Spectators and Actors

This note was originally published at 8am on April 30, 2013 for Hedgeye subscribers.

“We have become both spectators and actors in the great drama of existence.”

-Niels Bohr

 

You can’t geek out on quantum mechanics without giving a big shout-out to the great Danish atomic physicist, Niels Bohr. He won the Nobel prize for Physics in 1922. He would have been a beauty running the Hedgeye Research Team. No offense, DJ.

 

I was on a plane to Kansas City from Denver yesterday and couldn’t stop thinking about the progress that our research team has made. I’m actually becoming quite humbled when I read the work of junior analysts who have matured into senior analysts at our firm. They are well ahead of where I was 5 years into being in the game. A collaborative culture provides them a convex learning curve.

 

Applying chaos theory, predictive tracking algos, and the principles of thermodynamics to our Global Macro research is what we are doing. Yes, we are early. And, no, we don’t need to call a management team for “edge” on what the Euro is going to do next. In order to execute on our process, we have to submit ourselves to being both attentive spectators of the game and proactive actors within it.

 

Back to the Global Macro Grind

 

Not unlike playing team sports, you have to adapt to the game that you are in and play it accordingly. Because, no matter where you go this morning, here you are – at the all-time highs in the SP500 (+11.7% YTD). And the great drama of our existence within the game continues…

 

A few weeks ago I contrasted approaching markets from a Darwinian (evolutionary) rather than a Newtonian (time-independent) perspective. “Newton’s 17th century view stipulated the physical world as a closed system dominated by cause and effect” (Cosmic Evolution, pg 34). Whereas opening your mind and risk management process to non-linearity, uncertainty, and interconnectedness is the new frontier.

 

In both calling market tops on “valuation” and picking stocks irrespective of style factor risks, what we are learning here is that we all have a lot more to learn. “Gone is the deterministic and mechanistic paradigm” (Chaisson). Gone is the idea that central planners can smooth economic gravity and/or the unintended consequences associated with their trying to control the game.

 

Tomorrow and Thursday, central planners will once again attempt to do precisely the opposite of what I just wrote:

  1. Fed’s Open Market Committee will hopefully do nothing to our intermediate-term #StrongDollar TREND
  2. European Central Bank (ECB) will either cut rates or allude to cutting them soon

Rather than get upset about what we think these people who are paid to print political compensation should do, what we’ve done is build a model that front-runs their proactively predictable behavior (yes that’s sad). We call it our GIP Model (Growth, Inflation, Policy) where:

 

A)     POLICY is causal to a currency’s price, volatility, and expectations (across risk management durations)

B)     INFLATION is local (to currency moves) and will accelerate or decelerate based on POLICY (causal)

C)     GROWTH reacts (on a currency adjusted basis) to real-time local inflation expectations

 

No one is going to give my team a Nobel Prize for this. We’d have to had racked up debt and toiled in academia to prove out our practitioner’s model (with no real-world experience) for decades – and by that time we would have been way late. But, our Growth and Inflation forecasts have been better than anyone in the marketplace for the last 5 years, and I’m not going to apologize for that. We’re proud of it.

 

So back to the why on an ECB rate cut:

  1. #CommodityDeflation is perpetuating “lower than expected inflation readings” across Europe
  2. Both European employment and real (inflation adjusted) consumption growth remain weak
  3. So, in their central planning box of thinking, this provides theoretical air-cover to devalue the Euro

In market speak, this won’t save what the Europeans have been desperately trying to solve for (GROWTH). To the contrary, this POLICY to INFLATE will devalue the Euro versus the US Dollar, rally European stock markets, and plug the people (again). #EuroCrats, Unite.

 

Sound familiar?

  1. United States of America’s monetary POLICY to inflate (2010-2012) = US Dollar hits 40yr lows
  2. Japan’s Weimar Republic POLICY to inflation (2012 to ?) = Burning Yen, to be continued

Perversely, this is a great opportunity for America. This provides both the President of the United States and his conflicted and compromised Fed and Treasury an opportunity to get out of the way (Treasury just announced they’ll pay down $35B in borrowings!) and let the US Dollar strengthen versus her socialized European and Japanese counterparts.

 

Politically driven causal factors driving entropy into an unstable and non-linear market ecosystem of colliding global currencies, commodities, and country factors … Yes, this is war - a Currency War (thank you Jim Rickards). We’re just spectators and actors trying to perform within it.

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1362-1493, $97.13-104.38, $3.06-3.26, $81.93-83.31, $1.29-1.31, 97.11-100.94, 1.66-1.76%, 11.71-14.61, and 1570-1603, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Spectators and Actors - Chart of the Day

 

Spectators and Actors - Virtual Portfolio


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