McCullough: Was it really surprising that inflation and bond yields have been breaking out? The way our model has worked since the beginning of time is that what happens in the 10-year Treasury yield is front-run by what’s happening in Commodities.
Commodities front-runs the headline CPI. Then you get your move in interest rates.
This is continuing to happen as people continue to be surprised by inflation. When we first started making this call inflation wasn’t even at 2%. Once it got towards 2%, bond yields had already gone up and Wall Street had an interest rate panic.
Bond yields have been going up globally, particularly in Europe. Getting back to the most recent move in the U.S., the 10-year yield is up almost 10 basis points in the past month. One month moves really matter to quantitative risk management systems and systematic trading (what we call “The Machine”).
In Italy, the 10-year is up 33 basis points in the past months. None of this is new as of this morning.
So again, what caused this move in inflation and bond yields? Look at Commodities. The CRB Index is the equivalent of the S&P 500 for Commodities and it hit a new cycle high yesterday. It’s been going up almost every day. This shouldn’t surprise you based on what’s happening in Copper, Corn, Lumber or the Oil price for that matter. They have been inflating.
If you’re a little surprised that the CPI or PPI number was higher than some linear econ’s expectation, that doesn’t matter. If you get the direction of inflation right, you’ve had the direction of Commodities right and you get the direction of bond yields right.
I lost money yesterday. I was down -32 basis points of my hard-earned capital. I generally don’t like losing money. But consider the alternative. Imagine I was long Long-Term Bonds (TLT), Gold (GLD) and Utilities (XLU).
You’re going to lose money in stocks sometimes. I’ve been doing this for 22 years. Get used to it.
But getting to Volatility here, what if the VIX can’t get above 31? Well, we’ll be in the chop bucket (where traders flourish) and the low end of my risk range suggests we could even get as low of the investable bucket (where even a monkey can make money long stocks).
Let’s review. The chop bucket is 21-29. That’s where people get chopped up. Below that is the investable bucket. A sustained move above that is where everyone gets blasted long stocks.
When VIX is above 28-29, you have to ask, ‘Is this an episodic and non-trending move in the VIX that’s going to break down?’ If the answer is yes (like I think it is), you buy the damn dip at the low end of the range.
If you have a rules-based process that you’re very consistent with it’s not that complicated.