“We don't know the probabilities of future events. Still, you have to take action, and so you do it on gut feeling. That's the world we live in.”
-Robert J. Shiller
Just over 10 days ago I rushed myself to the hospital via Uber and was very quickly diagnosed with acute appendicitis. While it wasn’t a fun experience, it is a relatively common one. In fact, according to a number of studies the odds of getting appendicitis in your lifetime is about 1 in 14.
The downside of appendicitis is that there is really nothing you can do to improve your odds. The catalyst is a random blockage of the appendix, which is part of the large intestine that we don’t use, that then leads to swelling and infection. And if you try to tough it out like me . . . your appendix may ultimately burst! #NotFun
Generally, in life and work we can do things to improve our odds. Obviously, luck will always have a role, but improving your odds on the margin adds up over time. One of the best ways to improve your odds for a successful outcome is by having more information and data.
Our health is a perfect example of this. Since becoming a father just over 9 years ago, I’ve become much more fastidious about my health. To be fair, I still do enjoy the odd late-night shift of cocktails and storytelling, which probably isn’t great for me, but I’ve become much more serious about annual physicals and tracking data.
One example of this is related to heart health. Traditional evaluations of heart health include blood pressure, cholesterol, and genetics and while these no doubt have their place, a recent study from the Northwestern University:
“ . . . directly compares genetics CT scans for coronary artery calcium and demonstrates that the CT scan does a better job than genetics at predicting risk for heart disease in middle age.”
A calcium scan is just more piece of data, which then may shift you into a higher risk category and enable you to address heart disease risks sooner. Which, ideally, then leads to more positive outcomes in the future.
Investing is not so different.
Back to the Global Macro Grind…
A fair bit has changed since I was admitted to the hospital just under two weeks ago. The most significant shift is probably related to interest rate cut expectations. Below I outline what was priced into Fed Funds Futures a week ago compared to today:
- June meeting a week ago had a 56% probability of a cut and today it is 19%.
- July meeting a week ago had a 51% probability of a cut and a 24% for an additional cut. Today the probability is 53% for no cut; and
- September meeting a week ago had a 41.5% probability of two cuts and a 16% probability of three cuts. Today those probabilities are 22.1% and 3.3%, respectively.
So, in very simple terms, roughly two interest rate cuts have been removed from the market expectations set by Fed Funds Futures in the last two weeks.
The key catalyst for this shift was last week’s hotter than expected March CPI report. Headline CPI hit a 6-month high of 3.5% Y/Y and Core CPI, ex-food and energy, accelerated versus February to 3.8% Y/Y.
On the positive, these numbers are a lot lower than a year ago. Conversely, they are obviously re-accelerating and not exactly signaling to the Fed that now is the time to cut rates. In fact, Chair Powell said as much late yesterday:
“Given the strength of the labor market and progress on inflation so far, it is appropriate to allow restrictive policy further time to work and let the data and the evolving outlook guide us.”
After three months of CPI exceeding expectations, it seems the Fed has become data dependent again!
Within that CPI report, Shelter and Energy contributed more than half of the increase. Shelter comprises roughly 1/3 of headline CPI and was up +5.7% Y/Y and +0.6% M/M. Meanwhile, Energy, and this should be no surprise if you follow the commodity markets, was up +3.1% M/M!
The Shelter component of CPI will likely continue to increase the odds of higher for longer inflation. On the supply side, this is about a tight of a market as we’ve seen, especially given that 30-year mortgage rates remain near 7.0%. At the moment, as highlighted in the Chart of the Day, U.S. housing inventory is close to a 40+ year low.
This tight inventory dynamic should continue to put upward pressure on home prices. Rent is a bit more of a deflationary tailwind than buying a house, but even here the story isn’t great. According to Zillow.com, in March rents were up +3.6% Y/Y nationwide. This is basically tracking inline with inflation.
Back in market land, we’ve had both equity and bond market volatility “blow out” to the upside. The VIX is now Bullish Trend at 17.96 and the MOVE, a measure of bond market volatility, is up more than 2,000 basis points in the last week to just over 119.
On the topic of higher odds of a potential short-term bottom in equities, we do now have IVOL Premiums across all equity subsectors. This implies investors are cautious and hedging their positions.
Finally, according to our partners at Tier 1 Alpha:
“Dealers remain short gamma, which means the conditions for higher volatility are still firmly in place. However, it's important to note that we're now closer to the bottom of our gamma curve, which begins to level out below the 5000 strike . . . making the 5000 strike a strong potential support level in the near term.”
In our Portfolio Solutions product, Keith has adjusted the positions systematically for this higher volatility, higher rate, and more inflationary environments. As of yesterday’s close, these are the top ETFs by size rank:
- FDRXX, BUXX, TFLO, TBIL, AMLP, XLE, XOP, GSG, EWG, INDA, WOOD, IAK, UUP, MSOS, URA, GLD, KSA, CPER, EWN, SLV, PINK, KEMX, XLG, SPMO, UGA, KBWP, NORW, IBIT, BDRY
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets
UST 30yr Yield 4.49-4.81% (bullish)
UST 10yr Yield 4.30-4.75% (bullish)
UST 2yr Yield 4.69-5.09% (bullish)
High Yield (HYG) 75.40-76.68 (bearish)
Investment Grade (LQD) 104.02-106.81 (bearish)
SPX 5024-5209 (bullish)
NASDAQ 15,655-16,422 (neutral)
RUT 1 (bearish)
Tech (XLK) 199-207 (neutral)
Insurance (IAK) 108.23-117.91 (bullish)
S&P Momentum (SPMO) 77.46-81.20 (bullish)
Healthcare (PINK) 28.55-30.66 (neutral)
Shanghai Comp 2 (bullish)
Nikkei 37,695-39,501 (neutral)
BSE Sensex (India) 72,544-75,099 (bullish)
DAX 17,521-18,452 (bullish)
VIX 14.46-20.18 (bullish)
USD 104.54-106.99 (bullish)
Oil (WTI) 84.26-87.29 (bullish)
Gold 2 (bullish)
Copper 4.15-4.40 (bullish)
Bitcoin 60,527-68,715 (bullish)
Keep your head up, stick on the ice, and probabilities in your favor,
Daryl G. Jones
Director of Research
