JS Global Macro Notes

[darkhorse]

Global Macro Notes: Pondering the High Cost of Food

Next to guaranteed reelection, what is a politicians' fondest wish? Perhaps benign economic conditions -- the ability to enjoy upturned economic indicators, positive sentiment, and increased feelings of voter satisfaction all at the same time. "A chicken in every pot."

When fortunes are tied to the ballot box, this is what Washington wants. And it is what the Federal Reserve (with the help of China) appears to have delivered, for the investing classes at any rate: Unrelenting paper prosperity, in which an overall "crisis contained" attitude seeds complacency along with profits.

In this world of levitating asset prices -- never mind the possible correction brewing this week -- what could derail the Fed's "higher market mandate?" Is there any factor that could rudely intrude and kill the dream of perpetual paper gains?

Well, there's the rising cost of food, for one thing...

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[m22au]

Quote from darkhorse:

Global Macro Notes: Pondering the High Cost of Food

Is there any factor that could rudely intrude and kill the dream of perpetual paper gains?

Well, there's the rising cost of food, for one thing...

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Thanks for your notes again Darkhorse.

I agree that shorting restaurants are a good way to "play" the effect of higher commodity prices caused by loose monetary conditions.

However I prefer to short airlines, as outlined here:

http://www.elitetrader.com/vb/showthread.php?s=&threadid=193390

and here:

http://www.elitetrader.com/vb/showthread.php?s=&postid=3066125

If peak oil is real, and manifests itself more noticeably in the coming years, it's entirely possible that all US airlines except LUV, DAL and UAL go bankrupt before the decade is over.

I assume that you prefer shorting restaurants instead of airlines. Is there / are there particular reasons for this?

 

[darkhorse]

Quote from m22au:


If peak oil is real, and manifests itself more noticeably in the coming years, it's entirely possible that all US airlines except LUV, DAL and UAL go bankrupt before the decade is over.

I assume that you prefer shorting restaurants instead of airlines. Is there / are there particular reasons for this?

Hi m22au,

Our lack of focus on airlines is not a rejection of the idea. Under the right circumstances they could certainly be good shorts, and it may be worthwhile for us to conduct further investigations in that area.

The oil question is slightly problematic, between airlines' ability to hedge and the threat of medium-term commodity contraction (as deflationary forces are still in play). But again, it's something that could be worth further investigation. I don't have a firm opinion because I'm not up to speed on airlines at moment. We'll take a closer look.

cheers!

 

[m22au]

Quote from darkhorse:

Hi m22au,

Our lack of focus on airlines is not a rejection of the idea. Under the right circumstances they could certainly be good shorts, and it may be worthwhile for us to conduct further investigations in that area.

The oil question is slightly problematic, between airlines' ability to hedge and the threat of medium-term commodity contraction (as deflationary forces are still in play). But again, it's something that could be worth further investigation. I don't have a firm opinion because I'm not up to speed on airlines at moment. We'll take a closer look.

cheers!

You make some great points there, which I will do my best to address.

** Fuel hedging **

You are right that airlines can hedge, however any hedging is only part of the fuel expense, because (1) airlines prefer to underhedge than overhedge and (2) counterparties reluctant to hedge close to 100% of budgeted fuel expense, due to uncertainty of future fuel usage.

Furthermore, if we assume that oil prices to not decline materially (eg. below $80 maybe), then any fuel hedges "rolling off" will need to be replaced with hedges at current / higher prices.

** Deflation / commodity contraction **

I agree that deflation remains a threat, especially if the influence of the Fed wanes. However even if there is another economic downturn, it's likely that airlines will suffer significant revenue declines, and therefore stock price declines. If you look at a chart of airline stocks going back to 2007, you will see the oil-induced decline up to July 2008 (oil at $147). However airline stocks actually fell to lower levels in March 2009 (oil at much lower prices) due to the economic downturn accelerating in late 2008 / early 2009.

** Specific stocks **

Although I think most airline stocks will decline - there is a wide range in performance amongst individual stocks.

ALK is not a stock I would short: its chart is strong and I have read that it hedges a large amount of its fuel exposure.

On the other hand, LCC does not hedge, and its chart looks much weaker.

 

[BCE]

Quote from m22au:



However I prefer to short airlines.

Warren Buffett famously asked:
"How do you make a small fortune in airlines?....................... Start with a large fortune."

 

[m22au]

Quote from BCE:

Warren Buffett famously asked:
"How do you make a small fortune in airlines?....................... Start with a large fortune."

Yes I generally agree, except that for the period from March 2009 to November 2010, airline stocks went up by a lot, because the economic slowdown of 2007 to 2009 hurt their revenue.

I think now is the 'sweet spot' for shorting them, because if and when oil goes above $100, that's when the higher fuel costs will really hurt them, both from the obvious expense effect, but also the not-so-obvious revenue aspect (businesses / consumers reduced discretionary income as a result of a more cautious economic environment caused by higher oil prices).

This week we saw DAL down on an earnings miss, AMR selling off despite a fairly good report, and Easyjet down massively following a quarterly update.

 

[darkhorse]

Weekend Comment: "Diary of a Professional Commodity Trader" Review

Full disclosure: This is not an unbiased perspective, as the reviewer has developed a warm friendship with the author (Peter Brandt).

With that said, hopefully you can overlook the bias for two reasons:

* Having read literally hundreds of trading books over the years -- most of them mediocre, a small handful worth revisiting -- your reviewer knows excellence when he sees it. By any standard, this book stands out.

* The author, Peter Brandt, has the ultimate in trader bona fides: An audited track record, spanning 30 years, of better than 41% compound returns! (No, that is not a typo.)

So with that out of the way, let's begin...

There is an old saying among professional racetrack handicappers: The losing player is the one who tells you he breaks even; the breakeven player is the one who tells you he is a consistent winner; and the winning player is the one who tells you it's a tough, tough game, with great dedication required for success.

Peter Brandt, a lifetime winner in the great game of trading, falls in the third category. While clearly someone who loves the game, he does not shy away from the hard realities of trading.

In describing his method of trading, Brandt comes across as refreshingly humble, underscoring that his approach is far from the only approach, cheerfully adding that other methodologies may be superior. (Though of course the vast majority of money managers would give a kidney, or maybe even a lung, for compound returns like his.)

Read full review here

 

[darkhorse]

Global Macro Notes: The Deflationists Are Still In It To Win It

Let's begin with an interesting observation. From the time QE2 was initiated, the $USD is actually higher, not lower.

This is especially curious given that the euro -- the major forex counterweight in the $USD index -- has not collapsed.

Dial back the clock to November, when many were predicting QE2 as a watershed event. China's ministry of commerce spoke of "continued and drastic US dollar depreciation." The imminent death of the dollar was (and still is) a widespread refrain.

Yet the buck is higher now. What gives?

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[darkhorse]

Weekend comment: Earthquakes, Power Laws, and Market Behavior

Note -- this was originally written May 2009.

I review this book with a specific message (and specific audience) in mind: The driving insight behind "Ubiquity" is of potential great worth to active traders and investors.

The book is excellently written -- an easy and engaging read. I first read it many years ago, found it effortless to pick up and read again with fresh eyes a year or two on, and am only now returning to review it (in May 2009) having stumbled across an interesting market-related connection.

(The book touches on out-of-the blue market crashes, but I suppose it took the awe-inspiring volatility of Q408 and Q109 to really open my eyes to the point in question.)

To briefly summarize the key idea, no one knows how big an earthquake will be before it starts. This is so because the earthquake itself does not know how big it will be until events actually play out...

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[darkhorse]

Global Macro Notes: Deeper Implications of Middle East Turmoil

Thanks to the many narratives and themes competing for dominance, Mr. Market often behaves like a child with ADD (Attention Deficit Disorder).

Some breaking piece of news or shiny data point will grab his attention for the pulse of a few trading sessions -- then the focus switches elsewhere.

So it seems, as of this writing, with the unfolding situation in the Middle East.

As soon as investors realized the Suez Canal is not going to be shut down -- the Egyptian government has no interest in losing billions of dollars in revenue -- it became "game on" for broader risk assets, the market focus shifting back to positive U.S. economic data.

But it would be foolish to view Egypt's uprising through a short-term lens only. There are deeper implications here, some of them quite serious...

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