Shadow Capitalism

Market Commentary by Naufal Sanaullah

Naufal Sanaullah Absence of BAB extensions in tax compromise and rumors

naufalsanaullah@gmail.com
www.shadowcapitalism.com
of a weekend PBoC hike helps to send US yields surging and
stocks paring gap-up gains
The Bush tax cut extension naturally led to selloff in USTs today as the “stimulus” further
dampened the creditworthiness of the United States, with Moody’s announcement that “we have
long-term concerns about the US [AAA] rating outlook and they're not being addressed” didn’t
help things in fixed-income space. But perhaps the most troubling development was the lack of
extension in Build America Bonds offered in the Bush tax compromise, and with just over three
weeks remaining before they expire, the risk of them maturing without extension is high and the
implications of this in muni space are very pervasive.

I have been predicting an extension of QE2 used to monetize munis and if the BAB expiration does
indeed lead to acute concerns in muni space and the Fed does indeed use emergency monetary
policy in response, this merely socializes the risks into federal debt, which is already seeing yields
surge since QE2 began and the discounting of it completed. It is important to realize that such a
monetization (of muni bonds) would not put downward pressure on Treasury yields, as QE2 did in
its purchases of US govys, but would do the opposite.

With today’s selloff in fixed-income (with the belly’s weakness in particular) and the significant
technical breaches from today’s market action, combined with the gap-and-trap in US equity, a
combination selloff in bonds and stocks may be in order, which would be rational given the
concurrent rallies in these securities during the QE2 discounting. This would be doubly bullish for
the USD, which would have drastic implications on the Eurozone crisis, which today’s EU FinMin
meeting showed is an acutely political one, with German policy grossly winning over at the
moment and preventing the introduction of any new facilities, irrespective of their efficacy. Look
for gold and silver to be at risk if stocks drop, particularly after today’s large selloffs.

The S&P closed today up 0.05% after gapping up near the highs of today and closing at the lows.
This type of technical development has nothing bearish about it and I unwound some longs and
went long a bear ETF to lower my risk exposure while prices are still high. Follow through on the
gap to the upside later this week could change my bias back to bullish but for now I am remaining
defensive.

Gold & silver are showing very high correlation to stocks, and have been ever since QE2
expectations started getting discounted after Bernanke’s Jackson Hole speech. Today’s sharp
selloff in silver (which I mentioned as possible yesterday while explaining why I was taking profits
into the big rally in PMs) and gold showed significant technical damage and set up for likely
continued selling, especially with silver posting a very bearish engulfing candle today. Silver below
$28 probably leads to significant continued selling. PBoC weekend hike rumors aren’t helping.

December 6, 2010|1
FI space showed marked deterioration today, as the tax cut extension combined with a very weak
3yr auction, which showed a 50% yield increase from the last matched-maturity auction and a very
low bid-to-cover at 2.91, led to 30yr yields confirming their recent 200d bounce and breaking out
to new cycle highs and 10yr yields breaking their 200d in a massive 7.62% rally today. Yields are
now sitting at levels not seen since before QE2 began being discounted (back to where deflation
expectations were driving bonds higher), which highlights the structural weakness in US govys, as
well as the buy-the-rumor/sell-the-news nature of the summer rally.

December 6, 2010|2
I’ve been noting that DXY 80 is the level that likely will lead to further euro selling upon breach and
we got just that today, with EURUSD following through with an almost two big fig selloff. The
1.3250 support level has now been breached, and coupled with renewed widening in periphery
spreads and sell-the-news reaction to the Irish budget vote passing (the two independent MPs
signaling yes-vote intentions was not news and has been highlighted in my pieces several times in
the last few weeks), EURUSD could be set for its next leg down. The combination of US bonds &
stocks both selling off helped contribute to USD weakness and may be setting into motion the next
leg of Eurozone issues.

AUDUSD broke back below its 55d today, after dovish comments from the RBA (which held rates at
475bps) combined with Chinese weekend hike rumors and the overall risk-off sentiment to send
Aussie selling off over a big fig. Like in EURUSD, Friday’s NFP USD selloff has now been reversed in
AUDUSD as well. Keep watching mortgage rates in Australia, as well as mortgage serviceability,
which was one of the reasons cited by the RBA to keep rates on hold and express its overall dovish
sentiments. Chinese tightening concerns are also acutely implicative to Australia, and at the risk of
beating a dead horse, I’d like to repeat the high contagion risks between Australia’s & China’s
markets (and, concerningly, economies as well).

December 6, 2010|3
After a sharp selloff last week, USDJPY has recovered all of its losses in the last couple trading
sessions and is testing 8400. I re-entered long today and will be buying on dips, as I expect its
current basing pattern to lead to another breakout and higher prices. The 55d is acting as key S/R
so that will be vital to watch, as of course will be the rates markets. By the time JGB yields start
getting bullish JPY, I think the market sentiment will have shifted toward all-out outflows from
Japanese markets as sovereign debt concerns become the theme to watch. Below is chart,
courtesy of Zero Hedge, highlighting one of the reasons why I think that the JGB crisis everyone has
been waiting for finally has the potential for hitting next year. Demographics and debt
serviceability confirm the risks.

December 6, 2010|4
Netflix CFO Barry McCarthy’s resignation and replacement was announced today, sending NFLX
stock down almost 3% after-hours. ZH noted last week that McCarthy sold about 100,000 shares of
stock around $200 average PPS and recent NFLX weakness around that century mark may partially
due to his selling. The “false breakout” through $200 is a bearish technical development for NFLX
(and one of the reasons I went short the stock on Friday of last week) and century marks that don’t
hold often tend to mark tops or precede weakness. Given NFLX’s AOL-esque business model and
the unsustainability of their weak technical server infrastructure (not to mention the new fees
Comcast is charging), I think the fundamentals were ripe for an overvaluation-driven selloff for a
while, and the technicals are aligning for such a thesis to come to fruition. The asymmetric
risk/reward profile of my short was vital to my entering it, however, and stocks like this are
notorious for going from too-expensive to outrageously-expensive so be watching the charts. The
high-volume selloffs last week and now a potential bear flag in the making are looking bearish for
NFLX, and if the $180 level doesn’t hold, the CFO’s departure may have marked the top for this
roaring stock.

December 6, 2010|5
 Trades
OPEN
Long VECO | 39.00 | stop 45.70 | +19.72%
Long ACAS | 6.67 | stop 7.55 | +14.694%
Short EUR/CHF | 1.3725 | stop 1.3210 | +645 pips
Long USD/HUF | 195.45 | stop 192.70 | +150 pips
Short ACOR | 28.00 | stop 27.30 | +5.07%
Short /HG | 4.06 | stop 4.15 | +1.72%
Short AUD/USD | 0.9980 | stop 1.0075 | +205 pips
Long SGD/JPY | 63.60 | stop 62.95 | +15 pips
Long SNE | 33.70 | stop 32.30 | +7.12%
Long HIT | 47.35 | stop 44.80 | +5.36%
Long /NKD | 9768.00 | stop 9686.00 | +4.63%
Long N | 24.00 | stop 23.20 | +9.17%
Long NOG | 22.20 | stop 21.80 | +10.32%
Long AAPL | 307.50 | stop 295.35 | +3.48%
Long CSTR | 63.45 | stop 58.15 | +2.24%
Long MAT | 25.25 | stop 24.80 | +1.58%
Long SNDK | 42.95 | stop 40.35 | +11.18%
Long CMCSA | 20.15 | stop 19.70 | +3.18%
Long REGN | 29.25 | stop 28.35 | +3.67%
Long VSAT | 40.75 | stop 39.90 | +6.13%
Long THRX | 21.65 | stop 20.55 | +23.88%
Long XEC | 81.00 | stop 78.15 | +7.44%
Long FWLT | 28.30 | stop 27.00 | +8.13%
Long GRA | 33.40 | stop 31.00 | +4.43%
Short GBP/USD | 1.5700 | stop 1.5850 | +10 pips
Long CHF/HUF | 208.00 | stop 205.00 | +50 pips
Long NG | 14.05 | stop 13.50 | +14.02%
Long CIE | 10.85 | stop 10.10 | +22.21%
Long STT | 43.50 | stop 41.80 | +4.62%
Long PCAR | 54.95 | stop 52.00 | +1.58%
Short FRO | 26.10 | stop 27.00 | +2.34%
Long /CL | 85.00 | stop 82.80 | +3.29%
Short /NG | 4.33 | stop 4.60 | -1.39%
Long SINA | 63.75 | stop 62.05 | +8.39%
Long CLW | 80.80 | stop 78.50 | +0.25%
Long IO | 7.03 | stop 6.64 | +14.94%
Long /ZW | 690.00 | stop 675.30 | +11.78%
Long /ZC | 550.00 | stop 541.90 | +0.91%
Short GBP/SEK | 10.905 | stop 11.115 | +50 pips
Long X | 48.10 | stop 46.40 | +10.10%
Long MEE | 49.10 | stop 47.25 | +3.71%
Long WLT | 104.50 | stop 100.05 | +8.37%
Long BTU | 58.00 | stop 55.00 | +5.98%
Long RIMM | 60.50 | stop 57.70 | +2.68%
Long XTXI | 9.35 | stop 8.95 | +0.21%
Long PRX | 37.30 | stop 35.50 | +1.88%
Long AIN | 21.80 | stop 20.80 | +8.26%
Short AUD/CHF | 0.9700 | stop 0.9810 | +20 pips
Long CNQ | 40.60 | stop 39.20 | +4.80%
Short EUR/NOK | 8.050 | stop 8.080 | +100 pips
Short NFLX | 191.25 | stop 196.10 | +3.35%
Long DRYS | 5.60 | stop 5.35 | +7.50%
Long SOHU | 71.50 | stop 67.95 | +7.71%
CLOSED
Long EK | 4.79 | sell 4.70 | -1.88%
Long AMR | 8.22 | sell 8.25 | +0.36%
Long TGA | 14.65 | sell 19.80 | +35.15%
Long VSH | 14.15 | sell 15.00 | +6.01%
Long SLW | 34.80 | sell 41.60 | +19.54%
Short CCE | 24.00 | cover 25.75 | -7.29%
Long SWC | 19.80 | sell 22.50 | +13.64%
NEW
Long VXX | 39.95 | stop 38.50
Long SPXU | 20.95 | stop 20.50
Long ZSL | 10.95 | stop 10.15
Short JKS | 23.10 | stop 25.10
Long ONXX | 33.25 | stop 32.45
Short JPM | 39.60 | stop 40.40
Short ISRG | 267.00 | stop 272.00
Short SCCO | 46.80 | stop 48.10
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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.
December 6, 2010|6