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“Systematic scaling relationships are highly counterintuitive.”
-Geoffrey West 

Do you know what percentage of daily trading in the US stock market is systematic? Did you know that “aortas and tree trunks scale in the same way” (Scale, pg 93)? Did you know that a one legged-duck swims in a circle?

Instead of having a small and distracted mind anchoring on Trump tweets this morning, let’s try to maintain deliberate and disciplined study… and learn something that can help us nowcast where economies and markets are going next.

Systematic scaling laws are something to be, at a bare minimum, aware of when building a multi-factor and multi-duration Global Macro Risk Management #process. As West went on to teach us in Scale, “there are probably well over 50 such scaling laws…”

Systematic Bear Market - 09.27.2018 hear no see no math cartoon

Back to the Global Macro Grind…

Did the emergence of “the quants” and the proliferation of systematic and “rules-based” trading change The Game that you’re tasked with winning out there in the market every day? Big time.

Are you fighting that or using the knowledge of The Game to win more often?

As the US stock market was having one of the many bounces you should have been selling into since September yesterday (SPX ended up down for the 4th day in 5), I was on the phone with who I think is one of the best Quantamental PMs (portfolio managers) in the business.

For the sake of anonymity I’ll call him Q…

Q: “See the MSZZBETA (MS beta factor on Russell 3) is down 24.4% since Oct 1. Wow.”

KM: Yep.

Q: “That means that as The Machine resets for 3 and 6 month factor exposures, your Quad 4 call could just be getting started.”

KM: That makes sense.

Q: “I still don’t think the fundamental guys are getting that.”

KM: Nope.

You see, the thing about my buddy Q is that he’s worked with and been hedge fund partners with lots of “fundamental guys.” There are plenty of gals in that camp too. He’s not just a quant. He’s the special kind of quant who is aware of how non-quants think.

Q also stands for Quantamental. What does that mean?

  1. Someone who is both quantitatively and fundamentally oriented
  2. Someone who starts with data (numbers) instead of political opinions

I’ll stop there before I insult someone (I’d never do such a thing!) because some people take what it is that they do so dogmatically that there’s no room to learn never mind, God forbid, change their process and/or what it is that they do.

I’ll readily admit that I used to be a fundamental guy. Long/Short Captain Stock Picker, I was – oh yeah, I knew everything about the companies – I thought I was pretty sweet, until my super duper stock picks got run over by the macro.

Through my biggest mistakes I realized (at a relatively young age, thank God) that if I didn’t do macro, it would eventually do me in. So now I’m a Quantamental guy who is just trying to not be wrong when everyone else is.

Back to the Systematic Bear Market in Global Equities that continues to develop with the mean and mode of the Global Economy in Quad 4 here in Q4:

  1. Chinese Stocks are down -27% their 2018 peak
  2. Italian Stocks are down -23% from their 2018 peak
  3. Russell 2000 is down -17% from its 2018 peak

There are certainly people who don’t want to call this a “bear market” never mind a systematic one that’s had fractal patterns as interconnected as they always become in Quad 4, so that’s why I’ll call it one this morning. Someone has to be the realist.

If you haven’t been a data-driven realist, you’ve lost a lot of money buying what haven’t been dips in Global Equities this year. Even if I look at the Japanese stock market (which peaked right as Quad 4 in Japan started in Q4 in the first week of OCT), what do I see?

  1. Bearish @Hedgeye TREND for the Nikkei with a series of lower-highs (on bounces) and lower-lows (on selloffs)
  2. Japanese Machinery Tool Orders DOWN -16.8% year-over-year in NOVEMBER

Quant-(bearish TREND signal)-Amental (down -16.8% year-over-year growth)!

There’s no irony that the market signal front-ran the fundamental data point. If that’s not fundamental Quad 4 #slowing, what is it? This is precisely why a reformed fundamental guy came up with this 4 Quadrant Model.

What would Captain Stock Picker’s fav Semiconductor long idea do if the company saw revenues drop -16.8% from #PeakCycle?

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

UST 10yr Yield 2.78-3.02% (bearish)
SPX 2 (bearish)
RUT 1 (bearish)
Utilities (XLU) 54.50-57.39 (bullish)
REITS (VNQ) 80.01-83.40 (bullish)
Nikkei 205 (bearish)
VIX 16.96-25.49 (bullish)
USD 96.27-97.56 (bullish)
GBP/USD 1.25-1.28 (bearish)
Oil (WTI) 49.65-53.82 (bearish) 

Best of luck out there today,
KM 

Keith R. McCullough
Chief Executive Officer

Systematic Bear Market - 12.12.18 EL Chart