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This note was originally published at 8am on February 24, 2014 for Hedgeye subscribers.

“All men can see the tactics whereby I conquer, but what none can see is the strategy out of which victory is evolved.”

-Sun Tzu

That’s most likely a familiar quote to any winner in this world – and it should be. Author John Hamm uses it effectively in his intro to chapter 5 of Unusually Excellent (pg 103) in order to link leadership to processes and plans.

As we like to say here @Hedgeye in terms of positioning for new Global Macro Themes, the plan is that the plan is going to change. That’s because real-time prices and market signals do. Our risk management process doesn’t change so much.

Neither did Team Canada’s in this weekend’s Gold medal hockey win at the Olympics. Sure, offense might win shootouts, but defense wins championships. En route to their second consecutive Olympic win, Team Canada shut out both USA and Sweden. It’s really hard to lose if you don’t get scored on (Canada allowed only 3 goals in 6 tournament games). #GoldenDefense

Golden Defense - 44

Back to the Global Macro Grind

Backcheck, Forecheck, Paycheck. That’s another saying meat-head hockey players like me use when we think about grinding out wins. Note that back-checking comes first. Defense always does.

There are obvious ways to apply this mentality to your risk management strategy. In a US stock market that literally went straight up last year, if all you did was not lose money on the short side, you probably won the season for your investors.

Sure, doing crazy stuff (like trading) may look like “short-term” tactics (primarily because they are) but don’t confuse my tactical back-checking  with a lack of a longer-term strategy to win championships.

What is your long-term strategy?

Mine is don’t lose money. That’s why how you did in 2000, 2001, 2002, 2008 and 2011 matters.  That’s also why most of our Global Macro Themes incorporate what to stay clear of (on both the long and short side) if a big macro theme starts to trend.

Examples?

  1. During #GrowthAccelerating – don’t short high-short interest, high beta, growth stocks that can beat expectations
  2. During #InflationAccelerating – don’t short commodities, breakevens, etc.
  3. During #InflationAccelerating + #GrowthSlowing – don’t short bonds, utilities, or Gold

If you aren’t in the business of shorting things, substitute the word “short” with SELL! Obviously, the other side of “don’t sell” is buy or hold. And I think anyone who has bought and held commodities for the last 3 months is winning YTD too.

Update on our non-consensus 2014 call for #InflationAccelerating:

  1. US Dollar Index is down again this morning and -1.4% in the last 3 months
  2. CRB Commodities Index was up another +2.8% last week and up again this morning to +7.8% YTD
  3. US Consumer Prices (CPI) hit a 4-month headline high of +1.6% year-over-year last week (JAN report)

I know. I know. The government says there’s no inflation, and since they’ve neutered the inflation report so that the headline number can rarely remain above 4% (or below 1%) for long, academics can argue amongst themselves on that.

Reality is that market expectations trade on the rate of change for both GROWTH and INFLATION expectations. And currently the rate of change on both makes our macro call a very easy one to make:

  1. INFLATION: up from its 3yr low of +0.9% y/y CPI in OCT 2013, CPI is going towards 2%, fast, in February
  2. GROWTH: down from its Q313 sequential peak of +4.12% GDP, you’ll probably see a 2% handle in Friday’s GDP report

So, irrespective of your views on how to play Macro Defense, what if?

  1. Inflation doubles (from 1% to 2%)
  2. Growth gets cut in half (from 4% to 2%)

Market #history fans will recall that when inflation slows growth, stock markets get MULTIPLE COMPRESSION. In other words, with the SP500 trading at 16x this year’s #OldWall projection for “earnings”, all you need is 2 points of multiple compression to get you 1638 (14x) at some point this summer. If the “earnings” (and multiple on them) start to fall, it’ll get gnarly out there, faster.

And while I am sure that the “weather will turn” and that some American consumers are dumb enough to go lever themselves up with a few more houses to flip, that doesn’t change the fact that inflation will A) slow real-consumption-growth and B) have a big impact on reported US GDP via a rising “deflator” (note: the deflator, which is subtracted from GDP, hit a 50yr low last yr and is rising).

With Natural Gas (+17.7% last wk to +46.3% YTD) and Coffee price (+19.1% last wk to +50.1% YTD) #InflationAccelerating to 52-week highs last wk, #GrowthSlowing has both Utilities (XLU) and Gold +7% and +11% YTD, respectively. So don’t be short those. Buying and holding them for the last 3 months has been a #GoldenDefense. Being long the American consumer, not so much.

Our immediate-term Macro Risk Ranges are now as follows:

UST 10yr Yield 2.66-2.78%
SPX 1803-1848

VIX 13.44-16.69
USD 79.81-80.41

Brent Oil 108.54-110.69  

Gold 1306-1340

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer

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