Scared Yet?

“Fear is one of the best friends a champion has.”
-Jose Torres 

Puerto Rican Hall of Fame boxer, Jose Torres, won the WBA Light Heavyweight Championship of the world after winning Silver for the United States at the 1956 Olympic Games in Melbourne, Australia.

The aforementioned quote comes from a new book I just started reading titled Mastering Fear by former Navy SEAL, Brandon Webb. The best chapter, so far, is called “The Battle Is In Your Mind.”

The battle in this profession is also in your book. What do you own today? Are you improving your positioning? The best time to do that is every day. Being captive to your emotions and fears is no way to do that. You need a systematic process to risk manage your mind.

Back to the Global Macro Grind…

While my small community of former hockey players and I may not be that bright, mostly everyone else reading this rant every day is pretty darn smart. On paper, that is. Book smart isn’t always Street smart though. Mastering The Game takes a lot of introspection.

In order to master either The Game itself or your fears, I highly suggest your risk management process includes measuring and mapping the ROC (rates of change) embedded in The Machine.

What’s The Machine? It’s that damn thing you’re staring at right now. It calculates your score, daily. Almost 90% of what’s trading within The Machine is now systematic. If you fear, hate, or loathe that, good. Stop whining about it and start capitalizing on it.

One of the many market-based factors we measure and map daily as a proxy for fear vs. complacency is the relationship between the volatility that’s already been REALIZED in the marketplace and what’s expected or IMPLIED in the future.

For those of you who don’t do options and/or look to the futures and options market for information about market sentiment, positioning, etc., you should. A significant percentage of people and PM’s you compete with don’t. So use that to your advantage.

Given how many people run shorter-term money at either platform or pod shops these days, you have to know that a significant percentage of the aforementioned systematic short-term trading is delta-hedging with the directional move of the market.

If you don’t know what delta-hedging is, look it up. If you’re running “market neutral”, that’s what you do. The constant “re-hedging” of these portfolios perpetuates The Machine’s relevance like never before.

Need a basic example?

1. AFTER the SP500 goes down for 4 days in a row…
2. IMPLIED VOLATILITY has already ripped in kind

To put some context around these moves:

1. At the close of trading on SEP 20^th, 2018, IMPLIED volatility (vs. 30-day REALIZED) for the SP500 dropped to +14%
2. The SEP 20^th closing price of the SP500 was the ALL-TIME HIGH
3. As of last night, the SP500’s IMPLIED VOLATILITY (vs. 30-day realized) ripped to +117%

For those who “feel” something AFTER market moves (i.e. the market felt “great” on SEP 20^th and “omg” on yesterday’s close), whatever you feel equated to a 3.0 standard deviation move in volatility expectations vs. the last 12 months.

Since I used to play this game like I’d play hockey (i.e. on a knife’s edge of emotion, whipping my gross and net exposure around like a teenager playing Fornite), I feel what people feel when they feel. Why else do you think I built a process to risk manage myself?

So, if you weren’t selling Momentum, High Beta, Growth, etc. (all of the Factor Exposures you should reduce as you were heading into Quad 4 in Q4) at the end of August, you did have another selling opportunity at the end of September.

Btw, at the end of August (when both the Russell 2000 and NASDAQ were registering all-time closing highs):

1. Implied Volatility (vs. 30-day realized) for the SP500 had dropped to +9%... and
2. Implied Volatility (vs. 30-day realized) for Tech (XLK) had collapsed to an implied volatility DISCOUNT of -2%

Yep, two trading days ago, the implied volatility PREMIUM (vs. 30-day realized) for Tech (XLK) ballooned to +79%... then the NASDAQ finally tried to bounce intraday yesterday partly on that fear factor capitulating.

Why use 30-day as the duration?

1. It has the best back-test as predictive for future market moves
2. It’s also the duration that an entire profession is under duress trying to perform against

Why not use that signal exclusively? That’s simple. It only back-tests as predictive with a A) fundamental macro research overlay and B) a quantitative signaling process that issues #overbought and #oversold signals all the while.

Here’s another basic example of how I use market information to make real-time decisions: our Short Euro (FXE) position. Only 3 weeks ago, Old Wall technicians said the Dollar was “breaking down” and the Euro “breaking out.” Meanwhile:

1. At the time, the EUR/USD was making a lower-high within a Bearish @Hedgeye TREND view AND …
2. EUR/USD was tapping the top-end of my $1.14-1.17 @Hedgeye Risk Range AND…
3. Implied Volatility vs. 30-day realized for the Euro (FXE) dropped to a -4% DISCOUNT

Fast forward to this morning and…

1. European Economic data continues to #slow (Italian Industrial Production DOWN -0.8% year-over-year)
2. EUR/USD is at $1.14 (the low-end of the @Hedgeye Risk Range) AND…
3. Implied Volatility vs. 30-day realized for the Euro (FXE) has shot up to a +28% PREMIUM

That was a +2.1 standard deviation move vs. TTM for whoever bought the Euro on it “feeling” like the chart was “breaking out.” When you’re on the other side of moves like that, that’s how you get paid.

I’m not trying to scare you into doing this. I’m trying to do what I’ve always done in building the Hedgeye research platform for the past decade. Unlike many, I’m trying to show you my work. I’m trying to explain why I’m doing what I’m doing and when.

In a not so subtle way, I’m also trying to tell you that some of your greatest market hopes and fears are my friends.

Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:

UST 10yr Yield 2.96-3.26% (bullish)
SPX 2 (bullish)
RUT 1 (bearish)
NASDAQ 7 (bearish)
Utilities (XLU) 51.50-54.67 (bullish)
VIX 11.35-16.78 (bullish)
USD 93.90-96.22 (bullish)
EUR/USD 1.14-1.16 (bearish)
Oil (WTI) 72.00-77.91 (bullish)
Gold 1179-1202 (bearish)
GOOGL 1134-1190 (bearish) 

Best of luck out there today,
KM 

Keith R. McCullough
Chief Executive Officer