“You see a shadow moving in the long grass – should you worry about lions?”
-Phil Tetlock
I guess it depends if you are in Thunder Bay, Ontario (it could be a wolf or a bear), NYC, or Africa…
In an excellent excerpt from Superforecasting titled Probability For The Stone Age, Phil Tetlock reminds us that “it was remarkably late in history, arguably as late as the 1713 publication of Bernoulli’s Ars Conjectandi, before the best minds started to think seriously about probability. Before that, people had no choice but to rely on the tip-of-your-nose perspective.” (pg 137)
Sadly, over 300 years later, I wouldn’t say the Old Wall’s “blue chip” forecasters have evolved much. I hear a lot about how GDP “feels like it could be 2.5%.” Then again, this comes from people who were “feeling” like it was 4% only six months ago. I can assure you that I feel absolutely nothing about the numbers that run through our predictive tracking algos.
Back to the Global Macro Grind…
Let’s start with some questions I asked the CFA Society at a lunch in Pittsburgh yesterday (Go Pens!):
- JOBS: given that the rate of change in US Non-Farm Payroll growth TRENDS toward negative 100% of the time after putting in its cycle-peak, is the probability rising or falling that the US labor market is doing what it always does at the end of a cycle?
- RATE HIKES? With US #EmploymentSlowing, does the Federal Reserve have it in its non-SP500-dependent mandate to be raising rates as that slowing labor and consumption data is reported?
- USD: If both the US Dollar and US Interest Rates go DOWN, every day, pricing in that the answer to question #1 Is YES and the answer to question #2 Is NO, can all assets priced in Dollars ramp to infinity and beyond?
Answer to question #3: possibly.
But in probability speak, possible is not the same word as probable. This isn’t my first bubble reflation chasing rodeo. Every 5-7 years of my 17 year career on Wall Street, I’ve been told that the US stock market just cannot go down, for real, ever again.
If both US and Global Growth continues to slow, it’s much more probable that US Equities crash from here (greater than 20% draw-down from its cycle-peak) than they go to infinity because “this time is different.”
As you know, 100% of the time that US corporate profits slow to negative (year-over-year), the SP500 has had a draw-down (crash) of 20% or more. We’re about to see the 3rd consecutive quarter of a US #ProfitRecession. And Q3 of 2016 will probably be the 4th.
During stagflation (Quad3) in Q3, can the US equity market see multiple expansion?
- Anything is possible
- But the probable answer is no
Why? Because the probable answer starts with what probability theorists call Frequency Theory. Most of the time when nominal growth slows while inflation is accelerating, profits get squeezed and multiples compress on that.
Now if you’re long Bernanke’s Bubbles again (i.e. Reflating the mother of all Commodity and Cost of Living Inflations), the market is telling you that you can (once again) get paid on that. How?
- Late cycle employment and consumption growth slows
- The Fed hurries to protect asset inflation via Dollar Devaluation
- In Dollars, you get paid by Reflation’s Shadow
I know. If you’re just looking at a 50-day moving monkey, most things Reflation (Commodities, Energy Stocks, Emerging Markets, etc.) look like they can outrun any lion right now. The 3 month performance (price) charts are breaking out the bananas. It’s a party, baby!
But, god forbid you are a longer-term investor, you pull back those same charts to 5, 15, and 30 year charts, and you’ll see that you might be the monkey hanging out by the tall grass line somewhere in Africa.
This, of course, has happened 100% of the time in my carreer. And the non-fiction bubble reflation story goes something like this:
- 1 #TheCycle peaks and there was one mother of a Q1-Q2 rally to lower-highs in Tech Stocks
- 2007-2008 #TheCycle peaks there was one mother of a Q1-Q2 rally in everything levered to Consumer/Housing
- 2015-2016 #TheCycle peaks and there’s been one mother of a rally in Commodity Inflation
Is it demand or is it the Fed? (i.e. the Dollar)
I realize that some big EM like Brazil has its own political story, but does Russia? Both China and Europe continue to slow as Japan falls somewhere inside its own economic abyss (Nikkei and DAX -1% this a.m. and -19-20% from last year’s cycle peak).
How about the divergence between 2 big 2011-2012 Bernanke Bubbles that imploded – Oil vs. Copper?
- Oil (WTI) is up +41% in the last 3 months, but is still down -12% year-over-year
- Copper is down -7% in the last 3 months, and remains in crash mode -23% year-over-year
Ok. So Energy stocks (XLE +15.0% YTD) look almost as awesome as Utilities (XLU +16.2% YTD), but is that because Oil’s volatility (OVX) has crashed from 80 in FEB to 35 in JUN? Or is that because everything demand is awesome again and suppy will never come back?
I’ve been much more vocal on the Long Utilities (XLU) vs. Short Financials (XLF) view than I have been on being long Reflation and that’s basically because it was an easier call to make that growth would slow than it was that being right on #GrowthSlowing would get people to chase Reflation Charts that have been blowing investors up for 3 years.
I don’t think of this as a mistake yet (this “bull” only started in MAR/APR). I’m actually thinking of it as an opportunity. While I haven’t been short Energy this year (we were last year with our #StrongDollar Deflation call), I haven’t been long it either.
Do I buy something that I’ve initially missed (that’s already had a huge move) that doesn’t have global demand behind it?
Maybe.
I have no problem buying or selling anything, don’t forget. If Energy stocks (XLE, XOP, OIH, etc.) are about to put on a 6-12 month move (higher) from here, it’s my job not to miss that inasmuch as it’s my job not to get sucked into the allure of its momentum.
Maybe it’s a bull. Maybe it’s a bear. Maybe it’s a lion.
I just don’t want to end up becoming the monkey in Reflation’s Shadow.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.64-1.78%
SPX 2082-2121
RUT 1139-1195
USD 93.15-94.87
Oil (WTI) 47.78-51.37
Gold 1
Copper 2.02-2.11
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
