“Structure determines virality.”
-Niall Ferguson
That might be one of the best new Global Macro Risk Management quotes of the year. It comes from a very timely and topical book about the history of networks that I’ve been citing as of late: The Square and The Tower, by Niall Ferguson.
In Chapter 9 Ferguson tries to summarize his definition of Network Theory with 7 Insights:
- No man is an island
- Birds of a feather flock together
- Weak ties are strong
- Structure determines virality
- Networks never sleep
- Networks network
- The rich get richer
Ferguson isn’t a fractal strategist, but many of his evolved views adopt the principles of fractal geometry. Insights 4-7 in particular should resonate with most of us who respect and understand market realities like power laws, exponential functions, and asymmetry.
“Some ideas go viral because of structural features of the network through which they spread… Networks are not static, but dynamic… When a network disrupts an ossified hierarchy, it can overthrow it with breath-taking speed.” (pg 47)
Back to the Global Macro Grind…
I get asked about the “structure of the market” a lot. Since I worked as a PM for one of the more sophisticated hedge funds using Factor Models before most of our industry did (Magnetar Capital), I think my experience helps contextualize what market signals are saying.
That’s not to say I know anything more than someone else who analyzes markets on a multi-factor, multi-duration basis. It means that I understand why causal factors like the rates of change in growth, inflation, and policy can determine virality within the market network.
So what if the Fed, ECB, or any central bank tightens into a slow-down?
To be clear, most central bank tighten pro-cyclically. Moreover, they often keep tightening too late. The ECB (European Central Bank) TIGHTENED during epic local and global (growth) slow-downs of 2008 and 2011, don’t forget. Nice job, Trichet!
How about this time?
- The ECB’s econs, once again, are trying to tighten into a European slow-down… and
- The Fed is threatening to do the same into what we’re now-casting as a US growth and inflation slow-down in Q418
- Oh, and the Chinese tightened into their slow-down in Q1 of 2018, but you already know that
And what about these cool new EM Econs (who were educated at fancy schools like the one I went to)? What do you think central bankers in Brazil, Turkey, and Argentina are going to do as they enter the thralls of economic stagflation? Tighten? #Great.
I know. Our now-cast on the pending 2H18 US growth and inflation slow-down from the cycle peak A) isn’t consensus (that’s the point) and B) isn’t the way most central banking econs think about risk (they think about “levels”, not rates of change).
But there’s a really important Macro Strategist out there who currently agrees with our now-cast. His name is Mr. Market. This is how he read yesterday’s US inflation data and the Fed’s hawkish stance:
- Post the a white-hot PPI (producer price inflation) report of +3.1% year-over-year growth, UST 10yr tested 3.00% and backed off
- Post the Fed upping their forecasts for both growth and inflation, UST 10yr Yield re-tested 3.00%... and backed off again
This shouldn’t surprise anyone who uses our #process the way they should. The top-end of the @Hedgeye Risk Range on the UST 10yr Yield is currently 3.01%. On the #InflationAccelerating news (that the market has been discounting for 9-10 months), bonds were flat.
Since not everyone thinks about it this way, here’s how I think about the forward outlook:
- In the next 2-3 months, both headline inflation (CPI) and PPI will be > 3.0%
- In the next 2-3 months, headline (q/q SAAR) US GDP will be close to 3.0% for the 4th quarter in the last 5
- In the next 2-3 months, the US will be entering the Quad 3 and Quad 4 zone of Mr. Market’s expectations
*all the while, China, Europe, and EM will continue to slow on a real growth basis
Since the Fed’s hawkish/dovish playbook (which Powell is sticking to) doesn’t allow him to “go dovish” in the aforementioned US domestic scenario (and his boss wants some serious cheer-leading on the economy into the mid-terms), I think the Fed’s in a box.
And, again, so does Mr. Market. Just look at the US Yield Curve Compression this morning:
- UST 2yr Yield is sticking at 2.56%
- UST 10yr Yield is correcting to 2.94%
- Yield Spread (10yr minus 2yr) is compressing to a new YTD low of +38 basis points (see Chart of The Day)
I didn’t try to scare you out of your mind on the “yield curve” (like many strategists did) throughout 2017 and early 2018 because the curve was “flattening” with a 10yr Yield breaking out to new highs on US growth and inflation data #accelerating.
Now though, the curve is flattening with the 10yr Yield making LOWER-HIGHS and the Fed trying to jam 4 rate hikes into the short-end as US growth and inflation are setting up to slow within 3-6 months.
Since market expectations (for the 10yr to rise, not fall), positioning (all-time high net SHORT positioning in the 10yr Treasury in 2018), and structure (machines chase the first sniff of a Phase Transition in growth and/or inflation), all really matter…
What are you going to do, God forbid, if both our and Mr. Market’s growth and inflation forecasts continue to be right? I know what I’m going to do. I bought REITS (VNQ) in Real-Time Alerts yesterday and am no longer shorting Treasuries.
The rich only get richer when they don’t have double-digit drawdowns during causal Phase Transitions in growth and inflation. When real growth slows, bad things happen. Ask EM growth bulls about that.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.87-3.01% (bullish)
SPX 2 (bullish)
RUT 1 (bullish)
NASDAQ 7 (bullish)
REITS (VNQ) 78.39-80.84 (bullish)
Industrials (XLI) 74.32-76.90 (bearish)
VIX 11.38-15.22 (bearish)
USD 93.10-94.50 (bullish)
Oil (WTI) 64.40-67.73 (bullish)
Corn 3.65-3.88 (bearish)
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
