“One thing we have lost, that we had in the past, is a sense of progress, that things are better. There is a sense of volatility, but not of progress.”
-Daniel Kahneman
The Daniel Kahneman quote above is more of a general observation on society and our modern lives, but it also feels oddly appropriate for the market action this year. Just as things start to “feel” good, volatility takes over and we are back to where we started. Very little progress and another bout of getting caught leaning too far because of complacency.
Thanks to the stock market getting beaten like a rented mule yesterday, the SP500 is now down -1.46% on the year, the Nasdaq is up a mere +1.76%, while the Dow down -2.81%. Meanwhile, the VIX has spiked back above 18.00 and the VIX futures curve is once again in backwardation. The implication, of course, is that there is an expectation for more volatility in the short run.
For those that don’t know, the VIX takes as inputs the market prices of the call and put options on the S&P 500 for the “front month” and “second month” expirations and is the volatility of a variance swap calculated in percentage terms. As such, it represents the expected range of movement in the S&P 500 over the next year, at 68% confidence level (one standard deviation). So, despite its moniker as the Fear Gauge, the VIX actually implies wider expected returns in BOTH directions.
A heightened VIX makes the idea of trading around your exposures that much more important and valuable. In the Early Look, we include risk range levels at the bottom of each note. For institutional subscribers, we also provide customized risk range work on specific stocks and/or markets. So vol baby, vol? Well, then trade the range! (Updated risk range for the VIX is included in our "Chart of the Day.")
This “lack of progress” is even more meaningful in the bond market with the 10-year yield poking its proverbial head above 3.0%, settling in at 3.01% as of 7:00am this morning. While much has been made of the 3.0% line in the 10-year yield, we would caution you not to be overly focused on arbitrary lines. This is something Daniel Kahneman would call “anchoring” and is dangerous in the best of times.
Back to the Global Macro Grind...
On the inflation #accelerating front today, the newest data point comes from the world of home construction. According to Random Lengths, a composite measure of lumber for framing increased by 16% between December and March. Based on the same report, the price of other construction inputs, particleboard, plumbing materials, concrete, and insulation, increased by 5.1% year-over-year in March . . . this is the largest jump in 8 years!
Since construction costs typically account for north of 55% of the costs of a single-family home, this has real implications. Interestingly, this week’s consumer confidence index showed the highest percentage of respondents since 2009 indicating they intend to buy a new home. Given higher costs to construct and finance, not to mention low inventory, the desire to buy a new house seems likely to taper off.
Setting aside just lumber, commodities have been one of the top performing asset classes this year. Most commodity basket ETFs are up between 6 and 7% in the year-to-date and some of the underlying components have obviously been spiking big time. If you want evidence of the percolating bull market in commodities, pull up the one-year chart of Cocoa!
Cocoa, while it will drive up the price of our Mochas at Starbucks (incidentally SBUX is one of Howard Penney’s top short ideas), doesn’t have a broad impact on the economy or CPI. On the other hand, oil does have a direct impact on inflation and the economy.
Our Energy policy Sector head Joe McMonigle did a great video outlining developments expected to continue giving oil prices a bid (it can be viewed here: https://app.hedgeye.com/insights/67153-mcmonigle-my-take-on-trump-s-opec-tweet-and-the-iran-deal). His case is three-fold:
- OPEC, despite President Trump’s tweets, is expected to keep production limits in place at least through 2018;
- Iran has added about a million barrels a day in exports since sanctions were lifted, this production is at serious risk if, and when, Trump re-implements sanctions; and
- Production in Venezuela is down 800k barrels per day from 2016 and losing about 50k barrels per day every month.
Certainly, a lot of reasons to believe that the price of oil, at a minimum, won’t be going down from here, especially heading into the summer driving season in the U.S. when demand for gasoline is 10 – 15% higher than in the fall and winter.
In other news, just in time for yesterday’s correction, we saw a spike in bullishness in the latest U.S. Investor Intelligence poll. Bearish sentiment only decreased mildly to 19.6% from 19.8%, but bullish sentiment jumped from 43.6% to 48.0% and those expecting a correction decreased to 32.4% from 36.6%.
Not surprisingly, of course, we are now poised to have a correction . . . . and just in case you were about to ask, the Hedgeye Risk Ranges on the SPX is bearish at 2624 – 2678 and also bearish on the Nasdaq at 6984 – 7167.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.76-3.03% (bullish)
SPX 2 (bearish)
NASDAQ 6 (bearish)
Energy (XLE) 70.21-74.75 (bullish)
VIX 14.57-19.78 (bullish)
USD 89.75-90.99 (bullish)
Oil (WTI) 65.61-69.40 (bullish)
Gold 1 (bullish)
Copper 3.02-3.19 (bearish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
