Conclusion: Measures of investor complacency are signaling to us asymmetric risk from an intermediate-term perspective. As such, we’re either at/near a cyclical top in “risky assets” or we’ve achieved “escape velocity” and are entering a new era of investing. We believe this is the key market debate to focus on.
After recently shifting out of being long the Inflation Trade from an asset allocation perspective, we’ve been loud in recent weeks highlighting the risks to real GDP growth, both domestically and internationally. Further, we continue to anticipate those risks (namely higher input cost inflation in the absence of commensurate employment and wage growth) to roll through the global economic system and slow growth on a lag. At these market prices (SPX = ~1,400; MSCI All-World Country Index = ~160) we find there is asymmetric risk to the downside.
Of course, that risk is mitigated if we have reached “escape velocity” (to borrow the Fed Chairman’s own academic theory within the soft science of macroeconomics). At Hedgeye, we are inclined to defer to the math backing hard sciences, like physics, for example. Central plan as they may, we remain of the view that economic gravity can’t be arrested in perpetuity. Furthermore, we continue to hold steadfast on our views that Big Government Intervention does two things:
- It shortens economic cycles; and
- It amplifies market volatility.
Speaking of market volatility, we’ve been in print lately flagging the risk to U.S. equities that is a CBOE SPX Volatility Index at/south of the 15 level (closed at 14.26 on Monday). Specifically, as we’ve seen over the last ~4yrs, VIX-15 has been key contrarian indicator to fade consensus bullishness at cyclical equity market highs:
Broadening our read-through on volatility as a measure of investor complacency, we’ve created a proprietary cross-asset class volatility index that uses an unequally-weighted average of the following volatility indices:
- CBOE SPX Volatility Index (VIX);
- Merrill Lynch U.S. Treasury Option Volatility Estimate Index (MOVE);
- CBOE Oil ETF Volatility Index (OVX);
- JPMorgan G7 FX Volatility Index; and
- JPMorgan EM FX Volatility Index.
On this score, the Hedgeye Global Macro VIX is at levels last seen since early OCT ’07. Note: that date is coincident with the all-time peak in U.S. equities amid consensus faith that “shock and awe” interest rate cuts and other modes of central planning would ultimately prove effective in delivering a shallow, manageable domestic growth slowdown.
At such levels of consensus complacency, we feel it is prudent for investors to pick sides and make a call on which is the more probable of the following two scenarios:
- Scenario A: We’re at/near a cyclical top in assets perceived to be generally more risky (equities; HY credit; EM currencies and debt); or
- Scenario B: Measures of volatility will trade sustainably around these depressed levels for the foreseeable future, as we’ve entered a new era of global growth and financial market returns (akin to the mid-90’s and early-00’s).
You know where we stand. At a bare minimum, we think you should be having this debate with your respective teams.
Lastly, and certainly not to mine for contrarian data points, but the following anecdote is worth flagging for those of you who aren’t yet familiar:
The latest II Bulls/Bears Survey Spread (% Bull less % Bears) came in at 2,900bps – good for the widest spread since APR ’11. Per Keith’s commentary on yesterday’s Morning Macro Call:
“This is the other problem with [no] volume. We all know there’s no inflows into U.S. equities… there also isn’t going to be any more short covering. If this is how low the bears can go, this is what perpetuates the crash. Ben Bernanke’s policies have [many] unintended consequences… one of the big ones is that it gets the short sellers out of the game. They can’t efficiently cover stocks and keep that bid alive, so you get these real big draw-downs. That’s what we’ve seen: 1Q08, 1Q10, 1Q11. Are we going to have one in 2012? We’ll see…”
Measures of investor complacency are signaling to us asymmetric risk from an intermediate-term perspective. As such, we’re either at/near a cyclical top in “risky assets” or we’ve achieved “escape velocity” and are entering a new era of investing. This is the key debate we feel investors must focus on at the current juncture.