Prophecies of a Risk Manager

“One need not be a prophet to be aware of impending dangers.”

-F.A. Hayek

 

With the US stock market down for its 4th consecutive day yesterday I moved to our most invested position of 2011. The Hedgeye Asset Allocation Model now has a 37% position in Cash and the following allocations:

  1. Cash = 37% (down from 52% last week)
  2. International Currencies = 30% (Chinese Yuan, Canadian Dollar, British Pound – CYB, FXC, FXB)
  3. Fixed Income = 12% (Long-term US Treasuries and a US Treasury Flattener – TLT and FLAT)
  4. US Equities = 9% (Dividends and Technology – VIG and XLK)
  5. International Equities = 6% (China – CAF)
  6. Commodities = 6% (Gold – GLD)

This certainly doesn’t imply that I am a raging bull. Neither does it suggest that I am a raging bear. I really don’t think there’s a lot of value in being raging anything when you are tasked with being a Risk Manager.

 

In the past week I’ve moved from a zero percent asset allocation to US Equities to 9%. With virtually every sell-side strategist cutting their US GDP Growth estimates, and the US stock market’s price now down for the month-to-date, expectations for Growth Slowing As Inflation Accelerates are starting to get priced in.

 

JP Morgan’s earnings can be as good today as Alcoa’s were bad yesterday – then Bank of America can have no earnings on Friday. Managing risk in an environment where everyone isn’t a winner on earnings day anymore is going to present tremendous opportunities for the proactively prepared.

 

One of the hallmarks of effective risk management isn’t just having it in you to short and/or sell things when they are up – it’s having a repeatable risk management process to cover and/or buy them when they are down. Some people in this industry will tell you they can’t do that because that’s called “market timing.” And if you saw what some of these people do when under pressure, you should definitely take their word for it on that.

 

I’ve made two “Short Covering Opportunity” calls in 2011.  The first was on March 16th and I made the second one intraday yesterday (send an email to if you’d like our intraday Risk Manager notes). That’s not me pumping my own tires – that’s just me telling you what I did.

 

Short Covering Opportunities in these interconnected times aren’t raging bull calls to action. In this case I see every opportunity for the SP500 to bounce to another lower-long-term-high and lower-immediate-term high up at 1328. Then you start making sales again. If it’s not in your investment mandate to manage risk on a short to intermediate-term basis like this, that’s cool. I don’t have that mandate.

 

If the US stock market sees a breakdown below 1310 and Volatility (VIX) breaks out above $18.03 (intermediate-term TREND line resistance) again, this call to cover shorts and get more invested will likely be a bad one.

 

Why would it be a bad one? Because I made a short-term risk management decision to get longer yesterday in the face of mounting long-term risks. This is what we call Duration Mismatch – and every Risk Manager is hostage to its uncertainties.

 

Notwithstanding that the world’s reserve currency (US Dollar) has gone no bid and appears to be on a crash course to nowhere, here are some of the other major market risks that I called out on Thursday April 7th (before this 4-day correction in US Equities, Commodities, etc.):

  1. Hedge fund net leverage in February 2011 hit its highest level since October 2007 (the last market top)
  2. Hedge fund net-long exposure to Commodities has eclipsed the prior 2007-2008 peak in 2011 (special thanks to The Bernank)
  3. Institutional Investor’s Bullish-to-Bearish weekly survey just tanked to one of its lowest Bearish readings ever

The good and bad news is that all of these factors change in real-time. While it probably felt pretty cool to be levered-long oil and everything that is The Inflation trade last week, it didn’t feel so good yesterday – or the day before that. From their YTD highs last week, the price of oil (WTI) and energy stocks (XLE) are down -5.8% and -5.7%, respectively, in pretty much a straight line. Yes, chasing The Bernank’s Beta can leave a mark.

 

So… after prices fall:

  1. The largest net-long commodities position EVER in the hedge fund community will come down…
  2. The widest spreads ever between Bulls and Bears in the Institutional Investor weekly sentiment survey will come in…

And we’ll all go on in life dealing with the today.

 

Not surprisingly, today’s Bullish-to-Bearish weekly survey saw the spread between Bulls and Bears narrow by 2 points to +38 for the Bulls (down from last week’s +41). And the prophecy of this Risk Manager is that this spread will narrow again next week. At only 16.3% of institutional investors admitting they are Bearish, that number only has one way to go when stocks and commodities come down like they just did – and that’s up.

 

My immediate-term support and resistance levels for oil are now $105.23 and $109.02, respectively. My immediate-term support and resistance levels for the SP500 are 1310 and 1328, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Prophecies of a Risk Manager - Chart of the Day

 

Prophecies of a Risk Manager - Virtual Portfolio


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