“Many of the tricks pilots rely on in training can get them killed in combat.”
-John Boyd
Using short-cuts like Moving Monkeys or Magic EPS Multiple tricks? That’s all fun and games if there’s no Equity Volatility. But, if there’s a Phase Transition in that Volatility to Bullish @Hedgeye TREND (from Bearish), you can get crushed.
Most pilots of portfolios you compete with don’t think like one of the best fighter pilots in US military history did. In 1956, John Boyd “published an article in the Fighter Weapons Newsletter entitled A Proposed Plan for Ftr. Vs. Ftr. Training.”
“It was one of the first things he ever wrote. The extraordinary thing about the piece is that it was less concerned with teaching tricks or specific maneuvers than it was with teaching pilots a new way of thinking.” (Boyd, pg 75)
Back to the Global Macro Grind…
My teammates and I publish “newsletter” format content, every single market day. Is our #process and way of thinking the only way? Absolutely not. But what does the market practitioner engaged in daily combat have as alternatives?
What most pilots of portfolios (either their own or of other people’s money) get from conflict-of-interest ridden Old Wall research departments and their politicized and biased media are short-cuts, sound-bites, and “data points”…
To be clear, all of that information (however consensus and/or qualitative most of it may be) has #behavioral value. But it’s certainly not a fully integrated Global Macro Risk Management #process.
What is your #process? Can it handle non-linear breakouts in volatility?
I, for one, have spent 20 years as a market practitioner trying to answer these basic questions. God willing, I’ll spend the next 20 years trying to figure out what else I don’t know.
All I know right here and now is that if this recent ramp in US Equity Market volatility holds, I have a #process that deals with that. If it doesn’t, I have a #process to deal with that too.
Using the most basic definition of US Equity Market Volatility, let’s think about what just happened with the VIX:
- Only 3 trading days ago the VIX had -180,390 net SHORT contracts
- That net SHORT position in “I don’t need to worry about volatility” was a 3 YEAR HIGH
- And 3 trading days later, the VIX has broken out from Bearish to Bullish @Hedgeye TREND
Part 3 of that pattern of market conflict is what I call a Phase Transition. I, of course, didn’t invent Phase Transitions – nature did. Every complex and non-linear system has those. Timing them is not easy.
Since volatility itself is often episodic and non-TRENDing (especially in raging bull markets), I’ll usually take a cluster of volatility as a buying opportunity (cover shorts and buy-more of fav longs)…
The problem with buying those damn dips is that, every once in a while (read: infrequently), they aren’t dips. They are the beginning of the end of Bullish @Hedgeye TRENDs in market prices (see our Quad 4 in Q4 Phase Transition call for details).
So, Dow Bro… is this the beginning of the end?
Wouldn’t it be cool to “make that call” this morning? If I worked for a brokerage I could make a lot of money making calls on just about anything. And, in the words of everyone’s favorite President, “believe me”, if I had that call I would make it.
Right here and now is precisely the spot (especially if they open US Equity Futures in the 2 SPX zone) where I wouldn’t be playing my #process out properly by making that call, however.
Why would I buy/cover in that SPY zone instead of freaking out emotionally and selling at 3-day lows?
- I didn’t chase the highs 3-days ago (#process said sell-some at the top-end of the @Hedgeye Risk Range)
- That 2 SPY zone is the LOW-END of the @Hedgeye Risk Range
- Implied Volatility on SPY just rocketed to a +96% PREMIUM vs. 30-day realized
Part 3 of that pattern of market conflict (btw I’m using those words because Boyd called them Patterns of Conflict) is where I get a lot of pilots of portfolios saying ‘huh’?
You see, it’s easy to see a 1-factor moving average “break” (that’s why I call them Moving Monkeys). It’s not easy to see the relationship between multi-factor PRICE and VOLATILITY relative to the expectations of future VOLATILITY.
Unless you measure and map it (in order to be combat ready), daily, that is…
- Implied Volatility PREMIUM (vs. 30-day realized) for SPY just ripped to a new cycle-high of +96%
- Implied Volatility PREMIUM (vs. 30-day realized) for QQQ just ripped to a new cycle-high of +86%
- On a 1-yr Z-score those PREMIUMS register as +3.5x (for SPY) and +2.9x (for QQQ) respectively
In other words, only 3 days AFTER seeing the most complacent net positioning in the VIX in 3 years, now we have one of the most asymmetric short-term setup days in a year to buy/cover.
What do you buy and cover? We have a #process for that too. We buy what Quad 3 asset allocators should be buying on dips (although buying Treasuries today at 2.43% on the 10yr is not a dip!). And we cover-some Quad 3 shorts.
Then I’ll give it another 1-3 days and I might reverse some of that. All the while, I’ll be data and #process dependent on those decisions, regardless. My goal isn’t to be your favorite academic. It’s to not get you killed in market combat.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND signals in brackets) are as follows:
UST 10yr Yield 2.42-2.54% (bearish)
UST 2yr Yield 2.21-2.39% (bearish)
SPX 2 (bullish)
RUT 1 (neutral)
NASDAQ 7 (bullish)
Utilities (XLU) 56.61-58.93 (bullish)
REITS (VNQ) 84.25-88.39 (bullish)
Energy (XLE) 61.39-68.72 (bullish)
Financials (XLF) 26.42-28.46 (bearish)
Shanghai Comp 2 (bearish)
DAX 12050-12561 (bullish)
VIX 13.98-20.27 (bearish)
USD 96.52-98.36 (bullish)
EUR/USD 1.11-1.13 (bearish)
USD/YEN 109.69-111.46 (bearish)
Oil (WTI) 59.42-66.49 (bullish)
Nat Gas 2.44-2.66 (bearish)
Gold 1 (bullish)
Copper 2.70-2.87 (bearish)
FB 183-198 (bullish)
GOOGL 1070-1223 (bearish)
NFLX 354-386 (neutral)
TSLA 220-267 (bearish)
Bitcoin 5135-6165 (bullish)
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
