This note was originally published December 12, 2012 at 07:41 in Early Look
“Man has only one tool to fight error: reason.”
-Ludvig von Mises
The goal of this game isn’t to be bullish or bearish; it’s to be right. A long time ago, I’d start with my own pig-headed fundamental reasoning on why a market price should go up or down. Now I let the market tell me what to do. It’s a humbling learning process.
So is embracing uncertainty. And that’s really what we do here as a research and risk management team. Every day we wake-up with a clean sheet of paper in our notebooks. We’re always looking forward to markets surprising us with something bullish or bearish.
All the while, Old Wall Street is still trying to sell you certainty. ‘The SP500 will trade at this PE’ and ‘our year-end target is’ this or that. That’s as over as people assuming that market risk isn’t non-linear. Risk changes fast. It’s globally interconnected – and it goes both ways.
Back to the Global Macro Grind…
Whether it was the German DAX breaking out to higher-highs yesterday or the SP500 busting a move back above our intermediate-term TREND line of 1419 resistance yesterday, bullish is as bullish does.
If the SP500 were to sell off from here and close back below 1419, I’d call that bearish. Everything that matters in our macro model occurs on the margin. It’s really not that complicated once you accept the deep simplicity of it all.
What’s the Bullish Reasoning behind the SP500 trading higher from here?
- Commodity Deflation = a global consumer tax cut (Consumption = 71% of the US Economy)
- Treasuries Making Lower-Highs = big opportunity for US Equity fund flows (which we haven’t seen in months)
- Hedge Fund Sentiment: our US Equity model is showing short interest at its highest level since September
I could probably make up 7 more reasons and give you a Top 10 sell-side looking list for 2013. Most of it would be storytelling about things no one has any business claiming certainty about. ‘Stocks are cheap, earnings have bottomed…’ blah, blah, blah.
Lets dig into points 1-3 a little deeper:
1. CRB Commodities Index (19 Commodities) is down on the week (stocks are up) and has deflated -8.7% since the September Bernanke Money Printing Top. Oil is in a Bearish Formation (bearish TRADE, TREND, and TAIL). Food prices are getting smoked.
2. Treasury Bonds finally just made their 1st lower-high all year (bouncing off 1.59% in the last week, the 10yr UST yield didn’t make a lower-low this time versus either the July or November closing lows of 1.44% and 1.57%, respectively). Bond bulls are giddy and fund flows to Fixed Income are bubbly (ex ETFs, US Equities had outflows of $4.1B last week).
3. Hedge Fund behavorial factoring is fascinating right now. Plenty hedge funds have become beta. For whatever reason, they keep shorting low and covering high. Our composite short interest study shows short interest up in the most recent 2-wk period to 3.69% of total shares outstanding versus 3.64% last. Directionally that’s a contra-indicator that you want to fade alongside volatility.
To be fair to the bearish side of the trade, aggregate short interest isn’t as high as it was when hedge funds got squeezed out of their short positions in September (it was 3.78% then, and the Russell proceeded to drop 10% from there), but it’s just inside of it.
At the same time, as I pointed out in yesterday’s Early Look with the 6 Hedgeye Best Ideas (LONGS) we came up with in mid-November, it’s a lot easier buying stocks on red with the VIX is trading 17-19 than it should be at VIX 14 when hedge funds typically capitulate.
I’m certainly not trying to submit that I nailed every move. No one does. I just tend not to get plugged at tops and bottoms because I have made enough mistakes in my career to evolve what it is that I do. Fading Beta works.
Where do we go from here?
1. The Fed - that’s midday today, and it will matter, reflexively, because bonds would become immediate-term TRADE oversold at 1.68% on the 10yr, and stocks should signal an immediate-term TRADE overbought around 1432 in the SP500.
2. The Macro Calendar – has 3 pending bullish catalysts on the Commodity Deflation front in the next 3 days (Import Prices, PPI, and CPI all release in the US Wednesday-Friday).
3. Japan’s Election – that’s this weekend and the currency market (Yen hitting 8 month lows this morning as it front-runs the LDP ‘s Abe’s promise to do what Bernanke did, debauch the Japanese currency through money printing)
What’s bearish for the Yen is bullish for the Dollar. What’s bullish for the US Dollar is bullish for the US Consumer. What’s bullish for the US Consumer is bullish for Global Growth.
I know, now I am thinking too much on the fundamentals. So I’ll stop, and get back to letting the market tell me how to reason.
Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, German DAX, and the SP500 are now $1690-1719, $105.92-109.38, $3.60-3.71, $79.59-80.31, $1.29-1.31, 1.59-1.68%, 7451-7611, and 1419-1432, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer