“He doesn’t look for market correlations, markets correlate to him!”
-The Most Interesting Investor in the World (unreleased Hedgeye parody video)
For the past twelve years, I’ve been the proud practitioner and beneficiary of a contrarian, peri-holiday phenomenon.
I generally tend to lose weight during the holidays.
Universally, studies show that sitting for 8 hours a day significantly increases the risk for all sorts of cardiovascular, inflammatory and degenerative disease.
Sitting for 12-16 hours a day (not atypical in investment space) … they don’t even bother studying that – it’s kind of like a (analytical) rhetorical question.
Anyway, it’s not that the period is devoid of indulgence or dietary indiscretion, it’s that holidays and physique transformation are correlated through a 3rd variable …. time
When market activity slows modestly into year end, I actually get more than zero minutes to hit the gym. And more than zero is generally good because, you know, numbers.
And for you complexity-philes, this is where the network effects cascade and nonlinearity show up.
In addition to the direct and more immediate benefits of exercise, catecholamine and other catabolic activity reverses and sleep quality improves, which, together, work synergistically to facilitate positive physiological adaptation and optimize endocrine function - all of which drive a favorable shift in the psycho-emotional and hormonal profile which, collectively, is you.
You, simply, become a better version of yourself, biophysically and metaphysically.
Now, Time, in this case, governs this phenomenon globally but also features across important exercise related physiological subconditions.
When exercise begins, ATP and other immediate energy stores are marshalled in support of activity.
These more immediately accessible stores only serve to support performance for a relatively short period. Prolonged (aerobic) exertion requires the engagement of the endocrine system which shifts the body’s primary mechanism of energy regulation to hormonal control.
It typically takes around ~20 minutes for hormonal activation to ‘get going’ and take the handoff with respect to regulating energy production and is significantly more impactful as it relates to the breakdown and utilization of fat, etc.
The transition from that tired, trudging feeling you get when you first start exercising to feeling ‘in the zone’ after a while is chiefly a function of hormonal activation, which itself is a function of time.
Back to the Global Macro Grind ….
There are a few easily accessible macro and risk management cross-walks here:
- TRADE: The @Hedgeye Trade duration (3 week or less) is kind of like the first minutes of exercise. They matter, they can have a positive immediate and cumulative effect and you can’t get to minute 20 without minutes 0-19. They also serve a critical risk management function. If something’s not right, you can shut it down early to avoid more consequential harm.
- TREND: The @Hedgeye Trend duration (3 months or more) is kind of like the post 20-min, hormonal activation state. This is where our biggest calls are made - the nexus of our risk management and fundamental research process where short-term dynamics cede control to the favorable hormonal milieu of a slow, collective (investor) realization of a new investing regime and the progressive release of PnL endorphins as the consensus rotation takes shape.
What’s our enigmatic 3rd variable …. the ‘strange attractor’ around which Trending global macro correlations typically coalesce?
The $USD.
To be sure, market correlations build and decay but, much of the time, the interconnected macro-verse orbits around phase transitions in the global reserve currency.
Here, it’s important to remember that the dollar functions within a two way communication and feedback loop, both cause and effect - catalytic agent and passive recipient.
Again, to invoke a physiological metaphor.
Suppose some critical, cellular threshold is breached (i.e. the stimulatory effects of exercise) such that a particular enzymatic pathway is activated.
Activation of the initial, gatekeeper enzyme serves to catalyze a cascade of derivative activity that propagates along a given physiological response channel such that each successive wave of activation is larger than the one preceding it.
In this way, inside the complex system that is the body, a single, initial signal gets amplified and propagates nonlinearly to influence the performance of a vast array of biophysical ‘assets’.
Meanwhile, the system as a whole remains under larger homeostatic control, so the response builds via a positive feedback loop until the stimulus is removed or internal conditions reach some acute imbalance.
Now, through the prism of complex physiological system dynamics, consider the prevailing U.S. Dollar dynamics going into our #PeakDollar and #InflationAcceleratings call in 4Q19.
Quad 4 remained the prevailing global reality, representing a macro condition set that perpetuates a stronger dollar – particular under a scenario of relative growth divergence domestically and/or an under-dovish Fed (both of which we had) - which further perpetuates global and local disinflationary conditions, further tightens financial conditions, further exacerbates already acute dollar liquidity dynamic, further vice-grips non-U.S. holders of dollar denominated debt, directly impacts real rates (& thus gold) and further hamstrings the capacity of other Central Banks (China) to initiate more meaningful stimulus measures.
Most macro integrations of consequence are reflexive cycles and a strong $USD inside prevailing Quad 4 conditions functions as a positive feedback loop with negative consequences whereby slowing growth begets a strong dollar and a stronger dollar cultivates both disinflation and tighter global financial conditions, both of which serve to further pressure growth and around we go.
To tether back to our activation function and biophysical cascade, Quad 4 and Trending $USD strength perpetuate a global macro condition set whose derivative effects propagate through cross-asset performance, conspicuously and globally.
Our call for a transition out of Quad 4 and into Quad 3 carries specific implications for the Dollar. Will Quad 3 associated dollar softening represent a direct and expeditious unwind of all the strong dollar effects described above?
Whether a weaker dollar can support Quad 1/Quad 2 inflections in EM or DM markets already flirting with underlying inflection and thus help cultivate a larger, gradual rotation towards improved growth (where global growth improving more passively feeds back on the dollar to propagate a self-reinforcing weakening dollar cycle) is what we continue to measure, map and probability weight in real time.
I’m purposefully dancing around some of the explicit investing and allocation implications of a $USD phase transition so as not to give away the thunder ahead of our 1Q20 Macro Themes call this morning so that broader (metaphorical) framework for contextualizing the dollars role within a complex market system will have to satisfice for now.
Institutional investors (ping ) are invited to join us at 11am this morning. Here are the Top 3 Themes for 1Q20:
- Quad 3 Stagflation: With the Quad 4 (in Q3) to Quad 3 (in Q4) reflation in the books, the time is now to look ahead at what a second consecutive quarter of Quad 3 domestically and a third consecutive quarter of Quad 3 in China means for financial markets. Our models suggest a Bean Deal-driven recovery is a lower-probability outcome than faster inflation taking a bite out of real economic growth in both economies.
- Down Dollar: With “not QE” perpetuating rapid balance sheet expansion, it would appear the Fed has finally engineered a breakdown of the greenback. Will it be the kind that perpetuates an amelioration of dollar funding stress that leads to global Quads 1 and 2 (e.g. 2009, 2013, 2016), or will their liquidity provision mostly fuel a further rebound in raw materials prices (e.g. 2008, 2011)?
- Earnings Slowing, Again: Consensus expectations for an expeditious and meaningful recovery in domestic corporate profits are simply misaligned with the broader business cycle and the late-cycle realities of unit labor cost inflation running hotter than unit level demand growth. In the presentation, we’ll detail what’s driving this divergence, as well as its likely path for recoupling.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND signals in brackets) are now:
UST 10yr Yield 1.77-1.91% (bearish)
SPX 3 (bullish)
RUT 1 (neutral)
Utilities (XLU) 63.51-64.94 (bullish)
REITS (VNQ) 90.46-92.99 (bullish)
Energy (XLE) 59.01-61.11 (bullish)
Tech (XLK) 90.42-93.50 (bullish)
USD 95.76-97.12 (bearish)
Gold 1 (bullish)
Copper 2.76-2.86 (bullish)
As always, well do our best to simplify the complex while providing a little cerebral and portfolio exfoliation into the New Year.
We hope you can join us,
Christian B. Drake
Macro Analyst
