“It was the elegance of it all, the concepts were beautiful.”
- Jim Simons

For those of you who haven’t read The Man Who Solved The Market yet, Renaissance Technologies founder, Jim Simons, was a mathematician before he became a hedge fund manager. Specifically, he was a geometer.

The way that powerful theorems and formulas could unlock truths and unify distinct areas in math and geometry captured Simons – and he realized he had a unique approach to arriving at original solutions.” (pg 15)

To me, the most important concept in fractal geometry is that of similar sets. Simons didn’t give the WSJ guy (who wrote the book) his codes or algos, but I’d be shocked if probing for fractal patterns wasn’t part of his data-driven process.

Got Portfolio Construction? - 04.13.2018 old wall cartoon  1

Back to the Global Macro Grind…

What’s your process? I can’t ask you to ask yourself that question enough times. After a day like yesterday, I am humbly reminded of how many people subscribing to my risk management process, also don’t fully understand it, yet.

That’s not a bad thing. There’s a big teaching opportunity in that.

Instead of lighting your hair on fire searching for WWIII headlines or Global Virus hedges, the most basic thing you should always have at the start of every day is good portfolio construction with defined max positions

As a reminder, from a Global Macro Asset Allocation perspective, here’s how I allocate my own capital:

A) Foreign Currency (and Gold) MAX positions = 12%
B) Fixed Income positions = 10% MAX
C) Equity (Indices, Sectors) = 6% MAX
D) Commodities = 4% MAX
E) Options = 1-2% MAX

Since I actively trade around my gross exposures (commissions = $0, so I’m doing that more frequently than I ever have), I have no problem selling-some when something appreciates towards my MAX. A good example of that will be Treasury positions today.

For illustrative purposes, this is what my Long Only asset allocations might look like:

A) FX: Gold 8%, British Pound 6%, Canadian Dollar 2%
B) FI: Short-term Treasuries 10%, TIPs 8%, Long-term Treasuries 8%, Zeroes (ZROZ) 3%
C) EQ: Utes (XLU) 5%, REITS (VNQ) 5%, Tech (XLK) 3%, Energy (XLE) 3%, EM (EEM) 3%, etc.
D) CRB: Oil (USO) 3%, Cocoa (NIB) 4%, Coffee (JO) 3%, Bitcoin (2%)
E) Options: 5-10 positions of 1-2%

So, on something that I’ll get a lot of fear and feedback on (only things that are going against me), like Oil (USO) I can’t be at my 4% MAX (I’m actually at 3.3% this morning) because I’ve been dead wrong on it, losing $ for the last week.

Not that everyone who is still long Oil alongside me might remember this, but when I said I was selling-some Oil (and Gold) back in early January on the Iran news, both of those positions ramped to my MAX, so I booked gains.

However you want to SIZE and trade around your MAX core positions is up to you.

But, if you can’t tell me what your Portfolio Construction #Process is, you should really think about it within the context of what you’re trying to achieve with your hard earned net wealth.

Some other basic things to callout and/or consider in terms of the illustrative portfolio I laid out:

A) Gold gets grossed up as a CURRENCY (FX) in my portfolio when Gold Volatility (GVZ) breaks down below 16
B) On Fixed Income (FI) I went MAX on TIP in early OCT because the process called for #InflationAccelerating
C) On Equities, those are the Top 4 Sector Styles (back-tested) when the US economy is in #Quad3
D) On Commodities, I’ve been in/out of many since October (sold my Lumber and Cattle, recently bought Bitcoin)
E) Options – I trade those when something is A) at the bottom or B) top-end of my @Hedgeye Risk Ranges  

Hopefully that helps.

Essentially my portfolio construction parameters and rules are a function of Volatility Adjusting my market exposures. Having an 8% position in Gold with a volatility of 10 is much different than a 3% position in Oil with a volatility of 40.

That’s why I stop myself out of asset allocations when either:

A) The Quads change or
B) The Volatility Signals change

If Oil (WTI) Volatility were to hold a breakout above the 38 level, not only will my SIZE in Oil go down (because I’ll lose more money being long it!), but I’ll stop myself out of it… assuming the market is starting to discount another #Quad4.

Similarly, if US Equity Volatility (VIX) were to hold a breakout above the 16 level, I’d expect to see more down days for Tech (XLK) like we saw yesterday (XLK was down -2.4%)… assuming the market is, again, starting to discount #Quad4 in Q2.

Remember, as The Quads change from #Quad3 to #Quad4, both Energy (XLE) and Tech (XLK) go from Top 4 Sector Style longs to shorts.

Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND signals in brackets) are now:

UST 10yr Yield 1.56-1.79% (bearish)
SPX 3 (bullish)
RUT 1 (bearish)
Utilities (XLU) 65.49-69.37 (bullish)
REITS (VNQ) 92.96-96.53 (bullish)
Energy (XLE) 54.81-60.70 (neutral)
Tech (XLK) 93.71-98.69 (bullish)
VIX 13.41-18.95 (neutral)
USD 96.80-97.99 (neutral)
GBP/USD 1.29-1.31 (bullish)
Oil (WTI) 52.65-58.30 (neutral)
Nat Gas 1.81-2.14 (bearish)
Gold 1 (bullish)
Copper 2.57-2.77 (bearish) 

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer

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