Is Your #Process Rational?

04/05/19 08:20AM EDT

“It’s essential to note that rational and unemotional investors are very much in the minority.”
-Howard Marks 

Depending on what the definition of “unemotional” is, I agree with Marks on part of that statement. The more unemotional, #process-driven, and rules-based I am, the better my results have been over time. 

What’s “rational” to many, though, is irrational to me. Unless you’re paid lots of money to try (compensation incentives are rational!), it’s irrational to remain permanently bullish or bearish on any asset class at every time and price. 

In Mastering The Market Cycle (pg 134), Marks defines the “rational investor” as “diligent, skeptical, and appropriately risk-averse at all times.” Verbatim, I don’t agree with all of that either. 

Back to the Global Macro Grind… 

Is Your #Process Rational? - z rational investors cartoon 01.24.2017

Many investors define their “rationale” with “valuation.” I never start with that. The most rational starting point for me is always the ROC (rate of change). 

Yes, it would be nice for the asset to be “cheap.” But markets are rarely nice to me, especially if I’m buying something because it looks “cheap” on the wrong numbers. 

How do we get closer to the right numbers vs. the majority of our competition that has absolutely no macro mapping and measuring #process to calibrate those numbers? 

A) Get the ROC (rate of change) right in trending GROWTH
B) Get the ROC (rate of change) right in trending INFLATION
C) Get the ROC (rate of change) right in trending PROFITS 

Unless God put you on this good Earth to naturally just know the prevailing conditions of GROWTH and INFLATION in an economy, you absolutely have to grind to go from ignorance to awareness. 

Some of the former hedge fund (pre Reg FD) gods like to think that if they “meet with management” more than anyone else (been there, done that), they’ll just naturally know… because the management team tells them. 

That’s cool, as long as it’s compliant. But I still have to help my analysts (who meet with and speak with management all of the time) with the base-pack prep that most CEOs and CFOs don’t do macro either. 

Then we have The Quants… 

The purely rules-based algo quants don’t do macro AND don’t meet with management. They believe that last price rules and whatever legal/illegal information is being obtained in “management meetings” is being priced in anyway. 

The quants also believe what I believe – and that’s that the ROC (rate of change) of every price, volatility, and factor exposure matters to returns, big time. So I want to do my best to front-run their proactively predictable behavior. 

And we also have The Fed… 

The Fed is the last to know in this generalized hierarchy of people who need to know. Their behavior is as proactively predictable as anyone’s, on a 3-6 month lag. 

PE (Private Equity) Powell should be commended on this front. The GROWTH and INFLATION data (Quad 4 in Q4) was only able to front-run his hawkish to dovish pivot by 3-4 months this time. He then moved the US into Quad 3 in a hurry! 

Essentially this is why we call our 4 Quadrant macro model our GIP Model… 

A) Get the ROC in (G) GROWTH right … and
B) Get the ROC in (I) INFLATION right … and
C) You’ll get the next (P) Policy moves right 

Does my macro risk management #process sound “rational” to you? If it doesn’t I’m always getting feedback on what may or may not make sense. If it doesn’t make sense to you, what does? I sincerely want (and need) to know. 

Like all of you, my goal is to be constantly questioning and evolving my process. If that’s what Howard Marks meant about being “diligent and skeptical”, I’m 100% on board with him on that. 

Being “appropriately risk-averse” needs some editing. If the US economy is going from 9 consecutive quarters of being in Quads 1 and 2 (GROWTH #accelerating) into Quad 4, the rational investor needs to be aggressively risk-averse! 

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

UST 10yr Yield 2.33-2.55% (bearish)
SPX 2 (bullish)
RUT 1 (bearish)
NASDAQ 7 (bullish)
Energy (XLE) 64.96-67.35 (bullish)
Financials (XLF) 24.95-26.88 (bearish)
VIX 12.49-16.59 (bearish)
USD 95.47-97.24 (neutral)
EUR/USD 1.11-1.13 (bearish)
Oil (WTI) 57.90-63.59 (bullish)
Gold 1 (bullish) 

Best of luck out there today,


Keith R. McCullough
Chief Executive Officer

Is Your #Process Rational? - Chart of the Day

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