This note was originally published at 8am on May 29, 2013 for Hedgeye subscribers.
“This story illuminates, as only great history can, not only the past but also the present.”
That’s how the late Richard Holbrooke (1941-2010) ended his foreword to the latest macro strategy book I started reading this weekend – Paris 1919: Six Months That Changed The World, by Margaret Macmillan (winner of the Samuel Johnson Prize).
With the US launching its first drone attack on Pakistan since the US election, I am certain that the likes of Holbrooke (former United States Special Envoy to Afghanistan and Pakistan) could illuminate the history of this US engagement for us. Maybe his sons will tell his stories. Maybe they won’t. Someone always knows something in this world. History teaches us that the herd tends to get the truth on delay.
Markets teach us different versions of the truth. They also reflect upon history. Market prices build upon stories told. Whether those stories are fact or fiction is of less concern to me than what people will expect happens next. Holbrooke said his only regret about the 1919 Peace Conference story was that “it was not available a decade ago.” The book was published in 2003. The truth was now 86 years old.
Back to the Global Macro Grind…
“What is the truth?” That’s the most important question to one of the best macro risk managers of our generation (Ray Dalio), so it’s definitely one of the most important ones to me. From a behavior economics perspective, I really care about the truth of expectations.
Is it true that rising US Treasury bond yields are a pro-growth signal? Is it true that rising yields (combined with a #StrongDollar) predicted the truth about both the 1982 and 1993 US economic growth recoveries? How do you know the truth if you haven’t studied history?
I started on Wall Street during an internship in 1997. The people have changed. But the game of expectations hasn’t. Some people try to game the game by front-running inside information. Apart from potentially going to jail and having history write about you as a cheater, what’s the downside in that? Inside information is, after all, the truth.
Then there’s the knucklehead hockey player approach to mapping expectations about the truth (I don’t like orange jump suit risk):
- First, have a quantitative process that signals what the truth about expectations are, across multiple-durations
- Then, overlay a multi-factor model of research that helps contextualize those market expectations (correlation and/or causality)
- And finally, either move – or choose to do nothing
With a multi-duration, multi-factor model contextualized by history in hand each morning, you can:
- Do nothing
- Do more of what you have been doing
- Unwind everything you were doing and do the opposite of that
Contextualizing yesterday’s newsy “breakout” in bond yields is a good working example of how people get whipped around:
- US Treasury yields have been breaking out on our TREND duration for almost 3 weeks (1.82% breakout signal)
- The causal factor in driving Treasury yields higher, faster, continues to be economic data (jobs, housing, confidence)
- Most who are clinging to getting inside info from Bernanke on when the Yield Chasing thing is over, are getting run-over
Again, as I wrote 3 weeks ago, Front-running The Fed is a legal and profitable business. All you have to do is have an accurate process that signals how wrong Bernanke’s forecasts on growth are going to be and then act accordingly. By the time he tells his boys and/or his boys tell their Washington “consultants” that he’s going to “taper”, Mr. Market will have already moved.
So, if you still think both Old Wall and Bernanke are too bearish on growth, how do you front-run the herd’s expectations changing?
- You don’t do nothing (especially if you are long Yield Chasing securities like Utilities, Treasuries, MLPs, etc.)
- You do more of what’s working – buy growth, which includes US Dollars, Consumer, Healthcare, and Financials
At a capitulation point (like yesterday) people who are still bearish on #GrowthSlowing (like we were until late November 2012) have to go with option #3 (unwind everything they were doing and do the opposite of that). That’s when you really get paid. #Flows!
When people said “sell in May and go away”, they must have meant selling the end of the world #GrowthSlowing trades and buying the living daylights out of #GrowthAccelerating. That’s not me pushing a progressive agenda; this is just the score May 2013 will record:
- Utilities (XLU) down -7.4% for May 2013 to-date
- Financials (XLF) up +6.6% for May 2013 to-date
That’s about as eye opening an equity sector level divergence (one the key risk factors in our multi-factor risk management model) as you will ever see on a 1-month duration. So is a +31% one-month rip (+52 basis points) in 10yr US Treasury yields in Bernanke’s face.
Unfortunately (for Bernanke’s legacy), I can’t tell you what history will tell you about all the unintended consequences associated with the US Federal Reserve and Bank of Japan seeing rates rip off of the zero-bound.
All I can tell you is that the present is already reflecting asymmetrically on the past – and May 2013 has been illuminating.
Our immediate-term Risk Range for Gold, Oil (Brent), Corn, US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1351-1404, $101.74-105.28, $6.36-6.71, $83.92-84.58, 101.23-103.67, 1.98-2.18%, 12.29-14.82, and 1644-1674, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer