Gambler's Ruin

“The risk that you end up bankrupt despite having the odds in your favor.”

-Lasse Heje Pedersen


For any of you who have studied statistics, the Gambler’s Ruin is a classic in risk management. It’s part of a general theory by Dutch math/physics genius (a real one), Christiaan Huygens and a critical lesson for fund managers – liquidity risk.


As Pedersen explains in a discussion about Liquidity Spirals,  “investors hope to have an edge (alpha) but have limited capital (with leverage) that is subject to margin requirements. In investments, this risk is often referred to as funding liquidity risks. Whereas market liquidity risk is the risk that you cannot sell your securities without incurring large transaction costs, funding liquidity risk is the risk that you must sell them!” (Efficiently Inefficient, pg 81)


Being forced to sell because you aren’t allowed to buy more is one thing. If you gave them the capital, some of the super “smart” people in this profession would average down the whole way assuming that their edge is their own perceived genius. What happens when what they thought was “right” (in their favor) becomes dead wrong? Oh boy.


Gambler's Ruin - Whiplash cartoon 03.26.2015


Back to the Global Macro Grind


“A liquidity spiral is an adverse feedback loop that makes prices drop, liquidity dry up, and capital disappear as these events reinforce each other. The spiral starts when some kind of shock to the market causes leveraged traders to lose money.” -Lasse Heje Pedersen


Sound familiar?


The most important question about a liquidity spiral is what caused the “shock”? This is where the storytelling from the Old Wall and all of its conflicted compensation schemes begins. With the SP500 and Russell 2000 closing at fresh 2016 lows yesterday (down -14.1% and -26.4%, respectively, from their all-time #Bubble highs), I’ve heard everything at this point, including:


  1. China
  2. Oil
  3. The Weather
  4. “Risk Parity”
  5. Algos


And while it humors me to consider that none of these factors were blamed for all of the compensations we had during the bull market, it is nice to see that Jamie Dimon is putting some of that money back to work trying to be the causal factor in JPM’s stock.


Newsflash: no bear market ended (after it just started) with a guy buying his own stock.


I hear Dimon is a great guy (so is my Dad) but I completely disagree with him on the US economy right now. The real debate here is about two of the most basic causal factors in all of macro – GROWTH and INFLATION.


Dimon (a big time Democrat – and a much more big time man of the Old Wall than I’ll ever be) believes, like Barack Obama, that a non-partisan-independent-researcher like me is “peddling economic fiction.” Whereas I believe, like markets, that I’m telling the truth.


“So”, as Janet Yellen prefaced every answer during her confused testimony on Capitol Hill yesterday, what is the truth?


  1. On INFLATION: Is #Deflation Risk “transitory” or pervasive?
  2. On GROWTH: Is the US Economy accelerating or decelerating?
  3. On Liquidity & Leverage: is the risk on Dimon’s sell-side balance sheet or the buy-side’s?


Gambler's Ruin - CoD inflation


I think anyone who runs money (different than running for office or running a bank) knows that the answers to these questions are becoming as obvious as negative bond yields have become.


When you boil down what Yellen had a very hard time distilling yesterday, the most basic market expectation implied by $7 TRILLION (and climbing) negative yielding sovereign bonds is called #Deflation.


If you haven’t understood the causal factor behind Global #Deflation all along (Bernanke devaluing the US Dollar to a 40 year low in 2011 – creating unprecedented mountains of supply and leverage on the premise that 0% rates = 0% risk), you need to meet with me.


Yes, Jamie. I want to meet with you (can someone forward this to him please).


I’ll humbly submit that I know the bear case for both growth and inflation as well as anyone else who has authored it. The risk here is the other side of my free-market-opinion.


That risk is really simple. The belief system that central-planners and bankers around the world can arrest economic gravity via currency devaluation and “easing” is seeing the odds fall out of its favor. You can end up bankrupt by being dead wrong on that too.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.58-1.81%

RUT 935-990

VIX 23.97-29.50
EUR/USD 1.07-1.14
Oil (WTI) 25.98-29.99

Gold 1170-1245


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Gambler's Ruin - Chart of the Day11

The Macro Show Replay | February 12, 2016


Cartoon of the Day: Train Wreck

Cartoon of the Day: Train Wreck - VIX train wreck cartoon 02.11.2016


Rising global volatility and credit risk have dominated year-to-date performance. The VIX Volatility index, the implied volatility of S&P 500 index options, is up 54% this year as equity markets crash.

Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

McCullough: Why Global Equity Markets Are Getting Eviscerated


In this brief excerpt of The Macro Show this morning, Hedgeye CEO Keith McCullough explains why global stock markets are crashing and why 10-year Treasury yields are hitting new all-time lows.

A Quick Look At The (Ugly) 2016 Global Equity Scorecard

A Quick Look At The (Ugly) 2016 Global Equity Scorecard - long helium cartoon 01.22.2016


If you were long equities, just about anywhere in the world, you're not having a good year. Below is a chart of the year-to-date performance of equity markets around the globe.


A Quick Look At The (Ugly) 2016 Global Equity Scorecard - global equity scorecard


Here's some added analysis from U.S. Macro analyst Christian Drake in today's Early Look:


"And with futures red and global equity & energy commodity markets continuing in crash mode overnight, the carnage score is currently (% chg off of 52wk high):


  • Brazil: -31.1%
  • China: -46.6%
  • France: -25.5%
  • Germany: -28.9%
  • Greece: -54.9%
  • India: -23.6%
  • Italy: -33.9%
  • Japan: -25%
  • Russia: -38.6%
  • Spain: -33.7%
  • USA (Russell 2k): -25.7%"


Keep your head up. It's getting ugly out there.

[UNLOCKED] Flashback (7/20/2015): Dangerous New Highs for the Market?

Takeaway: A well-timed Macro research note from the Hedgeye vault. About stocks, Macro analyst Darius Dale asks if investors should "sell everything."

Editor's Note: Below is a particularly prescient Macro research note written by Hedgeye Senior Macro analyst Darius Dale and sent to institutional subscribers. It was published on July 20, 2015. The S&P 500 had just hit an all-time high and Dale laid out our bearish view on U.S. equities.


Well timed. The market ultimately tumbled -12% in August after that note was published. Dale's thinking is instructive for investors still wondering what is happening in the more recent stock selloff. We were and still are bearish.


[UNLOCKED] Flashback (7/20/2015): Dangerous New Highs for the Market? - Bubble bear cartoon 09.26.2014  1


After nearly two months under water, the benchmark S&P 500 has finally made a new all-time high. While optically impressive, there are a myriad of quantitative signals underneath the hood that do not support chasing the market here.


Immediate-term TRADE Duration Risk: The SPX is at the top end of its immediate-term risk range of 2,091-2,130.


With nearly 2% downside, 0% upside and the VIX nearing the low end of our 11.29-14.59 immediate-term risk range, investors would do well to book gains in U.S. equities here (i.e. reduce gross and/or tighten net exposures). As Keith highlighted on today’s Macro Show, if 2,091 breaks, there’s no support to 2,035.


[UNLOCKED] Flashback (7/20/2015): Dangerous New Highs for the Market? - SPX


Intermediate-term TREND Duration Risk: Our Tactical Asset Class Rotation Model (TACRM) is now generating a “DECREASE Exposure” signal for U.S. equities. Currently, TACRM is generating a commensurate bearish signal for each of the six primary asset classes tracked by the model (slide 6).


Sell everything? As predicted in our previous refresh, the recent bullish-to-bearish reversals in Emerging Market Equities, Foreign Exchange and Commodities were, in fact, a harbinger for similar breakdowns across the Domestic and International Equities asset classes. Our recent decision to add SPY to the short side of our thematic investment conclusions confirm how we are thinking about this risk in real time. At the bare minimum, it implies investors would do well to reduce their gross exposure and/or tighten up their net exposure to global asset markets.  


CLICK HERE to learn more about TACRM, what these signals imply and how best to incorporate them into your investment process.


Long-term TAIL Duration Risk: Market breadth is broadly deteriorating and in dangerous territory.


One of the conventional “isms” of stock market analysis is that benchmark indices tend to peak very late into the economic cycle – well after broad-based signs of deterioration have emerged at the single-stock level.


In the face of a #LateCycle slowdown, benchmark indices are able to continue higher due to the fact that investors increasingly crowd into large-caps and/or stocks that have idiosyncratic growth opportunities that are less tethered to the [deteriorating] economic cycle, at the margins. Ultimately the cycle always prevails (see: 2000-2002 or 2007-2009), but positive absolute returns can be sourced from an increasingly narrow group of stocks and/or style factors well into the start of any given bear market.


[UNLOCKED] Flashback (7/20/2015): Dangerous New Highs for the Market? - SPX 2000 02

Source: Bloomberg L.P.


[UNLOCKED] Flashback (7/20/2015): Dangerous New Highs for the Market? - SPX 2007 09

Source: Bloomberg L.P.


There’s a number of ways to measure market breadth on a trending basis (e.g. % of stocks making new highs, % of stocks correcting, % of stocks crashing, etc.), but for the sake of simplicity we track the percentage of stocks below their respective 50-day and 200-day moving averages in the Russell 3000 Index – which, at covering about 98% of the investable public equity market, makes it the broadest measure of the U.S. stock market.


On this measure, broad U.S. equity market breadth is as poor as it has been at any local peak since 10/9/07 – the previous cycle’s all-time high closing price for the SPX – surpassing the deterioration we saw at the 5/21/15 high, which was very much on par with the 7/19/07 local peak.



[UNLOCKED] Flashback (7/20/2015): Dangerous New Highs for the Market? - BMBI 7 20 15


October 9th, 2007:

[UNLOCKED] Flashback (7/20/2015): Dangerous New Highs for the Market? - BMBI 10 9 07


May 21st, 2015:

[UNLOCKED] Flashback (7/20/2015): Dangerous New Highs for the Market? - BMBI 5 21 15


July 19th, 2007:

[UNLOCKED] Flashback (7/20/2015): Dangerous New Highs for the Market? - BMBI 7 19 07


While not useful as a timing indicator, the aforementioned deterioration does imply the duration and scope for prospective returns are substantially worse than many investors may assume given consensus expectations for the length and strength of the current economic cycle, which we can loosely infer from consensus expectations for U.S. monetary policy.


Checking back in with TACRM, we are seeing market leadership increasingly concentrated amongst the exact style factors we’d expect to outperform in the latter innings of an economic and market cycle: large-caps (defensive safety and dividends), healthcare (increased consumption and the ability to maintain pricing power during economic downturns) and growth (many biotech and new tech companies don’t have earnings to speak of, therefore investors don’t have to worry about earnings misses derailing the momentum of the respective charts).


[UNLOCKED] Flashback (7/20/2015): Dangerous New Highs for the Market? - 8


All told, we hope you find these quantitative signals helpful with respect to your individual investment mandate. As always, feel free to email us with questions.


Best of luck out there,




Darius Dale


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