“The only real failure in life is not to be true to the best one knows.”
Yesterday was the biggest down day for US stocks since August 11th of last year. If and when the US stock market starts to really break down again, I think the only real failures in our industry will be revealed by those who have chosen not to evolve their global risk management process from 2008.
One down day certainly does not a bearish trend make. But a -2.1% drop in price momentum on an accelerating volume study of +31% (week-over-week) combined with a one-day rip of +27% in volatility (VIX) should definitely have the bulls’ attention.
PRICE, VOLUME, VOLATILITY …
That’s the core 3-factor model I use across risk management durations. That’s what I have stayed true to since I re-built the model in 2007. That’s just part of my process. In order to embrace uncertainty as a given, I think a risk manager is best equipped to be Duration Agnostic.
The only real failure in my process would be choosing not to change the process as this globally interconnected marketplace changes. One of the key changes that I’ve made in the last 3 years is changing the durations in my models, dynamically, as volatility levels change.
I model all security level volatility from the bottom up, but to simplify this point I’ll use the VIX. Here’s where a closing price of 21.11 in the Volatility Index (VIX) fits across my 3 core risk management durations (TRADE, TREND, and TAIL):
So, in Hedgeye-speak, what’s happened to the VOLATILITY factor in the SP500’s 3-factor model is critical to acknowledge. Whether the TRADE and TREND lines of bullish VIX support hold or not is something that Mr. Macro Market will decide but, for now, what was overhead resistance in VOLATILITY is now support – and that’s bearish for US stock market price momentum. A breakout in the VIX above the TAIL line will make things crash.
Now if you take this 3-factor model:
And overlay it with a critical correlation – the inverse correlation between the SP500 and the VIX – you’ll see that this relationship has been one of the most important concurrent risk management indicators we’ve been offered since the early part of 2008. Ignore it at your own risk.
In the chart below, you can see that this isn’t foreign land for me to be treading on. When I made the bearish call for a US stock market correction in April of 2010 (our Hedgeye Macro Theme was “April Flowers, May Showers”) I gave you the same signals.
Well, almost the same…
Nothing in my models are ever really the same, particularly when I blow out the vantage point to that other sneaky little critter called The Rest of the World. That’s why my baseline Global Macro Risk Management Model includes 27-factors (which also change and re-weight dynamically) and include important real-time prices like the US Dollar, Indian stocks, Copper, etc…
And this is really where I can look myself in the mirror and say, despite the fierce lobbying for me to chase US stock market fund “flows” into their mid-February crescendo, I stayed true to the best top-down risk management process I know – when Global Inflation Is Accelerating, and Global Growth Is Slowing, it’s time to build up a large asset allocation to Cash.
Now not a lot of people have Street credibility on moving to Cash. Not only because they didn’t start making this move in early 2008, but because they don’t have an investment mandate that allows them to move into Cash. That’s an industry problem, not yours.
Global Growth Slowing is perpetuated by Global Inflation Accelerating. Anyone who has ever invested in emerging markets recognizes this basic reality. Everyone who is short Emerging Markets (EEM), India (IFN), and Brazil (EWZ), like we are in the Hedgeye Portfolio gets the profitability of it too.
The biggest question about Growth’s Failure in virtually all of Asia and the austere side of Europe that you can answer for yourself is will Global Growth Slowing affect the said “safe havens” of US and Japanese stocks?
My answer to this is not only implied by the high-frequency growth data that I grind through every macro morning, but it’s amplified by the math that stands behind the reality that Structural Long-Term Growth Is Impaired By Rising Sovereign Debts.
Whether it’s American, Japanese, or Western European debt, it’s all the same thing – debt. And that’s why we’re not surprised to see consumption growth slowing in these Developed Debtor countries as we infuse them with $95 oil and other inflation related taxes.
Growth’s Failure won’t be crystal clear to Wall Street until it’s in the rear-view mirror, but yesterday’s PRICE, VOLUME, and VOLATILITY readings combined with continued breakdowns in Asian Equities and a breakout in oil prices should read true “to the best one knows” about globally interconnected risks.
My immediate term support and resistance lines for the SP500 are now 1307 and 1330, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Notable news items/price action over the past twenty four hours.
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In preparation for PNK's Q4 earnings release tomorrow, we’ve put together the pertinent forward looking commentary from PNK’s Q3 earnings call.
VFC front-loaded a lot of good ‘ol fashioned optimism. But you need a lot of Hope and Luck to get ’11 guidance. The risk/reward here looks flat out bad.
VFC isn’t the kind of company that tends to surprise us on the average EPS print. After all, it’s a $14bn portfolio of brands (about the same size as Gap) that spans just about every relevant category out there. In other words, the company realistically should not dramatically outperform the industry, because it IS the industry.
We understand the ‘quality of management’ factor. But two days ago, if you’d have asked me what the probability is of VFC beating the quarter, AND taking up estimates to a level suggesting 10% sales AND EPS growth in 2011, I’d have said (and did say)…
“Even if they think they can do these numbers, there’s 87% of the year left to go. They do themselves no favors by doing this now.” That’s particularly the case due to VFC’s expectation for success in large part to a consumer and retailer-led price increase.
I sat here for two hours on this VFC model, and I legitimately cannot find a way to get above $7.00 for the year. I’m shaking out at about $6.45 (flat year/year).
Here’s what you’ve got to believe to get their numbers
And lastly, I’ve got to point out something related to cost inflation that we published earlier today. It’s quite relevant here. There are three stages we think companies are (or are not and should be) concerned about cost inflation. Let’s go in order of simplicity.
1) Control what you can control. The companies see the same tape we do and where prices are headed, and they plan accordingly with their own procurement. Focusing solely on this will blow them up.
2) Workup a strategic plan as to how they think their supply chain partners will react when faced with a meaningful change in their cash flow. I’m referring to how a brand like Lee, Wrangler and North Face react when price is altered by Levi’s or Columbia, respectively.
3) In addition to the two preceding points, the most successful companies are planning for how a supply chain partner will look to squeeze when it’s hurt in other categories. For example…what happens if the ‘food inflation pass through’ is maxed out and Wal-Mart needs to face a food price increase at risk of losing additional traffic?
Why not push it through to more discretionary and highly fragmented categories like apparel and toys?
Go out and ask a CEO of a ‘basics’ apparel company if he has ever knowingly funded markdowns in fresh fruit. He’ll say no, and he’s not lying. He’s simply unaware.
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