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This note was originally published at 8am on October 21, 2014 for Hedgeye subscribers.

“There is something in the New York air that makes sleep useless.”

-Simone De Beauvoir

I’m not known as a big sleeper. I’ve been krolled (not to be confused with being trolled on Twitter) a few times during the due diligence process for different ownership/partnership stakes and positions, and “irregular hours” always comes up as a “flag.”

Back when we started the firm in 2008, that’s why I called this morning rant the Early Look. And so my amateur writing career began… with the promise of only one repeatable competitive differentiator: getting up early and writing to you at the top of the risk management morning.

Last night we hosted a small group dinner in NYC to talk about how everything has “bottomed.” While the feedback (and fear) is that most don’t want to “miss” the next move up, I couldn’t sleep last night thinking that fear itself might just be the biggest #Bubble of them all.

Useless Sleep - EL chart 2

Back to the Global Macro Grind

When someone uses the word “fear”, it tends to have negative connotations. And, to be clear, I am thinking very negative things could happen if I am correct in calibrating that many got longer of #bubble exposures on the equity and junk bond market’s most recent bounce.

Sure, they may have sold short indices and overpaid for volatility, protection, etc. in the heat of last week’s melt-down, but they A) didn’t sell all of their crashing small/mid cap equity exposures and/or B) their junkie “high-yield” positions either.

In risk management speak, in bear markets we call this cardinal sin “selling what you can, not what you should”… and while my calibration might be wrong, I can’t see that in the market’s futures/options positioning (which is getting longer of beta, not shorter).

To review where some of the hardest core #Bubbles are in this interconnected world:

  1. Central Planning
  2. Carry Trading
  3. Complacency
  4. Small Cap Illiquidity
  5. Fixed Income Junk
  6. Hedge Fund Levered Long Beta

To me, a lot of this is one and the same thing. And it really starts with the 1st #Bubble (Central Planning) because that’s what drove macro markets to inheriting the mother of all interconnected risks (see exhibit 52 in the Q4 Macro Themes Deck) – the #Bubble in Spread Risk (see Chart of The Day):

  1. All-time Low in Spreads (Investment Grade over Treasuries)
  2. All-time low in Volatility (across asset classes)
  3. All-time high in Debt Outstanding (globally)

What’s fascinating about this 3D risk picture is that almost every equity only PM we meet with agrees with it much more adamantly than any of my US stock market centric #bubble charts (like the one that has Russell 2000 at 55x earnings with low liquidity).

There’s obviously confirmation bias in that, but reality is that unless you think it’s different this time (almost every “the bottom is in” thesis has something to do with markets not being able to go down anymore), this is how The Waterfall of Spread Risk works:

  1. Global Growth continues to surprise to the downside
  2. US Long Bond Yields continue to fall in kind (mean reverting to what Japan and Germany’s did)
  3. Both volatility and spread risk continue to break-out from their all-time lows

You see, the core differentiator in our call this year has always been fundamental – that growth slows and starts to get priced into expectations.

“So”, instead of living in fear of your own performance and/or what the “other funds” did last week when the Russell was -15% from its July #bubble high, why don’t I hear most people focusing on what was causal to the gap down in bond yields and equity markets to begin with?

You can lose sleep over what everyone else is doing, or you can focus on what you need to do to get the fundamental research right. And this early riser humbly submits that if you get the rate of change in growth and inflation right, you’re going to get both bond yields and your exposures right.

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 2.09-2.25%

SPX 1830-1935

RUT 1040-1106
VIX 15.15-28.82

WTI Oil 79.97-83.95

Gold 1215-1258

Best of luck out there,

KM

Useless Sleep - Chart of the Day