“Scaling simply refers to how a system responds when its size changes.”
-Geoffrey West
That’s a foundational quote from a book I cited last week that received plenty of positive feedback: Scale – The Universal Laws of Life, Growth, and Death in Organisms, Cities and Companies, by former President of the Sante Fe Institute, physicist Geoffrey West.
What happens to markets when the rates of change of growth and inflation change in an economy? What happens when market volatility changes? Are market prices and their respective volatilities linear or non-linear?
These are the questions I spend most of my time trying to answer. We already know what happens to markets when growth and/or inflation in an economy slows. We also know that there’s a lot of money to be saved and made in accurately timing that.
Back to the Global Macro Grind…
Let’s get after it. It’s Macro Monday here @Hedgeye. Thanks to those of you who are new to joining our apolitical and data dependent #process. On Mondays we review week-over-week changes in macro markets within the context of @Hedgeye TRENDs.
As is customary, let’s start with what happened in Global Currencies last week:
- US Dollar Index was up another +0.4% last week to +3.8% YTD and remains Bullish TREND @Hedgeye
- EUR/USD was down -0.4% last week to -4.1% YTD and remains Bearish TREND @Hedgeye
- Japanese Yen was down -0.3% vs. USD last week to +0.1% YTD and remains Bearish TREND @Hedgeye
- British Pound was down -0.6% vs. USD last week to -3.2% YTD and remains Bearish TREND @Hedgeye
- Canadian Dollar was down -0.6% vs. USD last week to -4.1% YTD and remains Bearish TREND @Hedgeye
As a reminder, #StrongDollar is what’s supposed to happen (i.e. back-testing it against our 4 Quadrant GIP Model) when both the US economy and Global economy in the aggregate is trending in Quad 4.
*GIP stands for GROWTH, INFLATION, POLICY. When growth and inflation are slowing at the same time, that’s Quad 4.
Even though the US 10yr Yield bounced +3 basis points to a lower-high of +3.19% last week, most market-based inflation expectations ticked into Quad 4:
- CRB Commodities Index was down -0.3% last week to +1.7% YTD and remains Bearish TREND @Hedgeye
- Oil (WTI) deflated -3.1% last week to +18.4% YTD, breaking @Hedgeye TREND support (that’s new)
- Copper was down -0.8% last week to -17.1% YTD and remains Bearish TREND @Hedgeye
- Corn was down -1.8% last week to -4.4% YTD and remains Bearish TREND @Hedgeye
- Aluminum was down another -1.0% last week to -12.2% YTD and remains Bearish TREND @Hedgeye
- Hog prices were down another -6.2% last week to -19.2% YTD and remains Bearish TREND @Hedgeye
If you don’t eat bacon, don’t worry – what you personally consume or think other people should consume has no bearing on what our predictive tracking algo forecasts for future headline US “inflation.”
Instead of opining on what inflation should do, we Bayesian boys measure and map what inflation is doing. Even if you look at break-evens, the 5yr 5-year Forward Break-even rate was down on the week to 2.21%.
The other not surprising takeaway from the bond market was the new Bearish @Hedgeye TREND break-down in both Junk (JNK) and High Yield. High Yield saw its yield jump another +5 basis points last week to +6.17% (that’s up +28 basis points in a month).
*note: Junky High Yield is not where you want your portfolio to be levered in Quad 4 either
Where you want your portfolio to be in Quad 4 is long US Dollars, long Low Beta assets (with low volatility), and safe Dividend Yields (like Utilities, for example). On that score, the S&P Sector #Divergences were glaring:
- Utilities (XLU) were up another +3.1% last week to +3.6% YTD and remain Bullish TREND @Hedgeye
- Consumer Staples (XLP) were up +4.4% last week to -3.9% YTD and remains Bullish TREND @Hedgeye
- REITS (XLRE) were up +3.0% last week to -5.9% YTD and are a Bearish TREND @Hedgeye
While the Quad 4 playbook says REITS (XLRE or VNQ) should be Bullish TREND @Hedgeye, my quantitative signaling process (TRADE, TREND, TAIL) isn’t agreeing with that fundamental view, yet. That’s probably because long-term Treasury yields haven’t broken down yet.
For my own money (the ole p.a.), I don’t try to make everything fit with a beautiful blue bow in a Tiffany box. I simply buy more of the assets where both my FUNDAMENTAL (GIP Model) and QUANTITATIVE (TREND) components of my process agree.
On the short side, where Mr. Market definitely continues to agree with Quad 4 are in both Sector and Factor Exposures wedded to backward looking US growth and inflation expectations:
- Consumer Discretionary Stocks (XLY) led losers, down -2.0% last week to +7.8% YTD and are a new Bearish @Hedgeye TREND
- Energy Stocks (XLE) led on the downside as well, down -2.0% last week to -1.0% YTD and remain Bearish TREND @Hedgeye
The NASDAQ, Russell 2000, and Tech (XLK) were all down alongside Momentum, High Beta, and Growth Factor Exposures. These are all playbook Quad 4 moves where both the FUNDAMENTAL and QUANTITATIVE components of the process are in agreement too.
What would change that or the ongoing declines in Chinese, European, and Emerging Market Equities? Well, either Quad 4 would have to change (that data is reported daily) or the market signals would have to lose their trending volatility.
I guess the Chinese are going to try to centrally plan their stock market’s volatility away this morning. We’ll see if that’s going to be met with more selling after the short-term bounce. If their system doesn’t respond, I’ll recommend prayer for them next.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.99-3.24% (bullish)
SPX 2 (bearish)
RUT 1 (bearish)
NASDAQ 7 (bearish)
Utilities (XLU) 52.62-54.84 (bullish)
REITS (VNQ) 75.10-79.77 (bearish)
Shanghai Comp 2 (bearish)
USD 94.56-96.11 (bullish)
EUR/USD 1.14-1.16 (bearish)
YEN 111.55-113.98 (bearish)
GBP/USD 1.29-1.32 (bearish)
Copper 2.71-2.84 (bearish)
Corn 3.60-3.80 (bearish)
Best of luck out there this week,
KM
Keith R. McCullough
Chief Executive Officer
