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“We tend to make money out of surprises, and people are very bad at foreseeing surprises.”

-David Harding

Following up on the David Harding (Winton Capital Management) interview that I cited last Thursday, I wanted to highlight what I am sure many of you have had to deal with in 2016 YTD – surprises.

Are you surprised that the latest bull market (in US Equities) catalyst is a dovish Fed? Were you surprised (like the Fed was) at the pace of the slow-down towards 1% GDP and SP (FEB 11, 2016 closing low)? Or are you surprised that almost 2 months later SP500 is back up at 2072 and the Long Bond’s Yield this morning is only up to 1.76% (vs. 1.68% on FEB 11)?

As Harding reminded Pederson in Efficiently Inefficient, “luckily, most surprises do unfold gradually” (pg 227) and that’s how history would characterize economic, profit, and credit cycles. They take time to play out in full. On that score, Friday’s US jobs report was yet another rate of change slow-down from its #LateCycle peak. We’ll contextualize that on our Q2 Macro Themes Call on Thursday.

Surprised? - jobs pig cartoon 02.05.2016

Back to the Global Macro Grind

Sure, you can anchor on “ISM manufacturing surveys have bottomed.” Or you can stay with the reality that ISM Services (much larger part of the economy) continue to slow from their survey cycle peak in 2015. You’ll get confirmation of the latter tomorrow.

Bond Yields get it (TLT = +8.4% YTD). So do Utilities (XLU = +15.1% YTD). And The Financials (XLF = -4.7% YTD) get that too.

Instead of anchoring on one-off sequential data points (shorter term surprise moves like Oil had off its lows), Mr. Bond Market has an excellent historical track-record of mapping and measuring the intermediate-term TREND of the economic cycle.

If the US economy was even half as “good” as the bulls would lead you to believe, the Fed would be raising rates and the US Dollar would be ripping higher (as opposed to closing -1.8% lower last week to -4.1% YTD).

The reason why both stocks and long-term Treasury bonds are rallying in sync right now is the same reason they always do when the market is begging for the Fed to replace what is disappointing economic growth with the illusion of growth (inflation).

As you can see in the 30-day inverse correlations that the machines are chasing:

  1. SP500 vs. US Dollar Index -0.86
  2. CRB Commodities Index vs. USD -0.89

That’s what has mattered most to the US Equity and Commodity market for the last month.

You definitely won’t hear this from the equity-centric bulls, but there has been literally 0% correlation between that US stock, bond, and commodity-linked equity strength and the rest of the world’s equity markets:

  1. European Stocks (EuroStoxx 600) down another -0.6% last week to -8.9% YTD
  2. Spanish and Italian Stocks (IBEX and MIB Indexes) down another -2.1% each last week to -9.9% and -17.0%, respectively
  3. Japanese Stocks (Nikkei) down another -4.9% last week to -15.1% YTD

Yes, Chinese and Emerging Market Equities bounced (again) on Down Dollar. But most of you get why Down Dollar (remember 2011) drives bullish expectations in Gold (+15.3% YTD) and EM. I don’t want to rehash that history in this note this morning.

Instead, I simply want to remind you of what should not surprise you this morning. Contrary to popular “markets will never go down, ever, again” #BeliefSystem, The Currency War is alive and well. Unless your FX is falling, your stock market isn’t rising.

Here’s how the futures and options market sees things (non-commercial CFTC net positioning):

  1. SP500 (Index + Emini) net SHORT position of -132,850 is its LOWEST in a month (-0.06x 1yr z-score)
  2. 10YR Treasury net SHORT position of -18,579 vs. its 3 month avg net LONG position of +10,075 contracts
  3. USD Dollar net LONG position of +17,620 is right at YTD lows (-2.06x 1yr z-score)

In other words, consensus is betting that A) stocks go down less, B) long-term bonds go up less, and C) the US Dollar keeps going down. In the very immediate-term, I don’t doubt that could be right (I wouldn’t doubt anything short-term at this point!).

While my favorite long positions going up less (The Long Bond, Utilities, and Gold) and my favorite shorts going down less (XLF, SPY, and QQQ) would annoy me in the short-term, I’ll be less annoyed as the converse plays out over the intermediate-term (i.e. Q2).

The longer-term TAIL shift in investing styles that I’ve been calling for (towards good balance sheets and liquidity) played stronger than being long Oil did last week (WTI down -6.9% on the week). From a US Equity Style Factor perspective, here’s how that looked:

  1. Low Debt (EV/EBITDA) Equities were +2.4% to +3.2% YTD
  2. Low Beta Equities were +2.4% to 9.8% YTD

Like the Long Bond (TLT) and Utilities (XLU), some of our Investing Ideas (longer term ideas) like McDonald's (MCD) and General Mills (GIS) have turned into bigger momentum stocks in 2016 than Amazon (AMZN) and Netflix (NFLX). That multiple expansion in Low-Beta Liquidity vs. multiple compression in High Beta (-2.2% YTD) shouldn’t surprise any of our subscribers this year either.

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 1.74-1.87%

SPX 2015-2077


Nikkei 16043-16889
USD 94.11-96.12
Oil (WTI) 36.08-39.32

Best of luck out there this week,


Keith R. McCullough
Chief Executive Officer

Surprised? - 04.04.16 chart