This note was originally published at 8am on September 25, 2013 for Hedgeye subscribers.
“Money, not morality, is the principle of commercial nations.”
That’s the opening quote to chapter 7, “The Birth of The Dollar”, in Jack Weatherford’s economic history classic The History of Money. We study history so that we can attempt to contextualize the madness of the moment in which we are living. Watching Bernanke debauch the value of the American People’s money is obviously immoral – but who cares?
Morals? This isn’t about morals. This is about getting paid. And for political types, since the speech circuit pay-wheels have already been greased for life, you only get paid by politicians if you can spin. Storytelling that this recent 4-day drop in the US stock market is “all about Congress” is paramount to the unaccountable @FederalReserve’s fiction.
That’s the short-run. In the long run, most politically conflicted narratives are dead. We’re a long way removed from 1787 (1st issuance of coins in the United States) when “copper coins bore the motto “Mind Your Business” (Weatherford, pg 119).” But my business of protecting against the loss of your capital to poorly timed policy decisions remains.
Back to the Global Macro Grind…
My business adheres to a rule that Warren Buffett used to uphold as “Rule #1” of investing (before he went all chuckles @CNBC and pro government socialization of his P&L’s risk on us): “Don’t lose money.”
In order for we commoners who don’t get insider and government “preferred” investment terms to execute on this rule, we need to let Mr. Market tell us what to do next.
As of this morning, the most obvious of the new obvious in our Correlation Risk model is the US Dollar moving to an immediate-term correlation versus bond yields of almost 1.0 (US Dollar Index 3-week correlation to US 10yr Treasury Yield = +0.98).
What does that mean?
- Bernanke’s causal impact on the value of American Purchasing Power (US Dollar) is massive
- There’s an explicit link between US currency and bond yields in the face of policy information surprise
- When moving in tandem, US Dollars and Bond Yields are coincident (leading) US growth indicators
I realize that this isn’t the framework you are going to read from Morgan Stanley this morning. And that’s precisely why our contrarian bull case on US Growth was right this year. Consensus economists and market strategists don’t use our framework.
To review our (and world history’s) account of mapping economic gravity:
- When a country’s currency is rising alongside its country’s interest rates = #GrowthAccelerating signal
- When a country’s currency is falling alongside its country’s interest rates = #GrowthSlowing signal
To be clear, a signal can whip around and change direction more often than you can remain solvent trying to trade every move. But the intermediate-term TREND signals don’t lie nearly as often as the Fed’s forecasts do.
This is why we overlay our A) fundamental research with B) a quantitative risk management signal that is multi-duration and multi-factor. Since I never know what Mr. Market is going to start signaling as risk, I just need to wait and watch for trending signals.
Now some might say that doesn’t make sense because the trends can change. But that is precisely the power of the process. As policies, prices, correlations, etc. change - we do. The alternative strategy is dogmatic naval gazing about what “should” happen.
In summary, what’s “new” in our model as of the last week?
- US DOLLAR: our intermediate-term TREND line of $81.35 broke on Bernanke’s decision to break it
- US 10YR TREASURY YIELD: our immediate-term TRADE line of 2.79% broke; and TREND support of 2.55% is under attack
Since the #1 Style Factor leading market performance in 2013 YTD = LONG GROWTH, this very immediate-term information surprise to the market on both the US Dollar and Bond Yields matters, big time. Why? Because, unlike the Fed’s marked-to-model dogma of 0% interest rates on the short end of the curve, US growth expectations are marked-to-market.
One other way to consider Mr. Market’s current #GrowthSlowing message within this Down Dollar, Rates Down move was in yesterday’s US stock market sub-sector divergences. The Financials (XLF) led losers on the day (-0.6%). The why on that isn’t that complicated to follow – as long-term rates fall, the leading indicator for the Financials (Yield Spread) compresses.
Since Larry Summers was eliminated as a prospective Fed head (his policy would have been more hawkish = #StrongDollar, #RatesRising), the Yield Spread (10yr minus 2yr yield) has compressed by -8.5% to +229 basis points wide. That’s not a point of difference between Bernanke and my definition of morality; that’s just going to eat into the principle of profits.
Our immediate-term Risk Ranges are now as follows (we have 12 Global Macro ranges in our Daily Trading Range product too):
UST 10yr Yield 2.61-2.79%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer