EARLY LOOK: Motivated Illusions

“A man must learn to understand the motives of human beings, their illusions, and their sufferings.”

-Albert Einstein

One basic risk management premise that we operate with here at Hedgeye is that people lie. I know that sounds a little harsh, but it is what it is. The truth about lying is that people do it.

Some people don’t know they aren’t telling the truth. Some people don’t know what they don’t know. Some people wake up every morning and get paid to be willfully blind. The power of combining groupthink with compensation has unlimited potential, and the risk embedded therein works both ways.

Rather than create a list of liars this morning, I’ll take my queue from the college campus my office sits on and make this basic risk management lesson sound more academic. I’ll label these global macro risks Motivated Illusions:

1. Greece

Motivate Illusion: One of the top headlines on Bloomberg this morning is “Greek Financial Crisis Is Over, Rest of Euro Region Is Safe, Prodi Says.” Now this comment from the former head of the European Commission, combined with Greece’s Prime Minister telling Washington groupthinkers yesterday that Greece has been the victim of “unprincipled speculators and malicious rumors” is what it is – over the top.

Reality: After their one-week global storytelling road-show that spammed us from Germany, to France, to the USA ends, Greece will be selling another 10 BILLION Euros in debt to the marketplace. Piling debt, upon debt, upon debt is what a country who has lived through generations of serial default does. Watch what they do, not what they say…

2. China

Motivated Illusion: China isn’t going to continue to tighten monetary policy, raise the value of its currency, or raise interest rates any further.

Reality: That’s a Western view held by debtor countries that cannot afford to lose their flailing hopes that levered up Chinese demand is going to save their deficit spending. Overnight, China reported a +46% year-over-year export growth number for the month of February. That’s up huge versus an already big January export growth rate of +21%. While the entire political leadership of the Western world tries to remind you that this is still the great depression and we have no global inflation, you can read tomorrow’s pending Chinese inflation report for what it will be to the Chinese – inflationary.

3. US Federal Funds Rate

Motivated Illusion: Ben Bernanke is going to keep rates of return on his citizenry’s hard earned savings accounts (or fixed incomes) at ZERO percent in perpetuity. There is no inflation because the narrow calculation that the government has changed 9 times since 1996 doesn’t say there is any…

Reality: If we haven’t recognized that massive credit issuance and sovereign debt and currency crises, globally, haven’t led to 8 centuries of predictable inflation, please go back and re-read Reinhart & Rogoff’s “This Time is Different.” Apparently some of the boys at the Fed have been doing the required reading. Charles Evans (Fed head of Chicago) gave a speech last night and didn’t use the phrase “exceptional and extended” when talking about prospective monetary policy. Instead he said the Fed would keep rates low “for some time” and when asked after the speech what “exceptional and extended” means, he said “3 to 4 FOMC meetings.”

Call Goldman Sachs esteemed Fed forecasters this morning and ask them if that was the duration and definition they thought Bernanke’s Fed was using in defining “extended and exceptional” when Goldman laid out their forecast that the Fed was on hold until they get their 2011 bonuses. Depending on their answer, I’ll tell you who is storytelling. By the way, the FOMC meetings are 8 times a year, and by Q2 the clock on “3-4 meetings” runs out.

Markets don’t lie; people do. The score on all 3 of these Motivated Illusions is right up there this morning for all participants in this game to see:

  1. Despite rallying +2% early this morning on people hoping Prodi isn’t lying, Greek stocks have lost over -27% of their value since October 14, 2009.
  2. Despite having some of the best GDP and export growth stats in the world so far in 2010, China closed down another -0.66% overnight (down -7% YTD), because local investors realize that growth like this will be met with higher interest rates and/or an appreciated Chinese Yuan.
  3. Despite interest rate doves hoping government bonds higher, global interest rates continue to make a series of higher-lows and higher-highs.

At a point, reality gets recognized by the investors who win or lose every season by discerning who is motivated to elude them. As reality sets into Mr. Macro Market’s prices, consensus becomes the direction of those prices… and the game of trying to figure out who doesn’t know what they don’t know goes on.

My immediate term support and resistance lines for the SP500 are now 1122 and 1149, respectively. On yesterday’s rally in both US Tech and Volatility, I sold out of both my XLK and VXX positions, and I bought US Healthcare (XLV) on the pullback.

Best of luck out there today,

KM


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