU sovereigns continue to hold these levels, funds will flow from bunds and bonds into their higher yielding debt.

Within the slowing of global growth view, I remain short the Euro and Aussie dollar, materials and transportation, CSX (dicey), and long technology, big US banks, and defensive value.  The market will continue to pause, but not collapse, into earnings season and unlike each of the other reporting periods since the bottom in March 2009, expectations are much lower setting up for decent equity performance for the next quarter unless sentiment regarding Europe and China fall off a cliff.  I realize this straddle risks my being likened to a sell-side strategist, a label more feared than “moderate Republican” but that’s how I see it.

 

Did You Hear the One About the Bull… China, Europe and Global Growth Stocks

There is an oft told, though not particularly amusing story about an old bull and his son who stood atop a hill glancing down at a herd of attractive heifers. Exercising his fatherly duties, the newly divorced elder bull cautioned the youngster about charging down the steep slope to, let’s politely say, curry favor with the cows that grazed below.

“Com’on, Dad. Let’s go get ’em.”

“Easy there, boy,” the father cautioned, “it’s not always good to move too far too fast. Just ask the hare that lives in that hole next door to the barn.”

“I guess you’re right,” the son responded. “Slow seems to win an awful lot.”

“Slow is not the same thing as deliberate. Deliberate is what I’m after.” “But what about the Roadrunner, Pops?” the young stud inquired, “That darn bird seems to win every time and he looks like he’s havin’ an awful lot of fun racing around.”

“You may have a point there, kid,” came the response as the father looked below, a smile forming on his lip, a twinkle brightening his dark brown eyes. “Let’s deliberately run down there and have a good old time. Don’t know what I was worried about.”

Setting aside his discipline and years of experience, the old bull was drawn in by visions of what could be if all went right. He galloped down the hill, pausing ever so briefly to enjoy himself along the way. But all good things eventually come to an end and often the easier it seems in the beginning morphs into greater difficulties at the end. Well, it didn’t end well that day for the elder bull who would eventually keel over, ending up as a set of loafers and matching billfold. In the interim, though, he sure had fun.

As with the bovines portrayed above, it’s been a quick and happy romp for the Wall Street bulls, of which I have been one. However, I have no intention of keeling over while hanging on for one more conquest. To some, the bull market is showing signs of tiring while to others, the indices will continue to move higher. Me – well, I have ratcheted down my exposure to a slight positive bias to the market – short global growth, long defensive. I am positioned this way because I see the cows at the bottom of the hill looking decidedly less attractive in the second half of the year when the slowdown in Europe and China become much more evident. That will be when the austerity measures come full measure and the realization hits that Germany alone can’t drive the EU economy but, rather, is itself dependent upon an increasingly inward looking and slowing China as well as its EU brethren who were the direct beneficiaries of Deutschland’s indirect largess via the troika. It is also when we will revisit Greece, if not sooner, and possibly Portugal. So without EU governments being able to stimulate their own economies through major public works projects; without their banks, despite the LTRO, having enough balance sheet to lend (or choosing instead to make easier money through the risk-less carry trade); without the ECB actually being able to print money; and with China’s property bubble gushing air instead of hissing, the headwinds will likely cause a downdraft in the averages.

China lowering their GDP target doesn’t bother me that much for a few reasons. First of all, it wasn’t a surprise – in fact, I mentioned it last week. No great vision on my part since it was the consensus estimate. Even more supportive of my fortune telling acumen, the government had leaked major portions of the statement. The bears fear not though for China has always outperformed their targets and is perhaps setting the bar low for the new comrades coming into office. And doesn’t it matter that 7.5% growth, which may in fact turn out to be 8% if history is a guide, will equate to just slightly less than the same amount of growth as in 2011 owing to a larger base from which to measure the change? (I actually find it somewhat amusing that much of what I read from the Street believes that China will continue to grow at 9-10% despite a clear trend lower.) But the action will turn inward as China grows the domestic economy through consumption rather than exports. This, to me, means less fueling of the global economy. And, of course, slower growth is, at the end of the day, slower growth. I am still not convinced China will have a soft landing – far from it. The property bubble is continuing to deflate and the central government still has little interest, it appears, in bailing out the Rolex wearing, Ferrari driving, developers. This has been made extremely clear in the beating back of measures enacted by local governments, including Wuhu and Shanghai, to foster a recovery in property prices through employing mechanisms such as relaxing credit or allowing the purchase of a second home. Not least of all, let’s not forget that some important economic indicators in China are showing contraction or multi-year weakness. There is the school of thought, of which I am not a student, that believes we shouldn’t worry about China and Europe since U.S. GDP is not overly reliant upon either Europe, 2% of total U.S. GDP, or China, 0.6% of GDP, but given that our economic revival is not particularly robust, any potential hit to growth has to be regarded seriously. And it is the strengthening domestic economy, abetted by perhaps misplaced optimism on the global economy that overshadows the current weakness abroad.

Not a lot has changed in my favorite longs and shorts with the exception of initiating a short position in U.S. bonds but I will leave that story for another note. I still prefer domestic focused companies that provide downside protection through yield or have branded franchises with a strong IP advantage or value proposition: VZ, QCOM, WLP, HK and CSC, a very interesting value name with a new CEO, low valuation and strong prospects for a turnaround. JPM is very attractive, as is WFC. They will pick up significant share from the moribund European banks, a taste of which was in WFC’s recent moves including announcing an expansion in Europe and buying BNP Paribas energy business. Strong foreign banks such as UBS will also benefit. This is an incredible opportunity for domestic banks to replace the earnings they lost from Dodd-Frank. Coal remains a core short, despite the decline in the price of the shares. Aside from WLT, which derives almost its entire earnings from met coal, virtually every other coal company generates 70-80% of revenues and earnings from steam coal. This is true of even two of the world’s largest met coal producers, ACI and BTU. Reportedly, ACI’s acquisition of Massey is not going well, an asset they clearly overpaid for, and Moody’s put them on negative watch. Additionally, as part of China’s 5 year plan, they intend to increase coal production by only 3.7%. This is despite the fact that reportedly, 40% of power generators in China that use coal lost money in 2010. Imbedded in the 4% inflation target in the 2012 plan are higher utility prices which is intended to provide relief while lowering usage. Domestically, the warm weather has resulted in stockpiles that utilities will take a long time to work off and the conversion to natural gas from coal at these plants is continuing, arguably picking up momentum. This is occasioned not just by price, but more so by environmental mandates. As to bituminous or met coal, my view on steel remains that as Europe falls into broad recession, China cools and construction continues to weaken, steel prices will continue to weaken. This will lead to more exports from Europe into the U.S. and, of course, China keeps adding to steel mill capacity. I am also short JCP, purely an issue of timing on the turnaround and what is already reflected in the stock price, and KSS. Both troll for customers in a very tough space. On the other side, I am long M.

To bottom line it, the market is in a consolidation phase and faces the likelihood of a minor correction near term while remaining highly dependent upon data in the U.S. and continued optimism about the European and Chinese economies. This Friday’s jobs number could untrack the indices either way but watch out for the second half when the can hits the wall.


Enter your email address to follow this blog and receive notifications of new posts by email.