Shadow Capitalism

Market Commentary by Naufal Sanaullah

Naufal Sanaullah Portuguese auction goes as expected, risk bid as EU officials

naufalsanaullah@gmail.com
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offer encouraging words & Beige Book confirms US growth
Noisy day today as Portugal issues €1.25b in 5yr & 10yr paper, although higher-range allotment did
require a bit of low bidding. 5yr BTC worsens from 2.8x prior to 2.6x, while the 10yr sees a step-up
from 2.1x to 3.2x bid-to-cover. Although the 2020 paper saw a decline in 10yr auction yield from
681bps to 672bps, the lower-duration notes jumped from 404bps prior to 540bps. Despite initial
weakness, encouraging comments from EU officials and rumors of further EFSF expansion sparked
a squeeze in euro assets and contributed to a pervasive risk-wide bid. Meanwhile, November
Eurozone IP jumps to 1.2% MoM vs 0.5% consensus vs 0.7% prior, and a constructive Beige Book
and bullish supply/demand figures from crude inventories and the WASDE report contribute to an
overall risk-on/USD-off day.

The S&P broke through the 1280 level I pointed out last night, on its way to a 0.90% gain on the
day, as the march upward continues unabated. However, significant resistance at 1300 is coming
up ahead quickly and may mark an interim cycle high in the next few weeks, perhaps leading to a
correction to 1225. Corporate default rates are back to levels typically marking lows in default risk
(chart courtesy of DoubleLine Funds), and as rates rise (as per my expectations) this year across
the board (with the exception of very short-end funding), this could put a damper on the current
rally, particularly if rising rates lead to a muni crisis in the US and/or the end of the Fed’s QE 2 leads
to rising vol. Still, growth is looking strong in the States from an economic standpoint, and
especially energy and other inflation-linked stocks should continue to outperform even against the
backdrop of rising rates.

January 12, 2011 |1

EURUSD slices through its 200d to the upside on the back of relieved Portugal auction jitters and
expansionary potential from EU officials regarding EFSF and rescue plans: Rehn mentions
deliberations about “size and scope” of Fund while Merkel issues positive willingness in response
to question about expanding EFSF. It is important to note that the euro did indeed selloff after the
530am EST Portuguese auction, and didn’t recover until less than an hour before NY session open.
In other words, short squeeze. I covered my EURUSD short around the 200d to book some profits,
but maintain my bearish outlook and QE prediction. 1.29 remains the short trigger, and a similar
resistance level in the /DX’s consolidation will add context. I remain highly net-short euros via
other crosses. ECB conference tomorrow: be looking for more book-talking from Trichet &
PRC/Japan. The ECB bought €1-1.5b in sov bonds in the last two days, according to Nomura, and it
will be interesting to see how this can be kept up without eliminating sterilization. It is important
for the ECB to act proactively before QE is forced upon it via failed sterilization.

January 12, 2011 |2

The US Dollar Index will provide significant context to both FX price action and risk as a whole, as it
is caught between its 55d & 200d. A break either way will likely see significant follow-through.
Through 81.65, I am back short EURUSD in size. Rising US yields should support USD, and imminent
resistance in equity indices (about 1.2% away) should bid USD.

A 2.15m drawdown in crude stocks, as per the DoE, vs 1.40m expected declines, sent crude
extending its rally again today. It is important to note that these figures are as of January 7, a day
before the Trans-Atlantic Pipeline leak, and as such don’t take into account the leak’s impact on
inventories. Oil continues to look very constructive, especially when global inflation is taken into
account.

Just take a look at some of today’s headline stories and data releases: US input prices rose 4.8%
YoY last month vs 4.5% expected and vs an upwardly-revised 3.9% in November. Australian 5yr
inflation compensation broke the 300bps level mark today, to four-year highs (which incidentally is
hawkish Aussie rates and increasingly troubling for mortgage serviceability in the world’s largest
property bubble). The Bank of Korea has declared an all-out “war on inflation” as it raised rates
again today, joining the ranks of several other NJA economies feeling the inflationary pressures of

January 12, 2011 |3

hot money inflows from low-yielding, CB-easing nations. Inflation- and unemployment-driven
rioting in Tunisia is heating up (and has even traveled west to Algeria), while the Interior Minister’s
sacking and troop deployment has done little to quell the riots. And to top it all off, a week after
the UN FAO warns that the world could be on the brink of another food crisis, an article entitled
“World move closes to food price shock” dawns the front page of the FT today.

It is obvious that inflationary pressures are absolutely existent and reaching pivotal points in many
economies, and this means politics are set to heat up. With (my mother country of) Pakistan still
holding nuclear weapons, host to Taliban in the northern FATA provinces, suffering crippling
domestic politics (especially after the assassination of Punjab’s governor, the ruling PPP’s
stronghold in the southern province that accounts for 50% of the entire nation’s economy, due to
opposition to extremist blasphemy laws), and carrying Asia’s highest inflation rate at 15.48%
CPI/24.65% wholesale YoY (as of November data), geopolitics are the last thing that need to be
heated up right now. And even besides longer-term macro issues, today’s WASDE report confirms
supply constraints in food commodities here in the States, particularly in soybeans and corn.

But behind all of the pessimism, there is a lot of positivity being represented by my recent trading
and holdings, as I’ve been loading up on US equity and continued to do so today. Below are some
nice charts that I wanted to point out, of fundamentally strong companies with nice earnings
growth, particularly in tech/semiconductors and defense.

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January 12, 2011 |5
And the last one, courtesy of ShadowCap contributor and University of Michigan senior (Ross
School of Business BBA) Aaron Murphy:

January 12, 2011 |6

$21b in 10yr Treasury supply was mopped up 1.2bps through auction-time open market prices, but
with the risk bid and sharp muni selloff, the rally was reversed and USTs closed the day back down
again. The record low primary dealer takedown (bringing the total outflows to $70b since
November, as per ZH) added fuel to the fire. With $112b in POMO purchases over the course of
the next four weeks, it will be hard for yields to break out of their current consolidation pattern,
but barring a breakdown, February could turn ugly for US fixed-income. And of course, when (if?)
the Fed’s easing programs mature, where exactly is the bid for bonds left coming from? Perhaps
rising yields & taxes will cause another second-half slowdown here in the US, but the safe haven
trade has gone from 80/20 Treasuries/PMs to more like 60/40. It all boils back to when the
risk/USD inverse correlation regime witnesses a paradigm shift. My guess is H2 2011.

Tomorrow brings NIESR UK GDP estimates, UK IP & manufacturing, BoE & ECB meetings, US PPI &
jobless claims, and the Spanish bond auctions.

January 12, 2011 |7

 Trades
OPEN
Long ACAS | 6.67 | stop 7.55 | +27.14%
Short EUR/CHF | 1.3725 | stop 1.3210 | +1035 pips
Long SGD/JPY | 63.60 | stop 62.95 | +80 pips
Long SNE | 33.70 | stop 32.30 | +8.01%
Long HIT | 47.35 | stop 44.80 | +15.63%
Long /NKD | 9768.00 | stop 9686.00 | +8.57%
Long N | 24.00 | stop 23.20 | +18.71%
Long NOG | 22.20 | stop 21.80 | +24.68%
Long SNDK | 42.95 | stop 40.35 | +20.77%
Long CMCSA | 20.15 | stop 19.70 | +11.81%
Long VSAT | 40.75 | stop 39.90 | +9.99%
Long XEC | 81.00 | stop 78.15 | +16.74%
Long FWLT | 28.30 | stop 27.00 | +30.32%
Long GRA | 33.40 | stop 31.00 | +9.73%
Long CHF/HUF | 208.00 | stop 205.00 | +85 pips
Long CIE | 10.85 | stop 10.10 | +26.08%
Long /CL | 85.00 | stop 82.80 | +8.25%
Long SINA | 63.75 | stop 62.05 | +27.92%
Long IO | 7.03 | stop 6.64 | +20.77%
Long /ZW | 690.00 | stop 675.30 | +12.75%
Long /ZC | 550.00 | stop 541.90 | +15.95%
Long MEE | 49.10 | stop 47.25 | +18.21%
Long WLT | 104.50 | stop 100.05 | +30.78%
Long ONXX | 33.25 | stop 34.95 | +7.46%
Long MELI | 67.80 | stop 70.75 | +8.10%
Short IVN | 27.90 | stop 29.50 | +11.72%
Short AUD/CAD | 1.0165 | stop 1.0260 | +360 pips
Short EUR/CAD | 1.3670 | stop 1.3290 | +750 pips
Short SCCO | 48.55 | stop 51.10 | +2.73%
Long USD/JPY | 81.90 | stop 80.95 | +110 pips
Long ZSL | 10.40 | stop 9.55 | +1.15%
Long TBT | 37.90 | stop 36.00 | +2.61%
Long VMW | 93.80 | stop 89.90 | +1.45%
Long NTAP | 57.80 | stop 55.60 | +1.96%
Long FFIV | 141.10 | stop 136.95 | +1.07%
Long DECK | 79.80 | stop 75.80 | -0.50%
Long ARUN | 24.50 | stop 22.65 | +1.18%
Short SLW | 34.20 | stop 35.75 | -0.96%
Short ANN | 23.05 | stop 24.80 | -4.77%
Short CAKE | 29.45 | stop 30.75 | +0.14%
Long CLF | 83.15 | stop 79.95 | +6.35%
Long LVS | 50.50 | stop 47.30 | -3.74%
Long /CT | 150.00 | stop 138.50 | -0.67%
Long RDN | 9.30 | stop 8.70 | +0.97%
Long AGU | 90.95 | stop 86.80 | +3.08%
Long SLM | 13.75 | stop 13.15 | +2.98%
Long OIH | 140.65 | stop 135.00 | +2.22%
Long CLR | 62.15 | stop 59.90 | +0.47%
Long DF | 9.80 | stop 9.25 | +0.41%
Long EWZ | 76.56 | stop 74.90 | +2.71%
Short GMCR | 35.15 | stop 36.50 | -0.51%
CLOSED
Long USD/HUF | 195.45 | sell 212.45 | +170 pips
Long REGN | 29.25 | sell 32.70 | +11.79%
Short EUR/NOK | 8.050 | cover 7.720 | +330 pips
Short EUR/USD | 1.3365 | cover 1.3065 | +300 pips
Short AUD/USD | 1.0015 | cover 0.9912 | +103 pips
NEW
Long /ZS | 1418.85 | stop 1381.75
Long CCME | 17.55 | stop 16.70
Long ADI | 37.90 | stop 36.90
Long BRCM | 46.00 | stop 44.00
Long MXIM | 25.02 | stop 24.45
Long TER | 13.80 | stop 13.25
Long NVDA | 20.66 | stop 19.00
Short ACOR | 28.90 | stop 30.60
Long MOS | 78.65 | stop 74.55
Long ERJ | 30.10 | stop 28.90
Long TDY | 45.05 | stop 44.85
Long ELX | 12.55 | stop 11.50
Long LUFK | 62.80 | stop 59.90
Long LULU | 72.90 | stop 68.50
Short CGA | 7.48 | stop 8.05
Short ECH | 73.40 | stop 76.10
Long TITN | 21.30 | stop 20.45
Long HBAN | 7.27 | stop 6.95
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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 12, 2011 |8