A Thousand Pebbles

This note was originally published at 8am on July 24, 2013 for Hedgeye subscribers.

“Fragility is the quality of things that are vulnerable to volatility.”

-Nassim Taleb


We have quoted Nassim Taleb a number of times at the start of the Early Look and, admittedly, I didn’t check to see if this was a recycled quoted. Nonetheless, it is a very apropos quote for the topic of today’s Early Look and for contemplating risks in markets generally.


 The title for today’s note comes from a story, which is referenced in Taleb’s most recent book “Antifragile”, that emanates from rabbinical literature (Midrash Tehillim) and is about a king that is angry at his son.  In fact, the king is so angry at his mischievous son that he explodes one day and tells his son he will crush him with a large stone. 


Herein lies the dilemma according to the story: a king who breaks his oath is considered unfit to rule.  The king is now faced with the decision to either crush his son, or to give up his throne.  Luckily before the poor prince was crushed, an advisor (the Hedgeye of the era perhaps?) came up with a solution.  The king should cut the stone into very small pebbles and pelt his son with these pieces.


Taleb’s point in this analogy is to explain how fragility stems from non-linear effects.  That is, if you double the dose, you get more than twice the effect.   By way of a practical illustration, if you have five shots of Jack Daniels, you have a buzz.  But if you have ten shots of Jack Daniels, your wife (or husband) makes the couch up for you to sleep on that night.


Back to the global macro grind . . .


As it relates to non-linear impacts on the global markets as of late, interest rates have certainly had the most critical impact.  In the Chart of the Day, we highlight a slide from our most recent Q3 Theme Presentation that looks at quarter-over-quarter moves in interest rates.  As the slide shows, the move in interest rates in the last quarter was the largest percentage increase in fifty years.  (Yes, the last time this happened Sandy Koufax was pitching for the L.A. Dodgers.)


We were on the road in Europe talking to clients last week and not surprisingly interest rates were a key topic of discussion.  Many of the more astute investors actually narrowed in on this precise point of interest rate volatility.  Our view is that volatility of rate increases will be more benign moving forward, which, as we’ve been stating, should be positive for the U.S. dollar, domestic economic activity and U.S. stocks.


To the extent that volatility picks up, the effects of interest rate increases will be non-linear.  In reality, a move from 1.63% on the 10-year treasury to 2.63%, or an increase of 100 basis points, shouldn’t have a meaningful impact on asset classes or the economy.  The markets become fragile, though, when this 63% back up in rates occurs in a very compressed time period, as it did in May – June.   In pushing the interest rate ball under water, the global central banks have created a set up in which interest rates are very fragile (to use Taleb’s definition).


In addition to the risk of rates increasing at a rate that is highly volatile, the other key focus area of investors in Europe on our visit related to the impact of #RatesRising to housing.  This is certainly a legitimate question as the wealth impact from home price increases is a key reason we are bullish on U.S. consumption.  Specifically, as a consumer’s balance sheet improves via an increasing home price, so too does their confidence, ability to borrow and subsequently spend.


Based on our long run analysis of housing, the recent accelerated move in rates has not altered the fact that the affordability of purchasing a home remains at historic lows.  On the basis of median mortgage payment as a % of median income, the housing market is at 22% and well below the twenty-five year median of 28%.  On the basis of median mortgage payment to median rent, the housing market is at 99%, which is also well below the long run average of 131%.


This is not to say, of course, that housing won’t be impacted by a volatile move in rates, but the housing market is still so depressed based on historical levels it should have the ability to manage through #RatesRising.  June data from the NAR seems to support this as existing home sales were up 15.2% year-over-year and the national median home price in June was up 13.5%.  So yes, housing can do well if rates continue to rise.


Switching to infomercial mode for second, I want to highlight that we will be expanding our U.S. financials research coverage and are launching on U.S. asset management stocks on Monday July 29th at 11am.  Jonathan Castelyn has joined Josh Steiner’s team in a senior role and will be initiating on these names.   As always, we will be actionable and Jonathan will have 2 short ideas and 2 long ideas.  Please email  for access.


Our immediate-term Risk Ranges are now:


UST 10yr 2.47-2.71%

SPX 1684-1702

VIX 11.59-13.54

USD 82.01-82.89

Brent 107.21-109.14

Gold 1249-1346


Keep your head up and head on the ice,


Daryl G. Jones

Director of Research


A Thousand Pebbles - Treasury L vs NL


A Thousand Pebbles - Virtual Portfolio

August 7, 2013

August 7, 2013 - dtr



August 7, 2013 - 10yr

August 7, 2013 - spx

August 7, 2013 - nik

August 7, 2013 - ftse

August 7, 2013 - dxy

August 7, 2013 - euro

August 7, 2013 - oil



August 7, 2013 - VIX

August 7, 2013 - yen

August 7, 2013 - natgas
August 7, 2013 - gold

August 7, 2013 - copper






According to research published in the British Medical Journal (BMJ), it was very likely that the H7N9 flu virus that emerged in eastern China this year was transmitted directly from human-to-human.  "To our best knowledge, this is the first report of probable transmissibility of the novel virus person-to-person with detailed epidemiological, clinical and virological data," the scientists wrote.


Experts commenting on the research said while it did not necessarily mean H7N9 is any closer to becoming the next flu pandemic, "it does provide a timely reminder of the need to remain extremely vigilant."  The scientists who led the study stressed, however, that the virus has not yet gained the ability to transmit from person to person efficiently - meaning the risk is very low that it could cause a human pandemic in its current form. 


The new bird flu virus, which was unknown in humans until February, has so far infected at least 133 people in China and Taiwan, killing 43 of them, according to the World Health Organization.



Lei Chin Ion, director of the Health Services, said, “We are now collecting opinions and our work is progressing well, so we will conduct a first revision of the law in 2015.”  Lei Chin Ion said that, following an assessment period, the government will reveal what kind of measures will be applied to casinos that do not meet air quality standards.  He said that the administrative regime predicts the reduction or removal of smoking areas for casinos that do not comply with the Health Bureau standards. 


This month it was revealed that 28 casinos failed the first air quality test conducted by the Health Services Bureau.  Those casinos had to undergo a second test and the Bureau is currently analyzing the results and looking to decrease the size of some smoking areas.

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Coaching Corrections

“A coach is someone who can give correction without causing resentment.”

-John Wooden


I’ve been blessed with great coaches and teachers in my life. They were never easy on me. Their criticisms didn’t cause any resentment either. To the contrary, they drove me to improve. Trusting your coaches is the first step toward opening your mind.


I make a lot of mistakes. And since I’m the front man for this Hedgeye show, that means every mistake I make is front-and-center in the arena of public market debate. That’s not a bad thing. That’s right where I want to be.


What I do isn’t for everyone. I get that. But the first 5 years of building this firm alongside my teammates has given me a keen appreciation for having the opportunity to make mistakes in an open and accountable forum. It speeds my learning process.


Back to the Global Macro Grind


One of the toughest things to do in US Equities in 2013 has been to coach myself through market corrections. The new normal correction can last anywhere from 4 hours to 4 days. I know, it’s end of the world type stuff. Remember, nothing is normal.


So, from its all-time closing high of 1709 in the SP500 last week, what will the latest US stock market “correction” be?


A)     -0.9% to 1693?

B)      -1.9% to 1676?

C)      -4.6% to 1630?


Yes, that is a Hedgeye Poll. If you have time, ping me with A, B, or C. One of the most important aspects of working in an open/transparent forum of debate is collaboration. I’m pretty sure the days of opaque #OldWall sentiment checks are dead.


Since I actually need to #timestamp an answer to this question, I’ll choose B.


That’s the highest probability choice because the S&P futures already showed me they can snap my mo mo line of 1693 support this morning. And there’s very little fundamental and/or quantitative evidence that 1630 is in play, yet.


What is the “mo mo” line?


That’s the line I use to front-run the machines. It’s home brewed. It’s my most immediate-term risk management duration. It’s especially useful for day-trading, scalping, etc. Label me long-term cycle guy or Mucker, I’m cool with both. Better to scalp, than be scalped.


Put another way, across our core risk management durations:

  1. SP500 immediate-term mo mo line of support = 1693; and 1714 is resistance (our Daily Risk Range)
  2. SP500 immediate-term TRADE support = 1676
  3. SP500 immediate-term TREND support = 1630

The upside down of the is US Equity front-month volatility (VIX):

  1. VIX mo mo risk range = 11.71-13.72
  2. VIX immediate-term TRADE resistance = 14.64
  3. VIX immediate-term TREND resistance = 18.98

In other words, the bullish TREND in US Equities (and bearish TREND in Fear) isn’t in the area code of being challenged, yet. Therefore, if contextualized within the framework of our risk management process, you woke up every morning reminding yourself to not “fight the TREND”, I’d wholeheartedly agree with that. I’d rather fight the Fed than fight things like math and/or gravity.


One of the biggest challenges I have personally is trying to communicate risk management strategies to clients who all have different risk profiles, holding periods, etc. Through consistent feedback and criticism though, I’ve learned that there’s only one answer to this challenge: keep doing what I do - be Duration Agnostic, and keep working on communicating what that process means.


In my humblest of dreams, that would be my happiest retirement: that my teammates and I were successful in not only communicating our multi-factor, multi-duration Global Macro risk management process – but that the players and peers that we coached trusted us.


Trust isn’t allocated. You have to re-learn how to earn it, every day. We have a long road of learning and teaching ahead.


Our immediate-term Risk Ranges are now as follows (*we have 12 Macro Risk Ranges in our Daily Trading Ranges tool now too – as an example, this morning I’ve attached all of them; the bracketed “bullish” or “bearish” comment is on our TREND duration (3 months or more) whereas the range itself is on our most immediate-term duration):


UST 10yr 2.56-2.73% (bullish on yield)

SPX 1 (bullish)

Nikkei 137 (bullish)

FTSE 6 (bullish)


VIX 11.71-13.72 (bearish)

USD 81.49-82.43 (bullish)

Euro 1.31-1.33 (bullish)

Yen 97.01-98.94 (bearish)


Brent 107.23-109.79 (bullish)

NatGas 3.21-3.46 (bearish)

Gold 1 (bearish)

Copper 3.05-3.18 (bearish)


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Coaching Corrections - Chart of the Day


Coaching Corrections - Virtual Portfolio


TODAY’S S&P 500 SET-UP – August 7, 2013

As we look at today's setup for the S&P 500, the range is 38 points or 1.26% downside to 1676 and 0.98% upside to 1714.                                    










  • YIELD CURVE: 2.33 from 2.34
  • VIX closed at 12.72 1 day percent change of 7.43%


MACRO DATA POINTS (Bloomberg Estimates):

  • 7am: Mortgage Applications, Aug. 2 (prior -3.7%)
  • 11am: Fed to buy $1.25b-$1.75b debt in 2036-2043 sector
  • 10:30am: DOE Energy Inventories
  • 1pm: U.S. to sell $24b 10Y notes
  • 1:40pm: Fed’s Pianalto speaks on monetary policy in Cleveland
  • 3:00pm: Consumer Credit, June, est. $15b (prior $19.6b)
  • Bank of Japan sets target rate, 2014 monetary base rate


    • 6:30am: Quinnipiac Univ. N.J. likely voter poll on Senate race; including Democratic, GOP primary voters
    • 3:50pm: President Obama delivers speech to troops at Camp Pendleton in Calif.


  • Amgen said to boost Onyx Pharmaceuticals bid to $130/shr
  • Mead Johnson to pay $33m to end China formula probe
  • Disney profit little changed, “Lone Ranger” hits film unit
  • Bats said glitch yday was network issue, not w/ software
  • Direct Edge, Nasdaq exchanges also had issues yday
  • Anadarko doubles qtr div. to 18c/shr from 9c, est. 11c
  • Wal-Mart may bid for Li Ka-Shing’s ParknShop: Reuters
  • TPG, Carlyle, GIC may bid for H.K.’s Quality Healthcare: SCMP
  • Omnicom Investor sues over merger with Publicis Groupe
  • Yuan advances to 19-yr high on PBOC fixing, convertibility bet



    • AMETEK (AME) 7am, $0.52
    • AOL (AOL) 7am, $0.43
    • Ariad Pharmaceuticals (ARIA) 7:35am, $(0.40)
    • Avnet (AVT) 8am, $0.96
    • Carlyle Group (CG) 6:30am, $0.55
    • Cimarex Energy (XEC) 6am, $1.27
    • CommonWealth REIT (CWH) 6:28am, $0.64
    • Devon Energy (DVN) 8am, $0.95 - Preview
    • Duke Energy (DUK) 7am, $0.93
    • Gogo (GOGO) 7:30am, $(0.37)
    • HollyFrontier (HFC) 7:30am, $1.39
    • Icahn Enterprises (IEP) 8am, No est
    • ING US (VOYA) 5:55am, $0.63
    • Lexington Realty Trust (LXP) 7:30am, $0.24
    • Marsh & McLennan (MMC) 7am, $0.67
    • Melco Crown (MPEL) 7:51am, $0.27
    • Molex (MOLX) 7:30am, $0.35
    • Newcastle Investment (NCT) 6:30am, $0.11
    • Pepco Holdings (POM) 6:03am, $0.23
    • Ralph Lauren (RL) 8am, $1.94
    • Sinclair Broadcast (SBGI) 7:30am, $0.15
    • SunEdison (SUNE) 6am, $(0.15)
    • Time Warner (TWX) 7am, $0.76
    • Valeant Pharmaceuticals (VRX CN) 6am, $1.28


    • Agrium (AGU CN) 5:30pm, $4.97 - Preview
    • American Water Works (AWK) 4:15pm, $0.61
    • Array BioPharma (ARRY) 4:19pm, $(0.13)
    • ARRIS Group (ARRS) 4pm, $0.26
    • Brookdale Senior Living (BKD) 4:43pm, $-
    • CenturyLink (CTL) 4:07pm, $0.66
    • Concho Resources (CXO) 5pm, $1.00
    • Continental Resources (CLR) 4:37pm, $1.25
    • Corrections Corp of America (CXW) 4:10pm, $0.65
    • Diamond Resorts Intl (DRII) After-Mkt, No est.
    • DryShips (DRYS) 4:05pm, $(0.07)
    • Energy Transfer Equity (ETE) 5:05pm, $0.54
    • Energy Transfer Partners (ETP) 5:09pm, $0.47
    • Fifth Street Finance (FSC) 4:28pm, $0.28
    • Franco-Nevada (FNV CN) 5:18pm, $0.21
    • Frontier Communications (FTR) 4:01pm, $0.06
    • Fusion-io (FIO) 4:05pm, $(0.03)
    • Green Mountain Coffee (GMCR) 4pm, $0.76
    • Groupon (GRPN) 4pm, $0.02
    • Halozyme Therapeutics (HALO) 4:05pm, $(0.14)
    • MarkWest Energy (MWE) 4:01pm, $0.22
    • MBIA (MBI) 4:01pm, $0.14
    • Mondelez Intl (MDLZ) 4:01pm, $0.34 - Preview
    • Polypore Intl (PPO) 4:01pm, $0.39
    • Prudential Financial (PRU) 4:07pm, $1.99
    • Redwood Trust (RWT) 4:15pm, $0.34
    • SolarCity (SCTY) 4:01pm, $(0.38)
    • St Joe (JOE) 4:01pm, $0.02
    • Sun Life Financial (SLF CN) 5:10pm, C$0.66
    • Tesla Motors (TSLA) 4:01pm, $(0.20)
    • Transocean (RIG) 4:30pm, $1.08
    • Tronox (TROX) 5:43pm, $(0.05)
    • WageWorks (WAGE) 4:05pm, $0.17


  • JPMorgan Sued With Goldman Sachs in Aluminum Antitrust Case
  • p Commodities Market, Industry News »             
  • Palmer’s ‘Mad’ Mine Costs China on Learning Curve: Commodities
  • Gold Drops to Three-Week Low on Speculation Fed to Trim Stimulus
  • Wheat Declines as Iraq, Egypt Shun Grain From U.S. in Tenders
  • Copper Falls on Speculation Fed Will Opt to Limit Debt Purchases
  • WTI Crude Fluctuates Amid Signs of Declining U.S. Inventories
  • Rebar Climbs to Three-Month High as Iron Ore Prices Gain
  • Bank of America’s Blanch Says WTI Crude Could Fall $8 to $10
  • Palm Oil Declines to One-Week Low as Peak-Output Cycle Begins
  • BHP’s CEO Sees US Shale Expansion as Mineral Demand Grows
  • Silver ETF Holdings Approach Record and Critical Price Levels
  • Palladium’s Pennant Pattern Signals Increase: Technical Analysis
  • Easy Cash Ebbs for $300 Billion Asean Port-to-Rail Cost: Freight
  • Corn in U.S. Seen by Cordonnier at Risk of Damage From Frost


























The Hedgeye Macro Team












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