There is a massive opportunity for investors to use modern day risk management tools to peer into the future and see where markets are likely headed next. While the future is obviously uncertain, the primary goal of any successful investor (and our investing research) is simple: Be more right than wrong. That's how investors win long term. 

The Hedgeye Macro process is designed to deliver just that: Superior investment ideas.

In the presentation below, we provide an overview of our current market outlook (updated as of 11/3/2021) along with a number of slides on our risk management process. 

CLICK HERE to access our current market outlook

Our Growth, Inflation, Policy (GIP) model is “the hallmark of our fundamental research process."

We find two factors to be most consequential in forecasting future financial market returns: economic growth and inflation. We track both on a year-over-year, rate of change basis to better understand the big picture then ask the fundamental question: Is growth and inflation heating up or cooling down?

From there, we get four possible outcomes, each of which is assigned a “quadrant” in our Growth, Inflation, Policy (GIP) model and the typical government response as a result (neutral, hawkish, in-a-box or dovish):

• Growth accelerating, Inflation slowing (QUAD 1);
• Growth accelerating, Inflation accelerating (QUAD 2);
• Growth slowing, Inflation accelerating (QUAD 3);
• Growth slowing, Inflation slowing (QUAD 4)

After building this base of knowledge, we select what we like (and don’t like) based on our historical back-testing of the different asset classes that perform best in each of the four quadrants.

If this regime-based framework sounds familiar, it’s because billionaire investor and Bridgewater founder Ray Dalio employs a similar risk management process also focused on growth and inflation.

Our primary goal is to help our subscribers avoid getting blown up by the big stuff.

If we can help steer you into our preferred factor exposures on the long and short side, that’s great too. We make this point often, differentiated processes lead to differentiated perspectives and differentiated perspectives help investors generate alpha.

We have created a significant amount of research over the years which remains relevant for investors eager to dig deeper into our research process.

Investing, and life, is all about getting better with each passing day. Learning is key to your personal investing evolution.

We want you to improve the way you think about financial markets. From Hedgeye investing webcasts to long-form interviews with some of the sharpest minds in the business, links to our research archives below should help get you up-to-speed very quickly:

• Hedgeye Webcast Replays: We host deep-dive research investing webcasts with CEO Keith McCullough and our 40+ analyst research team.

• Real Conversations: These interviews feature CEO Keith McCullough discussing markets with some of the smartest minds in finance.

• Podcasts: You can also listen to our webcasts and more in podcast form on our Apple Podcasts page.

We look forward to learning more about financial markets together.

We owe a debt of gratitude to those financial market founding fathers from whom we've learned so much from over the years. In response to overwhelming subscriber demand for our favorite book suggestions we've put together a collection of reading lists for you to check-out.

First things first. We want to highlight three excellent books which come highly recommended by our CEO Keith McCullough. We call these our "Must-Read Process Books."

MUST-READ PROCESS BOOKS

1. The Misbehavior of Markets

By Benoit Mandelbrot

If you're looking for a thoughtful and rewarding read about how to simplify the complexities of financial markets, look no further. We highly recommend you read "The Misbehavior of Markets" by mathematics legend Benoit Mandelbrot.

"This is somewhat of a Bible to me," says Hedgeye CEO Keith McCullough. "I learned a ton from this guy, if only what not to do. It's an alternative to establishment economics. It's certainly an alternative to how people think about markets relative to economic data." Click here to watch Keith's entire book review on "The Misbehavior of Markets."

2. Thinking Fast & Slow

By Daniel Kahneman

Hedgeye CEO Keith McCullough discusses Daniel Kahneman's seminal book, Thinking Fast and Slow. According to McCullough, this must-read book written by the Nobel laureate and founder of behavioral economics has been an invaluable resource in enhancing his approach to investing.

"This book provides a real baseline for understanding, 'What is behavioral finance?'" McCullough says. "What this book does is it teaches why human beings should embrace uncertainty." Click here to watch Keith's entire book review on "Thinking Fast & Slow."

3. Models of My Life

By Herb Simon

Hedgeye CEO Keith McCullough discusses Nobel laureate Herb Simon's autobiography, Models of My Life. "I'd like to thank Mr. Simon for being not only a revolutionary in this space, but for challenging the status quo," McCullough says. "That's a really important component of this book. It contextualizes where we were in economics back in the 1970s and outlines a better path forward." Click here to watch Keith's entire book review on "Models of My Life."

Below is a "Top-10 Reading List" – featuring a collection of our favorite ten books covering markets, investing and hard work.

TOP-10 READING LIST

1. A Man For All Markets – by Edward Thorp: The card-counting mathematics professor turned hedge fund manager who taught the world how to beat the dealer and, as one of the first great quantitative investors, beat the market.

2. Principles – by Ray Dalio: The world’s largest hedge fund manager shares the unconventional principles he’s developed, refined, and used over the past forty years to create unique results in both life and business.

3. Deep Work – by Cal Newport: A valuable skill that's becoming increasingly rare, Deep Work is the ability to focus without distraction on a cognitively demanding task. It's a skill that allows you to master complicated information and produce better results in less time.

4. The Undoing Project – by Michael Lewis: Forty years ago, Israeli psychologists Daniel Kahneman and Amos Tversky invented the field of behavioral economics. Michael Lewis shows how their Nobel Prize–winning theory altered our perception of reality.

5. The Most Important Thing – by Howard Marks: The co-founder of Oaktree Capital Management is renowned for his insightful assessments of market opportunity and risk. In The Most Important Thing, Marks breaks down his time-tested, fundamental investing philosophy.

6. The Runaway Species – by Anthony Brandt and David Eagleman: What lies at the heart of humanity’s ability―and drive―to create? But where does our creativity come from, how does it work, and how can we harness it to improve our lives, schools, businesses, and institutions?

7. Scale – by Geoffrey West: A pioneer in the field of complexity science, explains the science of emergent systems and networks. West discusses the underlying simplicity that unites the seemingly complex and diverse phenomena of living systems (in our bodies, cities and businesses).

8. Mastering Fear – by Brandon Webb: A former Navy SEAL turned media CEO, draws on his experiences in combat and business to show how people from all walks of life can stretch and transcend their boundaries, by learning to use their fears as fuel to achieve more than they ever thought possible.

9. Boyd: The Fighter Pilot Who Changed the Art of War – by Robert Coram: John Boyd may be the most remarkable unsung hero in all of American military history. Some remember him as the greatest U.S. fighter pilot ever -- the man who, in simulated air-to-air combat, defeated every challenger in less than forty seconds. Some recall him as the father of our country's most legendary fighter aircraft -- the F-15 and F-16. Still others think of Boyd as the most influential military theorist since Sun Tzu.

10. Superforecasting – by Philip Tetlock and Dan Gardner: Tetlock and Gardner explain how ordinary people—including a filmmaker, a retired pipe installer, and former ballroom dancer—turned out to be astonishingly good forecasters beating prediction markets and the collective judgment of intelligence analysts with access to classified information.

(There are a ton of great books that didn't make our top-10 list but still come highly recommended by our team. Check out our "Hedgeye's Bookshelf" below to see all of the books CEO Keith McCullough has listed since 2018.)

• Hedgeye's Bookshelf (2018)
• McCullough: My Top-20 Book Recommendations (2019)
• 15 Books On Hedgeye's Quarantine Reading List (2020)
• McCullough: My 2020 Summer Reading List (2020)
• 10 Books Keith McCullough Has Recently Read (2020)
• 10 Books Keith McCullough Has Recently Read (May 2021)

We encourage you to check out these reading lists to help you dive deeper into how we approach financial markets.

We produced an exclusive 14-minute video hosted by Hedgeye CEO Keith McCullough to help bring you quickly up to speed on our unique Macro process. In the video below, McCullough will walk you through everything from:

• How we model the top 50 economies around the globe
• How our quantitative Risk Range™ Signaling model helps investors buy low and sell high
• How we help investors beat Wall Street by tracking consensus positioning

We encourage you to watch this primer on our repeatable risk management process.

To learn more, we also created this "Macro Playbook." In it, we share additional details about our research process - how we model global economies, what "Risk Range™ Signals" are, how we arrive at our investing conclusions and more. We think you'll find it useful. 

CLICK HERE to read our entire "Macro Playbook".

“You gotta be in it to win it!” How often have your heard that? Wall Street has consistently told customers they need to be invested in the US stock market. But investors need to know there are plenty of markets, risks, and asset allocations to think about above and beyond that.

“Success” on Wall Street has traditionally been defined as success for the brokers (in trading commissions), success for the traders (in trading spreads), success for the bankers (in fees), and success for the analysts (who participate in commissions, spreads, and fees).

What about your success?

If you were “in it to win it” at either of the 2000 or 2007 #bubble tops, we think it’s safe to say that your definition of success may vary from theirs. As a result, most have awakened to the fact that Wall Street’s longstanding business model is inherently conflicted, compromised, and constrained.

We call that, the #OldWall.

It’s time you self-direct yourself to do what #OldWall people have never had to do: put your interests first. It’s time for you to be the change you want to see in your wealth management.

Investors spend a ton of time vetting ideas and building their thesis around that idea. But when it comes time to actually put on a trade, most investors don’t have a framework for sizing that position, which is equally critical to the success of that investment.

“I’m going to show you how I do it, and you need to figure out how you do it,” explains CEO Keith McCullough in the video below discussing how he thinks about position sizing.

The video below should not be perceived as guidance for individuals. “Everyone has different risk parameters, different ages, etc. There are a lot of different permutations of what you’re trying to do,” McCullough explains. “But the most important thing is to have a rules-based process. You need a process that lays out what it is you’re trying to do, and why you’re trying to do it. Process is the most important thing.”

Here are some basic portfolio sizing guidelines:

1. Follow your own rules-based process
2. Your longs should always be bigger than your shorts
3. Average into your positions based on conviction

In addition, beta adjust your positions. “Beta adjusted” positioning is adjusting position size based on the volatility of that asset. In other words, a more volatile asset (i.e. higher beta) should generally be a smaller position in your portfolio.

In the video above, McCullough explains how he executes position sizing from both a broader asset allocation perspective and also in constructing a long-short equity portfolio.

Here’s a key takeaway from McCullough: “Think in terms of basis points or percentage of capital at risk when you’re trying to make decisions in both the long-short portfolio, asset allocation or otherwise.”

“I can get long a lot of different things within my asset allocation,” McCullough says. “But again make that decision before you start getting whipped around or transacting in the market. That’s how I do it. How you do it is totally up to you but have a framework.”

Before launching Hedgeye in 2008, Founder & CEO Keith McCullough spent a decade in the hedge fund world. During that time, he consistently refined his risk management model, both in the day-to-day management of his portfolio, and in rigorous back-testing against historical market data.

This risk management model is multi-factor meaning it’s based on the price, volume and volatility of a publicly-traded security. This model is what drives our Real-Time Alerts, throwing off red and green Bullish/Bearish risk management signals throughout the course of the trading day.

PRICE

What does a security’s last price tell you?

The most popular price-based answers to that question are the 50 and 200-day moving averages, based on closing prices of an index or an individual stock. 

Other systems, such as Candlestick Charts, track daily open, high, low and closing prices. But they still work off only a single factor, and thus do not present a full risk management picture. 

Price charting is based on the assumption that forces beyond mere Supply and Demand set the price of goods or securities. We don’t disagree with that. We disagree with how consensus tools contextualize it.

VOLUME

Since most investors care about the price of their holdings, shouldn’t they care about liquidity? 

If the price of your stock goes up, did you make money? The reality is that you only make money when you sell at that higher price, and in order to do that, you need liquidity. If there is not sufficient volume traded, you will not be able to sell at your price – maybe not at all.

Price moves perpetuate TRENDs. Volume either confirms (rising volume) a bullish TREND, or calls it into question (decreasing volume). 

Strong overall volume is generally seen as a sign of health in the markets, though isolated moves in Volume can signal turning points. 

Stocks moving UP on decelerating volume have the potential to create a Liquidity Trap and could signal a coming correction, while an outsized burst of volume on a strong UP move in a stock could signal a breakout to new price levels. 

VOLATILITY

If you are combining VOLUME with PRICE, you’re already well ahead of the single-factor technicians. But you’re not quite there yet. Hedgeye’s Model tracks multiple factors in three categories: Price, Volume, and Volatility.

Does it matter? Immensely. But how many people proactively solve for it?

Many Institutional Investors analyze the relationship between Price and Volume. Analyzing volatility is far less trivial – and for some reason, far less common.

Volatility is the statistical dispersion of prices of a security or index; the variance, or the standard deviation of prices for the security. 

The higher the Volatility, the greater the price uncertainty of a position. That doesn’t mean that Volatility is bad. It means that you have to take it into account if you want to make good buy/sell decisions, across durations. That's why you use our Risk Range™ Signals.

If you don’t incorporate an analysis of volatility in your buy/sell decision making process, you will have to get used to “averaging down” to offset your timing mistakes. And as any seasoned trader can tell you, averaging down presupposes two things, both of which are unreasonable: an endless supply of money, and a stock price that finally goes back up.

Volatility is measured against other positions in your portfolio (relative Beta), and against broad market averages (market Beta). A “high Beta” stock is more volatile than the broad averages and is likely to both fall and rise by a greater percentage than the market does. 

Risk-oriented investors are drawn to Volatility because they generally believe they can get in and out at the right time, and they believe they are better at timing Volatility than most other traders. 

This is often based on a small number of lucky trades, or on forgetting unsuccessful trades. This common psychological trap is called Confirmation Bias. There’s also the adrenaline factor, which is great if you want thrills at a casino, but it has no place in a risk management strategy.

The rise of "quants" – investors who use algorithms and program-based mathematical models to trade markets – has changed the game for investors. Ever-increasing computer processing power and the proliferation of "machine learning" tools will only escalate this arms race.

For "fundamental" investors – investors diligently modelling companies to gain an edge on stock valuation – all is not lost. At Hedgeye, we think investors can gain an edge on Wall Street consensus by marrying both quantitative and fundamental investing.

We call this "quantamental."

What Does A 'Quantamental' Risk Management Process Look Like?

We are obsessed with delivering superior investment ideas. You likely know this by now.

Our hybrid investing approach combines:

1. Proprietary quantitative analysis
2. Bottom-up sector research
3. Top-down macro research with an emphasis on duration

The end result is an intelligent, high-octane suite of products that draws on insights from over 40 research analysts. We cover everything from Global Macro and Retail, to Energy, Restaurants and Washington Policy research.

Our unique research team at Hedgeye is composed of some of the most highly-regarded analysts in the industry. Our quantitative models and fundamental research teams complement one another.

Here's how.

1. QUANTITATIVE Risk Range™ SignalS 

Our quantitative trading range model was developed by CEO Keith McCullough during his years as a hedge fund manager. It was specifically designed to risk manage the reflexive nature of markets.

This Risk Range™ Signaling model is utilized throughout the entire suite of Hedgeye research products to augment our 40+ person research team's fundamental views. Think about it. All investors have some basket of core investing ideas (stocks, bonds, ETFs or all of the above). Identifying those investing ideas is tough enough, then you have to deal with the uncertainty of markets.

When McCullough built his proprietary Risk Range™ Signaling model the aim was simple: Create a quantitative risk management tool to help investors actually buy low and sell high.

The model uses three core inputs - price, volume and volatility - to determine the likely daily trading range for any publicly-traded asset class. These Risk Range™ Signals are dynamic. They are designed to change as the data changes. At its core, you sell at the top end of the range and buy at the low end.

2. BOTTOM-UP SECTOR RESEARCH

Our investment research team is headquartered in Stamford, Connecticut. It is made up of analysts with buy-side and sell-side experience. Our research team based in Washington D.C. is composed of seasoned policy veterans with many decades of experience. They possess high-level experience and contacts having worked in a variety of influential positions over the years.

Together, our team of 40+ research analysts cover 19 different Sectors - from Housing to Industrials to Technology - and have an unparalleled understanding of what's driving specific stocks, sectors, policies, global markets and economies.

Our goal is simple. Since "Day One" more than ten years ago, our focus has been to build the most thoughtful and thorough team on Wall Street. We seek to translate our unique, combined knowledge into successful investment opportunities for all of our subscribers-big and small.

Our collective investment experience includes time at Carlyle Blue-Wave, Ardsley Partners, Buckingham Research, Morgan Stanley, Dawson-Herman Capital, Wells Fargo Securities, to name a few, while our combined policy experience includes time at the U.S. Court of Appeals, U.S. Energy Department, U.S. Office of Defense, U.S. Federal Reserve, U.S. Chamber of Commerce, and more.

3. TOP-DOWN MACRO RESEARCH

In addition to a deep bench of 18 fundamental equity and Washington policy research teams, our Macro team measures and maps economic data for the top 50 economies around the world, covering 90% of global GDP. We run predictive tracking algorithms for both growth and inflation for each of these economies to forecast the likely path for financial markets.

Bottom Line: Our Macro team is focused on generating investable ideas based on this research that combines their deep study of market history, the tracking of Wall Street consensus positioning and the volatility signals embedded in futures and options markets.

(We encourage you to dig deeper by reading our "Macro Playbook.")

Bottom Line

The combined "quantamental" knowledge of 1) proprietary quantitative analysis 2) bottom-up sector research 3) top-down macro research makes your Hedgeye subscription the best bang-for-your-investing-research-buck out there.

There are few concepts more fundamental to our research process than measuring and mapping economic data on a “rate of change” basis. Rigorously tracking year-over-year growth across economic indicators illuminates pivotal inflection points in macro markets.

Now, consider the following chart. That's a sine curve. It represents the rate of change of a particular data set over a given period of time. You’ll hear us referencing this lot.

The mainstream financial media is fond of touting levels – reporting, for instance, that “such and such” indicator “rose to a level not seen since 2008.” Levels are misleading. As CEO Keith McCullough says in the video below:

“It’s not whether something is good or bad. It’s about knowing whether the data is getting better or worse." 

Changes on the margin, like this, are what move markets, not the narratives of big-brain, masters-of-the-universe. "When Wall Street talks about an asset's valuation being 'cheap' or 'expensive' or how the data 'feels,' those are opinions" Keith continues. "The rate of change of the data are economic and empirical facts. That’s a much better place to start.”

Measuring and mapping economic and inflation data in this way (and systematically plugging this data into predictive tracking algorithms) helps us consistently spot inflections in the performance of key factor exposures, across asset classes, 3-6 months ahead of investor consensus.

“A very simple example in 2020 was our call that inflation was bottoming in June 2020,” Keith explains. “We didn’t have to make up a narrative about inflation being ‘transitory.’ We measured and mapped the data as it was reported and our proprietary inflation forecasting tools suggested inflation was breaking out.”

A LESSON IN "BASE RATES" & WHY IT MATTERS

An important factor to understand in measuring the rate of change in global economic data are "base rates." The base rate is the level one year ago against which the year-over-year growth rate is calculated. Simply put, the comparative base rate is the level above which an economic indicator must surpass to realize any growth in the following year.

Our back-testing of historical data shows that measuring and mapping rate of change data helps us spot key inflection points. Specifically, tracking the base effects helps predict the likely pace of future growth. In the U.S. specifically, 78% of the time the marginal rate of change in the 2-year average Real GDP growth rate in the comparative base period carries the opposite sign of the marginal rate of change of the growth rate over the trailing 10-year period. That same figure is 70% of the time for Headline CPI.

If this sounds confusing just know that it basically boils down to the simple fact that the U.S. economy is inherently cyclical. In other words, measuring and mapping the data reveals track-able accelerations and decelerations along the growth and inflation sine curve.

It's worth noting that as the economy has gotten increasingly more reliant on financial leverage to replace lost organic growth potential both growth and inflation have become decidedly more cyclical throughout the post-crisis era and since commodities took off in the early-2000's, respectively.

• Directional Accuracy of Base Effects for Pre-Crisis Growth: 60%
• Directional Accuracy of Base Effects for Post-Crisis Growth: 81%
• Directional Accuracy of Base Effects for Pre-Commodity Boom Inflation: 63%
• Directional Accuracy of Base Effects for Post-Commodity Boom Inflation: 71%

As the economy has become more prone to booms and busts, there's opportunity for investors in predicting the future path of growth and inflation.

How We Forecast Growth & Inflation

We use two distinct models to forecast the high probability outlook for both growth and inflation based on the near-term momentum in various indicators: 

1. Intraquarter, we use predictive tracking algorithms to adjust the base rate based on the marginal rate of change in various growth and inflation-oriented factors.
2. In out-quarters, where we don't yet have high-frequency reported data, we employ a "Bayesian inference process" that adjusts each of the preceding forecasted base rates inversely and proportionally to the marginal rates of change in the base effects. As mentioned above, the 2-year average growth rate in the comparative base period backtests as having the most forecasting validity.

This model is very effective at identifying pivots in growth and inflation.

Our U.S. GDP model has an intraquarter tracking error of 33bps, an average absolute forecast error of 23bps and an r-squared of 0.87 with a success rate of 88% in terms of projecting the directional outcome. Our U.S. CPI model has an intraquarter tracking error of 33bps, an average absolute forecast error of 21bps and an r-squared of 0.79 with a success rate of 88% in terms of projecting the directional outcome.

Bottom Line

Our research process, anchored in rate-of-change data analysis, is designed to get a lot more right than wrong. Our ultimate goal is to keep you ahead of the big moves in macro. It’s a grind and every day we’re here measuring and mapping the data for you.

To understand how our growth and inflation forecasts impact our market calls check out the section on our "Growth, Inflation, Policy Model."

In the interest of simplifying the complex, Hedgeye CEO Keith McCullough explains the process behind how we select our favorite investing ideas. This process follows a simple risk management checklist you need to follow to effectively execute the Hedgeye Macro playbook. Our ultimate goal is to bring these investing tools to your disposal, so you can develop your own framework for executing the Hedgeye process.

McCullough breaks down the entire risk management process start to finish.

Our proprietary GIP model is designed to separate the economy into four distinct regimes that correspond to marginal rates of change of growth and inflation, which are two of the three principal components of forward-looking asset returns. The third – monetary policy – is accounted for in this analysis by overlaying how central bankers are likely to respond to the implied changes in economic conditions.

From there, we get four possible outcomes, each of which is assigned a “quadrant” in our Growth, Inflation, Policy (GIP) model and the typical government response as a result (neutral, hawkish, in-a-box or dovish):

• Growth accelerating, Inflation slowing (QUAD 1)
• Growth accelerating, Inflation accelerating (QUAD 2)
• Growth slowing, Inflation accelerating (QUAD 3)
• Growth slowing, Inflation slowing (QUAD 4)

“What we’re trying to do is measure and map an economy,” explains CEO Keith McCullough. “So the output of that fundamental research gives us the expected Quad, and we have a playbook based on the back-tests in each of the Quads that tells you what to buy and sell.”

There’s also the Trade/Trend/Tail Risk Range™ Signaling model.

“I have this framework that tells me what I want to do in each of the quadrants, but the question is does the market agree with that?” McCullough explains. “So that’s the second part, which is the tougher part. That’s the market signal. It’s our Trade/Trend/Tail signal based on Price/Volume/Volatility.”

Speaking specifically about the Trade/Trend/Tail signal, core to the Hedgeye process of selecting our preferred macro factor exposures is whether or not that ticker screens well from the perspective of Keith’s proprietary risk management process. This Trade/Trend/Tail risk management model employs price, volume and volatility as discrete factors in the calculus of Risk Range™ Signaling levels that back-test well as critical momentum thresholds.

So back to the Risk Management A/B test. “If an asset is signaling bullish trend [via our Trade/Trend/Tail Risk Range™ Signals] and that asset is one we like in the current Quadrant – take for instance the 3^rd Quadrant you can see that I like Tech, Utilities and REITs – I’ll be buying it aggressively at the low end of the Risk Range.”

But what if you get conflicting signals on the A/B test?

Here’s McCullough again. “Conversely, if we’re in the 3^rd Quadrant, and it’s an asset in that our back-test tells us we shouldn’t like – like Financials – but the Trade/Trend/Tail signal says Financials are in a bullish trend, then that’s telling me it’s not a good time to short Financials.”

Thinking more deeply about disconfirming signals between the GIP model and Trade/Trend/Tail Risk Range™ Signals, it’s really simple. Here’s another example.

“REITs and Biotech both score well in Quad 3, but if REITs are bullish trend and Biotech is bearish trend, why would I buy Biotech when I could buy REITs? The market is already agreeing with the position that I like, so I’d much rather go with the position that’s working for the reasons that the market has decided.”

Why use the risk management A/B test? “This helps me with not only the size of my positions but also assess my conviction,” McCullough says.

Using both the GIP model and Trade/Trend/Tail Risk Range™ Signals together helps us make better investing decisions.

Watch the video above for more of CEO Keith McCullough explaining this process. He even goes a level deeper into “the A/B tests within the A/B test.”

While there are many different Hedgeye tools, understanding the process behind the risk management A/B test is a must-watch.

A lot of Wall Street-types wake up in the morning and try to tell Mr. Market what they think it should be doing. Our Risk Range™ Signaling process is designed to measure and map what the Market is actually doing. This provides investors with a repeatable risk management process which complements our rigorous fundamental research views. 

CEO Keith McCullough's quantitative Risk Range™ Signaling process was developed during his years as a hedge fund manager. This Risk Range™ Signaling process generates a probable range to make better buying and selling decisions.

“It's simple. At the top end of range you sell. At the bottom end of the range you buy," Keith explains in the video below. "You’re fading the market. That’s a great way to do it. When the market is going down you’re buying. When the market is going up you’re selling.”

Keith's quantitative Risk Range™ Signaling model was designed to incorporate the “reflexive” and behavioral nature of financial markets. The model uses three core inputs – price, volume and volatility – to determine the likely daily trading range for any publically-traded asset class.

Bottom Line: This is a "multi-factor" proprietary model (not your grandfather's 50-day moving average!). These immediate-term Risk Range™ Signals are dynamic. In other words, the immediate-term Risk Range™ Signals change as the underlying price, volume and volatility of a particular asset changes.

To break it down conceptually, if an asset's price and volume are rising while its volatility is falling, generally its Risk Range is bullish. It means investors are buying with conviction. In this scenario, an asset's Risk Range™ Signal generally narrows as the probable outcome of that asset heading higher goes up.

On the other hand, if an asset's price is falling, while volume and volatility are rising, that's bearish. It means investors are selling with conviction. In this scenario, an asset's Risk Range™ Signal generally widens as the probable outcome of that asset heading lower goes up. 

This is an overly simplistic explanation but conceptually sound.

At its core, our Risk Range™ Signaling model is designed to be intuitive: You sell at the top end of the range and you buy at the low end.

Multi-Factor, Multi-Duration

Hedgeye CEO Keith McCullough’s quantitative Risk Range™ Signaling model was also designed specifically to be multi-duration. This means our Risk Range™ Signals dynamically adjust to suggest critical thresholds over three different time periods:

• Short-term = Trade: 3 weeks or less
• Medium-term = Trend: 3 months or more, and
• Long-term = Tail: 3 years or less

The idea is to give investors a clear framework for understanding how an asset is trading over short-term, medium-term, and long-term time horizons. Assets above the immediate-term "Trade" threshold are said to be "Bullish Trade" (and so on up the duration thresholds).

Within this "multi-factor, multi-duration" framework, there are also critical market set-ups of which to be aware. Here are two important ones.

#1. "Bullish & Bearish Formations"

“When you have something that’s bullish over the Trade, Trend and Tail durations, that’s called a ‘Bullish Formation,’” Keith explains in the video above.

Simply put, assets where last price is greater than all three durations (Trade, Trend and Tail in ascending order) are said to be in a “Bullish Formation” and all dips should be bought, insomuch that assets in the converse “Bearish Formation” should be repeatedly shorted on strength.

#2. "Bullish & Bearish Phase Transitions"

Another important market set-up to watch: Assets that transition from Bullish to Bearish Trend and vice versa. “When you have something that goes from Bullish Trend to Bearish Trend, that’s called a 'Bearish Phase Transition,'” Keith explains.

“Be careful of those," Keith continues. "That set-up is where you’re going to find your best shorts. Similarly, when something goes from Bearish Trend to Bullish Trend, that’s called a Bullish Phase Transition (and where you find your best longs).”

Furthermore, spotting fundamental catalysts that ultimately lead to bullish or bearish phase transitions are a great source of alpha-generation. “The biggest winners you’re going to have are things that are breaking out on a trending basis, so on the long side it’s assets that have just gone from Bearish to Bullish Trend," Keith explains. "Those are the assets that consensus isn’t long enough of yet and people have to chase them.”

This is an important point about our Trend threshold. As an asset's price falls and breaches the Trend line, it signals a major shift in sentiment and momentum from bullish to bearish (according to the model’s measurement of price, volume and volatility).

Make no mistake, when an asset dances around its Trend line, we’re monitoring it closely for confirmation that it either it maintains its Trend or we see a sustained breakdown confirmed by the asset’s price, volume and volatility. When an asset confirms a Bearish Trend breakdown, and you're long, you get out! (Conversely, if you're short a Bearish Trend that confirms its Bullish Trend, you get out!)

A FINAL NOTE ON TRADING USING RISK RANGE™ SIGNALS

The smart trader is highly incremental in their trading using our Risk Ranges. Here's a key excerpt transcribed from the video above with Keith.

For more, we highly recommend checking out Keith's detailed primer on "Position Sizing."

Changes in financial market sentiment can whipsaw even the sharpest of investors.

Our Macro risk management process is designed to monitor key style and thematic factor performance allowing us to quantitatively map evolving market trends.

The pioneering work of Eugene Fama and Kenneth French identified some of the early style factors – like "quality," "size" and "value." Subsequent research by market practitioners like AQR's Cliff Asness helped propagate additional factors like "momentum." These factors have historically been associated with outperformance for both behavioral and risk reasons.

Here's Hedgeye CEO Keith McCullough:

The rise of ETFs has made "factor investing" – a strategy of tilting your portfolio to various style factors in an effort to capture outperformance – more accessible investors. Assets invested in ETFs and ETPs listed globally surpassed $5 trillion by mid-2018. Moreover, BlackRock anticipates ETF/ETP AUM to more than double to $12 trillion over the next 5 years.

Regardless of whether or not you agree with this projection, you have to agree that the proliferation of factor-based index investing and the growth of platform-oriented, market-neutral hedge fund strategies has made financial markets more sensitive to Macro risks than ever before. For example, JPM estimates systematic trading accounts for over 90% of U.S. equity trading volume.

We call this systematic trading "The Machine," as rapid changes in what these systematic trading strategies are buying and selling ruthlessly perpetuates the underperformance and outperformance of different "style factors."

Here's Keith again:

We help investors gain on edge on Wall Street by tracking style factor performance and utilizing the various inputs of our research process to anticipate changes in "The Machine."

We systematically break "style factors" down to measure what's outperforming and underperforming. 

Data as of 11/3/2021

“As you can see, it’s not subject to debate as to what factor exposures are working in your portfolio,” explains Keith in the video below. “Every single stock that you’re long or short can be categorized by factor exposure.”

This is important because The Machine and the flow of assets tell you whether something has changed. “In the last month, for instance, Sales Growth as a factor exposure is the #1 thing you could’ve been long,” Keith continues in the video above (which aired on 10/27/2021). “All of the sudden, The Machine is front-running a probable change in market conditions.”

Why does this matter? Here's a really important point from Keith again:

The investing landscape has changed rapidly in the past 20 years. The rise of modern computing power (combined with Reg FD) has neutered the strategies of many former hedge fund darlings.

In this day in age, quantitative-oriented investors and algorithmic trading bullies the market in one direction or another. At the same time, technological and financial innovation has also empowered millions of investors to trade on their own behalf.

Here's the key.

Investors who understand the factors that dictate the flow of funds (what we call "The Machine") can use it to their advantage and front-run it.

"When we talk about 'The Machine' we’re talking about the flow of assets," says Hedgeye CEO Keith McCullough in the video below. "It’s the nearly $7 trillion in passive assets that 'The Machine' keeps pushing in a direction based on market conditions."

"Look at how passive assets have really dwarfed the hedge fund community," McCullough explains pulling up the chart above. "I started in the business in the late 1990s. It was a different game." Back then, big block trades determined market flow of funds. Large investors pushed their books and the media lionized their stock-picking prowess.

"It’s very different than the game we play now," McCullough says. "Hedge fund correlations have basically gone to 0.9 or 1.0 in some cases."

So what should an investor do? "If you accept that The Machine is part of the game you’re starting to understand why frontrunning The Machine is important," McCullough says. "It puts you in the highest probability positions so that The Machine is complimenting the positions that I take."

In a word, that’s how we manifest our principles of Transparency, Accountability, and Trust. Everything is time-stamped.

Every signal we’ve issued since founding the firm in 2008 has been #timestamped. We don’t hide our history. When we’re wrong, it’s right there for all to see – every win, loss, and tie.

Every day our CEO, Keith McCullough, puts up his Real-Time Alerts. These are risk management signals indicating immediate-term calls on the stocks and ETFs we follow here at Hedgeye. Every Alert is time stamped, and the entire history of the Alerts resides on our website. Fully #Transparent. Fully #Accountable.

Since risk is non-linear (it happens fast, and slow, and episodically), it makes sense to attempt to contextualize changes in price and volatility across time.

Mainstream “technical” measures consider time/price relationships using a one-factor price momentum model (like a simple moving average). That doesn’t work.

These consensus metrics have become the Received Wisdom of Wall Street. Every “chart” is crystal clear, in hindsight. But these charts tell you nothing about power laws and/or phase transitions. No single-factor linear model does.

Hedgeye’s proprietary system breaks the investment time horizon into three core durations:

• TRADE – the next three weeks or less
• TREND – the next three months or more
• TAIL – the next three years or less

At any given moment, every position in your portfolio will exhibit characteristics in each of these three durations, depending on a broad range of factors ranging from company-specific, to sector-specific, to broad market, to the global macro level.

Trade

The TRADE duration measures risk over the very immediate-term (3 weeks or less), and it shouldn’t surprise you to realize that an awful lot can happen in that time frame. 

TRADE is the point of departure for measuring risk in the immediate term. And TRADE is the first signal you might look at if you are an active short-term trader. 

The TRADE duration keys off of current events and macro correlations. As an example, a good earnings report may drive a lot of buying, causing the stock to look overbought on an immediate-term TRADE basis. Whereas a bad one might signal immediate-term TRADE oversold.

If you are a longer term holder, you can use the immediate-term TRADE duration to help you risk manage (sell some high, so that you can buy more low) your best ideas. 

Trend

The TREND duration in the Hedgeye model measures risk over the intermediate-term (3 months or more) and back-tests as the most manageable in our model.

That shouldn’t surprise you as this is the duration where many investment strategies purport to live. Three-months or more captures Institutional Investors trying to handicap “the quarter.” 

While immediate-term TRADE volatility can present you with buy/sell opportunities, contextualizing TRENDs, and whether the probability that they continue is rising or falling, is the most important skill set within the longer-term risk manager’s game.

Tail

The TAIL duration measures risk over the longer-term (3 years or less). After more than 15 years of trial/error developing this model, we’ve been humbled into submission on this front. It’s very difficult to dynamically risk manage investment ideas beyond that time frame.

Not to be confused with the popular definition of Black Swan “tail risks” that can often be qualitatively defined, we’ve submitted ourselves to Mr. Macro Market on this front and decided that TAIL risks are manageable, if you subject yourself to change and uncertainty.

Across all of our core risk management durations, the fulcrum point in the analysis is the rate of change. This is a critical difference compared to other modeling approaches. The key questions aren’t about whether things are good or bad – they are all about probability weighing whether risk factors are getting relatively better or worse.

Mathematically speaking, we’re talking calculus here (2^nd derivatives). Physically, you can also think about it in thermodynamic terms. What factors are undergoing “phase transitions” (from one state to another)? Because once something has moved from bullish to bearish TREND, it’s often too late.

Put simply, TRADEs often educates us about the stability/fragility of TRENDs, whereas the direction of longer-term TAILs can be shocked when a TREND undergoes a phase transition.

Understanding volatility is an essential tool in your macro toolkit. At Hedgeye, we have a nuanced view about how to incorporate this measure into your portfolio decision-making process.

Core to our risk management overlay here at Hedgeye is using not only price, but also volume and volatility as indicators of a security’s immediate-term and intermediate-term price range.

In other words, we use volatility to get an edge on consensus in predicting the highest probability outcome for future asset prices. "Volatility is the number one thing that will drive fear," says Hedgeye CEO Keith McCullough in the video below. "When volatility is rising, your amygdala is triggered, you're panicking and your brain starts to look for reasons (political or Wall Street narratives) to explain this bout of volatility."

When the unprepared investor is panicking, Hedgeye Nation is proactively prepared to generate alpha.

The video below is critical. In it, Keith explains the buckets of volatility for the broad stock market using the VIX as an example.

• The Investable Bucket: VIX = 10-19 → "That's when anyone can make money long stocks."
• The Chop Bucket: VIX = 20-30 → "When you go back and forth in that bucket, you can make a lot of money as a trader because there's a lot of panic at the top end of the range and complacency at the bottom end."
• The F#$k Bucket: VIX = > 30 → "When you're greater than 30 volatility and it stays there, that's trending volatility. That's where even some of the best investors die."

Being aware of the regimes of volatility and, critically, which regime we're heading toward next gives you the confidence to fade your emotions and execute on high probability outcomes. Said simply, you know when to "buy the dip" or "sell the rip."

"From a practitioner's perspective, this isn't dissimilar to sports," Keith says. "The greatest enemy to you making money is yourself."

"You can have all the talent in the world, but some of the smartest people I know are some of the worst traders," Keith explains. "Why? They don't have a process to be resilient in the face of adversity."

A Deep(er) Dive On VOLATILITY

Volatility is a market-based signal that reveals past or expected price action in a given security. More specifically, it reveals a market’s variation in price or returns. Volatility is an important addition to changes in the price of a security.

The important relationship between “realized” and “implied” volatility and why this market signal is critical.

Breaking it down as simply as possible, “realized volatility” is the historical volatility of an asset over some set time period of time. “Implied volatility” gives us the market’s expectations of future volatility for a specific asset based on what’s implied in futures and options markets. More technically, realized volatility measures the variance in a stock’s price. Implied volatility tells us about the market’s forward-looking expectation for price or return variance in a given security.

Now, here’s the critical risk management concept to understand on realized relative to implied volatility: Implied volatility “premiums” and “discounts.” As a very basic example, if implied volatility is 15% and realized volatility is 10%, that’s a 50% implied volatility premium (so 15/10-1= 50%). If implied volatility is 5% and realized volatility is 10%, that’s a -50% implied volatility discount (so 5/10-1= -50%).

What does this mean?

If an implied volatility premium is widening out (getting larger), the market is expecting higher volatility than what has been realized in the past (i.e. more expensive options prices because these insurance premiums are going up). Therefore, a higher volatility assumption will get priced in when investors are nervous about a correction.

Conversely, an implied volatility discount widening out (getting more negative) suggests investors expect lower volatility than what has been realized in the past (i.e. cheaper options prices because these insurance premiums are going down).

Therein lies the contrarian market signal for savvy investors. By taking the pulse of implied relative to realized volatility, we can get a good read on whether investors are becoming more fearful or more complacent.

• Fearful: Expectations of future, implied volatility are in excess of the historical, realized volatility because investors are seeking downside protection on that asset in options markets. That’s called an implied volatility premium.
• Complacent: Expectations of future, implied volatility is below historical, realized volatility because investors are going long that asset in options markets. That’s called an implied volatility discount.

What we like to do is track the spread between implied and realized volatility over time and recognize the critical pain points to suggest that investors are as bullish or as bearish as they can be.

So let’s say there is a historical range [at the extremes of implied volatility premiums and discounts], when the implied volatility premium hits the top end of the range it suggests investors are about as fearful as they can be and, conversely, when a discount is particularly steep it’s a signal that investors are increasingly complacent relative to the recent past in that asset. To us both of these are an immediate-term signal that investors should consider fading investor expectations in that particular asset or asset class.

**Data as of 9/29/2021

Hedgeye is the change. Our founding principles are Transparency, Accountability, and Trust. Our mission is lift the veil of mystery from the investment process, to educate and empower your decision making.

We provide research and insight for a subscription fee – not against trading commissions, not to participate in banking deals. We don’t manage money, we don’t trade our own account. Our sole focus is to provide guidance for you to risk manage your own portfolio, using the same tools and research we provide to the top professionals in the industry.

While our main objective is to be right, sometimes we aren’t. But we make that trivial for you so that you don’t have to guess. 

We #Timestamp all our calls – research, trade signals, etc. It’s all there for you to see, in real-time.

We also tend to be kind of loud in public places. But that’s ok (the Old Wall guys are pretty loud too!). We want to give you a voice. We want to give you the truth.

Wall Street 2.0 is about the democratization of investment and risk management research. There are no “first calls” or “secret huddles.” 

We play favorites with everyone. For the first time, the individual investor has a fighting chance.

Just as important as vetting the fundamentals of any investing idea is knowing the investment community’s positioning around that idea. Namely, is this a consensus or contrarian trade?

In short, understanding consensus positioning is another essential tool in your investing toolkit since, if Wall Street is too bullish or bearish, you may have already missed the move.

At Hedgeye, we measure and map the CFTC’s Commitments of Traders report, across asset classes, to learn precisely that: What does current investor consensus positioning look like and where can we add the most value with a non-consensus market call?

We focus on the CFTC report’s “non-commercial” investors because this group is made up of Wall Street speculators betting on the future direction of the underlying asset class, be it the S&P 500, U.S. Dollars, Treasury bonds, Crude oil or Soybeans. Meanwhile, the “commercial” side of the report is matching say farmers or corporations trying to hedge out business risk with intermediary banks facilitating those transactions.

We also look at “net” contract positioning, so the balance of Wall Street’s contracts to see directionally how consensus is skewing on either the long or short side. Focusing on the speculators within the CFTC report plus their net positioning gives us the best read on how Wall Street is positioning around the asset in question.

This is a reasonably real-time way to gauge investor sentiment. What we’re effectively trying to do is spot not only is the market positioned long or short a particular security, but how long or short they are relative to the recent past.

On measuring and mapping current positioning relative to the past, we use the Z-score of this net contract positioning. Z-score is a form of standard deviation that allows different time series to be compared apples to apples. It provides context for where CFTC contract positioning is relative to the measures over say the past one year, three years or other time period.

More technically, it is an indication of how many standard deviations an asset class is from its mean over some specified time period.

Why does this matter?

It’s not just enough to identify whether a particular asset market is net long or net short. To us, what is really important is how this position has changed over time to identify a particular pain point in factor crowding.

That’s where the Z-score comes into play. What you typically see is that when Z-scores get really extended, say 2 or even 3X standard deviations in one direction or another you see big reversals. “Anything plus or minus 2x on a Z-score basis is a good contrarian signal to do the opposite,” explains Hedgeye CEO Keith McCullough in the video above. “So the crowd is positioned over here, our Quads and Risk Range™ Signal says to do the opposite and those are the best set-ups.”

What you want to do is track the CFTC data on a Z-score basis to see when investors are crowding into a trade. That’s when you want to consider fading or doing the opposite. Instead of using Old Wall surveys, idea dinners, or narratives about whether the market "feels cheap" or "expensive," we suggest you track actual Wall Street positioning data.

Watch the video above for CEO Keith McCullough's explanation of how we use CFTC positioning data.