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This note was originally published at 8am on August 16, 2012 for Hedgeye subscribers.

“I follow the lightning, And draw near to the place that it strikes.”

-Navajo Chant

Now I know that a lot of our clients want to talk about what consensus versus contrarian thinking is, in this no-volume marketplace, but I’m thinking they’d have a tough time advising their kids to go hard core contrarian like the early 19th century Navajos did.

Admittedly, I am developing a Darwinian confirmation bias in my reading list this summer as I delve into more Native American history with a book I started reading this week titled Blood and Thunder – “The epic story of Kit Carson and the Conquest of the American West.”

Whether it was the ability of the Navajo and Comanche tribes to adapt and survive the late 18th and early 19th centuries, or it’s what you are staring at on your screen this performance chasing morning, our goals remain common in human nature; evolve or die.

Back to the Global Macro Grind

Buy stocks or bonds?

Rarely can I time that question as critically as I’ll timestamp it this morning. Yes, these are the thralls of August. But Mr Macro Market couldn’t care less about our summer vacations. Timing matters right here and now, big time.

Timing was especially important in answering this same basic asset allocation question in the middle of March 2012 (see Darius Dale’s Chart of the Day): 

  1. Stocks wouldn’t go down
  2. Bonds wouldn’t go up
  3. Volatility went away 

In fact, by the time the VIX hit 14.26 on March 26th (the Russell2000 topped for 2012 on the same day at 846, +5.2% higher than where it is today), there was a massive consensus (both buy and sell side)  that “growth was back” and “earnings are great.”

Fast forward to June… and US stocks were gasping for air in the middle of a double-digit drawdown (Russell2000 and SP500 down -13% and -10% from their late March highs) as US Treasuries put on a massive move to the upside (10yr yield dropped -42%, from 2.4% to 1.4%).

What drove the correct answer to the stocks vs bonds question?

Global #GrowthSlowing. Period.

What will get you to the correct answer for the next 1-3 months, from here?

Follow The Lightning.

The most abysmal volume and volatility readings I have ever recorded in my US Equity model aside, there are 2 basic realities that both bulls and bears have to deal with this morning: 

  1. US stocks are making both intermediate and long-term lower-highs
  2. US bonds are making both intermediate and long-term higher-lows 

In other words, if you believe Growth is going to improve from here, you buy stocks. If you’re more confident (like we and the data are) on #GrowthSlowing, you buy bonds.

Our predictive tracking algorithm (the one that called for #GrowthSlowing when few did in March), which is a multi-factor, multi-duration model, is telling us that this is a fairly straightforward call to make because:

A)     Oil prices are up +32% (Brent) from the June low (that slows growth)

B)      Corporate Revenue growth’s slope is as weak as it has been, globally, since Q308

C)      Chinese Growth continues to surprise on the downside

Chinese what? Yes, while I suppose you could say that China’s Foreign Direct Investment (FDI) print this morning of -9% year-over-year was better than India’s Export growth tanking to -15% year-over-year earlier this week, we highly suggest you take China’s word for it:

“In the second half, China’s foreign trade and export situation will be more grim, there will be more difficulties, harder tasks, and the pressure of achieving the full-year target will be bigger…” –China Ministry of Commerce (this morning)

Now, before you zap me with the bull counterpoint (for stocks) to this (rate cuts, stimuli, bailouts, etc.), just remember that doing more of the same will only keep food/energy prices higher (and growth slower) for longer. That’s bullish for bonds, longer term. And our long-term TAIL risk line for growth (bond yields) remains intact at 1.94% on the US Treasury 10yr.

My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500 are now $1601-1612, $111.69-116.21, $82.34-82.97, $1.22-1.24, 1.56-1.82%, and 1391-1410, respectively.

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer

Follow The Lightning - Chart of the Day

Follow The Lightning - Virtual Portfolio