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This note was originally published at 8am on April 08, 2015 for Hedgeye subscribers.

“Learning involves assessing relationships between stimuli and their effects.”

-Ed Hess

If that isn’t the truth about risk managing Global Macro markets, I don’t know what is. It’s Ed Hess’ opening volley in an excellent chapter from Learn or Die titled “Learning: How Our Mind Works.”

As our catalogs of stimuli and their effects grow, we develop stories that link them together so that we don’t have to remember them all individually… When we gain confidence with our stories, they become our reflexive, more automatic shorthand for interpreting the world. That is, they become our internal operating system…” (page 9)

Again, I think that is bang on. It’s all about the storytelling. And while we all know people who live, profitably, through plenty of lies, the fabrication of the truth eventually catches up to you in our profession. Long-term repeatable alpha is non-fiction.

Stimuli and Effects - 345

Back to the Global Macro Grind

The thing about the stimuli and their effects in markets is that they are constantly changing. For now, for example, you have to believe that A) Chinese growth and inflation are slowing in order to believe that B) the government is going to provide massive stimuli as a result. Then, by respecting market expectations, you are both bearish on Chinese growth/inflation and long its stock market!

I didn’t always think this way. I used to think that I was smarter than the market and that things like the aforementioned Chinese example couldn’t happen because the fundamental truth was that if growth was slowing, I could be short that market and eventually kill it (then I tried that more than a few times, shorted those types of markets … and got killed).

If you truly understand the fundamentals, the most important thing for you to solve for next is how that stimuli will be priced from a market expectations perspective. You don’t need a Ph.D. to master either expectations or your emotions. You need to check both your intellect and ego at the door, and risk manage the market you have, as opposed to the one you want.

Let’s apply some multi-duration, multi-factor stimuli and effect analysis to the oil market:

  1. Oil (WTI) is down over 47% year-over-year on #StrongDollar, Rising Supply, and Slowing Demand
  2. Oil was up +3.3% yesterday, taking it to +13% for the month-to-date on Saudi headlines  (with USD +1% on the day)

Ok. If my story about that isn’t 100% accurate, please email me and we’ll see if you have a better testament of what you believe is the truth (I’ll publish it on our site). I’m open to being edited! Internally, our commodities analyst, Ben Ryan, edits me all of the time.

Here’s the story Ryan told me about the head-fake stimuli (i.e. what the Saudi Oil Minister actually said vs. what mainstream media thought he said) yesterday:

  1. “I think this is very similar to what he's said all year”
  2. “He said it's not in their interest to cut production, but he'll work with other OPEC members”
  3. “They aren't in competition with shale producers and Oil prices will go up and down, adjusting for market forces”

One other thing Ryan noted is that the Saudi's are really the only OPEC member that has a significant amount of spare production capacity (more than half of all of OPEC). Their take is "we're already doing our part."

Again, to me that sounds as reasonable as any other story I read (from a credible independent research source) on the matter. So I rolled with that and sent out a SELL signal in Oil at 3:32PM EST in Real-Time Alerts. #timestamped

Then I got lucky as the lead supply story on Oil for the last 3-6 months (rising Oil production) hit the tape:

  1. The API reported domestic crude inventories increase another 12.2MM barrels week-over-week
  2. That was basically the biggest sequential increase we’ve seen through this whole downturn
  3. A DOE number in that area code (10:30AM EST today) would be the biggest sequential ramp since DEC 5th, 2014

But you make your own luck in this business by being able to:

A)     Contextualize a price/volume/volatility move within what we call our immediate-term TRADE risk range and

B)      Overlay that quantitative signal with an intermediate-term TREND research view

I went through this in our Q2 Global Macro Themes Call yesterday in what we’ve coined as Oil’s #DeflationDeck, which is effectively a bearish intermediate-term view of West Texas Crude Oil with an intermediate-term range of $36.11-57.54/barrel.

No, that’s not the “price deck” your Canadian Investment Banker is going to give you from his latest confab in Alberta. Neither is it the price your favorite “buy your own oil well” radio advertiser is going to tell your stories about from Midland, Texas.

It’s our story (born out of our process) on why our call on Global #GrowthSlowing and #Deflation will perpetuate lower-Oil-for-longer and why all of the #DeflationDomino risks associated with that to both levered Energy debts and equities remain firmly intact.

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 1.84-1.93%

SPX 2060-2089
RUT 1242-1269
DAX 11909-12164
VIX 14.06-15.93
USD 96.65-98.98
WTI Oil 46.48-53.39

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer

Stimuli and Effects - 04.08.15 chart