“There is nothing wrong with change, if it is in the right direction.”
We are starting today’s Early Look on a more administrative note. Our Founder and CEO Keith McCullough will be retiring as CEO of Hedgeye effective today, and going forward will be Chairman Emeritus of Hedgeye. Keith’s decision was motivated by a desire to spend more time with his family and to pursue some long standing personal interests. Later this morning, we will be announcing our new CEO, someone who we think will be able to rightfully build and grow on Keith’s legacy. We wish you the best Keith! (If you would like to send Keith a personal note, you can email and we will forward it to him.)
With that, we’ll now turn back to the daily morning macro grind.
Continuing on the theme of change, we want to highlight three key areas of risk management change that have been percolating over the last few weeks:
1. TRADE Duration Change – 3 Weeks or Less – A key investment theme over the past two years, and really since the inception of the U.S. government’s weak dollar policy, has been the high negative correlation between the U.S. dollar and both U.S. equities and global commodities. As we noted earlier this week in an Early Look, this has changed on a shorter duration. In fact, currently the 3-week correlation between the USD and SP500 is +0.29. So, while it is not strongly positive, it is positive and this is new. We’ve long submitted that a stronger USD is ultimately positive for the U.S. economy and stock market and, on the margin, we are starting to see this reflected in market prices. As you manage risk in your portfolios in the coming weeks, this is an inflection point of change to keep front and center.
2. TREND Duration Change – 3 Months or More – Over the course of the last eight weeks, we’ve witnessed an extreme acceleration and deceleration in volatility (as measured by the VIX), which has been reflected in the price movements of U.S. stocks. While the market has recovered from its March lows, the risks of The Inflation, sovereign debt, and interconnected global risk remain. The obvious next potential negative catalyst is potentially earnings season in the United States, which will begin in fervor in mid-to- late April, where we will potentially see the impact of The Inflation tax on both consumer demand and corporate earnings.
In the Chart of the Day, attached below, we’ve shown the volatility in the U.S. stock market from February 18th to the close yesterday. In effect, we had a more than 10% move, which was 5%+ down and then 5%+ up. At the same time, volatility in stock market prices, as measured by the VIX, had a comparable move up and then down. While the last couple of quarters saw a steady climb in the stock market, beginning with the catalyst of The Bernank’s announcement of The Quantitative Easing Part Deux in Jackson Hole, the last 6+ weeks seems to be a new paradigm of price volatility both up AND down.
3. TAIL Duration Change – 3 Years or Less – A longer term theme, or risk, that has developed over the course of the last month is accelerating geopolitical uncertainty in the Middle East and North Africa. In early January, this all began with the Jasmine Revolution in Tunisia, which, at the time, was perceived to be limited in scope. Since then civil unrest has spread throughout the MENA region and the threat of regime change is becoming the norm. While some regime changes have been largely peaceful, like in Egypt, others have been much more violent, like Libya. As the Obama administration continues to evolve their foreign policy strategy real time, these outcomes will remain largely uncertain.
We wrote a note to our Macro subscribers earlier this week titled “Obama’s Foreign Policy . . . Bush Doctrine Take Two”, which compared Obama’s preemption, as he articulated in his speech earlier this week with the expression “refusing to wait”, to the Bush Doctrine, whose primary objective was to preempt threats. As the Obama strategy continues to evolve, it is likely increasingly difficult that he can both “refuse to wait” in humanitarian interventionist situations, but also abide by his promise of “no boots on the ground”. In any event, despite early gains by the Libyan rebels, Gadafi’s forces appear to be taking ground back, which suggests the Libyan conflict will continue much longer than was expected after the initial NATO intervention. Oil, which is hitting a 30-month high this morning, implies as much and is also signaling that future stability in the Middle East is far from certain.
As we analyze the changes highlighted above that we have seen over the last few months and contemplate how to utilize them in making future investment decisions, it certainly seems that this is not change “in the right direction”. This is true in that heightened price volatility and increasing geopolitical uncertainty are not positive. That said, as it relates to future monetary and fiscal policy in the U.S., the positive correlation between a strong USD and equity prices is a positive change and hopefully a signal that The Bernank will heed accordingly.
On the U.S. dollar front, our view, unlike perhaps the Obama foreign policy, has been quite clear and consistent. As Winston Churchill also said:
“When you have an important point to make, don't try to be subtle or clever. Use a pile driver. Hit the point once. Then come back and hit it again. Then hit it a third time - a tremendous whack.”
Best of luck out there today.
Keep your head up and stick on the ice,
Daryl G. Jones