“How Many Times Can You Fold A Piece of Paper in Half?”
- Me, elementary school exponential growth curriculum
I’ve led with that question on multiple occasions when making a guest teacher cameo at my kids elementary school.
No one has ever guessed a single digit number!
Note: if you’ve never played this exponential growth game: 25 folds ≈ height of empire state building, 50 folds ≈ to the moon … & back!)
Our intuition, shaped by everyday experience and the need/utility for simple extrapolation/heuristics, tends to be overwhelmingly linear.
The more and earlier we cultivate an intuitive understanding of nonlinear dynamics the better, imho.
Q: How does something go down -95%?
A: By going down -78%, twice.
VOYG or crypto alt coin exposure anyone?
Bear market math, market non-linearity and knife-catching PnL intuition remain important lessons to internalize early.
Back to the Global Macro Grind…
So, nominal yields down (again), Inflation expectations (Breakevens, 5Y5Y forwards) making lower 2Y lows (again), corporate spreads widening further (again), higher highs in Treasury (MOVE) and Fx Vol, Inversions percolating across the curve, Industrial & Ag commodities in trap door formation, the 3AC and CeDefi dominoes still in contagion mode, rate hike expectations falling (again), rate cut expectations for 1H23 in crescendo and fresh highs for the $USD.
That right there mi macro amigos is a quintessential, interconnected Quad 4 cross-asset class factor cocktail!
Oh … and the lone holdout to not yet break @Hedgeye TREND, oil, decided playing atlas for late commodity longs was a shitty gig and capitulated as oil vol ripped and crude crashed through the $107 TREND line.
So, the Fed pivot is imminent and the post-GFC pavlov bid to high beta, unprofitable, expensive growth is ripe for front-running, right?
We are indeed baby stepping towards policy capitulation and they will need to pivot, at least rhetorically and/or on the margin. I think they know that.
But here’s the issue, and there’s nothing particularly profound about this take, but I think the gravity associated with it still allows it to define the near-term macro-policy nexus …
What’s a likely outcome if they don’t hold the hawkish line sufficiently long enough?
Equities rally, financial conditions ease, the $USD falls, everything priced in dollars (oil, commodities, etc) goes up, still acute demand-supply imbalances re-worsen and inflation expectations don’t re-anchor.
Everything their fledgling tightening campaign aspired to gets unwound … with a good chance re-inflation ultimately leads to a larger disinflationary/deflationary bust.
All of those things need a credible reset. The goal is to annualize the (inflation) growth numbers, then slow walk macro fundamentals back so the changes become measured. In effect – and this is an oversimplification but I think its conceptually sufficient - reset to 2019 and attempt another run at controlled secular growth.
None of that happens if they pivot before QT even really starts, before (mostly) fulfilling the promise of protracted tightening, before the price data prints protracted disinflation ….
…. And before the profit cycle reckoning actually plays out.
Remember, denominator risk (the E in P/E) remains front and center and regardless of ‘technical’ recessions or shifting ‘soft landing’ probabilities, a profit purge remains in queue.
As we highlighted on our 3Q Themes call, the setup is basically this:
Consensus is still modeling +10% Y/Y growth in 3Q against one of the hardest comps ever and +10% Y/Y growth for the year despite an already conspicuous slowdown in the data, intensifying layoffs & hiring freezes, another +200 bps of hikes all but guaranteed, a burgeoning inventory overhang, all manner of still acute labor/commodity input cost pressures, still ATH margins, a massive negative wealth effect impulse, a historically strong dollar, a Quad 4 outlook for most DM economies globally, negative growth in 1Q, -2% growth in 2Q (by the Feds own model estimate) and an expectation for domestic conditions becoming dire to the point of the mkt forecasting outright recession and prospective rate cuts in 1H23.
If that framing feels hyperbolic or overly one-sided then simply re-frame the contextualization and filter it though a balance of risk lens.
Given the prevailing RoC trajectory of macro fundamentals, the near-to-medium term Quad trajectory, both globally and locally, and the profit cycle realities listed above, is it more likely the asymmetry (for estimates, guidance, earnings growth) is to the downside or upside?
For its part, with Treasury and Equity Vol diverging again and Corporates Spreads continuing to cast a dismissive, circumspect eye at any schizo beta rally in equities, credit continues to (consistent) vote in favor of ‘reckoning’.
Now, if you’re in the market for some discounted silver lining, here are some bull scraps:
- 2Q21 represented some of the toughest ROC comps ever. While base effect gravity will remain strong into 2H, it does ease on the margin, particularly as we move beyond the stimulus comps
- Wholesale gas prices are tanking which should see flow through to pump prices over the coming weeks. Gas price are one of the most tractable/real-time inflation measures visible to consumers and inflation there tends to flow through to sentiment and consumer confidence.
- Job openings (Indeed weekly data) are declining, Initial claims are increasing modestly, payroll gains are moderating and the momentum in hourly earnings growth is fading. This is what the Fed wants. To the extent labor supply goes up, labor demand goes down (but hiring remains positive), wage pressure ebbs on the margin, output/supply increases (supply pressure eases) and (supply shock driven) Inflationary pressure eases … the need for tightening goes down. That remains the elusive ‘soft landing’ policy needle thread scenario. Possible? Yeah. Probable? Nah rily.
With respect to tactically risk managing the right now, here’s the Top 3 from KM this morning:
- OIL – the only major Commodity to NOT break @Hedgeye TREND support broke TREND ($107.03 WTI) yesterday and was like a hot-knife through butter towards the low-end of my Risk Range… so now we have a proper #Quad4 Disinflation playing out (Energy Stocks broke my TREND support in mid-June, don’t forget). With Copper’s crash now at -31% since March and Softs like Cotton and Oats down -9% and -27% (in a day!); reiterating our SELL call on Commodities as an Asset Class vs. Long USD
- GOLD – could have been worse! (see all other Commodities that you could/should be short against Gold)… but they took Gold down through @Hedgeye TREND support of $1771/oz yesterday and we’ll see if that TREND break holds – with my Vol of Vol (#VASP) Signal saying all Gold Volatility did was make emotional types cry at the top of a 18-22 Volatility Range (GVZ), I’ll have patience with my Long position here as it continues to generating alpha vs. Commodity Shorts
- CURVE – properly inverted with front-month at -3 basis points now on 10s minus 2s AFTER the Bond Market just priced-in -1.97 LESS rate hikes since the last rate hike (2yr Yield down -60bps since mid-June); like Oil crashing, this too is proper #Quad4 price response to the Fed TIGHTENING into #RecessionRisk Rising – 8 of 11 US Equity Sectors down on that yesterday with the 3 of 11 that were up being the ones that have crashed the most – entering a recession is not a buy signal – if anything both my 2yr and 10yr Yield Signals are that Yields are going to bounce here into Fed Minutes and another hawkish CPI print for June
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:
UST 10yr Yield 2.77-3.34% (bullish)
UST 2yr Yield 2.78-3.21% (bullish)
High Yield (HYG) 72.75-74.86 (bearish)
SPX 3 (bearish)
NASDAQ 10,672-11,618 (bearish)
RUT 1 (bearish)
Tech (XLK) 124-132 (bearish)
Shanghai Comp 3 (bullish)
Nikkei 25,680-26,920 (bearish)
DAX 12,326-12,933 (bearish)
VIX 26.19-32.63 (bullish)
USD 103.60-106.98 (bullish)
EUR/USD 1.020-1.053 (bearish)
USD/YEN 133.81-137.00 (bullish)
GBP/USD 1.191-1.227 (bearish)
CAD/USD 0.763-0.778 (bearish)
Oil (WTI) 97.06-110.13 (bearish)
Nat Gas 5.21-6.88 (bearish)
Gold 1 (neutral)
Copper 3.33-3.85 (bearish)
Best of luck out there today,
Christian B. Drake
Macro & Housing
