“This [macro conditions set] is not a story we’ve seen before so the ending is not as predictable”
- Stan Druckenmiller
Derivative thinking is effectively a pre-requisite for macro analytical alpha.
There’s invariably some measure of selection bias inherent to the space … do higher-order thinkers gravitate to it, or does involvement in the space cultivate that capacity? I’m sure it’s both.
And there are some ‘interesting’ derivative effects.
If you’re constantly thinking in multiple steps, there’s a tendency to play forward an entire conversation in your head, determine there is invariably only one outcome, and then just fast forward the whole discussion to the conclusion … effectively skipping the actual ‘discussion’ part and moving on.
While conducive to decision making in dynamic, multi-dimensional problems, this tendency comes with real-life liabilities.
For a derivative_thinking_conditioned INTP macro-crypto analyst married to a Feeling Extrovert, recurrently attempting to unemotionally skip to the end of a conversation without actually having the conversation brings, um … “volatility”
What’s the point?
The most frequent question following our 1Q22 Macro Themes call (not 2Q, 1Q … as in the beginning of January) was some version of:
The comp setup is pretty obvious … aren’t base effects and any associated deceleration priced in already?
Just because you know the destination, doesn’t mean you don’t actually have to walk down the road. And the more unprecedented and uncertain the road, the more “interesting” the prospective journey.
If the scope and depth of the first order effects remain uncertain, then understanding and convictedly discounting higher order effects becomes intractable.
In other words … and maybe this is straining the metaphor …. if you don’t know how steep, or long, or littered with debris the road is, how can you effectively discount the likelihood of spraining your ankle or getting mugged and, then, the associated flow through impact on the probability of successfully or expeditiously completing the journey.
Invariably, Trending or acute clustering of volatility is what emerges …. a fascinating, two way transmission channel whereby volatility sits as both symptom and (progenitor) catalyst.
Back to the Global Macro Grind…
Quad 4 is more a journey than a destination.
It’s plotted as a discrete point on the GIP map but, practically, the game consists exclusively of front-running better/worse and getting ahead of prospective inflections in trajectory.
Let's contextually map where we are across the macro factor constellations that matter …
Consumption:
Consumer confidence is at all-time lows. Real-earnings growth is negative and falling while revolving credit (credit card balances) jumped to all-time highs and, at the same time, the interest rate on credit cards step functioned higher. Nominal spending has mostly held in but real consumption has moved to negative. For the bottom 20-40% of earners, excess savings has been (more than) fully depleted while for the top decile -$15.5T (equity + bonds) in financial wealth destruction is not the stuff wealth effect spending is made of. The demand-supply imbalance remains in the labor market but Job openings are now in retreat. Payroll trends will follow on a lag and labor trends define the trajectory for (organic) consumption capacity.
TREND = No Change = Deceleration
Investment/Industrial Activity:
Capex has remained relatively resilient – a move that, thus far, has been a fairly rational move for corporates, collectively, in the face of historic labor supply tightness/cost increases and a persistent demand-supply imbalance. But …. capex growth will invariably follow the consumption and profit cycles.
Meanwhile, the ISM’s date with sub-50 contractionary destiny remains about as pre-ordained as it gets. The cratering in the Fed Regional Survey’s for June or this morning’s Eurozone PMI (decline) sit as the ghost of ISM present and the sequencing observed in 2008 serve as an apt stylistic analog for present conditions.
In short: New Orders (demand) slows → Supplier Delivery Times slide → Prices follow on a short but variable lag.
*A note on Supplier Deliveries: The recent decline in Supplier Delivery Times in the ISM is arguabley a positive and indicative of easing supply constraints. We’ve detailed this recurrently over the past two years but to quickly recap …
The Supplier Deliveries series in the ISM Survey’s is scored inversely. That is, an increase in Supplier Delivery times is scored positively as it is conventionally a result of demand related production constraints. In the peri-pandemic period, there has existed a demand-supply imbalance but the increase in supplier delivery times has been largely from production related supply side constraints. This has created a bit of a false optic effect. That is, the outsized gains in the series amplified the Headline reading as it was rising while failing to capture the nature of underlying conditions. So, in the present instance, a decline in Supplier Deliveries is actually a fundamental positive even though it is scored negatively with respect to impact on the Headline reading
TREND = No Change = Deceleration
Profits et al:
CEO confidence is collapsing, IG and HY spreads continue to widen and corporate CDS remain on a one-way trek northward. Earnings are un-compable against artificially elevated 2021 demand, margins remain at/near all-time highs while operations remain beset by all manner of labor and commodity input price pressures.
Meanwhile, inventory depletion has fully reversed to an inventory overhang, much of which will need to be discounted and perhaps heavily to attract consumers, many of which have already begun re-trenching amidst the inflationary onslaught.
TREND = No Change = Deceleration
On Zombies, Policy & Inflation:
First, remember that an inherent side effect of large-scale interventionism/policy accommodation/QE is a distortion of the price discovery mechanism in markets and a further perpetuation of “zombie” dynamics.
A company that is otherwise operating unprofitably or inefficiently represents excess supply. Excess supply represents a disinflationary force and a productivity drag ... which perpetuates slower growth … which perpetuates the low rates which helped cultivate the problem in the first place.
This remains the larger policy paradox for global central banks and the Fed in particular. It has, arguably, only been further perpetuated by pandemic related policy initiatives
The longer inflation persists, profit cycle pressure persists and rates remain elevated, the higher the probability that decade(s) long zombification dynamics slam into reverse.
Inflation/Prices/Policy:
On the one hand, we now have bourgeoning disinflation (falling commodities/industrial metals/gas/Oil teetering on a TREND break) and recession concerns and on the other you have still acute stagflation angst. You also have falling breakevens (inflation expectations) and the market challenging the Fed's view on the terminal Fed Funds Rate while also pulling forward the timeline on rate cut expectations.
This represents the market transitioning to more discretely pricing in #Quad4.
Could renewed peak inflation hope and the Quad 4 catalyzed backslide in both rates and the dollar support some reflationary price action given the locus of concerns and the current strength of macro correlation trades?
Sure!
Markets are exquisite discounting machines. But generally only when there’s a tractable understanding of what’s being discounted and when balance of risk can be reasonably measured and observed shifting.
Filtering our process through this same lens:
- The Quads tell you the macro destination and the probable slope of the road.
- The #VASP Signal tells you what (and to what extent) and when something has been discounted, or not.
Now, to quickly circle this back to some humanistic messaging.
It’s not enough to adopt an empathetic mindset or harbor altruistic intentions. You have to actually ‘walk down the road’.
Seed the mojo you want to see propagated.
“Paying it forward” may be life’s highest convexity derivative.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:
UST 10yr Yield 3.00-3.56% (bullish)
UST 2yr Yield 2.83-3.51% (bullish)
High Yield (HYG) 71.80-76.30 (bearish)
SPX 3 (bearish)
NASDAQ 10,306-11,538 (bearish)
RUT 1 (bearish)
Tech (XLK) 118-133 (bearish)
Shanghai Comp 3 (bullish)
Nikkei 25,217-26,791 (bearish)
DAX 12,802-13,416 (bearish)
VIX 27.03-36.24 (bullish)
USD 102.46-106.14 (bullish)
Oil (WTI) 103.05-115.24 (neutral)
Nat Gas 6.00-7.90 (bearish)
Gold 1 (bullish)
Bitcoin 16,116-23,987 (bearish)
Have a great day,
Christian Drake
Macro & Housing
