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Dynamic Risk Management

“Schumpeter’s ambition was to replace static with dynamic economic theory.”

-Sylvia Nasar

 

Chapter V of Nasar’s “Grand Pursuit”, Creative Destruction: Schumpeter and Economic Evolution, was my favorite. While I am not sure if it’s politically correct to say that I like to creatively destruct things, I’m not sure I care. I’m not exactly a politically correct kind of a guy.

 

While Joseph Schumpeter ended up becoming a compromised man of government later in life, his early days of collegiate thinking were some of the most formative in all of modern economic theory.

 

Shakespeare wrote that youth is ‘ambition’s ladder.’ Being left to the devices of his own commoner’s experiences (“born in a small factory town” in the Czech Republic, page 171), Schumpeter defined “creative destruction” using common sense.

 

Back to the Global Macro Grind

 

First, in order to contextualize this morning’s sharp squeeze higher across Global Equities, we need to take a step back and remind ourselves of what pricing of risk that we are bouncing from:

  1. US Dollar Index was up another +2.1% to close the week at a fresh Q4 high of $79.69 (up +9.2% from the April low)
  2. EUR/USD was down -2.2% to our immediate-term TRADE oversold line of $1.32
  3. US Stocks (SP500) were down another -4.7% week-over-week to close at a higher-YTD-low of 1158
  4. Italian, German, and French stocks were down -8.3%, -5.3%, and -4.7%, respectively (all crashing and in Bearish Formations)
  5. Asian stocks were down across the board again (Taiwan -6.2%, Australia -4.5%, Hong Kong -4.3%)
  6. CRB Commodities Index (19 commodities) was down another -2.2%
  7. Gold was down another -2.1% (in-line with the weekly US Dollar move up)
  8. Volatility (US Equities) was up another +11% to 34.47 (taking the cumulative rip in Bernanke’s “price stability” since April to +130%!)
  9. Long-term US Treasuries rose again as 10-year yields dropped to 1.96%
  10. Yield Spread (10s minus 2s) compressed by another 4 basis points week-over-week to 169bps wide

Dead cats bounce.

 

That would be a polite way of putting it actually. Last week was the worst week for US stocks during a Thanksgiving week since 1932 (not a good historical reference point, fyi).

 

In a world dominated by Keynesian policy makers perpetuating immediate to intermediate-term price moves in their respective fiat currencies, what we have left is called Correlation Risk.

 

The Correlation Crash (one of our 3 Global Macro Themes for Q4 alongside King Dollar and Eurocrat Bazooka) is born out of what the world’s fiat reserve currency (US Dollar) does relative to everything else.

 

If you get the US Dollar right, you’ll likely get mostly everything else right.

 

To be clear, correlations, like political careers, are not perpetual. So don’t expect this to stay with you for the rest of your born life. Just expect to have to deal with its implications in your portfolio again today.

 

Today’s immediate-term TRADE inverse-correlations to the US Dollar Index are as follows:

  1. US Stocks (SP500) = -0.94%
  2. European Stocks (EuroStoxx) = -0.94%
  3. Commodities (CRB Index) = -0.87%
  4. Bond Yields (UST 10yr) = -0.81%

Now if you are still using a static Marshallian or Keynesian economic model to manage risk, you’re probably not too happy with your 2011. What you should have done in the last 4 years is use this tremendous learning opportunity to evolve your risk management process into a dynamic one – a process that embraces the uncertainty associated with a Globally Interconnected Market’s last price.

 

Today’s uncertainty leads me toward one question – can this EUR/USD bounce extend itself this week so that the following immediate-term TRADE and TREND lines of resistance are overcome:

  1. SP (TREND)
  2. Germany’s DAX 5893 (TREND)
  3. France’s CAC 3089 (TRADE)
  4. Italy’s MIB 15135 (TRADE)
  5. Hang Seng 19443 (TREND)
  6. Shanghai Composite 2449 (TRADE)
  7. Japan’s Nikkei 8601 (TRADE)
  8. Brent Oil $110.61 (TREND)
  9. Gold $1726 (TRADE)
  10. Copper $3.45 (TRADE)
  11. UST 10-year yield 2.12% (TRADE)
  12. EUR/USD $1.37 (TRADE)

I know. Those are a lot of lines and a lot of durations. But that’s the point about Dynamic Risk Management – its construction needs to be multi-factor and multi-duration. And its principles need to adhere to one of the greatest mathematical discoveries since relativity (Chaos Theory).

 

“… just as Darwin had swept aside traditional with evolutionary biology” (Grand Pursuit, page 177), I’m very comfortable climbing Schumpeter’s ladder of creative destruction on Old Wall Street this morning. Change is good.

 

My immediate-term support and resistance ranges for Gold, Brent Oil, France’s CAC40, and the SP500 are now $1, 104.65-109.39, 2, and 1143-1195, respectively.

 

Best of luck out there today,

KM                        

 

Keith R. McCullough
Chief Executive Officer

 

Dynamic Risk Management - Chart of the Day

 

Dynamic Risk Management - Virtual Portfolio


The Week Ahead

The Economic Data calendar for the week of the 28th of November through the 2nd of December is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.

 

The Week Ahead - 1. LA

The Week Ahead - 2. LA


AN: Covering Trade

 

Keith covered AN in the Hedgeye virtual portfolio at $33.98 (please note correction on price) for a nice gain managing risk and trading the range this morning.

 

We continue to be concerned near-term with CapEx having doubled back to levels more in-line with investment prior to AN shrinking to half its size from ’05-’10 and is on pace to increase even higher as a % of sales this year. Returning to prior levels to offset deferred investment will impact FCF and the company’s ability to buy back shares and manage earnings near-term.

 

AN: Covering Trade - AN 11 25 11

 

 


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THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - November 25, 2011

 

As we look at today’s set up for the S&P 500, the range is 42 points or -0.67% downside to 1154 and 2.94% upside to 1196. 

 

SECTOR AND GLOBAL PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - levels 1125

 

THE HEDGEYE DAILY OUTLOOK - daily sector view

 

THE HEDGEYE DAILY OUTLOOK - global performance

 

 

EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: -2332 (-708) 
  • VOLUME: NYSE 876 (-.025%)
  • VIX:  +33.98 -2.85% YTD PERFORMANCE: +91.44%
  • SPX PUT/CALL RATIO: 1.67 from 1.76 (-5.1%)

 

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD: 49.64
  • 3-MONTH T-BILL YIELD: 0.02%
  • 10-Year: 1.92 from 1.88    
  • YIELD CURVE: 1.65 from 1.86

 

MACRO DATA POINTS (Bloomberg Estimates):

  • No U.S. economic data releases scheduled
  • Italian borrowing costs surge at bill, coupon auctions

 

WHAT TO WATCH: 

  • Many retailers opened on Thanksgiving Day, others at midnight, as Black Friday marks traditional beginning of holiday-shopping season; discounting more widespread than last year as retailers try woo shoppers spooked by global economic uncertainty, stagnant job growth
  • AT&T said yesterday will take $4b charge, pulled application from FCC to buy T-Mobile USA to focus on DOJ clearance
  • Microsoft yesterday said to sign non-disclosure agreement with Yahoo
  • Chevron yesterday was blocked from drilling in Brazil while government probes recent spill
  • Olympus’s former president Michael C. Woodford pledges to work with board to try and avoid delisting after 3 executives implicated in scheme to hide losses resigned
  • India approves allowing overseas companies to own as much as 51% of retailers selling more than one brand, paving the way for global cos. such as Wal-Mart Stores and Tesco to own stores
  • Hungarian bond yields rise most since February 2009 after Moody’s cuts rating to junk
  • ECB’s Coene says rate cut probable if current trends continue
  • Egypt’s ruling military council asks former Prime Minister Kamal el-Ganzouri to form new government
  • German Chancellor Angela Merkel yesterday ruled out joint euro-area borrowing, expanded role for ECB in fighting debt crisis
  • Italy meets max target of EU2b zero coupon auction, borrowing costs surge.
  • No IPOs expected to price

 

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

  • Bank Commodity Staff Turnover Seen Gaining as Rules Tighten
  • Record Gold Hoard Spurs Bullish Bets From Traders: Commodities
  • Copper Falls, Heads for Weekly Drop on Europe Borrowing Costs
  • Oil Heads for Second Weekly Loss on Europe; Mirae Sees Iran Risk
  • Gold Declines as Investors Turn to Dollar for Haven From Europe
  • Wheat, Soybeans Slide Amid Concern Crisis Will Weigh on Demand
  • Sugar Slides to Five-Month Low on Indian Exports; Cocoa Falls
  • Aluminum Traders Probably Added to Wagers on Declining Prices
  • Fonterra Aims to Double China Sales by 2020, CEO Spierings Says
  • First Beef Bonds in Two Years Set For Market: Argentina Credit
  • Copper Shortfall Likely to Remain in 2012, OZ Minerals Says
  • No Coal Rebound Seen in Asia on Power Price Curb: Energy Markets
  • Global Rubber Demand to Grow 4% Through 2020 on Emerging Markets
  • Vale’s Puts at Record as China’s Iron Ore Demand Slows: Options
  • India May Permit More Sugar Exports After Assessing Crushing

THE HEDGEYE DAILY OUTLOOK - daily commodity view

 

 

CURRENCIES

 

KING DOLLAR – big long-term TAIL breakout in the US Dollar continues to hold its gains this morning as the Euro moves to immediate-term TRADE oversold at 1.32. If the Germans aren’t going to cooperate with the Bailout Beggars, Draghi is going to move towards more aggressive ECB rate cuts = bearish for the Euro, bullish for the USD (intermediate-term TREND)

 

THE HEDGEYE DAILY OUTLOOK - daily currency view

 

 

EUROPEAN MARKETS

 

ITALY – complete mess as the Italians sell €10B of 6mth fiat at 6.50% vs 3.53% last; that’s just a monster jump in funding costs and both the Italian bond and stock markets continue to have this right. Markets don’t lie; politicians do. MIB Index moves to immediate-term TRADE oversold at 13,711.

 

HUNGARY – small country but they all matter in this game of dominos; Hungary is begging for an IMF bailout and Moodys decided to cut their credit rating to junk this morning = -4.6% drop in Hungarian stocks and the story just moved to #1 on Bloomberg most read.

 

THE HEDGEYE DAILY OUTLOOK - euro performance

 

ASIAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - asia performance

 

 

MIDDLE EAST

 

THE HEDGEYE DAILY OUTLOOK - MIDEAST PERFORMANCE

 

 

The Hedgeye Macro Team

Howard Penney

Managing Director

 

 

 


Powerful Turbulence

This note was originally published at 8am on November 22, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“In a time of turbulence and change, it is more true than ever that knowledge is power.”

-John F. Kennedy

 

Contextualizing market moves within the scope of Global Macro fundamentals is as critical right now as it’s ever been. That’s why we built a firm around our multi-factor, multi-duration, Global Macro risk management process.

 

Every morning we wake up at the same time and do the same thing. We Embrace Uncertainty. Functionally, what that means is that price, volatility, and volume factors strike our models on a real-time basis – and we accept them for what they are.

 

Much like the rain and tide pounding the contour of an ocean line, what you end up seeing is what you get – patterns. Time and patterns create a series of probabilities, scenarios, and ranges. This is how we apply Chaos Theory to markets.

 

Back to the Global Macro Grind

 

This morning’s embrace of uncertainty issued me a not-so-friendly risk management kiss. I’m in a hotel room on the road – and that’s not cool coming from a laptop. But I guess that’s too bad for me – the market doesn’t care about how I am positioned.

 

I am long the US Dollar and short the Euro.

 

The Germans decided to support the Euro this morning by telling the rest of the world’s Bailout Beggars to go pound sand. This isn’t the kind of sand in Benoit Mandelbrot’s fractal model (falling one grain at time). This is the big beachhead of fluffy expectations stuff.

 

“We don’t have any new bazooka to pull out of the bag… we see no alternative to the policy we are following… we need to tell markets very clearly – and this must be done soon – that there is no other way forward than the one we’re pursuing.” –Michael Meister

 

Meister, one of Merkel’s senior guys, went on to add that if Italian and the French central planners don’t like that, they can go pound some more sand, and “sit tight through the turbulence.”

 

The Euro finally bounced on that (I know – how dare the Germans defend the common currency and purchasing power of their people!), rallying straight back up to an immediate-term TRADE zone of resistance ($1.35-1.36).

 

In turn, the US Dollar sold off, holding immediate-term TRADE support of $77.07 (US Dollar Index).

 

Thankfully, it will take more than one morning, week, or month of Powerful Turbulence to take me out of this globally interconnected game of risk. Pursuing its outcomes is what I love to do. And I love being long our King Dollar theme on red.

 

Dollar Down = reflation of some of yesterday’s deflation. Dollar up = Deflates The Inflation.

 

Since 71% of US GDP = Consumption, that’s what we need to see more of to bring growth back in the country – not another super-committee of central planners. Newt has that part of it right.

 

Strong Dollar = Strong America. Period.

 

While that may create some Powerful Turbulence in the stock market in the short-run, in the long-run most of our children and grandchildren won’t be dead.

 

The short-run performance of the stock market doesn’t reflect the long-term health of the country – full employment and price stability do.

 

US stocks are down -12.5%, -7.6%, and -5.6% from their April, October, and November highs, respectively. Volatility (VIX) is up +120% since April’s SP500 price of 1363. Unemployment in America hasn’t moved off of 9%.  

 

Having learned the 1920s lessons of structural unemployment and price volatility the hard way, maybe there’s a part of this that the Germans have right for the long-run too.

 

My immediate-term support and resistance ranges for Gold, Oil, German DAX, and the SP500 are now $1684-1722, $95.35-98.42, 5567-5769, and 1186-1203, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Powerful Turbulence - Chart of the Day

 

Powerful Turbulence - Virtual Portfolio



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