Instructive Corrections

“Pictures can deceive as well as instruct.”
-Benoit Mandelbrot 

Looking for some help in risk managing the latest epic US Equity market correction? Let’s bring back The Brot! Benoit can help you with all those fancy charts some of your friends are looking at.

“The brain highlights what it imagines as patterns; it disregards contradictory information. Human nature yearns to see order and hierarchy in the world. It will invent it where it cannot find it.” (The (mis)Behavior of Markets, pg 189)

Especially when you think about Old Wall Street “technicians”, isn’t that the truth!

 

Back to the Global Macro Grind…

I didn’t ask a technician for permission to make the call that the US stock market was signaling immediate-term TRADE overbought on Tuesday. I used my risk management process.

In sharp contrast to how I’ve taught myself to manage market risk (multi-factor, multi-duration, across macro), the good news is a LOT of people who run a LOT of money still use 1-factor-point-and-click-simple-moving-price-averages.

For that, we should all be grateful. Without consensus chasing charts high and selling what we’ve liked all-year lower (Tech, for example), what would I have to back-slap myself about?

One of the key factors we use to time markets is volatility. Moreover, Mandelbrot taught us a lot about the importance of measuring and mapping the volatility of volatility. An example of that is as follows:

1. Looking at a general level of volatility like front-month US Equity Volatility (VIX) is instructive
2. The immediate-term @Hedgeye Risk Range for the VIX = 9.51-12.15
3. Therefore the volatility of volatility tells us to sell/short US stocks at 9.51 and buy/cover around 12.15

If Mr. Market changes his mind on that risk range, cool. We change with it.

But until the market tells us that A) there’s been a regime change (from bearish-to-bullish on our intermediate-term TREND duration) in volatility and/or B) a cross-asset-class corroborating macro narrative that could indeed be signaling a change in the rate-of-change in major macro market factors like GROWTH and/or INFLATION…

Then we simply keep on keeping on, and keep doing what we’ve been doing…

Something else that’s always critical to consider within the lens of ‘the volatility of volatility’ is the Consensus Macro market expectation of future volatility (i.e. implied volatility):

1. SP500: in 2 days just saw implied volatility (vs. 30 day realized) move to a +37% PREMIUM
2. NASDAQ: in 2 days just saw implied volatility ramp to a +26% PREMIUM
3. TECH: in 2 days just saw implied volatility rip to a +24% PREMIUM

What’s the difference between a rip and a ramp? Ha! I’m not sure. Just try to picture both in your P&L and let me know what you like more. I have an open mind on words vs. numbers.

If you were measuring and mapping realized vs. implied volatility (across durations), what you’ll have noticed is that at the all-time high for the SP500 on Tuesday, August 8^th, 2017:

1. SP500: barely had an implied vol PREMIUM (vs. 30-day realized) of +2%
2. NASDAQ: had an implied volatility DISCOUNT of -5%
3. TECH: had an implied volatility DISCOUNT of -2%

And within those Nasdaq/Tech implied volatility discounts, some of the components looked like this:

1. Apple (AAPL) -10% implied volatility DISCOUNT
2. Google (GOOGL) -19% implied volatility DISCOUNT
3. Netflix (NFLX) -45% implied volatility DISCOUNT!

Think about what implied volatility DISCOUNTS of -19-45% mean. Forget about these “market corrections”, especially with something like NFLX, we’re talking about an epic confluence of capitulation and complacency.

That’s right, AFTER the NFLX “earnings” event, bears capitulated and bulls got complacent… and now on new “news” the stock is able to correct back to the low-end of the @Hedgeye Risk Range.

In other epic complacent-chart-chaser turned mad-twitter-bro news this morning, being “Long Europe because it’s cheaper than US” continues to get pounded:

1. Germany’s DAX is down another -0.3%, taking its correction to -6.0% from June’s high
2. France’s CAC is down another -0.4%, taking its correction to -5.5% from its May high
3. In the last month alone, the DAX is DOWN -2.7% vs. the Nasdaq 100 UP +3.7%

This puts the trials and tribulations of chasing “the chart looks good” in context, doesn’t it? “BUY EUROPE” even looked great enough to be on the cover of Barron’s, right when those prices topped.

While my big call for a massively yuuge -0.24% correction from the SP500’s all-time high of 2080 on Tuesday was a helpful short-term market-timing-tool, measuring and mapping consensus positioning is more instructive.

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

UST 10yr Yield 2.21-2.31% (bearish)
SPX 2 (bullish)
NASDAQ 6 (bullish)
DAX 12061-12337 (bearish)
VIX 9.51-12.15 (bearish)
EUR/USD 1.16-1.18 (neutral)
Oil (WTI) 47.80-50.24 (bearish)
AAPL 154.55-163.50 (bullish)
GOOGL 933-960 (neutral)
NFLX 173-185 (bullish)

Best of luck out there today,
KM

Keith R. McCullough
Chief Executive Officer