This note was originally published at 8am on November 05, 2012 for Hedgeye subscribers.
“By knowing more about what we don’t know, we may get a few more predictions right.”
First, my prayers go out to the 2 million Americans who are still without heat this morning on the East Coast. I am part of the 14% without power in Westport, CT. It’s getting colder. If you have the means to help others, please do.
Predictions, about the weather, politics, and markets, can get you in trouble; especially if your own money is behind your opinion. I guess the upside to being a partisan political pundit is that you’ll probably be gainfully employed regardless of your predicted outcomes. Right or wrong, someone will probably send you a sticker for effort; particularly if you drove ad revs.
From my model’s vantage point, markets have been predicting a closer election than the “expert” polls have been predicting for months. The recent strength in the US Dollar reflects Romney narrowing the gap. Whether or not he can beat Nate Silver’s Obama odds is something neither of us know. After all, that’s the conclusion of Silver’s book (The Signal and The Noise) – don’t trust the polls.
Back to the Global Macro Grind…
Last week, the US Dollar Index was up another +0.65%. It has only had 1 down week in the last 7 and is now breaking out from an immediate-term TRADE duration perspective (after holding its long-term TAIL line of $78.11 support).
Nate Silver’s model doesn’t account for this, but those of you who trade markets do. The causality behind a Debauched Dollar has been weak fiscal and monetary policy. Heightening probabilities of Romney not getting crushed raises the probability that Ben Bernanke and Tim Geithner will be employed by Citigroup by 2014. That’s been Dollar Bullish, on the margin.
The Known Unknown here is that we don’t know who will win this election, but:
- If Obama wins, the US Dollar probably goes down from here
- If Romney wins, the US Dollar probably goes up from here
The key word in those Bayesian (conditional probability) statements is probably. Probably doesn’t mean certainly. If neither holds true (what if they tie?) markets could have a tough time digesting what to do next. Like it or not, all the quant machines are trading Correlation Risk, in size.
Causality doesn’t always drive correlation; sometimes it does – and big time. For the last 3 months (90 day Correlation Risk model), here are the inverse correlations between the US Dollar Index and the Big Beta driving your portfolio performance:
- SP500 = -0.91
- Eurostoxx600 Index = -0.97
- MSCI World (Equities) = -0.94
- CRB Commodities Index = -0.62
- Copper = -0.88
- Gold = -0.97
Yes, these intermediate-term TREND correlations are surreal. Which makes it likely that if Obama wins, you want to buy the living daylights out of Gold and European Stocks. If Romney wins, you want to respect the likelihood of known knowns (correlations) continuing.
Like my not having power for 6 days, legitimate TAIL risk is defined by the unknown unknowns. I didn’t know that was a known unknown until maybe 2 weeks ago. Risk happens fast.
Known knowns: for the last month, here’s what Strong Dollar has been doing to Bernanke’s Bubble (Commodities):
- Coffee = -15.8% (down -1.9% last week)
- Silver = -10.8% (down -3.6% last week)
- Copper = -8.4% (down -1.9% last week)
- Oil (WTIC) = -7.6% (down -1.6% last week)
- Gold = -5.3% (down -1.9% last week)
Sometimes Strong Dollar deflates commodity prices faster than a Debauched Dollar inflates them. That’s been the key risk management lesson of front-running Bernanke’s multiple QE experiments. What goes up, can come down in a hurry.
Bernanke has been at the helm of the Federal Reserve for 6 years. He has never raised interest rates. Never is a long time. So, that’s another Known Unknown to consider here that the market doesn’t yet consider a legitimate risk – what it means for the bond market.
If Romney wins but:
A) He appoints Glenn Hubbard as his Fed Chief
B) He appoints John Taylor as his Fed Chief
There are 2 very different possible outcomes for the US Bond market overall. Don’t forget, Hubbard is a hard core Keynesian - he could very well make Romney look like Bush, fast. Taylor would raise rates – and could scare the bond market, faster!
On the economy, it’s not a secret that I don’t think Obama is a good President. I didn’t think Bush was either. From a US fiscal and monetary policy perspective, those are known knowns in my model. Whether Romney can be any worse is an unknown.
My immediate-term risk range for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1672-1701, $105.17-108.26, $3.44-3.54, $79.86-80.79, $1.27-1.29, 1.67-1.75%, and 1399-1419, respectively.
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer