“To truly understand something, you must experience it.”
- Benoit Mandelbrot
After yet another episodic-and-non-TRENDING bout of panic selling in the US stock market yesterday, I’m going right back to the wood – i.e. the primary modeling principles of market volatility that I learned from Mandelbrot.
On short-term market turbulence: “We sat and listened. Just listened. Loud high pitch, then low rumblings. Then high pitch again; more rumblings…” -The Misbehavior of Markets, pg 227
Instead of listening to some Old Wall person make a “call” on the ISM or freaking out about what Janet said, what did we do yesterday? We let the market signals tell us what to do. We didn’t panic sell. We bought the damn dip.
Back to the Global Macro Grind…
The aforementioned passage from The Brot is not only beautiful in its sense of calm, but also its reality. It’s what happens in real-life. Markets don’t go up and down, on a TRENDING basis, based on what people say.
They do what The Cycle is doing.
Mandelbrot said that the particular real-world experience that I am citing (listening to a submarine travel through turbulent water) “underlies all of my thinking about financial markets.”
That’s why I paid particular attention to it.
“The turbulent water through which the submarine’s nose plowed in a one-dimensional line was not one long alternation of fast and slow water. Instead, seen in all three dimensions, it was a complicated pattern of churning eddies and torrents, all interrelated… in effect, over an infinite span of time and space.” (pg 227)
Now you can think about that however your mind thinks about things. Instead of thinking in straight lines, over a long period of time I have incorporated fractal dimensions into my risk management #process.
Thinking in a straight line is so simple a Macro Tourist can do it. Someone “says” something and you draw a line (conclusion) that’s either bullish or bearish as a result of that statement. It’s the same as headline chasing.
Thinking on a multi-factor & multi-duration basis within the context of a Full Investing Cycle #process that is constantly volatility adjusting its assumptions stochastically? No, Ray Dalio didn’t teach me that.
I taught myself that by experiencing that.
Whether it’s measuring and mapping cotton prices (like Mandelbrot did initially) and/or the turbulence of water, one only comes to truly understand the relationship between data and markets by trading markets.
One of these days I’ll buy the damn dip in #Quad2 exposures… and it won’t be a dip.
But my process is built to come to realize that something is changing (the Volatility of Volatility). When the math and signals change, I will. My last buy order on Gold, for example, was on SEP 24th. I only knew that was the beginning of the end of Gold’s #Quad3 Cycle Peak by experiencing Gold’s 2-year Bull Market (from the long side) prior.
“But, but, when does #Quad2 end. When does it end, KM?”
A) I don’t know
B) But I do know it didn’t end yesterday… because
C) Every damn dip that I bought worked… and
D) I didn’t even get a bloody dip in the BIG things that work in #Quad2… because
E) They were all UP on the day!
What are those Big Macro things?
A) Commodities (CRB) Index made a new Cycle High yesterday
B) Commodity Stocks like Energy (XLE) and Materials (XLB) were up on the day
C) Financials (XLF) and Industrials (XLI) were up, making new Cycle Highs, on the day too
And… yes, I see that. SPY is down an epic -1.1% from its all-time closing high. What a bear market that looks like, eh?
With our 4 Horsemen (XLF, XLB, XLI, and XLE) running hot, why wouldn’t new all-time closing highs for SPY be pending? Behaviorally, we have both sentiment and market positioning on our side too.
Yesterday’s implied volatility PREMIUMS on SPY and XLI ramped to +45% and +93% (vs. 30-day realized volatility), respectively. No, those aren’t typos. And no, most people don’t even know what those panic/fear signals mean.
That’s totally cool with me. If Old Wall people want to believe that one-off “calls” or a a one-dimensional moving average would help them understand submarine turbulence, let them be selling to us on those assumptions.
Immediate-term @Hedgeye Risk Range with TREND signal in brackets:
UST 10yr Yield 1.56-1.71% (bullish)
SPX 4141-4229 (bullish)
RUT 2 (bullish)
NASDAQ 13,548-14,270 (bullish)
Energy (XLE) 46.95-52.35 (bullish)
Financials (XLF) 35.44-37.55 (bullish)
DAX 146 (bullish)
VIX 15.63-20.39 (bearish)
USD 90.31-91.50 (bearish)
EUR/USD 1.198-1.216 (bullish)
Oil (WTI) 62.56-67.21 (bullish)
Nat Gas 2.78-3.04 (bullish)
Gold 1 (bearish)
Copper 4.29-4.62 (bullish)
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
