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Fearing the Bull

One of the most recent factors to turn bullish in the Hedgeye Risk Management process is the price of Oil.

“Our fear is a precision instrument.” -Andrew Lo

That’s a truthful quote from a new economics and markets book I just started reviewing titled Adaptive Markets, by Andrew Lo. He’s a professor at MIT Sloan and the Chairman and Chief Investment Strategist at AlphaSimplex in Cambridge, MA.

Here’s an excerpt from the first page:

“Neuroscientists have shown that our fear reflexes are highly refined, and that we react much faster out of fear than our conscious mind is able to perceive. The same neural circuits are often triggered when we’re threatened in other ways – emotionally, socially, and financially – and therein lies the problem.”

For those of you who already understand and embrace the uncertainties associated with markets, this isn’t your problem. Using a behavioral overlay in your risk management process helps you take advantage of consensus fears. Most people who missed both US profits and GDP growth accelerating in 2017 have been fearing The Bull in growth investing.

I’ve been on the road this week meeting with investors in Kansas City, Denver, San Francisco, and Los Angeles. Most of these meetings focus on what might slow and/or be bearish. But my team’s current macro views have plenty to remain bullish about too.

One of the most recent factors to turn bullish in the Hedgeye Risk Management process is the price of Oil. When something moves from bearish-to-bullish on our intermediate-term TREND duration, we call that a “Bullish Phase Transition.”

Since my core quantitative signaling process uses 3 factors (PRICE, VOLUME, and VOLATILITY), when something is signaling Bullish TREND, that always means that the volatility of that something is Bearish TREND.

In other words, for Oil (WTI):

  1. PRICE – intermediate-term TREND support = $48.18/barrel
  2. VOLATILITY – OVX (Oil’s Volatility index) TREND resistance = 30.77

This signal moved to bullish TREND (on price) in the first week of September on accelerating volume. Within a few weeks of that Oil move, long-term US Treasury Yields broke out to Bullish TREND as well.

There is no irony in that relationship.

If you get the price of Oil right, you’ll get a lot of headline “inflation” and reflation readings right. That’s why we use Oil as a heavy weight in the Hedgeye Macro Commodity Price Sample in order to accurately forecast inflation expectations.

The year-over-year growth rate in our Commodity Price Sample clearly peaked (on a 2nd derivative basis) in Q1 of 2017, then rolled over, hard in Q2 of 2017. That’s why 2 of our Global Macro Themes for Q1 and Q2 were:

  1. Reflation’s Peak (Q117)
  2. Reflation’s Rollover (Q217)

With Oil not only heading higher in September and October, but signaling Bullish TREND, our call is for some sequential reflation. You saw that yesterday with US Producer Prices (PPI) for September hitting a 68 month-high!

With our current 2-3 month “long reflation” view in mind, we’ve also been saying you should:

  1. Buy Financials (XLF), Tech (XLK), and Biotech (IBB) at the low-end of the @Hedgeye Risk Range
  2. Buy the Russell 2000 (26% weight = Financials), SP500 and Nasdaq at the low-end of the range
  3. Sell Treasury Bonds and their proxies (like Gold, Utilities, and Consumer Staples) at the high-end of the range

That’s right. Buying at the low-end of the range (and selling at the top-end of our Risk Range) requires some patience. Chasing high and freaking out low is no way to live an alpha generating life.

Neither is fearing bulls or bears.

If your risk management process is A) data driven and B) goes both ways, you can get comfortable being uncomfortable. I’d much prefer that state of mind than being held hostage to my emotions.

By Keith McCullough, the Founder and CEO of Hedgeye Risk Management.

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