This note was originally published at 8am on July 24, 2014 for Hedgeye subscribers.
“Why would we ever predict when we can know?”
-Dan Heath
Great question. I guess that’s why some people like to trade on inside information.
In Global Macro Risk Management, there is no inside information. Or at least not the hard core stuff like Galleon used to get. Maybe there was back in the day when someone could literally call their boy at the Bank of England and just get the next rate move prior to it being announced. But even the biggest bureaucrat on the planet is scared of orange-jump-suit-risk #accelerating at this stage of the game.
As the game changes, our #process does. We believe that the best prediction of the future is based on what we already know. I’ve spent a lot of time talking to investors about how our models work. Sometimes at least 2/3 of our forecast is based on what we already know. In other words, we use real-time data and measure its rate of change vs. historical data in order to gauge a forward looking probability.
Back to the Global Macro Grind…
Thinking in rate of change (slope) and probability terms works a heck of a lot better than the ‘I’m smart and it feels like’ this is going to happen approach. Most of that spew anchors on what already happened – not on the measurable factors underneath the hood that could cause whatever happened to undergo a phase transition.
There are those two thermodynamic risk management words again – phase transitions. To put that in the most simpleton speak I can, there are two types of phase transitions I really care about:
- Bearish to bullish TREND reversals
- Bullish to bearish TREND reversals
While always considering our intermediate-term TREND duration within the context of our other durations (TRADE and TAIL) is critical, when something undergoes a phase transition on our TREND duration, that something often ends up becoming the best calls we make.
Don’t forget that if you go both ways like I do (don’t think dirty – think hockey: back-check, fore-check, paycheck), sometimes the most important call to make is to get out of the way.
How do you do that?
- If you’re short and something is going from bearish to bullish = COVER
- If you’re long and something is going from bullish to bearish = SELL
If you’re a longer-term investor, just cover or sell some. Only average players take coaching personally.
If you analyze your P&L across your entire career, what you’ll realize is that your performance distribution has big tails (i.e. your biggest losers kill you). Since risk management Rule #1 is don’t lose $$, that makes getting out of stuff really important.
Who gets you out?
We know who gets you in. Every bank, broker, and buds out there is trying to get you into what they get paid on next. This is Wall Street don’t forget. But getting you out of your “best idea” (might be your marriage too!) before it’s about to go really bad, #priceless.
I didn’t know what I was going to write about this morning (I usually don’t – I have 45 minutes to write something before it gets edited), so I certainly hope you can poke holes at this. I can.
I can poke holes at every single idea we have; especially if my intermediate-term TREND signal is reversing versus the desired direction of the position. Maybe that’s why a lot of PM’s ask me to scrub their portfolios (we call it a Ticker Scrub). It’s so easy a Mucker can do it.
What looks greasy dirty out there right now? (i.e. what is signaling a bearish to bullish TREND reversal):
- Chinese Stocks (Shanghai Comp) which closed up another +1.3% last night after China’s best PMI in 18 months
- Copper prices are up another +1.2% this morning to $3.24/lb after breaking out above @Hedgeye TREND
- US Equity Volatility (VIX) as the front month makes a series of higher-all-time-lows
Greasy? Yeah, you know – like when I score a goal in men’s league hockey off my elbow. I’m getting older and slower, so I love those. And I really love seeing something breakout for fundamental reasons that neither I nor my analysts can see. Those are beauties.
Is there anything better in this business than that? When all of the super smart people in this world are all wrong, at the same time, for the wrong reasons? Most of the time no super duper slide deck can arrest gravity.
Embrace the uncertainty out there. I can guarantee you’ll be really wrong less times. And you’ll smile more often too. After all, playing this game is a lot more fun when you can know how to be right by not being really wrong. You just have to know when to get out of the way.
Our immediate-term Global Macro Risk Ranges are now as follows:
UST 10yr Yield 2.45-2.51%
SPX 1964-1992
RUT 1134-1164
Shanghai Comp 2051-2099
VIX 10.32-12.51
WTI Oil 101.75-104.15
Gold 1286-1324
Copper 3.17-3.28
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
