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    A Decade of Revolution Declare Your Research Independence

Below is an excerpt transcribed from a recent conversation between hedge fund manager and MacroVoices podcast host Erik Townsend and Hedgeye CEO Keith McCullough.

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Erik Townsend: Joining me next is Hedgeye founder Keith McCullough.

Keith, it’s been a year – I can’t believe it – since we had you on the program. Last time that you were on, I think that you were very much bullish real growth and there were a lot of naysayers saying the market was headed lower. You were adamant, and you were proven right.

Now things have changed and we actually got a little bit of a heads up from your colleague Darius Dale when we had him on the program. He said, hmm, we are not firmly bullish anymore. We’re starting to think twice. As I look at Slide 5 in your deck, it looks like you guys have moved into the fourth quad. So talk about the four quads, why you use them in your process. But, particularly, how did we end up here underneath the neutral line in the fourth quad? And where is it headed.

Keith McCullough: I appreciate you recapping that Erik, because being a bull or a bear permanently is no permanent position to take. And, really, we’ve built the process, or I have, over the course of the last long while trying to use the two most causal things that change markets, which are the rates of change and growth in inflation to get ahead of any change from bullish to bearish or bearish to bullish. And what you find is that there is always something to buy and there is always something to sell.

So in our four-quadrant map, as you can see there on Slide 5, I think everyone can see – when you’re in the first or second quadrant, those are pro-growth quadrants. You have growth accelerating. When growth and inflation are accelerating at the same time, interest rates go up, the Fed goes hawkish, that’s why in the box here it says monetary policy bias is hawkish. So that’s what we were set up for.

Really, we were there for nine quarters in a row, which, by the way, is a new US record. The prior record was seven quarters coming out of the early 1990s. And you had tax reform really provide the extra juice on top of that. We didn’t stay bullish because of tax reform. We stayed bullish because the data that was borne out of tax reform kept accelerating.

So, again, all I care about is whether the data is accelerating or decelerating. And, really, that’s the point here. That call that we made at the end of September was that we’re changing –effectively, flipping everything that we liked into things we don’t like and then doing the opposite with things that we didn’t like – starting to get bullish on long-term bonds, bond proxies. Because we’re basically going to what we call the fourth quadrant (in which year-over-year U.S. GDP growth and inflation slow).

The fourth quadrant, as you can see in that map, Q418 is a drastic shift from where we’ve been. And I’d say that the market’s reaction at this point has actually been quite drastic and it’s in the right spot. I mean, typically, when a market sniffs out that the economy is going into the fourth quadrant they don’t have to sniff out a recession or anything like that, which we get a lot of questions on. You just have to have the prevailing conditions of growth and inflation, which were tailwinds, become headwinds. And that’s what’s happened.

The three worst places to be when that happens is momentum, high beta, and tech stocks. Tech stocks are obviously high beta and momentum, so it was all one and the same thing. And I think we’re just in the early stages of this correction on those in particular, those things that do the worst in the fourth quadrant.

McCullough on MacroVoices: Short Momentum, High Beta & Tech - slide

Erik: Keith, I absolutely love your Hedgeye chart books, among the best in the business. Our long-time listeners have seen a lot of this, but I’m going to strongly encourage any new listeners to really spend some time on this chart book if you’ve never seen it before. Some of this, though, is boilerplate that our regular listeners have seen before.

So I’m going to skip ahead to Slide 12, which is where we get back to your next current data outlook in terms of GDP forecasts. Talk us through, starting at Slide 12, what you see on the horizon, where we’re headed.

Keith: As I pointed out, nine quarters in a row. Again, I’d encourage anyone who hasn’t done this before to acutely measure and map the data. These are facts. The data that’s released is a fact. You might believe the government made up the numbers, but the reality is that it’s a made up number versus a prior made up number. So it’s either accelerating or decelerating versus made up numbers.

But if you actually believe the numbers, which in this case I do, I believe that US growth accelerated (on Slide 12) from 1.3% to 3%. It took nine quarters. That’s, again, a new US record. And the green bar, which is our forecast – this is our predictive tracking algorithms that we’re dropping new data into the algo every time we get a new data point – is not only below Wall Street for the first time in really six to nine quarters, but it’s the first rate-of-change slowdown.

If you go to Slide 13, how that reads to Wall Street is going to be a pretty violent move in GDP. Wall Street doesn’t look at the year-over-year. They look at the quarter-over-quarter seasonally annualized GDP number. If you don’t know what that is, that will be the number that gets released when GDP gets released.

As you know, only because Trump was trumpeting it, 4.2% was the high number. A lot of pundits and strategists tell you that there was sustainability to that. We told you that the next number was going to be 3.5%. It actually ended up being 3.5%. We got that one right on the screws.

Now we’re saying that if it just a modest slowdown year-over-year [that] gets you a drastic sequential slowdown. This is where the surprise factor really come in. We’re at 1.29% for GDP for Q4. That number is going to be reported in Q1. Okay?

So I think, first of all, that’s well below consensus, Wall Street consensus. But it also comes, Erik, right after the Fed rate hike. Because you’ve got the rate hike in December, which we think they’re going to do. And then you’re going to get a big GDP negative surprise that’s going to have a bunch of numbers that continue to be revised to the downside in terms of high frequency economic data points.

So I think that market participants are going to see what the market already sees. The market is always front running us. If you don’t know that, you’re going to figure that out the hard way. Eventually you end up with the data point that the markets had already been discounting. And this is what I think is ultimately the number the market is looking ahead to in January, even though it’s only November.

McCullough on MacroVoices: Short Momentum, High Beta & Tech - slide2