This note was originally published at 8am on April 27, 2015 for Hedgeye subscribers.
“The real issue is not whether you have a mental model, but whether you’re fixated.”
That’s an excellent risk management #process quote from a conversation Ed Hess had with Dr. Gary Klein (senior scientist with Macro Cognition) in chapter 8 of Learn Or Die – Using Science To Build A Leading-Edge Learning Organization.
Klein made an astute point about expectations in reminding me that “so much of decision making is taught and treated as if you can pre-define the options” (pg 90). My experience with markets is that the options are both non-linear and constantly changing.
Sometimes expectations change fast; sometimes slow. It isn’t my job to tell the market which catalyst or correlation to fixate on. It’s my job to try my best to accept change.
Back to the Global Macro Grind…
Since the last Fed meeting (March 18th) I’ve been fixated on whether or not the Fed is for real on raising interest rates into both #Late-Cycle (see our Q2 Macro Themes deck) employment gains and Global #GrowthSlowing.
While it may have sounded a little over the top, our “buy everything” call on that March 18th Fed decision to go dovish, since then (from Chinese to Japanese stocks and/or US stocks and bonds), that was the right asset allocation decision to have made.
Front-running central planning expectations (especially when they are changing, on the margin, from hawkish to dovish – or dovish to uber dovish) will remain a major macro market fixation, until this epic experiment has nothing left to give.
In US Dollar devaluation terms, here’s what macro markets saw last week:
- US Dollar Index down another -0.6% week-over-week, taking its 1-month correction to -1.5% (+7.4% YTD)
- Euro (vs. USD) up another +0.6% in kind, taking its 1-month counter-TREND bounce to +1.3% (-10.1% YTD)
- Canadian Dollar up +0.5% vs. USD last week, taking its 1-month counter-TREND bounce to +4.1% (-4.6% YTD)
In other words, the closer you got to being long anything that looked like a Commodity Correlation trade (for the last month) – from oil itself, to energy stocks and junk bonds, to a resource driven currency – you crushed it.
With the Dollar off its highs, Rates #LowerForLonger, and the SP500 closing at her all-time highs on Friday, could all of this dovishness be priced in? I’m not so sure it is, yet. Chinese stocks closed up another +3% overnight to a 7yr high, +40% YTD!
With USD Down, the other big obvious last week in Global Equities was the outperformance of inflation oriented markets:
- Brazil’s Bovespa was +4.9% on the week to +13.2% YTD
- MSCI Latin American Equity Index bounced back to break-even YTD with a +4.5% wk-over-wk move
- Emerging Markets Equities (MSCI Index) had another big week, +1.7% to +10.9% YTD
If you boil all of this down in growth vs. inflation terms (using a 1-2 month duration), this is all one massive macro re-rating of inflation expectations (to the upside) within the context of what was a nasty 6 month #deflation scare.
On a reported basis (from governments) #deflation or disinflation (or whatever you want to call it) is going to be reality through the summer time. Government data is reported on a year-over-year basis, don’t forget.
But what if the Fed not only backs off on rate hikes, but starts to talk about incremental easing again? I don’t think they’ll do that. But being fixated on what the Fed should do vs. what they will do has proven to be quite costly for the past 6 years.
In the meantime (as in this week), this is where US stock and bond investors are at:
- SP500 was +1.8% week to an all-time closing high of 2117 = +2.9% YTD
- Tech Stocks (XLK) led the charge at +4.0% wk-over-wk = +4.3% YTD
- Consumer Discretionary (XLY) stocks squeezed the shorts +3.2% last wk = +7.6% YTD
Especially when I look at moves in big cap Tech names like Amazon (AMZN) and Microsoft (MSFT) of +14% and +10% (on the day!) on Friday, last week’s beta chasing move in the US stock market tells me that:
- Hedge funds are getting squeezed again (forced to cover shorts high and get net longer)
- Long-Only funds are being forced to chase performance again into month-end
- It’s going to be really hard to be bearish into the Fed meeting on Wednesday
To accentuate this view, the net SHORT position (CFTC non-commercial futures/options contracts) in SP500 Index (+ E-minis) hit a new monthly high of -45,673 contracts last week. To put that in context (when consensus didn’t respect the risk of #deflation) the trailing 6 month average net LONG position in SP500 futures/options contracts is +32,687.
In this game, the real issue is not whether or not you’re “smart”; it’s whether or not you can be mentally flexible enough to fixate on the right things, at the right time.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.85-1.99%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer