This note was originally published at 8am on December 29, 2014 for Hedgeye subscribers.
“Our interdisciplinary approach sets us apart and gives us a chance to lead new discovery.”
While he won’t lead you to where the latest Air Asia flight went this morning, 84 year old Nobel Prize winning physics professor Leon Cooper has had his fair share of discovery in his lifetime. From synaptic plasticity to superconductivity, being first (and right) is how you get that done.
This weekend I learned about Cooper’s interdisciplinary research while reading about one of my favorite topics (#monkeys) in a book called The Medici Effect, by Frans Johansson: “Tiny implanted electrodes read signals from the monkey’s brain cells… data from the brain could now be translated into what the monkey was thinking… turning thoughts into action in real time.” (pg 12)
Now if only Cooper’s team at Brown University could send us a real-time feed on what 50,000 fund managers were thinking during 5-10% corrections in stocks (in December) that are followed by sharp v-bottoms and epic no-volume ramps to new highs… oh, while commodities and global bond yields crash…
Back to the Global Macro Grind…
Thankfully, I learned a long time ago that making a living trying to call what SPYs are going to do next is no way to live. That’s why I built our Global Macro Risk Management #Process to be both multi-factor and multi-duration, across asset classes.
If you do macro the way we do, you don’t have to be one-dimensional. You don’t have to have as many blind spots as I used to have either. From a research perspective, there’s always a new discovery to be made on both the bullish and bearish sides of markets.
In our research process, new discoveries are driven by what many probability theorists would call Bayesian Inference. That basically means that what we learned yesterday might change what we think about today.
Discoveries don’t always have to be progressive or regressive – sometimes they should just stop you from doing anything at all. While you may think you know your “companies” better than anyone on earth (and I genuinely hope you do), it’s next to impossible to have that kind of conviction on global macro risks.
If you had to pick one major new discovery (if you’re long Energy stocks, Emerging Markets, Junk Bonds, etc., it’s probably in your “diversified portfolio”!) in global macro risk that you should have proactively prepared for in the last 3-6 months, would it be?
A) Global #GrowthSlowing
B) Global #Deflation
Since the dogmatic +3-4% US growth forever bulls are still staring at non-year-over-year GDP growth data for Q3 (newsflash: it’s the end of Q4, and Q314 was +2.7% y/y, not +5.0), and inflation expectations continue to get hammered, I’ll take B).
While the causal factor for #deflation may be global #GrowthSlowing (think demand), for the last 3 days of the compensation calendar, who actually gets paid to care? What most of you really care about is the score, and here’s how that risk looked last week:
- US Dollar up another +0.5% week-over-week with Burning Euros and Yens down around the same
- CRB Commodities Index (19 commodities) down another -2.3% last week to -16.2% YTD
- Oil (WTI) continued its #crash -4.2% week-over-week to -40.1% YTD
- Copper down another -2.4% last week to -16.0% YTD
- US 5yr Breakeven Rate hit fresh YTD lows of 1.19% last week (-65 bps, or -35% YTD)
For those of you who don’t know that breakevens are a leading indicator for the rate of change in inflation expectations, now you know. For all of you who know that falling bond yields and flattening yield curves are leading indicators for #GrowthSlowing, well, you still know that… but need to ignore it on low-volume SPY ramps into your year-end!
In the last 6 months, what we (and physicists like Cooper) call a phase transition (from bullish to bearish) in #deflation has been much more pronounced than the macro market acknowledging it as a #deflation risk in the 1st 2 weeks of December. To put that in time/price context, check out these 6 month moves:
- Japanese Yen -15.5% vs. USD (yes, that was on Japanese #GrowthSlowing to the point where they needed more QE)
- Euro -10.5% vs USD (as the Draghi devalued in response to #GrowthSlowing)
- CRB Commodities Index #crashed -24.8% in the last 6 months
- Oil (WTI) #crashed -45.7% in the last 6 months
- Natural Gas #crashed -34.3% in the last 6 months
And 5yr breakevens were actually down a lot more in the last 6 months (-90bps, or -43%) than they’ve been for the YTD (remember when late-cycle inflation accelerated in the first half of 2014 and the perma growth bulls just called that bullish for consumers too?).
While the growth bulls finding a new narrative at all rates of change in prices doesn’t surprise me, what will definitely surprise me when the macro market’s volume comes back next week is if #deflation isn’t a marked to market risk for high yield debt.
On the bullish side, with the macro market marking up everything US consumer assets (Consumer Discretionary, XLY +1.9% last week vs Energy, XLE -0.6%) on the “down gas prices” theme, it wouldn’t surprise me if the Russell (domestic pure play) continued to outperform Emerging Equity Markets linked to #deflation either. With new discoveries come new positions in the new year.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.05-2.31%
Oil (WTI) 54.01-57.43
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer