Agonizing Math

“He who will not economize will have to agonize.”

-Confucius

 

Yesterday was a great day for risk management. I don’t say that because most markets were down. I say that because markets actually did what the math said they should. In other words, from Spanish equities to US volatility, the macro moves were proactively predictable. Markets don’t lie; people do.

I went into the US equity market part of the day with a similar position to Ben Bernanke – at least in terms of absolutes. Rather than posting a zero percent rate of return to prudent American savers who refuse to be dared to speculate, I posted a zero percent asset allocation to US Equities.

If you are me, making a short call on the SP500 to correct on the order of 4-7%, it stands to reason that I would not only have been short the SP500 but not, at the same time, telling our clients that I want assets allocated to a market that I think is going down. Only a full service super-market-ing broker/dealer would tell you do something like that with your hard earned net worth.

You know I love to be right. I’m not one of those people who wakes up every morning expecting to be wrong. I don’t get paid what I used to, but I am certainly having more fun. My goal this morning isn’t to grandstand. It’s actually to explain what it is that I do. My friends call me Mucker, and I am your Risk Manager.

Every short call starts with a top down Global Macro Theme. We change these themes every three months because market prices and the expectations embedded in them do. As a reminder, our Q2 Macro Themes at Hedgeye Risk Management are:

1. Sovereign Debt Dichotomy (short the Euro, long the USD; short Spain, long Germany)
2. Inflation’s V Bottom (long TIP, oil, Aussi dollars, Chinese Yuan; short SP500, short term Treasuries and select US Equities)
3. April Flowers/May Showers (short the SP500 with a topside target of 1214)

If you’d like the slide presentation for these themes, email the ex-Captain of the Colgate Women’s Field Hockey team who show jumps as our head of sales, Jen Kane, at . Jen plays center link for us in New Haven and she is flanked by a recently retired pro hockey player named Leclerc and our race car driver, Bergie.

Once we establish these top down themes, we lock, load, and refresh our multi-factor risk management model. We refresh our view (upside/downside bands of probability across 3 investment durations: TRADE, TREND, and TAIL) every 90 minutes of marked-to-market trading. We refresh because prices, volatility, and volumes are constantly changing.

We call this dynamic (real-time) risk management. At the Bloomberg Hedge Fund Conference yesterday afternoon in NYC, I had a great discussion with John Taylor (CEO of FX Concepts) and Dean Curnutt (CEO of Macro Risk Advisors) about being a risk manager in these globally interconnected times. Both gentlemen agreed that managing risk doesn’t occur in your ideologies or politics. It occurs daily and mathematically.

We don’t need to geek out on the math this morning, but we do need to remind you that there is a huge difference between managing risk in an interconnected ecosystem whereby you accept certainty (ie. I know Mastercard is going to have a good quarter) and uncertainty (chaos and complexity theory). The last price is what matters, and your daily objective should be to manage the risks associated with probable outcomes based on that real-time price.

Back to the grind… and explaining what we did yesterday… and what we’ll do this morning…

Like Jim Chanos, who seems perfectly ok with talking about his Chinese short position in transparent forums these days, we like to make all of our moves on a live marked-to-market investment portal. Here’s what we did yesterday as the market weakened – everything is time stamped:

1. 1012AM, sold Mastercard (MA) after a solid EPS report
2. 1019AM, sold the US Dollar ETF (UUP) on strength
3. 1040AM, covered our short position in Ross Stores (ROST) on weakness
4. 1044AM, covered our short position in the Euro (FXE) on weakness
5. 1051AM, bought China (CAF) on weakness
6. 1223PM, bought Intercontinental Exchange (ICE), on weakness
7. 1226PM, covered our short position in the SP500 (SPY) on weakness

That’s it. That’s the best transparency I can give you on what it is that we actually do with all of our math. We have a research team that’s approximately 22 people in size (depending on what Big Alberta eats for breakfast). We grind research. We fade the market’s price action. We rinse and repeat.

As of this morning’s real-time prices, here are some critical risk management thoughts.

1. SP500 immediate term TRADE support and resistance levels are now 1170-1192 (we’ll look to re-short the bounce)
2. SP500 intermediate term TREND line of support = 1143; so ultimately, this correction has another -2.6% to go from last night’s close
3. VIX (volatility) was up +18% yesterday to 23.84 and is now bullish on both TRADE and TREND with TREND line support = 19.51
4. US Equity market volume was up a moon-shot +34% on our daily risk management study = bearish when combined with price/volatility
5. Spanish equities have officially crashed, down another -1.5% this morning and down -21.5% since January
6. The Euro is immediate term oversold and now has refreshed support/resistance levels of 1.29-1.32
7. Brazil’s Bovespa finally broke its intermediate term TREND line = 68,334 after Brazil raised interest rates by 75bps to 9.5%
8. Hong Kong’s Hang Seng is now broken from a TRADE and TREND perspective after trading down another -2.1% overnight
9. Dr. Copper is signaling abort mission to the global growth trade; breaking its intermediate term TREND line of support at $3.35/lb

There are plenty of other “fundamental” news items this morning affecting prices. From Dodd/Shelby on Financial Reform to Putin Power taking this Euro freakout as an opportunity to seize Ukrainian energy assets, the “news” is always there.

All the while, our role as your Risk Manager, is to have our feet on the floor earlier than most, consume the news, and register the price action. No one said this is easy. That’s why we do it. And global macros risk waits for no one – so there are no days off.

Proactively sell high; buy low; and remember, “he who will not economize, will have to agonize” reactively. So capitalize on his consensus emotions.

Best of luck out there today,

KM