“Except for some effects that I attribute mostly to age, my intuitive thinking is just as prone to overconfidence, extreme predictions, and the planning fallacy as it was before I made a study of these issues.”
- Daniel Kahneman
Human beings love to make predictions. If we include the specter of social media where everyone has a voice, and global markets where everyone has an opinion, there is obviously room for a lot of silliness in predictions.
Consider some of these beauties below from my investing career:
“As the rate of technological change in computing slows, the number of jobs for IT specialists will decelerate, then actually turn down; ten years from now, the phrase information economy will sound silly.”
- Paul Krugman in 1988
“It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of these Credit Default Swap transactions.”
- AIG Management in 2007, shortly before the company collapsed and received a $95 billion bailout
“I believe that it is virtually certain that Google’s stock will be highly disappointing to investors foolish enough to participate in its overhyped offering – you can hold me to that.”
- Whitney Tilson in 2004
“These subprime assets are so riskless that their capital for holding them should be under 2 percent.”
- Fannie Mae in 2004
"Ether could reach as high as $20,000 before 2022 and Bitcoin could see around $250,000 to $400,000 by year-end or fairly March 2022."
- Raoul Pal on the Bankless Podcast in 2021
In reality, investing isn't simply about definitive calls and nice round price targets. It's more about utilizing a repeatable process that assesses probabilities about outcomes, then adjusts in real-time as more information becomes available.
When you read articles or see so-called "experts" (or company management) saying things like “riskless”, “virtually certain”, “any kind of realm of reason”, or voicing absolute certainty about an outcome . . . more often than not it is time to take the other side of that trade.
Back to the Global Macro Grind...
So, what's Hedgeye’s view at the moment? Well, based on the Bayesian inference process we utilize in our macro models, this is what we see:
- Q3 2022E → Quad probabilities - Quad 1 → 61%, Quad 2 → 2%, Quad 3 → 1%, Quad 4 → 36%
- Q4 2022E → Quad probabilities – Quad 1 → 25%, Quad 2 → 4%, Quad 3 → 8%, Quad 4 → 63%
- Q1 2023E → Quad probabilities – Quad 1 → 46%, Quad 2 → 1%, Quad 3 → 1%, Quad 4 → 52%
If you are an optimist looking at these probabilities, you could conclude there is a chance for #Quad1 over the next three quarters. But, (and this is a big but) as time has progressed, the probabilities of #Quad4 have increased in aggregate for the next three quarters.
Rate of Change matters.
Incoming data also matters. This morning we got the NFIB Small Business Sentiment survey. The forward outlook component of the survey came in at -61 (featured in the Chart of the Day below). The outlook from small businesses in the U.S. is as bad as it has ever been.
Despite what the markets or asset prices may do from a day to day perspective, this #Quad4 scenario remains the high level picture. Into Q1 2023, the U.S. and most of the world will likely be in a #Quad4 environment. What could change that? Well, potentially inflation slowing quicker than expected and growth (and employment) decelerating faster. This would likely cause the Fed to go from tightening to easing and create much different comparisons moving forward in our models.
Will this type of shift happen in the short term? It is hard to say without a crystal ball! On inflation, we will get a few river cards this week with U.S. June CPI being reported on Wednesday and PPI being reported on Thursday. While we do think these reports have the potential of coming in lighter than expectations, they are unlikely to slow to a level that causes the Fed, or other global central banks, to alter the tightening path.
As for the global outlook, in many places inflation is much higher than the U.S. and growth is decelerating at a faster rate. Consider this morning’s Germany Zew Economic Sentiment Indicator for July . . . it came in at -53.8. This compares to the prior reading of -28 and consensus expectations of -38.6. Economic sentiment in Germany (and most of Europe for that matter) is worse than it was during the pandemic. Perhaps we get a quick rebound off these dismal sentiment indicators, though with financial conditions tightening and a looming energy crisis in Europe . . .that does seem unlikely.
One region that looks interesting in our models is China. For the next two quarters, China is in #Quad2, which is effectively a “risk on” environment.
Over the last week or so, that hasn’t seemed to be a very apropos call with regulatory concerns re-emerging and COVID bubbling up again. To the extent, our Trade, Trend and Tail models change on China, we will let you know. And if they do, that is probably a signal that the economic environment in change is changing as well.
While this all sounds a little dismal this morning, it shouldn’t. This is how cycles and markets work. They go from boom to bust and back again.
If I can leave you with two pieces of input it is: 1) don’t believe the “experts” and 2) the goal in #Quad4 markets is to play conservative and protect your hard earned capital. There will be a time to buy risk assets again. When that time comes we will be pounding the proverbial table.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:
UST 10yr Yield 2.77-3.28% (bullish)
UST 2yr Yield 2.77-3.22% (bullish)
High Yield (HYG) 72.69-75.11 (bearish)
SPX 3 (bearish)
NASDAQ 10,816-11,701 (bearish)
RUT 1 (bearish)
Tech (XLK) 124-133 (bearish)
Shanghai Comp 3 (bullish)
Nikkei 25,819-26,880 (bearish)
DAX 12,404-13,113 (bearish)
VIX 24.24-30.68 (bullish)
USD 104.76-108.42 (bullish)
EUR/USD 0.998-1.041 (bearish)
USD/YEN 134.91-137.43 (bullish)
GBP/USD 1.183-1.219 (bearish)
Oil (WTI) 96.13-106.17 (bearish)
Nat Gas 5.10-6.88 (bearish)
Gold 1 (bearish)
Copper 3.29-3.84 (bearish)
Keep your head up and stick on the ice,
Daryl G. Jones
