“What you can do is call up your clients and tell them, ‘Hey, we’re going to lose money on our Tech and Energy holdings because we’re long-term, low-turnover investors.’”
-Hedgeye CEO Keith McCullough
Yesterday we held a conference call detailing the rising probability of the U.S. and global economies returning to #Quad4 this summer. That [obviously sarcastic] reply was in response to the following [anonymous] client question:
“If you’re a low-turnover, long-term investor, do you stay with core positions you’ve built up in energy and tech? How would you play this? Buy XLE and XLK puts against those longs?”
Obviously #Quad3 is not #Quad4 and 22-year-old Darius (245lbs and chiseled) ≠ 32-year-old Darius (275lbs and balding). As such, whenever we see material risk of a draw-down in any exposure that goes from a top long in the GIP Model Quadrant we’re currently in to a top short in the Quadrant our model anticipates next, we’re going to get loud about the need for investors to either book gains or take small losses before they turn into bigger ones.
Back to the Global Macro Grind…
We understand that not every investor can trade their way in/out of core positions as deftly as Keith can in his p.a. But that doesn’t mean subscribers shouldn’t at least try to risk manage highly probable downside in “at risk #Quad3 exposures” – namely Tech, Energy, and [Organic] Growth – as much as humanly possible.
In honor of it being Memorial Day Weekend here in the States, please grant me the following [American] football analogy: imagine if the head coach of your favorite team was committed to running fullback dive in every third-and-long situation because he preferred a quote/unquote “smashmouth” style of play? As someone who knows a lot about football from both a playing and advanced analytics perspective, I can assure you your probability of victory will trend towards zero by halftime.
You might not convert too many third-and-longs, but you at least have to try to air it out if you want to be successful over the course of a football game, let alone a season.
The same holds true for portfolio management. You might not nail every v-bottom or market top perfectly, but you have to be willing to adjust your exposures if you want to be consistently successful over time. Over the short-to-intermediate-term time horizons that we focus the bolus of our calls on, Mr. Market doesn’t give a damn about your valuation opinions or investment mandate.
Along that same token, if you want to have a good 2019, you’d do well to proactively prepare for the following global #Quad4 risks this summer:
In the US:
- The risk of #Quad4 in 3Q19E heightened materially this week with WTI breaking down below its [former] intermediate-term TREND support level of $59.76 yesterday.
- That outcome was causal to the nudging down of our YoY Headline CPI nowcasts for 2Q19E and 3Q19E to 1.82% and 1.81%, respectively.
- Because the latter estimate represents a negative sequential delta from the Q2 estimate, our GIP Model is now officially projecting a #Quad4 outcome domestically for the third quarter. With measures of Real Final Sales broadly trending lower as of APR/MAY, a further deceleration in economic growth is hardly up for debate heading into the cycle-peak comparative base effects Q3 has to offer.
- The risk of #Quad4 in 3Q19E is what it always was: near cycle-peak comparisons for Real GDP growth, as Bund and OAT yields continue to confirm our dovish inflation outlook. Said simply, easing comps ≠ easy comps. Comparative base effects don’t really imply much of an acceleration in European economic growth until Q4 and this mathematical reality continues to underpin our long-held “L-Shaped” recovery view for continental Europe.
- Our GIP Model already has France projected to descend back into #Quad4 in 3Q19E from a nowcast of #Quad3 in the current quarter, so that puts the onus on Germany to pull through for the region by confirming its #Quad1 projection in Q3. Unfortunately, yesterday’s MAY Manufacturing PMI data (-0.1pts to 44.3; 6MMA = 46.9) is suggestive of an economy that could be teetering on the edge of a structural breakdown as a casualty of the growing “US vs. everybody” trade war.
- I, too, am weighed down by “Brexit fatigue” when it comes to discussing the UK, so the only thing I’ll say here is that our GIP Model, too, has the UK economy descending into #Quad4 in 3Q19E from a nowcast of #Quad3 in the current quarter. This morning’s slowing APR Retail Sales print and Tuesday’s crashing MAY CBI data is suggestive of an economy that should slow further against even tougher comps.
- #Quad4 in 3Q19E was always the most probable outcome, but the risk that the ongoing slowdown in emerging market economic growth is deeper and more protracted than it otherwise would’ve been heighted materially last week with the Chinese economy crashing into #Quad3 here in 2Q19E with the advent of its APRIL (read: pre-trade fallout) high-frequency data.
- Our GIP Model has #Quad1 as the most probable outcome in the mainland economy for the balance of 2H19E, but that projection is a function of comparative base effects that, despite easing marginally, are still as difficult as anything the Chinese economy has comped against since growth began structurally downshifting back in 2012.
- It’s worth noting that China is the largest trading partner in 7 of the 9 emerging market economies for which our GIP Model is projecting an acceleration into Quads 1 or 2 next quarter; only India and Mexico are “spared” by outsized demand from the US. And when you layer on recent confirming data points like Brazil’s MAY CNI Industrial Confidence Index (-1.9pts to 56.5; lowest since OCT), Turkey’s MAY Consumer Confidence Index (-8.2pts to 55.3; lowest reading EVER), South Korea’s MAY Exports (-300bps to -11.7% YoY; slowest since JAN), and Argentina’s MAR Economic Activity Index (-210bps to -6.8% YoY; slowest since DEC) and it’s easy to arrive at the conclusion that a lot of investors are trapped long of EM assets on an increasingly false recovery narrative. If we’re right on our US + EM #Quad4 view this summer, expect a retest of the OCT/DEC lows in something like the EEM.
In short, investors should ignore these developing #Quad4 signals at their own risk. I’m no Canuck, but I believe the old hockey adage reads: “Skate to where the football is thrown, not where you’d like it to be.” There are hardly, if ever, any “perfect passes” in Macro Risk Management.
The team and I are proud to send a heartfelt “thank you” to the skies above for all those that fell defending the ideals of this great nation, both at home and abroad. Happy Memorial Day.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.28-2.44% (bearish)
SPX 2 (bearish)
RUT 1 (bearish)
NASDAQ 7 (bearish)
Utilities (XLU) 57.61-60.20 (bullish)
Shanghai Comp 2 (bearish)
VIX 13.17-20.98 (bullish)
USD 96.85-98.26 (bullish)
Oil (WTI) 57.46-62.09 (bearish)
Gold 1 (bullish)
Keep your head on a swivel,