Loss Aversion

“The concept of loss aversion is certainly the most significant contribution of psychology to behavioral economics.”

-Daniel Kahneman

If you got the US Dollar and Growth Slowing right, you got a lot of other things right in the month of May. With the US Dollar Index +5.5% for the month, mostly everything stocks and commodities deflated, big time. We call that Deflating The Inflation.

Gains on the short side were bountiful, but how do you deal with the losses? What institutional pressures, if any, do you feel? If you are no longer institutionalized, do institutional performance pressures affect how your positions move?

No matter where you go in this profession, these are behavioral questions that an over-supplied industry still needs to answer. It may not be what every strategist is allowed to write about, but it’s what all of our clients talk to me about. As Kahneman astutely summarizes in Chapter 28 of Thinking, Fast and Slow, “Still, threats are privileged above opportunities, as they should be.”

Back to the Global Macro Grind

Just because you need a certain return on your invested capital doesn’t mean Mr. Market owes you one. If I can tell you at 14-15 VIX that Growth Slowing is your research call (VIX YTD low = 14.26 on March 26th), that’s a huge opportunity to manage your risk.

Notwithstanding that it’s been glaringly obvious that all of Asia and Europe have been slowing since February-March (the data doesn’t lie; perma-bull economists do), here’s what the US Growth Slowing data looked like:

  1. US GDP: Q1 slows to 1.88% (versus 2.97% in Q4)
  2. US Fixed Investment Growth: Q1 slows to 0.61% (versus 0.78% in Q4)
  3. US Final Retail Sales Growth: Q1 accelerates to 1.67% (versus 1.16% in Q4)

Accelerates? Oh, right – we have to take the inflation from the gas pumps, groceries, etc. out of the Final Retail Sales acceleration. That’s called the GDP Deflator. That matters, primarily because you have to subtract the Deflator from US GDP:

  1. Q4 2011 US GDP Deflator = 0.84%
  2. Q1 2012 US GDP Deflator = 1.65%

In other words, inflation (using the Government’s conflicted calculation of it) doubled, sequentially, in Q1 versus Q4, and that’s why real growth (inflation adjusted) slowed.

This is why we are so focused on getting the US Dollar right. Get that right and you’ll get growth’s slope right. Gas is priced in Dollars. Therefore, when Ben Bernanke arbitrarily opted to devalue the US Dollar on January 25th, 2012, oil, gold, etc. ripped to their final February crescendos … and that, in turn, slowed real (inflation adjusted) US Consumption Growth.

It also freaked out fixed investments made by people like me who run small to medium sized businesses in this country. Growth Slowing is what Soros would call reflexive. It feeds on itself, erodes confidence, and slows the pace of hiring.

It also slows the pace of asset price appreciation. Stocks, Commodities, and Bonds are leading indicators – they get it:

  1. US Stocks = SP500 was down -6.2% in May and the Russell 2000 is down -10% since peaking on March 26th
  2. Commodities (CRB Index, 19 commodities) = down -16.2% since topping in late February
  3. Bonds (US Treasuries) = 10-year bond yields are down -35.9% from their March 2012 lower long-term high

I don’t need to take a “survey” or ask a company like CAT’s CFO for a look on Growth Slowing. Been there, tried doing both – it doesn’t work. Markets are a lot smarter than both of those qualitative narratives. These are lessons we all should have learned and incorporated into our risk management and research process since 2008.

Where do we go from here?

I don’t know.

I Embrace Uncertainty each and every risk management morning. I take the economic data as issued. And I work with my team on probability weighting what the new price (markets) and fundamental (economic) data means in our models.

Today’s data was not good. China’s PMI (50.4 in May vs 53.3 in April) showed a re-acceleration of Growth Slowing on the downside. South Korea printed its 3rd consecutive y/y decline in Exports (another May number) and in the US, yesterday’s PMI print for May of 52 (a 7.4% decline versus April), was nasty. So are June 1 declines in stock and commodity market prices.

No one likes losing. I think it was Billy Beane in Moneyball who said “I hate losing more than I like winning.” And when it comes to dealing with Loss Aversion, I think your clients probably think about it that way too.

My immediate-term support and resistance ranges for Gold, Oil (WTIC), US Dollar, EUR/USD, and the SP500 are now $1, $84.92-90.14, $82.24-83.51, $1.22-1.25, and 1, respectively.

Best of luck out there today,


Keith R. McCullough
Chief Executive Officer

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