This note was originally published at 8am on March 14, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“No amount of experimentation can ever prove me right; a single experiment can prove me wrong.”
If your portfolio is 50% long SPY and 50% long AAPL, you are all set – Bonds, Gold, Currencies are all getting crushed. So much for Global Macro diversification.
In terms of US Equities, I’m sure most people absolutely nailed it yesterday, but I didn’t. I’d already sold my Long Financials (XLF) position (Sector Rotation into Utilities) and I wasn’t long anything big beta Basic Materials or Energy yesterday.
For those keeping score since February, not being long anything Commodities or International Currencies has actually been a very good risk management decision. Not to call out crashing currencies, but the Japanese Yen is down -9.1% since February 1st. Small Caps (Russell 2000) are dead flat from that same date.
Back to the Global Macro Grind…
Since no one who made money in 2011 was long the Financials (XLF) and now, less than 3 months later, everyone I see on TV proclaims to be long them, what are we to do with this Storytelling about a “successful stress test” by the US Federal Reserve?
Well, my Being Wrong about the US stock market yesterday is one thing, but being wrong about what this test was all about is not what we do. Check out the parameters of this so called “test”:
- US GDP Growth: “stress” was measured using a down -8% GDP scenario
- US Unemployment: 13% was the bogey there (after Bernanke is celebrating his contributions to full employment)
- US Stock Market (not clear why this is such a critical part of Bernanke’s test) = Dow 5,500
Not a typo. Not Dow 15,000. Dow 5,500. Good thing most of these revolutionary banking outfits passed the test!
If I had the insider information that some apparently traded in front of on the pre-release of the “stress test” (someone bought a boat load of Citigroup $38 puts, right before they “failed” the “test”), I wouldn’t have changed my positioning ahead of it anyway. That’s illegal, last I checked.
I don’t know what level of experimentation my risk management models could have been stress tested with for me to have not made the risk adjusted decisions I’ve made throughout March either.
To put yesterday’s Global Macro move in context, it was a 3.7 standard deviation event across asset classes. Since I have scored/back-tested my model (2007), this has happened less than 1% of the time. Evidently, the 1% in this country still matters.
Moreover, what I learned the hard way yesterday was that “a single experiment can prove me wrong.” I cannot understate the 3 dimensional risk associated with US interest rates rising from the ZERO bound. This baby is all on Bernanke’s lap too – don’t forget that he’s the one who has trained us, like Pavlovian dogs, to carry trade 3D Risk:
- Daring us to chase yield (got dividends?)
- Delaying Balance Sheet restructuring (bad sovereign deficit spending, including the USA)
- Disguising Financial Market Risk
Again, if you are long the 50/50 AAPL/SPY portfolio, no worries about this. But, in the rare case that you are long Gold, Bonds, or Currencies, this Disguise of Financial Market Risk doesn’t need to be explained to you. This morning, it’s in your account.
For March 2012 to-date:
- GOLD = -3.1% (down -7% from its FEB 2012 peak)
- TREASURIES = 2 and 10-year UST Bond yields are up +24% and +13%, respectively (bonds smoked)
- CURRENCIES = the 2 majors vs the USD (Yen and Euro) are down -3.7% and -1.8%, respectively
So what do I do from here?
My risk management process doesn’t chase stock prices on no volume and bombed out volatility signals – so don’t expect me to change my process after Being Wrong on that asset class for a few days. It was only last Tuesday when I was getting long at 1345.
Across durations, here’s what my core 3-factor risk management ranges (PRICE, VOLUME, VOLATILITY) are telling me to do:
1. PRICE: immediate-term risk range = 1367-1397, so we are immediate-term TRADE overbought or I wouldn’t have shorted SPY yesterday at 3:08PM into the close. Long-term, lower-highs (down -10.9% versus all-time high) are obvious – so is intermediate-term TREND support at 1290.
2. VOLUME: flat out nasty volume signals, across durations, will only be considered irrelevant by people who have blown up in any of the massive Q1 to Q3 US Equity draw-downs of 2008, 2010, and 2011. Long-term volume signals are at generational lows, while yesterday’s immediate-term volume was only the AVERAGE volume of the 30-day composite in my model.
3. VOLATILITY: Yesterday’s Chart of the Day showed you how, like clockwork, this 14-15 Equity Volatility (VIX) zone has been as clear a signal to sell long Equity and Commodity exposure as the sun rising in the East. Snapshot VIX: up +9% in 30mins yesterday to 15.89 before the almighty “stress test” leaked, then straight back down to close at 14.80. Fast.
Being Wrong doesn’t make me happy. I have no excuse for it – neither am I searching for one. As Billy Beane said in Moneyball, “I hate losing more than I do winning.” Today, I’ll wait and watch. Being forced to move is no way to win.
My immediate-term support and resistance levels for Gold, Oil (WTIC), US Dollar Index, and the SP500 are now $1663-1698, $124.21-127.41, $79.59-80.49, and 1367-1397, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer