Global Market Comments
July 1, 2009

Featured Trades: (VIX), ($BVSP), (RSX), ($BSE), (FXI), (EEM), ($KOSPI), (TBT), (JNK), (PHB), (HYG), (FCX), (X), (CHK), ($XEU)

1) Equities: UP

The collapse of the volatility index (VIX) is telling us that the horrific, gut churning, 10% daily moves are over. But equities are no longer a US play. Extracting the insane leverage of the last decade means chopping the US growth rate down from a booming 5% to an anemic 2%. This is not a strong argument to buy American companies, which is why most analysts only see the indexes recovering 10%-20% this year. You might just get tedious range trading after the late 2008 dead cat bounce. The real action will be in the BRIC countries, which will see upside returns double what you will get with the S&P 500. Buy Brazil?s Bovespa ($BVSP), Russia?s RSX (RSX), India?s Bombay Sensex ($BSE), and China?s FXI (FXI) or Hang Seng. And it may be time to spell BRIC with a ?K? by throwing in the Korean Kospi ($KOSPI) as a sweetener.

Grade: A+. The VIX went down virtually every day this quarter, plunging from 46% to 25%, so a ton of money was made on short volatility and time decay plays. My call that the export sensitive BRICK?s were a ?Buy? was a total home run, as they massively outperformed the US. At their H1 highs, Brazil was up on the year 45%, Russia 100%, India 58%, China 41%, and Korea 32%. At its highpoint the S&P 500 was up on the year by a woefully anemic 6%. With 80%-90% of the world?s economic growth over the next ten ears expected to come from emerging markets, Bricks are the place to be.?? Although you may get a decent pull back this summer, this trade has much, much further to run. We are still in the first inning of a 12 inning overtime game. If you want to be conservative and diversified, buy the iShares MSCI Emerging Market basket ETF (EEM), up 38% on the year, on the next major dip.

2) Bonds: Treasuries Down, Private Debt Up.

As I have been vociferously arguing in these pages for months, US Treasury bonds are witnessing the final stages of an overinflated bubble, and you don?t want to be anywhere near this asset class when it bursts. Take out the flight to quality and year end balance sheet window dressing bid from this market, and you have an accident begging to happen. Take in the long term inflationary impact of Obama?s plans, and you have a 30 year contract that peaked at 142 last week which is really only worth 70. It?s just a matter of time before massive government issuance buries largely foreign buyers. Throw in the 50:1 leverage offered by a long bond futures contract, and the profit potential of a short position is so enormous that there are not enough zeros on my calculator to total it up. Buy the Lehman 20 year plus ultrashort bond ETF (TBT). Unfreezing of the debt markets will move the prices for every other type of debt off of their current throw away levels. Buy corporates of every grade with a heavy weighting in junk, or fixed income securities backed by REIT?s, emerging markets, credit cards, student loans, or subprime loans. A convenient way to do this is to buy the ETF?s for the Lehman High Yield Bond Fund (JNK), the PS Corporate High Yield Bond Fund (PHB), and the iShares iBoxx Fund (HYG).

Grade: A+. My recommendation to short the Treasury?s long bond was spot on, with the US Lehman 20 year 200% short ETF (TBT) soaring by 60%. With the government?s printing presses running overtime, this is going to be your new free lunch. We have had a ten point pullback from the top, which may allow latecomers an entry point. The junk bond ETF?s PHB (up 16%) and HYG (up 11%) also were profitable, but did less well, as credit concerns linger. I believe these positions have further to run. But we need to see a real economic recovery, not just a mirage of a few green shoots, to get some serious upside movement from here. For the short term, the easy money has been made.

3) Commodities: UP

After giving up almost all of their 21st century gains, virtually all commodities, including grains, softs, energies, and metals, are due for a recovery. A good part of the sell off resulted from the disappearance of financing, which is slowly working its way back into the market. Now that newbie investors who never should have been involved, like pension funds, have bailed on this asset class, conditions are set for some serious base building. Commodities will be the principle beneficiaries of an epochal trend away from paper assets, towards hard assets, that will be the dominant investment theme for the next decade or two. Chinese and Indians still want to raise their standard of living faster than these substances can be grown, or ripped, or pumped out of the ground. Now Obama is adding America to the infrastructure build out story. A safe way to play this is through beaten down, dividend yielding, producing equities like Freeport McMoran (FCX) for copper, Chesapeake Energy (CHK) for natural gas, and US Steel (X) for steel and iron ore.?? However, don?t expect huge gains until we see signs of a global economic recovery by the middle of the year. Then watch out.

Grade A+. Commodities and their underlying stocks have been the place to be in 2009. You really couldn?t miss, with grains, softs, energies, and metals all doing well. Freeport McMoran rocketed by 148% on a robust 75% move in copper.?? Oil is up 78%, and gold ran 17% before its current pullback. The only letdown has been natural gas, which due to huge new discoveries, supply and storage difficulties unique to this one energy source, and the threat of imports, has fallen by 30%. However, my stock pick in the area, Chesapeake Energy (CHK), jumped by a robust 53%. Again, this trade has a long way to run. While they stopped making almost everything in this recession, the world hasn?t stopped making more people. They are all going to need to eat, travel on more roads, and live in more houses. The emerging market thirst for a higher standard of living is as strong as ever. Look for crude to move to $200/barrel on the next spike. Move your portfolio out of paper assets into hard ones.

4) Currencies: Dollar and Yen Down, Everything Else Up

Since we are smack dab in the middle of a six year trading range, I don?t really have a handle on what the buck is going to do short term. Could we see $1.20 or $1.00 for the greenback in an event driven overshoot, short term? You betcha! But longer term, the trend is still down. Obama?s highly inflationary reflationary policies will eventually lead to an utter collapse in the dollar. If they are successful, the economy will recover, bringing Americans back to their old low saving, high consumption, high importing ways, adding fuel to the fire. Don?t bet against the 45 year trend. No one ever got rich betting against the US consumer. Expect to pay $2.00 for a Euro in the years ahead. Take that European vacation now!

Grade: Pass. Here we are, Uncle Buck dead unchanged against the Euro on the year at $1.40. Since I really didn?t take a view, I don?t deserve a grade, so pass/fail applies. Even so, the collapse of the dollar is a mathematical certainty resulting from current US government reflationary policies in the extreme, and may be the trigger for the world?s next big financial crisis. Expect more action in the second half.

4) Real Estate: Down

With markets still deleveraging, and the son of subprime, the Alt-A loans on our doorstep, real estate is dead money at best. Although the cost of carry for home ownership is rapidly approaching equivalent rental costs on an after tax basis, fewer and fewer buyers are qualifying for loans. Add 1.2 million unsold homes from builders, to three million existing homes already on the market, and you have a staggering 4.2 million homes for sale in the US. There are at least another two million homes being held off the market waiting to smack down any recovery in prices. This is 7% of the total American housing stock. Probably 20% of US homeowners are underwater on their mortgages, and they?re not buying anything anytime soon. We also have an impending crisis in commercial real estate to deal with, generating lots of mall bankruptcies and empty retail space. Remember, ?debt? is a four letter word. I don?t see a meaningful recovery in residential real estate for five years, and then it will be a slow claw back at best.

Grade: A+. There is so much inventory out there it is unbelievable, yet the relentless tide of foreclosures keeps dumping more properties on the market. The sickness has metastasized to commercial real estate, which may be the next big shoe to fall. Look at the chart of the Case-Shiller Real Estate Price Index, which shows us back at 2003 price levels. If this were a stock, would you want to buy it? It is starting to take on the flavor of an all out capitulation. Only the 1990-1997 bottom looks safe. Stay away. Rent, don?t buy.

Final Grade: A. OK, so my self grading is biased. But I am sticking to my guns on all of my core trades for 2009. The big question is, do you sell your doubles? All of the good trades are now overextended on the upside and begging for a pullback. What do you do here? It all boils down to your time frame, your risk tolerance, and your propensity to trade. Short term traders should get out (see ?Sell in May and Go Away?), but look to get back in on serious dips. Long term investors should sit back and hang on, even if the next few months grow violent, scary, or just plain tedious. The wind is at your back.

Call me what you want. You can even call me ?Mad?. Does anyone have a billion dollar hedge fund they want me to run? E-mail me.

The Mad Hedge Fund Trader

1) For those who missed the 70% move in the TBT this year, the double short Treasury bond ETF, another window is setting up for you to get in. After running up from $35 to a meteoric $60, we have backed off to $50. Similarly, the bond futures, which plunged from 142 to 112, have bounced back up to 118.5. The yield on the ten year has backed off from 3.99% to under 3.50% in just a few weeks. I think the prospect of a retest of this year?s stock market lows triggered a lot of flight to safety buying of government paper in the last few weeks. If we don?t get that retest, which I think is unlikely, then it?s back to the races for the TBT. End of month, end of quarter, and end of half window dressing has also been goosing prices. Things certainly aren?t getting any better on the fiscal front. According to the Congressional Budget Office, the national debt is now growing so fast, that it will reach 100% of GDP by 2023, seven years earlier than was predicted only 18 months ago. Some 90% of the increase came from burgeoning Medicare and Medicaid spending. It seems that hardly a week goes by without Congress passing another humongously expensive package that has wonderful long term benefits for the economy and society, but has to be paid for with hard cash dollars up front. Watch the TBT.

2) It?s sad to see a once great country fall on hard times. It?s like watching a formerly leading hedge fund manager apply for food stamps. I?m talking about Japan, which in 1989 boasted the world?s most valuable stocks, largest banks, and strongest currency. Oh, how the mighty have fallen. This week the Ministry of Finance published the trade figures for May showing a 42% YOY drop, and that the cataclysmic fall in exports continues unabated, as foreigners keep their money in their pockets instead of buying high quality cars and electronics. Even exports to China fell 29.7%. I?m sure the chart below will be found in business school textbooks for decades to come as proof of the risks of running an overly export dependent economy. Although a giant fiscal stimulus package will start to hit in the second half of this year, most economists have GDP forecasts for the year of minus 6.8% or worse. This would take GDP back to the 2004 level, and make our economy look positively bubbliscious by comparison. This is all happening when the numbers of those retiring is going through the roof, causing welfare payments to skyrocket. Taking a page out of Obama?s playbook, the government is borrowing to meet these costs, so the national debt is expected to reach the certifiable nosebleed territory of 197% by next year! Prime Minister Taro Aso has so far fought off increased consumption taxes, but it is just a matter of time before those efforts are tossed out the window. Continued deflation is a no brainer. Real estate prices are still stuck at 30% of their 1990 levels. This is what an ?L? shaped recovery looks like up close and ugly. In the meantime, the yen strengthens, making exports ever more expensive and uncompetitive. Better to stand aside from the Land of the Rising Sun and watch with tears. Is the US next?

3) The Wall Street Journal made some prescient comments yesterday about how the flood of hedge fund capital into commodities is fundamentally changing the nature of those markets, confounding the old timers. The Northeast is experiencing the coldest summer in 27 years, and you would expect Natural Gas to crater (see my June 2, 2009 Newsletter). But chart buying by the proliferation of new NG ETF?s out there has been holding it up. Excessive rain has delayed wheat plantings, normally a very positive development for wheat prices. But traders are obsessing over weather Chinese stockpiling of food is leveling off, knocking prices for a loop (see my June 16, 2009 Newsletter). I avoided trading the soft commodities for most of my life, because, basically, making a bet on the weather always seemed like a loser to me. Better to bet on two flies crawling up a wall.?? The pros relied on Cray supercomputers processing complex algorithms and historical data to come up with forecasts that were wrong half the time. I actually prefer the new order. I rather place bets on what the Chinese are up to than Mother Nature any day.

4) As the California budget battle reaches white hot temperatures, Fitches has cut the rating on the state?s debt to A-, and placed it on ?credit watch?, a warning of further downgrades. The move is a delayed recognition of reality, as is the rating agency industry?s practice. The legislature tried, but failed to pass $12 billion in budget cuts, which governor Arnold Schwarzenegger said he would veto anyway, because they didn?t meet the full $24 billion tab (see my previous dispairing piece here). In the package were increases in motor vehicle registration fees, $1.50 a pack in additional tobacco taxes, cancellation of health insurance for one million children, a production tax of 9.9% for in-state pumped crude oil, the firing of thousands of teachers, firefighters, policemen, and probation officers, and more smoke and mirrors accounting shenanigans that kick the can into the future. Some of the changes were only possible through a redefinition of the English language that turned ?taxes? into ?fees.?As California goes, so goes the nation, as many states will follow the Golden State into financial Armageddon. In a new era of soaring unemployment, restrained consumption, high savings, and crashing stock and property prices, states dependant on taxes on incomes, sales, capital gains, and property appraisals don?t do well. Make sure those muni bonds are insured. Why do I get the sickening feeling that I am watching a rerun of Thelma and Louis?

QUOTE OF THE DAY

?Recession-Plagued Nation Demands New Bubble to Invest In,? says The Onion in a headline, a satirical publication.

1) Now that we are solidly into a correction, I have been flooded with requests from readers to call the next bottom in the S&P 500. Well here it is. Brace yourself. Put it on a Post-it-Note on your computer. It is without a doubt and unquestionably going to be 880, 850, 830, 800, 750, 666, or 320. That last number works out to be 90% of the book value of the S&P 500, which was the low seen in the 1930s depression. Yes, that depression, not this one. You are really asking me to solve a one billion variable equation, because that is the number of direct and indirect participants in global stock markets. If the few green shoots out there start to die off, the meltdown in commercial real estate accelerates, the Fed missteps by draining liquidity too soon, or there is another unforeseen shock to the system, then you can go with the lower of these numbers. If we are distracted by the health care debate, emerging market economies continue to perk up, and this strength helps our technology stocks stay alive, then sleepy narrow trading ranges will dominate, and the higher support levels will hold. But no matter what happens, I will be able to come back to you in three months and claim that I was right.

2) What is the new normal? This is the debate that is raging in hedge fund research departments around the world. I?m afraid that today?s equity investors are not taking into account some unpleasant new realities. The last thirty years have seen an average PE multiple of 15 times, and peaked at 20 times during the really great years. Unfortunately, this multiple expansion was fueled by an explosion in leverage. Even companies that hated debt had to drink the Kool-Aid to compete. Now we are moving in reverse on the leverage front double time. Debt/EBIDTA has shrunk from three times to two times in just two years. Even if corporations want to leverage now, they can?t, because the lenders have gone missing. If you wean the patient off of steroids, shouldn?t this mean that the range of PE multiples is permanently downsized? Should the new normal of 1-2% economic growth and an ?L? shaped recovery demand an average of only 12 times, 10 times, or Heaven forbid, the eight times low we endured in the seventies? Logic like this makes today?s 13.4 multiple look frightening rich, and the stock market insanely expensive.

3) There is something that really irks me today about the government?s announcement of the first of the loan guarantees promised by its $25 billion Advanced Technology Vehicles Manufacturing Incentive Program. Ford (F) will get $5.9 billion, Nissan (NSANY) $1.6 billion, and Tesla Motors $465 million. The money will be used to boost fuel efficiency through the development of battery power systems that can be competitive with those coming out of China (see my piece on BYD.) Have the Feds got this ass backwards or what? Imagine what Tesla could do with $5.9 billion? They could take advantage of economies of scale to build an entire new, all electric auto industry from scratch in California, creating tens of thousands of manufacturing jobs. Droves of auto engineers would happily vacate the frozen industrial wasteland that is Michigan for the sunny climes of California, and might even take up eating bean sprouts. This would accelerate the creative destruction that has to happen before the US auto industry can move forward. The money in question is equivalent to the two months worth of negative cash flow that General Motors (GMX) is currently burning. Why not invest in the future, instead of bailing out the buggy whip makers? The Chinese must think we?re nuts, but will happily clean out our pockets, as long are we are in this diminished condition.

4) I have been covering the solar industry for nearly 40 years now, and for most of this time it has only been economic in space stations. But times are changing. If you look carefully at your electric bill and calculate the cost per kilowatt hours each month as I do, you will notice that the price has been going up for the last ten years. This is partly because of ineptly handled deregulation, but also because our utility, Pacific Gas & Electric (PCG) is mandated by state law to reduce greenhouse gas emissions. Last year, the collapse of the economy and crude prices drove the cost of thin film solar?s primary raw material, polysilicon, down dramatically. The cost curve is falling, the demand curve is rising, and it is only a matter of time before they cross. The gap now is only a few cents per kilowatt, and that can easily be bridged with government subsidies. This industry is on the verge of becoming truly profitable. All it might take is another rise in crude prices, something you can count on. Watch behemoth First solar (FSLR) position itself to cash in, as well as Suntech Power (STP) and SunPower (SPWRB). But also watch the volatility, as this is definitely an ?E? ticket ride.

QUOTE OF THE DAY

?When we declared war in 1941 there were not 8,000 earmarks attached,? said Warren Buffet, in chiding congress in its handling of the economic crisis.

1) Ok, people, the sucker's rally is now over. If you had any doubt, take a look at the insider selling figures for April and May. Corporate selling of stock has soared from $10 billion in April to $63 billion in May.?? Insider selling jumped from $1.9 billion to $2.2 billion, an enormous amount. Who were the suckers? Inflows to mutual funds and ETF's ballooned from $7.0 billion to $10.3 billion. Retail investors are always the ones who ring the bell at the top of a move. That explains why dozens of technical indicators are rolling over. They're are not signaling a crash, but they are not saying we are going up any time soon, either. If for whatever reason you can't get out, sell short dated calls against all of your positions.

2) Paul Krugman made an insightful point on his New York Times blog (see http://krugman.blogs.nytimes.com/). The surprise 17% improvement in new housing starts for May, which many heralded as a bonafide green shoot, is not what it seems. Sure, 17% is a nice number, but we're coming off such a low base the number is meaningless. 17% ain't what it used to be. It's like General Motors (GXM) (note new ticker symbol) going from $2 to $3. Sure, it's a 50% move, but it doesn't mean the bankrupt company is back in the pink of health. You could use the same argument for the 40% move in the S&P500. Since virtually all of our economic data is recovering from once a century extremes, they will have to be viewed with many grains of salt. When you meet Paul in person he is a pussycat, but in print is he Freddy Kruger meets Jack the Ripper.

3) One of the joys of having small children is that you get to know the guy at the local plumbing supply shop really well. It's amazing what will fit down a toilet these days. He once told me that when Troll Dolls hit the market, every plumber in the country was guaranteed a job for life. When I went there yesterday I thought I'd pick up some leading economic indicators as well. After a deadly winter, business is picking up a bit. Sure, it is still down a third from two years ago, but there is a definite improvement going on. The Eureka moment! His comments confirm the sort of 'L' shaped recovery I have been expecting. We aren't going to zero anymore, but it is not exactly off to the races either. Throughout the nineties, a salesman at Circuit City (RIP) walked me through every generation of technology, and he was worth his weight in gold. All I had to do was buy a new TV from him every year, and they kept getting bigger and more expensive. Sometimes figuring out the direction of the economy is as simple as going down to the local butcher, baker, or candlestick maker and asking. They are on the front lines of economic activity, and they will see any changes months before those of us glued to computer screens.

4) Since I have been pelted daily with predictions that residential real estate has bottomed for the last 18 months, like hail in a Midwestern summer thunderstorm, I feel a public duty to tell you that is just not the case. Now that the state and federal moratoriums are off, foreclosures are accelerating. There are over a million Option ARM and Alt-A loan resets about to hit the fan. Since many owners will not see positive equity in their homes in their lifetimes, banks are seeing more walk always. The run up in mortgage rates from 4.5% to 5.5% has yet to hit the market. Some 18 million homeowners divert 50% of their incomes to pay for housing, double the 25% that is considered healthy, and many of them are losing jobs. While the volume of units sold has rebounded, the action is dominated by speculators, flippers, and bottom feeders bidding for properties at 10-40 cents on the dollar, not exactly a sign of health. Call me when Ozzie & Harriet Nelson come back to the market. I listen to industry insiders call the bottom of the Japanese real estate market for 15 years, until they finally died, and the market is still a fraction of its 1990 high. I thing we are closer to the bottom than the top in terms of price, but closer to the top than the bottom in terms of time. You can take that to the bank.

QUOTE OF THE DAY

'We won't see a 'V' shaped recovery, but a recovery nonetheless,' Said Abbey Joseph Cohen, senior strategist at Goldman Sachs.