“We sail within a vast sphere, ever drifting in uncertainty, driven from end to end.”
- Blaise Pascal

One of the more challenging aspects of investing (and life for that matter) is dealing with uncertainty.  As stock market operators, we buy or short stocks in which, by law, the amount of information we have is limited.  From the macro perspective, we often make asset allocation decisions based on government data that is often lagging and many times dubious in nature (think about CPI as a gauge of inflation).

As Hedgeye, we deal with the reality of uncertainty by collecting as much data as possible, both on the company and country level. Then we use modern tools including predictive tracking algorithms and artificial intelligence to more effectively interpret that data. Of course, we also use market-based indicators – our Trade, Trend and Tail model – to instruct and guide us.

Despite all of this work, we are still left with probabilities and unknowns.  There are always uncertainties.

There all also environments where the unknowns are amplified. Currently, we are operating in a prime of example of that environment. 

  • We are in the middle of a global pandemic
  • We are less than a week out from a highly contested election
  • The VIX is north of 35
  • And it's unclear what's next for the largest fiscal and monetary policy program in modern history

Got all that?

The French mathematician Blaise Pascal was one of the forefathers of dealing with uncertainty in his early and groundbreaking research on probability theory. While his early studies certainly led to the creation of tools that help us investors, he also created tools for all of us degenerate gamblers. The most famous of Pascal’s theories on probability, though, had nothing to do with investing or gambling.

Pascal’s wager, as it is known, argues that a rational person should live as though God exists and seek to believe in God.  According to Pascal, if God does not actually exist, such a person will only suffer a finite loss, but if God does exist the person will have infinite gain. In investment parlance, that would be akin to owning a cheap option with no expiration.  Typically, not a bad “trade.”

It’s still a little bit early to get too deep this morning, but the point is that we should embrace uncertainty and realize that almost everything in life, including investing, is a probability-based decision.  The sooner we can get comfortable with, as Annie Duke writes, thinking in bets, the easier it is to accept this uncertainty.

Embracing Uncertainty - 10.28.2020 Feddy Bear cartoon

Back to the Global Macro Grind…

As my macro colleague Darius Dale noted yesterday on The Macro Show, it is somewhat less important where we are at any moment, but more important to consider the rate of change of the probability of where we will be in the future.  Yesterday, of course, was more of a #Quad4 day.

In the Chart of the Day below, we’ve highlighted yesterday’s subsector performance.  As we like to say, everyone was a loser!  Technology led the way on the downside at -4.2% and real estate was the relative outperformer at -2.2%.  In terms of Keith’s real-time thinking, these are the changes he made in Real-Time alerts, our shorter duration signaling product:

  • Longs added: FDX and NKE
  • Longs sold: KBA, COST, IIPR, UTZ, BYD
  • Shorts added: OLLI, NFLX, NTES
  • Shorts covered: SMPL

So net-net, we exited the day with three fewer longs and two more shorts.  Basically, no exposure was spared yesterday, not even the almighty Bitcoin, the exceptions being sugar, the U.S. dollar, the Chinese Yuan, and the Japanese Yen.

On the topic of Asia (and this is where it gets interesting) we continue to get confirmation that #Quad3 is more likely.  If the U.S. Dollar was poised to breakout (above 94.21 in the USD index) and push us back into #Quad4, then Asia would, to use a scientific term, get “smashed”.  Copper and all of agriculture also continue to support #Quad3.  That said, the volatility regime is what led to the shift, outlined above, in real-time alerts and keeps us more cautious, for the time being, on U.S. equity exposure.

Inasmuch as there is more uncertainty in the U.S., Europe has been decidedly in #Quad4 and we received more confirmation of that this morning. 

Consider a few data points from the morning grind:

  • Both Germany and France instituted new lockdowns today driven by the resurgence of COVID.  Germany will lockdown for a month and France will lockdown until new positive COVID-19 cases reduce to 5,000 per day;
  • Eurozone economic confidence, a flash report for October, came in weaker than expected came in at 90.5 with consumer confidence down -15.5;
  • A survey from the Royal Chartered Institute of Surveyors indicated that 78% believe the European office market is in a downturn; and
  • Italy, Spain, France, and really all of Europe have reported record positive COVID-19 tests in the last 24 hours.

Now of course inasmuch as the data from Europe isn’t great and is likely to decelerate in the short term, we will all be watching the ECB meeting with bated breath today to see if the glorious and omnipotent central bankers will show us any cards to help us adjust our probabilities and save us.  After all, as Ben Bernanke once said:

“History proves . . . that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse.”

Indeed . . .

Immediate-term @Hedgeye Risk Range with TREND signal in brackets:

UST 10yr Yield 0.72-0.87% (bearish)
UST 2yr Yield 0.13-0.18% (bearish)
SPX 3 (bearish)
RUT 1 (bearish)
NASDAQ 10,892-11,638 (neutral)
Tech (XLK) 110.21-119.12 (neutral)
REITS (XLRE) 33.54-35.63 (bearish)
Utilities (XLU) 62.37-65.31 (bullish)
Financials (XLF) 23.20-24.77 (bearish) 
Shanghai Comp 3 (bullish)
Nikkei 235 (bullish)
DAX 115 (bearish)
VIX 28.01-42.35 (bullish)
USD 92.41-93.85 (bearish)
Oil (WTI) 35.73-39.98 (bearish)
Nat Gas 2.68-3.45 (bullish)
Gold 1 (bullish)
Silver 23.08-24.86 (bearish)

Keep your head up and stick on the ice,

Daryl G. Jones
Director of Research

Embracing Uncertainty - CoD Sector Performance