"Victorious warriors win first and then go to war, while defeated warriors go to war first and then seek to win."
- Sun Tzu
Have you been a victorious warrior in the markets this year? That's a challenging question for many investors because if you are long only... almost all global asset classes are down for the year. The big exceptions are oil, natural gas, other subsectors of commodities, and the dollar.
In years like this, winning isn't necessarily about positive performance. But much more so about downside protection and limiting those nasty drawdowns. Protecting your family and client’s hard-earned capital is critical in years like this. It provides financial support, fire power, and the mindset to start taking on risk when the moment arrives.
As to benchmarks for whether you have been a Victorious Warrior, consider the YTD performance of a few of the largest ETFs so far this year:
- SPY -21.5%;
- QQQ -30.2%;
- VTI -22.5%;
- VEA -20.5%
- AGG -11.79%.
Some 3/4s of a trillion of dollars in just five of the largest ETFs are down more than -20% on average less than six months into the year. If you are beating those numbers by a meaningful amount, you are a Victorious Warrior in many respects.
The challenge with suffering losses is that it induces something called The Hot Stove Effect. This idea was popularized by that great behavioral economist Mark Twain. According to Twain, if a cat jumped on a hot stove, then she would never jump on a hot stove again.
Similarly, in true bear markets a real characterization of a bottom will likely come when investors have been so “burned” by being long risk that they will be reluctant to take any for the foreseeable future. Are we at this point now? Probably not as the checklists of a bottom and comparisons to prior cycles from the frequentists proliferate almost daily.
Back to the Global Macro Grind…
On the topic of capitulation, where are we at today? Two of our favorite measures of positioning are CFTC futures and IVOL. As of this morning, this is where we sit on these measures:
- CFTC positioning in equities came into the week mixed. On one hand, Russell 2000 has a net short position of -98K contracts. But on the other hand both the SP500 and Nasdaq had net long positions with the Nasdaq’s net long position at a +1.58X Z-Score on a 1-year basis; and
- As of this morning, the majority of equity sub-sectors were trading at IVOL discounts. Leading the way on the discount side is $XLY consumer discretionary at -23%. Conversely, those subsectors with IVOL premiums were mostly in single digits, with the exception of $XLU utilities at +21%.
So, are we at a bottom based on capitulation? Well not so much.
The most interesting global data over the last 24 hours comes from Europe where we again saw accelerations in inflation readings from both Germany and the United Kingdom. Yesterday, Germany’s PPI came in at +33.6% Y/Y and logged another all-time high. This morning we had U.K. CPI at +9.1% Y/Y and input PPI at +22.1%, which were both new 40+ year highs.
These global PPI readings are particularly important because they are typically leading indicators for CPI. As inflation comes into the system via PPI, it is eventually passed on to the consumer through price increases. In the Chart of the Day, we take a look at these divergences in Europe.
At the moment, the difference between Eurozone CPI and PPI is -29.8. As the chart shows, this is like nothing we’ve seen in the last 25+ years. In fact, at the moment this divergence has a Z-score of -6.5, a reading this high is extremely rare. Ultimately, CPI will likely narrow the gap with PPI and provide consternation for the ECB, whose policy makers have been relying on the other global central banks to do their monetary tightening dirty work.
But... just as inflation continuing to hit new highs globally, we have oil and other commodities starting to roll over. This morning both Brent and WTI oil are down -4.5% and also down some -12% over the last two weeks. Now to be fair, oil is still up +42% Y/Y and has easy comps into Q1 2023, but this is a deceleration of inflation expectations nonetheless.
If all these cross currents are confusing, that is probably the market’s intent. As Sun Tzu also famously wrote:
“The whole secret lies in confusing the enemy, so that he cannot fathom our real intent.”
To offset this confusion, stick with the process and the game plan. We effectively see global #Quad4s into Q1 2023 and, at the moment, our top macro ETFS are:
- UUP, PXE, KWEB, BNO, GLD, and AMLP
While BNO may hurt this morning, being long dollars, underinvested, and having a large cash position will still make us Victorious Warriors.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:
UST 10yr Yield 3.06-3.57% (bullish)
UST 2yr Yield 2.85-3.57% (bullish)
High Yield (HYG) 71.71-76.44 (bearish)
SPX 3 (bearish)
NASDAQ 10,204-11,601 (bearish)
RUT 1 (bearish)
Tech (XLK) 117-134 (bearish)
Energy E&P (PXE) 26.56-36.50 (bullish)
Shanghai Comp 3 (bullish)
Nikkei 25,111-26,724 (bearish)
DAX 12,712-13,533 (bearish)
VIX 26.99-37.15 (bullish)
USD 102.30-106.12 (bullish)
EUR/USD 1.033-1.065 (bearish)
Oil (WTI) 103.90-126.05 (bullish)
Nat Gas 6.12-7.99 (bearish)
Gold 1 (bullish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
