“Fractals are supremely visual, hence supremely intuitive.”
-Benoit Mandelbrot
Yep. After an epic 3-day decline in the US stock market (SP500 down -0.33%, -0.29%, and -0.23% in the last 3 days), I’m going right to the wood. I’m going all fractal on the growth bears, bringing back The Brot!
“All fractals start simply. In its first stages, any scientific investigation had better be simplistic; otherwise it will never fly. Every fractal is the logical expression of a few straight forward ideas, rules, or mathematical relations.”
-The (mis)Behavior of Markets, pg 128
One really simple idea we’ve had is that as the rate of change in US growth data goes from slowing (Q115 to Q216) to accelerating (Q316 to now and into the back half of 2017), US interest rates will rise (after crashing to all-time lows).
Back to the Global Macro Grind…
In simple fractal construction, there’s an initiator, a generator, and a rule. For me, the most important moves in macro are the initiations of a Phase Transition.
When something big (like growth, inflation, or profits) goes from bearish (slowing) to bullish (accelerating) on an intermediate-term TREND duration, that’s what I’m talking about – I call that a bearish-to-bullish Phase Transition.
The thing about Phase Transitions is that consensus gets caught stuck in the prior phase! Instead of re-calibrating, Bayesian style, each and every day, most Macro Tourists anchor on what was trending yesterday.
One obvious example of this is consensus being long Oil and Commodities into what we’ve called Reflation’s Peak!
- We call it “Reflation’s Peak” (Theme #2 of our Q1 Macro Themes Deck) because the compares bottom in Q1
- Ex-this week’s decline in Oil and Commodities, INFLATION would have decelerated in Q2 (rate of change) anyway
- If this week’s deflation of the reflation holds throughout Q2, inflation is going to slow faster
Again, instead of my initiator being GROWTH (which consensus hasn’t been Bullish Enough on), I’m talking about the initiator being INFLATION’s rate of change, and consensus being Too Bullish on that.
Don’t take my word for it (or any Old Wall “surveys”) on what consensus is or how it “feels.” Just look at both the positioning of the market and its implied volatility premiums and discounts:
- The #1 net LONG position in macro (absolute and relative to itself) = Crude Oil (+563,593 net LONG contracts)
- Oil, Copper, Natural Gas, etc. all have implied volatility discounts vs. 30-60 day realized volatility
Put simply:
A) When consensus is net long a macro exposure and
B) Consensus isn’t pricing in the expectation of a correction (that’s what an implied volatility DISCOUNT implies)
Then things can correct, hard – and in some cases generate so much short-term momentum (to the downside) that is counter to the TREND that it feeds on itself and reflexively forces the market to consider a legitimate Phase Transition.
While this may not make sense to everyone, it makes as much sense to me as it ever has. Never in my 18 year career have I seen so many chasing so few macro “things” on short-term durations. Systematic trading represents 80-85% of daily flow!
That’s why the fractal model of measuring and mapping market risks (and opportunities to the upside) using an initiator, generator, and rules continues to make more and more sense to me too.
On Commodities, Oil, and related equity exposure – here are 3 TREND signals to consider:
- COMMODIITIES – CRB Index just broke its intermediate term TREND level of 188
- OIL – WTI Crude Oil is testing a break-down of its $48.90 TREND level
- XOP – Oil & Gas Stocks broke TREND (when I sold it last week) of $38.91
While I made up my own dynamic modeling rules to measure and map these risks, I didn’t tell the market what it should do. I’ll let the “valuation” experts write to you about that.
As The Brot taught me, “fractal geometry is about spotting repeating patterns, analyzing them, and quantifying them – it is a tool for both analysis and synthesis.” Thank goodness for that.
Our immediate-term Global Macro Risk Ranges (with TREND views/signals in brackets) are now:
UST 10yr Yield 2.45-2.61% (bullish)
SPX 2 (bullish)
RUT 1 (bullish)
NASDAQ 5 (bullish)
XOP 35.05-37.90 (bearish)
RMZ 1130-1161 (bearish)
VIX 10.53-12.29 (bearish)
USD 101.25-102.60 (bullish)
Oil (WTI) 48.90-54.40 (bullish)
Nat Gas 2.65-2.96 (bearish)
Gold 1 (bearish)
Copper 2.54-2.74 (bullish)
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
