“Old economists never change their mind.”
-Richard Thaler
I guess comments like that help you win the Nobel Prize in Economics these days! Our congratulations to both Richard Thaler on his 2017 win and to all of you who changed your mind on the US economic cycle over a year ago. From this day in 2016, the Nasdaq is +27%.
What gets you to change your mind? Do you look for answers to economic questions that fit your positioning or politics? Or are you data dependent? Do you incorporate the #behavioral factors of markets into what you believe to be true?
“Prospect Theory, scarcely cited in the 1st decade after its publication, would become by 2010 the 2nd most cited paper in all of economics. By 2016, every 10th paper published in economics would have a behavioral angle to it.” (The Undoing Project, pg 342)
Back to the Global Macro Grind…
After yet another all-time (which remains a very long time) closing high for the SP500 of 2659 yesterday (+18.8% YTD), it is once again signaling immediate-term TRADE #overbought within its Bullish @Hedgeye intermediate-term TREND.
Inasmuch as I’m becoming overly comfortable being uncomfortable about what the next economic data point will be, I’m also comfortable considering those fundamental realities within a multi-duration risk management framework.
TRADEs vs. TRENDs = the immediate (3 weeks or less) vs. the intermediate-term (3 months or more). Then I try to contextualize these sometimes conflicting realities within the long-term TAIL view (3 years or less).
While I’m never “certain” about a macro position, the most sure I can be is when most of the economic data rhymes with ALL 3 of my TRADE, TREND, and TAIL signals.
The @Hedgeye Risk Range #process is designed to get me out of gross and net long exposure at the top-end of the range inasmuch as it provides me the opportunity to re-load (or buy the damn dip) on “corrections” to the low-end of the range.
My #process isn’t perfect. No one’s is. But I am tasked with explaining it to you each and every market day.
The most critical component to my quantitative signaling process is measuring and mapping the relationship between PRICE and VOLATILITY. While we’ve seen clusters of short-term US Equity Volatility this year, they haven’t manifested into TRENDING volatilty.
Another way to look at the SP500’s all-time highs are TRENDING all-time lows in front-month SPX volatility (VIX):
- VIX was down another -16% last week taking its 2017 crash to -32% YTD
- VIX currently has an immediate-term @Hedgeye Risk Range of 9.13-10.81
- Every short-term VIX cluster of volatility has been to a lower-high in 2017
What is the TRENDING volatility of volatility? That’s a question that another #behavorial beauty, Benoit Mandelbrot, was in a constant quest to consider. A life of deliberate data-driven study sure beats chasing one’s tail like a Macro Tourist does, doesn’t it?
Another critical volatility study that I consider after markets close every day is the relationship between REALIZED and IMPLIED volatility. While the SP500 currently has an implied volatility PREMIUM of +18% vs. 30-day realized, the following Sector Styles have DISCOUNTS:
- Industrials (XLI) have an implied volatility DISCOUNT of -11% vs. 30-day realized
- Consumer Staples (XLP) have an implied volatility DISCOUNT of -10% vs. 30-day realized
- Energy Stocks (XLE) have an implied volatility DISCOUNT of -6% vs. 30-day realized
If you don’t know what that means, you need to teach yourself. One of the most obvious market signals of both capitulation (bears covering) and complacency (bulls getting too cocky) happens when:
A) The market PRICE is signaling immediate-term TRADE #overbought and…
B) Implied volatility PREMIUMS collapse and crash into DISCOUNTS vs. 30 and 60-day realized
With all of this market positioning information on the tape, I can start to consider which, if any of these US Equity Sector Styles, I’d like to sell short. Since Consumer Staples (XLP) has been an explicit short of ours this year, that one is easy to pick.
It’s going to be harder to pick and choose when to short either Industrials (XLI) or Energy (XLE). I might not short either. That said, I’m quite interested in shorting sub-sectors of these exposures, especially those tied to our Macro Theme of #ChinaSlowing.
Unlike US stocks, Chinese Stocks (Shanghai Composite Index) dropped another -1.3% last night. Don’t look now, but the Shanghai Comp is down -4.4% in the last month and signaling Bearish TREND @Hedgeye.
While many perma-China-bears got run over not changing their minds when the Chinese opted for unprecedented stimulus in 2016, we did not. Why? We’re not perma anything. The Old China data didn’t start slowing until Q3 of 2017, so that’s when we changed our mind.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.32-2.43% (bullish)
SPX 2 (bullish)
NASDAQ 6 (bullish)
VIX 9.03-10.82 (bearish)
USD 92.69-94.22 (neutral)
Oil (WTI) 56.01-58.86 (bullish)
Gold 1 (bearish)
Copper 2.91-3.06 (bearish)
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
