“This non-intuitive observation contradicted the accepted Aristotelian dogma.”
-Geoffrey West
Q: When does something stop going down?
A: Well, in the case of falling objects originally observed by Galileo, when they hit the ground.
The aforementioned dogma that Galileo debunked as fake news was that “heavy objects fall faster than lighter ones in direct proportion to their weight.” As West goes on to remind us in Scale, “this fundamental misconception was universally believed for almost 2,000 years before Galileo actually tested it…
He ended up paying a heavy price. At the age of 69 (in poor health) he was brought before the Inquisition and found guilty of heresy. He was forced to recant and after a brief imprisonment spent the rest of his life put under house arrest.” (pages 36-38)
It’s a good thing Darius and I aren’t going to be incarcerated for making the call on Quad 4!
Back to the Global Macro Grind…
Yeah, nice call guys. “But when does it stop?” When does the market stop going down. When does this damn Quad 4 thing of yours end?
We spent the last 2 days in Chicago seeing both Institutional clients and prospective ones. Existing clients would ask us some version of the aforementioned questions. New clients just want us to explain the process in full.
On when it stops, there are multiple answers to that question because there are multiple durations that our risk management process is constantly considering:
- TRADE (immediate-term) is where the @Hedgeye Risk Range matters most (low-end of the range today = 2704 SPX)
- TREND (intermediate-term) is where the timing of “the Quads” matters most – how bad will the data get in Q4 and Q1?
- TAIL (long-term, i.e. 3 years or less), is where you can go completely squirrel if you’re always trying find “recessions”
Since the Quad 4 in Q4 data hasn’t even been reported yet and:
- We have the USA in Quad 4 for both Q418 and Q119, there’s plenty of time and space between when this may or may not stop
- We have the USA in Quad 3 for Q2 of 2019 with year-over-year SP500 Earnings Slowing against #PeakCycle compares
Therefore, the intermediate-term (quarterly) TREND to long-term TAIL risk call on US Equity and Credit markets certainly isn’t one that I look at as ending yesterday because the Spoos bounced off the low-end of my immediate-term risk range.
And no, that’s not the answer people generally want to hear. What a lot of people want is certainty. I don’t sell that. I sell probabilities. What was the most probable outcome for Q4 of 2018? A: Quad 4. What do I think happens next? A: Quad 4.
Still that isn’t enough for some people. What really matters to them are market “levels”, whereas what matters most to me are Rates of Change (ROC). If growth and inflation start to slow faster and market volatility breaks out to higher levels in kind, I see more risk.
If growth and inflation doesn’t slow, the probable outcome (and commensurate market volatility) changes in kind.
Why Rate of Change instead of “levels”?
On slide 11 of the process component of our Q4 Macro Themes Deck, using the SP500’s returns as a case study, we review what we’ve observed via historical back-test vs. what many on the Old Wall believe to be true:
- ROC (Rate of Change) sees intuitive and investable dispersion in the return profiles of key macro Factor Exposures
- Absolute Levels have limited and un-investable dispersion in the return profiles of key macro Factor Exposures
On slide 12 we use the Long Bond as a case study and come up with the same historical conclusion across the Hedgeye GIP (Growth, Inflation, Policy) model regimes.
No, were not the only independent research or buy-side firm that has actually back-tested this. We are, however, the only firm with a dynamic nowcast for growth and inflation that is measured, mapped, and published daily.
No one else publishes either our GIP (4 Quadrant) model or the @Hedgeye Risk Ranges to contextualize where the market is pricing in what we think are probable, albeit usually non-consensus, economic outcomes. That’s a good thing, especially during this Quad 4 October.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 3.01-3.21% (bullish)
SPX 2 (bearish)
RUT 1 (bearish)
NASDAQ 7 (bearish)
Industrials (XLI) 71.07-75.58 (bearish)
Shanghai Comp 2 (bearish)
VIX 16.10-25.56 (bullish)
USD 94.50-96.35 (bullish)
EUR/USD 1.13-1.15 (bearish)
Oil (WTI) 65.62-70.92 (bearish)
Gold 1 (neutral)
Copper 2.70-2.82 (bearish)
Corn 3.62-3.79 (bearish)
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
