“One of the main tenets of prospect theory is that people don’t evaluate things in absolute terms.”
Prospect Theory was originally developed by Dan Kahneman and Amos Tversky in 1979 (i.e. after all the Keynesian economic policy makers who worked for Nixon and Carter failed). But Kahneman didn’t win his Nobel Prize for #behavioral economics until 2002. And one of the most important books you’ll ever read, Thinking, Fast and Slow, wasn’t published until 2011.
All the while, this thing called the US economic and policy crisis happened. And linear (Keynesian) economic theorists working for Bush and Obama didn’t change a damn thing. There is no #behavioral or non-linear chaos theory embedded in what they do. Almost every lick of what comes out of the US Treasury and/or Federal Reserve deals in absolutes, on a lag – not forward looking rate of change.
While that is a national embarrassment for a country that hangs its entitled hat on meritocratic evolution and technological change, it remains your opportunity. Whether it’s Jonah Berger teaching social influence (marketing) at Wharton, or me ranting about macro every morning – it’s what happens on the margin that matters most. Prospect Theory is winning.
Back to the Global Macro Grind…
Rate of change, or the accelerations/decelerations in the slope of a line measuring momentum, is easy to understand; especially when you show it in pictures. This is why a lot of people in our profession look at charts.
But, as Henry David Thoreau wrote, “it’s not what you look at that matters, it’s what you see.” And, in a general sense, that is the Hedgeye Risk Management process when I talk about considering multiple factors and multiple durations, all at the same time.
In other words, it’s easier to see what’s going on in this globally interconnected macro marketplace of colliding factors, policies, and prices if you take a step back and look at the big picture. So let’s do that this morning, and take a look at 3 big places:
- JAPAN – on both our immediate-term TRADE and intermediate-term TREND durations the Japanese stock market remains bearish. From a GIP (Growth, Inflation, Policy) modeling perspective, Japanese #GrowthSlowing continues to be our call.
- EUROPE – mostly every major European stock market is still bullish on both our TRADE and TREND durations - in sharp contrast to the Dow (-2% YTD), the Italian stock market is +17% YTD (they don’t have social media or biotech bubble stocks). From a GIP modeling perspective, the Eurozone growth recovery is lagging what was the US one in 2013 by 6-18 months.
- USA – both the Nasdaq and the Russell 2000 have recently broken both @Hedgeye TRADE and TREND support levels. The SP500 is bearish on our immediate-term TRADE duration (1869 resistance) and barely bullish TREND (1830 support). In our GIP model, US #InflationAccelerating still sets up to slow US growth until at least the end of the 3rd quarter.
Accelerate and decelerate, fast and slow. That’s what centrally planned economies do. Get used to it.
Considering macro markets across multiple-factors also helps. I still can’t for the life of me understand how you’d have an informed opinion on multiple expansion or compression in stocks, if you don’t have a repeatable process considering:
- Interest Rates
But that’s just me. And to be crystal clear on this, I didn’t get that I needed to develop a process to consider all of the non-linear factors within the dynamic ecosystem that I invested in until I got run-over in my “best stock ideas.” Macro phase transitions can crush alpha, fast.
What is a phase transition?
- It’s a term used to explain thermodynamic systems
- “the transformation from one phase to another by heat transfer” (Wikipedia)
I realize that the alternative to considering market risk this way is using a 50-day moving monkey average. I also get that the guys who taught me about this business used to hold up pieces of paper to their trading screens trying to delineate higher-lows and higher-highs.
But guess what, without considering multi-factor, multi-duration global macro, they were still right in considering rate of change:
- Higher-lows + higher-highs = bullish momentum
- Lower-highs + lower-lows = bearish momentum
That said, that’s only considering 1-factor (price). And while it’s a good one to start with if only considering price momentum, you don’t have to stretch too far to start adding other factors, like volume and volatility, in order to front-run #OldWall’s behavior.
I’m not saying I have all the answers. I’ve made more mistakes with live ammo than almost anyone my age in this business. I have seen people lie, cheat, and lose. I have seen others evolve, learn, and win.
So I wanted to thank you for the opportunity to learn from all my mistakes out loud. Sometimes I learn fast; sometimes it’s slow. Building Hedgeye in an open, transparent, and accountable environment has helped us improve our process. I’m grateful for that.
We’ll be hosting our Q2 Global Macro Themes conference call this morning at 11AM EST. If you have time, we’re looking forward to your questions about what our risk management process is signaling next.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on March 25, 2014 for Hedgeye subscribers.
"Kings are not born, they are made by general hallucination."
-George Bernard Shaw
On this day more than 700 years ago, Robert the Bruce became the King of Scotland. Robert was one of the most well known warriors of his generation and led the Scots in their wars of independence against Britain.
Prior to successfully defeating the British, according to legend, Bruce was hiding in a cave on Rathlin Island off the north coast of Ireland. While in the cave Bruce purportedly watched a spider spinning a web in an attempt to connect one area of the cave's roof to another area. (Clearly, Robert the Bruce had some spare time on his hands.)
The spider repeatedly failed but after each failed attempt kept turning back to the task at hand. Eventually the spider succeeded. According to legend, Bruce is said to have used this as inspiration to continue his war against Britain where he eventually inflicted on them a number of critical defeats on the path to Scottish independence.
This story also supposedly inspired the maxim: "If at first you don't succeed, try try try again."
Back to the Global Macro Grind ...
As the story of Robert the Bruce teaches us, becoming king is not an easy task. As it relates to asset class performance this year, there aren't a lot of kings in the year-to-date. On a country basis, the top three decliners are as follows:
- Russia -19.5%
- Venezuela -14.8%
- Czech Republic -12.6%
Japan is a close runner up to the top three and comes in fourth with a -11.5% decline on the Nikkei in the year-to-date. Incidentally, the Japanese Mothers Index (more small cap focused) is down a staggering -5.7% today.
As the reigning King of Russia, Vladimir Putin is certainly learning the pain of trying to broaden his kingdom. On the back of Russia's literal annexation of Crimea, Russian equities are getting clobbered as noted above.
This morning the West is implementing more actions to further alienate Russia. The big symbolic one is that the G-8 summit, which was originally scheduled for Sochi this summer, has now been moved to Brussels and Russia has been uninvited.
In part, this and the myriad of sanctions that have been implemented against Russia are largely symbolic. No doubt the most significant sanction is the one that has been implemented by the markets themselves as noted above by the almost -20% decline for Russian equities in the year-to-date. To the extent Russian equities continue to decline and Russian companies are challenged to tap the public markets to raise capital, Putin will certainly be wondering whether it is all worth it to become king.
The King of Fed watching, Jon Hilsenrath from the Wall Street Journal, wrote an interesting article yesterday highlighting the odd (for lack of a better word) nature of economic target setting by the Federal Reserve. According to Hilsenrath, even though the Fed expects a 5.4% jobless rate in 2016, a normalized level, they are still likely to keep interest rates at a level that is well below normal (typically considered 4%-ish on the Fed funds rate).
To the extent this turns out to be accurate, it is likely that we continue to see inflationary assets (Gold) continue to front run this long term dovish policy. The broader concern, of course, is the arbitrary nature of employment targets such as the jobless rate. In the Chart of the Day, we highlight a chart we have shown many times in the past which is the labor force participation rate.
As the chart shows, the U.S. is literally at generational lows in terms of participation in the labor market. In fact, labor force participation peaked at just under 67.5% in 2000 and has been in relatively steady decline ever since. Currently, the labor force participation rate is just over 62.5% and at an almost 35-year low.
This emphasizes the oddity of the Federal Reserve using an arbitrary data point such as the jobless rate to highlight the health, or lack of health of the economy, since the jobless rate doesn’t take in to account the people simply dropping out of the labor force. For today, we’ll leave a discussion of whether the Fed’s extreme dovishness has helped the economy to the side, but certainly the arbitrariness of their targets has and continues to confuse the markets. This is likely why the 10-year treasury rates are down almost 10% on the year and down again this morning. Simply put: investors don’t believe what the Fed is saying.
To add to the confusion, this morning Philadelphia Fed chief Charles Plosser is indicating he believes that Fed Fund rates will hit “2-something” by the end of 2015 and 3% by the end of 2016. This is more than a 300 basis point move in the next couple of years. Plosser also indicated he finds the market’s reaction to Yellen’s press conference last week confusing. Well, Mr. Plosser, confusion breeds contempt, as they say.
Conversely, the United Kingdom, despite losing Scotland to Robert the Bruce many years ago, appears to have a central bank that is at a minimum providing some confidence to the markets and allocators of capital. The U.K. reported CPI this morning at +1.7%, which suggests an inflationary environment in the U.K. that is relatively benign.
Certainly, we’d be somewhat hypocritical if we assumed the CPI was the best gauge of inflation in the U.K. (it is a government constructed number after all), but nonetheless the key economic indicators in the U.K. continue to trend the right way as evidenced by CPI coming in lower versus the +1.9% reading in January.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.62-2.81%
Best of luck out there today and long live the king!
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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TODAY’S S&P 500 SET-UP – April 8, 2014
As we look at today's setup for the S&P 500, the range is 37 points or 0.82% downside to 1830 and 1.19% upside to 1867.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.30 from 2.31
- VIX closed at 15.57 1 day percent change of 11.53%
MACRO DATA POINTS (Bloomberg Estimates):
- 7:30am: NFIB Small Business, March, est. 92.5 (prior 91.4)
- 7:45am ICSC weekly sales
- 8:55am: Redbook weekly sales
- 9am: IMF releases biannual world economic outlook
- 10am: JOLTs Job Openings, Feb., est. 4.020m (prior 3.974m)
- 1:30pm: Fed’s Kocherlakota speaks in Rochester, Minn.
- 2:45pm: Fed’s Plosser speaks in Philadelphia
- 4pm: Fed holds open board mtg in Washington on leverage ratios
- 4pm: Fed’s Evans speaks in Washington
- 4:30pm: API weekly oil inventories
- 10am: House Ways & Means hearing on supporting economic growth through “a Fairer Tax Code”
- 10am: House Armed Services Cmte hearing on Russia’s military developments, implications
- 10am: Atty Gen. Holder testifies on Justice Dept. at House Judiciary Cmte
- 10am: PPP hearing at House Transp. and Infrastructure Cmte
- Senate leaders hold news conferences after party luncheons
- FY15 budget panels/hearings:
- 9:30am: NASA Admin. Charles Bolden, House Appropriations
- 9:30am: Gen. Raymond Odierno, National Guard Bureau Chief Gen. Frank Grass, Army Reserve Chief Gen. Jeffrey Talley, Senate Armed Services Cmte
- 10am: Secretary of State John Kerry, Senate Foreign Relations
- 10:30am:Education Sec. Arne Duncan, House Appropriations
- 2pm: GSA Admin Dan Tangherlini, House Appropriations
- 2:30pm: Senate Judiciary marks up patent troll bill S. 1720
WHAT TO WATCH:
- Takeda, Lilly jury awards $9b over hiding Actos risks
- Citigroup agrees to $1.13b settlement over mortgage bonds
- Koch said to near deal for CVC’s Flint Group with Goldman Sachs
- Fed holds open board meeting in Washington on leverage ratios
- GM SUVs get top marks in insurance-industry front crash test
- U.S. Court of Appeals hears Apple/Google patent arguments
- Long-term jobless benefits stalled even with Senate passage
- China approves Microsoft, Nokia deal with conditions
- Express Scripts threatens to blackball Gilead’s Sovaldi
- Barclays settles U.K. Libor case weeks before trial to start
- BOJ refrains from boosting stimulus as recovery seen
- U.K. industrial output rises more than forecast on factories
- Weekly release of FDA warning letters
- IMAX to sell 20% stake in China business for $80m: WSJ
- Alcoa (AA) 4:03pm, $0.05 - Preview
- International Speedway (ISCA) 7:30am, $0.34
- Science Applications Intl (SAIC) 4:01pm, $0.65
- WD-40 Co (WDFC) 4pm, $0.68
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Gold Climbs to Two-Week High as Dollar to Ukraine Spur Demand
- EU Pig Farmers Miss Out on Boom as Russian Ban Spurs WTO Case
- WTI Rebounds as Gasoline Stockpiles Seen Shrinking; Brent Gains
- China Corn Glut No Barrier to Farmers as State Buys: Commodities
- Copper Falls 0.4% to $6,648 a Ton in London; Nickel, Tin Drop
- Coffee Extends Gains in London as Arabica Climbs for 4th Day
- Soybeans Snap Two-Day Drop as USDA May Report Reduced Stockpiles
- Rebar in Shanghai Climbs to One-Month High as Stockpiles Decline
- U.S. Beef to Japan May Decline on Australia Deal, Ministry Says
- Age of Gas Seen as Sideshow to U.S. Producers Preoccupied by Oil
- Copper Producers Keep Faith in China as Rout Belies Demand
- Gold’s Open-Interest Drop Signals Rally Ending: Chart of the Day
- Ending Iran Oil Ban May Cut Refiners’ Supply Cost: Bull Case
- Turkey’s Fracking Push Won’t Be Stalled by Bribery Probe: Energy
The Hedgeye Macro Team
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Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.