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This note was originally published at 8am on January 29, 2015 for Hedgeye subscribers.

“The best way to get a good idea is to have a lot of ideas.”

-Linus Pauling

Linus Pauling was one of the most influential American scientists of the 20th century. He locked down his officialdom prize (Nobel) in chemistry in 1954 and is widely considered the forefather of molecular biology and quantum chemistry.

I love his creativity quote. I found it in a chapter of The Medici Effect (page 103) titled “How To Capture The Explosion – MacGyver and Boiling Potatoes.” I highly recommend you take the time to read that book.

I’d also suggest you take Pauling’s independent research advice one step further and apply it to your risk management #process. The best way to manage the risk in your portfolio of ideas is to ask yourself lots of macro questions.

Lots of Questions - Linus Pauling

Back to the Global Macro Grind

With the SP500 down for 3 of the last 4 trading days and down -2.7% for the YTD (vs. the total YTD return of our TLT up over +9%), have you asked yourself whether or not earnings season is what you thought it was going to be?

If you’re honest with yourself, you’ll note that the SP500 has only had 1 up week in 2015, and that had nothing to do with nothing other than the Europeans forcing yet another central plan on what used to be free-markets.

This leads me to asking myself lots of questions in the Global Equity sphere:

  1. On Europe, post the 3-day Viagra ramp, what’s next? Buy European stocks because things are that bad?
  2. On China (down -3.8% in the last 3days on #GrowthSlowing), do I buy it because it’s slowing?
  3. Do I buy #Deflation Domino markets that got crushed yesterday (Argentina -2.8%, Brazil -1.9%, Canada -1.6%)?

What if you can only buy US Equities?

  1. Energy Stocks (XLE) got smoked for another -3.9% down day yesterday as Oil/Nat Gas continue to crash
  2. Financials (XLF) underperformed a -1.3% SPY, closing -1.8% on the day at -6.2% YTD
  3. Industrials (XLI) “outperformed” at -0.9% on the day but are down the same as SPY YTD at -3.1%

Since all 3 of these S&P Sectors remain on our “avoid, sell, short, etc.” list (they are both late-cycle and carry explicit Global #Deflation risks), I’ll just reiterate that call this morning – because it’s easy to.

Back to the questions…

  1. Do we buy more Long Bonds (TLT, EDV, ZROZ), Munis (MUB), and low-volatility-high-return securities like them?
  2. Do we book some gains in some of those and buy more equally “expensive” stock sectors like Utes (XLU) and REITS (VNQ)?
  3. Do we own both long-duration bonds and some lower-beta, higher-return sectors like Staples (XLP) and Healthcare (XLV)?

Oh, and how does one justify bucking up for something that is “expensive” if one didn’t get that they should have bought it when it was less-expensive to begin with? That’s their storytelling problem. Let them deal with it.

Another question on valuation: what if you bought Energy stocks because you thought they were “cheap”, and the earnings just got cut in half, so now you own what’s one of the most expensive sectors in the S&P 500 anyway?

Two more very basic questions in risk managing the macro side of your portfolio:

  1. Doesn’t “expensive” get more expensive when investors seek liquidity and shelter (Long-term Treasuries)?
  2. Doesn’t “cheap” get cheaper when investors shun illiquid investments that have deteriorating fundamentals?

If you’ve studied macro market #history, you know the answers to these questions are not what you will find in bottom-up Value Investing books. In the intermediate-term, Mr. Macro Market doesn’t care about valuation – he cares about risk.

Individual stocks clearly care about their own rate of change fundamentals. If growth is accelerating and margins are expanding, they get multiple expansion. Whereas companies who show #GrowthSlowing and margin compression get multiple compression.

That’s why identifying bottom-up stock ideas like AAPL in an environment like this helps you crush your competition. Don’t you want to own stocks that can generate multiple expansion in a market like US Equities that has multiple compression risk? Indeed.

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 1.71-1.82%

SPX 1983-2022

VIX 16.73-23.27

Oil (WTI) 43.69-46.44
Gold 1265-1310
Copper 2.42-2.54

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer

Lots of Questions - 01.29.15 Chart