“Courage is willingness to take the risk once you know the odds. Optimistic overconfidence means you are taking the risk because you don’t know the odds. There is a big difference.”
- Daniel Kahneman
Earlier this week I had to make a quick trip to Rochester, NY and randomly ran into someone in the Rochester Airport from my hometown. That might not seem like much of coincidence, but Bassano is some 2,000 miles from Rochester and has a population of only 1,200 people (and no stop lights).
What are the odds?
Ironically, I had just listened to an episode called “What are the Odds?” on the podcast “The Hidden Brain”. This particular episode dealt with the idea that these coincidences, or low probability events, may not be as rare as our brain initially expects them to be. There are many reasons, but basically the law of large numbers implies that we will all experience a low probability event at some point.
As stock market operators, we know this lesson all too well. In fact, some would argue that we just experienced a very rare event in the market sell off as the pandemic stared to gain momentum. Specifically, the “sequence of panic selling on March 9th, 12th, 16th and 23th of 2020 that led to the cumulative 26% percent drop of DJIA”. This was one of the more significant stock market crashes of modern times.
What are the odds?
Well, if we go back less than 5 years to June 24th, 2016, we had a series of one day market events that were seemingly even more rare thanks to Brexit. On that day, the IBEX 35 (Spain) dropped -12.4%, which is a “8-sigma event”, so according to statisticians occurs once ever 6.4 trillion years.
Misinterpreting real-life probabilities versus financial market probabilities, often occur for very different reasons. In real life, we likely misunderstand the odds unique to us specifically or the number of low probability events that actually occur. While in financial markets, the issue is that the whole framework for understanding probabilities is wrong.
In much as we would like them to be, markets are not linear and do not have normal distributions. On a basic level, a sigma denotes how far from the average a specific data point falls. But if we all agree that markets are not normally distributed, why create odds around that assumption? In some corners of Wall Street Group Think, it probably makes risk managers sleep better.
In reality, markets are chaotic, fractal, messy, and prone to seemingly “low probability events”. Understanding and preparing for this actuality is what will make us all sleep better.
Back to the Global Macro Grind...
Later this morning we get July’s U.S. CPI reading. This is last of the CPI comparisons that are below pre-pandemic levels. CPI in July 2020 also increased +0.5% from June 2020, so from a comp perspective the probability is reasonable that we get an above consensus and high, sticky report for CPI. Shelter, at 32% of the reading, will likely be the river card (highlighted in the Chart of the Day) as it came in at only +2.6% Y/Y last month and remains well below its pre-pandemic average of between 3.2 – 3.5%.
The NFIB Small Business report from yesterday certainly under scored the expectation of inflation among small business owners. On the topic of prices, small business are indicating that actual prices (past 3 months) and planned price increases (next 3 months) are at the highest levels since the 1980s.
It’s just transitory . . .
Speaking of CPI, it accelerated again this morning in the European Union. German July CPI came in at +3.8% Y/Y and 0.9% M/M, while EU harmonized came in at +3.1% Y/Y and 0.5% M/M.
While still below CPI in the U.S., this is a very sharp acceleration from June for both Germany (+2.3%) and the EU (2.2%). This has underscored our call on European equities, the acceleration economically and inflation related has lagged the U.S. As a result, we will likely continue to have a period in which the rate of change acceleration in Europe is higher.
Finally, for you stock junkies out there. As of yesterday, these are top stocks (not ranked) based on signal strength across our firm’s Best Ideas:
- POAHY, MP, FWONK, AMH, AMN, FB, GOOGL, ROK, V, PSA, TWTR, ADDYY, MTCH, SBUX, DASH, DFS, IRM, PLAN, JNPR, CUBE
As you can see, we think the “odds” still weight more towards a #Quad3 environment in the intermediate term.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:
UST 10yr Yield 1.17-1.41% (neutral)
UST 2yr Yield 0.18-0.28% (bullish)
SPX 4 (bullish)
RUT 2188-2260 (bearish)
NASDAQ 14,623-14,944 (bullish)
REITS (XLRE) 45.89-47.02 (bullish)
Tech (XLK) 152.08-155.40 (bullish)
Utilities (XLU) 66.06-68.05 (bullish)
Energy (XLE) 48.03-51.00 (bullish)
Shanghai Comp 3 (bearish)
Nikkei 27,8 (bearish)
DAX 15,495-15,896 (bullish)
VIX 15.43-19.76 (bearish)
USD 91.60-93.19 (bearish)
Oil (WTI) 65.21-74.92 (bullish)
Nat Gas 3.88-4.25 (bullish)
Gold 1 (neutral)
Copper 4.23-4.58 (bullish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
