“If you don’t get this elementary, but mildly unnatural, mathematics of elementary probability into your repertoire, then you go through a long life like a one-legged man in an ass-kicking contest.”
-Charlie Munger
Charlie Munger said many wise things in his long life. The quote above has always been one that has resonated with me.
Understanding probability is critical to investing. It is also critical to the gaming industry. Since probabilities are always in the favor of casinos, they typically generate strong cash flow. My colleague Todd Jordan, who has been following the gaming industry for almost two decades, knows this well.
But investing isn’t gambling. Or it shouldn’t be.
As investors, we should look for situations that we believe have a decent probability of providing a positive outcome. What’s the upside? What’s the downside? And what does your math (an important word) suggest is the likelihood of those scenarios occurring?
Now, obviously, you are never going to be successful with every single investment. But if you can consistently keep the odds in your favor over time, you can become the casino and not the guy blowing his paycheck drinking watered-down cocktails at The Flamingo.
Before I get into the morning Macro Grind, I’m going to leave you with a probability riddle (and don’t google the answer!).
You own two stocks. Both are at 100 today.
Stock A rises at 10% per year.
Stock B either rises 30% in a year or falls 10% each year with a 50/50 probability.
So, if you follow the math, in any one year B “averages” (30% -10%)/2 . . . or 10%. The same as A.
After ten years, what’s the probability that Stock B is higher than Stock A?
- Less than 25%
- 25% to 40%
- Greater than 40% to 75%
- Above 75%
What is your answer? We will send a copy of Neil Howe’s newest book, “The Fourth Turning Is Here”, to the first correct answers emailed to .
Back to the Global Macro Grind...
Probably one of the most interesting probability questions facing the markets now is related to when the Fed is going to cut rates.
Stepping back for a second, isn’t it amazing how much can change in a few months? Way back in September and October, the market took the 10-year yield from roughly 4.25% to 5.0%. Fast forward to November and the 10-year yield went from almost 4.8% to roughly 4.2%.
If these moves in rates are making you dizzy, you probably aren’t alone. Some people might call it downright bi-polar. In the span of 60 or so days, we’ve gone from expecting the Fed to potentially tighten to now expecting rate cuts to begin in Q1 2024.
The truth, as usually, will probably be somewhere in the middle.
Last week Chair Powell said the following:
“Inflation is still running well above target, but it’s moving in the right direction. So, we think the right thing to be doing now is to be moving carefully, thinking carefully about about how things are going on and let the data tell us what the story is.”
That commentary doesn’t sound like someone who is ready to advocate for rate cuts imminently. But one thing that is likely to help the data case is the price of oil, which has been in absolute free fall and is down ~23% over the last 2.5 months.
Yesterday was actually a very interesting day in the oil markets. We had a surprise draw W/W of oil inventories from the DOE at down -4.6MM barrels. Normally this would be a bullish data point for the price of oil, but oil was down -4% yesterday.
So, what’s the rub you might ask? Well, simply put, the oil market is likely signaling that oil demand is weak based on weakening global economic activity.
At face value, this is good for those that are data dependent. Lower oil translates into lower inflation, which then translates into cowbell (or at least rate cuts). But this all comes at a cost. That cost is declining, or more likely, recessionary economic activity.
Admittedly, alongside this increasing probability of decelerating GDP an increasing probability of rate cuts is reasonable.
According to the CME, the market is currently pricing in a 60% probability of rate cuts of 1.25% or more in 2024. We have highlighted this in the Chart of the Day.
Said simply: significant rate cuts are already priced into the market!
With the market now leaning so aggressively into easing, there is some risk that an inflationary or pro-growth data point could lead to a little bit of a backlash. Even though we have had soft labor data in JOLTS and ADP employment this week, Non-Farm Payrolls on Friday will be an important one to watch on this front.
And then next week we get the FOMC meeting.
There is a lot to think about as an investor.
To simplify our thoughts, these are our current top Macro ETFs ranked by size and updated daily for Macro Pro subscribers:
- TBIL, TFLO, BUXX, GLD, AAAU, PPLT, EWY, EWM, URA, SHY, EZA, BNDD, NLR, SLV, XLG, AMLP, MTBA, URNM, INDA, KBWP, SPMO, SIVR, IAK, GXG, BITO, ETHE, SMIN, GDX, UUP.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets
UST 30yr Yield 4.21-4.55% (bearish)
UST 10yr Yield 4.10-4.51% (bearish)
UST 2yr Yield 4.47-4.99% (bearish)
High Yield (HYG) 74.30-76.13 (bearish)
SPX 4 (bearish)
NASDAQ 14,109-14,303 (bullish)
RUT 1 (bearish)
Tech (XLK) 180-186 (bullish)
Energy (XLE) 81.65-84.92 (bearish)
Utilities (XLU) 61.85-63.92 (bullish)
Shanghai Comp 2 (bearish)
BSE Sensex (India) 66,452-70,091 (bullish)
VIX 12.46-15.59 (neutral)
USD 102.63-104.53 (neutral)
Oil (WTI) 69.08-76.99 (bearish)
Gold 2006-2099 (bullish)
Copper 3.71-3.91 (bearish)
Silver 23.55-26.21 (bullish)
Uranium (URA) 27.88-29.71 (bullish)
Bitcoin 38,626-45,572 (bullish)
Keep your head up and stick on the ice,
Daryl G. Jones
