“In tennis, you strike a ball just after the rebound for the fastest return. It’s the same in investing.” -Masayoshi Son
I picked up tennis in the last couple years and I've become a bit obsessed. As a late comer to the game, there is so much to work on. Footwork, grip, strategy, stroke . . . the list goes on of things to improve. But what I've realized in amateur tennis is that the real key is to get the damn ball back over the net!
My realization is born out in the data. Based on a number of studies, most points in tennis are won in 5 shots or less. So, if you're playing the odds, your odds improve dramatically simply by getting the ball back to your opponent twice. Seems easy enough.
Investing isn’t much different. We need to take what Mr. Market gives us and despite our style or thesis put some points up in our portfolios. This can be challenging in times when the market is going against that thesis (as it has been in some assets for us over the past 6 or so weeks). Practically speaking, playing the odds typically prevails over time.
One could argue that leading off with a quote from Masayoshi Son isn’t the best nod to risk management. The CEO of Softbank doesn’t necessarily have the best batting average in his investments. During the dot-com bust he lost some $70 billion. But when he was presented with the opportunity to hit the ball perfectly, he did by turning $20MM into ~$180 billion via a 30% stake in Alibaba.
In our process, we have a built-in stop loss tool via our Risk Ranges. Despite the prevailing macro environment, if the risk range turns bullish on an asset class, even if our macro models are telling us we should be bearish on that asset, we will get out of the way. This approach of having two countervailing views is challenging, but important to master when successfully investing.
Back to the Global Macro Grind . . .
At the moment, the big debate is whether inflation has peaked and what the implications of that could be for Fed policy. In Europe, there is much less of a debate because inflation hasn’t peaked. Consider some of the inflation data from Europe over the last 48 hours:
- Eurozone July CPI came in at +8.9% Y/Y, which is an acceleration over June’s reading of +8.6%
- U.K. CPI came in at +10.1% Y/Y, Retail Prices at 12.3% Y/Y, and Output PPI at +17.1% . . . all of which were near 40-year highs
- German PPI came in at +37.2% Y/Y today and +5.3% M/M, which is an all-time high
Decelerating inflation? Well, not so much in Europe.
At the same time, Eurozone GDP also decelerated in Q2 to +3.9% Y/Y from +5.4% Y/Y in Q1. Given some of the recent sentiment surveys from Europe, like today’s all time low in U.K. consumer confidence or Monday’s drop in Eurozone economic sentiment to -53.8, the growth slowing party may just be getting going across the Atlantic.
From a positioning perspective, our top 3 signal country level shorts in Europe are Poland $EPOL, Italy $EWI, and Germany $EWG. Maybe we will be wrong in shorting these regions, but sentiment collapsing, growth slowing, and inflation accelerating will likely help our cause. The icing on the cake? The ECB will probably be forced to hike into an economic slowdown because of these high levels of inflation.
Back here in the U.S., investors experienced a bit of a bi-polar moment earlier this week when the Fed minutes came out. Initially, the minutes were viewed as incrementally dovish. The market bounced. But then the market sold off as maybe they weren’t dovish enough? We’ve always found it hard to parse commentary from the Fed, but the data itself is more conclusive.
On that last point, at the moment the U.S. yield curve is inverted at -32 basis points, the 1-year forward curve is at -30 basis points, and the expectation for rate hikes for the remainder of the year is 4.82. Taken together, these market indicators explicitly point to slowing economic activity and tightening financial conditions.
Equities may be rallying, but the message here is quite clear.
Admittedly, the economic data in the U.S. is a bit more mixed than Europe. That said, it’s not good. In some cases it's pretty dreadful. As an example, on Monday (which seems like a lifetime ago in these markets) the Empire State Manufacturing Index dropped 42 points to -31.3. That's the second largest decline on record. Now of course that is one region and one statistic, but it's still downright ugly.
On the flip side, the bulls will say that the ever important U.S. retail sales weren’t all that bad coming in flat with last month’s report and up +10.3% versus a year ago. The caveat on the year-over-year numbers is a large driver was gasoline sales up +40% from last year. Also, when considering the impact of inflation, retail volumes were somewhat anemic (if not negative) as compared to last year.
There is certainly fodder for both the bulls and bears in these markets. Also, a lot of asset price moves are testing our conviction. As always, the mental and risk management part of the game are as important as ever. As the legend Venus Williams famously said:
“Tennis is mostly mental. Of course, you must have a lot of physical skill but you can’t play tennis well and not be a good thinker. You win or lose the match before you even go out there.”
The same could be said for the stock market game.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets
UST 30yr Yield 2.98-3.22% (bullish)
UST 10yr Yield 2.71-2.96% (neutral)
UST 2yr Yield 3.15-3.35% (bullish)
High Yield (HYG) 76.22-78.95 (bearish)
SPX 4011-4313 (bearish)
NASDAQ 11,884-13,186 (bearish)
RUT 1 (bearish)
Tech (XLK) 138-152 (bearish)
Utilities (XLU) 73.27-78.95 (bullish)
Healthcare (PINK) 25.49-26.63 (bullish) `
Shanghai Comp 3 (bearish)
Nikkei 27,835-29,443 (bullish)
DAX 13,401-13,935 (bearish)
VIX 19.00-24.22 (bullish)
USD 104.84-107.95 (bullish)
Oil (WTI) 86.01-94.78 (bearish)
Nat Gas 7.75-9.90 (bullish)
Gold 1 (bullish)
Copper 3.45-3.71 (bearish)
Bend your knees and focus on the contact point,
Daryl G. Jones
Director of Research
