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CHART OF THE DAY: Don't Go Chasing the Bounce With This Kind of Volatility | $VIX

Editor's Note: The following chart and excerpt are from today's Early Look written by Hedgeye CEO Keith McCullough. Click here if you'd like to say goodbye to lousy research and access some of the best around.

 

CHART OF THE DAY: Don't Go Chasing the Bounce With This Kind of Volatility | $VIX - zz dd 09.01.15 chart

 

...Volatility certainly has. And I’m not just talking about US Equity VIX ripping through 30 (again) this morning. Cross-asset-class volatility was a Phase Transition call we made in our 2014 Q3 (July) Macro Themes deck. So maybe that one is 12 months in!


Disenchanting Signals

“Disenchantment, whether it is a minor disappointment or a major shock, is the signal that things are moving into transition.”

-William Bridges

 

That’s a quote about life. But it fits my risk management framework for not only proactively preparing for Phase Transitions in markets, but for having the patience and #process to see those transitions play out.

 

Patience? It’s a word “long-term investors” seem quite amenable to using, other than when explaining why one of the lowest-beta, high return, positions during a slower-for-longer phase in both the Global and US economies, is the Long Bond.

 

We’re most bullish on Treasuries and Gold here. Others still like stocks. Will they be disenchanted with the selloff we’ll see to start September? Yes. How many others reworked and reset their risk parameters for causal risk factors that changed? We’ll see.

Disenchanting Signals - Gold Bond cartoon 07.10.2014

 

Back to the Global Macro Grind

 

Selling into a bounce (on decelerating volume) should be a lot easier than selling into the all-time highs. That said, when you seek a bullish confirmation bias, that risk management exercise can be trying.

 

To review: Hedgeye didn’t add the SP500 to our Best Short Ideas until we released our Macro Themes Deck for Q3 in July.  I won’t rehash the many interconnected macro reasons for that this morning, as I think I’ve been as clear as I can be.

 

At -6.3%, August of 2015 was the worst August for the SP500 since 2001. From a Sector Style perspective, Financials shocked the most amount of people at the most inopportune time (XLF -7.1% on the month) as consensus continued to bet on “higher rates.”

 

Other Sector Style callouts were:

 

  1. Utilities (XLU) outperforming early in the month, then getting slammed into month-end to close AUG -3.5%
  2. Healthcare (XLV) underperforming for most of the month, closing AUG -7.96%
  3. Energy (XLE) outperforming at the end of the month, closing AUG -4.3%

 

So, I guess, the new bull case from my competitors is “higher gas prices is clearly bullish for back-to-school.” Or something like that. But in all seriousness, this is getting serious – and there’s no value in debating Old Wall’s perma bull marketing ways.

 

It’s serious (and unnerving) because it appears that consensus is now LONGER (net) than they were last time the SP500 tested 1930. And since I have no support to 1, I think you should seriously think about that risk (the crowd) if it continues to manifest.

 

Another way to think about risk isn’t so much about depending on the market telling you where volatility adjusted “levels” of probable risk are (see my draw-down risk levels from my Friday Early Look note). It’s to overlay those signals with research.

 

Research, in rate of change terms, should go both ways. When undergoing a bullish (growth) to bearish Phase Transition, I like to think of the “research call” (different than the daily quantitative flow of the call) in three phases:

 

  1. Taking a non-consensus position early, but not too early (in July, Long Treasuries, Short Stocks)
  2. Staying with the short call after the 1st big “bounce” until your research catalysts play out
  3. Getting out of the call once something like #LateCycle + #Deflation becomes priced in as consensus

 

Currently we’re in Phase 2. And a lot of people are still trying to figure out what Phase 1 was all about (hint: it wasn’t just “China”).

 

While I suspect that Phase 2 can take some time (6-18 months, for starters – and we’re 3 months in), market history suggests that there’s nothing typical that maps out the “pricing in” of big top-down risks.

 

#EmbraceUncertainty

 

Volatility certainly has. And I’m not just talking about US Equity VIX ripping through 30 (again) this morning. Cross-asset-class volatility was a Phase Transition call we made in our 2014 Q3 (July) Macro Themes deck. So maybe that one is 12 months in!

 

Look at Oil, for example.

 

  1. BREAKING NEWS (on Bloomberg yesterday): “Oil Enters Bull Market”
  2. Lol
  3. Oil Volatility (OVX), meanwhile was making a 3-month high at 54!

 

Now what?

 

  1. Hedgeye’s long-term TAIL risk level of resistance for Oil (WTI) remains overhead at $60.74
  2. Oil’s (WTI) immediate-term risk range (the quantitative signal) = $35.74-48.93
  3. With Oil down -2% this morning, it could drop -25% (crash) from here, with no surprise

 

No surprise to our #process, that is. But I’d say that would probably be a tad disenchanting to whoever covered their Chesapeake (CHK) shorts into the close yesterday. We waited and watched and sent out another SELL signal on that into the close.

 

Contrary to popular “long-term” marketing beliefs, timing does matter; especially when in a Phase Transition. And our goal isn’t to rub that in our competition’s face. It’s to pound it into the keyboard so that it finds some place in your process.

 

Whether it is a minor disappointment or a major shock, our goal as a risk manager is to help you during transitions. After the last two cycle tops (2000 and 2007), we’re thinking your clients want to see that you’ve evolved your process and don’t have to make excuses.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.99-2.22%

SPX 1
DAX 9604--10272
VIX 20.82-42.50

Gold 1111-1165

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Disenchanting Signals - zz dd 09.01.15 chart


The Macro Show Replay | September 1, 2015

 


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Sell the Beta Bounce

Client Talking Points

JAPAN

There was a big opportunity for former bulls (us) to sell Japanese Equities on the bounce, and thankfully we did. The Yen is up +1.2% this morning and pulverized the Nikkei making it the biggest loser in a sea of Asian September red overnight, down -3.8%.

EUROPE

Never mind the “China” – all of Europe (and the U.S.) continues to slow here in Q3 (vs. Q2) as well. Slowing PMIs + Deflation doesn’t make the Norwegians happy (their PMI dropped to 43.3, so we guess the bull case is it bounces from there!); no DAX support to 9,604.

OIL

Oil is down -4% this morning with another -20-25% of immediate-term downside in what we call the probable range. Oil volatility (OVX) busting a move towards 60 (again) on that - #NoWorries says consensus – all good, chase charts (in other news we reiterated the SELL call on CHK yesterday).

 

**Tune into The Macro Show with Hedgeye CEO Keith McCullough at 9:00AM ET - CLICK HERE

Asset Allocation

CASH 65% US EQUITIES 0%
INTL EQUITIES 0% COMMODITIES 3%
FIXED INCOME 32% INTL CURRENCIES 0%

Top Long Ideas

Company Ticker Sector Duration
MCD

We recently tried out the "Create Your Taste" experience at the newly remodeled McDonald’s location in Midtown East on the corner of 58th street and 3rd Ave. Walking into the newly remodeled MCD, we were greeted by the brand new self-order kiosks with attentive staff there to assist you. Customers were very interested in using the kiosks, and everyone using them seemed to be having an easy time with it.

 

For it being only two weeks into the process we were very impressed by the efficiency and mastery the staff is already displaying. We plan to head back to the same McDonalds location and check on their progress.

PENN

Our Gaming, Lodging & Leisure team is going to furnish a new update following their recent meeting with Penn National Gaming's management. They note that the stock has held up quite well despite increased market volatility. The bullish thesis on shares of PENN remains intact. Regional revenues remain strong in addition to the 2-year growth story, etc. Stay tuned.

TLT

As we outlined through various channels, we expect that high levels of volatility are here to stay for the foreseeable future. The biggest shift last week that we’ll call out is a bullish to more neutral intermediate-term view on the U.S. dollar which is why we added GLD to investing ideas in replace of UUP. To be clear, if growth continues to slow we want to be long of bonds (that view hasn’t changed in a year and a half).

 

From an asset allocation perspective here is the set-up:

  • Growth slowing: Long bonds and low-beta yield chasing sectors (TLT, EDV, XLU)
  • Shift to more dovish policy: long of GOLD as the shift weakens the value of the USD

We re-iterate the same view we’ve had since the beginning of 2014: Growth is slowing, and deflation remains a real risk (central bankers can’t solve this by talking down the currency). The fed will continue to push out the dots on “policy normalization.”

Three for the Road

TWEET OF THE DAY

Gold has resistance up at $1165, so if you're long some from last week's low, book some

@KeithMcCullough

QUOTE OF THE DAY

When all think alike, then no one is thinking.

Walter Lippman

STAT OF THE DAY

Late last week, it was reported by EPFR that global equity fund outflows totaled $25.9B, which was the largest sum on record (data going back to 2002). U.S. equities experienced a $12.3B outflow – the most in 16 weeks


September 1, 2015

September 1, 2015 - Slide1

 

BULLISH TRENDS

September 1, 2015 - Slide2

September 1, 2015 - Slide3 

BEARISH TRENDS


September 1, 2015 - Slide4

September 1, 2015 - Slide5

September 1, 2015 - Slide6

September 1, 2015 - Slide7

September 1, 2015 - Slide8

September 1, 2015 - Slide9

September 1, 2015 - Slide10


Are You Positioned Bearish Enough?

Key Takeaway: A myriad of quantitative signals suggests investors would do well to be positioned rather bearishly (within the context of their respective mandates) as we progress throughout 2H15.

 

Late last week, it was reported by EPFR that global equity fund outflows totaled $25.9B, which was the largest sum on record (data going back to 2002). U.S. equities experienced a $12.3B outflow – the most in 16 weeks. Per Jonathan Casteleyn of our Financials Team:

 

Domestic equity funds continue their streak of outflows, now at 25 consecutive weeks with another -$5.2 billion reined in by investors in the most recent 5 days. The table below shows all domestic equity outflow sequences greater than 4 consecutive weeks in data going back to 2008. We considered a streak of outflows broken by 4 weeks of consecutive inflows. Within these parameters, there have been 8 total outflow sequences with the mean lasting 40 weeks with $105 billion lost on average. The current sequence, as of August 19th, is only the 8th longest in weekly duration, but at -$101.0 billion in total outflows lost, it is the 4th largest in magnitude. With an average outflow of -$4.0 billion per week, the running 2015 outflow is fastest pace on record in our data back to '08”.

 

Are You Positioned Bearish Enough? - 1

 

So everyone is bearish, right? Right.

 

While it’s easy to naval gaze at flows data or feel warm and cuddly about the spate of bullish reports from bulge-bracket U.S. equity strategists that hit the tape last week, more thoughtful analysis of trends across global macro markets suggests investors would do well to remain on the defensive. The current setup is not unlike the setup we identified in our 7/20 note titled, “Dangerous New Highs for the Market?” where we flagged the pervasive deterioration of market breadth as a bearish indicator, in addition to other factors.

 

Are You Positioned Bearish Enough? - 2

 

I: Credit Concerns

Much ado has been made over the trending backup in domestic credit spreads. While certainly not a new factor, we found it worthwhile to analyze what such a backup might imply for U.S. stocks after coming across the following anecdote from Bloomberg:

 

“Yield premiums on investment-grade debt have widened by 32 basis points over the past three months, according to Bank of America Merrill Lynch index data. Since 1996, there have been five occasions when credit spreads showed similar expansions. Two of them preceded recessions in 2001 and 2007 when stocks went on to drop 50 percent or more. In the other three instances, the S&P 500 fell at least 16 percent while the economy continued to grow. The latest was in August 2011, when the S&P 500 was mired in a 19 percent retreat that almost ended the bull market. Assuming the U.S. economy will be able to avoid a recession this year, as predicted by economists surveyed by Bloomberg, and stocks fall by the average magnitude to reflect similar credit stress in the past, the S&P 500 would hit 1,742, a 18 percent decline from its all-time high reached in May.”

 

Given the seemingly arbitrary nature of the aforementioned look-back period, we thought we’d perform a similar analysis that holds both the historical OAS observation period and prospective SPX return period constant – at 6 and 12 months, respectively:

 

Are You Positioned Bearish Enough? - SPX vs. OAS

 

Based on this analysis, which uses weekly closing price data going back as far as we can get it (2001), the S&P 500 has declined an average of -11.1% over the following twelve months whenever HY OAS have widened as much as they have over the most recent trailing 6-month period (+116bps).

 

Obviously the Frequentist nature of this study leaves a lot to chance, but if there’s anything to the old adage “credit leads equities”, there may still be a fair amount of downside ahead for the U.S. equity market.

 

II: Consolidated Positioning

Heading into the drawdown, hedge fund investors were net short of the S&P 500 to the tune of 127,130 futures and options contracts. More importantly, this lean was -1.5 and -1.7 standard deviations below its TTM and trailing 3Y averages, respectively, which implied that said bearishness was becoming rather crowded.

 

Looking at that same data set, we see that said positioning had tightened by 86,285 contracts WoW heading into last week’s bounce (data though 8/25). While we won’t know for sure until late Friday afternoon, we’re willing to bet that last week’s dead-cat bounce on waning volume was perpetuated by additional short-covering. Even without that information, we can be sure to conclude that the short position has consolidated with a z-score of 0.4 (TTM) and -0.8 (3Y).

 

Are You Positioned Bearish Enough? - 14

 

In summary, the data currently suggests that investors aren’t positioned nearly as bearishly as market chatter would imply. Incremental consolidation would imply that investors aren’t at all positioned appropriately for the next leg down.

 

III: TACRM Signaling Very Bearish

Our Tactical Asset Class Rotation Model (TACRM) continues to be dynamite at prospectively signaling meaningful inflections in performance at the primary asset class level. It’s latest two signals (SELL U.S. equities and SELL international equities) continue to appear appropriate in spite of last week’s short squeeze across global equity markets. The signals prior to that – specifically SELL foreign exchange, SELL commodities and SELL emerging market equities – appear equally as prescient. Refer to slides 6-13 of the following presentation for more details:

 

http://docs3.hedgeye.com/macroria/TACRM_08312015.pdf

 

With TACRM signaling to reduce exposure to all six primary asset classes, the only thing for investors to do is raise cash – although the “SELL” signal on domestic fixed income, credit & equity yield plays could be sidestepped by deft factor exposure selection (i.e. long long-duration treasuries vs. short credit – particularly junk bonds – as the Fed risks perpetuating deflation by tightening into a global growth scare and a classic #LateCycleSlowdown in the domestic economy).

 

Other not-so-bullish factors worth highlighting:

 

  • TACRM is not generating a BUY signal for any of the 117 factor exposures the model tracks across the U.S. (47), Developed International (33) and Emerging Market (37) equity markets. In fact, only one (Irish equities, ticker: EIRL) is registering positive volatility-adjusted VWAP momentum across multiple durations. Refer to slides 17-19 of the aforementioned presentation for more details.
  • Looking beyond domestic and global equity markets, TACRM is generating a BUY signal for only one factor exposure in the entire global macro universe – the ever-defensive Japanese yen (FXY). Refer to slide 16 of the aforementioned presentation for more details.
  • The trending breakout in cross-asset volatility continues unabated, having remained intact since the first week of October. Recall that the model accordions its [independent] historical observation periods according to the trend in global macro volatility, shortening the periods when volatility is trending higher and elongating the periods when volatility is trending lower. The thought behind this is that A) trending breakouts in volatility are usually associated with material changes in the fundamental narrative underpinning any asset class and B) VaR models force investors to de-risk their portfolios and shorten their holding periods on existing and prospective investments. In the context of cross-asset volatility trending higher since 2H14, it is reasonable to conclude that the recent breakout in U.S. equity volatility is unlikely to be a one-off event.

 

In short, neither domestic nor global macro markets are signaling that it’s appropriate for investors to do anything other than be positioned as bearishly as they can be within the context of their respective mandates.

 

IV: Broken Market

Keith’s PRICE/VOLUME/VOLATILITY model remains core to our quantitative process. And across all three durations (TRADE: 3 weeks or less, TREND: 3 months or more and TAIL: 3 years or less), the S&P 500 remains broken.

 

Are You Positioned Bearish Enough? - SPX

 

The key takeaway for investors here was best summarized by Keith on today’s RTA Live broadcast: “I’d be a seller of pretty much anything U.S. equities until we get the right flush to the downside.”

 

All told, the aforementioned three signals suggest to us that domestic and global capital markets are likely to remain under pressure throughout 2H15. We expect a series of lower-highs for almost any factor exposure that isn’t tightly correlated to the U.S. Treasury market.

 

Best of luck out there,

 

DD

 

Darius Dale

Director


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