Shadow Capitalism

Market Commentary by Naufal Sanaullah

Naufal Sanaullah US equity reverses gains on muni plunge, but risk overall bid
naufalsanaullah@gmail.com
www.shadowcapitalism.com
as Spanish & Italian auctions follow on tail of Portuguese,
while ECB & BoK focus on inflation
Two more less-bad auctions in Europe today, as Spain sold $3b of 5yr paper and Italy sold $5b of
5yr & 15yr notes. Spain’s was a bit less positive, coming in at 454bps and an only marginal increase
in bid-t-cover to 2.2x, and both sovereigns widened a decent amount from their day’s tights. The
euro surged, however, first on the auction results, and again as Trichet issued hawkish sentiments
and addressed rising Eurozone inflation. Meanwhile, the Bank of Korea hiked 25bps in its “war” on
inflation (which has included the Korean Finance Minstry releasing emergency food supplies), and
issued hawkish forward-looking statements, sending Kospi down marginally. UK IP came in around
expectations and US initial claims a bit higher than consensus (but without a consequent negative
reaction in spoos), but the big data print of today was US PPI rising in December to 1.1% MoM vs
0.8% consensus & prior. The theme of input price inflation in America seems here to stay, and the
dynamics of passing on inflation through the supply chain and eventually the consumer will be vital
to watch this year.

The S&P gave back 0.17% today as initial gains were reversed on further selloffs in munis (three
ETFs for which are being cancelled in fact), with no new significant technical developments except
for a slight uptick in volume today. I am continuing to watch the 1300 level and am likely to get
short some index futures at that level, particularly with my heavily net-long equity book currently.
Nineteen consecutive weeks above the 55d and 31 consecutive trading sessions above the 21d
spell eventual (read: imminent?) correction.

January 14, 2011 |1

EURUSD spiked higher again today on the auction results and hawkish JCT comments, although the
real gains were in EURXXX crosses, particularly EURCHF (which I covered all of today). I went back
short EURUSD at the 55d/100d/Jan resistance for a punt and long EURJPY on a clean technical
break, but I am on the sidelines for now in other EUR crosses, especially with EURCHF slicing
through the 1.275 pivot I’ve been highlighting. I find the Trichet inflation comments ironic,
considering any tightening or inflation-fighting at this point would immediately send Portugal
reeling and needing a bailout, and continue to think that €1-2b of unsterilized ECB bids before each
periphery auction (and issuance is increasing still, might I add) is unsustainable. Whether
proactively (the better scenario) or due to failed sterilization (the scenario better fitting EU & ECB
leaders’ recent actions), the ECB will be forced to go way of QE, in my opinion, and (here is where
the irony comes in) that will send the euro plunging and inflation expectations surging. However, it
would also send periphery spreads tightening (and benchmark bunds plunging), and politically, I
don’t see any other resolution to this issue, considering the core’s desire for a lower euro to export
its way out of the periphery-fueled mess and periphery’s desire for lower funding costs.
Nevertheless, today’s technical action is constructive, and although I am short EURUSD on a
technical trade, I am patiently waiting (rather than anxiously watching) for an opportunity to re-
enter on the short side. And for novelty’s sake, I went short German equity via an ETF today, as
both an increase in EFSF and unsterilized monetizations are bearish scenarios for the core.

January 14, 2011 |2

Today’s $13b 30yr UST auction was met with a positive response, although the bid-to-cover saw a
decline to 2.67x and the yield rose to 452bps, the highest since April (the 2010 high in Tsy yields).
The USD continues to track yields on the long-end, a paradigm shift from the flight-to-safety trade
(which made the liquid USD correlate well with UST safety bids), which I consider a significant
indication of the beginning of the end for low Tsy yields, with the long-end going first. The belly got
a nice bid today despite the auction tail, likely due to the empty issuance calendar for the near
future and the big acceleration in POMOs in the next four weeks. It’s interesting to note that USTs
are again diverging from equities, in a very similar pattern as April 2010.

Metals declined today, despite the weaker USD, which can be chalked up to the periphery
sovereign tightening and lower US yields. After a very sizable rally since QE2 expectations first
began influencing the market, I think PMs are in for a correction and I added a bit to my silver
short today. As regular readers are aware, I am bullish precious metals on longer-term timeframes,
and hold a sizable portion of my worth in physical bullion in Australia, but in the near-term I see a
strong bearish case for gold and silver on a technical and sentiment extreme basis. As you can see
below as well, gold miner equities are drastically underperforming the S&P (the white line the GDX
ETF priced in SPY and the blue line is the GLD ETF); relative strength is an important indicator and
one of the few technical tools I use besides price, volume, and moving averages (most everything
beyond that is little more than voodoo in my opinion, as it lacks an a priori basis to its predictive
power).

Big developments from Coinstar today, as lower-than-expected video title sales at Redboxes led to
lowered Q4 2010 revenue guidance by 11%. The first obvious thought is if and how this will impact
Netflix stock going forward and if this is a more pervasive issue in demand for on-demand and
rentable media. CSTR equity is down almost 25% after-hours. On the other hand, better-than –
expected Q1 guidance from Intel is sending semiconductors shares rallying after-hours on good
volume, helping some of my recent purchases, including ADI, BRCM, MXIM, and TER, all of whom I
bought yesterday.

January 14, 2011 |3

The muni market took another beating today, while three muni ETFs were cancelled due to recent
market volatility. Meanwhile, Illinois lawmakers are trying to push through an $8.75b bond
issuance to finance $6b in overdue payments to pension funds and other “backlogged bills.” The
obvious analogy to a company issuing debt to raise capital for missed coupon payments clearly
shows the precarious predicament facing the US’s worse-funded states, including Illinois,
California, Michigan, and New Jersey. As rates rise in 2011, so will some key state & municipality
borrowing costs and CDS spreads.

And last but not least, I went long some VXX today in small quantity as the VIX has declined back to
lows seen around April 2010 highs in risk assets, right as S&P 1300 resistance weighs overhead.
VXX is an absolutely horrific proxy for the VIX, but I figured I’d bid some up for a punt and add if vol
does expand. The highly negatively-convex nature of an ETF like VXX makes it a candidate for a
significant short squeeze if/when volatility does begin rising again. Stops are tight for such a high
beta name and I also have a conditional stop for if the VIX breaks below 15.

January 14, 2011 |4

 Trades
OPEN
Long ACAS | 6.67 | stop 7.55 | +25.79%
Long HIT | 47.35 | stop 44.80 | +13.81%
Long N | 24.00 | stop 23.20 | +17.63%
Long NOG | 22.20 | stop 21.80 | +26.53%
Long SNDK | 42.95 | stop 40.35 | +19.67%
Long CMCSA | 20.15 | stop 19.70 | +11.86%
Long VSAT | 40.75 | stop 39.90 | +5.93%
Long XEC | 81.00 | stop 78.15 | +18.47%
Long FWLT | 28.30 | stop 27.00 | +30.99%
Long GRA | 33.40 | stop 31.00 | +9.55%
Long CIE | 10.85 | stop 10.10 | +26.08%
Long /CL | 85.00 | stop 82.80 | +7.24%
Long SINA | 63.75 | stop 62.05 | +34.16%
Long IO | 7.03 | stop 6.64 | +18.06%
Long /ZW | 690.00 | stop 675.30 | +12.90%
Long /ZC | 550.00 | stop 541.90 | +16.86%
Long MEE | 49.10 | stop 47.25 | +17.21%
Long WLT | 104.50 | stop 100.05 | +30.78%
Long ONXX | 33.25 | stop 34.95 | +8.06%
Long MELI | 67.80 | stop 70.75 | +8.20%
Short IVN | 27.90 | stop 29.50 | +8.57%
Short AUD/CAD | 1.0165 | stop 1.0260 | +305 pips
Short SCCO | 48.55 | stop 51.10 | +4.49%
Long USD/JPY | 81.90 | stop 80.95 | +65 pips
Long ZSL | 10.40 | stop 9.55 | +8.08%
Long VMW | 93.80 | stop 89.90 | +1.85%
Long NTAP | 57.80 | stop 55.60 | +1.46%
Long FFIV | 141.10 | stop 136.95 | +2.07%
Long DECK | 79.80 | stop 75.80 | +0.80%
Long ARUN | 24.50 | stop 22.65 | +3.58%
Short SLW | 34.20 | stop 35.75 | +4.97%
Short ANN | 23.05 | stop 24.80 | -3.69%
Short CAKE | 29.45 | stop 30.75 | -2.24%
Long CLF | 83.15 | stop 79.95 | +5.15%
Long /CT | 150.00 | stop 138.50 | -3.23%
Long RDN | 9.30 | stop 8.70 | +0.97%
Long AGU | 90.95 | stop 86.80 | +2.08%
Long SLM | 13.75 | stop 13.15 | +2.58%
Long OIH | 140.65 | stop 135.00 | +1.82%
Long CLR | 62.15 | stop 59.90 | -1.29%
Long DF | 9.80 | stop 9.25 | +1.63%
Long EWZ | 76.56 | stop 74.90 | +1.10%
Short GMCR | 35.15 | stop 36.50 | -0.91%
Long /ZS | 1418.85 | stop 1381.75 | +0.14%
Long CCME | 17.55 | stop 16.70 | +17.66%
Long ADI | 37.90 | stop 36.90 | -0.13%
Long BRCM | 46.00 | stop 44.00 | -0.30%
Long MXIM | 25.02 | stop 24.45 | +2.80%
Long TER | 13.80 | stop 13.25 | +1.59%
Long NVDA | 20.66 | stop 19.00 | +13.21%
Short ACOR | 28.90 | stop 30.60 | +5.05%
Long MOS | 78.65 | stop 74.55 | +2.59%
Long ERJ | 30.10 | stop 28.90 | -0.30%
Long TDY | 45.05 | stop 44.85 | +1.33%
Long ELX | 12.55 | stop 11.50 | +1.43%
Long LUFK | 62.80 | stop 59.90 | -0.35%
Long LULU | 72.90 | stop 68.50 | -1.56%
Short CGA | 7.48 | stop 8.05 | -4.28%
Short ECH | 73.40 | stop 76.10 | -1.50%
Long TITN | 21.30 | stop 20.45 | +2.53%
Long HBAN | 7.27 | stop 6.95 | -2.06%
CLOSED
Short EUR/CHF | 1.3725 | cover 1.2715 | +1010 pips
Long SGD/JPY | 63.60 | sell 64.25 | +65 pips
Long SNE | 33.70 | sell 35.90 | +6.53%
Long /NKD | 9768.00 | sell 10591.00 | +8.43%
Long CHF/HUF | 208.00 | sell 221.00 | +130 pips
Short EUR/CAD | 1.3670 | cover 1.3005 | +665 pips
Long TBT | 37.90 | sell 38.50 | +1.58%
Long LVS | 50.50 | sell 47.30 | -6.34%
NEW
Short AUD/NOK | 5.885 | stop 5.915
Long VXX | 33.00 | stop 31.50
Long DANG | 34.80 | stop 33.20
Long BG | 68.60 | stop 67.55
Long WFMI | 52.70 | stop 51.20
Short X | 56.80 | stop 58.20
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DISCLAIMER: Nothing contained anywhere in this commentary, including
analysis and trade ideas, constitutes or should be construed as investing or
financial advice, suggestion, or recommendation. Please consult a financial
professional and do due diligence before engaging in any purchase or sale of
securities.
January 14, 2011 |5