“Economics tends to let theory gallop well ahead of its evidence.”
-Benoit Mandelbrot 

Short-term bullish-catalyst-seekers tend to let their theories gallop well ahead of The Cycle too. Is that because most are in the business of being long and looking for bullish catalysts? What kind of market catalysts are you looking for? 

“I prefer to keep theory under control and stick with the data I have and the mathematical tools I have devised.”
-Mandelbrot 

Oh, I love The Brot. He saves me from having to explain the same answer to the same question (“when do you go bullish?”) over and over and over again. It’s not a political catalyst or a “valuation” one. It’s The Cycle and my market signaling process! 

The Process Is The Catalyst - z dino 03.15.2018 just trust my gut cartoon

Back to the Global Macro Grind… 

Not to go off on a rant this morning (something I’d never do!), but the intro to this morning’s Early Look has a little bit of frustration embedded in it. That’ll happen to me when 90% of the questions I am getting are essentially the same question. 

And it’s not just the “ok, where do we get out of Quad 4 and go bullish?” question itself, it’s the ongoing bias of bullishness I’ve been observing both qualitatively (in meetings, webinars, etc.) and quantitatively (in terms of consensus positioning). 

I’m not frustrated with the opportunity associated with this bullish bias (because being Bearish has personally made me a lot of money since the end of SEP!); I’m frustrated that more of our subscribers aren’t beating their competition by a wider margin. 

To be crystal clear on some of my biggest goals: I want to help you A) be right and B) crush your competition. 

Enough about the crazy competitive capitalist stuff. In terms of quantifying both positioning and market sentiment: 

A) We know that consensus still thinks the “tail risk” in the market is “rising interest rates”
B) We also know that consensus was way too long of Momentum, High Beta, and Growth at #PeakCycle
C) We’re starting to know where #LateCycle buyers of low-quality Credit are trapped 

In sharp contrast to ABC, we think The Cycle #slowing from its peak is the intermediate-term @Hedgeye TAIL risk to have been proactively preparing portfolios for ahead of back to back Quad 4s in both Q4 of 2018 and Q1 of 2019.

And, on literally every HIGH BETA bounce like yesterday’s, what does consensus want to get long? The stuff they’re already still long (Tech and Growth stocks) and/or the hope that they’re buying it with Quad 4 in Q1 of 2019 “already being priced in.” 

Again, frustrating if it’s a client who gets our process (and pays for it) but, to a degree, it’s predictable human behavior. You can see that in terms of how consensus has been pricing “protection” since the big HIGH BETA bounce off the OCT lows.

Here’s this morning’s quantified IVOL (implied volatility vs. 30-day realized) look on that: 

  1. SP500 has implied volatility trading at a -23% DISCOUNT to what’s been realized in the last 30 days
  2. TECH (XLK) has implied volatility trading at a -29% DISCOUNT to what’s been realized in the last 30 days
  3. OIL (USO) has implied volatility trading at a +38% PREMIUM to what’s been realized in the last 30 days 

In other words, AFTER Oil crashed -35% from the OCT highs, consensus is aggressively pushing PREMIUMS higher. Whereas AFTER every bounce in either the US stock market or Tech, consensus gets complacent. 

Again, this isn’t how the market “feels” … or how I want or need it to be positioned… it’s simply how the market IS positioned vs. where it USED TO BE positioned: 

A) 1-month ago, TECH (XLK) had an implied volatility PREMIUM of +22% (vs. 30-day realized)
B) 1-month ago, Oil (USO) had an implied volatility DISCOUNT of -5% (vs. 30-day realized) 

As opposed to calling up some of my hedge fund buddies and talking ourselves into “how beared up everyone is” or “who’s getting killed” (code for we suck right now but we don’t suck as much as they do)… or whatever I used to do 10-15 years ago… 

I’m measuring and mapping the rate of change of futures & options pricing and positioning relative to: 

A) Where the a market price is trading within my @Hedgeye Risk Ranges and
B) Within the context of the latest economic data point 

What’s my catalyst? My process is my catalyst. 

As a short seller, it’s not my first rodeo so I’m not going to be blind to all the self-evident “catalysts” that market participants are anchoring on (i.e. the effervescent hope for a wonderful G20 meeting between Trump and Xi)… 

But I certainly don’t live in fear of not being LONG every one of those alleged catalysts; especially when The Cycle and signal have trumped them all year long. 

Case in point: Brazil (EWZ) and Mexico (EWW) saw their Equity Beta drop -3.3% and -4.9%, respectively, in an up US Equity tape yesterday. Why? I thought Trump’s “trade deal” with Mexico and the Brazilian election were only bullish for stocks? 

Evidently not. That’s why I prefer to keep consensus theories in check and stick with my data and timing tools. 

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

UST 10yr Yield 3.01-3.15% (neutral)
SPX 2611-2726 (bearish)
NASDAQ 6 (bearish)
Shanghai Comp 2 (bearish)
VIX 17.35-23.87 (bullish)
USD 96.00-97.49 (bullish)
EUR/USD 1.11-1.14 (bearish)
Oil (WTI) 50.07-55.73 (bearish)

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer

The Process Is The Catalyst - 11.27.18 EL Chart