Complex Games

“Thanks to their ability to invent fiction, sapiens create more and more complex games.”

-Harari

That’s a big bridge between biology and human history. It’s both #behavioral and a summary point at the end of a chapter in Sapiens (by Yuval Noah Harari) titled The Tree of Knowledge. Good thinkers book. I’m enjoying it.

I’ve also enjoyed spending the week in the great state of Texas (my crystal ball had me book dates in Austin, Dallas, and Houston for the epic short squeeze in US listed Oil & Gas stocks).

West Texas Crude Oil is not only +10% in the last week, it’s +37% in the last month! No, I didn’t nail that. But, thankfully, I didn’t get nailed by it either. There is going to be a fantastic short-selling opportunity in levered Oil names again, hopefully a little higher.

Complex Games - fossil fuel cartoon 01.27.2016

Back to the Global Macro Grind

Fortuitously we took both Oil and Oil related indexes (XOP, XLE) off our Best Ideas in the Macro Themes deck on January 5th and replaced them with Utilities (XLU) on the long side and Financials (XLF) on the short side.

While plenty of our best SELL ideas (bottom up stock picks from my analysts) have been squeezed here in the 1st week of March, our best Macro Equity Sector Ideas have acted just fine:

  1. Utilities (XLU) were up another +0.5% yesterday to +11.0% YTD
  2. Financials (XLF) were down another -0.1% (in an up tape) to -7.9% YTD

That said, in Real-Time Alerts (shorter term signaling product) yesterday, I signaled that I wanted to cover some Financials and Housing related short ideas with me really having no idea what the market could do on today’s central-market-planning (ECB) event.

This morning I don’t want to get into the complexity of the Game of Slowing and how central planners (ECB this morning – BOJ and Fed next week) fundamentally believe that they can bend and/or smooth economic and profit cycles. I’d rather just wait and watch.

By the time this Early Look hits your inbox I may very well have an entirely different “market call” as we’ll have “new news” (or not) that the #BeliefSystem is or isn’t breaking down. How much longer will players in this complex game believe fiction?

Embrace uncertainty.

Even though many publicly traded US companies do not report earnings on a GAAP (Generally Accepted Accounting Principles) basis anymore, one thing I can tell you with certainty this morning is that Draghi and Yellen cannot Ctrl+PRINT Sales & Earnings growth.

With 494 out of 500 companies in the S&P 500 having reported their recent quarter (many non-GAAP):

  1. Aggregate SALES growth slowed to -4.0% year-over-year
  2. Aggregate EARNINGS growth slowed to -7.5% year-over-year
  3. With Consumer Staples squeaking out a +0.8% y/y EPS gain, only 4 of 10 Sectors have positive EPS growth
  4. Yes, Energy and Materials have y/y EPS declines of -73% and -18%, respectively
  5. But our favorite Sector on the short side (Financials) had a -9.4% year-over-year decline

Sure, you can dial-a-sell-side-strategist who’s been “backing out Energy” for the last 6-9 months, but how many of these characters proactively predicted that during a “rate hike” that Financials would be the biggest rate of change loser in their narrative?

Reminder: there are 90 companies in the S&P 500 that are categorized as “Financials”, whereas there are only 40 companies that are currently classified as “Energy.”

Oh, and by the way, “Financials” earnings got slammed BEFORE A) the recent crash in rates and B) the commensurate compression in one of the core leading indicators for “Bank Earnings” – The Yield Spread.

The spread between the 10yr US Treasury Yield and the 2yr is testing new cycle lows at 98 basis points wide. It’s a leading indicator for bank stocks because it’s a proxy for what they call Net Interest Margin (NIM).

The wider the Yield Spread, the wider bank profit margins. The narrower the spread, the faster bank earnings slow.

This brings us all the way back to the #BeliefSystem. What can the ECB’s Mario Draghi or the Fed’s Janet Yellen do other than “cut rates” and, in doing so, impose further pressure on long-term rates and bank earnings?

We’ll have to see, won’t we…

But it appears that this complex game of storytelling is reaching the beginning of the end more so than the end of the beginning.

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 1.69-1.95%

SPX 1

DAX 9

VIX 15.88-22.66
EUR/USD 1.08-1.11
Oil (WTI) 30.89-38.99

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer

Complex Games - Yield Spread CoD