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“The strongest weak hand suffers the largest loss.”

-Lasse Heje Pedersen

That’s an old poker maxim that Lasse Heje Pedersen effectively uses to explain the concept of draw-down risk (crashing portfolios) in what’s turned out to be a great book for anyone who needs a tutorial in modern day market strategies, Efficiently Inefficient.

Bad poker players (not knowing who the sucker is at the table means it’s probably you) are also great metaphors for schizophrenic levered long hedgies and chart chasers who continue to buy high and puke this US stock market up lower.

“Eventually they cave and sell near the bottom as their funding dries up or panic ensues. Why are most of them selling near the bottom? Because this defines the bottom.” (Efficiently Inefficient, pg 61)

The Weakest Hands - bull cartoon 02.08.2016

Click here to join Hedgeye CEO Keith McCullough live on The Macro Show at 9am. 

Back to the Global Macro Grind

Bottom? Did you say bottom? Oh, Keith – we need a bottom. Please call a bottom.

That defines a not un-consequential percentage of discussions I’ve been having on the road. As if I’m the catalyst for a bottom! Bottoms aren’t up to us humanly creatures to “call.” They are processes, not points.

Evidently the bottom is not in in Japan. Last night the Japanese stock market (Nikkei) moves right back into #crash mode (-22.8% since July) after closing down an eye-opening -5.4%. Why?

  1. Japan is losing control of the central-market-planning belief system (if we devalue Yen, you buy Nikkei)
  2. Instead, as Japanese Government Bonds (JGBs) yields officially go negative (10yr -0.04%), the Yen is ripping
  3. And, as the Up Yen, Down Nikkei trade goes, panic on the consensus side of the hedge fund community ensues

Do you know how many hedge funds are short the Japanese Yen? Moreover, do you know how many of them have the exact same catalyst? What happens when they actually get the catalyst (negative yields) and their position reacts opposite to expectations?

You can apply this line of risk management questioning to the entire macro market:

  1. What happens if European stocks stop going up on Draghi’s #cowbell?
  2. What happens if the Fed comes around to Hedgeye’s view, stops raising rates, and stocks crash?
  3. What happens if your entire positioning is based on the weakest “strong” hand, that is a government catalyst?

There was a time last year when I was bullish on both European and Japanese stocks. That was mostly an extension of our #StrongDollar view (Down Yen and Down Euro was correlating inversely with European and Japanese equities).

But, every day, I’d get on our Macro Show (morning call, daily at 9AM EST) and say that there’s absolutely no fundamental growth and/or inflation reason to be buying Japanese stocks. How weak of a perceived strong hand was that?

That is the thing about sitting at the poker table and/or at your desk trying to not lose all your (or your client’s) money – #perception risk. What if everyone at the table (in the market) has the same weak hand as you?

How many pundits and PMs had a pair of 7s, long “European stocks because they’re cheap”?

A) Lots (if they were long Spain it was a pair of 4s; if long Italy a pair of 2s)

B) Now the Italian Stock market is down -33% since July 2015 (when the SP500 peaked)

C) If the SP500 had that crash/draw-down from its July #bubble high, it would be at 1436!

But no, no, no. No one is talking about Italy or Greece (still crashing) or Spain this morning. They’ll all be talking about Japan, just like they were all talking and talking and talking about China and Oil…

The strongest vs. weakest hands you can have in this poker (macro metaphor, stay with me here!) game is currently:

  1. Royal Flush – Long The Long Bond (TLT), Utilities (XLU), Gold (GLD), Volatility (VXX) and Cash
  2. 7 (of hearts), 5 (of diamonds), 4 (of spades), 3 (of spades), 2 (of spades)

That worst hand would look something like this:

  1. Long Italian Stocks (MIB Index) for “diversification”
  2. Long the Financials (XLF) -14.3% YTD on “rate hike expectations”
  3. Short Utilities (XLU) +7.2% YTD on “rate hike expectations”
  4. Long Oil and a basket of levered Energy stocks like Chesapeake (CHK) and Linn (LINE)
  5. Long Ackman

Most of the perceived “strong hands” had LEVERAGE to either inflation or growth expectations gone bad. In other words, they had the 2-3-4 of spades and were praying for a central-planner to deliver them the 5 and the 6 of the same suit.

That’s why the biggest risk to the entire game is that the belief-system (ideology) of central-market-planners being able to bail out markets breaks down. That’s why you’re already seeing the strongest weak hands suffering some of the largest losses.

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 1.72-1.91%


Nikkei 157

VIX 22.07-28.91
USD 95.66-98.40
YEN 114.99-118.68

Best of luck out there today,


Keith R. McCullough
Chief Executive Officer

The Weakest Hands - 02.09.16 chart