This note was originally published at 8am on August 04, 2014 for Hedgeye subscribers.
“I am trying to understand the origins of every form of front-running in the history of the United States.”
-John Schwall (Flash Boys)
John, sorry buds - you’re going to have to look a lot deeper than high-frequency-trading. Front-running proactively predictable #behavior on Wall Street is entirely legal, and it can be quite profitable at that!
How do you think about the #behavioral side of this game? Do you spend a lot of time thinking about the other side of your ideas? And/or do you have a process to cleanse the confirmation biases and emotions naturally embedded in your positions?
Front-running what my process is going to tell me to do next is a big part of what I do. I guess I can call it front-running myself. #fun
Back to the Global Macro Grind…
After dropping another -2.6% last week, the Russell 2000 is -4.3% for 2014 while one of our favorite ways to be long #Q3Slowing in the USA (long the Long Bond in TLT terms) is +12.8%. It’s definitely a bull market, in long-term Treasury Bonds!
But it wasn’t just early-cycle US stocks that got tagged last week – the selling in most things beta was broad based:
- Dow Jones Industrial Index -2.8% to -0.5% YTD
- Industrials (XLI) were down -3.7% to -0.9% YTD
- Consumer Discretionary (XLY) was down another -1.8% to -1.8% YTD
- European Stocks (EuroStoxx600) were down -2.9% to +1.1% YTD
- German Stocks (DAX) got tagged for a -4.5% loss (-3.6% YTD)
- Portuguese Stocks (PSI 20 Index) dropped -10.1% to -11.6% YTD
- Commodities (CRB Index) dropped -2.0% on the week to +4.4% YTD
- Oil (WTIC and Brent) was down -3.3-4.1% to +3.3% and -2.8% YTD, respectively
- Gold corrected -0.8% to +7.4% YTD
- Food (CRB Food Index) corrected -1.1% to +18.5% YTD
I’m not going to surprise you this morning in reiterating why I’d be selling early-cycle US Equities and/or European ones. We’ve been making the call on the former for the better part of the year, and on the latter we have been crystal clear on since the beginning of July.
Where I might surprise you is in taking down our asset allocation to the Commodities component of our 2014 #InflationAccelerating call. On July 7th, when the Russell 2000 re-tested her all time high (+8% higher at 1208), I had a 24% allocation to Commodities. This morning I have 10%.
Why? How about why not? At the beginning of the year it was a contrarian call that even surprised us to the upside. Now, being long commodity inflation is more of a consensus position that is not only correcting, but in some cases breaking my TREND lines on the downside.
What hasn’t broken TREND?
- Gold’s intermediate-term TREND line of support = $1271, so we’ll stay with that
- Cattle and Coffee were up another +0.9-7.4% last week to +29.3% and +64.2% YTD, respectively #StrongSide!
- And some of the base metals like Copper and Nickel are still bullish TREND
In other words, it’s not so easy that a monkey can do it (like it was in Q1) just buying anything commodities. You need to get into the price/volume/volatility weeds and start front-running some #divergences within the commodities market.
What are #divergences?
They’re risk management-speak for the ole Romper Room, “one of these things is not like the other – one of these things just doesn’t belong…” I.e. China! Yes, Chinese stocks not only flashed a bullish #divergence vs. US and European Equities last week, they did again this morning:
- Shanghai Composite Index +2.8% last week (and +1.7% this morning) to +8.2% YTD
- Hong Kong Stocks (Hang Seng) +1.3% last week (and +0.3% this morning) to +8.7% YTD
- Indian Stocks (BSE Sensex) up another +1% this morning to +23.1% YTD
India isn’t China. Silly Mucker. I know (but we still like India too!). That’s why the Hedgeye Asset Allocation model has a higher allocation to International Equities than it does to Commodities today. While it’s weird to be buying Chinese+ Indian stocks and liking Dr. Copper on the long side vs. short the Russell 2000 (after they bounce it), sometimes weird is what works.
Another thing to think about in #behavioral front-running terms is that the NET SHORT position in SP500 (SPX + Emini) is back, baby! After tilting to a NET LONG position for the first time since Q1, the CFTC Non-Commercial net short position moved back to -41,210 contracts on Friday.
That means hedge funds who covered high on the newsy Q2 GDP report last week, shorted low (again) into the weekend. So SPY (and Russell, IWM) should bounce now. Front-running the #behavior of emotional Consensus Macro hedging has become quite profitable as well.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.43-2.54%
Shanghai Comp 2156-2241
WTIC Oil 96.99-100.61
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer