“The steeper the slope, the more crinkly the curve.”
-Geoffrey West
Crinkly? That would be a deferential word to describe what this US stock market rally “off the lows” of December has felt like. Then again, how markets “feel” really has nothing to do with the math in our models.
“Crinkliness, later to become known as fractality, is quantified by how steep the slopes of the corresponding straight lines are on Richardson’s logarithmic plots.” (Scale, pg 138)
Multi-duration slopes, logs, and fractals? Why would you use those? Isn’t it as easy as using a 50-day Moving Monkey average and whether or not the company “beat earnings”? Or do you just need to know if Trump has a “trade deal” with China and you’re all set?
Back to the Global Macro Grind…
After the worst December for the US stock market since 1931, it’s hard to believe that one might forget the sequencing of The Cycle’s economic data that proactively predicted epic market declines…
But believe it. This morning we’re pricing in the steepest decline in the slope of “risk on” expectations, since September.
I realize that not everyone measures and maps both the economic data and market signals in ROC (rate of change) terms. But I’m quite thankful for that. Especially at critical economic turns, how else would we help you generate alpha?
One way to measure the fractal dimension of market expectations is through what’s priced into volatility expectations:
- SP500 (SPY) – as of yesterday’s close has a -50% implied volatility DISCOUNT to what’s been realized in the last 30-days
- Tech (XLK) – as of yesterday’s close has a -50% implied volatility DISCOUNT to what’s been realized in the last 30-days
- High Yield (HYG) - as of yesterday’s close has a -54% implied volatility DISCOUNT to what’s been realized in the last 30-days
I’m not going to go off on The Cycle (#EarningsSlowing) risks associated with the High Yield market again this morning. All you need to remember about “risk on” is that it took a +200 basis point widening of HY spreads to shut that market down in December.
What I am going to focus on this morning is that:
- Across the board, all 3 of the aforementioned (SPY, XLK, and HYG) IVOL DISCOUNTS are the steepest of The Cycle
- The Cycle’s #decelerations in GROWTH, INFLATION, and PROFITS are NOT going to be smooth straight lines
Q: For Euclidian fans of the “smoothing mechanisms” of Old Wall moving averages, what’s the difference between a smooth straight line and a fractal dimension?
A: “For very smooth traditional curves, like circles, the slope or the exponent is zero because its length does not change with increasing resolution but converges to a definite value.” (Scale)
If a 1-factor simple moving average and/or magic market (ting) “multiple” had predictive value at critical turns in GROWTH, INFLATION, and PROFITS Cycles, newsflash… I’d use them.
So, it’s back to the lonely frontier of modeling economies and markets fractally, I go…
Here’s your crinkly real-time Q4 of 2018 US Earnings Season (PROFIT Cycle) update:
- 247 of the SP500’s companies have reported aggregate year-over-year EPS growth of +14.5%
- That’s a big ROC slow-down from #PeakCycle aggregate year-over-year EPS growth of +24.5%
- The +14.5% ROC is being juiced by Energy seeing aggregate year-over-year EPS growth of +84.0%
“So”… what happens come Q2 and Q3 of 2019 when Energy companies (and really any cyclical/industrial company that saw #PeakCycle INFLATION in their reported headline revenues) have to compare (or cycle against) peak pricing power?
While you may or may not believe in the “beats” or “misses” versus beaten down expectations here in Q4, do you really believe than anyone has any idea how steep the slope is going to be in year-over-year profit declines come Q3?
Oh, right, it’s going to be that “Chinese Trade Deal”… isn’t that a convenient way to simplify the complex?
I’m not trying to be the crinkly guy today. If I didn’t have to write about my multi-factor, multi-duration process, I’d just buy more puts on XLI, XLF, and SPY against my TLT, GLD, VNQ, ITB, XLU longs and let Darwin decide if I got it right in December for the right reasons.
The steeper the declines and bounces, the more opportunities to make money.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 2yr Yield 2.44-2.61% (bearish)
SPX 2 (bearish)
NASDAQ 6 (bearish)
Utilities (XLU) 52.58-55.30 (bullish)
REITS (VNQ) 78.55-84.89 (bullish)
Industrials (XLI) 67.96-73.37 (bearish)
Housing (ITB) 31.59-34.70 (bullish)
VIX 15.11-21.42 (bullish)
Gold 1 (bullish)
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
