"It is a habit of mankind to entrust to careless hope what they long for. ”
-Thucydides
In Destined For War, that’s one of the timeless #behavioral Greek quotes that Harvard historian, Graham Allison, uses to review the past 500 years of wars between established world powers and their rivals. As Thucydides goes on to remind us, “war is a violent teacher.”
And raging bull markets in US stocks can be humbling teachers to “valuation” driven bears when US growth is accelerating.
Since I’ve capitalized on two US stock market crashes (and their ensuing bear markets in 2000 and 2008), make no mistake – I’m no perma bull. I understand the habits of bears and I’ve learned Lesson #1 of Bull vs. Bear War. That’s quite simply that valuation is not a catalyst.
Back to the Global Macro Grind…
Rather than trying to constantly call tops, if you want to risk manage (trade around) raging bull markets, that’s entirely doable. To do that though, you have to rid your mind of the lazy habit of telling yourself that “you can’t time markets.”
If timing doesn’t matter, who needs active managers?
While it’s nice to have helped people make a lot of money in US Growth exposures buying-the-damn-dips in 2017, what I’m really happy about going into year-end is that we were able to teach people about our #process. It has two big parts:
- Fundamental Research
- Quantitative (Rules Based) Market Timing
As any long-term investor in markets knows, anyone in this business can get lucky. Some people have massive years, then they flame out. Some never put up the big numbers, but never blow up either. Over time, no asset management strategy sells like a repeatable #process.
I’ve worked on mine for going on 20 years. God willing I have at least 20 more in me to evolve my #process using technological, mapping, and measurement tools. A world I don’t yet know is the one I look forward to most at the top of the risk management morning.
Back to those dirty words I like to use like market-timing…
Yesterday’s trifecta of all-time closing highs for the Nasdaq, SP500, and Russell 2000 were proactively predictable given that:
A) The recent “correction” in US stocks came on both political and “rotational” (Fins for Tech) fears, not fundamentals
B) The recent “correction” in Tech (XLK) didn’t break either my TRADE or TREND signal lines of support
C) The recent “correction” was simply to the low-end of the @Hedgeye Risk Range in mostly everything we like
If you want to be an alpha-generating-dip-buyer in bull markets, you need to get the fundamentals and quantitative signals right.
Fundamentally, as I pointed out in yesterday’s Early Look, US GDP #accelerating to YTD highs post the US Retail Sales and Industrial Production reports was obvious. The US Retail Sector ETF (XRT) led US Sector Style gainers yesterday too.
In the last 3 months, Mr. Market priced in both US GROWTH and INFLATION #accelerating beautifully. Reflation’s Ramp was really a SEP-NOV event and both the Financials and the Russell (which has a 26% weight in Financials) loved that.
Here are 3 month returns in US Sector Styles we like when both GROWTH and INFLATION are accelerating at the same time:
- Financials (XLF) = +12%
- Tech (XLK) = +11%
- Consumer Discretionary = +11%
The 3 month returns for US Sector Styles we do NOT like under those prevailing GROWTH and INFLATION rate of change conditions are:
- Consumer Staples (XLP) = +3%
- Utilities (XLU) = 0.4%
- Telecom (IYZ) = -3%
If you’re in the long/short or underweight/overweight business, there’s always a relative bear market somewhere! If your investors cared about your performance for the past 3 months, you absolutely should have cared about US Growth & Reflation’s 3-month Ramp!
Great. Now what? Here are 3 more things to think about:
- Most things we’ve liked (the aforementioned 3 Sectors, the Nasdaq, SP500, etc.) are back to signaling immediate-term #overbought
- At its all-time highs in price, Tech (XLK) has an implied volatility DISCOUNT of -8% vs. 30-day realized (that implies capitulation)
- Reflation (in terms of my Commodities Signal) is signaling lower-highs within the @Hedgeye Risk Range (that’s new as of DEC)
Oh, and our fundamental research call is that Reflation’s Rollover (in headline reported inflation data) is coming back to a theater near you in Q1 of 2018, perpetuating the #acceleration in REAL consumption growth.
Since the habits of perma-bulls are as predictable as perma-valuation-bears, what I think will happen into year-end is the last part of the beta-chase (many bench-hugging PMs are forced to chase performance because that’s how they get paid) is happening now in the Financials.
But, at the same time, my quantitative signaling process is suggesting lower-highs for both the UST 2yr and 10yr yields, respectively. So my move would be to book your gains up here in rate-sensitive Financials and keep buying Consumer Discretionary and Tech on dips.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.33-2.42% (bullish)
SPX 2 (bullish)
RUT 1 (bullish)
NASDAQ 6 (bullish)
XOP 33.81-35.90 (neutral)
VIX 8.92-11.00 (bearish)
USD 92.70-94.25 (neutral)
EUR/USD 1.17-1.19 (neutral)
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
