“Large price changes tend to be followed by more large changes, positive or negative. Small changes tend to be followed by more small changes. Volatility clusters.”
If there was ever a Macro Monday morning to go back to the wood of complex systems Professor Mandelbrot taught us how to chop, it’s this one.
Did Trump’s tariff tweets cause this morning’s cross-asset volatility or were they merely the incremental grains of sand that collapsed what had become a dangerously unstable system in the face of #Quad4 re-emerging, globally?
Almost by definition, it’s impossible to answer that question “correctly”. But thanks to the seminal works of Kahneman and Tversky all the way down to Andrew Lo, it’s a question we must answer – if only because we humans have biologically evolved to spot patterns that help build the narratives we need to make decisions.
Back to the Global Macro Grind…
With respect to Sino-US trade tensions, what was the narrative heading into today? On the domestic side, it was mostly about a deal being agreed upon as soon as this Friday, May 10, as evidenced by stocks closing out last week at an effective all-time high amid a fresh record net SHORT position in VIX futures and options (data through Tuesday):
- Current Reading: -180,359 contracts
- Prior Record (late-2017): -174,665 contracts
- Z-Score (1yr): -1.84
On the Chinese side, not so much. Even before today’s -5.6% plunge in the Shanghai Composite Index, the A-Shares had already been signaling something was amiss with respect to the trending “coast is clear” narrative, having knifed down -5.9% in a straight line from their 4/19 YTD closing high heading into last week’s holiday.
If you ask Dr. Copper, the global vol. suppression trade started to get long in the tooth when it effectively peaked in late-FEB and traded sideways from there through its 4/17 YTD closing high. From there it declined -6.5% in a straight line to last Thursday’s local-low and is down -0.4% today.
If you’re in the camp that the retail-driven A-Shares are overreacting to Trump’s “Twitter fingers”, then you’re likely citing that lack of follow-through in such a key indicator of Chinese economic growth. You’re also probably citing the +2.6% rally of the down -2.8% intraday lows in Brent crude oil as confirming evidence.
On our quantitative factoring, copper is bearish TREND and crude oil remains bullish TREND, even after the recent correction. It’s impossible to know which market signal is “correct” ex ante, but we do know that after the busiest week of global economic data of the year last week, Global #Quad4 has re-emerged as a critical factor to risk manage:
- #Quad4 is once again the MODE GIP Model quadrant projection of the world’s 20 largest economies.
- The Chinese economy continues to track solidly in #Quad2 even after the soft APR PMI data, but…
- The European economy has yet to find firm footing, as most recently evidenced by the weak start to Q2 in leading survey data.
That setup coupled with #Quad4 nowcasts in Australia, Brazil, Indonesia, Russia, and the UK implies ongoing strength in the US dollar – a deflationary force in and upon itself. Recall that the only Quad where the DXY has a positive expected value according to both our domestic and global GIP Model backtests is #Quad4:
- #Quad1: -0.4% with a 46% percent positive ratio for the US vs. -1.0% and 50% for the Global economy
- #Quad2: -0.4% with a 39% percent positive ratio for the US vs. -0.5% and 38% for the Global economy
- #Quad3: -0.1% with a 50% percent positive ratio for the US vs. -0.7% and 45% for the Global economy
- #Quad4: +1.4% with a 76% percent positive ratio for the US vs. +1.9% and 68% for the Global economy
Even in the face of one of the most aggressive dovish pivots in Federal Reserve history, the dollar has continued to grind higher, up another +0.1% today and contributing to its measured +1.3% advance over the past three months. That this has occurred amid one of the sharpest reversals in US monetary policy expectations in recent memory is astounding to say the least:
- Eurodollar futures swung into a net LONG position of 175,972 contracts via a WoW delta of +193,184 contracts (recall that Eurodollar pricing works in the opposite direction of interest rates;
- That compares to trailing 3-month average of -433,306 contracts and a trailing 12-month average of -1,021,310 contracts; and
- The current net LONG position of 175,972 contracts is good for a 1yr Z-Score of +2.1.
So everyone thinks the Fed is going to cut rates, and yet the dollar still grinds higher in the face of that? That’s about as #Quad4 as it gets.
Or perhaps not? The only thing that would be more #Quad4 is if the US economy were to join the RoW in #Quad4 here in Q2. That’s certainly not our forecast, but considering that our forecasted +4bps acceleration in Headline CPI on a quarterly average basis is well within our model’s 23bps of intra-quarter tracking error on forecasting inflation, that’s a real risk – one that got priced into the US equity market last week:
- Energy Stocks (XLE) led losers, closing down -3.0% WoW;
- The Russell 1000 Growth Index lagged its Value counterpart at flat WoW vs. up +0.5%; and
- The NASDAQ 100 lagged the Russell 2000 at up +0.3% WoW vs. up +1.5%.
To be clear, we are NOT moving to the #Quad4 camp with respect to our US asset allocation and are of the mind to use immediate-term weakness to build intermediate-term core #Quad3 positions. This discussion was merely to highlight the risk we may see an incremental clustering of volatility in exposures we like while Mr. Market debates #Quad3 or #Quad4 over the next month or so.
Who knows, whether or not the US was narrowly in #Quad3 or #Quad4 in Q2 might be a moot discussion by the time US inflation is gapping higher alongside Chinese and European economic growth in 4Q19E, according to our models.
Trade the chop appropriately.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.46-2.60% (bearish)
SPX 2 (bullish)
Shanghai Comp 2 (neutral)
VIX 11.76-16.08 (bearish)
USD 96.35-98.13 (bullish)
Oil (WTI) 59.92-66.84 (bullish)
Gold 1 (bullish)
Copper 2.74-2.89 (bearish)
Keep your head on a swivel,