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Editor's Note: Below is a complimentary Early Look written by CEO Keith McCullough on 10/9/18. Click here to learn more about the Early Look.

Are You Prepared for the Quad 4 Hurricane? - el head

That’s what my old boy, The Brot, had to say about the economics departments of the establishment. “Much of what passed for orthodoxy in economics and finance proves, on closer examination, to be shaky business.” (The (mis)Behavior of Markets, pg 226) 

In other news, the IMF is cutting its Global Growth forecast again this morning. Thanks for coming out. In ROC (rate of change) terms, China, Europe, and Emerging markets have been slowing for almost a year now with Europe starting to slow at this time last year. 

All the while, US Equity Markets are getting hammered by a Quad 4 Hurricane. If you’re wondering why the SP500 isn’t down as much as the Russell or NASDAQ in the last month, it’s because there are Bond Proxies in those Quad 4 insured portfolios! 

Are You Prepared for the Quad 4 Hurricane? - beach

Back to the Global Macro Grind… 

I know, I know. But I’m long Treasuries (TLT) and there’s pain there too. No doubt, lots of pain. But one position that is in capitulation mode after going down for 3 straight years (like Treasuries have) does not a portfolio make: 

A) In terms of FX, Long US Dollars vs. mostly anything else is crushing it
B) In terms of US Equities, Long Utilities (XLU) vs. Short Tech (XLK) is crushing it too 

That’s right. Even though the UST 10yr Yield has had a multi-standard-deviation move higher in the immediate-term, so has the relative performance of your Quad 4 Low Beta, Minimum Vol hurricane insured US Equity book: 

  1. Consumer Staples (XLP) were +1.4% on the day yesterday
  2. REITS (XLRE) and Utes (XLU) were +1.3% and +0.8% on the day yesterday
  3. Tech (XLK) was down another -1.1% on the day yesterday

Throw a big overweight US Cash position in there and you might just be looking forward to when bond yields back off the top-end of the @Hedgeye Risk Range (for the UST 10yr Yield that’s 2.98-3.28%). Imagine the market is already front-running that move? 

I can. It doesn’t take much imagination to consider the next 3 months of US and Global economic data (summary outlook: Quad 4). We just need to get the final Quad 2 data for Q3 (SEP data) reported in the coming weeks and get right into Earnings Season

Oh, right – Q3 Earnings Season… 

We’ve already highlighted the risks associated with epically high earnings expectations there but to review the ABC test you should have interrogated your CFO’s on pre Q3 quarter end: 

A) Where are you on Chinese, European, and Emerging Market demand?
B) Where are you on US Dollar impact to earnings?
C) Where are you on #LateCycle US Wage Inflation #accelerating and your margins? 

As another one of my old boys (William Shakespeare) liked to say, “expectations are the root of all heartache”… and Q318 Earnings Expectations for the SP500 are for +36.7% year-over-year growth with US Tech being up +41.9% year-over-year! 

Is that why the most globally cyclical sector of Tech (Semiconductors, SMH) acts like the eye of the hurricane is running right through it? With semis (SMH) down another -1.2% yesterday and down -4.5% in the last month, I’m not waiting on establishment CFOs to tell me. 

In sharp contrast to being long Tech (XLK), the NASDAQ (down -4.6% since AUG 29), or the Russell (down -6.4% since AUG 31), a classic Quad 4 Sector Long like Healthcare Stocks (XLV) is +1.8% in the last month. 

So you’re not going to nail everything all of the time in a globally diversified long/short portfolio unless your name is Madoff. When Quad 4 Hurricanes hit, most people in the portfolio management area get hurt. Lots of reactionary mistakes are made too. 

What we want to focus on is not making incremental mistakes above and beyond ones we’ve already made. We also don’t want to capitulate on short-term price moves that are counter to what our process suggests we do going forward. 

While I’m covering most of my short exposure here (on immediate-term #oversold signals) so that I can re-short the bounce, I think the biggest mistake left is going to be buying the damn dip in Quad 4 Momentum, High Beta, and Growth exposures. 

The perceived wisdom with Tech in particular is that it is different this time. But, for the last month, that’s been dead wrong. How many momentum and growth bulls can be prepared for a Quad 4 Hurricane if they’ve never seen or weathered one? 

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

UST 10yr Yield 2.98-3.28% (bullish)
SPX 2874-2928 (bullish)
RUT 1614-1686 (bearish)
NASDAQ 7716-7950 (bearish)
Utilities (XLU) 51.27-54.50 (bullish)
REITS (VNQ) 77.80-81.01 (bullish)
VIX 11.70-16.83 (bullish)
USD 93.90-96.21 (bullish)
Oil (WTI) 71.07-77.05 (bullish)
FB 153-165 (bearish)
GOOGL 1148-1194 (bearish)
NFLX 344-371 (bearish)
TSLA 242-287 (bearish) 

Best of luck out there today,

KM 

Keith R. McCullough
Chief Executive Officer

Are You Prepared for the Quad 4 Hurricane? - 10.09.18 EL Chart

Are You Prepared for the Quad 4 Hurricane? - early look