(Editor's Note: This commentary was originally published on Thursday June 20. It was subsequently featured on Fortune. If you are an individual investor, and would like more information on how you can subscribe to Hedgeye's services, please click here.)
FORTUNE -- What an epic 48 hours it has been. Just. Total. Chaos.
We are officially going over the waterfall now. Boats are in midair. People are hanging on trees. Everybody is scrambling, trying to explain what they missed. Trying to make sense out of it all. Hat tip to Bernanke-sponsored bedlam with a big assist from our Central-Planning Fed Overlords.
The reality? Everything is playing out precisely how it should have played out.
If you're data-dependent, if you have a rigorous quantitative process backing the research (God forbid), this was a fairly straightforward call to make. U.S. growth has been accelerating as we have been saying all along (well ahead of consensus).
Here are the facts: U.S. economic data stabilized from December 2012 through March 2013. From April to June, growth accelerated. On June 18th the Russell 2000 hit an all-time high. On Wednesday, the Fed basically repeated all of this and outlined its view on tapering. Cue market mayhem.
All of these market dislocations were percolating underneath the surface of consensus well before this frenzy. When markets don't trust something, the forward curve of implied volatility starts to rise. When they really don't trust something, that volatility rises at a faster rate. It's called convexity.
In terms of implied volatility in everything that was already crashing (gold, Treasuries, emerging markets, etc), that concept has been pretty straightforward for going on for six months now. For U.S. equities, it's relatively new.
As consumption, employment, and housing growth accelerated in the last three months, stock market expectations went right squirrel. While it may seem strange, it does make sense. We have a Federal Reserve that is A) horrendous in terms of forecasting and B) compromised and conflicted in terms of timing its "communications." Bernanke made his legacy bed – now we all have to sleep in it.
Turning our attention to the rest of the world: What a disaster. Asia is a bloody mess. Go back to the tapes, we've been sounding the alarm here for a while now. Asian markets overnight were a debacle with the Nikkei "outperforming" its peers by only declining 1.7% (no, we still don't like Japan).
As for China -- just nasty. I don't know what else you would call it. Meanwhile, the Hang Seng is down 14.4% since the end of January. Now it's not as nasty as Brazil, or Russia, but it's pretty darn nasty. India is down 2.9%; Indonesia down 3.7%. Even though we like the Philippines, (it's an interesting micro story within the broader disaster which is Emerging Markets) we sold that as well. We realized the research there was going to be trumped by the risk management signal.
You can't be dogmatic in your stance. When the macro flows take over, get out of the way.
Europe? It doesn't look good, either. That's not new. Now if the DAX trend line at 8013 breaks, that would definitely be news. That is a critical line. Most trend lines in Europe are broken. The FTSE just broke its trend. So if the DAX breaks, there will not be one—not one—out of the 86 countries whose equity markets we follow that will have held its trend line, other than the U.S. stock market.
Investors are running out of places to put their money. So in a sense, the S&P 500 is the last of the Mohicans. Keep a close eye on the 1583 level on the S&P 500.
Now the question is at what point do growth expectations in equities get prices in? I don't know the answer to that. That's what we've been trying to convey recently. What we have been saying is No. 1: Don't buy fixed income and don't buy commodities or anything that we haven't liked for six months. No. 2: Take down your equity exposure. That's the risk management order of the day.
Ranting and raving about what has transpired these last six months is no longer my task. It's history. Right now you take a deep breath. You wait and you watch.
One of the first things we'll be buying is Financials (XLF). We like the Financials. Particularly with the yield spread at 211 basis points wide and climbing. That's a very bullish indicator for the group. Your buy list should have a lot of financial names on it. After that, we'll go to the old bailiwick which is consumption-oriented names in healthcare and consumer itself.
Keep an eye on that 1583 level on the S&P 500 (SPX). It's key. If that breaks, it's bye-bye to the Mohicans.