“I work off this matrix I developed 25 years ago based on the flows of money. Money is always going somewhere no matter what. I follow it. It’s directional. I don’t like to pick targets.”
–Yra Harris
On the topic of traveling for idea generation, Harris is weary of distraction: “The flows of money are much more important. You could lose your perspective being there by just seeing a lot of anecdotal stuff that doesn’t really matter. If you’re watching the flows and listening to what the market’s telling you, you will know a lot more.”
Yra Harris works off a matrix he developed 3 decades ago to track global money flows. Perhaps a purposeful omission, process around the “Matrix” was elusive in his interview with Author Steven Drobny in “Inside the House of Money.”
Take it or leave it, but the wisdom that more sound decisions can be made with less is a common conclusion among investors who have stood the test of time. In other words, find the things that really matter in your framework and be disciplined about blocking out the noise.
Even though there is an endless amount of commentary, we know that “market sentiment” is not a hard science. Component factors can be tested and approached scientifically, but we’re still only hoping to get a couple pieces to a chaotic puzzle.
Back to the Global Macro Grind…
After spending time in client meetings in January, we addressed some of the pushback to our Q1 2018 macro themes presentation in a blackbook three weeks ago (Which Side of the Boat Are You On? ).
On the theme of Reflation’s Rollover, many investors took the other side on any meaningful market impact of a muted rollover which was:
- Counter to our CPI estimates which baked in a slight, but potentially meaningful, rollover.
- The same consensus viewpoint that we heard qualitatively in meetings was observed in derivatives markets via futures & options positioning and relative volatility in sectors like energy and financials to name a few.
More money appeared to be flowing into this theme, harvesting our behavioral premise that small marginal changes can be impactful at sentiment extremes (more on specifics below).
Fast forward 3 weeks and a violent market draw-down later... We’ve so far seen at least some market impact to certain pockets of crowded reflation trades, namely energy.
Pockets in the energy space have lagged in a big way this month, which was directly contrary to consensus positioning.
Month-to-date relative underperformance vs. SPX:
- XLE (SPDR Energy): -667bps
- XOP (E&Ps): -623bps
- IEZ (Services): -911bps
Some of the key headline inflation components in our inflation front-running commodity price basket have also declined month to date, mitigating the risk that market prices would overrule the driver of this theme: difficult inflation comps from hot inflation readings in January and February of 2017:
Month-to-date performance:
- CRB Index: -1.6%
- Brent Crude Oil: -5.3%
- CRB Raw Industrials Index: -9bps
The question we are now contemplating is what’s left of this theme in relative performance terms? Put simply, we think the “more left” scenario is an underappreciated risk. We were communicative of staying long of the same real growth exposures we had all of 2017 into Q1 while remaining underweight slower growth, yield-sensitive sectors, but how about more pureplay headline reflation exposures?
After last week’s January CPI print, our CPI nowcast model for Q1 is tracking to “less rollover” to put it simply. Our Q1 estimate ticked 22bps higher to 1.98% YY. Therefore the “rollover” is tracking at just 14bps for Q1 2018 and just 12bps below Bloomberg consensus before reaccelerating in Q2:
- Q4 2017 CPI Print: 2.12%
- Q1 2018 HE CPI Est.: +1.98% vs. +2.10% Bloomberg Consensus
- Q2 2018 HE CPI Est.: +2.31% vs. +2.50% Bloomberg Consensus
On the contrary to the more muted rollover set-up which changes in real-time, there has been little washout in positive sentiment toward reflation type of exposures in those three weeks since flagging this positioning as a key risk, especially coupled with the pick-up in volatility:
- Relative Volatility: As we show in our chart of the day, relative volatility or “implied dispersion” in the S&P 500 Energy ETF (XLE) vs. SPY registers TTM and 3yr Z-Scores > -2.5x across the term structure of volatility. Even a 3Yr Z-score tells a short-term story, but the longer duration picture is the same which we show in the chart (5yr & 10yr). Not surprisingly with the performance flow through from rates-rising, the other S&P 500 sector with the widest downside dispersion right now is financials (XLF).
- CFTC Net Futures & Options Positioning: The net long position in crude oil from the speculative pool of investors hit an all-time high going into the 1st week of February at +784k contracts. This net long pile-in coincided with the lowest level of 30-Day realized volatility since June of 2014 at $110/barrel. While this net long position has been trimmed to +736k, it’s still well above any net long position prior to 2018.
- Market Structure Factors: We track speculative open interest (CFTC Net Long) to total open interest and average daily trading volume. In the crude oil market these two market structure factors hit all-time highs in the first two months of 2018. Spec OI/ADTV has been cut to the 87th percentile of historical observations, but Spec OI/Total OI is still near the all-time high. It’s typically a forward volatility-up with these ratios extended like they are.
We’re waiting and watching on this theme of “reflation’s rollover” in the coming weeks. While we were happy to steer clear of the ugly near-term performance in energy-sector equities, the continued ascent of long-term nominal rates, inflation swap rates, and break-evens suggest the market continues to shed any semblance of a rollover risk this quarter.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.80-2.94% (bullish)
SPX 2 (bullish)
RUT 1 (bearish)
NASDAQ 6 (bullish)
VIX 14.62-33.19 (bullish)
USD 88.41-90.77 (bearish)
Oil (WTI) 58.44-62.81 (bullish)
Good luck out there today,
Ben Ryan
Macro Analyst
