“My life has been a study of risk.”
- Benoit Mandelbrot
If you have friends who weren’t proactively prepared for this part of The Cycle’s #Quad4 Equity and Commodities risk, have them read/study Mandelbrot’s (The Misbehavior of Markets) chapter on “Risk, Ruin, and Reward.”
Risk usually happens slowly, then all at once.
Back to the Global Macro Grind…
God bless Benoit’s soul and may he rest in peace. As your Hedgeye Risk Manager, I didn’t get much sleep last night. Not because “markets were in turmoil” @CNBC or anything like that. I got home late from California.
Inspired by Mandelbrot since my days in New Haven, my life too has turned into not only the deliberate study of risk, but being held to transparent account on what I am buying and selling, in real-time, as a result.
I think that’s helped me iterate and learn faster. Having to explain what you are doing and why perpetuates process evolution.
My risk management process doesn’t change if markets are moving or not. Brownian motion is the general state of markets. It’s when a cluster of volatility turns into a @Hedgeye TREND that they phase transition.
That’s happened to both US and Global Equity markets in the last week.
But, as you know, it already happened to the rest of the Global Macro market (FX, Rates, Commodities) over a month ago. Yes, indeed. The bond market nailed The Cycle, once again.
Pre-virus, US Durable Goods #slowed to a recessionary -3.9% year-over-year, don’t forget.
Away from more #slowing economic data (South Korean Industrial Production -2.4% year-over-year for JAN), the most important thing that’s happened in the last 24 hours is that both US and Global Equity Volatility has moved (and held above) the 30 level.
Simplifying the complex, VIX > 31 makes most, if not all, US Equity exposures uninvestable.
Uninvestable?
Not if you’re Warren Buffett. But if you’re at most hedge funds, you’re not allowed to have a 6% draw-down of your capital in a week, never mind the 12-20 plus percent some fund managers already just lost in the month of February.
The problem with an @Hedgeye Risk Range of Equity Volatility of 21.70-45.42 VIX is that the downside in the low-end of the Risk Range drops at an #accelerating rate. Most humans and their linear “risk management” assumptions can’t handle these types of power laws.
Ok, in English what does that mean?
- The low-end of the SP500’s Risk Range just went from 3070 to 2832, in 1 day
- The 3-day Risk Range (in points) for the SP500 just went from 67 handles wide (2 weeks ago) to 565
- Volume continues to #accelerate alongside the ROC (rate of change) of realized volatility
That last part is actually the most important point. In fractal math we call these similar sets. One perpetuates the other. So, as the VIX broke out > 31, Total US Equity Volume (including dark pool) #accelerated +49% yesterday vs. its 1-month average.
Again, in Old Wall technician terms you won’t see what I see when I look at the same market. That’s because I don’t use a 1-factor model like a simple moving average that only sees the surface area of a market’s price.
It’s what’s happening on a multi-factor and multi-duration basis within the lens of price/volume/volatility that helps you study rising and/or falling risks. As risks rise beyond certain thresholds, even the #Quad4 Longs (stocks) can A) go down and B) break @Hedgeye TREND.
Since @Hedgeye TREND signals are a function of price, volume, and volatility, 31-41 VIX just broke my TREND risk management signal levels in both Consumer Staples (XLP) and REITS (VNQ). We’ll see if that holds. But, in English, that’s bad.
Neither Treasuries (across the curve) nor Gold have broken @Hedgeye TREND. The US Dollar Index remains Bullish @Hedgeye TREND as well. So, until something in vol space changes, I’ll have low gross exposure to anything that is signaling Bearish TREND anyway.
Uninvestable is as uninvestable does, until the process signals otherwise.
Immediate-term @Hedgeye Risk Range with TREND signal in brackets:
UST 10yr Yield 1.15-1.496% (bearish)
UST 2yr Yield 0.95-1.30% (bearish)
SPX 2 (bearish)
RUT 1 (bearish)
NASDAQ 8193-9328 (bearish)
Utilities (XLU) 63.11-71.10 (bullish)
REITS (VNQ) 87.50-97.09 (bearish)
Consumer Staples (XLP) 57.75-63.28 (bearish)
Tech (XLK) 84.89-96.80 (bearish)
Shanghai Comp 2 (bearish)
Nikkei 200 (bearish)
DAX 118 (bearish)
VIX 21.70-45.42 (bullish)
USD 98.25-99.95 (bullish)
Oil (WTI) 44.76-51.46 (bearish)
Nat Gas 1.64-1.91 (bearish)
Gold 1 (bullish)
Copper 2.50-2.60 (bearish)
AAPL 261.23-304.93 (bearish)
AMZN 1 (neutral)
FB 181-205 (bearish)
GOOGL 1 (bearish)
NFLX 350-383 (neutral)
TSLA 612-830 (neutral)
Bitcoin 8 (neutral)
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
