“Everybody has a plan until they get punched in the mouth”
-Mike Tyson
Cross-walking the chin-music metaphor to investment space always packs some extra potency after days like yesterday. And particularly so when “planning” has largely represented a fun, abstract thought exercise performed in the aseptic confines of a low volatility, multi-year growth accelerating passive investing-palooza.
Timing (i.e. Risk Management) matters. Particularly as the probability for large-scale phase transitions across global macro fundamentals begins to build.
We’ve been reemphasizing that reality recurrently in recent weeks.
It’s also why you’ve seen us ratchet down our gross exposure in Real-Time Alerts (RTA) and selectively tighten our net exposure (i.e. add more shorts) at the top end of the risk range or when we breach Trend support to the downside.
Prices change, the process doesn’t.
Here’s what we did ~10:20am yesterday when SPX broke Trend support of 2703:
- Sold APD
- Shorted TSLA
- Shorted RDFN
That took us net short in RTA (4 shorts, 3 longs) for the rest of the -2.2% drawdown in beta. Recall, the @Hedgeye Trend line implicitly captures the critical price and decision levels for the market's largest constituency of investors (traders and medium-term investors). So the probability for some measure of a price vacuum rises considerably alongside a breach of the Trend line in either direction.
To extend the boxing metaphor:
If the quantamental process can reliably tell you when the punch is coming, it’s significantly more likely you take it off the gloves than on the mouth.
Even better, if the plan (expectation) itself is to get punched in the mouth (i.e. negative fundamental outlook + bearish quantitative setup), when the flurry comes you’re already covered up and can rope-a-dope the chop associated with another round of volatility and price clustering.
Back to the Global Macro Grind ….
Was it the expected implementation of China targeted tariffs and the not unexpected retaliatory response that drove yesterday’s price action? Was it the bolt-on acquisition of Bolton? Was it the crush of growth slowing PMI’s out of Europe?
Let’s stick and move with the macro context and keep it tight here for Friday morning.
Here’s how we’ve been narrating evolving macro dynamics in recent weeks. Starting broadly and narrowing:
Globally/Thematically:
- Our call since the beginning of the year has been for reflation/inflation expectations to peak and roll into the end of 1Q18 and for “harmonized” global growth to transition increasingly and conspicuously towards #GlobalDivergences
- The accumulation of flows and positioning associated with multiple quarters/years of improving growth and low volatility is significant. The unwind – partial or otherwise – as those dynamics shift represent a cactus garden of risk.
Europe:
- To keep it simple …. if growth is slowing, price pressures will generally be ebbing, all else equal. And if price growth is already decelerating when the growth inflection is manifesting, a negative revision to inflation expectations and downward pressure on nominal yields should not come as a real surprise.
- The probability for a rhetorical shift out of the ECB also rises which should be reflected in the currency.
- The Eurozone PMI’s were certainly softer across the board yesterday, but underwhelming growth data has been the prevailing reality for over a month, European economic surprise indices are in full backslide, nominal yields continue to retreat alongside downward revisions to the inflation outlook and the euro has transitioned from bullish to neutral @hedgeye.
- European Bond Yields continue to get smoked by #EuropeSlowing expectations (German and French 10yr yields down to 0.51% and 0.75%, respectively this am)
China:
- We’ve been calling out the risk to China for months now as #OldChina continues to slow and the growth data comps against the largest concentrated stimulus ever.
- China remains bearish Trend with the Shanghai Comp down another -3.4% to close the week (-11.5% since JAN).
U.S:
- The major Equity Benchmarks have been signaling lower highs
- Bond proxies have been signaling higher lows
- Nominal yields were signaling overbought
- Speculative net short positioning in bonds remains extended
- Inflation expectations have been in steady retreat
- We are below the street on 1Q18 GDP .... the first such instance since growth inflected back in 3Q16.
- Corporate Profits: Base effects get increasingly more difficult beginning in 1Q. This is particularly true for the Tech sector … increased scrutiny and the prospect for tighter regulation (i.e. higher costs, lower margins, lower mojo) would only amplify the comp dynamics.
the peak in inflation expectations was very likely rearview - Comps: Domestic fundamental comps – particularly across the industrial economy - get progressively harder as we move through the year. As base effects steepen the probability for a rate-of-change deceleration rises – its just simple gravity embedded in simple rate-of-change math.
- $USD: The idea that the dollar may be in position for some durable/investible strength is decidedly non-consensus and the implications are significant. Inverse correlations to the dollar (across equities and commodities) remain strong and pervasive, global portfolio positioning with implicit short dollar exposure has risen over the past year+ and EM flows on the back of dollar weakness have not been immaterial. Dollar-denominated EM bond spreads are already rising alongside dollar stabilization. In a scenario where the dollar appreciates and EM growth slows, that spread widening has some upside along with the more obvious implications for equities.
Remember, something doesn’t necessarily need to have an outsized move for “a call” to work .... if the probability for a particular event moves from 0% to 30%, it carries discrete price implications as the market discounts that rising probability (even though it may remain ‘improbable’).
Also, remember, vapid conviction is a defining characteristic of macro tourist consensus. After all, it was only 14 months ago that consensus was perfectly convicted in their long dollar, “trade-of-the-year” call.
To be clear, I’m purposefully profiling the negatives here this morning and overstating our general level of concern.
We don’t think growth in the U.S. is in imminent threat of collapse or that inflation is going to careen into a deflationary spiral or breakout sharply to the upside in the near-term.
I really just want to emphasize the point that dynamics are shifting. The sanguine, above-consensus growth outlook we’ve authored over the past 7 quarters is shifting as well.
Tops remain processes. Profitably traversing the market internalizing and pricing that transition remains a risk management exercise.
Lazy long had a good run.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.78-2.90% (bullish)
SPX 2 (bearish)
RUT 1 (bearish)
NASDAQ 7139-7609 (bullish)
Biotech (IBB) 106-112 (neutral)
Energy (XLE) 65.95-68.90 (bearish)
REITS (RMZ) 1030-1063 (bearish)
Nikkei 205 (bearish)
DAX 115 (bearish)
VIX 15.98-24.45 (bullish)
USD 89.05-90.10 (neutral)
EUR/USD 1.22-1.24 (neutral)
YEN 104.59-106.75 (bullish)
GBP/USD 1.38-1.41 (bullish)
Oil (WTI) 59.53-65.41 (bullish)
Nat Gas 2.51-2.80 (bearish)
Gold 1 (bullish)
Copper 2.99-3.09 (bearish)
Have a great weekend,
Christian Drake
US Macro Analyst
