Finally #Overdone

“It’s very hard to dramatize something factual and not make it look overdone.”

-Julia Sawalha

In stark contrast to the culture clash Steve Bannon has been dramatizing (partly, using Neil Howe’s 4^th Turning source code) since his post Goldman and media banking days, there’s nothing dramatic about rate of change data and/or macro market signals.

For the last 3 months, it’s been as clear as the sun rising in the East that both US growth and inflation data have accelerated. That’s largely why the US stock market closed at all-time highs, again, on Friday.

But with every incremental all-time high comes a rising probability of a correction. And, while I haven’t been calling for one the whole way up, I think this is as interesting as any time/price in the last 3 months to consider the possibility of one.

Back to the Global Macro Grind…

In rate of change process speak, everything that happens on the margin matters the most. On Friday, 3 things subtly changed:

1. US STOCKS: Volume didn’t accelerate on the up move (it was -2% versus the 1-month average)
2. VOLATILITY: front-month VIX signaled its 1^st higher-low (within my risk range) in 3 months
3. CONFIDENCE: Univ. of Michigan US consumer confidence slowed to 95.5 in FEB vs. 98.5 last

The thing about non-fake, anticlimactic, subtleties is that sometimes they matter and sometimes they don’t. From a market perspective, only in hindsight are topping and bottoming processes crystal clear. That’s what makes this job a lot of fun.

There’s no doubt that I love embracing uncertainty. I’m especially into the uncertainty associated with why something factual “can’t possibly be happening.” Consensus betting that Trump = Volatility is a great example of that…

Volatility crashed while consensus was stuck trying to answer every question about every component of potential policy with 100% certainty. All the while, Trump set his own rhetorical pace, confusing a large % of people who despise him.

Volatility Crashed? Big time. Look at these market scores vs. 3 months ago:

1. US Dollar Index +1.9%  to $100.71
2. Commodities (CRB Index) +5.8%
3. Dr. Copper +8.1%
4. Oil (WTI) +14.9%
5. SP500 +6.9%
6. Nasdaq +10.1%
7. Financials (XLF) +10.0%
8. Tech (XLK) +10.2%
9. Russell 2000 +11.0%
10. US Equity Volatility (VIX) -26.5%

Now you should logically ask yourself why 3 months matters? For you, it may not. For me, it’s simple. I’m accountable for every call my team makes and it was 3 months ago that I made one of the biggest asset allocation pivots I’ve ever made in my career.

That could have easily blown up in my face inasmuch as overstaying my welcome on the long side of this move might have. And “believe me”, I have plenty of paying subscribers who were after me to book it weeks and, in some cases, months, ago.

This isn’t a victory lap. I got smoked in week 1 post Trump’s win. This is more of an open note to consider why I think the next few months should be a lot harder (to make money on the long side of US Equity Beta) than the last few have been.

In trying to consider, contextualize, and question how “overdone” (i.e. overbought) the US stock market really is – here are some of the big things that I’m thinking about:

1. LEVELS: yes, my signal says this 2 zone for the SP500 is overbought
2. VOLATILITY: yes, my signal says the 10.03-10.36 zone for front month VIX is oversold
3. POSITIONING: no, it’s still not in the area code of what I’d call Bullish Enough, given the move

Looking at positioning from a non-commercial CFTC futures & options net long/short perspective:

1. SP500 (Index + Emini) net LONG position dropped -35,712 contracts last week to +27,047 (1yr z-score +0.11x)
2. Russell 2000 (mini) net LONG position dropped -3,340 contracts last week to +51,106 (1yr z-score +1.33x)
3. US Dollar net LONG position was flat at +46,676 contracts last week (1yr z-score +1.08x)

So, yes, consensus is net long both US Equity Beta (SP500) and Small Cap Domestic/Bank (Russell) exposure. And yes, if only because it’s working, I think consensus gets why. #StrongDollar could indeed make America great again.

But does consensus (and Trump) really get how central a #StrongDollar is to this equation? The fact of the matter is that using a 3-month correlation, all of the aforementioned 3-month returns coincide with a USD/SP500 correlation of +0.72.

And while that’s hard to dramatize, it’s even harder to explain to ideologues who aren’t factual about “great” periods in US economic history.

Down Dollar, Down Rates, QE Forever? That Bush/Obama “policy” was finally overdone at the lows for Q2 2016 GDP too.

Our immediate-term Global Macro Risk Ranges (with TREND views in brackets) are now:

UST 10yr Yield 2.34-2.54% (bullish)

SPX 2 (bullish)
RUT 1 (bullish)

NASDAQ 5 (bullish)

VIX 10.36-12.13 (bearish)
USD 99.50-101.20 (bullish)
Oil (WTI) 51.90-54.39 (bullish)
Copper 2.65-2.80 (bullish)

Best of luck out there this week,

KM

Keith R. McCullough
Chief Executive Officer