Macro Evolution

This note was originally published at 8am on April 03, 2013 for Hedgeye subscribers.

“The book of nature is written in the language of mathematics.”

-Galileo

More so than in any other year since we started the firm (2008), we are getting tons of questions from clients about our process – specifically, how we’ve applied breakthroughs in modern chaos theory (fractal math) to our global macro risk management process.

What’s interesting about answering these questions is that there is no silver bullet book you can read. No, they don’t teach this in business school (yet) either. I built the process on mathematical principles that are relatively new. When I want to consider evolving the process, I don’t read Jeremy Siegel – I dive into behavioral science, applied math, big history/data, etc.

Of the top 3 books that have inspired me on the interconnectedness of the Global Macro ecosystem, Eric Chaisson’s Cosmic Evolution (2001) is one of them. If you are looking to learn about my framework, all you have to do is read his Preface and Prologue. Unless you are in the business of not constantly re-learning how to operate in markets, I guarantee you can’t put this book down after 20 pages.

Back to the Global Macro Grind…

Change is good. So is being long gamma. Convexity in market pricing works on the upside too. And being long a market that continues to make higher-lows (on no-volume down days), and higher-all-time-highs on up days, works for me.

Much to the Crisis-Mongering and bit-coin advertising business chagrin, the SP500 made another fresh all-time closing high yesterday at 1570. That puts the SP500 up +10.1% for the YTD.

But, but (the most commonly used word when I keep telling people I am bullish on Asian and US Equities), “look at copper, coal, corn and…” Yes, precisely – that’s why we think both US Consumption Growth and Consumption oriented Equities are going higher.

To review how the Macro Evolution gods have scored the YTD, there are massive divergences developing between:

A)     Consumption assets

B)      Commodity assets

And no, an asset doesn’t have to be an asset class – that’s what people call something like Gold, after it’s gone up for 12 straight years. For the YTD, being long Gold (or Gold Miners) is what I call a liability.

#StrongDollar is driving this – there are both positive and negative correlations associated with this breakout in the US Dollar Index. For starters, let’s look at Countries (major macro equity Style Factor):

1. US Equities (SP500) +10% YTD vs Brazil (Bovespa) -10% YTD
2. UK (FTSE) +10% YTD vs Russia (RTSI) -6% YTD

So, Russia is not Brazil, but both are in an irrelevant #OldWall acronym (BRIC), and neither of these stock markets like it at all when Metal, Food, and Oil prices deflate.

In fact, this morning there’s a headline on Bloomberg that says “Gazprom Falls Under $100B, Putin Frets.” I know, poor Putin. But seriously, who the hell cares about Russians fretting over US Consumption taxes at the pump and their Cypriot laundry?

Enough about that – let’s look at the US Equity market and dig down beneath the ecosystem’s crust to look at another important quantitative Style Factor – Sector Style Risk:

1. US Healthcare Stocks (XLV) +17.2% YTD
2. US Consumer Staples (XLP) +15.1% YTD
3. US Consumer Discretionary (XLY) +11.8% YTD
4. US Basic Materials Stocks (XLB) +2.4% YTD

Yes, ‘one of these things is not like the other, one of these things just doesn’t belong’ (when you are modeling fractals you can go right batty at night, so listen to Romper Room tunes and you’ll be fine).

One of these things (Basic Materials) is being impacted by who wins/loses under a pervasively #StrongDollar macro environment.

But, but –

1.       “Copper and Coal and Corn going down is a bearish demand signal …”

2.       “Consumer Staples outperforming is a defensive signal… “

3.       “Italian Elections, Cypriot Chariots of Fire, and North Korean Chubby Wubby, are big risks…”

C’mon man. Let’s get real here.

1. Commodity Deflation = good for corporate input prices and real (inflation adjusted) consumption growth, globally
2. Consumer Staples companies (especially Food, Restaurants, etc.) have massive y/y margin expansion opportunities
3. Crisis-Mongering about Korea? Join the club – CFTC SPY net long position hitting YTD lows as Treasuries net longs ramp

I know I’m whipping around and ranting a bit – but if you truly believe in Embracing Uncertainty like we do, you want to do more of that – especially when our globally interconnected signals do.

“Contingency – randomness, chance, and stochasticity – pervades all of dynamic change on every spatial and temporal scale… science today is no longer in the prediction business… evolution predicts little of the future, yet strives to explain much of the past.” –Chaisson

Changing our positioning as the ecosystem does. Macro Evolution, Hedgeye-style.

Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, Russell2000, and the SP500 are now $1569-1602, $109.11-111.54, $82.58-83.49, 93.07-96.04, 1.84-1.94%, 12.15-13.41, 933-955, and 1559-1576, respectively.

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer