#Behavioral Front-Running

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:

  1. Dow Jones Industrial Index -2.8% to -0.5% YTD
  2. Industrials (XLI) were down -3.7% to -0.9% YTD
  3. Consumer Discretionary (XLY) was down another -1.8% to -1.8% YTD
  4. European Stocks (EuroStoxx600) were down -2.9% to +1.1% YTD
  5. German Stocks (DAX) got tagged for a -4.5% loss (-3.6% YTD)
  6. Portuguese Stocks (PSI 20 Index) dropped -10.1% to -11.6% YTD
  7. Commodities (CRB Index) dropped -2.0% on the week to +4.4% YTD
  8. Oil (WTIC and Brent) was down -3.3-4.1% to +3.3% and -2.8% YTD, respectively
  9. Gold corrected -0.8% to +7.4% YTD
  10. 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?

  1. Gold’s intermediate-term TREND line of support = $1271, so we’ll stay with that
  2. Cattle and Coffee were up another +0.9-7.4% last week to +29.3% and +64.2% YTD, respectively #StrongSide!
  3. 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:

  1. Shanghai Composite Index +2.8% last week (and +1.7% this morning) to +8.2% YTD
  2. Hong Kong Stocks (Hang Seng) +1.3% last week (and +0.3% this morning) to +8.7% YTD
  3. 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%

SPX 1921-1962

RUT 1110-1141

Shanghai Comp 2156-2241

USD 80.79-81.69

WTIC Oil 96.99-100.61

Gold 1281-1304

Copper 3.19-3.26


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


#Behavioral Front-Running - Chart of the Day

CHART OF THE DAY: Highest Cash Position in 24 Months

CHART OF THE DAY: Highest Cash Position in 24 Months - Chart of the Day

At 52% Cash in the Hedgeye Asset Allocation model this morning, that’s the highest Cash position we have had in at least 2 years. 

TV Markets

“They got their politics on TV and were not persuaded by policy descriptions or rational arguments.”

-George Packer


I showered, shaved, and slapped on a suit to do Fox News in NYC yesterday (yep, just what I wanted to do on a summer Sunday). On my way out, my son Jack was riding his bike in the driveway and said to me “Dad, good luck.” I thought to myself, man isn’t this country going to need it.


The aforementioned quote comes from a book I’m reading right now that I highly recommend: The UnwindingAn Inner History of The New America. It cuts through many of the threads I’ve been trying to weave in 2014 (history, behavioral, demographics).


From Jay Z to Newt to Oprah and Sam Walton, this collection of histories contextualizes why so much of what this country has become is made for TV. Sound bites, quick fixes and bling. “Yes We…” … uh… maybe No We Can’t, from here…


TV Markets - f3


Back to the Global Macro Grind


No we can’t get back to 3-4% US GDP growth. Not this year. And probably not next year either. Never mind what you hear on TV. The real US economy is slowing in Q3. The bond market reiterated that last week, big time.


The 10 yr US Treasury Yield dropped another -7 basis points last week to 2.34%. In case you are keeping context’s score, that’s:


  1. A fresh YTD low for the leading indicator for the rate of change in US growth
  2. Down -23% (69 basis points) from where the 10yr started 2014 (3.03%)
  3. And isn’t in the area code of Consensus Macro’s 3.25-3.5% “forecast” for the 10yr in 2014


Alongside falling bond yields and the Russell 2000 (a proxy for US growth expectations) being -1.9% YTD what’s interesting now is that some of the more cyclically sensitive (read: LATE CYCLE) stuff like inflation and employment growth is starting to wane:


  1. CRB Commodities Index was down another -0.9% last week to +3.5% YTD and is now bearish TREND @Hedgeye
  2. CRB Food Index was flat last week (still +17% YTD) and is now bearish TRADE (losing momentum) within a bullish TREND
  3. Oil prices continued to fall last week (Brent -2%) and remain a bearish intermediate-term TREND @Hedgeye


Let me write that one more time – inflation and employment gains are late, not early, cycle indicators. “So”, as both the European and US economies slow in Q3 of 2014, why can’t we see both inflation and employment rates of change deteriorate from their 1H 2014 peaks?


One way to play this from a US stock market investors perspective is:


  1. Rotating out of Energy (XLE) stocks (which led losers last week at -0.2%)
  2. Rotating into more Healthcare (XLV) exposure (which led gainers at +2.4% last wk)


That’s a later cycle portfolio move than the early cycle ones we have been signaling since the beginning of the year (which we’d stay with and include):


  1. Short Housing (ITB)
  2. Short Consumer Discretionary (XLY)
  3. Short Regional Banks (KRE)


Getting out of late-cycle commodity inflation is also very defensive in the sense that you can’t be as “invested” as we thought you should be in #inflationAccelerating for the first 6 months of the year. You won’t hear this on TV either, but in risk management speak that means RAISE CASH.


At 52% Cash in the Hedgeye Asset Allocation model this morning, that’s the highest Cash position we have had in at least 2 years. On the 48% “invested”, my Top 3 positions (rank ordered in terms of size) would be:


  1. Long the Long Bond (TLT)
  2. Long Emerging Market Equities (India, China, Indonesia)
  3. Long Gold (GLD)


In other words, if I was running my old hedge fund, I’d still be running net long Bonds and International Equities in Global Macro, but scaling into net short positions in both US growth and European Equities.


While we haven’t re-signaled the short calls in places like Portugal (PGAL), Italy (EWI), or the SP500 (SPY) yet, the best way to see me do that in real-time is in our Real-Time Alerts product. From a short seller’s perspective, you won’t get that trying to learn market timing on TV either.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.34-2.43%


RUT 1115-1151

BSE Sensex 251

VIX 11.84-14.92

WTIC Oil 95.41-98.46

Gold 1


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


TV Markets - Chart of the Day

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.52%
  • SHORT SIGNALS 78.67%

The Week Ahead

The Economic Data calendar for the week of the 18th of August through the 22nd of August is full of critical releases and events.  Attached below is a snapshot of some of the headline numbers that we will be focused on.


The Week Ahead - 08.15.14 Week Ahead


Commodities: Weekly Quant

Commodities: Weekly Quant - Chart1 Divergences

Commodities: Weekly Quant - Chart2 wow delta

Commodities: Weekly Quant - chart3 USD Correls

Commodities: Weekly Quant - chart4 S P Correls

Commodities: Weekly Quant - chart5 volume metrics

Commodities: Weekly Quant - chart6 volatility metrics

Commodities: Weekly Quant - chart 7 cftc sentiment

Commodities: Weekly Quant - chart8 1 mth correls

Commodities: Weekly Quant - chart9 3 mth correls

Commodities: Weekly Quant - chart10 6 mth correls

Commodities: Weekly Quant - chart11 1 yr correls

Commodities: Weekly Quant - chart12 3 yr correls

Investing Ideas Newsletter

Takeaway: Current Investing Ideas: BOBE, FXB, GLD, HCA, HOLX, OC, OZM, RH and TLT.

Below are Hedgeye analysts’ latest updates on our nine current high-conviction long investing ideas and CEO Keith McCullough’s updated levels for each.


We also feature three recent institutional research notes that offer valuable insight into the markets and the global economy.


Investing Ideas Newsletter     - levels1

Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers.

  • "Trade" is a duration of 3 weeks or less
  • "Trend" is a duration of 3 months or more
  • "Tail" is a duration of 3 years or less



BOBE: This week Bob Evans Restaurants (BOBE) released an investor presentation providing their take on a series of (what they characterized as) "misleading" statements made by Sandell Asset Management, an activist investor in the restaurant company.


The level of activism in the restaurant industry has never been more rampant.  


In the past year alone, we’ve seen CBRL, DAVE, DRI, BJRI and BOBE attract largely uninvited attention from these investors. BOBE has a long history of mismanagement, evidenced by flawed strategic rationale, an excessively bloated cost structure and severe underperformance relative to peers.  Fortunately, its poor operating performance presents a tremendous opportunity.


Our analyst team believes activist investor Sandell has correctly identified significant and largely feasible opportunities to enhance shareholder value.  Particularly, we see tremendous upside value in selling the foods business, transitioning to an asset light model and refocusing capital allocation.


FXB: We added the British Pound to Investing Ideas earlier this week. Click here to read the full report.


GLD: Gold continues holding its range in the face of expectations for a more dovish Mario Draghi as European economic data continues to decelerate and surprise to the downside. From a quantitative perspective, we are looking for:

  • a breakout ABOVE @Hedgeye Long-Term TAIL line of resistance at $1321= bullish signal  
  • a breakdown BELOW @Hedgeye Intermediate-term TREND support at $1271 = bearish signal

Investing Ideas Newsletter     - GLD Investing Ideas Update 08.15.14 

European economic data continues its deceleration and European equities are broken down in our model from a TREND perspective. Equity indices got a bounce Friday but a weaker Euro and record-low sovereign yields are likely front-running a marginally more dovish move from Draghi:


1-month changes:

  • EUR/USD: -1.4%
  • German 10-year Bund Yields: -19 bps to 1.0%
  • French 10-year yields: -23bps to 1.39%
  • Italian 10-year yields: -21 bps to 2.61%
  • Gold: +55bps

In the face of a breakdown in European equities and a sharp decline in Eurozone economic strength (Q2 sequential GDP comped a goose egg yesterdayà 0.0%!), the market believes in a similar response from Yellen. The 10-year hit new YTD lows this week (2.39%) as the centrally-planned currency war heats up. Both the United states and European growth has not slowed simultaneously since Q3 2011. The outlook for the USD will continue to be the driving force.


The Euro has devalued 1.4% against the USD over the last month.  


HCA: The high yield debt market was hit hard recently as signs of slowing global economic growth accelerated and military hot spots appeared to deteriorate.  At least, that was the narrative put to actual negative fund flows (client withdrawals) from high yield bond funds.  


So, what does this have to do with HCA? If we wind the clock back to 2009, high yield markets were the single most important factor to hospital stock prices. 


In 2009, yields spiked, the HYG price collapsed, and doubt set in about the ability for highly indebted hospital companies to refinance or add new debt for acquisitions.  What we have witnessed in the last few weeks has been the complete opposite of 2009. In other words, as high yield was getting hit, HCA and other hospital stocks rose. 


Investing Ideas Newsletter     - hca1


We think this potentially means a few things:

  1. The high yield debt market prefers domestic US consumption over global exposure
  2. The Affordable Care Act is a bigger driver than the potential yield headwinds
  3. Medical consumption is recovering in the US, again offsetting concerns over yield pressure.

The Hedgeye Macro Team has us vigilant for signs of stress and slowing growth, so we’ll stay vigilant. But for now, it appears good fundamentals are taking a back seat to bad market trends.


HOLX: Healthcare sector head Tom Tobin has no update on Hologic this week.


OC: Last month, the largest competitor, GAF/ELK, announced a price increase of 4% to 7% for its roofing products beginning in September. Owens Corning followed with a price increase of 6% to 9%. These price increases signal a more stable environment for the remainder of 2014. A price increase in its roofing segment may help margins, while improving roofing capacity utilization may help OC’s roofing sales (see chart below). OC’s management expects to take back market share it lost in 1H 2014 for 3Q and 4Q as a result of these price increases and a more favorable industry environment. 

Investing Ideas Newsletter     - oc1


OZM: Shares of Och Ziff were down marginally this week on misplaced fears about insider selling. Dubai International, one of the original investors in the company, along with publishing magnates the Ziff brothers, filed a new institutional 13F filing showing a slightly reduced position in the leading hedge fund manager. Essentially over the course of last quarter Dubai International sold 3 million of OZM or just a 10% reduction of its original position of 33 million shares.


The Street and several media outlets viewed this as projecting a negative outlook for OZM because of Dubai potentially cooling on its forecasts for its holding. However, we view the modest reduction of the OZM holding as a reasonable way for a large institutional holder to diversify and that it lowers the future potential of a large amount of OZM stock to come to market with this dribble out selling strategy in effect.


Over time, we expect that a more diversified shareholder base and less concentrated large holders of OZM shares to be a more healthy aspect for the company.  


RH: Market share trumps store productivity. For the most part, people are underestimating the ramp in Restoration Hardware’s addressable market as the company continues to expand into new categories. Over the next five years, there should be $45bn upside in market opportunity for RH simply by expanding its presence into new categories at retail, including kitchens.


An important note: we analyzed every market of the US, and isolated only consumers making over $100k annually. The government’s aggregate numbers include every income level. But the fact of the matter is that the average American spends $857 annually on home furnishings, while those making over $100k spend $1,779.  


This bodes well for our favorite name in retail.


Investing Ideas Newsletter     - rh1


TLT: It was a great week to be long the Long Bond. The 10-year US Treasury yield slid to another fresh 2014 low, slipping six basis points to 2.34%.The TLT (iShares 20+ Year Treasury Bond ETF) which we added to our high conviction list last week is up 2%.


Our bullish view remains counter to macro consensus expectations. Incidentally, on January 1, the consensus forecast of the 66 most senior economists for the year end 10-year US Treasury yield was (drumroll...) 3.44%. 


* * * * * * * * * * 


Click on each title below to unlock the content.


KATE: Kate Spade Isn't Broken

Botched communication ≠ a broken story. This story is fundamentally on track. Could be dicey for a qtr. But the roadmap to $70 is there.

 Investing Ideas Newsletter     - Kate Spade pinwheel


We Think Fed Will Surprise to the Dovish Side

All told, we remain the bears on US interest rates/bulls on long-term Treasuries as growth is likely to slow throughout 2H14.

Investing Ideas Newsletter     - Fed bubbles cartoon 07.09.2 14


ICI Fund Flows: Tantrum and Struggle

In the most recent ICI survey, taxable bond funds experienced a substantial snap outflow joining domestic stock funds with dour trends

Investing Ideas Newsletter     - dol1



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